Visa’s Charged Up For $126 Despite Debit Fees Taking Some Lumps

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Visa (NYSE:V) saw a steady decline in debit card transaction volumes in the U.S. over the last two months, as new regulations imposed by the authorities took their toll on debit spending. [1] The Durbin amendment to the Dodd-Frank bill, which came into effect last October, drastically reduced the interchange fees charged on payments via debit cards by the bank which issued the card. The fee, which is paid by the merchant handling the transaction, has been capped to 21 cents plus 0.05% of the transaction, which is nearly half the amount that was previously charged.

See our full analysis of Visa here

Debit Transaction Hit as Banks Discouraged…

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The interchange fee was a major source of profit for banks such as Bank of America (NYSE:BAC) and JPMorgan (NYSE:JPM), which used the revenues to offer reward program incentives and subsidize services such as checking accounts and cost – free ATMs. [2] However, as the fees have now been reduced, these institutions are disinclined to offer the same provisions and are expected to promote credit cards over their less profitable debit counterparts. This trend was evident in Visa’s performance as the company reported a decline of 12% in debit spend in April, coinciding with an 8% increase in credit card spending during the same period.

…But Prepaid Holds the Answer

Prepaid debit cards are not covered by the Durbin amendment and are now being actively being promoted by card companies, banks and retail stores who stand to profit from their use. Visa has recently announced collaboration with Obopay to enable disbursement of funds from corporate accounts directly onto Visa prepaid cards. [3]

This announcement came in conjunction with the unveiling of a rewards program in partnership with CITGO, which offers rewards to consumers who shop at CITGO fuel stations. [4] We expect an increase in the use of credit and prepaid debit cards through the next few years, to offset the decline of debit cards and fuel an increase in the total transactions processed by Visa.

More Trouble with the Authorities

In another ruling, which came into effect this April, the Federal Reserve declared that all banks are required to use two different networks for processing debit transactions authorized via signature and those authorized by PIN. This move was primarily intended to break the Visa – MasterCard (NYSE:MA) duopoly in the U.S. and will make the market more competitive and open for other card companies such as Discover Financial (NYSE:DFS) and American Express (NYSE:AXP).

Earlier this year, Visa, in an effort to protect its market share implemented a new pricing strategy, which is more cost efficient and lucrative for merchants.

This strategy includes:

  1. Fixed fees which must be paid to use Visa’s interlink network.
  2. Variable fees charged as a % of each transaction processed.
  3. Incentive payments to merchants.

Although this strategy has been effective so far, it has come under scrutiny from the authorities. The Justice Department, last month, issued a civil investigative demand to probe the strategy for potential violations of anti-competition laws. The company however, insists that the strategy is in compliance with regulations and does not expect any significant impact on its performance from the probe.

International Trade Going Up

Visa’s cross border transaction volume went up by 13%, worldwide in both April and May and we expect international transaction volumes to continue to rise over the summer as the UEFA Euros in Poland and Ukraine and the summer Olympics in England lead to increased tourism and merchandise sales. (See Visa Expects Mobile Payments Surge At Olympics) International fees account for 20% of our price estimate for Visa.

We have recently revised our price estimate for Visa’s stock to $126, nearly 10% above the current market price (See Visa’s Charged For $126 On Emerging Markets And Mobile Growth) and lack of exposure to European markets on the company’s part keeps it in good stead as the region goes through a rocky patch in the next few months.

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Notes:
  1. 3rd Update: Visa Shares Slip As Debit-Card Spending Declines, May 30th, 2012 []
  2. The Durbin Amendment Explained []
  3. Visa and Obopay Collaborate for Near Real-Time Electronic Disbursements to Visa Prepaid Cards, June 6th, 2012 []
  4. CITGO Introduces CITGO Good Rewards Program For Visa Account Holders, June 6th, 2012 []