Small Banks Avoiding Big Interchange Losses — for Now

A lower cap on debit card interchange fees is hitting small and midsize banks more lightly than expected … so far.

Losses at the nation's biggest banks are mounting from the cap, which Congress aimed directly at them. While small and midsize banks have braced themselves for substantial hits, data compiled by Javelin Strategy and Research of six such banks found that their annual losses tied to the cap could be 8% below predictions.

All of the banks Javelin evaluated are larger than $10 billion, and are forced to accept a lower cap, also known as the Durbin Amendment to the Dodd-Frank Act.

Industry observers warn that no bank can breathe easy. There is still concern that the debit card market will soon adjust in a way that could give every bank a reality check.

"Small banks are still very nervous about the ultimate effects from the Durbin Amendment," says David Luigs, a lawyer at Debevoise & Plimpton LLP.

A lower cap was implemented in October, reducing the fees many banks collect from merchants by 45%, to about 24 cents per transaction. The smallest banks successfully lobbied Congress for an exemption, saying that losing of big chunks of revenue would pose a greater threat to them.

Fourth-quarter results were the first time banks could show how much the change is costing them.

The $2.1 trillion-asset Bank of America Corp. lost about $430 million in the quarter, or 22% of its net income. However, Iberiabank Corp., with $11.8 billion of assets, lost only $900,000, or 5% of earnings.

Industry observers are reluctant to say that banks have escaped the worst of the lower cap.

Javelin, for instance, stands behind its original loss estimates of $6.6 billion annually for the industry. "The largest issuers will have the greatest effect on total industry losses," says Beth Robertson, director of payments research at Javelin. "Further, fourth-quarter data for a handful of smaller debit issuers is not indicative of what subsequent quarters may reveal."

Gerard Cassidy, an analyst at Royal Bank of Canada's RBC Capital Markets, says several factors could explain why some banks are performing better than expected. First, the banks could have had difficulty forecasting the change. Another factor could be a spike in debit-card use, which would offset lower fees. "We will need another six to nine months to get a full representation of what the impact of Durbin is going to be," Cassidy says.

Smaller banks exempt from the lower cap also run the risk of an eventual revenue hit, says Viveca Ware, senior vice president for regulatory policy at the Independent Community Bankers of America. "Market forces are going to kick in, and the networks will ultimately have to reduce the pricing for exempt institutions so it's closer to nonexempt" banks' rates, she says.

Ware says that, starting April 1, merchants will be allowed to pick the least-costly network for debit-card transactions, reducing fee income for all banks.

Sen. Richard Durbin, D.-Ill., the amendment's sponsor, is working to prevent small banks from being hurt by the lower cap. He sponsored language in a separate bill that instructs the Federal Trade Commission to issue a report on how the small-bank exemption is working.

The report, set for release later this year, would explain whether the FTC found evidence that payment-card network companies like Visa Inc. and MasterCard Inc. have tried to make it harder for smaller banks to compete in the debit-card market.

Doyle Arnold, the chief financial officer at Zions Bancorp., told analysts during a Jan. 23 conference call that the Salt Lake City company reported an $8 million loss for the fourth quarter, or 11% less than what it expected to lose.

Bankers say they expect to replace some lost revenue with other fees. "We're looking at various combinations of what others have done: monthly service charges, higher minimum balances," Arnold said, adding that he expects Zions will replace a third to two-thirds of the lost revenue.

Zions was among the banks that Javelin evaluated. The others were Fulton Financial Corp., M&T Bank Corp., People's United Financial Inc., Synovus Financial Corp. and Webster Financial Corp.

Yet, some bankers, such as R. Scott Smith Jr., Fulton's chairman and chief executive, are reluctant to move too fast to replace lost fee income. "Our goal was to mitigate the impact of lost Durbin-related revenues," Smith said during a Jan. 18 conference call. "We also explained that the introduction of fee increases to do that would be somewhat contingent on the competitive environment because we did not want to jeopardize customer relationships."