Bank of America, Big Banks Face Massive Credit Card Case
Private antitrust litigation pitting some five million retailers against Visa, MasterCard, and 13 large banks, including Bank of America, Citigroup, Capital One Financial, JPMorgan Chase, U.S. Bancorp, Wells Fargo, PNC Financial, Fifth Third Bancorp, SunTrust Banks, HSBC and Barclays Plc has slipped under the radar of many analysts and investors who follow those companies, but the case may deliver a multi-billion dollar shock to bank bulls in the coming months.
Estimates of the potential cost of a settlement of the antitrust case vary dramatically — from a few billion dollars into the hundreds of billions. At least as worrisome to the financial companies, according to Deutsche Bank research, is the risk that a settlement or judge's ruling could take the 2 percent "interchange" fees banks and card companies charge retailers on credit card transactions to as low as 0.5 percent, That would equal the rate in Australia, but still be higher than the 0.3 percent charged in the European Union, according to a report by Sanford Bernstein analyst Rod Bourgeois.
The impact of such a change would be several times as costly as the Durbin Amendment, which caps fees banks can charge on debit cards and is one of the new rules most hated by the big banks.
According to a Jan. 4 report by Deutsche Bank analyst Matt O'Connor, reducing credit card interchange fees by 75 percent would cost US Bancorp about $1.2 billion of 2012 revenues — some four times O'Connor's estimate of revenue the bank lost from the Durbin Amendment, For JPMorgan Chase , the implied cost would be $5.38 billion, more than five times the $1 billion the bank lost to Durbin, according to O'Connor's estimate. For Bank of America , the implied cost would be $3.68 billion, nearly double the $1.9 billion O'Connor estimates the bank lost to Durbin. Citigroup , essentially unaffected by Durbin, would take a $3.02 billion hit if credit card interchange fees fell to 0.5 percent.
Spokespeople for Bank of America, JPMorgan, Citigroup and US Bancorp declined to comment.
The antitrust case is in many ways a sequel to a 1996 class action lawsuit led by Wal-Mart Stores and Limited Brands against Visa and MasterCard . The settlement in that case included more than $3 billion in monetary damages, as well as changes in business practices worth $25 billion "conservatively," according to a Nov. 16 report by Deutsche Bank analyst Bryan Keane. Many antitrust experts believe it to be the largest antitrust settlement in history.
While that case led to lower interchange fees for debit cards, Visa and MasterCard increased credit card fees "to offset this decline and thus increased overall transaction costs for merchants," according to Keane's report. The present case, set to go to trial Sept. 12, will be heard by Judge John Gleeson of the U.S. Eastern District, the same judge who approved the Wal-Mart settlement. Judge Gleeson's involvement "may play out favorably for the plaintiff," Keane writes in his report.
The current case will be "much more expensive" to Visa and MasterCard than the Wal-Mart case, assuming it goes forward, according to Henry Polmer, an attorney who specializes in payments systems issues and has represented both merchants and large banks on separate matters.
The plaintiffs, which include Payless ShoeSource, the National Association of Convenience Stores, and the National Restaurant Association, among many others, argue that the banks, Visa and MasterCard have illegally colluded to charge fees for credit card transactions that are far higher than an open, competitive market would dictate they should be. Ten individual plaintiffs, including Kroger , Walgreen and some other large chains, have opted out of the class, and MasterCard stated in its latest quarterly earnings filing it has made "substantial progress" in settlement talks with those plaintiffs. However, they represent less than 5 percent of the purchase volume of the class plaintiffs, and "there has not been similar progress," with the class plaintiffs, whose settlement demands "remain unacceptable" given the size of the monetary demands and "unacceptable changes to MasterCard's business practices," according to the filing.
The class plaintiffs' claim argues banks' decision to spin off MasterCard and Visa through initial public offerings in 2006 and 2008 was a disingenuous effort to avoid the appearance of a monopoly. It seeks compensation for alleged overcharges "for the fullest time period permitted," by statutes of limitations and the Wal-Mart settlement (thought to be 2004). The claim also requests defendants be found in violation of antitrust laws and barred from violating those laws in the future.
More concretely, Bourgeois believes they are seeking either a fee reduction or new terms to foster competition. K. Craig Wildfang of Robins, Kaplan, Miller & Ciresi, the lead attorney representing the class plaintiffs, declined to comment on settlement talks, or to provide specifics on his clients' demands. Calls to Richard Arnold, an attorney with Kenny Nachwalter, P.A. representing the individual plaintiffs, were not returned.
While the Justice Department settled an antitrust case against Visa and MasterCard in 2010, that case was more narrow than this one — focusing on retailers' ability to offer incentives to customers to steer them toward different forms of payment. A related case against American Express, is still pending. A Justice Department spokeswoman declined to comment on why the government has not brought a price-fixing case against the card companies or whether it might do so in the future.
Polmer, the payment systems attorney, believes the government may have avoided the price fixing issues because in the wake of the MasterCard and Visa IPOs it is more difficult to prove collusion between those companies and the banks.
"They can say 'We're not fixing prices. We have been for many years now [independent] publicly-traded companies and we make our own decisions about what we want interchange to be if you're a part of our system,'" Polmer says. "I think there are lots of holes in that argument, but that's their argument."
The plaintiffs make several counterarguments, one of the more compelling of which is that Visa's "member banks" — which is the way the Visa refers to the banks that assume credit risk for charges made on the cards and are also Visa shareholders — cannot sue Visa over interchange fees or anything else.
The plaintiffs' claim cites a Visa USA regulation stating that "Visa has no liability of any nature to any member arising from any cause or circumstance."
Estimates about the possible costs of the case to financial services companies vary dramatically. Deutsche Bank's Keane writes on page six of his 14-page report on the litigation that "a $4.2 billion liability limit could be on the lower end." Three sentences later, he writes that "damages could total a couple of hundred billion dollars." A Deutsche Bank spokeswoman said Keane was not available to discuss his report.
To Keane's credit, however, he is one of only a small number of analysts who have followed the case in detail.
One of the reasons the case may have fallen through the cracks is that there do not appear to be any analysts who cover Visa and MasterCard, considered part of the "financial technology" sector, as well as the big banks, which are a sector unto themselves where Wall Street research is concerned. Financial technology analysts have tended to pay more attention to the case, but they haven't sounded the alarm because many who follow the sector believe the brunt of the settlement cost will be borne by the banks.
Indeed, Visa states in its 10-K that it has something called a "retrospective responsibility plan," which consists of "several related mechanisms designed to address potential liability under certain litigation."
One of those "mechanisms" is a litigation escrow account Visa has had since at least 2008, the year of its initial public offering. On Dec. 23, Visa disclosed it had added $1.565 billion to the account, meaning it now stands at more than $4 billion.
In a neat accounting maneuver, increasing the size of the account actually led to a decrease in Visa's outstanding shares. That caused Goldman Sachs analysts to raise their earnings estimates on Visa.
By Visa's own admission, the retrospective responsibility plan is complex, critical to the company's financial health and — wait for it — subject to failure.
Visa's 10-K states that "these mechanisms are unique, complicated, and tiered, and if we cannot use one or more of them, this could have a material adverse effect on our financial condition and cash flows, or, in certain circumstances, even cause us to become insolvent."
Translation: the plan is really too complicated to explain, but it protects us — unless it doesn't, in which case shareholders may lose their entire investment.
A spokeswoman for Visa declined to comment, though according to Keane's report Visa's class A shareholders won't be impacted by the cost of a cash settlement unless Visa's part of the payment turns out to be greater than $13.7 billion. Instead, the funds will come largely from the big banks that comprise Visa's Class B shareholders.
Bank of America states in its 2010 10-K that it would have to pay 11.6 percent "of the monetary portion of any comprehensive Interchange settlement."
Citigroup also mentions the issue in its 10-K, noting that "as of December 31, 2010, Citigroup carried a reserve of $254 million related to certain of Visa USA's and MasterCard's litigation matters."
JPMorgan's 10-K gives no specific numbers regarding its exposure, but notes that, "based on publicly available estimates, Visa and MasterCard branded payment cards generated approximately $40 billion of interchange fees industry-wide in 2009."
Those numbers cited by JPMorgan would appear to point the way to a very large settlement, since the case covers at eight years and counting — from 2004 through the present. Eight times $40 billion is $320 billion, and an influential 2005 report on price-fixing by Purdue University economics professor John Connor that looked at 700 cartels going back to the 1600s found a median overcharge rate of 25.5 percent. But even if one assumes an overcharge of just 10 percent the figure used by the Justice Department in its antitrust cases — that would suggest $32 billion of overcharges over eight years. That number, however, would be trebled, as is the rule in antitrust cases, meaning damages could conservatively be estimated at $96 billion. If Bank of America had to pay roughly 10 percent of that, as per its 10-K, the bank would have to cough up $9.6 billion.
"We do not agree with your projections about the bank's potential exposure," wrote Bank of America spokeswoman Shirley Norton via email.
But the plaintiffs' lawyers led by Wildfang are not the type to be satisfied with a small settlement, according to Robert Lande, the Venable Professor of Law at the University of Baltimore.
"They are all serious heavyweight attorneys," says Lande.
Also keeping a close eye on the case is Bert Foer, president of the American Antitrust Institute (AAI), a non-profit think tank based in Washington, D.C.
"Reformation of the credit and debit card infrastructure would have a significant impact on commerce going forward," he said.
The next development in the case, expected any day, would be Judge Gleeson's ruling on whether the plaintiffs constitute a class for the purposes of litigation.
While class certification typically determines whether or not plaintiffs go forward with a case, the situation is different in this instance since the attorneys and the class representatives "seem to be committed to going forward with a trial even if they don't get certified as a class," according to one antitrust expert not involved in the case who says he has discussed it with one of the plaintiff's attorneys. Lead plaintiffs' attorney Wildfang did not respond to an email message seeking to confirm those intentions.
If a series of strong plaintiffs that does not constitute a class goes on racking up legal victories "it gets to be a very messy situation," says AAI's Foer. "There may be an advantage for everybody to get it certified so it can be dealt with once."
Even if it is dealt with in the U.S., however, banks operating in other countries will not be able to rest easily, according to the report from Deutsche Bank's Keane.
"We believe merchants globally are intently watching how the U.S. anti-trust lawsuit resolves, and any settlement could influence these lawsuits, potentially triggering lawsuits in the international markets," he writes.
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