ef"fc National Credit Union Administration ii"- <9 fm- Sw-> Office of the Chairman April 29. 2011 The Honorable Ben S. Bernanke Chairman Board of Governors of the Federal Reserve System 20m and Constitution Avenue, NW Washington. DC 2055l Dear Chairman Bernanke; This letter furthers the comments ofthe National Credit Union Administration (NCU A) on the Federal Reserve Board's proposed rule on interchange fees. NCUA collected data in March and recently completed a review of the direct costs and income related to debit card transactions for credit unions of different sizes. This analysis substantiates NCUA's prior concerns about the rulemaking. ln order to protect the safety and soundness of smaller credit unions and to ensure that the members of smaller credit unions may continue to have access to debit card services, NCUA urges the Federal Reserve Board to modify the proposed rule either to provide meaningful exemptions for smaller card issuers related to network exclusivity and merchant routing or to address NCUA's concems tlnough some other means. Background on Interchange Fee Rulemaking Congress incorporated the Durbin Amendment into the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. This provision requires the Federal Reserve Board to issue regulations to ensure that interchange fees charged to merchants for electronic debit transactions are "reasonable and proportional" to the cost of processing such transactions. The proposed rule would set this cap at I2 cents per transaction for all institutions with assets exceeding $10 billion As required by the Dodd-Frank Act, NCUA has previously participated in the interagency consultation process to assist the Federal Resewe Board in developing the rule to implement Durbin Amendment effectively. During these discussions, NCU A has advocated tor the development of a final rule with meaningful exemptions for smaller card issuers related to network exclusivity and merchant routing. Excepting smaller issuers from the network exclusivity and merchant routing rules would be consistent with the congressional exemption from the interchange fee rulemaking. In an earlier comment letter, NCUA has observed that 59 percent of federally insured credit unions offering debit card services have assets of less than $50 million. NCUA has also maintained that the proposed rule`s prohibitions against network exclusivity and merchant routing restrictions could significantly increase the tixed and variable costs for these small 17-175 Duke street - Alexandria, VA 22314-3428 - 703-518-6300 The Honorable Ben S. Bernanke April 29. 201| Page 2 institutions, resulting in an inability to remain competitive with larger debit card issuers. Unless changed, the proposed rule could also negatively affect the members of small credit unions by cutting off access to debit cards or unnecessarily increasing the costs of obtaining debit card services. Methodology for Analysis ln order to examine the potential effects of the proposed rule on interchange fee limits and to expand upon the Federal Reserve Board's prior survey of large financial institutions offering debit card services, NCU A canvassed credit unions undergoing on-site examinations during the first two weeks of March. During this exercise, NC UA staff reviewed the interchange contracts and data of individual credit unions. In completing this exercise, NCUA sought to collect data on the direct costs and income related debit card transactions for credit unions of different sizes. NCUA also gathered infomation on the types of` vendor relationships credit unions use for debit products. The review does not incorporate data related to indirect costs like labor, facilities, equipment and other overhead costs related to operating a debit card program. In completing this analysis, NCUA staff also excluded outliers, reporting errors, and incomplete data when such infbmiation appeared to skew the analysis and outcomes. As a result, the final data set for NCUA's review includes 296 credit unions. Results of NCUA's Review NCUA staff has now compiled, scrubbed and analyzed this data. The results of the sweep analysis are found in the enclosed table. In brief, the review confirms NCUA's position about the need for the Federal Reserve Board to adopt meaningful exemptions for smaller card issuers. Among other things, the sweep analysis reveals that the direct costs of providing debit card services are progressively higher for smaller credit unions. Direct costs per transaction do not fall below the proposed cap until credit unions reach $100 million to $500 million in assets. Median direct, per transaction costs for credit unions with $10 million or less in assets came in at 31 cents per transaction. For credit unions between $50 million and $100 million in assets, the median cost falls to 19 cents per transaction. For both groups. however, the median direct interchange costs significantly exceed the maximums allowed under the proposed rule on interchange fees. Additionally, the analysis likely underestimates costs for debit card transactions, as NCUA could not easily segregate and signature transactions in the information obtained during the brief canvassing effort. 'l`he NCUA staff review also finds that credit unions, especially smaller ones, often use a third party to access debit card payment networks. Because the networks may include a processor that only offers the large institution cap rate fee -- such as MasterCard which has previously signaled that it may not operate a dual system -- the proposed rule seems likely to result in market forces The Honorable Ben S. Bemanke April 29, 2011 Page 3 shifting income for credit unions under $10 billion to the large institution cap level of compensation. In other words, without exemptions for network exclusivity and merchant routing, credit unions belonging to a gateway with multiple networks may tind themselves subject to the large institution cap. The analysis further reveals that the smaller the credit union the more likely it was that the institution lost money on member debit card transactions. In fact, a large number of credit unions currently incur direct costs in excess of interchange fee income. The inability of small credit unions to achieve the economies of scale necessary to offer debit card services seems the likely factor in contributing to such losses on provided services. As a credit union increases in asset size, the analysis additionally finds that the median direct cost per card transaction drops. In closing, NCUA again urges the Federal Reserve Board to modify the proposed rule on interchange fees to take into consideration the unique circumstances of smaller credit unions. NC UA also looks forward to continuing to cooperate with the Federal Reserve Board on the interchange fee rulemaking. Please feel free to contact me or to have your staff contact NCUA staff about any questions that you may have about analysis. Sincerely, Debbie Matz Chairman Encl: Preliminary Results Identified in March 201 I Sampling of Credit Unions' Direct Interchange Costs and Income Copy to: Board Member Gigi Hyland Board Member Michael E. Fryzel Preliminary Results Identified in NCUA's March 2011 Sampling of Credit Unions' Direct interchange Costs and Income' $10 million and $10 tn $50 million to $100 million In $500 in Greater than under $50 million $100 million $500 million $1 billion $1 Median ASSELS ol Credit Union $6,771,898 $18,412,315 $57,915,518 $215,448,726 $640,945,662 Median Number of Dehi?lATM Cards 2,520 32,500 82.784 Month 3,185 5,068 31 633 95,590 170,270 336,778 Median Total 0' Card Transactions Pe' Median Transactions Per Card Per Month 12 11 7 11 Median Direct Cost Per Card Transactionz $0.31 $0.21 $0.19 $0.08 $0 10 $0 02 Median Gross Income Per Card Transaction $0.31 $0.27 $0.29 $0.27 $0.45 $0.38 Number of Credit Unions with Net Positive Interchan incomeative Interchan IncomeCredit unions Ne( Transaetitm |nc\udes bum and stgnature due lo the mabmty to segregate acttvity on matt reports mderto gain a NCUA measured total Cara am/tty from a erect mt and perspemve. am/tty wuna resmt tn at wgner net per tfansantm 2 umm equa\s and var\ab\e) fepmeu by a meat umon broken tm month\y apporuons ann uivtaea by the mat reported momnty we tfansamions 3 Positive income from debit card transadions means the Credit uniDn'S total network card services mcome exceeds total network Card services dwect C0515 Negative income from debit cam lransacttons means the credit unions total network card servtces dtrect costs exceed total network card sennces income