This article appears in the December 2009 issue of Cards&Payments.
Credit and debit card issuers in 2009 endured an unprecedented combination of economic, legal and technological upheavals. The year may be remembered as the one when the card industry hit bottom.
From the faltering economy and resulting record-high credit card account defaults to sweeping new legislation forcing major changes in card-issuing practices and seismic shifts in technology needs, the events of 2009 will permanently reshape the industry.
The year began on a gloomy note as the recession deepened, and rising charge-offs drove most issuers to report declining profits quarter after quarter. On the acquiring side of the business, a processor's announcement in January of a large data breach helped make data security the focal point for merchants.
A look at some of the top issues of 2009:
Apart from the economic crisis, the defining event of the year for card issuers came in May, when President Obama signed into law the Credit Card Accountability, Responsibility and Disclosure Act. The law was the culmination of nearly two years of congressional hearings and testimony from consumers outraged by steep penalty fees and unexpectedly sharp interest-rate hikes.
Though most provisions of the law go into effect in February, some kicked in this year, including provisions requiring issuers to mail card statements at least 21 days before the due date and also to provide 45 days' notice of any interest-rate increase. The new law already has generated big changes in card issuers' risk-management and marketing practices, and analysts say it will have far-reaching implications on industry profitability.
"The Credit CARD Act alone is causing the biggest changes the industry has seen in recent history. But combined with the worst economic crisis we have seen in several decades, credit card issuers are facing monumental challenges this year," says Michael Brauneis, director of regulatory risk at the U.S.-based consultancy Protiviti Inc.
Though the Federal Reserve Board and other regulators foreshadowed the major thrust of the new law with industry regulations approved late in 2008, Congress went further in drafting its version of similar rules. Key provisions of new Fed rules Congress affirmed include prohibiting issuers from raising cardholders' interest rates on existing balances except in certain limited circumstances and requiring issuers to apply payments first to cardholders' highest-interest outstanding balances.
The new law also requires issuers to revisit any interest-rate increase every six months, returning the rate to its original level if a cardholder makes six consecutive on-time payments or the circumstances prompting the increase no longer exist. Issuers also are prohibited from raising interest rates on new accounts for 12 months, and promotional rates must endure for at least six months.
Issuers also must allow customers to opt out of over-limit increases and their resulting fees, and they no longer can issue cards to consumers younger than 21 unless an adult co-signs or the cardholder can prove his ability to repay debt. Beginning next year, issuers also must include a schedule detailing amortization costs on outstanding balances in every cardholder's monthly statement.
The new law effectively eliminates the card industry's longstanding practice of changing cardholders' interest rates based on fluctuating individual risk profiles, and it complicates the process for introducing any other interest-rate changes. In preparation, this year most issuers converted cardholders' accounts en masse to variable rates tied to the prime rate from fixed rates, and this provided them with a bit of flexibility and a hedge against rising interest rates in the economy at large.
The ongoing debate about U.S. credit card interchange continued this year, reaching new heights of awareness with lawmakers and consumers. In late June, chain 7-Eleven Inc. launched a nationwide customer-signature campaign via petitions posted inside its 6,000 U.S. stores urging consumers to "ask Congress to stop credit card companies from charging unfair transaction fees" to retailers.
The U.S.-based convenience-store chain says it collected 1.66 million signatures, which it trucked to Washington for a U.S. House Financial Services Committee hearing in early October to demonstrate support for legislation to cut or regulate interchange rates.
Proposed interchange-regulation bills include one from House Judiciary Chairman John Conyers, D-Mich., which he reintroduced this year and would require banks to enter into collective-bargaining agreements with retailers when setting interchange rates. Another bill U.S. Rep. Peter Welch, D-Vt., introduced this year would enable merchants to introduce surcharges and ban higher interchange rates on certain cards.
MasterCard Worldwide and Visa Inc. sharply criticized 7-Eleven's signature campaign. MasterCard claims 7-Eleven misled consumers with its petitions, citing the results of its own survey conducted in July that suggest some 80% of consumers who signed 7-Eleven's petitions "mistakenly believed" they would directly benefit from a reduction in interchange fees. And Visa blanketed Washington with a "reputation campaign" highlighting the benefits of using credit cards versus cash and checks.
Further legislative action on interchange stalled as other matters crowded the Financial Services Committee's agenda during the fourth quarter. Merchants vowed to continue the fight, while card networks seemed relieved to have dodged a bullet this year.
During a conference call with analysts in late October to discuss Visa's quarterly earnings, Joseph L. Saunders, Visa chairman and CEO, appeared to declare a victory in this year's interchange debates. "We've continued to make good progress in Washington and believe that the interchange debate increasingly is viewed as a business-to-business issue" and not a consumer issue, as "the merchant lobby" portrays it.
Debit card overdraft fees also came under fire, as lawmakers introduced legislation in October that would require banks to get customer consent before enrolling them in overdraft-protection programs for debit card transactions at ATMs and at the point of sale. The proposed law would limit the number of overdraft fees banks could charge to one per month and six per year.
Banks and card issuers could lose some $24 million in annual revenue from debit card overdraft fees if the law is enacted, analysts say. Added to the sharp decline in revenue from credit card interest rates and credit card over-limit and other fees, some issuers are already exploring new types of fees to offset losses. For example, Bank of America Corp. in October said it is testing annual fees of $29 to $99 on credit cards "in response to market conditions."
Megan Bramlette, managing associate with U.S.-based Auriemma Consulting Group, says that after years of consumers enjoying rich rewards on no-annual-fee cards, BofA's test could represent "the beginning of a new trend we have expected to see around the world." Card issuers coping with the global recession and the rise of tougher regulations in various countries "have no choice but to introduce annual fees to offset some of these losses," Bramlette says, although other examples
remained scant through the fourth quarter of this year.
Painful as new card-industry laws may be for card issuers, at least one observer believes the recession had a larger impact on the card industry than nearly every other factor.
"The card industry got hurt this year, but it wasn't primarily because of new regulations," says Gene Truono, managing director with BDO Seidman LLP's BDO Consulting. "Most of the carnage to card issuers' profits this year was due to the economy. The industry may have to reinvent a few things and shrink a bit, but it will survive."
The Credit Crunch
For the majority of issuers and card networks, consumer credit card spending declined, while debit card spending volume held steady or rose slightly as consumers became more conservative with everyday expenditures. As unemployment rates rose, so, too, did credit card charge-off rates, reaching an historic peak in August with an industry average exceeding 10% of outstanding U.S. card receivables.
To reduce their exposure to further risk, issuers shut down millions of inactive card accounts, trimmed credit limits and sharply curtailed marketing efforts.
Escalating losses from charge-offs undid U.S.-based small-business card issuer Advanta Corp. In April, Advanta signaled trouble with skyrocketing charge-offs, and the following month it froze its 1 million credit card accounts. The issuer's average charge-off rate soared to above 24% in July, and in the ensuing months Advanta unwound its card-issuing business, selling its customer-referral list to American Express Co. for an undisclosed sum.
Data breaches and concern about card security continued to preoccupy issuers and merchant processors this year, prompted by a major data breach processor Heartland Payments Systems Inc. announced in January. The breach actually began in May 2008 when a hacker's "sniffer" program made it past Heartland's security systems and sat for months delivering data on an undisclosed number of cardholders to fraudsters until it was discovered in October of that year.
The payment industry's vulnerability to breaches sparked a movement to enhance data-security through so-called "end-to-end" encryption. Heartland throughout the year worked to develop such an encryption system to protect cardholder data as the information travels from the POS terminal to the processor and card networks.
VeriFone Holdings Inc. also says it is developing enhanced data-encryption options. Both efforts, though, have led to the companies suing each other (see story).
The card industry was caught somewhat off-guard this year when card issuers' longstanding practice of using mandatory arbitration to settle disputes with cardholders came into question. Although consumer advocates have grumbled for years about arbitration firms' sometimes-dubious practices, it came as a surprise in July when the National Arbitration Forum, which has handled many such arbitration cases, agreed to cease handling all cases.
The action came shortly after the Minnesota Attorney General filed a complaint accusing the organization of engaging in consumer fraud, false advertising and deceptive trade practices. Subsequently, several large issuers, including JPMorgan Chase & Co., American Express Co. and BofA, said they no longer would use mandatory-arbitration and would reevaluate their options for settling disputes.
Mobile And Contactless
While interest in next-generation payment technology continues to percolate, this year's economic downturn dealt a blow to general development of contactless and mobile-payment efforts, some analysts say.
While contactless payment seems to be undergoing a development surge in Europe (see story), the U.S. did not see much new contactless payment activity this year. And as a variety of mobile Near Field Communication contactless payment tests continue in various parts of the world, "the economy hasn't helped" development this year, says Ed Kountz, senior analyst with Forrester Research Inc.
"We are seeing mobile-payment trials evolving at different rates of speed in different markets around the world," Kountz says. "In Japan and parts of Europe, where there are clusters of opportunities around certain retail or transit operations, there is enough density and critical mass to do mobile-payment trials with handheld phones. But we are still at least a couple of years away from seeing widespread adoption of mobile payments in multiple markets."
But mobile payments saw development in a new direction this year with the emergence of a variety of downloadable smartphone applications that seem to lay the groundwork for certain mobile payment-enabling tools. Chief among them are applications that turn Apple Inc.'s iPhones or Research in Motion Ltd.'s BlackBerry devices into mobile POS terminals.
"The iPhone has grabbed a lot of attention for its potential for mobile-payment applications, but unlike NFC phones it cannot be used as a payment device at the point of sale, and it is not clear how the iPhone or BlackBerry could evolve in that direction," says David Evans, an analyst with U.S.-based Market Platform Dynamics.
But Evans could not rule out the possibility that downloadable applications for handheld devices might lead to new innovations that could supplant existing mobile-payment options. "Everyone agrees that in the long run handheld phones will be used as point-of-sale payment devices, but it's just a question of when. And while NFC is the most likely technology out there now to enable mass mobile payments, it may ultimately be some other technology that provides the breakthrough."
It was a tough year for the payments industry. But as the year draws to a close, some issuers and card networks are signaling a slowdown in losses and a leveling-off in consumer-spending declines. That could mean that the worst is over. CP