Reduced Speed Ahead

It’s been a great run for credit cards—eight straight years of volume growth after a nasty reversal in the Great Recession. But what are the implications for acquirers’ bottom lines when this long growth spurt ends?

Credit card issuers take delight when their cardholders spend freely, pay their bills on time, and, best of all, revolve balances that generate profitable interest income. And delightful it’s been for issuers ever since the Great Recession ended: eight straight years of volume increases accompanied by tolerable losses.

Merchant acquirers have gone along for the ride. After all, every time a consumer pulls out a credit card to pay for something in a store or uses a credit account for an online or mobile purchase, a merchant acquirer somewhere processes a revenue-generating transaction.

While debit card purchase transactions now vastly exceed credit purchases, what’s great about credit for acquirers is that its overall margins are higher than debit’s.

Part of that comes from the much higher average ticket—$89.19 for Mastercard Inc.’s U.S. credit purchases in 2017’s fourth quarter versus $39.18 for debit. Visa Inc.’s equivalents were $80.68 and $38.13. That leaves more meat on the bone, so to speak, for acquirers to claim via fees.

Also contributing are price competition and the vagaries of payment-industry economics. “Debit processing is a more competitive business than credit processing,” Himanshu Patel, chief financial officer at Atlanta-based First Data Corp., said on the company’s Feb. 12 fourth-quarter earnings call.

Changing the Game

The lending industry hit a milestone in November when consumer revolving credit finally surpassed, ever so slightly, its April 2008 peak of $1.02 trillion in receivables just as the Great Recession was getting under way, according to the Federal Reserve. As the recession wore on, consumers shed $188 billion in revolving debt before bottoming out in April 2011.

Credit card balances—which stood at $834 billion in 2017’s fourth quarter, up 7% in a year, the Federal Reserve Bank of New York reports—account for the great majority of revolving debt. The rest consists of personal revolving lines and related forms of credit.

In a rare contraction, credit volumes on all four of the leading U.S. general-purpose card networks—Visa, Mastercard, American Express, and Discover—collectively plunged 13% in 2009. After a small recovery in 2010, credit card volumes jumped 9.5% in 2011 and since then have grown in the 8%-to-9% range annually.

Several factors contributed to the revival in credit cards’ fortunes. A great purge of delinquent borrowers, who had pushed chargeoffs up to nearly 12% of receivables in 2009 and 2010, according to Fitch Ratings, cleaned up issuers’ balance sheets and enabled them to concentrate on customers with better credit scores and potential for higher spending.

By contrast, general-purpose card chargeoffs were running at just over 3% of receivables in the third quarter, according to Fitch, a New York City-based securities-rating firm.

The strong credit trends have led to loan growth for issuers and a steadily increasing flow of transactions for acquirers.

“We’ve been in an extremely benign credit environment the last five, six years,” says Michael Taiano, director of non-bank financial institutions at Fitch.

Surprisingly enough, a second factor spurring credit’s growth is regulation. Despite consumers’ warm embrace of debit cards, issuers, especially big ones, have pumped out credit cards with attractive loyalty programs and perks in the wake of the Dodd-Frank Act’s Durbin Amendment, which took effect in 2011.

As implemented through the Federal Reserve’s Regulation II, the amendment cut debit card interchange revenues in half for bank and credit-union issuers with more than $10 billion in assets, but left credit card interchange alone.

“The incentive [for] banks, especially the larger ones, to push debit has gone down considerably,” says Taiano.

Even before Durbin, Congress created an incentive for issuers to pursue more affluent, big-spending credit card users with the Credit Card Accountability Responsibility and Disclosure (CARD) Act of 2009. That law limited issuers’ ability to quickly re-price credit card accounts. The result was that the high-profit but high-risk subprime market suddenly looked less attractive to many issuers.

“That really changed the game from being able to originate subprime,” says Taiano. “You used to be able to re-price those accounts fairly easily.” The law forced issuers “to be more disciplined” in granting credit, he adds.

Credit Crunch

But subtle signs are now appearing that credit card growth rates could slow, and in turn affect merchant acquirers’ bottom lines.

One is the economic recovery that started when the Great Recession ended in June 2009 is going on 9 years old, making it one of the longest expansions in recent history. Some teeth-clenching, volatile February days in the stock market reminded everyone that business cycles haven’t been repealed.

To be sure, the aging expansion may have gained a new lease on life in December when President Trump signed the Tax Cuts and Jobs Act. The law permanently cut corporate tax rates, resulting in a flurry of announcements about one-time bonuses, enhanced retirement programs, or other good news for consumers, who are getting temporary tax cuts.

“People have money in their pockets,” says Thomas McCrohan, managing director, Americas Research, at New York City-based investment firm Mizuho Americas. “That all is a positive for consumer sentiment.”

But another cautionary sign for the credit card industry is an uptick in losses. Fitch data show chargeoffs for general-purpose issuers were up 46 basis points (0.46 percentage points) in the third quarter from a year earlier, though losses remain far below levels seen in the recession.

Delinquencies hit a five-year high for retail credit cards, however, and purchase-volume growth on cards issued by retail credit specialists such as Alliance Data Systems and Synchrony Financial slowed, Fitch said in a report. That slowdown undoubtedly is linked at least in part to the struggles many brick-and-mortar stores are having competing with online retailers.

Still another sign is consumers’ increasing preference for debit, which could mean lower margins ahead for acquirers. Some 61% of 800 consumers surveyed in the fourth quarter by New York City-based Auriemma Consulting Group cited a debit card as their most frequently used card, up from 52% a year earlier. Only 24% named a credit card, down from 35% at the end of 2016.

“Based on our consumer self-reported research, we have already begun to see [year-over-year] increases in debit card preference and spend over the past two years, as well as a growing proportion of consumers who are primarily using debit cards for online purchases,” Jaclyn Holmes, Payment Insights director at Auriemma, says by email.

Indeed, credit cards dominated e-commerce from its earliest days, but other payment forms are taking share from credit as alternatives come on the scene and consumers’ attitudes toward the safety of e-commerce become more accepting.

Auriemma’s survey found 50% of respondents used a debit card for online purchases compared with only 35% using credit in 2017’s fourth quarter. Two years earlier, 51% of respondents favored credit cards and only 34% debit. According to Auriemma, the change could be a sign that consumer trust in online commerce is rising.

‘Muted Impact’

So, what’s ahead for acquirers’ bottom lines if the post-recession growth spurt finally sputters, credit card losses rise, and consumers become less willing to use credit? Veteran industry observers say the sky’s not about to fall, but point to some caution signs.

Gil Luria, director of research at D.A. Davidson & Co. in Portland, Ore., predicts any credit card contraction would likely put only a mild damper on acquirers’ financials.

“Networks, acquirers, and processors proved quite resilient during the last downturn, and I would expect them to weather the storm relatively well in the next downturn as well,” Luria says by email. “While transactions may move from credit to debit, the overall reduction will likely be measured. Debit transactions may be less profitable than credit, but that would be a relatively muted impact compared to credit card issuers that will have to absorb credit losses.”

An “extreme slowdown with issuer failures,” however, could put both acquirers and card networks “at risk of counter-party default,” Luria adds. “This set of circumstances nearly happened during the 2008 meltdown and could happen this time.”

Dave Lott, payment-risk expert at the Federal Reserve Bank of Atlanta’s Retail Payments Risk Forum, says by email that “any decline in [credit card] usage will impact acquirers’ revenue since their transaction revenue will decline due to processing fewer transactions. But keep in mind there is often an inverse relationship between debit and credit card usage. In leaner times, cardholders will often shift from credit to debit.

“For an acquirer, generally a transaction is a transaction so there isn’t much difference in whether they are processing a credit or debit transaction,” he continues. “But clearly, fewer transactions or even lower average ticket amount will impact the revenue of an acquirer; just as it will impact the revenue flowing to the card issuer.”

For now, acquirers may need to be aware that growth in credit card transactions isn’t as certain as it was five years ago. But Mizuho’s McCrohan notes that both credit and debit cards still enjoy the tailwind of the conversion of cash payments to electronic forms. The tailwind isn’t as strong as it was in the 1990s, but it’s still in the neighborhood of 3% to 5% above the change in personal consumption expenditures, he says.

“I still see decent growth in the context of slowing volumes,” he says. “We’re not talking about a recession scenario.”