JULY 2009

Non-Bank Acquirers Suffer Acquirer Loss Rate: All Acquirers

(bps on sales volume)
More from Deteriorating 2
1.73
Risk Environment 1.8

1.6

1.4
By Nicole Schrader & Marc Abbey

Loss Rate
1.2

Acquiring losses are not the most significant financial issue for ac- 1 0.92

quirers by any stretch; however, the current environment continues 0.8

to put pressure on acquirers, and the non-bank community appears 0.6

to be more impacted than banks. In recent research, First Annapo- 0.4

lis examined loss rates due to uncollected chargebacks, fraud and 0.2

non-sufficient funds in 2008 and May YTD 2009 for 15 acquirers. 0

2008 2009 May YTD
The average overall loss rate nearly doubled between 2008 and
2009, but nevertheless, average losses were still under 2 basis Median .39 bps .88 bps

points. Median loss levels were under 1 basis point in both time
periods, though the median in YTD 2009 was more than two times Source: First Annapolis Proprietary Research
higher than 2008.

On closer examination, the trends in loss rates were somewhat

correlated to whether the acquirer was a bank or non-bank. Non-
bank acquirers tend to be more risk tolerant and to generate higher Components of Growth for
loss rates than bank acquirers, often with correspondingly higher Commercial Cards
revenues and returns. For example, in 2008, the non-bank acquir-
ers in our research had average losses 4.7 times the loss rates of The commercial card markets are currently focused, in part, on chal-
the bank acquirers. This same measure in 2009 is 5.2 times, indi- lenges inherent in the general economic environment, including
cating the loss levels between the two communities is widening. substantial declines in business travel (corporate cards), reductions
in indirect spend offset by increased electronification of purchasing
On balance, we believe these figures illustrate a deteriorating risk processes and payments (p-cards), significant increases in credit
management environment. In addition, the difference between av- risk (small business credit cards), and reductions in shipments cou-
erages and medians indicate that certain acquirers are generating pled with fluctuating fuel prices (fleet cards).
“outlier” type loss rates that may be significant for them as individual
institutions even if the overall industry average is modest. The dif- It’s unlikely that 2009 will result in significant market-wide spend
ference between the bank and non-bank figures indicates that risk growth for any of these commercial card products; however, com-
intensive acquiring models are predictably deteriorating at a faster mercial card program growth is still a very important and achievable
rate than other models. (As an aside, 25% of the attrition for the objective looking into 2010 and beyond. With so many potential
acquirers in our study was driven by business failure, but this figure levers to pull, an obvious question is where to focus to drive spend
ranged as high as 60%. The risk intensive acquirers are also at risk growth?
for more severe growth pressure due to attrition than acquirers with
other portfolio profiles.) One way to help highlight specific areas for growth is to deconstruct
spend growth into its component parts. For example, in Figure 1
The peaks in business failure tend to lag recessions by several below, we show an equation that can be used to analyze the com-
quarters, so it is likely that we will continue to see deterioration in all ponents of growth for any commercial card program.
these measures. Though the average and median loss levels are
not dangerously high, they will drift up and the institutions on the Figure 1
edges of the distribution may have significant financial issues due to
Overall Card Client Cards Transactions Amount
risk outcomes. Customer X Penetration X per X per X per =
Card
Spend
List of Customers Client Card Transaction
(Continued on Page 4)
Navigator JULY 2009

Enhancing Debit Performance in a Same-Store Sales Decline Stings

Slow Growth Environment Acquirers
Debit card volume growth remains the star of the U.S. payments A tripod with a bad leg is unstable. Acquirers are dependent on three
industry. Amid the worst recession in a quarter-century, and as the variables to generate volume growth – sales throughput, same-store
credit market weathers material declines in purchase volume and growth, and retention. Retention is under great pressure, but same-
receivables, debit volume remains remarkably resilient, posting mid store growth has been in serious decline beginning in the latter half of
to high single digit growth rates over last year. These gains can be 2008 and continuing in 2009 resulting in the most challenging growth
explained by the concentration of debit spend in non-discretionary environment for the acquiring industry in its history.
categories such as grocery and petroleum, a shift from credit to
debit caused by tightening of credit availability, and the long term First Annapolis recently completed research examining the same-store
secular shift from paper to electronic payment forms. While debit is growth characteristics of 17 acquirers. Eleven out of 17 of the acquir-
outperforming other payment segments, issuers can no longer ex- ers fully reported negative same-store growth. On average, the ac-
pect the rapid volume and revenue growth of recent years. quirers reported just under 1.5% growth in 2008, but this average fell
to -5% May YTD 2009. Three acquirers reported same-store growth
In this environment, debit issuers must look for creative ways to worse than -10% in 2009.
meet their performance objectives. One of the best places to look is
getting more from current portfolio activity – specifically, declined The merchant market is highly heterogeneous and certain segments
transaction authorization requests. We have observed issuers have been more impacted by the economic crisis than others; some
where transactions declined for non-fraud related reasons represent segments are even counter-cyclical. Consequently, there is great
7% to 10% of potential debit spend. Authorizing even a small por- variability in an individual acquirer’s performance driven by the con-
tion of this pool can yield material revenue improvement, without centrations in their portfolios. Interestingly, the bank acquirer commu-
asking any cardholder to change their behavior, or materially in- nity has proven to have more volatility on same-store growth than non-
creasing risk. Further, reducing declined transactions enhances the banks as a result of the economy. Bank acquirers reported positive
overall customer experience and can improve DDA balances and same-store growth of 3.4% in 2008 which fell to -6.9% by May 2009.
account retention.
In addition, though there is little commonality to the algorithms acquir-
Reducing declined authorizations requires a rigorous analysis of ers use to measure volume and revenue attrition, 11 of the 17 acquir-
declined transactions, the decline reasons, and the performance of ers reported elevated attrition in 2009 over 2008. On average, 25% of
the related DDA account over time. This review must consider the the attrition was driven by business failure.
processes, systems, and business rules employed throughout the
debit issuing lifecycle to isolate the “false negatives,” i.e., those Same-Store Sales Growth Average
declined transactions that should have been approved given the
6%
attributes of the transaction, the deposit account, and/or the cus-
tomer relationship. Issuers undertaking this review and analysis 4%
Sales Growth %

identified ways to minimize declined transactions, increase revenue, 2% 1.41%

and enhance customer experience, all with a high return on a small
0%
investment.
-2%
Case Study -4%

Total Authorization -6% -4.99%

Requests ($) Declined Transactions
2008 2009 May YTD

Median 1.40% -6.00%

Fraud
Screen Source: First Annapolis Proprietary Research
30%

8% Actionable For more information, contact [email protected] and

NSF/ Opportunity [email protected]
Funding 30%
40%

Source: First Annapolis Analysis of Issuer Data

For more information, contact [email protected] and

[email protected]

2
Navigator JULY 2009

Bank Acquirer’s Sales Network, Processor and Billpay

Management and Promotions Mobile Solutions
Visa recently announced the formation of an alliance with mobile plat-
Increasingly, the branch network is an important acquisition channel
form provider Monetise, which included a $13 million investment.
for acquirers. Bank portfolios typically generate better revenue and
Monetise offers a wide range of mobile banking and payments ser-
have lower attrition relative to non-banks, and branch networks are
vices, and is focused on growing its presence in the U.S. The com-
a key competitive advantage for bank acquirers in a market where
pany already has a relationship with NYCE and has several large bank
growth is a challenge. Recently, First Annapolis interviewed six
customers (e.g., HSBC and RBS) in the U.K.
large bank acquirers about their branch-based tactics, and we see
much evidence of acquirers investing in their branch sales proc-
The flurry of mobile technology partnerships that networks, processors
esses:
and billpay providers have formed demonstrates both the value these
 At five of the six bank acquirers, merchant services is a lead providers see in mobile solutions and the distribution support sought
product offering for prospective small business customers. by mobile technology providers. Much of the processor and network
 Two of the banks emphasized a funds availability advantage activity has been focused on providing turn-key mobile banking solu-
in their sales pitch (i.e., next day funding). tions to issuers of varying sizes. Providers such as CheckFree
 Two of the banks had specific promotions underway in which (Fiserv), Metavante, and Western Union are also taking an active role
business bankers received promotional compensation for in mobile payments for core billpay, P2P and remittance-type services.
sales of merchant accounts. These promotions were related While the adoption of these services still faces a variety of obstacles,
to the credit crunch and the banks’ desire to broaden the the recent increase in partnerships and investment suggest the major
small business customer’s perspective beyond credit offer- players recognize a significant opportunity in mobile payments.
ings.
 Interestingly, two other banks had specific promotions target- U.S. Processors and Network Mobile Technology Alliances
ing merchants with a ‘meet or beat’ type offer. In the case of Mobile Banking Mobile Payments

one of the two banks, if it cannot provide merchant services Inter-account Transfers, Balance Inquiry, Mini
Statements, etc.
Billpay
P2P /
Remittance
NFC

for a lower cost than the customer is currently paying, the VISA LOGO    
bank will give the merchant a $200 gift card. The other bank
is running a similar promotion but will give the customer a Master ¹ 
$300 gift card.
 At four of the banks we interviewed, the banker was able to
identify the merchant sales representative by name, which Fis   ¹ 
can lead one to conclude that the sales representative is
spending time in the branch building relationships with top First Data /   ² 
referral sources. In-house (GO-Tag)

The branch network will remain a strong source of growth for bank FIS / Metavante ³   
acquirers, despite a down economy, but maximizing the branches is
to a large degree a function of sales and sales management invest-  
ments.
Western   
For more information, contact [email protected]

1Select pilots
2mFoundry offers P2P for First Data through PayPal
What We Are Following… 3Monetise provides balance inquiry for any FI account switched through NYCE

Source: First Annapolis Consulting research, American Banker, company press re-
 Evolution and Implementation of CARD Act Legislation leases

 Interchange and the Legislative Agenda For more information, contact [email protected],
[email protected] or [email protected]
 Canadian Market Dynamics

3
 Navigator JULY 2009

Q2 2009: U.S. Credit Card Issuer (Components of Growth for Commercial Cards Continued from Page 1)
One could expand upon certain components of this formula for a
Performance Snapshot drill-down analyses. Figure 2 illustrates how this can be employed
for evaluating indirect spend penetration rates within a purchasing
The CARD Act took center stage in the second quarter when Presi-
card program.
dent Obama signed it into law on May 22, 2009 ushering in one of the
most significant legislative changes in the industry’s history. The
Figure 2
scope of practices that are prohibited, restricted, or required under the
CARD Act is staggering. Layered on top of rising unemployment and Universe of
% of Transactions % of such
Cardable P-Card
an awful credit loss environment, the CARD Act’s restrictions on re- Transactions
X with Suppliers X Transactions =
Transactions
pricing alone will force many issuers to tighten credit further and at- that take Cards on P-Cards
(e.g., <=$50,000)
tempt to replace certain pools of revenue that will disappear in a post-
CARD world. With respect to Q2 2009 performance, loss rates contin- (Once calculated, p-card transactions would then comprise the nu-
ued their expected increase in line with unemployment (which hit 9.5 merator in the transactions per card term from Figure 1.)
% in June). Most issuers indicate improvement in collections entry
rates, but once delinquent, the pressures of unemployment and the Specific parts of this equation can also be combined. For example,
financial difficulties facing consumers are evident in roll rates. Pur- in evaluating a travel agency or supplier-embedded ghost or lodge
chase volumes experienced double-digit decreases versus Q2 2008 card, one may elect to collapse cards per client and transactions per
driven by a combination of consumer de-leveraging and credit tighten- card into a transactions per client measure as shown in Figure 3.
ing. The card industry’s performance dynamics of 2009 and 2010 will
be complicated by an unprecedented number of moving parts – the Figure 3
recession and its cyclical impact, the stimulus package and its effects, Cards Transactions Transactions
the CARD Act and its potential to fundamentally reshape cardholder per X per = per
pricing, account acquisition, and segment-level strategies. The first Client Card Client
phase of the journey to a new competitive environment will be evident
in the next few months as issuers look at the future of the credit card A similar combination of terms would also be more relevant in evalu-
business. Ironically, the future may be strikingly similar to late 80’s ating a specialized single-use account number purchasing card
and early 90’s with respect to cardholder pricing regimes and the im- product or program.
portance of the most fundamental skill in the lending business – new * * *
account underwriting.
By comparing an individual commercial card product portfolio to
Issuer
A/R ($B)
2Q09
Change
(vs. 2Q08)
Purch Volume
($B) 2Q09
Change
(vs. 2Q08)
Net Loss
Rate 2Q09
Change
(vs. 2Q08)
Change
(vs. 1Q09)
After-Tax
ROA 2Q09
Change
(vs. 2Q08)
Change
(vs. 1Q09) established industry benchmarks across the above metrics, issuers
Chase
1
$171.5 $82.8 10.03% -1.55% can highlight areas in which they are strong and areas for opportu-
nity. In an era of scarce resources, such analysis can help to focus
#REF! -11.5% 505 bps 231 bps -221 bps -34 bps

Chase
$148.4 NR NR 8.97% NR NR NR
attention on those levers with maximum potential program growth
1
(ex-WaMu)
#REF! 399 bps 211 bps

Bank of
America
2 $169.8
#REF!
$51.9
-19.4%
11.73%
577 bps 311 bps
-2.94%
-391 bps 35 bps impact.
3
Citigroup $142.3 $69.1 11.95% -0.51%
#REF! -17.2% 540 bps 169 bps -104 bps -109 bps

4
$64.8 $23.6 9.23% 1.02%
For more information, please contact [email protected]
Capital One
#REF! -11.7% 297 bps 84 bps -99 bps 101 bps

American
5 $54.0 $84.1 10.00% -1.46%
Express
#REF! -15.9% 470 bps 150 bps -159 bps -128 bps

6
Discover $48.9 $21.5 7.99% 1.88%
#REF! -4.3% 294 bps 138 bps 28 bps 107 bps

7
Wells Fargo $23.1 NR NR 11.59% NR NR NR
#REF! 464 bps 146 bps

Sum /
8 $674.4 $333.0 10.68% -0.95%
Wtd. Avg. #REF! -14.8% 488 bps 210 bps -166 bps 4 bps

1
Includes income from acquiring business and private label receivables and volume. Purchase volume includes cash and BT volumes.
Ex-WaMu A/R and net loss excludes impact of WaMu.
2
Receivables, purchase volume, and net loss rates are for U.S. consumer and international consumer cards.

First Annapolis is a management consulting and M&A advisory firm with a

After-tax ROA includes U.S. consumer and business, International, and merchant acquiring.
3
Restated splitting between Citibranded North American and CitiHoldings Retail Partners from Q1 2008. Purchase volume includes cash advances.
All figures for combined portofolioes with the exception of ROA, after-tax ROA only includes Citibranded NA cards.
4

5
U.S. card business, small business, installment loans only. Purchase volume excludes cash advances. 2007 figures re-stated by issuer. focus on the consumer financial services industry and a specialty in
payment-related products, services, and delivery. Our clients include
Receivables and charge-offs are for U.S. Cardmember Lending business only. Purchase volume is for U.S. Card Services segment, consumer and small business.
Includes restated NCL rate.
6

financial institutions, retailers, travel providers, technology and service

Includes us domestic receivables and purchase volumes only.
ROA includes merchant services and implied U.S. Cards tax rate of 38% as well as a $473 mil pre-tax gain ($297 mil after-tax) related to the antitrust settlement.
7

providers, trade associations, government agencies, and affinity groups.

Wells Fargo A/R improvement includes ~$2.5 billion from Wachovia acquisition.
8
After Tax ROA and purchase volume totals exclude Wells Fargo

Our services include strategy development, program management, portfo-

lio/risk management, sourcing and marketing support/execution in areas
For more information, contact [email protected] and such as product design, rewards/loyalty program development, and cus-
[email protected]
tomer segmentation. We also offer a suite of M&A advisory services.