More Big Issuers are Pulling Card Processing In-House

  When Bank of America Corp. bought MBNA Corp. in 2005, many financial analysts thought the purchase would provide a windfall for credit card processor Total System Services Inc. The Columbus, Ga.-based transaction processor had just signed a five-year contract extension to process BofA's consumer and commercial cards, and it seemed that the purchase would drop all of MBNA's card business into TSYS's lap.
  But at the end of that year, BofA announced it would take its entire consumer card processing in-house.
  "That surprised a lot of people," says Brian Riley, senior analyst with TowerGroup, the Needham, Mass.-based market research unit of MasterCard Worldwide.
  In retrospect, he says, it should have been more apparent what BofA's strategy was. In 2004, BofA purchased all of the outstanding shares of National Processing Inc., one of the nation's largest credit card processors. Riley says that acquisition helped make it financially feasible for BofA to process its transactions without outside help.
  The MBNA acquisition was one of a series of banking industry buyouts and mergers during the last few years that has given large card issuers the economies of scale needed for in-house processing. Still, some experts believe there is a big demand for third-party processors, even among large issuers.
  TSYS is not the only processor to lose one of its biggest customers. In a U.S. Securities and Exchange Commission filing this past February, Greenwood Village, Colo.-based First Data Corp. acknowledged that Wells Fargo & Co. and two undisclosed banks would take their signature-debit processing in-house. According to the filing, the three banks generate about 4% of the revenue for First Data's financial institutions division.
  The decisions by major banks to handle their own processing reverses at least one industry trend. Throughout the 1980s and 1990s, as new products and technologies and increasing government and industry regulation made the payments business more complicated, most issuers began outsourcing their card processing to third parties. TSYS and First Data eventually surpassed all other processors in size, but some experts now wonder if the two big players can continue to grow, at least domestically.
  The changing market already has put these companies' fortunes on a roller coaster.
  On April 2, Kohlberg Kravis Roberts & Co., one of the nation's largest private-equity firms, agreed to purchase First Data for about $29 billion. The loss of Wells Fargo, in addition to the overall slowdown in the credit card processing volume, was a factor in the decision, contends Dan Schatt, a senior analyst for Celent LLC, a Boston-based research firm.
  First Data "has been a prime acquisition target for some time, particularly for large private-equity firms attracted to its low growth, yet steady annuity stream," he says.
  Neither Wells nor First Data would comment on the issuer's plan to take its processing in-house. A First Data spokesperson says the company continues to sign up major issuers, especially overseas. On Sept. 20, First Data announced that it had signed a long-term agreement to provide credit card processing for the United Kingdom-based Barclaycard, and on Nov. 3 it announced a similar deal with Paris-based Societe Generale Consumer Finance.
  TSYS officials were unwilling to discuss the details of the loss of BofA's business. However, while a spokesperson did acknowledge that, as banking consolidation trends continue, TSYS "won't win every deal," he says processors still provide value to issuers.
  TSYS invests 10% to 13% of its revenues in product development, the spokesperson says. "That's a level of investment that few financial institutions can sustain on their own, which is why outsourcing continues to be an important trend even among major banks and retailers," he says.
  A year ago, after BofA announced it would take its processing in-house, Gary Prestopino, an analyst with Barrington Research in Chicago, told Cards & Payments sister publication CardLine that things looked grim for TSYS. "It's hard to get excited about a company that will have a year of flat revenues from operations," he said.
  'BIG WINS'
  But there are signs that both TSYS and First Data can bounce back. The companies have had some losses, says Sarah Phelps, senior consultant with First Annapolis Consulting, "but they've also had some pretty big wins."
  For example, last July, Charlotte, N.C.-based Wachovia Bank announced it was going to begin issuing Visa consumer credit and debit cards and had chosen TSYS to process its card transactions. Thanks to the Wachovia deal, among others, TSYS belied the fears Prestopino expressed and boosted its 2006 revenues by 11.5%, $1.8 billion.
  "Our story might be a bit atypical," says Jennifer Darwin, a Wachovia spokesperson, acknowledging that many large issuers were moving their processing in-house.
  Wachovia had issued its credit cards through MBNA but decided to end that relationship after BofA bought the issuer. While Wachovia might have found it technically feasible to handle the processing, "time was really of the essence for us in launching our new business," says Darwin.
  So Wachovia officials decided it was best to bring TSYS aboard and take advantage of its expertise.
  CONSTANT SHIFTS
  The Wachovia experience shows that even the largest financial institutions still can find third-party processors useful, Phelps says.
  For one thing, security requirements will keep changing over the next few years, calling for constant adjustments to processing software. "Do [banks] want to keep fixing [their] platform or just outsource it?" she asks.
  Fortunes in the processing world can swing back and forth like a pendulum, Phelps says. Over a given period, some issuers move their processing "from one vendor to another, while others can take it in-house and then switch back to a [third-party] vendor."
  And many of the nation's largest issuers are, so far, also sticking with a third-party processor. Both Citibank and JPMorgan Chase & Co. still use First Data and TSYS, respectively, Riley says. In 2007, Chase will take its processing in-house but, under an agreement with TSYS, will handle its transactions with TSYS software, according to a Chase spokesperson.
  In 2005, Cincinnati-based Fifth Third Bank chose TSYS, which processed the issuer's commercial cards, to process its consumer credit cards as well.
  Large financial institutions are not all alike, and that can affect whether bringing processing in-house makes sense, Riley says.
  BofA, for example, has a far more extensive branch network than Citicorp does, and a far greater number of its customers use debit cards for small transactions. And since debit card use is growing much faster than credit card use, BofA saw an opportunity by becoming an in-house processor to tap into a new revenue source.
  BofA, which also is a leading merchant acquirer, now can get a share of both the card and merchant processing sides of transactions, Riley says. A move like this might be one of the few methods BofA has to continue growing, since banking consolidation has gone about as far as it can, he adds. "What's left to buy for BofA?"
  Whatever the larger financial institutions eventually decide to do, experts seem to agree that small and medium-size banks likely will continue to use third-party processors. A processing platform "requires a mainframe [computer] system that is difficult to maintain with a small bank's revenue," Phelps says.
  HARD TO HANDLE?
  Adding to the burden is the need to Assemble the technical expertise to manage the software, provide robust analytics and update the system every six months or so in response to changes from the card associations. "Unless a [smaller] bank has a philosophical reason to control the value chain," it makes sense to use someone like TSYS or First Data, Riley says.
  Furthermore, Phelps says processors such as First Data, TSYS and others do more than core processing. They also have contracts with issuers to produce statements, manufacture cards and handle collections. Exactly how much money this additional work brings processors is difficult to determine, according to Phelps, since the companies keep this information largely hidden.
  However, she says, "TSYS and First Data don't rise and fall on core processing."
  Riley agrees. He also points to First Data's 2006 acquisitions in South America, including Buenos Aires-based Argencard S.A., one of the largest payment processors on that continent. That, he says, is an example of how the company, even under its new ownership, still will have opportunities to grow. "That shows the market can be dynamic," Riley says.
  Although the market may have shifted under their feet a bit, large-scale processors still seem to have a role to play, even for financial institutions that, in some cases, may approach them in size.
  (c) 2007 Cards&Payments and SourceMedia, Inc. All Rights Reserved.
  http://www.cardforum.com http://www.sourcemedia.com