Interchange Fee Changes: What You Really Need to Know Now (MA, V, BAC, C, COF, TCB)

You most likely saw the carnage that came to MasterCard Incorporated (NYSE: MA) and Visa, Inc. (NYSE: V) today.  The markets were braced for more changes coming to the interchange fees, also called swipe fees, which get charged per transaction.  The problem is that the proposed fees to be charged are far less than even what was expected just yesterday.  Interchange fees are passed on to the merchant, which is therefore passed on to the consumer in higher prices on goods.  Many consider it close to free money for the banks.

The Federal Reserve agreed to advance a proposal today to prevent charging debit swipe fees to merchants with a cap of $0.12 per transaction.  Before you consider that the sky is falling, there is a public comment period.  That means that banks and lobbyists and others will get to speak about the pros AND the cons of this proposal.  That $0.12 cap is far less than what had been expected.  In short, rather than a 50% or 60% cut in interchange fees might now be a cut of 80% or even more.

Of two proposals, one would allow the card issuer (banks) to use a formula to determine the maximum fee based upon costs and processing fees.  A safe harbor standard would be set at $0.07 per transaction.  The alternative plan did not have a safe harbor of $0.07 but still capped out at $0.12.  The problem with thinking this will kill banks is that the banks would seem to be free to pass on other charges to card holders.

The cap, while harmful to the same institutions that the Fed has tried to save, is meant to prevent unreasonable interchange fees.  Many already argue that the fees are already too high.  The Fed has also proposed a review of the interchange fees each two years and those reviews would take actual costs into consideration.

The big consideration here at the retailer level is that this means more money to the merchants which may never at all be passed down to the consumer via lower prices.  That is very arguable, but that has to be a concern.

The big concern for the consumer is that the banks could begin to charge even higher use fees and other fees to their card holders.  A figure that is widely thrown around id an average of $200 per customer per year spent on higher goods prices due to higher prices.  The New York  Post projected $10 billion to $12 billion in lost revenues which is mostly profits.

Some of the banks deemed to be big losers in these interchange fees are TCF Financial Corporation (NYSE: TCB), which saw a 7.6% drop to $13.45 today on more than three-times normal trading volume.

There are risks of course to large card issuers such as Bank of America Corporation (NYSE: BAC), although its shares were higher today.  Capital One Financial Corporation (NYSE: COF) closed down 1.5% at $40.90 due to the concern that when retailers ask “What’s In Your Wallet?” that cash will be used instead of the plastic.

The risks to Visa Inc. (NYSE: V) and MasterCard Incorporated (NYSE: MA) are easy: fewer card transactions due to higher banking fees, which means less money to Visa and MasterCard.  MasterCard shares were down 10.3% at $223.49 on the day on about 8-times normal trading volume and Visa shares were down 12.6% at $67.19 on nearly 10-times normal volume.

Today was obviously a worse loss than what was expected.  What investors and consumers need to again consider is that this retailers AND banks get to comment on this proposal.

A simple argument is that on top of this cutting very profitable bank revenues, it will also leave the same banks on the hook for higher losses when credit or debit card fraud occurs.  The banks will also likely argue that this will only hurt consumers with higher banking fees and possibly a retail situation where retailers keep the profits rather than passing the savings to consumers.

The vote today is not the end of the road.  As it stands now, this might not come to a final head until the end of January or even a bit later.  This change has created a rough year-end and start for 2011 for the banks and particularly for the processing players like Visa and MasterCard.

Today was a blow to the finance side of the equation.  It was a win for the retailers, and whether it is a net-net win for Joe Public remains to be seen.

Right before publishing, MasterCard already released a statement that this would merely be a win for large retail merchants that would shift the transaction cost burden right to consumers.

Consider this a work in progress rather than the final chapter of the book.

JON C. OGG