The Durbin-Related Threat of Direct-Routing to Visa and Opportunity for FIS, ACIW, VNTV
“Rewards cards could crater tomorrow … and [the volumes] move over to the debit or charge card side”, Phil Heasley, Chairman of Visa 1996-2003 and current CEO ACIW, June 2014
In 2015, we expect large issuers (with the top-5 controlling near-50% of US debit volumes) to begin direct-routing debit transactions (so that they pass directly from retailers to issuers rather than routing through a network) so as to avoid network fees, minimize data leakage, and find relief from the Durbin cap on debit interchange (which applies only for network-processed transactions). This will create a meaningful headwind for Visa which generates 20% of global revenue (and 27% of global purchase volume – see Exhibit 1 below) from US debit, and will benefit issuer-processors such as FIS and ACIW able to provide retailers with alternative access to DDA-accounts.
- Through its core processing business and ownership of the NYCE PIN-debit network, we believe FIS can directly access ~70% of US DDA-accounts (with this breadth being a key reason for their appointment as network partner to the merchant payments consortium, MCX). ACIW claims DDA-access to “virtually every” bank in the US.
Durbin gives retailers the ability to direct-route debit transactions by providing that issuers and networks may not directly or indirectly “inhibit the ability of any person who accepts debit cards for payments to direct the routing of electronic debit transactions for processing over any card payment network that may process such transactions”. While there is a technical argument that cardholders who signature-verify a transaction are indicating a preference for the Visa network (so that it is the cardholder, rather than an issuer or network, that is restricting retailer routing), it is likely to be moot as the industry shifts to chip-and-PIN and as retailers allow more transactions without any verification at all so as to reduce checkout times.
Large issuers face a strategic imperative to move to direct debit routing since: (i) the Durbin interchange cap means that 40% of checking accounts are now unprofitable (and there is an average 5 cents loss on each signature-debit transaction vs. a 30 cents gain pre-Durbin and current 5 cents gain on PIN-debit); and (ii) Durbin-exempt competitors are taking share of checking accounts by using unregulated interchange to fund more price-competitive products, such as Serve from AXP and cashback checking from DFS. An important consequence of the shift to direct routing is that it will remove the regulatory advantage of credit cards (which are not covered by the Durbin interchange cap) over debit cards as a payment vehicle, and reverse the shift of spending from debit to “rewards” credit cards which has occurred since 2009. This, in turn, means that Visa’s exposure to direct debit-routing higher (by at least 20% when we work through the numbers) than current debit revenues suggest since some credit revenues will convert to debit and be direct-routed.
Direct-routing is a more serious threat to Visa than dual-routing (which the company managed through PIN-enabling its core infrastructure to create PIN-Authenticated Visa Debit or PAVD). The new routing flexibility of retailers has led to investment in alternative debit processing infrastructures including by the PIN-debit networks, by JPM in ChaseNet, by MCX and its network partner FIS, and by ACIW which launched its new “UP Base24-eps” direct-routing software in March. The challenge for Visa is that these competitors can pick-off debit share while leaving the Visa brand as a backstop rather than price-leader. This undermines the network-effect advantage that Visa has historically leveraged with ACIW, for example, commenting that “direct routing can create efficiency [with issuers paying 0.005 cents/transaction vs. at least 5 cents charged by Visa], but we still have the backstop of the ubiquitous systems”.
- Indeed, we believe the threat of entirely disintermediating Visa in debit allowed JPM to secure Visa’s agreement direct-routing over ChaseNet of credit transactions (which are not subject to Durbin routing options) as well as debit.
Beyond saved network fees and Durbin relief, direct-routing of debit reduces the risk of data leakage (because fewer intermediaries touch the transaction) and so will tend to encourage information-sharing between retailers (who have in-store SKU-level data) and issuers (who have out-of-store basket-level data). We expect this pooling of payments information to lead to rapid innovation and improvement in the design of rewards programs particularly when combined with the integration of rewards-redemption into the payments stream that is enabled by mobile payments. These dynamics will favor large issuers who have the information-scale to better leverage payments data in rewards-design and will create an opportunity for issuer-processors, such as VNTV, able to provide marketing services and offer-platforms to smaller issuers looking to remain competitive.
- A risk to VNTV is that its acquiring business is disintermediated by direct-routing of debit. In practice, we think it more likely that VNTV will be called upon by large retailers to integrate the processing of directly-routed transactions into back-end and marketing systems (just as it does for network-processed transactions), and by smaller retailers to provide connectivity to issuers (as an alternative to each retailer building its own dedicated direct-routing “rails”).