Big Week in the Cards

 | Aug 12, 2013 | 2:30 PM EDT
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In a hearing on Wednesday, Aug. 14, U.S. District Judge Richard Leon will try to force the U.S. Federal Reserve to either appeal his recent decision vacating the Fed board's debit-interchange rules or agree to a timetable for fixing them. The result could produce a key inflection point -- positive or negative -- for recently depressed Visa (V) and a mixed bag for MasterCard (MA).

Both of these stocks are multi-baggers since lows experienced during Sen. Richard Durbin's (D., Ill.) 2010 floor assault on debit "swipe fees" during the peak of populist fever that ultimately yielded the Dodd-Frank Act. Passage of his amendment (forcing the Fed to set "reasonable and proportionate" debit fee caps as well as new rules to force more routing competition) upended expectations of steadily growing revenue for the card networks.

After the Fed's first narrow interpretation of the rule in late 2010, Visa's shares bottomed. But a later easing of the debit curbs and "non-exclusivity" language (in the board's final July 2011 rules) helped to boost the company to near three-bagger status by this summer. Then Judge Leon spoiled the party by finding for merchants, who had protested the Fed's final rules, on July 31. 

Leon's decision caught investors off guard, and it could force the Fed to return to a narrow reading of the Durbin amendment provisions in Dodd-Frank. For the card industry, at worst, the result could mirror the board's initial interpretation of the statute in the context of its December 2010 Notice of Proposed Rulemaking. This not only could lead to a halving of the $0.24-per-transaction debit "swipe fee" cap that card issuers were ultimately afforded by revised rules two years ago, it could also impose routing-related changes that are seen as worrisome for Visa and could be a potential plus for MasterCard.

If the Fed signals that it will appeal, either at a Wednesday, Aug. 14, status hearing or at any point before late September, it might prompt a relief rally in Visa (which was recently down by 6%), while leading to profit-taking or a more complex reaction in MasterCard (which has rallied since the decision). This is largely because Visa's market share has been seen at risk to Judge Leon's ruling to force a more disruptive "Option B" regime with regard to non-exclusivity rules.

Card companies would be forced to give merchants two unaffiliated options for routing transactions made on each individual card, for each method of payment, PIN and signature debit. This would seem to require "four bugs" on all cards going forward, rather than the two bugs that are seen as satisfying the Fed's current "Option A" rules, or one affiliated provider for PIN and one for signature. In the absence of a Fed challenge -- viewed by most as a probability, but in my mind hardly assured -- the expected new expenses to reissue and accommodate multi-bugged cards could be a burden for the entire industry. But MasterCard might be positioned to gain share at the expense of Visa, which has worked for years to build up processing-fee share via exclusivity arrangements with card issuers.

Meanwhile, an appeal not only might reverse suspense over the Fed's resolve but might also point to a lengthy interregnum for re-litigation of the issue, with good prospects for ultimate success, say in about 18 months.

Conversely, should the Fed signal it will not appeal, the seeming decisiveness of such a result could create further concerns for both networks and, to some extent, card-issuing banks. (Even MasterCard faces likely pressures on future network fees.)

Stakeholders who are looking for a quick summary judgment this week could nevertheless be frustrated if the board declines to announce a decision on whether it will appeal. As a federal agency, the Fed has 60 days, or until the end of September, to appeal Leon's decision, although, as one source told us, Leon will likely hold the Fed's feet to the fire, ignoring such a prospect and pressing for a timetable.

I remain sanguine about the card networks' policy-related and growth prospects. Does anybody really see Americans reducing their use of credit card debt over the long term, albeit with notable industry challenges ahead as we shift to mobile payments? Nevertheless, I'm urging caution until evidence of the Fed's disposition becomes clear.



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