Credit and debit card issuers face another tough year this year as the economic recovery continues, consumers keep the brakes on spending, and new legislation and data-security rules kick in. But even as they plug holes that could lead to data breaches, adjust business plans to comply with new card rules and monitor the ongoing debate over interchange rates, issuers eagerly are watching and preparing to experiment with new mobile-payment initiatives.
A look at the top issues on card issuers’ plates for 2010:
Data Security
All organizations in the payments industry remain uneasy about card security, despite the emergence of the increasingly complex Payment Card Industry Data Security Standard.
The massive data breach Heartland Payment Systems announced last year that took place in 2008 jolted large and small payments organizations into realizing that general security-standards compliance may not be enough. But even general compliance is causing headaches for more merchants, including smaller players, says Scott Laliberte, a managing director with risk-management consulting firm Protiviti Inc.
Besides complying with Visa Inc.’s July 1 mandate for triple data encryption of cardholder personal identification numbers at the point of sale, smaller merchants processing more than 1 million Visa or MasterCard transactions annually must by June 30, 2011, submit to on-site evaluation by a qualified, third-party security assessor. Or they may instead use internal personnel certified by the PCI Council to perform self-assessment.
Previously, such smaller merchants, typically handling less than 6 million transactions annually, simply could fill out a self-assessment questionnaire. MasterCard last year advised all such merchants to hire a qualified assessor or certify internal audit personnel to perform self-assessment.
“MasterCard’s new requirements are in some instances doubling the work involved in issuing a compliance report,” Laliberte says.
In further efforts to block fraud and data-network breaches, more large merchants this year will add so-called “end-to-end encryption” technology to their transaction processing, Laliberte says.
“End-to-end encryption cuts down on some of the internal factors that can lead to data breaches, but it’s only one level of protection,” he says. “You still have risks at the point of entry, and risks for stored data and the human factor. Customer-service representatives, restaurant staff and a host of other opportunities for fraud will not be eliminated by data encryption.”
The myriad new mobile-payment applications in development, including those for Apple Inc.’s iPhone and other smartphones, create additional opportunities for fraud and data breaches, Laliberte says.
“So far, we have not seen a lot of attacks on mobile devices, but you can be sure that malicious code is in development, as smartphone usage becomes more widespread,” he says. “Mobile-payment applications will become the focus of a lot more security and controls.”
Despite constantly reaching toward higher security standards, systems are not safe from data breaches. “I feel like we’re fighting a never-ending battle,” Laliberte says. “Even as merchants follow new, more-elaborate procedures, we’re still seeing breaches.”
Mobile Payments
Card issuers this year also are likely to announce significant mobile-payment developments and partnerships, although most would involve experimental technologies designed to establish a position to capture future growth. While observers expect iPhone and other smartphone applications for mobile payments to continue mushrooming, Twitter founder Jim Dorsey also has promised to roll out Square, a card reader that would enable merchants to accept payments for merchandise and services through smartphones.
Dorsey, however, has yet to explain the details, which has prompted some observers to question whether Square is more hype than reality.
Indeed, hype may exceed reality on many new mobile-payment concepts, one observer suggests.
“There are so many different mobile-payment initiatives going on globally right now ... that it is hard to keep track of them and point to any that have any real momentum,” says Bruce Parker, vice president of product strategy and innovation at payment-software company ACI Worldwide. “People are developing mobile apps through phones, and radio frequency-based contactless stickers are gradually making progress, proving that mobile payment need not be tied to phones per se. You’ve got alternative online-payment services trying to inch their way out of the Internet box into mobile payments.”
Card issuers this year likely will announce strategic partnerships and alignments with mobile-payment providers that may go a long way toward determining future winners, Parker suggests.
This will be a year of “experimentation and trials” while the industry awaits the arrival of Near Field Communication-equipped phones that may ignite mobile payment on a broad sale, he adds. “It’s anybody’s guess which of the new mobile-payment innovations may rise to the top and whether any of them could achieve critical mass before NFC arrives,” Parker says.
Interchange Rates
Legislation to regulate and reduce interchange rates is likely to resurface this year, says Michael Brauneis, Protiviti director of regulatory risk. Lawmakers could resurrect aspects of two bills introduced last year, including one that would require banks to enter into collective-bargaining agreements with retailers to set interchange rates. Another would enable merchants to introduce surcharges and ban higher interchange rates on certain cards, such as those with rewards programs.
“At some point health care and bank-regulation reform will be decided, and lawmakers will move to the second tier of priorities, which is likely to include interchange,” Brauneis says.
But new developments may drive interchange legislation in different directions this year.
The General Accountability Office last November released a long-awaited study Congress ordered on the pros and cons of interchange fees. The report concluded that merchants’ costs indeed rise along with interchange rates, but legislation proposed so far to regulate interchange is flawed.
The report said no certainty exists that retailers would pass along to consumers their savings from lower interchange rates. It also suggested consumers might face higher costs to use their cards if issuers raised other fees or interest rates to compensate for lost interchange income.
“The GAO study weakened the case retailers have laid out about why interchange rates should be cut,” says Scott Strumello, an associate at Auriemma Consulting Group. “The study pointed out that consumers would not necessarily get a break at the point of sale if interchange is reduced, and issuers might raise rates and take away rewards. Retailers will need to build a new or different case this time around in order to advance their cause to cut interchange rates. It’s not enough to say that consumers are paying ‘hidden fees.’”
National Retail Federation spokesperson Craig Shearman says his organization continues to support laws enabling merchants to directly negotiate interchange rates with payment networks.
Profit Pressure
The effect of the recession, new credit card regulations and consumer behavior will make or break card issuers’ profitability this year, analysts say.
Charge-offs last September reached a historic peak of 11.52% of prime credit card outstanding receivables, according to Fitch Group’s Fitch Ratings. Although charge-offs eased to near 10% last summer, Fitch expects charge-offs to “re-approach 12%” in the middle of this year.
“We’re expecting unemployment to peak at around 12% toward the end of the second quarter, and charge-offs will be coincident with that rate,” says Cynthia Ullrich, a senior director in Fitch’s
asset-backed securities group.
But charge-offs could spike much higher if consumer bankruptcies surge this year, Ullrich says. Issuers tightened credit card underwriting standards and reined in credit lines in response to rising charge-offs over the last 18 months, resulting in lower charge volume and smaller card portfolios. The combination of elevated delinquencies, smaller card portfolios caused by issuers trimming accounts and credit lines, and potentially rising numbers of bankruptcies and charge-offs could put even higher pressure on card issuers’ profits this year, Fitch says.
Ullrich expects asset-backed credit card securities to be relatively stable. “Credit card securities profits are certainly being squeezed, but we are unlikely to see credit card trusts go into early amortization this year” given present trends, she says.
The Credit Card Accountability, Responsibility and Disclosure Act, which President Obama signed into law in May and most of which takes effect on Feb. 22, also has put a damper on profitability. Among other provisions, the law requires issuers to give cardholders 60 days’ warning before making any changes in interest rates and prevents issuers from raising rates on cardholders’ existing balances, except in certain conditions.
Issuers last year began to change their policies in response to the new law, and compliance efforts likely will further compress issuers’ profits this year, Fitch says.
If that were not enough, consumers have pulled back sharply on spending above and beyond lenders’ tighter policies. “Consumers coming through the recession have adopted more conservative spending habits,” says Brauneis. “If present trends continue, consumers this year will continue to reduce their debts and clean up their personal balance sheets. Altogether it means that credit cards will be utilized less, and overall credit card charge volume will continue to drop this year.”
Narrowing down which of the various negative forces will have the biggest effect on the card industry is difficult.
“The financial meltdown plus new card regulations has really shaken the fundamentals of how the credit card industry has operated over the last decade or so,” Strumello says. “Issuers can no longer adjust their lending policies based on individual risk, which means they will be much more cautious. We will see fewer offers mailed to consumers with low-rate promotional offers and fewer balance-transfer offers.”
Competitive Shifts
One likely effect of the demise of risk-based mass-marketing of credit cards is that banks likely will strive to build multiple account relationships with customers, Strumello says.
“In the past we saw more separation of business units so that one bank group was targeting credit card customers and another group was going after demand-deposit customers,” he says. “This year we will see banks coordinating their marketing efforts better and solidifying their customer relationships to achieve better profits. Customers with more than one account at a bank are far more likely to repay a credit card loan there.”
Observers also expect competition to intensify this year among commercial card issuers. They also expect travel-and-entertainment spending to rebound somewhat after a sharp decline last year caused by the recession, and T&E card issuers are eager to reap that business.
Kevin Phalen, senior vice president of card and comprehensive payables for Bank of America Corp., says T&E and purchasing card spending began to improve in August, and that trend is continuing.
“We are seeing modest increases in travel spending by corporations in the U.S. and abroad,” Phalen says, noting corporations still are paying very close attention to expenses, which is helping to drive new commercial card business.
Like several other large commercial card issuers, including JPMorgan Chase & Co., Citigroup Inc. and Bank of Montreal, BofA saw “phenomenal” growth in its purchasing card and T&E card businesses last year as the recession drove more corporations to shift spending from internal expense-accounting to cards to identify areas of redundant and excessive spending, Phalen says. Such patterns are easier to track through the spending-analysis tools inherent in cards, he says.
“The consolidated card-spending data we offer buyers now is very rich and enables corporations to get a better view of where they are spending money and how they can cut costs further by taking advantage of vendor programs,” Phalen says.
This year, Phalen expects to see more corporations migrating payments from checks to cards and to other electronic payment channels. Moreover, competition among card issuers will be “steadily heating up,” he says.
The economic outlook for card issuers this year is nevertheless not as bad as it could have been “given the apocalyptic predictions” of some analysts last year, says Protiviti’s Brauneis.
“When we started out last year, fear levels were very high. But by late 2009 there were signs that unemployment was stabilizing, and we saw signals that we might be hitting the bottom of this cycle sooner rather than later,” he says. “Unemployment will be the single most-important driver this year in whether or not we begin to see an economic recovery, consumers regain confidence and credit card issuers see light at the end of the tunnel.” PS
