Wednesday, May 03, 2006

Credit Card Companies Fear "Perfect Storm" (

By Martin H. Bosworth, ConsumerAffairs.Com, May 3, 2006

If you're an executive at Visa or MasterCard, times would seem to be great. You're making big bucks out of a seemingly endless hunger for purchases made with plastic, and the $800 billion in credit card debt Americans owe ensures a steady flow of revenue.

In the case of MasterCard, your company is ready to go public with an initial offering of $43 per share, after reporting first quarter 2006 earnings of $127 million.

So what's got card issuers and their partner banks so nervous?

After years of unchallenged industry dominance that enabled the two biggest players in the market to set prices and make deals with impunity, Visa and MasterCard are facing obstacles from all fronts, ranging from the ongoing merchant lawsuit against hidden "interchange fees," to competition from new card issuers, to consumers getting rid of their cards in ever-larger numbers.
Not only that, but increasing interest rates and the simple lack of new customers is leaving many in the credit card industry wondering if the financial equivalent of "the perfect storm" is on the horizon.

Interchange Lawsuit

The lawsuit filed by retailers and merchants against Visa and MasterCard over "interchange" fees was recently amended to include debit cards as well as credit cards. The lawsuit deals with the processing fees merchants have to pay to card companies and issuing banks when customers buy goods using plastic.

The plaintiffs allege that Visa, MasterCard and the issuing banks have so much power over interchange fees that they can set rates as high as they wish, causing merchants to lose profits from sales in order to process card transactions.

Henry Armour, chairman of the National Association of Chain Stores (NACS), said in a press statement that "price fixing of interchange is equally as problematic in debit cards as it is in credit cards… Because debit cards are commonly used at convenience stores, especially at the gas pump, this is a significant amendment to the complaint."

Merchants and retailers are concerned that the growing trend towards using plastic for small purchases, or "micropayments," will erode their profits even further.

When a coffee shop customer buys a latte with plastic, the money the retailer makes is almost entirely negated by the cost of processing the transaction, merchants complain.
Banks and lenders have claimed that if the merchants score a victory in the interchange fee lawsuit, it could cost the credit card industry $100 billion to reduce or remove the fees from transactions.

More Players, Fewer Payers

In an effort to demonstrate "good governance," Visa recently agreed to elect new independent members to its board of directors.

This was the first instance of the San Francisco-based credit card issuer opening its board to independent officers, a process begun late in 2005 and not scheduled to be completed until 2007.
Observers such as photo store owner Mitch Goldstone, a lead plaintiff in the merchant lawsuit, speculated last year that the move might be in response to increasing pressure to deal with interchange fees.

"Rearranging board seats a year from now is a good first step," he said on his blog, "It also furthers the argument that Visa's CEO is listening and slowly maneuvering the top over the cookie jar."

Some also speculate that Visa's move is designed to comply with New York Stock Exchange and Nasdaq rules regarding the composition of companies' boards of directors for public trading. Visa may be considering its own public offering to match MasterCard's.

Intensifying Competition

Competition in the credit card lending market is increasingly fierce.

As the average American carries four credit cards with balances of $9,000-$13,000, lenders are having a tough time gaining new customers, and so are resorting to luring existing cardholders with offers of low balance transfers, cash rebates, and so on.

Discover Financial recently announced its plans to offer its own debit card and processing system, and won praise from merchants for dropping the "
No Surcharge" rule from its transactions. The rule prevented merchants from passing the costs of credit card processing on to their customers.
The financial industry was abuzz with rumors that Bank of America (BOA) may
pull away from Visa and MasterCard, and offer its own credit and debit cards, as well as a separate payment processing system.

BOA's purchase of MBNA and its many card offerings gave the Charlotte, NC-based financial behemoth leverage to consider the move, in order stop paying Visa and MasterCard to process charges with its cards.

MSN Money columnist Liz Pulliam-Weston pointed out that as lending interest rates continue to rise, most card issuers are switching their offers from fixed rates to variable rates, which may entice more cardholders to pay their balances off faster or risk defaulting on the loans.

Some lenders are already feeling the pinch. Both J.P. Morgan Chase and Citigroup reported lower first-quarter earnings for 2006 due to increased numbers of American cardholders paying off their balances and closing their cards.