3 Questions to Optimizing Debit Card Profitability in a Deal

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As the banking industry shrinks each year, CEOs often ask what they should look out for to improve profitability during and after a merger or acquisition. There is one area that is all too often overlooked: debit card profitability.

As an ever-growing source of demand deposit account revenue, debit card portfolios require detailed profit and performance analyses to optimize return. Done correctly, the efforts can be extremely fruitful. But there are a few things acquiring banks should keep an eye on when evaluating any acquisition target’s debit card profitability, to learn what is working for them and why.

Three items to consider when entering the M&A process:
1. Know thyself. To accurately gauge the impact of acquiring another bank’s cardholders, prospective buyers should first know where their own institution stands. How much is your bank netting per transaction, or per debit card outstanding? Every bank must know how much money is to be made when they issue a debit card to their customer. This concept is simple enough and is considered the basics of nearly all business, but putting it into practice can prove difficult without the proper knowledge base. Know your institution’s performance before the acquisition, as well as where your institution should to be after.

2. Dissect the income. If an analysis of interchange income reveals that your bank, as the acquirer, is making less interchange income per purchase than the acquired institution, find out why. The acquisition target may have better interchange rates because of a better network arrangement or even just better network agreement terms. This evaluation should not only apply to the networks or the foundation of interchange earning. Oftentimes, the acquired institution has done a better job of marketing and getting their cards into customers’ hands for use. Bigger does not necessarily mean better when it comes to debit card profitability. Choose the arrangement and agreement terms from either institution on electronic funds transfer (EFT) processing, PIN network and card brand that is most profitable.

3. On expenses, timing can be everything. While the acquiring bank often has better pricing on processing expenses, they don’t always — especially on EFT. Most bankers know to evaluate the acquired institution’s contracts to determine buyouts, deconversion and termination penalties and get a general glimpse at the pricing. But there is a present need for a pricing deep dive across all contracts in every single deal — especially when considering a merger of equals or an acquisition that really moves the needle.

Further, this evaluation should not stop at traditional data processing contracts, like core and EFT. It must consider card incentive agreements. Executives should study the analytics around buyout timing on both institutions’ card brands, along with the interchange network agreements. Consider the termination penalties, but also the balancing effect of positive impact, to incentive income of the acquirer’s agreements. Although the bank cannot disclose details of the acquisition, they can keep the lines of communication open with card vendors. There will be a sweet spot of timing in the profit optimization formula, and the bank will want an open rapport with their card-critical vendors.

Debit cards as a potential profit center are often overlooked in the merger and acquisition process, which tends to be geared toward share price and the details of the buyout. However, it is valuable for acquirers to review debit cards in context of the combined bank’s long-term success of the bank, not just focusing on the deposits retained and lost when it comes to income consideration.

The Myth that Binds Banks to Their Payment Processors

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payment-7-22-19.pngBanks are losing a heavyweight fight, one in which they did not know they were participating. Their opponent? The ever-growing giants of debit card processing in an ever-shrinking ring of industry consolidation.

Over the past few years, interchange income has surpassed all traditional types of deposit-based fee income, making it the number one source of deposit-based non-interest income. But in order to maximize that income, interchange network arrangements must be effectively managed and optimized. Executives must sift through misinformation to consider several critical issues when it comes to protecting interchange income.

Many bankers aren’t aware they can choose which vendors process their customers’ debit card transactions from the point-of-sale and believe they are forced into selecting the PIN-based debit card transaction network provided by their core or EFT processor. This couldn’t be further from the truth.

Debit card transaction networks have varying negotiable switch fees, increasingly complex expense structures and several types of incentive offerings for transaction routing loyalty or priority. Most importantly, these vendors offer differing interchange income pay rates; some even support PIN-less routing, which negatively affects the interchange income bank card issuers can earn for certain transaction types. This means bankers must thoroughly evaluate their options to find a partner that can generate above-average interchange profit.

Oftentimes a bank’s core or electronic funds transfer (EFT) processor offers the least-competitive option when compared to other PIN networks. Since the Durbin Amendment awarded merchants the power of the card transaction network choice, EFT processors are negotiating with merchants to get as many transactions on their network as possible. The processors do this by offering lower PIN and PIN-less rates than their competitors.

Of course, if a merchant can divert less of the purchase amount in interchange with the bank, then they absolutely will. The merchant simply chooses the transaction-routing options that are less expensive to them, and pays less to the bank. In this type of situation—where it appears that banks have little control—what can a banker do?

One way for bankers to exert influence is by limiting network choices on their debit cards. Banks should limit the PIN networks available for routing their debit card transactions to a maximum of two. At the same time, banks must select the best two-network combination to force the merchants’ hands, providing the best rates possible. This tactic tips the power scales back toward the card issuers.

Some processors are creating networks to compete with Visa and Mastercard for routing dual-message, or signature transactions. These signature-routing networks, being rolled out by PIN network processors, will likely be structured to appeal to merchants in attempts to win as many transactions as possible. As one might guess, this will further pressure bank income.

Most recently, it’s also been observed that several networks setup for ATM-only routing by their participating issuers were gaining PIN point-of-sale transactions from merchants. They did this by allowing PIN-less routing and simply being present as a network option on the issuers’ debit card network arrangement. Both of these tactics create confusion for banks, and build a case for closely monitoring network performance.

Banks participating in their core or EFT processor’s PIN network should take a close look at how their PIN-based interchange income has performed over the past two to three years. They should compare their current PIN income rates to the rate averages in the FED Interchange Study, fully considering the historical trend being reviewed. This can be a great first step for banks to regain some control of their interchange income.

Seven Ways Financial Institutions Can Maximize Profitability

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FirstData-WhitePaper3.pngIn the past, financial institutions didn’t need to rethink the way they did business. But times have changed. Between today’s unpredictable global economy and new banking regulations recently enacted, it has never been more challenging to grow revenue, maintain profits and satisfy customers.

Today, banks and credit unions need strategic solutions to replace lost revenue, reduce costs and maximize profitability. First Data has created this white paper to help you explore new ways to effectively evolve your business in today’s world.

Our white paper addresses today’s big issues and critical areas, including:

  • The Durbin Amendment: Can you maintain checking profitability, despite lost DDA revenue? 
  • Debit Strategy: How can you rethink your debit programs in order to increase the profitability of your offerings?
  • New Technology: What do consumers expect when it comes to technology? How important is mobile banking? 
  • Fraud Prevention: Can centralizing fraud management help your institution reduce fraud?

To read the white paper, download it now.

Nothing for Something?

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empty-tray.jpgEvery consumer is intrigued by the offer of something for nothing. Retailers have depended on the positive, natural response of consumers to this marketing message for decades to generate purchasing interest.

So it is odd, strange and frankly confusing that mega banks (Bank of America, JPMorgan Chase and Wells Fargo), which claim to be retailers, are doing just the opposite by offering “nothing for something” when it comes to charging their customers for debit cards.

Sure, debit cards have inherent value. But financial institutions of all sizes have diluted that value by giving the cards away for many years. This has trained consumers to feel that banks can make money by providing them for free and are now being greedy by charging for them.

Three, four or five dollars per month for a debit card probably won’t put many more people in the poor house, but it sure feels unfair. Response has been overwhelmingly negative by customers, non-customers, consumer advovcates, politicians and even other financial institutions.

As a practicing amateur psychologist, it is easy to see why the reaction has been so negative. Nobody: rich/poor, male/female, black/white/brown, gay/straight, or city slicker/hayseed likes to get nothing for paying something. It violates what economists call the “fair exchange of value.” It violates what I call common sense.

And that’s what these big banks miscalculated here. It’s not the amount of the fee itself that is riling up the masses, nor is it the justification of why fees must be charged:—the government made us do it.

Rather, it’s the perception of the fee as unfair that’s causing the uproar. Earlier this year, Russell Herder, a Minnesota-based marketing research company, conducted a survey of more than 500 United States bank and credit union checking and savings account customers to ascertain if, and to what degree, loyalty to their financial institution is impacted by fees.

The bottom line, according to the survey: “The belief that a particular bank fee is unfair has a much stronger impact on consumer sentiment than the fee itself. In fact, as long as charges are perceived to be fairly assessed, the research showed no negative impact on consumer sentiment whatsoever.”

If you don’t believe these results, tell me how you feel about having to pay for your luggage when you fly.

It’s this miscalculation of the impact of these fees on the collective psyche that provides a fantastic opportunity for competing financial institutions. It offers a “bags fly free” type of marketing opportunity to gain market share and mind share of consumers just like Southwest Airlines has.

There are smarter ways to get more fee income from consumer checking customers than, in their minds, getting charged something and getting nothing. You have to be creative and not rely solely on traditional checking design and pricing, because these also face customer backlash given the value perception in customers’ minds anchored around “getting charged for using my money”.

But it can be done. Hundreds of banks are successfully doing this already and there are millions of checking customers gladly paying fees equal to or greater than what these big banks are requiring customers to pay for debit cards. Customers are willingly paying $5-$7 per month for benefits like local merchant discounts, identity theft protection and accidental death insurance (bundled with traditional checking benefits). These benefits provide tangible value to customers in terms of real savings and ample personal security. In other words, banks are simply asking customers to pay a modest fee for something that is perceived as and is valuable, instead of for paying something and getting nothing new for it in return.

Someone said “chaos creates opportunity”. And when it comes to consumer checking accounts, this is just the beginning of chaos that we’ll see as banks try to recapture lost fee income. For some of you reading this, it’ll be your “bags fly free” opportunity. For others that follow the lead of Bank of America, it’ll be just another reason for consumers to broadly brush banks as out of touch with their customers.

Which one are you? 

Why Smaller Banks Should Worry About Interchange Fees

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If you’re a bank CEO or director, you’re probably getting a little tired of Uncle Sam reaching into your institution’s pocket and pulling out handfuls of cash. Last year it was the new federally-mandated restrictions on account overdraft fees, which threatened to deprive banks of an important revenue stream just as they were struggling to recover from the effects of a deep recession in the U.S. economy. Fortunately for the industry, a significant percentage of retail customers opted into their bank’s overdraft protection plan, so the economic impact has turned out to be less than feared.

But then along came the Dodd-Frank Act, which not only imposes a greater and more costly compliance burden on the banking industry, but also drastically reduces the interchange fee that big banks–defined as $10 billion in assets or larger–are permitted to charge merchants on debit card transactions. The Act directed the Federal Reserve to set the maximum rate for debit card transactions, and in December the Fed proposed a cap of 12 cents–down from an average of 44 cents per transaction today.

The Fed is still soliciting comments under its normal rule-making process, and is required by Dodd-Frank to finalize the new rate by April 21. A 12-cent cap would result in a 70 percent to 85 percent reduction in debit card income for large banks, according to an estimate by the consulting firm Raddon Financial Group.

As bad as that sounds (and it is bad), the outcome of this latest threat to bank profitability is far from clear.

Raddon Vice President Bill Handel says that large banks like J.P. Morgan Chase & Co. are already considering a variety of strategies to mitigate the impact. For example, J.P. Morgan is testing a monthly $3.50 debit card fee in Green Bay, Wisconsin. (Under the current system, merchants end up paying the interchange fee, while retail bank customers are able to use their debit card for free.) The bank is also testing a $15 monthly checking fee in Marietta, Georgia.

One possible outcome of the new fee cap is that large banks will have to start charging for things–like debit cards and checking accounts–that used to be given away for the purpose of attracting core deposits. “The ‘free’ environment that we have been operating under will cease to exist,” says Handel.

The only problem is, Raddon’s research shows that consumers have become so accustomed to getting their retail banking services for free that they will balk at paying a monthly debit card fee. Instead, they will be more likely to either reduce their debit card usage in favor of paper checks (which are more costly for the bank to process)–or look for a free debit card at a smaller bank that isn’t affected by the cap. And that would seem to give small banks a huge competitive advantage since they could still offer their debit cards and checking accounts for free.

Not so fast. Smaller banks might think they’re shielded by Dodd-Frank from the sharp economic impact that large banks will feel, but that protection might not hold up in the real world outside of Washington, D.C. Predicts Handel, “We don’t believe the less-than-$10 billion exemption will hold up over the long haul.”

Visa Inc., the country’s largest card payments company, has said it will adopt a two-tiered pricing system for debit card transactions, one for large $10-billion-plus banks that will reflect the new Federal Reserve mandated cap on fees, and a second system for smaller banks that does not place a cap on fees. But Visa and its smaller payments competitor – MasterCard Worldwide – are member associations dominated by the same mega-banks that will be most hurt by a 12-cent cap. Handel says it’s not logical to assume that large banks like J.P. Morgan Chase and Bank of America will passively sit by while they lose debit card and checking account customers to small banks that can afford to subsidize those products with their higher interchange income.

“[The card companies’] brands are backed by the big banks,” says Handel. “If the big banks say to Visa and MasterCard ‘You can’t continue to have a two-tiered system,’ they will have to listen.”

A company spokesman said yesterday that MasterCard had not yet made a decision on whether it will adopt a two-tiered system for debit card fees, but don’t be surprised if the 32-cent per debit card transaction advantage that smaller banks seem to enjoy thanks to Dodd-Frank ends up much, much less.