Interchange is Uber Important

Over the last few years, interchange in our industry has been as volatile as ever. Members have shown credit unions—with impressive year-over-year growth—that cards are here to stay. They have also unequivocally demonstrated that the current mixture of convenience, fraud protection and reliability has become mainstream. Mobile might be the payment vehicle of the future, but today cards are king.

Interchange is one of the most important facets of a credit union’s card portfolio and should be regularly tuned so it’s firing on all cylinders. Defined as the transfer rate exchanged between the merchant’s and cardholder’s financial institutions each time a card-based payment product is used at a point of sale, interchange varies based on the individual transaction and can range from just a few pennies to a few dollars.

As with most things EFT (electronic funds transfer), this topic of interchange income is quite complex, but can be managed effectively. And it’s worth the effort. There is a large difference in the income potential of credit unions that actively manage their interchange vs. those that don’t. A good interchange strategy should contain these five key activities:

1. Understand how important interchange is from a quantitative standpoint.

Interchange is one of the most important aspects of non-interest income. Within the credit union industry, if we take a look back at 2012, debit interchange was estimated by Filene to be at $2.2 billion, with at least $2 billion to $3 billion in credit card interchange and net spread. Total credit union net income was estimated by Cornerstone Advisors at $8.6 billion. Take those numbers together and you have roughly 30 percent to 40 percent of net income directly attributable to interchange. So interchange is a big deal, and the first step in successfully managing it would be to build simple but effective reporting structures around it, such as a payments profit and loss statement.

2. Measure the credit union’s interchange income and variances from peer levels.

Every credit union should have the right tools for this job—tools that track progress and encompass all payments channels, not just interchange-generating ones. The payments P&L is the primary tool used for this purpose and is very powerful. This P&L evaluates the profitability of each individual channel, including checking, ACH/wires, person-to-person, bill-payment, credit cards, and debit/ATM/prepaid cards. The payments P&L is a very pragmatic tool that can be assembled with data that is readily available. When evaluating interchange specifically, a lot of data can be gathered without a huge investment, including information collected from the general ledger, invoices and existing reports.

Once the P&L is established, a payments scorecard should be created to track goals over time and enable review of trending information. This scorecard differs from the P&L in that, while the P&L is just numbers, the scorecard contains the benchmarks, metrics, goals and trend information.

Part of the payments struggle faced by many credit unions is that people don’t take it seriously enough or the information resides in multiple areas and is not brought together in a coherent manner. There may be one or two people at the credit union who take this seriously, but it is rare that credit unions manage this from the executive level. A short-term goal would be to elevate the discussion as a managed item leveraging the P&L to bring visibility into the mechanics of the revenue center. A longer-term goal would be one of recurring improvement and investment in the discussion of “where are we with our goal and how do we get there?”

A payments P&L and a scorecard are great tools that can identify and report on the card portfolio; but understanding the elements of the complex interchange equation is critical to knowing how to drive income potential.

3. Review member usage patterns and evaluate interchange opportunities.

A number of key elements within credit unions’ control of influence can have a drastic effect on the amount of interchange they collect: average ticket spend, categorical spending (fuel, groceries, retail, etc.), average transactions per card, and signature vs. PIN point-of-sale transaction mix. All of these elements are indicators of member behavior, which is the single greatest area of influence a credit union can have on its interchange income.

Credit unions should perform an analysis on each individual element by card type (consumer, business, credit, debit, etc.) and compare the elements to industry averages. This analysis should identify elements by product where opportunity exists to maximize the income potential of interchange.

Card portfolios today are a mixture of different card types, and it is important to break these into their own buckets when analyzing income potential. The elements to consider for business cards will be considerably different than for consumer cards. When performed effectively, such an analysis will start the conversation on how to put effort toward those areas that will maximize the benefit to the credit union.

Simply stated, how members use cards makes a huge impact on the potential income and profitability of any portfolio, and understanding whether top-of-wallet or bottom-of-wallet relationships with members exist is critical to maximizing interchange.

4. Tackle the inevitable regulatory pressure to decrease interchange income.

Unfortunately, interchange has been and continues to be under tremendous regulatory scrutiny over the last couple of years, which has forced a downward trend. On July 31, 2013, a federal judge overturned the Federal Reserve’s rule that currently limits interchange for issuers that are $10 billion and more in assets. Essentially the court invalidated these interchange limits and the non-exclusivity provisions pertaining to payment networks. Its decision essentially called the current limits too high and found that the ability for an issuer to have a single signature network did not meet the expectation of the Durbin Amendment. The Fed is currently appealing and a change in the Fed rule­ is expected in 2014.

The bottom line is this: Interchange income is on a downward trend that is expected to continue, even for financial institutions that are less than $10 billion in assets

5. Develop a contingency plan to address decreasing interchange income.

As reported by the Fed, the industry average exempt issuer’s (a financial institution with less than $10 billion in assets) interchange on a signature transaction in 2012 was $0.51, and on a PIN POS it was $0.30. These numbers are on the decline. As a practical example of this, see the tables below, which show volumes and metrics from a single Cornerstone client credit union that issues debit cards.

From a very practical standpoint, we could surmise that the amount of interchange revenue increased, but not at the same rate of transaction growth. The total dollar amount of interchange went up year over year by 9 percent, but interchange went down on a per-transaction basis. These are the reasons:

• The number of transactions increased by 15 percent.
• The average transaction amount had slight increases.
• The average interchange per transaction declined by 8 percent.

This is clearly an impact of a commoditizing business model. As volumes increase, margins are challenged. While usage and growth have been great ways to offset margin decreases, now is the time to start planning for the possibility that the trend doesn’t continue or isn’t supported moving forward.

Members have shown us that cards are here to stay and are mainstream today. The income potential is great, and the reward for active management is alive and well.

Ryan Rackley is a director with Cornerstone Advisors Inc., a CUES Supplier member and strategic provider based in Scottsdale, Ariz.