Within the next 24 hours, a settlement may be announced in the merchants' class action lawsuit (the "Brooklyn case") against MasterCard (MA) and Visa (V). Perhaps in anticipation of an end to the related uncertainty, shares of the two card networks were up strongly Thursday amid negative to flattish trading. That, moreover, comes on the heels of these shares climbing by 60% to 70% since Washington's "swipe-fee" fever broke last spring. By contrast, card issuers American Express (AXP), Discover (DFS) and Capital One (COF) were all slightly down.
As a result, I'd say that investors may have already broken the code. Prospects are not good for the merchants' 2010-to-2011 legislative assault against debit interchange to spread to credit cards, either. So those who loved what was "in the cards" Thursday should probably stay the course going forward.
It's widely expected that the legal agreement will involve an up-front cash payment (perhaps up to $10 billion), a temporary interchange-rate decrease and an easing of the card networks' rules, most notably against credit-card surcharges. Though the settlement will directly affect the two major card networks, it will also impact the bank issuers as they adhere to "can't-be-treated-any-differently" language that essentially drafts behind Visa's and MasterCard's rules and practices.
What's in Store?
A well-timed Morgan Stanley report, out Thursday, has sought to quantify the worst-case scenario. The firm employed a polling organization to survey a wide cross-section of consumers, and found that as many as 43% might react to a card surcharge by moving to either checks or debit. Going under a number of assumptions, analysts Glenn Fodor and Betsy Graseck found that credit volumes could ultimately contract by anywhere from 8% to 14%, although many of the companies would make up for the loss with increased debit transactions. They also found that they would likely have a wide range of options with which to further mitigate the earnings-per-share impact of any such changes, and that such impact could be a low as 1% to 3%.
The analysts meant to depict the far end of bad outcomes, which they argued these companies could manage regardless. There's a good case to be made that they've been too conservative, however, and that actual results might not prove half as bad.
Perhaps most important, more than 50% of volumes are generated in 10 states where anti-surcharge laws have been enacted, and that will greatly mitigate the impact of any agreed-to change. Those states include California, New York, Texas, Florida, Oklahoma, Colorado, Connecticut, Kansas, Maine and Massachusetts.
Should the merchants pursue repeal or modification of the 10 states' laws, Visa and MasterCard might be constrained in openly moving to block the settlement's broader implementation. However, such defensive moves will be much easier to mount, as surcharges are widely perceived as anti-consumer. This was why a related federal ban used to reside in the Truth in Lending Act (TILA) in the first place -- before it mistakenly fell out. In effect, these exact same arguments would be used to build resistance against debit fees, so I would expect them to be quite successful against those who might seek to employ or further advance card surcharges.
In anticipation of any such struggle, and in order to influence merchants' decisions as to whether they should employ surcharges, there will likely be a resumption of advertising from the card networks, thus reiterating the advantages of credit cards over cash or checks.
Meanwhile, based on international experience where surcharges have been allowed, airlines might be expected to be early movers. However, they would likely face huge pushback, given consumer resistance to baggage fees already in place.
Online purchases might be another natural first target, although any such movement in the U.S. might run afoul of the merchants' parallel efforts to force taxation of purchases over the internet via federal legislation (overturning the 1992 Quill decision). So let's assume online consumers are about to be hit with federally facilitated state tax collections -- ones that many now assume to be inevitable due to increasing bipartisan interest on Capitol Hill, multiplying state laws and focus on the effects of "showroom shopping." If so, it's hard to believe that they will be asked to take the double hit of credit-card surcharges as well.
For their part, the big box retailers -- who already have negotiated the lowest interchange fees available -- are likely to try to turn the surcharging green light into a corporate advantage by not surcharging.
Finally, a new legislative risk could emerge, should Sen. Durbin (D-IL) or other retailers' advocates seek to make permanent the settlement's temporary interchange curbs. Still, I see passage as being highly unlikely, and even less so in the event of a rightward political realignment this November. Indeed, I'd assume that passage of bipartisan legislation to fully restore a federal ban on surcharging might eventually have just as good or better prospects.
Net result: There's still too good a growth potential in the cards (pun intended) to let the story be spoiled by the threat of retailers' potentially suicidal surcharges.