The Bad News for Banks in the Card Settlement Reversal

A federal appeals court decision to toss out the $7.25 billion settlement between merchants and major card networks has reopened old industry wounds — and spells possible trouble ahead for banks.

Analysts and industry groups scrambled to make sense of the surprise decision, issued Thursday by the 2nd U.S. Circuit Court of Appeals in New York. The court tossed out the terms of a blockbuster 2012 agreement — one of the largest antitrust deals in U.S. history — resolving claims that Visa and MasterCard illegally fixed swipe fees on debit and credit card payments.

The decision promises to continue what has already been a long and complicated legal battle. The case was first filed in 2006 and, with the latest development likely sending it back through the court system for renegotiation, there is no end in sight, observers said.

It also opens the door to a handful of unfavorable — and expensive — outcomes for card-issuing banks.

Some banks — which are shareholders in Visa — could see an uptick in legal costs, particularly if negotiations result in a higher monetary settlement for merchants.

But perhaps more worrisome is the possibility that the terms of a new deal could result in lower swipe-fee revenue for banks, according to industry experts.

"Merchants would love to have lower interchange rates," said Chris Donat, an analyst with Sandler O'Neill.

Donat was quick to note that the next steps in the case are uncertain. From a financial perspective, "it doesn't mean much" in the short term until the case works its way — once again — through the legal system, he said.

Still, the risks inherent in a do-over raise unsettling questions, analysts said. The settlement did not include new limits on swipe fees, but banks and card companies fear merchants could attempt to add them in a renegotiation.

"The biggest risk in a future settlement is that there is some sort of pricing change made," said John T. Williams, an analyst with Compass Point.

It's still too early to estimate potential costs, Williams added. "It's hard to put a number on what this could mean — it could mean nothing."

Credit card swipe fees average about 2% of each transaction and amounted to about $30 billion a year at the time of the settlement, the National Retail Federation said Thursday.

In some ways, the timing could not be worse for the banking industry, which is just beginning to turn the corner on a long decade of post-crisis legal settlements.

Since the settlement was announced, the value had declined to about $5.7 billion, as several thousand retailers decided to opt out.

The case is expected go back to the U.S. District Court for the Eastern District of New York. From there, settlement negotiations could be "expedited," due to the troves of legal documents that have already been collected, Sanjay Sakhrani, an analyst with Keefe, Bruyette & Woods, said in a research note to clients.

How the legal battles play out from there is unclear. Several analysts declined to made definitive predictions about the potential timing of a decision, or the outcome.

But many noted that the card issuers — rather than the networks themselves — could bear the brunt of a settlement. That is due, in part, to terms put in place for Visa shareholders at the time of the company's initial public offering in 2008, analysts said. Those terms basically put certain of Visa's bank shareholders on the hook for the network's 67% share of the original settlement payment to the merchants. MasterCard would have paid 12% of the original settlement, and its member banks would have paid 21%.

"In the event that there is a renegotiation around the settlement terms higher, a large part of the increase would be borne by the card issuers," Sakhrani said.

In order issued Thursday, the appeals court the said that the attorneys who represented the 12 million merchants who brought the case did not adequately represent their clients.

As part of settlement, some merchants unfairly gave up their future rights to sue Visa and MasterCard on issues related to swipe fees, the court said.

"This is not a settlement; it is a confiscation," said Judge Pierre Leval, in one of two opinions issued on the case. The settlement "binds in perpetuity, without opportunity to reject the settlement, all merchants who in the future will accept Visa and MasterCard, including those not in existence."

While the decision came as a surprise, speculation about a possible reversal in the case had grown over the past year, amid allegations of improper conduct by attorneys in the case. Lawyers on both sides had been accused of sharing confidential client information. The misbehavior played a part in the unraveling last year of a separate settlement between retailers and American Express. However, those allegations do not appear to have played a role in the decision Thursday.

Trade groups supporting merchants praised the outcome.

"It's a very good result — and it's the right result," said Mallory Duncan, general counsel for the National Retail Federation. "This was a poorly conceived settlement."

A spokeswoman for Visa said that the company was reviewing the case, but she declined to comment further.

MasterCard, meanwhile, said that it was "disappointed" in the ruling.

"We believe we presented a clear case to the court that the settlement was fair and appropriate based on more than four years of negotiation," a spokesman for the company said in an email.