2007: The Year in Review

  Credit card charge-offs this year generally returned to the normal levels issuers experienced before a new bankruptcy law took effect in October 2005. The law, which makes it more difficult for holders of card and other loans to erase their debts, triggered a tsunami of bankruptcy filings shortly before it took effect and a dearth of filings for several months thereafter.
  But there was little else about 2007 that could be considered "normal."
  The year began with the announcement of the largest credit card data-security breach in history, and it will end with a subprime mortgage meltdown that has raised concerns about possible spillover effects on the consumer card market ("Issuers Take Steps to Sidestep Subprime Mortgage Meltdown," October).
  On a more positive note, most large issuers produced healthy earnings and growth through the third quarter, and analysts generally expect continued strong growth next year.
  Cards&Payments takes a look back at five of the top issues that affected the payments industry in 2007.
  THE TJX BREACH
  When the news broke in mid-January of a major data breach at TJX Cos. Inc., it signaled a disaster of unprecedented proportions in the card industry. Criminals had hacked into TJX's database, compromising millions of customers' debit and credit card accounts over several years. TJX, which owns 2,300 stores operating under such names as T.J. Maxx and Marshall's, initially said the breach affected 40 million card accounts stretching back to 2003.
  The news, however, steadily grew worse.
  In October, depositions of Visa USA and MasterCard Worldwide executives, made public part of a lawsuit by banks against TJX, brought the total number of accounts affected to at least 89 million. Commercial and consumer class-action lawsuits and claims against TJX for costs related to the breach began to hit the retailer's bottom line in the second quarter and could soar to hundreds of millions of dollars.
  Visa fined Fifth Third Bancorp, TJX's merchant acquirer in the U.S. and Canada, at least $880,000 for putting Visa and its bank members at risk. Analysts expect Fifth Third to pass the cost on to the retailer, but TJX says it blames banks for failing to ensure higher card-security standards.
  Other card-data security breaches also made headlines throughout the year, prompting thousands of retailers and card issuers to scramble to shore up security and reassure customers.
  Bob Russo, general manager of the Wakefield, Mass.-based Payment Card Industry Data Security Council, says there is more bad news ahead for Framingham, Mass.-based TJX. "Despite the sheer size of the case, I'm afraid we haven't seen the full magnitude of costs and damages to TJX," he says.
  The question of who is responsible for preventing-and paying for-card-data breaches is unclear. "The burden [for credit card-security compliance] has been on retailers, but a big debate is brewing about the roles of the banks, credit card companies and even consumers in protecting card data," Russo says.
  The TJX breach may have been the accelerated growth of the newly formed PCI Data Security Council. "A little over a year ago we had zero members. Now we have 300 of the biggest merchants and card processors, and we're all working together to help shape payment-industry security standards and practices," Russo says.
  DECOUPLED DEBIT
  A relatively new payment mechanism called decoupled debit surfaced this year as a potential threat to traditional debit card issuers.
  Decoupled cards enable third parties to issue cards that can draw funds from any demand deposit account and settle the transactions through the automated clearinghouse system. The decoupled debit transactions usually are processed within two or three days versus typical one-day settlements with traditional debit cards.
  This type of debit payment is less expensive for merchants because it bypasses traditional payment-network interchange. Merchants can pocket the interchange-fee savings, or plow the extra funds made available into consumer-retention programs.
  Capital One Financial Corp. launched its version of a MasterCard-branded decoupled debit card in June. In July, Tempo Payments Inc. teamed with HSBC Finance Corp. for a decoupled-debit test with Indianapolis-area CVS/Pharmacy stores; in October the two companies launched a similar test at selected Pathmark supermarkets in New York.
  Although decoupled debit is a very small niche and it is too early to tell how significant the concept could become, the Independent Community Bankers of America in October identified it as a threat to its members.
  "[Decoupled] debit is a threat to banks' existing relationships," says Al Funk, director of application development and integration at Fairfax, Va.-based CC Pace Systems Inc. "Because ACH transactions are much cheaper than going through a traditional payment network, decoupled debit could be disruptive to the credit and debit card industries if it takes off." Credit card issuers could see significant erosion of more-profitable credit transactions to the lower-cost decoupled debit platforms.
  These systems must overcome many hurdles before they are used widely, Funk says.
  "There are two vendors involved in a typical decoupled debit transaction, which could lead to hassles for consumers in resolving disputes, not to mention the inconvenience for users of not knowing exactly when a transaction will clear," he says.
  Funk notes that decoupled debit eventually could trigger an interesting political battle, as bank members of the National Automated Clearing House Association realize the low-cost network they help to maintain has become a channel for third parties to poach their transaction volume and interchange revenue.
  INTERCHANGE GRIPES
  Merchant unhappiness with rising credit card interchange rates boiled over this year, with the Merchants Payments Coalition intensifying its protests against rising fees paid to card issuers by merchant acquirers, which pass the cost on to their retailer customers. According to the coalition's data, credit card issuers collected $36 billion in interchange fees last year, up 17% from 2005 and 117% since 2001.
  The National Retail Federation and other retail-industry associations in the coalition say they are seeking an end to rising interchange rates through "legislation, litigation and innovation." ("Interchange Fees: The Pressure Builds," November.)
  During hearings in January and July, lawmakers got an earful of retailers' complaints about rising interchange rates that card issuers are using to fund their customer-loyalty programs while offering no benefit to retailers. Card-industry representatives, meanwhile, explained to the legislators the mechanics of interchange, which amounts to about 2% of each transaction carried over the networks of Visa, MasterCard, American Express and Discover.
  "We have a competitive system that works, and merchants are free to shop around for alternative payment channels," says Peter Madigan, executive director of the Washington, D.C.-based Electronic Payments Coalition that represents card issuers, adding that rates vary widely and include numerous components.
  Even if issuers escape regulatory caps, litigation may change the way interchange is handled.
  A major class-action lawsuit by a group of merchants filed in 2005 that broadly challenges the way Visa and MasterCard set their interchange rates is grinding its way through the legal system. Some experts believe the case may come to trial in 2008.
  EMERGING PAYMENTS
  Web-based payment methods and new mobile and contactless payment mechanisms generated news throughout the year. But despite the hype, their marketplace relevance remains relatively small.
  Visa in March attached the name payWave to its contactless payment technology. The following month Discover unveiled Zip as its new contactless product.
  Penetration of contactless payments is growing. American Express says its ExpressPay contactless option has been a success, though it has not provided usage figures. And at midyear MasterCard said its member financial institutions had issued 16 million PayPass cards worldwide.
  Use of contactless cards remains relatively low, but its potential to change business processes could be huge.
  Grand Rapids, Mich.-based supermarket chain Meijer Stores in October said that only 1% of its total transactions were contactless, two years after it began to accept all forms of contactless payment. But even with that low rate of use, Meijer says contactless speeds up transactions by two to 20 seconds. "To a merchant, a second equates to half a million dollars," Andrea Brandt, a manager at Meijer Financial Services, told attendees of the Smart Card Alliance 2007 meeting in October.
  Mobile-payment technology tests mushroomed throughout the year. Visa and Wells Fargo & Co. in June announced an extensive test of mobile payments tied to cell phones equipped with contactless Near Field Communication technology, which is featured in many similar market tests. NFC enables both the uploading and downloading of information, which provides considerable marketing opportunities for both merchants and card issuers.
  The mobile-payments market is promising but very premature, says CC Pace's Funk, a director with of Fairfax, Va. "Cell phones present a great opportunity for combining multiple payment and banking functions in one device, but we're a few years away from seeing a critical mass of consumers in the U.S. with cell-phone data plans," he says, noting that many technology and security standards must be developed before mobile payment is widely adopted ("NFC Standoff," January).
  Alternative Web-based payment schemes also gained ground. Bruce Cundiff, a senior analyst with Javelin Strategy & Research, says credit cards represented 60% of Web-based payments this year, but by 2012 that figure could shrink to 44% as such alternative programs as PayPal, Bill Me Later and Google Checkout take hold.
  Traditional payment companies would be wise not to ignore these evolving technologies, though Internet transactions represent just 3.5% of all retail and travel sales, says Jennifer Roth, a senior analyst in TowerGroup's global payments practice. "Traditional-payments players should keep a close eye on emerging-payment technology, but change will happen very slowly," she says.
  REVIEWS BY CONGRESS
  The Senate Committee on Banking, Housing and Urban Affairs scrutinized the credit card industry's business practices this year during a series of hearings. Consumer advocates urged committee members to limit the rates and fees that card companies can impose on consumers.
  At hearings in January, attention focused on universal default, the practice of raising a cardholder's interest rate based on unrelated negative financial activity, such as a late mortgage payment.
  Card-industry representatives told lawmakers that most card companies do not enforce universal-default policies on their customers, and they noted that issuers' rules clearly are spelled out in consumer disclosure statements. Citigroup publicly announced in March an end to its universal-default policies.
  The pressure on issuers continued in May, when two House committees called for improvements in "confusing" card-marketing and billing practices, and the Federal Reserve Board proposed several revisions to the Truth in Lending Act that would affect issuers' practices.
  Representatives of the American Bankers Association acknowledged the need for new rules, noting that existing regulations have not kept pace with card-industry changes.
  No new legislation has resulted thus far from this year's hearings, as policymakers and lenders during the latter half of the year became buried by the subprime mortgage crisis, says a spokesperson for the ABA.
  "We hear that credit cards will be back on lawmakers' radar screens next year, and we're closely monitoring any legislation that may affect the card industry," the spokesperson says.
  Looking ahead, it is likely that card issuers in 2008 will face more challenges on industry practices and interchange fees. The industry also may be affected by economic downdrafts from the subprime mortgage market's troubles.
  The one thing the payment industry can count on: new innovations and more competition.
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