Durbin Produces Contracts for First Data’s Star, But Results Are Months Away

Leading payment processor First Data Corp. reported on Wednesday that its merchant-acquiring operations are enjoying a temporary profit lift and its Star electronic funds transfer network has won more than 20 new contracts from financial institutions as a result of the Durbin Amendment. But whether those new contracts actually generate new transaction volume is uncertain, executives said at the company’s fourth-quarter earnings conference call.

Federal Reserve regulations implementing the debit card interchange price controls mandated by the Durbin Amendment in 2010’s Dodd-Frank Act took effect Oct. 1. Durbin imposed cuts of about 45% on pre-Durbin interchange revenues for debit card issuers with more than $10 billion in assets. In all, First Data's acquiring operation paid $115 million less in debit interchange than it did a year earlier because of Durbin, according to chief financial officer Ray Winborne.

But Durbin created a profit opportunity for acquirers, which are the parties that actually pay interchange to issuers and incorporate interchange into their overall pricing, or discount rates, that they charge to merchants. Acquirers are under no mandate to lower discount rates.

First Data’s acquiring joint ventures and independent sales organizations to which it provides processing services took advantage of the margin-boosting opportunity in Durbin’s early going, according to Winborne. These acquirers and ISOs, not First Data, set pricing to merchants.  “They did hold some of that benefit,” Winborne told analysts.

But Winborne added that competition is likely to eliminate that margin. “We do still anticipate this being a transitory benefit that will be competed out over time,” he said.

Further limiting the Durbin windfall are so-called interchange-plus pricing plans for many merchants, especially big ones. Such plans add processor charges to explicitly delineated interchange and change immediately or shortly after interchange rates change, impeding the acquirer’s ability to boost margins if rates fall. Winborne said about 80% of First Data’s merchant transactions are subject to interchange-plus pricing.

Another major part of the Fed’s Durbin rule takes effect April 1, that being the ban on transaction-routing restrictions for merchants. Durbin bars exclusive network deals between issuers and debit card networks, such as Visa Inc. for signature debit and the Visa-owned Interlink network for point-of-sale PIN debit. Each card must now offer at least one unaffiliated network, and issuers or networks can’t restrict merchants’ routing choices. Visa and Interlink dominate U.S. debit, but EFT networks such as Star, NYCE, Pulse, and others are expecting a windfall of business as issuers scramble to add another mark to their cards because of Durbin.

By recruiting about 20 new issuers, Star “has been pretty successful” in what Winborne called the first phase of the network-exclusivity rules, adding its mark to more debit cards. But whether the contracts actually produce more Star transactions won’t be known for months because many merchants will soon have multiple routing choices even if the customer presents a card with Star’s mark, according to Winborne. “We’re all sitting here waiting to see what that’s going to be,” he said. “Lots of the merchants are really looking at their options … there is still a lot to play out yet.”

While Durbin is still producing a high level of uncertainty in the acquiring industry, First Data does foresee a long-term lift from the coming of mobile and contactless card payments. Visa last year and now MasterCard Inc. this week announced plans to migrate to the so-called EMV chip in the U.S. to replace the magnetic-stripe card system. EMV would give a big boost to contactless cards and mobile phones enabled for tap-and-go payments.

The need for chip-accepting terminals, most if not all presumably offering near-field communication (NFC) technology, represents a major opportunity for First Data since the company services about 4 million POS locations. But, according to Ed Labry, head of First Data’s Retail and Alliance Services merchant unit, a “terminal refresh” could take three years once it gets started. “This is something that’s not just going to happen overnight,” he said.

Merchant resistance could slow this conversion because NFC has capabilities that go beyond payments to encompass loyalty and other applications and thus adds cost. An NFC peripheral that plugs into a small merchant’s terminal might cost only $50, but a new terminal for a bigger, more specialized merchant might cost $300 or $400. First Data executives did not discuss the company’s results from its participation in Google Inc.’s new, NFC-based Google Wallet for smart phones, which launched commercially in September.

Revenues in Retail and Alliance Services grew 6% to $925.5 million in the fourth quarter over the year-earlier period with revenue per transaction up 5% and total transactions up 7.6%. Revenues in First Data’s card-issuing Financial Services segment slipped 1.1% to $353.6 million, but debit card issuer transactions posted a 6% increase. Revenues in the international segment were flat at $441.5 million.

First Data reported an overall loss of $69.3 million for the quarter, an improvement from the $179.2 million loss in 2010’s fourth quarter. The heavily leveraged company reported an operating profit of $329.8 million in 2011’s fourth quarter, a 107% improvement from a year earlier, but paid $461.8 million in interest.