SCOTTSDALE, Ariz. — Credit unions are losing untold millions of dollars annually by overpaying on their debit processing payments, according to a recent study by Cornerstone Advisors.
The report, entitled "Drawing Back The Curtain On Vendor Pricing For Debit Processing," suggested that some financial institutions are paying up to five times what they should be paying on such transactions — largely due to a "lack of market transparency."
Based on a study of a database of some 15,000 pricing points collected from negotiating thousands of vendor contracts, Cornerstone noted that vendors now rely so much on payment processing for their revenue growth that they have little incentive to change the current system.
"Payments is a very lucrative and commoditized business, and as long as vendors are not publishing their rate cards, [financial institutions] can pay more than they should for services," said Bob Roth, managing director at Cornerstone.
In an interview with Credit Union Journal, Roth explained that the current condition of overpaying for debit processing was almost inevitable due to the complexity of payment rates as well as the nature of contracts with vendors. "It wasn't intentional," he said. "It's simply the natural outgrowth of a system that has been around since the 1960s."
From the financial institution side, debit processing fees are eating up an ever bigger piece of their total vendor bills. Indeed, for many CUs and banks, the cost of debit processing now exceeds the expenses associated with core processing.
"Debit processing has become a commodity, but it isn't priced like one," Cornerstone stated in the report. "Vendor pricing is kept purposefully opaque."
Cornerstone indicated, for example, that the average $1 billion financial institution now spends $1.17-million annually on debit processing, vs. $770,000 on core processing.
"This means that over the course of a five-year contract [with a vendor], a difference of just five cents per transaction amounts to more than $1.5 million in either lost income or resources lost for new initiatives," Roth said.
Roth also said that the overpayment phenomenon is just as acute at credit unions as in banks, especially for smaller-asset credit unions which lack the capacity or ability to conduct regular and sophisticated negotiations with their vendors (many of whom have their own professional negotiators on staff).
"Debit processing should be a moneymaker for credit unions," he said. "But we know of some credit unions, where they are actually incurring losses on these transactions." This alleged lack of transparency gives vendors considerable negotiating leverage and leaves banks vulnerable to inking contracts that cost more than they should.
So, how can financial institutions reduce overpaying on debit processing?
Cornerstone suggests that credit unions refrain from auto-renewing their vendor contracts (which would automatically carry over terms of the previous payment deals without any chance of modification); and instead "bundle" their core processing and debit processing contracts into one single arrangement.
But such "bundling" can be challenging.
"Oftentimes, the expiration dates of a bank's contracts for core and debit processing aren't aligned," Cornerstone noted. "Bringing two large pieces of business to the table instead of one, making them co-terminus — even if the contracts wind up with different vendors — and bidding them out can enhance a bank's negotiating leverage and result in better pricing on both debit and core processing."
CUSOs Are Skeptical
CO-OP Financial Services, which serves 3,500 credit unions for payments and network-related services, reported seeing reductions in price-per-transaction over the past five years.
This decline was driven by excess capacity amongst processors, the economic downturn and the emphasis placed on vendor due diligence by regulators, the Rancho Cucamonga, Calif., company said in a statement, adding: "It may be inappropriate to generalize about overpayment in a market where multi-year contracts are the norm and price compression dominates."
"CO-OP client credit unions are not overpaying for their debit processing services," Eric Porter, executive vice president- business development for CO-OP Financial Services told Credit Union Journal. "Our business philosophy is to continually work with credit unions of any size to enable them to evaluate their processing options and make the best possible financial decision to meet their requirements in the marketplace. We are a cooperative motivated to serve our members, not a public company driven solely by profits."
Porter added that CO-OP's focus is on "aggregating" their clients' processing work to enable credit unions to take advantage of the best pricing in the market.
"For many years we saw a movement toward bundling credit and debit processing, now, due to EMV, we see more emphasis on combining signature debit and ATM/PIN processing," said Porter. "We have seen both core and network brand bundling strategies that obscured exorbitant core and brand fees with attractive debit processing fees. With the advent of tokenization these considerations will become even more important."
Porter further stated that "we focus not only on price, but value to the members of our clients. CO-OP encourages good vendor management, inclusive of pricing review and negotiation, as healthy in all business relationships. This adds to the value of ownership and governance of our cooperative."
Similarly, Bill Lehman, senior vice president of consulting services at CSCU in Tampa, Fla., told Credit Union Journal that his company concentrates on delivering complete electronic payments solutions that are cost-effective for all members.
"Our ability to aggregate more than 12 million total credit and debit accounts to ensure our members receive a competitive offer from our processing partner is paramount to the success of our growing association," Lehman said. "We advocate for our credit unions to get the best balance of price, product, functionality and service that is necessary for them to run a profitable electronic payments offering."
Price is a key component to consider when a CU elects their long-term payment processing partner, but that credit unions should also "strongly consider" the product, functionality and service capabilities provided by potential partners, according to Lehman.
"They need to find the right partner to help them be successful in this ever changing, challenging, electronic payments industry," he concluded.
The Members Group (TMG), which creates customized, technology-driven card processing and payment solutions for credit unions and other financial institutions, also weighed in on the overpayment issue.
Chris Gunnare, TMG's senior vice president of growth, said his company firmly believes in andsupports the process of vendor due diligence, and values the role consultants play in this process.
"Because we are a client-centric organization, transparency and creating successful partnerships is part of our DNA," Gunnare said. "It is a key differentiator for our company and why we continue to achieve a 99-percent client retention rating."
Durbin compliance alone makes the U.S. debit market complex; it's only becoming more so as issuers and merchants approach EMV and tokenization project, he noted.
"It calls for vendors to step up their processes, build unique solutions and work with issuers and an immense number of providers (acquirers, regional PIN networks, major card brands, merchants, etc.) to craft a sustainable, secure and cost-effective debit processing program," Gunnare added. "Any time a provider offers a variety of solutions, you will have a varied cost structure. This does not equate to overpayment for debit processing services, however. TMG, for instance, takes a consultative approach to determining a particular issuer's individual needs. Delivering payment solutions that offer optimal functionality, service and cost structure will look different for different issuers. Solutions ranging from standard debit processing programs to systems that create competitive advantages for issuers are custom built to meet the needs of an issuer's cardholders."
Meanwhile, the escalating growth of electronic payments — part of the path towards establishing a "cashless society" — continues inexorably. Cornerstone cited that usage of debit cards has surged at a compounded annual growth rate of 15.6% over the past 14 years. The revenue derived from facilitating such payments is projected to climb to $177 billion by the year 2022, from about $117-billion in 2012. In addition, the average bank's annual interchange income-per-ATM/debit card almost doubled — jumping by 92% — from $36 to $69 between 2005 and 2014.
Moreover, in 2013, there were some 47 billion debit card transactions in the U.S., according to the Federal Reserve, vs. 8 billion in 2000. About 2% of the cost of a debit transaction is paid by the merchants, on average, to entities involved in the payment process; namely payments networks like NYCE and Pulse for PIN transactions or Visa/MasterCard for signature transactions; the banks and credit unions that issue debit cards to their customers/members; and vendors such as Vantiv, Fiserv and FIS which process debit transactions.
Cornerstone specifically noted how crucial payments processing has become to many core software vendors.
To wit: Jack Henry & Associates now receives more than one-third (36%) of its total revenue from its recurring payments business — a dramatic surge from only 5% in 2002. Similarly, Fiserv generates more than one-half of its revenue from payments, and less than one-third from core processing.
