Business Impact of the Dodd-Frank Debit Fee Cap

Transcription

1 Bloomberg Government Study» Business Impact of the Dodd-Frank Debit Fee Cap» BY CADY NORTH Senior Finance Policy Analyst Editor LISA GETTER Finance Analyst Team Leader NOVEMBER 18, 2011 To contact the author, Copyright 2011, Bloomberg L.P.»

2 TABLE OF CONTENTS Section Page Executive Summary... 3 Introduction... 4 Section 1: Timeline... 5 Section 2: Projecting Costs to Banking Industry... 6 Section 3: Banks' Mitigation Efforts... 9 Market Share... 9 Strategies Section4: The Networks' Reaction Section 5: Impact of Cap on Merchant Costs Merchants Pay More for Low-Dollar Transactions Under Fee Cap Section 6: Comparing Card Usage by Payment Type Driving Payments To Credit Cards Conclusion About the Analyst Appendix 1: Details on Bank Mitigation Plans Appendix 2: Comments by Payment Networks and Retailers Appendix 3: Glossary of Terms Appendix 4: Assumptions and Methodology Endnotes BGOV Study» Debit Fee Cap

3 EXECUTIVE SUMMARY The Federal Reserve s debit interchange fee cap, which went into effect on Oct. 1, may cost the banking industry $8 billion annually. The top 10 U.S. banks say they intend to recoup about 50 percent of that lost revenue by driving customers to new products, growing their customer bases and removing reward programs. They may also add new fees, though most of the large banks have discarded plans to charge for debit card usage. This Bloomberg Government Study explores how the fee cap, which was mandated under the Dodd-Frank Act, affects revenue for banks, merchants and payment networks. U.S. Senator Richard Durbin, an Illinois Democrat, first proposed the cap in part to limit the fees charged by Visa and MasterCard. This study finds, however, that they may be among the rule s beneficiaries. The study also finds that companies that own convenience stores, which supported the cap, may be unintended losers. These merchants will pay more for purchases less than $20, a large part of their business. Other findings: Commercial banks are affected more directly by the rules than savings institutions and credit unions, which process only one quarter of all debit payments. The Fed estimates that 601 individual banks, thrifts and savings institutions must comply. Debit cards, which increased as a choice of payment from 2003 to 2009, may decline in popularity. Networks, such as American Express Co. and Discover Financial Services, are altering their interchange fee schedules and renegotiating contracts with banks, seeing potential revenue opportunities. Grocery, home improvement and clothing stores have an incentive to create a $20 minimum purchase requirement for debit transactions. Companies, such as convenience stores, coffee shops and lunch counters that sell low-dollar items, may have an incentive to add fees or encourage customers to use another form of payment besides debit cards. Already, Redbox has announced it is adding 20 cents to its $1 daily DVD rental fee to make up the increase in debit card charges. 3 BGOV Study» Debit Fee Cap

4 INTRODUCTION On June 29, 2011, the Federal Reserve released final rules for capping debit interchange fees at 21 cents per transaction. Banks are allowed to charge an additional.05 percent of the purchase amount to cover potential fraud losses. The rules also impose restrictions on payment routing and network exclusivity. 1 The Fed s final rule saved the banking industry approximately $4 billion since it increased the 12-cent cap proposed on Dec. 16, 2010, according to data compiled by Bloomberg Government. 2 The rules were required by Section 1075 of the Dodd-Frank law. Companies such as Bank of America Corp. and Wells Fargo & Co. announced in September they planned to charge fees for the use of debit cards and then abandoned the idea after an outcry from customers. Still, banks say they plan to offset the loss of revenue by encouraging customers to use credit cards, pay for more than one product or maintain certain 3 balances. Banks are also eliminating rewards programs. Merchants such as Kroger Co. and Safeway Inc. are still estimating what the rule will do to their revenue, though they are likely to see a cost savings. The payment networks, including Visa Inc. and MasterCard Inc., have had to adjust their interchange fee schedules for both banks and merchants. Since this regulation changes specific pricing structures of debit fees, the direct impact can be quantified for each market participant. This contrasts with other Dodd-Frank rules, in which compliance costs are often the only direct cost that can be estimated. 4 BGOV Study» Debit Fee Cap

5 SECTION 1: TIMELINE Date May 13, 2010 July 21, 2010 Dec. 16, 2010 April 5, 2011 June 8, 2011 June 29, 2011 July 12, 2011 Oct. 1, 2011 Apr. 1, 2012 Event Senator Richard Durbin introduces an amendment to the financial regulatory overhaul requiring the Fed to ensure that interchange fees are reasonable and proportional to the costs issuers incur. The Senate adopted the amendment by a vote of as a part of what would become the Dodd-Frank Act. The Dodd-Frank Act is signed into law. Fed releases draft rules capping debit interchange fees at 12 cents per transaction and receives more than 11,000 comment letters during the open comment period. The Fed releases its updated 2010 Payments Study, analyzing electronic payment volumes including debit, credit and prepaid cards. A measure to delay the debit interchange rules by six month is rejected by the U.S. Senate by a vote of The Fed releases final rules capping debit interchanges fees at 21 cents per transaction with a five basis point allowance based on the purchase price for fraud loss, and extended the effective date from the July 21 deadline mandated in Dodd-Frank to Oct. 1, The Fed releases a list of the institutions with $10 billion or more in assets subject to the debit interchange cap. The debit fee cap goes into effect. The network exclusivity provision goes into effect. 5 BGOV Study» Debit Fee Cap

6 SECTION 2: PROJECTING COSTS TO BANKING INDUSTRY Total debit interchange fee revenue was about $16 billion in 2009, based on the average interchange fee of 1.15 percent per transaction, 4 according to Fed data. Since the new interchange rules created a fee cap for each transaction, Bloomberg Government used data from the Fed on the total number of transactions to estimate that banks would lose about $8 billion annually, or half of this $16 billion revenue source. The calculations are shown below. Table 1: Annual Revenue Loss for Banks Revenue Loss Projections for Banks Based on 2009 Data 5 Total value of debit transactions Number of debit transactions $1,420.6 billion 37.9 billion Interchange revenue under old rules (1.15% x $1,420.6 = $16.34) $16.3 billion Interchange revenue under new rules ($.21 x 37.9 = $7.96) $8.0 billion Fraud loss adjustment under new rules (.05% x $1,420.6 = $.71) $0.7 billion Total loss of revenue ($ = $7.67) $7.7 billion Source: Federal Reserve. This revenue loss will increase each year depending on the growth of debit as a payment method. In this section, Bloomberg Government uses historical data to project future costs to the banking industry. The Fed measures the number of debit card transactions for 2003 through 2009 in its payment study published every three years. Using these figures, Bloomberg Government calculated the compound annual growth rate, or CAGR, and used it to estimate growth in the number and value of future debit transactions. These projections are in Table 2. The estimates in Table 3 do not assume any change in how customers use payment cards, though debit cards may decline in popularity. The actual cost to the banking industry could be higher or lower, based on the use of debit versus credit cards as a payment method and the success of mitigation techniques discussed in Appendix 1. 6 BGOV Study» Debit Fee Cap

7 Table 2: Compound Annual Growth Rate of Debit Card Usage CAGR Total value of debit transactions ($ billions) $600 $1,000 $1, % Total number of debit transactions (billions) % Source: Federal Reserve. Table 3: Revenue Loss Projections for Banks Through A. Total value of debit transactions (expected to increase 15.45% per year) $1,640 $1,893 $2,186 $2,524 $2,914 $3,364 B. Number of debit transactions (expected to increase 15.95% per year) C. Interchange revenue under old rules (using average of 1.15% of transaction value) $19 $22 $25 $29 $34 $39 D. Interchange revenue under new rules (21-cent per transaction cap) $9 $11 $12 $14 $17 $19 E. Revenue from fraud loss adjustment (.05% of transaction value) $1 $1 $1 $1 $1 $2 Loss of revenue post Dodd- Frank (C minus (D plus E)) $9 $10 $12 $14 $16 $18 Note: All figures are estimated projections in billions, actual figures not yet reported. Numbers may not add due to rounding. Source: Bloomberg Government. Before Dodd-Frank, banks took in about $16 billion in annual debit interchange revenues. Table 3 projects banks would not surpass this annual revenue figure until 2014, assuming that the growth rate of debit card usage follows historical patterns. 7 BGOV Study» Debit Fee Cap

8 Chart 1: Debit Card Processing Explained 8 BGOV Study» Debit Fee Cap

9 SECTION 3: BANKS' MITIGATION EFFORTS Most large banks have said at recent investor conferences that they will stop offering free checking or debit rewards programs and may restructure product offerings to recoup revenue losses. The largest banks say they plan to mitigate at least 50 percent of the revenue impact within the next one to two years. Bank of America joined several other major banks on Sept. 29 in announcing new customer fees for using debit cards. Barely a month later, on Nov. 1, the bank abandoned its plan to charge a $5 monthly fee for debit cards. Lenders will find more subtle ways to make up for this lost revenue, increases that may fly under the radar, said Bill Hardekopf, chief executive officer of Birmingham, Alabamabased research firm LowCards.com. 8 These methods may include encouraging the use of multiple bank products, requiring minimum balances, removing reward programs or encouraging the use of more profitable products. Market Share The Fed rule applies to banks, savings and loan companies, thrifts and credit unions with assets of $10 billion or more, a list that includes 601 companies, according to the Fed. 9 There are 14,821 institutions that do not have to comply, according to the Fed. 10 Commercial banks are affected more directly than savings institutions and credit unions, which together process less than one quarter of all debit payments. Chart 2: Debit Payments Processed by Type of Issuing Bank 11 Savings Institutions 6% Credit Unions 18% Commercial Banks 76% Source: Federal Reserve. 9 BGOV Study» Debit Fee Cap

10 Strategies Bloomberg Government looked at the top 10 banks, ranked by debit purchase volume, 12 evaluating the potential revenue impacts and loss mitigation strategies for each based on public statements the companies made at recent investor conferences. See Appendix 1 for an accounting of what the companies have told investors. Table 4: How Much the Banks Expect to Mitigate Top 10 Bank Holding Companies By Interchange Fee Income Company Annual Impact Planned Mitigation Mitigation Strategy 13 Bank of America 14 $1.9 billion in revenue Make it up in through account conversions Grow usage, new fee structure Wells Fargo 15 $1 billion in earnings "at least half" Grow usage, new fee structure JPMorgan Chase 16 $1 billion in revenue "looking at products and services" Eliminate rewards, new fee structure, growth in credit cards U.S. Bancorp 17 $300 million in revenue "30 to 50 percent" Eliminate rewards, require minimum deposits or transactions PNC Financial 18 $250 million in revenue "non-interest income should increase in 2012 despite further regulatory impacts on debit card fees" Grow customer base, shift to credit cards Regions Financial 19 $170 million in revenue "make up this revenue shortfall over time during the balance of 2012 Eliminate free checking, new fees SunTrust 20 $180-$200 million in revenue "about 50 percent" Eliminate rewards, new fees TD Bank 21 $ million in revenue "two years to recover most of the cost" Focus on growth, new products and fees Citigroup Between $89 and $185 million 22 none Insignificant impact, focus on credit 23 Fifth Third Bancorp 24 $120 million in revenue "roughly two-thirds" Eliminate rewards, reduce costs 10 BGOV Study» Debit Fee Cap

11 SECTION 4: THE NETWORKS' REACTION The Dodd-Frank provision most affecting the card companies such as Visa and Mastercard is the network exclusivity requirement. It mandates that banks process debit transactions over at least two unaffiliated networks, allowing some of that business to flow to other networks for the first time. This provision becomes effective on April 1, 2012, and applies to all banking institutions. It has the potential to affect the payment networks revenue more than the fee cap. The debit cap directly affects banks and merchants revenue streams. Networks such as Visa and Mastercard set their own debit interchange rates and must comply with the rule by creating two separate fee structures: one for banks with $10 billion or more in assets and one for banks with less than $10 billion in assets. 25 Networks charge merchants and banks for the cost of processing payments, a cost not capped under Dodd-Frank. Even though the fee cap doesn't directly affect payment networks' revenue streams, Mastercard s stock price was down 10.3 percent and Visa s dropped 12.7 percent on Dec. 16, 2010, the day after the Fed released an earlier version of the rule. The market may have been concerned about banks renegotiating contracts with the payment network or further regulation of credit and debit cards. Discover says that the rules may increase revenue, especially if more banks offer Discover's Pulse Network on their debit cards. American Express said that the regulation will create incentives to use credit cards or prepaid cards over debit, providing new revenue because the company does not have a debit card business. Visa has 61 percent of market share by debit transaction volume, according to a previous analysis by Bloomberg Government. 26 Since this payment network dominates the debit marketplace, its revenue may decrease as a result of network exclusivity provisions. Visa and MasterCard are making changes to their fee structures to attract merchant customers. Appendix 2 shows a summary of what network company executives have told investors about the impact of the debit card rules. 11 BGOV Study» Debit Fee Cap

12 SECTION 5: IMPACT OF CAP ON MERCHANT COSTS Merchants Pay More for Low-Dollar Transactions Under Fee Cap The Fed's fee cap will also change merchant behavior. For instance, Visa announced that all purchases, regardless of the transaction amount, will carry a 21-cent fee with a.05 percent charge for fraud loss. 27 However, Joseph W. Saunders, CEO for Visa, indicated in an Oct. 26, 2011, fourthquarter 2011 earnings call that there may be changes made to this policy. "There were a series of events that occurred, and the end result is that smallticket prices from both associations were raised to the cap of the Durbin legislation. And I'm not sure that - I'm not ready to comment on whether that is absolutely the right thing to do or not. What I will say is that we're pretty confident that there is an answer somewhere on the continuum that will benefit both financial institutions, consumers, and merchants, and of course we will endeavor to be a part of getting to the right solution, and over a reasonably short period of time." 28 In most cases, debit cards will be more profitable for merchants after the implementation of the interchange fee cap. For now, purchases under $20 may cost merchants more than before Dodd-Frank was implemented, according to data compiled by Bloomberg Government. See Table 5 for more information. Table 5: Debit Fee Charged to Merchants by Purchase Price 29 $ $ $38.00 $20.00 $5.00 Average fee before Dodd-Frank (1.15% of purchase price) $2.88 $1.15 $0.44 $0.23 $0.06 Fee capped by Dodd-Frank $0.21 $0.21 $0.21 $0.21 $0.21 Fraud loss allowance (.05% of purchase price) $0.13 $0.05 $0.02 $0.01 $0.00 Merchants savings (costs) $2.54 $0.89 $0.21 $0.01 ($0.16) The average purchase price for all debit transactions is $38, according to Fed data. About 20 percent of all debit-card purchases are for small-ticket items, according to Brian Riley, senior research director at TowerGroup, a Boston-based research and advisory firm. 30 Merchants may steer customers to lower-cost debit cards as a method of payment or they may require customers to have a minimum purchase if they re using credit or debit cards. Before Dodd-Frank, networks could penalize merchants for such activity. 12 BGOV Study» Debit Fee Cap

13 This authority provided to merchants in Dodd-Frank will help them mitigate the potential costs of accepting debit cards for smaller purchases. However, companies that offer only lowdollar products, such as lunch counters, coffee shops, convenience stores and DVD rental companies such as Redbox, will be more affected than companies with high-value purchases. It will be more difficult for these types of stores to mitigate the increased costs of accepting debit cards, though Redbox already raised its price for DVD daily rentals to $1.20, citing rising operational costs, including increased debit card fees. 31 Other stores might instead offer incentives for the use of cash. Merchants say it's too early to tell the exact impact on their business. Only a few retail companies mentioned the debit fee cap at recent investor presentations. The summary of those comments is found in Appendix 2. Some of the largest retailers that lobbied 32 on behalf of the Durbin amendment, such as Wal-Mart Stores Inc., Target Corp., and the Home Depot Inc., have not made statements at investor conferences about potential savings post-dodd-frank. 13 BGOV Study» Debit Fee Cap

14 SECTION 6: COMPARING CARD USAGE BY PAYMENT TYPE Projections suggest that debit usage will increase. Estimating the actual growth rate is difficult due to economic conditions and the behavioral outcome of what will happen when merchants, network and banks either encourage or discourage customers from using debit. The Fed's payment study included information about the number of transaction for several payment types, including debit, credit, prepaid, and ATM cards. In 2006, debit transactions made up 45 percent of 55.8 billion electronic card payments. In 2009, debit usage increased to 53 percent based on the 71.5 billion electronic transactions that cleared. Prepaid card transactions also increased, while the share of credit and ATM payments decreased. Chart 3: Number of Card Transactions by Payment Type Prepaid 6% ATM 10% Prepaid 9% ATM 8% Credit 39% 55.8 Billion Debit 45% Credit 30% 71.5 billion Debit 53% Source: Federal Reserve. "The decline in credit card spending likely reflects the economic recession and may not represent permanent changes in payments preferences of consumers and businesses," said the Fed in its 2010 Payment Study. 34 The U.S. experienced a decline in outstanding revolving credit from 2009 through the first quarter of 2011, Fed consumer credit statistics show. From April to June 2011, revolving credit increased 1.5 percent, but in the third quarter, the U.S. experienced a 3.2 percent decline, according to Fed data. See Table 6 for more information. 35 Table 6: Percent Change in Revolving Consumer Credit Outstanding Q Q Q3 Percent increase (decrease) (9.6) (7.5) (3.7) 1.5 (3.2) 14 BGOV Study» Debit Fee Cap

15 Driving Payments to Credit Cards Some companies such as Capital One Financial Corp. said there may be a shift in payments away from debit and toward credit. Capital One's Chief Financial Officer, Gary Perlin, noted at a May 24, 2011, investor presentation this may be a business opportunity for them because their interchange income comes mostly from credit instead of debit-cards. "You know, there are some beliefs that folks will start to gravitate more towards credit, where the reward proposition remains strong. We believe that the credit card business continues to offer merchants, consumers and issuers all a sort of a mutual interest: consumers getting rewards, merchants getting the ability to have safe transactions and for issuers, able to amply cover the costs of providing the product. And we believe that the credit card proposition may well, simply by retaining its attractiveness, become relatively more attractive than debit." The next payment study conducted by the Fed may show an increase in payments by credit card, depending on economic conditions, and how well banks' economic incentives work to steer payments to credit and away from debit. The reverse is true for merchants, as their incentive is to steer customers toward the use of debit, especially for purchases over $20. While these factors may contribute to significant changes in revenue for banks or savings for merchants, this study does not attempt to forecast potential changes in payment usage based on these unknown variables. 15 BGOV Study» Debit Fee Cap

16 CONCLUSION The debit fee price caps are having a direct and measurable impact on banks, credit card networks and retail establishments. Even though retailers and their trade groups were active during the Dodd-Frank debate in pushing for the fee cap, large retailers are not publicly projecting revenue increases at this time. Instead, they are waiting to see how the change affects them. Another reason may be that they intend to pass along the cost savings to their customers, resulting in a revenue neutral outcome for the companies and their shareholders. What is certain is that merchants will have more authority to steer customers toward payment methods, including offering incentives to use cash over cards. This may help firms mitigate the ultimate higher cost of low-dollar debit card transactions under $20. The smallest retailers such as convenience stores or coffee shops may have the most difficulty since they offer only low-dollar goods. By adopting revenue mitigation techniques, banks will be able to recoup some, if not all, of the revenue lost due to the fee cap. They face a public outcry and congressional criticism for doing so, which might draw more official scrutiny of the fees they are charging customers as a result of the Dodd-Frank law. The card networks see revenue opportunities. Congress and regulators have not paid much attention to their plans to develop revenue streams unrelated to debit, or to take advantage of the network exclusivity provision. It requires banks to carry multiple networks on one card as well as allowing merchants to choose where payments are routed. The ultimate outcome could mean a very different landscape for electronic payments in the U.S. Though debit card transactions were on the rise during the past seven years, that trend could reverse direction. Additional regulation through the Consumer Financial Protection Bureau may also bring additional oversight to credit card payments, making it even more difficult to predict the mix of payments in the future.» ABOUT THE ANALYST Cady North is a finance policy analyst with Bloomberg Government. She joined Bloomberg from Financial Executives International, where she was senior manager of government affairs. She has a B.A. in government from the University of Texas at Austin. 16 BGOV Study» Debit Fee Cap

17 APPENDIX 1: DETAILS ON BANK MITIGATION PLANS 37 Company Date Quote Bank of America 7/19/2011, Q Earnings Call Brian Moynihan, CEO: "So how are we mitigating the activity? If you look, what we've been doing as the new account structure has now been rolled out in three states for new accounts, and then now for all accounts and converting the accounts. That is all going very well, so we'd expect that conversion to take place during And what that does is institute some monthly fees and other ways customers can pay us away from overdrafts or frankly the value of the interchange on Durbin. And so the pricing structure is set and will be set to generate the activity. The good news, reasonably good news is that where we ended up in Durbin is a place where we can continue to drive debit usage." Wells Fargo 11/3/2011, BancAnalysts Association of Boston Conference Timothy Sloan, CFO: "So we think that there is going to be more benefit... to us, from a convenience standpoint, but it's clear consumers are saying they don't want to pay higher fees, and so we're definitely thinking about how we're going to structure our products, how we're going to price our products, and we're going to continue to go through that. We don't have any - there's no question in our mind that in our consumer businesses we could continue to grow revenues even in this environment." JPMorgan Chase 11/4/2011, BancAnalysts Association of Boston Conference Gordon Smith, CEO, Card Services: "In terms of Durbin, we've articulated about $1 billion worth of impact on a pre-tax basis for the company. We expect that and we'll see if we start to see growth come additional growth from credit card as customers move to capture the rewards. So we'll - I haven't enough data, enough time to see what'll really happened there, but I think we'll see how customers react to that. U.S. Bancorp 11/4/2011, BancAnalysts Association of Boston Conference PNC 10/19/2011, Q Earnings Call Andrew Cecere, CFO: "And importantly as you look at our fourth quarter will be the first quarter that we have the impact of the Durbin Amendment, which will take out about $75 million out of fees or about $0.03. So that will impact us for the first time in quarter four; we've talked about that as a $300 million annual run rate. And as we've talked about, we expect over time to mitigate between 30% and 50% of that negative impact: the $1 billion to $1.1 billion, and that will migrate over time, some of it's already in the run rate, we'll continue to see some build as we move forward in 2012.". James Rohr, CEO: "And so, I know a lot of people want to look at Durbin, but we look at it from the point of view of how do we reprice the consumer relationship in order to get the appropriate return on the business, and that's why we still have a free checking product, we've got three relationship products, and now we have 70% of our customers buying relationship products, and so it's someone might say, well, it's because of Durbin, but Durbin is only a part of the revenue-expense relationship with the consumer. So I think the consumer pricing model will that will 17 BGOV Study» Debit Fee Cap

18 Company Date Quote just evolve over the next few years, and consumers will either purchase their products they want to purchase for different kinds of fees or balance requirements or not, or they'll change their behavior." Regions Financial 11/3/2011, BancAnalysts Association of Boston, Inc. Conference David J. Turner Jr., CFO: "We've already begun mitigating a loss interchange income through account changes, implementation of fees and new products and services. Between changes to our checking account fee structure and other revenue initiatives that we have implemented in the second half of this year, we expect to make up the revenue from Durbin over time. It is our job to help our customers understand the value they receive from having a checking relationship with Regions. SunTrust 7/22/2011, Q Earnings Call TD Bank 9/14/2011, Barclays Capital Global Financial Services Conference Citibank 1/18/2011, Q Earnings Call William Rogers, CEO: "For example, we recently eliminated our debit rewards program and I told you about the current roll out of our new checking product set. We also have other value added checking features that we plan to introduce later which we believe will be beneficial to our clients, as well as enhance our deposit fee income. So collectively, and over time, we currently estimate that the benefits from all these changes will enable us to recapture around 50% of the revenue loss from both Durbin and Reg E. Bharat Masrani, President and CEO: "So we feel comfortable that we have the right strategies, we are able to re-price given our own offerings given what's going on in the marketplace. And that's not impacting anything from a negative perspective. So I feel comfortable that within two years we'll mitigate the headwind on Durbin." John Gerspach, CFO: "You know, we don't have much of an impact on debit card interchange or, you know, overdraft fees. Those are really small impacts on us." Fifth Third Bancorp 10/20/2011, Q Earnings Call Daniel T. Poston, CFO: "We are being very deliberate in our actions with respect to this change. We have a multi-pronged mitigation approach that would include such actions as reducing the costs associated with debt card offerings, changes and eliminations to rewards, selected fees, incorporation of debt usage into bundled deposit product offerings, as well as the implementation of new products, like the DUO Card we introduced during this quarter. This mitigation will take place over time and may show up in processing fees, deposit service charges, higher deposit balances, and lower expenses rather than in a single line item. We've said that we expect to mitigate roughly two-thirds of the impact of this change by the middle of next year and ultimately most if not all of it. That continues to be our expectation." 18 BGOV Study» Debit Fee Cap

19 APPENDIX 2: COMMENTS BY PAYMENT NETWORKS AND RETAILERS ON DEBIT CAP IMPACTS 38 Company Date of Presentation Impact Card Networks' Quotes American Express 10/19/2011, Q Earnings Call Revenue Opportunities Daniel Henry, CFO: "We issued a new prepaid product that if you acquire that prepaid product online, there are no fees to acquire it and no fees over time. So if people move in that direction, we have a product that is available. To the extent that banks push customers more towards credit, we think that that would be an opportunity for us to grow our business as well. So we have to wait and see how this all plays out, but it could well be that this turns into more of an opportunity than a risk at the end of the day, although the whole script hasn't been written." Visa 10/26/2011, Q Earnings Call MasterCard 11/2/2011, Q Earnings Call Change Pricing Structure Revenue Opportunities Joseph W. Saunders, CEO: "Our first set of activities focuses on winning merchant preference. As a reminder, U.S. debit revenue impacted by the regulation contributes approximately 20% of Visa's total revenue today. Of that, Signature Debit contributes more than 75% of the U.S. debit revenue, and we are confident in our ability to retain the overwhelming majority of that as we move forward in the newly regulated environment. However, to address the pockets of debit revenue at risk as a result of the regulation, particularly revenues related to PIN debit, we are moving forward quickly with a program to incent routing decisions. In fact, between the start of the fourth quarter and today, Visa completed dozens of merchant deals and executed contracts with a handful of our largest acquirers". Ajay Banga, CEO: " We are focused on four objectives within our U.S. debit business: first, to retain our existing placement on the minority of our debit portfolios that are exclusive MasterCard debit portfolios. It's important to remember most MasterCard debit portfolios are already Durbin rule compliant; second, to get Maestro as the PIN debit brand on the back of competitive debit cards; third, to continue to convert competitive portfolios to MasterCard, as we have done with SunTrust, Sovereign, and the recently announced Huntington Bank; fourth, to win routing preference with selected merchants and acquirers." 19 BGOV Study» Debit Fee Cap

20 Company Date of Presentation Impact Card Networks' Quotes Discover 11/08/2011, CLSA Asia USA Forum Conference Revenue Opportunities Craig Streem, Investor Relations: "While it is too early still to tell what the ultimate impact of the share movement will be in PIN debit as a result of the Durbin Amendment, we do feel relatively good about PULSE's competitive position. We feel very good about that, as well as about our ability to continue to gain share. Company Date Retailers' Quotes 39 Walgreens Safeway Kroger 6/21/2011, Q Earnings Call 7/21/2011, Q Earnings Call 6/16/2011, Q Earnings Call Gregory D. Wasson, CEO: "And on the regulatory front, we are pleased that the Senate took action on debit card reform. While the substance of the Durbin Amendment to the Dodd-Frank financial reform bill is clear, both the timing and financial implications are still unknown and it's premature to speculate on any impact to our business." Robert L. Edwards, CFO: Regarding the Fed's decision to raise the debit cap, "Clearly we're disappointed by the ruling. But the rates that were set are the maximum rate sets and our fees are generally below that. So it hasn't actually been determined what the impact will be on the company." David B. Dillon, CEO: "Debit card fees, we have talked about credit card and debit card fees in the past. You know that overall fees have been challenging to the industry and us in particular. We view it as part of an expense of the business And as we find ways, even if it's the legislature that helps us, as we find ways to reduce our costs, it is our intention to take those cost saves and invest them in things that matter to the customer. So the answer is yes, we plan to pass that through in one form or another in ways that matter to the customer." 20 BGOV Study» Debit Fee Cap

21 APPENDIX 3: GLOSSARY OF TERMS This section provides descriptions of pertinent terminology in the Dodd-Frank law and the Fed's interchange fee cap regulations. 40 Acquirer The merchant's bank. This is the company that receives payment information from the pointof-sale purchase. The payment network then connects the merchant bank with the card issuer bank to move the payment from the customer to the merchant. Affiliate A company or business unit owned by a parent company. For instance, the Pulse Network is an affiliate of Discover Financial Services. Cardholder An individual with a bank account or credit line who uses a credit or debit card to access funds. Credit and Debit Interchange The fee charged merchants to process credit and debit card transactions, which ultimately serves as a source of fee income for the cardholder's bank, known as the issuer. Durbin Amendment Section 1075 of the Dodd-Frank law capping fees for debit card transactions. It was named for Senator Richard Durbin, a Democrat from Illinois, because he introduced the amendment adding the debit fee cap to the Dodd-Frank law. Four-Party System The payment-processing model used for most debit transactions. The payment flows through the following parties: Cardholder Issuer Acquirer Merchant. Fraud Loss Costs Losses incurred by the issuer, other than losses related to nonsufficient funds, that aren t recovered through chargebacks to merchants or debits to or collections from customers. A portion of these costs, up to 5 basis points, can be recovered under the Fed's regulations. Costs the bank incurs to identify and prevent fraudulent activity are recoverable under an additional one cent per transaction fee. Issuer The cardholder's bank. This is the company that authorizes the request for funds to transfer to the merchant's acquirer and is the bank that receives the interchange fee as revenue in exchange for authorizing and removing funds from the customers' account. 21 BGOV Study» Debit Fee Cap

22 Merchant The company accepting debit and credit cards as a form of payment for goods and services. Merchants must contract with payment networks to accept and process payments for a fee. Merchants also pay the interchange fee that is set by the payment network and provided as revenue to the issuer's bank. Network Exclusivity Debit-card issuers can limit card transactions to specific payment networks, even if a merchant would prefer to use a lower-cost network to process a sale. The new Fed rules require card issuers provide access to at least two unaffiliated payment networks (for instance, Visa and Discover) for processing sales. Payment Network The company that establishes and charges interchange fees for merchants. The merchant's bank the acquirer pays the fee established by the payment network to the issuer bank. Examples of payment networks are Visa, Mastercard and Discover Financial Services. Regulation II 41 The regulation title for the Fed's interchange fee cap rules that apply to banks with $10 billion or more in assets. Routing The new rules allow merchants to route payments over any network they choose. Small Bank Exemption The Fed's rules exempt banks with less than $10 billion in assets from the fee cap. These banks are allowed to accept interchange fee revenue per each transaction or based on the dollar amount of the transaction at any rate set by the network. Payment networks are developing two-tiered fee structures to service banks with $10 billion or more in assets and those with less than $10 billion. Transaction Costs Costs that issuers incur for data systems, computers, staff, fees and transaction monitoring when processing debit and credit card transactions. Under the Fed's rules, up to 21 cents of these costs of each transaction can be recovered through the interchange fee. 22 BGOV Study» Debit Fee Cap

23 APPENDIX 4: ASSUMPTIONS AND METHODOLOGY The $1.4 trillion in debit transaction value and the 37.9 billion in transactions in 2009 provided in the Fed's 2010 Payments Study represent figures for all issuers. The fee cap imposed by the Durbin Amendment only applies to banks with $10 billion or more in assets. As a result, Bloomberg Government's estimates for interchange revenue under the old rule ($16.3 billion) and the new rule ($8 billion) shown in Table 1 includes some interchange revenue for banks with less than $10 billion in assets, which will not be affected by the rule. Data suggest that the vast majority of debit interchange revenue is captured by banks with greater than $10 billion in assets. Utilizing data from Federal Reserve Y-9 reports, Bloomberg Government estimated that the top 10 bank holding companies by assets, the smallest of which had assets of $172 billion, captured 88% of debit interchange revenue in Thus, it is reasonable to assume that the remaining banks with $10 billion or more in assets would capture the vast majority of debit interchange revenue. Our estimates do not include revenue from cash-back purchases or prepaid cards. The average percentage debit interchange fee of 1.15 percent of purchase price under the rules prior to Dodd-Frank was provided by the Fed. Actual fees varied by purchase price and industry. The average percentage figure, rather than the average per -transaction fee of 44 cents, was used because, prior to the implementation of the fee cap card, networks calculated interchange fees on a percentage basis. 23 BGOV Study» Debit Fee Cap

24 ENDNOTES 1 Federal Reserve, Debit Card Interchange Fees and Routing, Final Rules, published in the Federal Register July 20, (retrieved Oct. 6, 2011). 2 The revenue loss from the original 12-cent cap proposed in December 2010 was approximately $12 billion. The final 21-cent fee cap will cost the industry $8 billion, saving the industry $4 billion. 3 Several of the largest banks reiterated their commitment to offsetting the revenue in recent investor presentations after they changed their policies on charging fees for debit cards. 4 Federal Reserve, Debit Card Interchange Fees and Routing, final rules, published in the Federal Register July 20, Page 4, (retrieved Oct. 6, 2011). 5 The 2010 Federal Reserve Payments Study, April 5, 2011, pages 59-60, (retrieved Sept. 30, 2011). 6 Ibid. 7 Using the CAGR reported in Table 2, Bloomberg Government estimated the annual growth from 2010 to 2015 with the 2009 reported figures as a baseline. Newer data is not yet available. 8 Hugh Son, "Bank of America Backs Off From Plan to Charge Debit-Card Fee," Bloomberg News, Nov. 1, As of Aug. 29, The list can be downloaded from the Fed here: (retrieved Sept. 28, 2011). 10 Ibid. 11 The 2010 Federal Reserve Payments Study, April 5, 2011, pages 59, (retrieved Sept. 30, 2011). 12 Debit purchase volume is provided by the Nilson report, an industry newsletter. 13 Except where footnoted, annual revenue impact and mitigation estimate was provided during 2011 company investor presentations. 14 Brian Moynihan, CEO, Bank of America, on a July 19, 2011 Q earnings call. From Bloomberg transcripts. 15 Timothy J. Sloan, CFO, Wells Fargo, on an Oct. 17, 2011 Q earnings call. From Bloomberg transcripts. 16 Jamie Dimon, CEO, JPMorgan Chase, on an Oct. 13, 2011 Q earnings call. From Bloomberg transcripts. 17 Andrew J. Cecere, CFO, U.S. Bancorp, at a BancAnalysts Association of Boston Conference on Nov. 4, From Bloomberg transcripts. 18 James E Rohr, CEO, PNC Financial,during an Oct. 19, 2011 Q earnings call. From Bloomberg transcripts. 19 O.B. Grayson Hall, CEO, Regions Financial Corp, on Oct. 25, 2011 at a Q earnings call. From Bloomberg transcripts. 20 Aleem Gillani, CFO, SunTrust, on an Oct. 21, 2011, Q earnings call. 50 percent planned mitigation includes an estimate of mitigating revenue impacts from Regulation E as well. From Bloomberg transcripts. 21 W. Edmund Clark, CEO, TD Bank, during a Sept. 1, 2011 Q earnings call. From Bloomberg transcripts. 22 BGOV estimate based on data from the Nilson Report. Citigroup has not announced a mitigation strategy because debit volume represents a small percentage of its overall interchange revenue and they say they will continue to focus on growth in credit offerings. 23 John Gerspach, CFO, Citigroup, during a Jan. 18, 2011, Q earnings call. From Bloomberg transcripts. 24 Daniel T. Poston, CFO, Fifth Third, during an Oct. 20, 2011 Q earnings call. From Bloomberg transcripts. 25 Visa's new fee structure for regulated versus unregulated banks is available here: (retrieved Nov 1, 2011). Mastercard's is here: (retrieved Nov. 1, 2011). 26 Scott Anchin and Arpan Punyani, In Their Own Words: Wall Street Quantifies Dodd-Frank Costs, Bloomberg Government Study, July 22, 2011, (retrieved Nov. 18, 2011). 24 BGOV Study» Debit Fee Cap

25 27 See Visa's new few structure as of October (retrieved Nov. 1, 2011). 28 From Bloomberg transcripts of the event. 29 Estimates by Bloomberg Government. The Fed also approved an interim final rule allowing issuers to charge an additional one cent for fraud prevention, if they adopt certain standards. Estimates did not include this additional one-cent per transaction allowance since it will be implemented on a case-by-case basis. The interim rule is available here, (retrieved Nov. 11, 2011). 30 Dakin Campbell and Donal Griffin, "Visa, Mastercard Risk 'Mom and Pop' Ire With Debit-Free Increase", Bloomberg News, Sept. 23, See (retrieved Nov. 8, 2011). 32 Phil Mattingly and Robert Schmidt, "How Wal-Mart Swiped JPMorgan in $16 Billion Debit-Card Lobbying Battle," Bloomberg News, June 28, The 2010 Federal Reserve Payment Study, page 22, (retrieved Nov. 9, 2011). 34 The 2010 Federal Reserve Payment Study, April 15, 2011, page 54, (retrieved Sept. 28, 2011). 35 Fed's Consumer Credit Report, G.19 Schedule, Sept. 8, 2011, (retrieved Nov. 9, 2011). 36 Ibid. 37 From Bloomberg Transcripts of investor presentations. 38 From Bloomberg transcripts of investor presentations. 39 From Bloomberg transcripts of investor presentations. 40 Definitions found in the Fed Interchange Fee regulations, Fed's 2010 Payment Study, and the Dodd-Frank law. 41 The rule and other documents related to the debit interchange fee cap can be found here: (retrieved Nov. 18, 2011). 25 BGOV Study» Debit Fee Cap