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Tickers in this Article: MA, V, JPM, WFC, C, BAC
Last week, credit card giants MasterCard Inc. (MA) and Visa Inc. V) entered into a formal agreement with the federal court of Brooklyn to settle a multi-state US merchant lawsuit. About 7 million merchants or retailers had charged the card companies in 2005 for fixing prices and unduly increasing processing or interchange fees on transactions made through debit and credit cards. Accordingly, Visa and MasterCard have agreed to pay about $6.0 billion to the retailers. While Visa is expected to incur a cash settlement charge of $4.1 billion, MasterCard projects to record $790 million (pre-tax) as lawsuit penalties in the second quarter of 2012.

MasterCard anticipates another pre-tax charge of $20 million during the second quarter of 2012. Another $525 million in damages are payable to the retailers who had individually sued these card companies. An additional future loss of $1.2 billion is estimated to be incurred by the card giants due to the reduction of interchange fees on credit cards by 10 cents for the next eight months.

Thirteen more banks, including Wells Fargo & Co. (WFC), Citigroup Inc. C), Bank of America Corp. (BAC) and JP Morgan Chase & Co. (JPM) are involved in this antitrust litigation. The overall settlement is estimated to be worth $7.25 billion, by far the largest in the history of antitrust settlements.

However, the National Association of Convenience Stores, a big part of the plaintiff's side, has rejected the settlement. This again poses the risk of bearing higher financial penalties by the card companies in the future.

Card Industry Awaits Complete Reform

Finally, the Consumer Protection Act enacted in 2010 is coming in handy to rescue the merchants and consumers one way or the other. While it was expected to introduce real prices to create a healthy competitive environment, the American Bankers Association opines that the merchants, and not the end-consumers, are more likely to benefit from these modifications made to the interchange fee rule.

Additionally, it eases the pressure on merchants, who now encourage cash payments by offering discounts or low cost debit or credit cards. The merchants who have more than one store can also choose to receive payments from MasterCard or Visa in some of their stores.

Under the antitrust settlement, the merchants also have permission to put a surcharge on some credit transactions above a certain limit. Although these modifications are liable to make the merchants powerful, the consumers may still have to bear the brunt of the cost of operating the card network from the issuing banks, directly or indirectly.

Litigation Deters Card Giants' Earnings

Moreover, as witnessed in the past, litigation settlements have marred the bottom line of both Visa and MasterCard. In 2003, both card giants settled a joint lawsuit for $3 billion, while another civil lawsuit by the Department of Justice was settled by them in 2010.

Consequently, Visa inflates its escrow account from time to time to meet such litigation expenses. The escrow account currently stands at $4.28 billion. Even MasterCard settled a $770 million lawsuit in the fourth quarter of 2011. We believe these hefty funds could have been otherwise used for growth purposes.

Going forward, the new rules are liable to weigh on the margins of the card giants. So far, however, both Visa and MasterCard do not foresee any changes in their annual growth guidance, which reflects their preparation to deal with the lawsuit.

While Visa is scheduled to release its fiscal third quarter results after the closing bell on July 25, 2012, MasterCard is slated to announce its second quarter results before the market opens on August 1, 2012. Currently, both the companies carry a Zacks Rank #3, which translates into a short-term Hold rating and long-term Neutral recommendation.

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