Mar 9, 2006

Capital One: 43% of card business net income attributable to interchange fees

Capital One is one of the largest issuers of Visa and MasterCard credit cards in the US. The company’s 2005 annual report, released last week, shows total interchange income of $691 million, which corresponds to 43% of total net income of the company’s card issuing business ($1,609 million).

A quarter of the interchange income was used to finance the company’s rewards program, the rest presumably went straight to the bottom line. This is the practice that got the Reserve Bank of Australia so angry, and caused US merchants also to complain loudly. Interchange is paid by merchants. Why use it to fund the card issuer’s rewards program?

Many other issuers also use part of their interchange revenue to fund their loyalty programs. A quick glance at MBNA’s 2004 annual report shows a similar model, with interchange also being used to fund the card issuer’s loyalty programs. MBNA does not report total interchange, only the net figure after deducting the cost of their rewards programs. Still, in 2004, the remaining interchange that went to the bottom line was reported as $442 million, 16% of total net income across all of the bank’s activities, including cards, housing and auto loans, insurance, etc. Most other banks lump interchange into non-interest income without specifying how much was generated.

Leaving out housing and auto loans and concentrating only on the card issuing business, the impact of interchange is huge. The Boston Consulting Group estimates that interchange accounts for one-third of card-issuer revenues in the United States today. That’s revenues, not net income. (This was reported by Green Sheet – but I haven’t found the source of this information. If anybody has more detailed studies on interchange fees within a typical bank's card related revenue mix, I would love to hear from you).

In Australia, the RBA also figures that a third of card issuer revenues come from interchange. The top revenue source is interest margin (50.6%) followed by interchange fees (35.3%) and annual cardholder fees at a distant third (12.3%).

Ironically, Capital One’s annual report includes a detailed description of the risks related to interchange litigation. The best way to deal with those risks is to reinvent the payment card into something much more attractive to merchants, so that they feel they are getting something in return for their money. This might sound radical, but card issuers could probably benefit by looking at merchants as customers, not just card acceptance locations.

No comments: