2011 debit issuer study

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Contents

1. Overview 2

Key fndings 2

Outlook 4

2. Research Metrics 5

3. Drivers o Debit Perormance 6

4. Debit perormance Consumer 7

5. Debit perormance Business 11

6. Debit P&L 12

7. The Durbin Amendment 13

8. Regulation E 15

9. Rewards 17

10. Fraud 18

11. ATMs 19

12. Prepaid cards 20

13. Alternative payments 21

Contactless cards 21

Mobile fnancial services 21

Alternative payments companies 22

2011 Debit Issuer StudyExecutive Summary


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2 2011 Debit Issuer Study Executive Summary

1. Overview

Te2011 Debit Issuer Studypresents an objective act base on debit card issuer perormance and perspectivesacross the spectrum o electronic payments. Te Study, the sixth annual report commissioned by PULSE, is basedon primary research with 50 nancial institutions (FIs) that collectively represent more than 50 million debit cards.Te sample is nationally representative, with FIs distributed by size, geography and debit network aliation.

Key ndingsTe presence o ongoing and impending regulatory changes Regulation E and the Durbin Amendment, respectively greatly inuenced participating FIs metrics and perspectives in the2011 Debit Issuer Study. A ull 96% o FIs listedthe Durbin Amendment and other regulatory pressures as a key challenge or 2011.

AsaresultofchangestoRegulationE,overdraftrevenuedeclinedby45%amongsurveyedFIs.

InresponsetotheFederalReserveBoardsProposedRegulationtoimplementtheDurbinAmendment,issuersexpect to lose as much as 79% o their current debit interchange revenue.

Te total annual revenue per active consumer debit card (combining interchange revenue and debit card overdrat

ees) was down to $107 in 2010 (rom $118 in 2009) and will likely go down even urther post-Durbin.Anticipation o the Durbin Amendment also inuenced FIs plans and outlook in several categories.

Performance metrics:raditional FI perormance measures penetration, activation and usage (PAU) arebeing revisited in light o debits anticipated new economic structure. For regulated issuers 1, most debit transactions

will be unprotable i interchange is regulated at $0.12 hence, FIs will need to rethink to what extent theyshould drive debit usage. Te signature/PIN debit transaction mix also is likely to change (in avor o PIN).

Instant issuance and branch incentives:2010 saw a signicant decline in issuers interest in instant issuance.Several FIs also are rethinking incentives or their branch personnel or issuing debit cards.

Rewards:Many FIs are considering eliminating or reducing rewards on debit cards, given lower interchangerevenue. O standard programs, only airlines miles-based programs are likely to survive, albeit with reducedbenets. As a result, there will likely be increased interest in merchant-unded rewards and relationship-basedprograms.

Prepaid Cards:Te Durbin exemption or general purpose reloadable (GPR) prepaid cards has increasedFI interest in the product, though it is unclear how FIs will bring it into their product suite alongsidetraditional oferings.

Alternative Payments:Te Durbin Amendment will make it signicantly harder or alternative paymentsto gain merchant acceptance, since they now need to price under the new debit ceiling which will beuneconomical or provide a superior value proposition which is untested. It also gives a shot in the armto PIN debit on the Internet, notably improving its prospects or FI adoption.

Despite these headwinds, rom a consumer preerence and usage perspective, growth in the debit market remains

robust. PIN transactions grew 8% in 2010, while signature transactions increased 10%. Te average active consumerdebit card now perorms 16.3 point-o-sale purchases per month, 68% signature-based and 32% PIN-based. Withaveragegrossinterchangeratesof$0.49perconsumersignaturedebittransactionand$0.31perPINdebittransaction,the average active consumer debit card currently generates $87 o interchange revenue per year or FIs. Tere is

wide variation between best-in-class FIs and the overall average in terms o the key perormance metrics.

1 Regulated issuers are nancial institutions with at least $10 billion in assets and are hence subject to the interchangecap o the Durbin Amendment. Exempt FIs are not subject to the cap, but are subject to other provisions.


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On a pre-Durbin basis, business debit ofers better economics than consumer debit, despite having lower activationand penetration rates than consumer debit: on a per-transaction basis, business debit delivers revenue that is ourtimes greater than that o consumer debit cards. Roughly one-quarter o surveyed FIs identied business debit asone o their top three opportunities to grow in 2011, though it remains to be seen i this will hold true post-Durbin.

Te Feds Proposed Rule (released on December 16, 2010) to regulate the debit card market, as required by the

Durbin Amendment, will signicantly alter the dynamics within the debit card market. For FIs with at least $10billion in assets, the Proposed Rule sets interchange to either (a) between $0.07 and $0.12 per transaction basedupon each issuers costs or (b) up to $0.12 or all issuers. Additionally, all FIs regardless o asset size will berequired to participate in at least two unaliated payment networks (and possibly two per payment method).

Issuers are strongly critical o the proposed interchange cap, arguing that the proposed rate is too low (the denitiono allowable costs is too narrow, the price is below issuers costs and the denition o reasonable and proportionalis anything but reasonable) and a cap is inconsistent with ree market principles (and the statute). On average,regulated FIs expect an 80% decline in interchange revenues; even FIs that are exempt2 rom the interchange capare expecting a 73% decline. Moreover, issuers believe that network exclusivity provisions are unnecessary giventhe interchange cap. Since debit is a key component o the demand deposit account (DDA), many FIs are already

working to reposition its value proposition and to retool their existing product set, including introducing additionalees, reducing or eliminating rewards programs and ofering more protable alternatives to consumers, such as

charge cards and prepaid cards.

Changes to Reg E, governing opt-in requirements or continued debit-initiated overdrat coverage, went intoeectlastsummer.Followingconcertedcampaigns,onaverage,24%ofallcardholdershaveoptedintooverdraftservices, notably lower than issuers earlier projections. However, o customers that incur more than ve overdratsperyear(thesecustomerscomprise14%ofaccounts,but93%ofoverdraftrevenue3), the opt-in rate was almosttwiceashigh,at45%.Asaresultofthesechanges,overdraftrevenuedeclinedby45%,from$0.36pertransactionto $0.20.

Debit rewards programs are expected to be adversely impacted by the Durbin Amendment. While 56% percentofFIscurrentlyoersometypeofrewardsprogram,54%ofthoseFIsareconsideringterminatingorrestructuringtheir programs. Many FIs are moving away rom points-based programs and are looking toward merchant-undedor relationship-based programs. Similar to past years, while the majority o FIs are satised with their currentrewards programs, ew are able to quantiy the programs benets. Post-Durbin, being able to understand thetrue value-add o a rewards program will become increasingly important as FIs evaluate the return on investment.

Actively managing raud losses also will be critical in the post-Durbin market. In 2010, the PIN debit net raudloss rate increased by 27% to 1.26 basis points (bps); the signature debit raud loss rate remained notably higher at7.50bps.Forty-ninepercentofFIsimplementedoneormorenewfrauddetectiontoolsin2010,and34%ofFIscite processor tools as being one o their most efective ways o managing raud. ackling raud is a never-ending

journey, requiring FIs to constantly invest and remain vigilant, as raudsters become ever more sophisticated.

Some o debits growth is rom displacing cash transactions, as illustrated by a continued decline in AM cashwithdrawals. On average, active cardholders perormed 2.6 AM transactions per month in 2010; down rom2.7 in 2009 and 3.0 in 2008.

Te number o FIs selling prepaid git cards, the most popular type o prepaid card, increased rom 67% in 2009to 73% in 2010. However, many FIs expressed dissatisaction with their git card programs, which tend to benon-strategicandlow-revenueproducing.Infact,oftheFIsthatsellgiftcardsthroughtheirbranches,47%sellless than 100 cards per branch per year. Moreover, the git card provisions o the CARD Act are prompting manyFIs, especially those already disenchanted with git cards, to reconsider their commitment to git card programs.

2 Issuers with less than $10 billion in assets are exempt rom the Durbin Amendment interchange cap3 Source: 2008 FDIC Study o Bank Overdrat Programs


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While some FIs are considering exiting or outsourcing their git card programs, others are looking into diferent segmentso the prepaid market, such as general purpose reloadable (GPR) cards. In part due to their exemption rom Durbin,GPR prepaid cards have become relatively more attractive, providing more and larger revenue streams than gitcards and ofering a potential lower-cost substitute or debit cards/checking accounts or low-balance customers.Asaresult,14%ofFIscurrentlyareoeringGPRprepaidcards,upfrom9%in2009.

Interest in contactless debit cards continues to erode: only 9% o cardholders with a contactless-enabled card actuallyuse the contactless eature and, overall, contactless represents just 0.03% o total debit transactions. As a result,some current issuers plan to backtrack and remove this capability rom their cards. Conversely, mobile nancialservices are growing, with 62% o FIs supporting mobile banking and 26% o FIs exploring mobile payments,upfrom46%and21%,respectively,in2009.

Outlook

FIs orecast an overall increase in consumer PIN transactions o 7% and in consumer signature transactionso 7.3% in 2011 (see Figure 1).

Figure 1: Projected 2011 PIN and signature growth rates4

Large Banks Credit Unions Comunity Banks

Signature txn growth (%)

PINtxngrowth(%)

10% 20% 30%

10%

20%

30%

Te two biggest challenges that FIs anticipate in 2011 are regulatory pressures and raud. Ninety-six percent o FIscitedtheDurbinAmendment/regulatorypressuresasakeychallengefor2011.BeyondDurbin,FIscontinuetobeconcerned with the impact o Reg E and how they will make up lost overdrat revenue. With regard to raud, 51%ofFIsexpectsignaturedebitfraudratestoincreaseoverthenexttwoyears,while43%expectPINdebitfraudratesto urther increase.

For 2011, FIs exempt rom the interchange provision o Durbin are ocusing on improving their overall debit

portolio perormance. FIs also believe there is untapped opportunity in business debit, particularly in capturingsmall business DDAs. Lastly, many FIs cited product design (in light o post-Durbin debit economics) as anopportunity or 2011.

In sum, 2011 brings greater challenges than in past years, reected in the impending Durbin Amendment regulatorychanges and continued consumer preerence or debit as a payment vehicle. Going orward, FIs will need to ullyunderstand the role o debit within the broader context o the DDA to strike a balance between ullling customerneeds and protable growth.


4 Weighted by 2010 transaction volume


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2. Research Metrics

Research was conducted in February and March 2011 and the data provided by FIs is or 2010, unless otherwisenoted. Debit card issuers perormance metrics were gathered and analyzed in 10 specic areas, as listed in able 1.

Table 1: Debit perormance metrics categorization

1. Debit perormance

Consumer

Penetrationandactiverates

Instantissuance

Incentives

Transactionsperactivecard

Signature/PINratio

Transactiongrowth

Averageticketsizesanddistribution

Spendbymerchantcategory

2. Debit perormance

Business

%ofFIsoeringbusinessdebit

Penetrationandactiverates

Transactionsperactivecard

Transactiongrowth

Signature/PINratio

Averageticketsize

3. Debit P&L SignatureandPINinterchangerates(consumer and business)

Interchangerevenuepercard

Cardholderpricing

Processorfees

Networkfeesandnetrevenue

Costofrewardsandfraud

4. The Durbin Amendment FIsopinionsondraftrules

Expecteddeclineininterchangerevenue

PotentialchangestodebitduetoDurbin

FIspreferencesforinterchangeand network alternatives outlined

in drat rules

5. Reg E Regulatorychanges

Overdraftprogramspre-andpost-RegErevisions

Communicationofregulatorychanges

Opt-inrates

Declinedtransactionrates

ImpactofRegEchangeson

overdrat revenue

6. Rewards Rewardsprogramoerings

Typesofrewardsprogramsand

program providers

Valuetothecardholderfromrewards programs

Consumerparticipationlevels

Rewardsprogramresultsand

FI satisaction

Outlookforrewardsprograms

7. Fraud SignatureandPINdebitlosses

Cardreissuancecriteria

Databreachesandcompromisedcards

Eectivefraudtools

Expectationsoffuturefraudrates

8. ATMs ATMtransactionspercard

ATMdensity

On-usvs.o-ustransactions

RatioofATMtodebitPOSusage

ATMfees

Surcharge-freenetworkparticipation

Surchargereimbursements

9. Prepaid cards Prepaidcardprograms

Giftcardsalesrevenueperbranch

Giftcardfees

Giftcardsalesprojections

ImpactoftheCARDAct

GPRcardfeaturesandoerings

Prepaidcardprocessors

10. Alternative payments Contactlesscards

Mobilebanking

Mobilepayments

FIsperceptionsofthreatsbyalternative

payments providers

In addition to these quantitative perormance metrics, FIs commented on the key opportunities and challenges thatthey expect in 2011, including the impact o the Durbin Amendment.


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3. Drivers o Debit Perormance

Te debit business begins with DDAs. Debit card managers need to penetrate these accounts with cards,encourage cardholders to actively use their cards (% o cards that are active) and promote greater debit cardusage (usage). Ignoring potential implications arising rom the Durbin Amendment or a moment, these threedrivers penetration, activation, usage (PAU) are the key perormance indicators that determine the success

o a debit card portolio.

Figure 2: Drivers o debit perormance5

Sig. transactions5,187 txns per yr

PIN transactions2,441 txns per yr

DDAs1005

Debit Cards73

Active cards39

Annual usage7,628 txns per yr

$307,281Signature/PIN ratio

68%/32%

Avg. sig. ticket

$36

Sig. interchange140 bps

Avg. PIN ticket

$42

PIN interchange74 bps

% txns chargedoverdraft: 0.3%

Overdraft fee$29

Active rate6

Penetration rate73%

Usage7

16.3 transactions peractive card per year

Annual sig.interchange

revenue$2,619

Annual overdraftfee revenue

$772

Annual PINinterchange

revenue$768

Interchange:annual revenue of $3,387equates to $34 per DDA or$87 per active card

Card performance

Performance driversunder inuence of FI

External drivers

FI drivers

Total revenue:annual revenue of $4,159equates to $42 per DDA or

$107 per active card

Overdrafts:annual revenue of $772equates to $8 per DDA or$20 per active card

5 DDAs exclude any revenue rom per-card ees, per-transaction ees or rewards program ees. All revenue totalsindex to 100 DDAs.

6 Active rate uses the most common denition among FIs o card activation, dened as any signature transactionwithin the last 30 days.

7 Usage is measured by average transactions per month or 2010 (past survey participants only).


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As illustrated in Figure 2, the number o DDAs is the top o the unnel, and FIs need to work to minimize leakageat every step along the activity chain. On average, FIs have penetration rates o 73%, active rates o 53%, usagerates o 16.3 transactions per active card per month, a 68%/32% signature/PIN transaction mix, and an averageticketof$36persignaturepurchaseand$42perPINpurchase.

Withtheseaverages,consumerdebitgenerates$107peractivecardperyear,equatingto$42peryearforatypical

DDA. Te ollowing sections discuss the key drivers o FI debit perormance in more detail.

4. Debit perormance Consumer

Penetration is the rst step in any debit card program getting cards into account holders hands. Te industryaverage penetration rate has remained at at 73% since 2007 (meaning that 73% o DDAs can be accessed bysome type o debit card). Penetration rates vary notably by account tenure, as new customers tend to have higherpenetration rates than legacy customers.

Once cards are issued, the second step is ensuring that the cards are active, or regularly used or purchases and/orAM transactions. FIs continue to dene active cards in a variety o ways, varying both the timerame o usage andtype o transaction that qualies a card as active. able 2 lists the percentage o FIs that employs each denition.

Table 2: Active denitions (by percent o FIs)

Type o transaction

Signature txns only Any POS txn Any txn

Time rame 30 days 30% 15% 24%

90 days 0% 2% 13%

6-12 months 0% 0% 7%

Ever 2% 0% 7%

Te two most common denitions continue to be Any signature transaction in the past 30 days, or which theaverage active rate is 53%, and Any transaction in the past 30 days, or which the average active rate is 60%.However, some FIs are shiting rom a signature-active to a purchase-active denition (meaning that the cardis considered active i used or either a signature or a PIN POS purchase). Additionally, 7% o debit cards are usedonly at AMs and never at the POS.

Usage o and interest in instant issuance has decreased rom 2009 to 2010. With instant issuance, cardholdersreceive a debit card at the branch as part o the account opening process. Without instant issuance, consumers opentheir checking accounts in a branch and receive their debit cards in the mail some time later, with a separate PINmailer. Historically, instant issuance has had a positive impact on card activation and usage rates. However, FIs areunclear about whether instant issuance ts into their debit strategy in light o the Durbin Amendment. Currently,26% o FIs ofer instant issuance in either all or some o their branches while an additional 20% o FIs are activelyconsidering its adoption (down rom 36% in 2009).


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o increase PAU, FIs can provide incentives to their branch personnel or the distribution o debit cards. Teseincentives can be in the orm o a direct dollar incentive (e.g. $X paid or each debit card issued), or in the ormo an indirect contributor to a broader compensation ramework. Tirty-eight percent o FIs ofered such incentivesin 2010; o these FIs that provided incentives, roughly hal o them provided a direct dollar incentive (see Figure 3).

Figure 3: FIs that incentivize debit card issuance and type o incentive awarded

38%47%53%

62%

Do not oer incentive

Oer incentive

Direct dollar incentive

Indirect contributor tototal compensation

O FIs that ofer incentives, one-third are currently looking to adjust or even eliminate their incentive programs.For most o these FIs, the catalyst or change is the upcoming regulatory reorm. Others want to more closely alignthe incentives with value created by their debit businesses.

In2010,theaverageactivedebitcardperformed16.3point-of-salepurchasespermonth.Figure4illustratestheaverage number o monthly transactions per active consumer card per month or each segment o FIs.

Figure 4: Monthly transactions per active consumer card (past survey participants)8

5.2

14.0

16.4

6.2

11.7

14.0

5.5

12.3

16.4 16.3

PIN Signature Total

Large Banks Credit Unions Community Banks

5.3

13.7

Overall

Best-in-classconsumerdebitcardissuersachieveanaverageof9.6PINand20.5signaturetransactionsperactivecard per month as shown in Figure 5. Historically, best-in-class consumer card issuers were dened as those havinghigh PAU.


8 PIN transactions per card and signature transactions per card do not sum to total transactions per card due to thepresence o dual-unction cards, which are both PIN- and signature-capable. Past participants are FIs that participatedin both the 2010 and 2011 studies and that reported the same active rate denition or both years.


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Figure 5: Best-in-class issuers9

PIN Monthly transactionsper active consumer card

Best-in-classAverage = 6.2

1st2nd3rd

Quartile

Transactions/card

4th

9.6

7.4

5.5

3.6

0

2

4

6

8

10

Signature Monthly transactionsper active consumer card

Best-in-class

20.5

13.910.6

9.8

5

0

10

15

20

25

Average = 13.2

1st2nd3rd

Quartile

4th

Unlike prior years, signature growth outpaced PIN growth in 2010. Signature transactions grew 10% over the prioryear and PIN transactions grew 8% (see Figure 6). As a result, signature transactions represented a higher proportiono the overall transaction mix than the prior year (68% in 2010 versus 65% in 2009). Te ratio o signature toPIN transactions is highly inuenced by ees or PIN usage, rewards programs, marketing promotions, merchantsteering and cardholder preerences.

Figure 6: Debit transaction growth10

2010 PIN growth projected and actualTransaction growth

2010 signature growth projected and actualTransaction growth

Expected 20092010 Actual 20092010

Large

Banks

Credit

Unions

Community

Banks

Overall

9%8%

12%

7%

17%16%

9%8%

Large

Banks

Credit

Unions

Community

Banks

Overall

8%

10%

12% 12%

17%

8% 8%

10%

For 2011, FIs project 7% growth or both PIN and signature transactions. Tese projections are slightly downrom 2010 levels, largely due to uncertainty around regulation and its impact on debit card usage.

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9 All quartile averages are weighted10 Weighted by 2010 transaction volume


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eaverageticketsizeis$42forPINpurchasesand$36forsignature,slightlyhigherthantheprioryearsaverageticketsizesof$41and$35forPINandsignature,respectively.Grossdollarvolume(GDV)growthfor2010was8% or PIN debit and 11% or signature debit.

Cardholder use o PIN versus signature debit varies considerably by merchant category (see Figure 7). Many PINtransactionstakeplaceinsupermarkets(40%),whichaccountforonly10%ofsignaturetransactionactivity.

Conversely, restaurants (standard and quick service) generate 30% o signature debit activity but only 1% oPIN POS transactions. Diferential card usage is driven by cardholder preerence, merchant PIN pad deployment,PIN prompting, use o cash-back and choice within the channel (PIN is not typically supported or card-not-present transactions nor or many bill payment transactions).

Figure 7: Usage by merchant category

PIN transactions Signature transactions

Supermarket

Retailer

Gas

Restaurant

Quick Service Restaurant

Travel & Entertainment

Other

40% 10%

21%

15%

16%

14%

21%

28%

22%

0%

1%

9%

3%0%



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5. Debit perormance Business

A large majority o surveyed FIs (82%) issue business debit cards; these cards represent 6% o the total debit card base.

Businessdebitcardshavelowerpenetrationratesthanconsumerdebitcards(46%versus73%).Foraccountsopenedin2010,56%ofbusinessaccountsarelinkedtoadebitcard,versus83%forconsumeraccounts.Business

debitcardsalsohaveloweractiveratesthanconsumerdebitcards(40%versus53%).Beyondpenetrationandactivation, usage also is lower or business cards, at 13.2 transactions per active business card per month versus16.3 transactions per active consumer card.

WhilePAUratesarelowerforbusinessdebit,theaverageticketsizeisnotablyhigherthanconsumerat$64forbusinessPINand$92forbusinesssignature,versus$42forconsumerPINand$36forconsumersignature.etransaction mix tends to skew more toward signature purchases (79% o all business debit transactions are signature-based versus 68% o all consumer transactions.) Lastly, business debit cards have much higher interchange ratesthan consumer cards, earning 2.35 bps (equating to an average o $2.10 per business signature transaction).

Overall, as shown in Figure 8, the average interchange revenue per active business debit card is more than threetimes the average interchange revenue per active consumer debit card. Not surprisingly, more than 20% o FIsnamed business debit as one o their top three growth opportunities or 2011, though this will likely change

post-Durbin.

Figure 8: Business vs. consumer debit card interchange revenue per year

32%

68%

21%

79%

$0.31

$0.49

$0.31

$2.10

Transactionmix

ConsumerPIN

Consumersignature

Business

PIN

Businesssignature

Interchange rate($ per transaction)

Blendedinterchange rate

($ per transaction)

Transactionsper active

card

Grossinterchangerevenue peractive card

per year

$87 per activeconsumer card

per year

$273 per activebusiness card

per year

$0.43

$1.72

=

=

16.3

Month

13.2

12

Annualized

12

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6. Debit P&L

Debit is a signicant contributor to FIs non-interest income, with an average active consumer debit card generating$87 o interchange revenue per year.

eaveragegrossdebitinterchangerateis$0.31perPINtransaction,$0.49perconsumersignaturetransaction,

and $2.10 per business signature transaction. Post-Durbin, regulated FIs will lose at least an average o 76% o theirinterchange revenue (see Figure 9).

Figure 9: Gross interchange rates pre- and post-Durbin11

Pre-Durbin

Post-Durbin

Pre-Durbin

Post-Durbin

Pre-Durbin

Post-Durbin

Pre-Durbin Pre-Durbin Post-Durbin(Consumer (Consumer)& Business)

Business signature interchange rate(at least 94% decrease)In $ per transaction

Consumer signature interchange rate(at least 76% decrease)In $ per transaction

PIN interchange rate(at least 61% decrease)In $ per transaction

Blended interchange rate(at least 76% decrease)In $ per transaction

Signature (Business)

$2.10

$0.07 $0.12

$0.07 $0.12

Signature (Consumer)

$0.49

$0.49

Overall

$0.43

PIN

$0.31

$0.07 $0.12

$0.07 $0.12


11 Percent decrease is or $0.12 interchange rate


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Te average gross margin on signature and PIN debit transactions is currently $0.33 and $0.23, respectively (seeable 3). Gross margin is reective o many o the per-transaction economics, but does not capture an FIs ull coststructure. Important additional costs include customer acquisition, card production and ulllment, debit programstaf and marketing costs, customer service and channel operating expenses (branch network, call center, etc.).

Table 3: Signature and PIN debit margin (in bps per GDV and $ per transaction)

Category Line item

Signature debit

(consumer) PIN debit

Consumer

blended12

Revenues15 Interchange rate13 140 bps ($0.49) 74 bps ($0.31) 119 bps ($0.43)

Cardholder pricing NA 2 bps14 ($0.01) 0.64 bps ($0.002)

Costs Networkfees 18 bps ($0.07) 6 bps ($0.03) 14 bps ($0.06)

Processing ees 10 bps ($0.04) 7 bps ($0.03) 9 bps ($0.03)

Rewards 616 bps ($0.02) 017 bps 4 bps ($0.01)

Fraud 7.5018 bps ($0.027) 1.26 bps ($0.005) 5.50 bps ($0.020)

Grosscontributionmargin 99 bps ($0.33) 58 bps ($0.23) 86 bps ($0.31)

7. The Durbin Amendment

Ninety-six percent o FIs cited the Durbin Amendment and other regulatory pressures as a key challenge or 2011.

Te Durbin Amendment, signed into law as part o the Dodd-Frank Act on July 21, 2010, primarily aims to regulatethe interchange revenue that large FIs can receive rom debit transactions and eliminate network restrictions,such as network-FI exclusivity agreements. On December 16, 2010, the Federal Reserve released its drat rules toregulate the debit card market, as required by the Amendment. For each o the two key provisions (interchangeee regulation and network exclusivity), the Fed proposed two alternatives, soliciting eedback rom the industryto guide their nal rulemaking.

FIs are highly critical o the interchange cap proposed by the Fed in response to the interchange provisions. Tey arguethat the rate is too low and the enorcement o a cap is inconsistent with ree market principles. Tere is consensusthat the proposed cap o $0.07 to $0.12 displays a lack o consideration o the ull costs required to operate a debitbusiness and provides or no return to FIs. However, o the two price structures proposed by the Fed, all FIs preerthe alternative o a at rate o $0.12 per transaction (plus allowable raud prevention costs) since it provides ahigher rate and does not require them to document their costs on an ongoing basis.

FIs argue that the Fed has taken an inappropriately narrow view o which costs are allowable in setting debitinterchange rates. First, FIs believe that the Fed should consider raud costs within allowable costs. Tese raudcosts include expenses related to raud detection systems, compliance with security standards, customer outreach due

12

Consumer blended is the weighted average o signature (consumer) and PIN debit13 Based on the average ticket or signature and PIN POS purchases14 Reers to revenues rom charges on PIN debit transactions, averaged across all FIs and all PIN debit transactions15 Overdrat ees are not explicitly included in the P&L calculation. For more inormation on the revenue generated by FIs

on overdrats, please reer to the Reg E section16 Rewards cost is the industry-wide expense associated with signature debit rewards programs, and reects the percentage

o FIs with a program, the percentage o their cardholders enrolled in the program and the cost. Te actual cost or anyindividual FI will vary widely

17 Te study sample did not include a sucient number o FIs who ofer PIN rewards to determine the average cost18 Reer to raud section or urther details


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to raud, card-reissuance, chargeback and other dispute processing, and conversion to chip and PIN technology.Second, in addition to raud prevention costs, FIs argue that raud losses also should be included in the denition,since they are signicant and not always in the FIs control. Fraud was cited by 72% o surveyed FIs as a keychallenge or 2011. Tird, on top o raud costs, the industry has argued that allowable costs should includeall incremental costs associated with processing debit transactions. Tese additional incremental authorization,clearing and settlement costs include production and delivery costs, network ees and attributable processing

costs (and raud losses and raud prevention), thereby raising allowable costs to a level much higher than theFeds prescribed $0.07.

Even FIs exempt rom the interchange cap do not believe that the carve-out will help them since, over time, marketorces will drive down interchange. O the exempt FIs that participated in the2011 Debit Issuer Study, 70% expecttheir debit interchange to decline by more than 50% (see Figure 10).

FIs are critical o the network exclusivity provisionand believe it is unnecessary in light o the inter-change cap. Tey believe, that by establishing a capo $0.12 per debit transaction, the Federal Reserve isnegating some o the perceived need or additionalnetwork choice at the point-o-sale. Tey also state

that the option o having two signature and two PINnetworks on each card is impractical and will createsignicant operational challenges. Hence, o the twooptions, all surveyed FIs preer Alternative A twounaliated debit networks per debit card.

Te Durbin Amendment is expected to dramaticallychange the payments landscape, with implicationsthat will be elt across every aspect o the debitindustry and several aspects o the broader DDA business. On average, FIs expect a 79% decline in interchangerevenue post-Durbin; regulated FIs expect an 80% decline in interchange revenues, while even FIs exempt rom theinterchange cap expect a 73% decline (see Figure 11).

Since debit is a key component o the DDA, FIs arealready working to retool their existing product set andto reposition its value proposition, including introducingadditional ees, reducing or eliminating rewards programsand ofering more protable alternatives to consumers,such as charge cards and prepaid cards. Fity-ourpercent o regulated FIs are evaluating charging addi-tional ees in order to make up or lost interchangerevenue. Even exempt FIs are rethinking the DDAand debit value proposition with 27% evaluatingadditional ees. Furthermore, FIs expect to eliminate

or signicantly reduce benets provided by currentrewards programs 67% o regulated FIs and 30%o exempt FIs are evaluating changes to their currentrewards programs.

Figure 10: Decline in interchange revenue

expected by exempt FIs (% o respondents)

0%

0% 50+%10-50%0 10%

70%

20%

10%

Figure 11: Expected decline in interchange revenues

(% o current revenues)

OverallExempt FIsRegulated FIs

79%

73%

80%



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pulsenetwork.com 15

8. Regulation E

On November 12, 2009, the Federal Reserve revised requirements or Regulation E to require opt-in consentrom cardholders beore any overdrat ees can be charged or one-time debit purchases or AM transactions.

At that time, most FIs expected the impact o the revised rules to result in reductions in debit transactions,interchange income and overdrat ee revenue. Now that the changes to Reg E have been implemented, we

are able to report on the actual impact to FIs.

PriortotheRegEchanges,74%ofFIsallowedtheircardholders to overdraw their accounts using their debitcards, either at the point-o-sale and the AM, or POSonly (see Figure 12).

o comply with the Reg E revisions, FIs reached out totheir customers and ofered the opportunity to opt-inor overdrat service. Te opt-in rates or the overallDDA base came in below initial FI orecasts. In total,24%ofdebitcardholdersoptedintocontinuedover-drat coverage, lower than the 29% projected in the

2010 Debit Issuer Study(see Figure 13). It is importantto note that opt-in rates include all cardholders; manycardholders did not respond to the communication and

were classied as opting out by deault, as per theregulatory rules.

Figure 13: Opt-in rates projected versus actual

27%24%

49%

20%

56%

35%

29%24%

Projected for 2010 Actual 2010

Large banks Credit unions Community banks Overall

Te efectiveness o FIs opt-in campaigns can be illustrated by looking beyond overall opt-in rates, since overdratrevenues are not evenly distributed across the customer base or most FIs. Rather, overdrat revenues are concentrated

amongasubsetofhigh-frequencyoverdraftusers;84%ofoverdraftrevenueisaccountedforbyonly9%of customers19. Among heavy overdrat users, dened as account holders incurring more than ve overdrats per year,45%optedinforcontinuedoverdraftcoverage(seeFigure14).

Figure 12: Percentage o FIs that allowed cardholders

to overdraw their accounts (pre-Reg E)

% of issuers

POS & ATM Cannotoverdraw

0%

ATM onlyPOS only

60%

26%

14%

19 Source: 2008 FDIC Study o Bank Overdrat Programs


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Figure 14: Overdrat opt-in rates or heavy overdrat users

OverallLargebanks

Creditunions

Communitybanks

ChaseRegions

Overdraft opt-in rates20for heavy overdraft users21

Transaction growth

Overdraft opt-in ratesPublic data22

44% 45% ~50%

56%

95%

Chase Customer opt-in rates

#overdrafts/year Opt-inrate

Less than 4 21%

4-9 41%

10 or more 53%

Te best opt-in results were achieved by issuers that segmented their outreach eforts according to overdratincidence, placing greater emphasis on reaching customers more inclined to use overdrat acilities. O issuersthatemployedmoretargetedeorts,theopt-inrateforheavyoverdrafterswas52%(versus43%forFIsthatdidnotsegmenttheircommunicationapproach).edataontheright-handsideofFigure14,drawnfrompubliclyavailable sources, helps validate the efectiveness o this approach.

On average, 1.6% o all attempted POS transactions would produce a negative balance. As tracked throughthis study, FIs saw a substantial increase in the number o declined transactions ater the Reg E changes wereimplemented. O attempted transactions that would result in a negative balance, the percentage o declines roserom 22% to 57%. As a result o the increased rate o declined transactions, overdrat revenue declined by anaverageof45%ofitslevelspriortothenewregulation(seeFigure15).eincreaseindeclinedtransactionsisdue to a large segment o customers who would have overdrawn their account prior to the regulatory changes,

but opted out o receiving overdrat services.

Figure 15: Overdrat revenue per average transaction (pre- and post-Reg E changes)

1.6%

1.6%

78%

43%

$29

$29

Overdraft revenueper average transaction

(pre-Reg E changes)

% of transactionsthat produce anegative balance

% of transactionsproducing a negativebalance that areapproved

Averageoverdraft fee

Overdraft revenueper average transaction

(post-Reg E changes)

$0.36 pertransaction

$0.20 pertransaction

=

=


20 Weighted by cardholder volume21 Dened as cardholders generating over 5 overdrats per year22 Source: Customers opt in or overdrat protection, Te Wall Street Journal, Nov. 26, 2010

As high as 53%

As low as 21%


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9. Rewards

Fity-six percent o FIs currently ofer a debit rewards program but, in light o the Durbin Amendment, morethanhalf(54%)plantoterminateorrestructuretheirprogram(seeFigure16).Infact,ofregulatedFIs,67%plan to make changes to their rewards program versus 30% o exempt FIs.

Figure 16: Rewards program changes

No changes plannedPlan to terminatePlan to restructure

FIs evaluating changes in currentrewards program

FIs plans for their rewards programs(of FIs with a debit rewards program)

Exempt FIs OverallRegulated FIs

46%

29%

25%54% of FIs plan torestructure orterminate theirrewards programs

67%

30%

54%

Te Durbin Amendment will shit the rewards landscape away rom issuer-unded points programs and towardmerchant-fundedoeringsand/orrelationship-basedprograms(SeeTable4).

Table 4: Post-Durbin rewards program outlook

Rewards Program Points Cash-back Miles

Merchant-

unded

Relationship-

based

Regulated FIs outlook orissuer interest in rewards

programs

Percentage o

regulated issuers notmaking changes to

rewards program

23% 50% 33% 60% 100%

Percentage ounregulated issuers not

making changes to

rewards program

71% 50% 50% 100% NA

Similar to past years, most FIs are unable to quantiy the impact o their rewards programs on key perormancemetrics. FIs will need to better quantiy the true value add o their rewards programs as they seek to makedecisions about their programs in the post-Durbin world. Moreover, FIs rewards programs tend to sufer rom lowcardholder engagement in terms o enrollment and registration (cardholders oten need to register or the programin order to view their points and redeem rewards). Fee-based programs tend to have lower enrollment rates, butgenerate higher registration rates.

pulsenetwork.com 17


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10. Fraud

More FIs track debit raud losses than in the past, as 88% o FIs now monitor raud losses in some orm. Creditunions showed the biggest improvement: only 7% o credit unions do not track raud losses, compared to 19%in the prior year and 38% in 2008. However, the level o detail available on sources o raud has not improved.Sixty-our percent o FIs that track raud losses are unable to ully identiy the point o use o transactions

resulting in raud (AM vs. PIN debit vs. signature debit).

FIs signature raud loss rates stayed consistent with 2009 at 7.50 bps, and PIN POS raud loss rates increased by27% rom 0.99 bps in 2009 to 1.26 bps in 2010. Figure 17 shows the raud unit loss rates or signature and PINdebit. FI efectiveness at detecting and preventing debit raud varies widely best-in-class FIs have been able toreduce their PIN debit raud to nearly zero.

Overall, issuers have a higher recovery rate on theirPIN debit gross raud losses than on their signaturelosses (78% o gross PIN raud losses are recoveredversus 56% or signature debit).

ApproximatelyhalfofallFIs(49%)implementednew raud tools in the past year. Te most efectivetools, according to FIs, are processor tools, Falcon andenhancements to in-house raud monitoring processes(see Figure 18). In addition to the use o raud tools,many FIs have ound success by investing in theirraud monitoring workorce. Overall, 51% o FIsexpect their signature debit raud loss rates to increaseoverthenexttwoyearsand43%expectPINdebitraud loss rates to increase.

Figure 18: Most efective raud prevention tools23

34%

32%

30%

28%

20%

12%

14%

Processor tools

Falcon

In-house monitoring

Real-time txn monitoring

Trend watching

Daily limits

Neural network

% of FIs using as tools

Figure 17: Signature and PIN net raud loss rates

(in bps per $)

2009 2010

Signature PIN

7.50

0.99

7.50

1.26


23 Does not sum to 100% because FIs were asked to indicate several tools


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pulsenetwork.com 19

FIs cite data breaches as the biggest source o raud, although raud rom card skimming and lost/stolen cards are alsoconcerns. Ninety-our percent o FIs were afected by a data breach in 2010; 9% o those FIs cards were potentiallycompromised but, on average, only 2% o their total card base subsequently experienced raudulent activity.

Tirty-one percent o FIs that were afected by a compromise reissued all o the afected cards; other FIs reissuedsome o the compromised cards depending on certain criteria. In deciding whether to reissue compromised cards,

FIs should weigh the expected raud losses against the costs o reissuance and impact to their cardholders.

11. ATMs

On average, active cardholders perormed 2.6 AM transactions per month in 2010. AM cardholder activityhas steadily declined, dropping rom 3.0 AM transactions per active card per month in 2008 to 2.7 in 2009to 2.6 in 2010 (see Figure 19). Some o the decline in AM use can be attributed to the displacement o cashin avor o debit cards and to the use o cash back at the point-o-sale.

FIs reported of-us transaction growth o 1.6% in2010, but a 1.8% decline in on-us volume. For 2011,however, FIs anticipate a decline in on-us and of-us

ATMtransactionsof1.7%and4.2%,respectively.

Credit unions tend to have the busiest AMs, correlatedwith the highest number o cards per AM. Meanwhile,large banks dominate the AM deployment market,accounting or more than 90% o total FI AMs.

On average, FIs charge their cardholders $1.65 per oreign(of-us) AM cash withdrawal within the United States,an increase rom $1.57 in 2009. Te distribution o suchees also reveals a shit toward the higher-end range o$1.75 to $2.00 (see Figure 20). Tirty-nine percent o FIs,mostly large banks, charge a higher ee or withdrawals

at international AMs versus of-us withdrawals atdomestic AMs.

Figure 20: Distribution o oreign ATM ees or domestic transactions

2008 2009 2010

$0.00 $0.75

$1.00

$1.25

$1.50

$1.75

$2.00

> $2.00

7%

3% 4%

30%28%

21%23% 24%

21%

43%

29%

34%

11%11% 10%

Figure 19: ATM transactions per active card per month

20102007 2008 2009

3.4

3.0

2.72.6


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12. Prepaid cards

Prepaid cards are pay beore payment card instruments spanning git cards, GPR cards, payroll cards, exiblespending account (FSA)/health spending account (HSA) cards and other types o prepaid cards. Seventy-six percento FIs currently ofer some type o prepaid card, with the most popular being git cards ofered by 73% o FIs(see Figure 21).

Figure 21: FIs ofering prepaid cards

2009 2010

67%

73%

Gift cards

27%29%

FSA / HSA cards

22%

27%

Payroll cards

9%

14%

GPR cards

6%10%

Other prepaidcards

However, an increasing number o FIs are re-evaluating theirgit card programs, in light o both poor program results andthe git card provisions in the CARD Act. For FIs that sellprepaidgiftcardsthroughtheirbranches,47%selllessthan100 cards per branch per year (see Figure 22).

GPR cards are efectively checkless checking products,replicating many o the eatures o a typical DDA, just withoutchecks and without access to branches. GPR prepaid cardshave more unctionality than single-use git cards, ofer

various potential sources o revenue and can substitute as lower-cost alternatives to checking accounts/debitcards. GPR prepaid cards are especially gaining momentum due to their exemption rom the interchangeregulations under the Durbin Amendment. Fourteen percent o FIs ofer GPR prepaid cards, up rom 9%in 2009.

Among other types o prepaid cards, FSA/HSA cards and payroll cards are the most popular, ofered by 29% and27% o all FIs, respectively. FIs are divided on the growth opportunities or these types o programs. In general,since such prepaid cards are not seen as core products, they are not strong areas o ocus or most FIs.

Figure 22: Prepaid git cards sales per branch

(o FIs that sell through branches)

< 100100 300300 500500 +

9%16%

28%

47%



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pulsenetwork.com 21

13. Alternative payments

Contactless cardsInterest in contactless debit cards continues to erode 22% o FIs ofer at least some contactless debit cards,but 18% o these FIs plan to discontinue doing so (see Figure 23).

Figure 23: Contactless cards

Plan to stop oeringPlan to continue oeringCurrently oerPlanning to oer

No plans to oer

FIs contactless debit card oerings FIs plans for contactless cards(of FIs who currently oer contactless cards)

22%

2%76%

18%

82%

Only 9% o cardholders with cards with contactless capability actually use the contactless eature. In total,contactless transactions represent just 0.03% o total debit card transactions. In general, FIs are discouraged bythe incremental cost o contactless cards, their low level o merchant acceptance and weak cardholder interest.

Mobile nancial servicesMobile nancial services span mobile banking and mobile payments. With mobile banking, the customer uses a

mobile phone to perorm certain unctions check balances, perorm account transactions/und transers, initiatebill payments and locate branches/AMs. With mobile payments, the consumer uses the mobile device itsel toinitiate a payment at a physical point-o-sale. Cardholders link card payment inormation to a mobile device anduse the phone to initiate a payment relying either on SMS or near eld communication (NFC) capability.


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enumberofFIsoeringmobilebankinghasgrownfrom37%in2008,to46%in2009,andnow62%in2010(seeFigure24).OftheFIsthatindicatedtheywereplanningonintroducingmobilebankinginlastyearsstudy,74%havefollowedthroughandlaunchedamobilebankingplatform.Mobilewebcontinuestobethemostcommon orm o mobile banking supported by FIs, although the popularity o downloadable applications andSMS has grown quickly.

Figure 24: Adoption and interest in mobile banking by FI segment 2010

Large banks

72%

Credit unions

57%

36%

7%

12%

16%

Community banks

46%

27%

27%

Overall

62%

22%

16%

Already oer Plan to introduce No plans

Te percentage o FIs exploring mobile payments increased rom 21% in 2009 to 26% in 2010. While some FIsare looking into ways in which they can participate, many believe that this alternative payment method has a long

way to go to become a proven and viable option.

Alternative payments companiesMost FIs do not consider any alternative payment companies as material threats to their core debit business.

However, o the various alternative payment methods, the most commonly cited concern was PayPal(see Figure 25).

For alternative payments players, Durbin-mandatedpricing undermines insurgent business models. Tebasis or innovation with alternative payments was togenerate a lower price point than traditional paymentorms. With the Durbin Amendment resulting insubstantially lower pricing, merchants no longer havean incentive to look or a cheaper payment optionthan debit.

Figure 25: Alternative payment methods

cited as threats by FIs24

NonePayPal Decoupleddebit / ACH

Other

20%

10%

26%

66%


24 Percentages add up to more than 100% because some FIs cited multiple threats


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pulsenetwork.com 23

About Oliver Wyman and PULSE

Oliver WymanTe2011 Debit Issuer Studywas conducted by the Financial Services practice o Oliver Wyman, a leadingindependent management consulting rm, and all opinions expressed are solely those o Oliver Wyman. Oliver

Wyman serves Global 1,000 clients on a wide range o strategic issues and counts 75 o the global top 100 nancialinstitutions as its clients. Te rm has guided some o the worlds most sophisticated institutions on their retailbankingandpaymentstrategies.OliverWymansstaof3,000operatesfromocesinmorethan40citiesin16countries. For more inormation, please visitwww.oliverwyman.com.

isreportwaspreparedbyTonyHayesandInderpreetBatra.TonyisaPartnerinthermsRetailandBusinessBankingPractice,specializinginstrategicissuesrelatedtoretailpayments;hecanbereachedat617-424-3283and tony.hayes@oliverwyman.com.InderpreetisaPrincipalintheRetailandBusinessBankingPractice,workingacross payments, operations and wealth management; he can be reached at 646-364-8789 and [email protected].

PULSE

As part o its ongoing commitment to industry thought leadership, PULSE commissioned the2011 Debit IssuerStudyand this report, but has no involvement in the execution o the project.

PULSE, a Discover Financial Services (NYSE: DFS) company, is a leading AM/debit network, serving morethan4,400banks,creditunionsandsavingsinstitutionsacrosstheUnitedStates.enetworklinkscardholders

with AMs and POS terminals at retail locations nationwide. Trough its global AM network, PULSE providesworldwide cash access or Diners Club and Discover cardholders through hundreds o thousands o AM locations.Te company also is a source o electronic payments research and is committed to providing its participants witheducation on emerging products, services and trends in the payments industry. PULSE provides additionalresources through its website to assist participants in responding to the changing debit landscape, includingcurrent research and insights rom various industry studies. In addition, the online Durbin AmendmentResource Center provides the latest inormation pertaining to the Durbin Amendment. For more inormation,

go towww.pulsenetwork.com.


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For more inormation about the2011 Debit Issuer Studyand to discuss its implications or your organization,

please contact Steve Sievert at 800-420-2122and [email protected].


CopyrightMay2011,PULSE.Allrightsreserved.Reproductionbyanymethodorunauthorizedcirculationisstrictlyforbiddenandisaviolationoffederalcopyrightlaw.


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2011 debit issuer study

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