Heartland Payment Systems Inc. experienced more merchant losses during the first quarter compared with previous quarters in part because of sustained economic weakness, the discontinuation of large individual merchants and shoddy management oversight of risk, according to Robert Baldwin, president and chief financial officer of the Princeton, N.J.-based processor. 

Heartland declined to provide additional details or specific data regarding its merchant losses during the quarter.

However, losses for processors typically occur when merchants are unable to fulfill customer orders and lack sufficient funds to cover charge-backs, says Meghna Ladha, associate analyst with Susqueheanna Financial Group LLLP, a Bala Cynwyd, Pa.-based trading firm. “If a furniture merchant goes bankrupt and can’t sell you furniture anymore and can’t pay you back, that’s when the liability goes to the processor,” says Ladha.

Given sustained economic weakness over the past two years, Heartland was “hit with an increased level of merchant losses this year,” Baldwin told analysts during a conference call May 6. “These results were exacerbated by some very large individual merchant losses as well as a failure of management to adequately oversee the performance of our risk-department personnel, which results in a few pretty significant losses.”

Indeed, Heartland had “lots of charge-back issues” during the first quarter, says Ladha, noting Heartland did not publish its loss numbers. The increase in merchant losses “was one thing everyone was concerned with,” she says. “We hadn’t seen that in the last few quarters, and then we saw a big increase.”

Besides the economic difficulties many merchants are facing, a Heartland manager in charge of risk analysis “frankly just neglected some violently waving red flags,” Bob Carr, Heartland chairman and CEO, said during the call with analysts.

In certain situations a risk manager “needs to shut down a merchant and say ‘that’s enough,’” yet sometimes merchants can convince a manager they can fix the problems and they should continue transacting, Carr said. “That is the job of the manager to not let that happen,” he said.

As of Dec. 31, Heartland provided processing services to roughly 173,400 small to midsize merchants and 75 large national merchants with roughly 54,0000 locations in the United States.

Despite the loss of merchant business, Heartland’s small and midsize merchant transaction-processing volume increased 7.2%, to $14.4 billion from $13.43 billion during the same quarter last year (see story). 

An increase in Discover Financial Services and American Express Co. activity and growth in other small and midsize merchant volume were the primary causes of the increase, according to Heartland.

Though same-store sales were down, they improved 370 basis points to minus-1.5% from minus-5.2% in the fourth quarter of 2009. It was the third quarter of sequential same-store sales improvement, according to Heartland. A basis point is one-hundredth of a percentage point.

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