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This story appears in the January 2009 issue of Cards&Payments.
The story is as old as the recession, which economists declare officially began in December 2007: Easy credit, the sugar daddy of so many consumer economies around the world, has turned sour.
The impact has shaken the financial industry. JPMorgan Chase & Co. has taken over Washington Mutual Inc., Wells Fargo & Co. now owns Wachovia Corp., and the U.S. Treasury Department's new Trouble Asset Relief Program is bailing out Citigroup to the tune of $45 billion.
Debates about how 2009 will shake out for the world economy are less about whether it will be a good or bad year and more about just how long and difficult the recession will be.
The economic downturn will affect all corners of the payments industry if consumers worldwide, as expected, continue to have less and, therefore, spend less this year, analysts say. But the malaise will not affect all forms of payments equally, and it will create opportunities for payment companies with the funds to bargain shop, they add.
First the bad news. With housing values still in the basement and unemployment expected to continue to rise, the bad-debt spotlight now has turned from mortgages to the uptick in credit card charge-offs. And issuers are warning investors to expect charge-offs to continue to increase well into the year.
Card lenders even have their own special corner under the tarp of U.S. federal assistance, called the Term Asset Backed Securities Loan Facility, or TALF, designed to revive investment in the asset-backed securities that comprise about half of issuer card-loan funds.
Ken Paterson, director of the credit advisory service at U.S.-based Mercator Advisory Group, has been studying previous recessions for clues to what issuers can expect from this recession. "Not to belittle a recession. It's not fun, and some issuers get into trouble. But issuers have been through them before," he says.
But Paterson's biggest concern, unique to this recession, is funding of issuers' card debts with asset-backed securities, a market that seized up in October (because of multiple "credit market stresses" that rattled investors, according to U.S. Treasury Sec. Henry Paulson) and whether TALF will jump-start investment in securities in time to help struggling issuers.
Layoffs on Wall Street and in the banking and payments industries remind Brian Riley, research director at TowerGroup, a U.S.-based independent research firm owned by MasterCard Advisors, of an old saw by President Harry S. Truman.
"Truman said recession is when your neighbor loses his job; depression is when you lose your job," he says. "There's much more impact to white-collar workers in this recession, which is affecting the bread and butter of revolving credit."
Global Impact
And this recession is different from downturns in the 1980s, 1990s and 2001 in that it has hit multiple banking and payment sectors around the world, especially credit and investments, Riley notes. "Before, you had one part of the business that was hurting while other areas were doing well," he says.
In a research note circulated in late November, Meredith Whitney, a bank analyst with Oppenheimer & Co., expected U.S.-based banks to post $44 billion worth of write-downs and credit-loss provisions during the fourth quarter of 2008. Many would tap funds from the U.S. Treasury's Troubled Asset Relief Program to shore up their balance sheets instead of lending money to consumers, according to Whitney.
"Overall, we do not believe these capital raises will spur meaningful growth for the industry," she wrote. "We remain cautious on the financial institutions as they continue to face asset-price declines and a prolonged weak economic environment."
Paul Tomasofsky, president of U.S.-based Two Sparrows Consulting, considers himself an optimist. His sunny disposition projects U.S. unemployment rising to around 8.5% from 6.7% in early December last year.
"I'm not expecting the 25% unemployment of the Great Depression," Tomasofsky says. "Regardless of what happens in credit activity, there will still be the megatrend that electronic payments will continue to displace cash and check."
Though credit card issuance and use likely will tighten this year, the debit and prepaid card markets will hold their own and even benefit in some ways from a bad economy, say analysts who concur with Tomasofsky. They argue that, whether by voluntary prudence or involuntary loss of access to credit, consumers will reach more for debit cards, which still will continue to displace cash and checks.
"There is a new age of frugality," Tomasofsky says. "If that becomes a megatrend, debit cards will continue to grow because folks will look at that as a budgeting tool more than credit cards."
Red Gillen, senior analyst at U.S.-based Celent LLC, is less optimistic about how much displacement of cash and checks can make up for less consumer spending overall in saturated debit card markets. "One of the two biggest threats to Visa and MasterCard are consumer spending downturns," he says.
But that fear will drive card networks to encourage debit card use even more, says Dana Gould, senior research analyst at Financial Insights, a U.S.-based consultancy. "There's a bigger push by a lot of the processors, Visa, MasterCard and so on for developing usage of debit cards," he says.
In the prepaid market, a recession may hurt gift card use, but employers and government agencies will spend more on prepaid cards to disburse pay and other benefits to unbanked employees and government benefits, such as unemployment and food assistance, to unbanked recipients of aid, Gould says.
Even so, "there's going to be pressure and competition to lower the fees," Gould says of prepaid reloading and transaction charges.
As in previous years, banks will continue to fear payment disintermediation by nonbank transaction enablers of all types, from online payment tools such as PayPal to nonbank mobile-phone funds-management and transfer tools a growing number of vendors offer. But Gillen expects encroachment of such alternative payments to be limited mostly to e-commerce. "In the brick-and-mortar space, cards still dominate," Gillen says.
Good For Processors?
Financial institution cost-cutting could be good for third-party processors looking to expand their markets and to reclaim some ground lost when banks in recent years brought many operations in-house, according to Tomasofsky. "Some financial institutions will look to sell their processing businesses," he says. "They'll need to sell."
Tomasofsky expects U.S.-based processor Total System Services Inc. and MasterCard Worldwide to be ready to pounce on such opportunities.
TSYS announced its third-quarter earnings a few weeks early last fall, after Chase and Wells Fargo absorbed TSYS processing customers WaMu and Wachovia, respectively. Chase says it will take WaMu's processing in-house.
In reassuring investors, Philip Tomlinson, TSYS president and CEO, noted that new and expected regulations, such as U.S. Federal Reserve rules related to credit card interest rates and fee and policy disclosures, could convince more issuers to leave card processing to third parties such as TSYS.
"We've talked to some issuers who say that they'll have to use every technical resource available to them for the entire year of 2009 to comply with the Fed's rules on credit cards," he said.
The Fed, the Office of Thift Supervision and the National Credit Union Administration approved the new card rules in December. They take effect in July 2010.
Among the rules, issuers will have to apply cardholder payments in excess of minimums first to balances that incur higher interest rates, and the rest to portions of the balance incurring lower, promotional interest rates.
Global Issues
At the time, Fed officials said they expected to release final rules before the end of 2008, but the agency had not released the rules by Cards&Payments press time.
In Europe, financial institutions have another deadline for the mandated Single Euro Payments Area, while European Union officials are expected to ratchet up the pressure on banks to accelerate compliance. The banks will face a key deadline in November, when they are supposed to have a pan-European debit system ready.
Worldwide, the uncertainty of regulatory and legislative changes remain a major source of angst for the payments industry, analysts note. In Australia, Reserve Bank officials have proposed dropping the national regulation of interchange some time in 2009 if card issuers and acquirers meet certain conditions.
In the U.S., the Credit Cardholders' Bill of Rights and proposed changes to interchange and payments-network security practices remain unfinished business in federal and state legislatures.
Democrats more so than Republicans tend to want to use regulation to prevent businesses from taking advantage of open markets, which potentially could harm consumers. But even given the election of a Democrat to the White House and a larger percentage of Democrats in the U.S. House and Senate, legislators may be more cautious this year than they were in 2008 about the unintended consequences of new restrictions on already battered card issuers.
"The biggest shoes that can still drop on that front got their start in the past," Paterson says, referring to U.S. legislation such as the Credit Cardholders' Bill of Rights. "I wonder if some of the momentum might slow down a little bit on that.There's great interest in protecting consumers, but I don't think anybody in this economic environment wants to put too many impediments in the way of consumer lending."
When It's Over
Looking ahead to an eventual economic recovery, Celent's Gillen says the trick for surviving credit card issuers will be springing into abandoned markets and wallets before competitors do the same. "Everybody's pulling back now," Gillen says. "But when we hit a U-turn on the economy, it will be interesting to see who exits the gate first."
Indeed, issuers still have long-term opportunities for credit card expansion in areas of the globe not already saturated with credit cards, Riley says. "China's attractive on the credit side," he says. "It will probably be eight to 10 years before it's profitable, but it's a great place to have an oar in the water."
The worst-case scenario for 2009 would be that federal and state laws make card issuing more risky while federal assistance to issuers arrives too late or too little to help struggling banks, Paterson says.
If legislators and regulators tread carefully on payments law, federal assistance helps free up lending, issuers are able to contain delinquencies and charge-offs, and consumer confidence in asset-backed securities and other investment vehicles rebound, "then this will begin to look like a regular recession–not fun, but manageable," Paterson says.
An old Chinese curse wishes its recipient: "May you live in interesting times." In a time of unprecedented uncertainty, 2009 certainly will be interesting. The trick for the payments industry will be to seek opportunities for growth amid current difficulties. CP
