Chief Investment Officer
Commercial Loan Automation
trends in the payments business
The Payments Business is emerging as one the the great fee income hopes of 2007-8 for our industry. The article below outlines recent developments that contribute to the rising importance of this line of business, as well as some key decisions that need to be made for SuperCommunity banks to successfully capitalize upon the opportunity window that is currently open for certain segments of the business, which is sure to close within the coming 6-12 months.
P.S. Liat's food article, panning Parisian food, recently posted on BirdDroppings, received rave reviews again . She is now working on her Chocolate Shop selections around the world, the result of years of painful research (with her mom), clambering from one chocolate maker to another, sampling countless truffles and other chocolate creations. She has just started as a freshman at University of Chicago, so there might be a slight delay in her contributions, but they are worth the wait! Be on the lookout for her wisdom on BirdDroppings on www.anatbird.com.
Also, my friend, Jeff Husserl, SVP of MB Financial, noticed my article on Chinese restaurants in San Francisco and recommends Nan King on 919 Kearney Street. He is a true gourmand, so his recommendation is certainly worth pursuing!
Last , Terry Theisse, the wine importer, offered the following description of the perfect wine for him, which I thought was most eloquent:
- Beauty is more important than impact
- Harmony is more important than intensity
- The whole of any wine must be more than the sum of its parts
- Distinctiveness is more important than conventional prettiness
- Soul is more important than anything, and soul is a trinity of family, soil and atrisanality
In fact, this description fits the best of many things, not just wine!
Trends in the Payments Business
Fee income is a perennial issue in banking; every year or two a new source of fee income sprouts, and banks quickly glom onto the bonanza, often exhausting it to the fullest. Customers slowly (but surely) proceed to change their behavior once the fees get to a level that bothers too many people too often, and the specific source of that income starts ebbing. Banks then find that this reliable source of fee income, the one that has been growing so very fast for a couple of years, has capped out and often is 25-30% off the peak. Then, the challenge of replacing the income growth sets in, and the search begins.
This cycle I described has been seen all too often in our business, and examples abound (consider ATM foreign fees and overdraft privilege, to name a couple). As 2007 looms ahead, banks are tinkering yet again with their overdraft privilege matrixes in search for another double digit growth spurt, but they already know that this dog won't hunt much longer, as my friends in Texas would say. Timing for this challenge couldn't be better, as trends in the payments business are encouraging and offer several opportunities for fee income growth in 2007 and beyond.
REMOTE DEPOSIT CAPTURE
There is roughly one debit card issued per checking account in the US, and only 0.15 debit card issued per business account. The average debit transaction is $40. 60% of the transactions are not PIN-based, with fee income of $.40 per transaction; the rest of the transactions are PIN-based, with $.22 of income per transaction. Overall, a debit card is worth, on the average, $40 of fee income per year.
Debit cards represent a $9 billion line of business in a $200 billion payment industry. They currently generate 16% of DDA fee income, and this volume is expected to double within 3 years. The growth trajectory is impressive. There were 19 billion debit card payments in 2004 (and 149 billion cash transactions), expected to reach 44 billion in 2009 (CAGR 18%) (with 172 billion cash transaction, CAGR 3%). The most significant growth in debit cards transactions, which is also the highest percentage of signature transactions, is in the $5 and under transactions, thanks to Starbucks and McDonalds. More customers use their debit cards to swipe-and-go with smaller transactions under $5 than larger ones (33% vs. 21%), which, of course, has profound implications to interchange income.
Debit cards are becoming more like cash in customers' mind every day. We need to thank Starbucks and McDonalds for this trend. Once they, and others emulating them, started accepting debit cards for all transactions, customers began revising their expectations as to the "acceptable" minimum debit card transaction amount. A whole generation of Starbucks, McDonalds and other fast food chain customers is being trained to use debit cards instead of cash for buying a cup of coffee. No bank could have done a better job of such massive, rapid and profitable sea-change. As a result of this shift, both the number and the profitability of debit card transactions will increase greatly (as more small transactions customers opt for non-PIN transactions) and, at least for now, banks will be the primary beneficiary.
While this income stream will be at risk in future years (have we mentioned Wal-Mart yet?), I believe it will serve as "the next big thing in retail fee income" for the next two years. It is ironic that so many banks still consider the debit card a credit-driven product, and are shy about putting too many such cards in their customers' hands. Here is my view: debit cards are NOT credit instruments. They are payment convenience vehicles that are used by customers to access their checking accounts in lieu of a check. The only risk (barring fraud, which is swiftly moving from checks to debit cards, much like customers have done) to the bank in spreading more debit cards around is getting more fee income. I'd take that risk!
Actively pursuing, distributing, mass-issuing and encouraging the usage of debit cards is a huge opportunity. Take it!
The largest banks are moving fast on RDC, with 62% of them already offering it. Many smaller banks are also offering RDC, but too many in the $1-10 billion range are still "fixing to do it". Most banks I know are in the process of testing the product or are moving slowly ahead.
Total operational DRC locations grew from 6,500 to about 50,000 between 2004 and 2005, and are projected to triple in 2006. The number of transactions processed has increased ten-fold, as did the volume processed.
Customer acceptance of RDCs is great among many different customer segments and sizes. It is NOT the purview of large companies. In fact, micro businesses love the product and are willing to pay for it. The ideal customer has 500 checks per month or less.
There are three fee elements to this product: A. The device (do you own it? lease it to the customer? charge for it?) B. Monthly fees C. Per item charge. Customer sensitivity is least to the per item charge.
The typical sales force for this product is the cash management or treasury management group. Most banks have not established goals for this product sales, and have not focused resources on it. Consequently, few install more than 5-10 machine a week, which, in turn, will significantly curb their ability to garner meaningful market share before the mega-banks crowd this space.
Manufacturers are running out of RDC computer inventory as demand outstrips supply.
The next technological enhancement of the product is "thin client" and wireless access.
Our industry has not been known for its innovation. In fact, since the CMA account of Merrill Lynch in 1979 and mutual funds, there hasn't been much new under the banking sun. I believe RDC is the next major innovation in our business, and its implications are profound and enormous.
RDCs mean that commercial customers won't visit the branch nearly as often as they did in the past. This by itself will have a significant impact on branch staffing and the sales process to small and micro businesses. In addition, as transactions are shifted from the bank's back office to the customers', operational implications will become profound as well. These are two strategic issues that banks need to start contemplating and preparing for now, even if they won't need to pull the trigger for a while.
Customer demand for the product is huge, yet awareness is still limited. Market positioning is key, and the opportunity window is open. The mega banks have the technological ability to introduce the product, but their sales process is ineffective in many markets. Who sells the product is an important question, and whether it is sold through the cash management group, the lending group or even the branch network would make a big difference in the product positioning.
There is much to say about RDC. I fear that most banks focus on the operational and technological issues, while the strategic implications and fee income opportunities become secondary. I recommend to spend more time on pricing and marketing strategies, defining and prioritizing target customer segments to go after (either by industry or by size), and executing as fast as possible. Like so many other products, the big banks will get their act together sooner than we think, and claim the position that is currently open. Those SuperCommunity Banks that capitalize upon this temporary market leadership void will garner windfalls of customer retention and fee income. Timing is critical in this product introduction, and the faster product introductions, so long ad they do work, will receive large paybacks.
A survey of small businesses indicates that, the smaller the business, the more they are concerned about their financial institution's ability to provide payment services. Over 50% of the businesses surveyed with sales under $10 million said they'd be willing to switch banks to acquire payment services.
Small businesses are aware of check imaging (45% of businesses with sales under $5 million said they are aware of the product; 55% of companies with sales of $5-10 million).
Small businesses use credit cards for short-term financing. 73% use a small business credit card, 36% use a purchasing card, and only 14% use a small business debit card.
17% of micro businesses with revenues under $1 million have other services with their primary card issuer and NOT their primary bank. The number grows to 20% of businesses with revenues between $1-5 million. The percentage then declines precipitously for larger companies.
Most banks have given up on credit cards as a relationship-oriented product. We deem cards to be purely transactional, and most of us view them as a nuisance, an accommodation product to our retail customers. While this might be a valid view of retail customers (although one might question that assumption as well), is certainly isn't true with respect to the small business market segment. For many small companies, the credit card is their lifeline, a short-term financing tool that often leads to other purchases of financial products. Yet so many of us abdicated this space to other non-bank vendors.
The facts above indicate to me that we need to re-examine our approach to business credit cards; their sales, profitability, bundling etc. While we can't control their pricing, given the concentrations in the business of issuing cards, we can improve our marketing of the cards and their usage for financing, as well as packaging cards for different business segments (both by size and by industry) with other value-add products.
Another neglected program has been the rewards that are offered for card usage. Many banks are reviewing current programs and are also considering uniting the debit and credit card rewards. There are opportunities embedded in this approach, especially considering the poor debit card penetration among businesses. The fraud argument might be raised here again, and, again, my response is that the bank already bears other, perhaps more significant risks, with such customers (need I mention ACH?).
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The payments industry is a large and complex one. Some of its lines of businesses are extremely scale-sensitive. Others, like the ones described above, are not. Any bank of any size can leverage these products to their customers' and shareholders' advantage. Opting out of these businesses, or even cautiously stubbing one's toe in the water, might be mistakes that will have significant long-term costs. Capturing more than your fair share of these markets is an opportunity that should not be missed.