U.S. Bancorp bets on prepaid cards

Besides boosting fee revenues, the latest acquisition will increase the volume of merchant transactions processed by the bank.

By Trefis Nov 30, 2012 2:42PM
Female customer handing credit card to receptionist copyright PhotoAlto, Frederic Cirou, PhotoAlto, Getty ImagesWhile its bigger competitors are busy defending themselves from a barrage of lawsuits and making significant changes to their business models in a bid to maintain income figures, U.S. Bancorp (USB) continues to grab any acquisition opportunity that comes its way. 

The fifth-largest U.S. bank is capitalizing on the strength of its balance sheet and depressed valuation across all industries to fuel its growth strategy. 

Earlier this week, the bank announced its decision to acquire prepaid card processing company FSV Payment Systems -- barely a fortnight after its decision to expand its alternative investments business with the acquisition of AIS Fund Management. U.S. Bancorp has announced a total of six acquisitions this year, including the failed BankEast.

Credit card and payment services contribute to a large part of U.S. Bancorp's value

As shown in the chart, our analysis estimates that nearly a sixth of U.S. Bancorp's value comes from its cards & payments business. This emphasizes the importance of the business to the bank -- more so because of U.S. Bancorp's focus on traditional, low-risk banking services.

But the cards business of all the major banks has been impacted by a series of regulations in recent years, including the CARD Act. Limits imposed on interchange fees for debit cards have curtailed card revenues to a great extent since mid-2011 -- something that is seen clearly in this chart below which represents U.S. Bancorp's average fee income every time a card is swiped as a percentage of the transaction value.

US Bancorp Card Revenue as Percent of Transaction VolumeBanks have been looking for alternative means to make good their loss in revenues, including additional charges and monthly/annual fees on debit cards and even extra per-use charges on cards. But most of these measures have failed with customers opposing these fees vehemently as witnessed by Bank of America (BAC) earlier this year.

Data compiled by the Federal Reserve shows that prepaid card transactions have grown at an annual rate of 20% between 2006 and 2009, making prepaid cards the fastest growing form of electronic payment. And the push for prepaid cards by banks and card issuers has only increased in the recent past as they are not subject to interchange limits imposed on debit cards.

Prepaid cards are generally marketed as an alternative to checking accounts, and have gained popularity among businesses and governments who cut costs by disbursing payroll and benefits through prepaid cards. And the enthusiasm among banks for these cards is easily understood from the findings of a Philadelphia Fed report which calculates gross revenues between $45 and $99 over the life of each prepaid card for the issuer.

U.S. Bancorp has been offering prepaid cards for a while now, focusing almost entirely on government agencies. The bank ventured into retail prepaid cards quite recently, and with the acquisition of FSV Payment Systems, it will not only be able to process these payments on its own but will also add existing FSV payments customers like Costco, Walgreen and McDonald's to its payments business. Besides boosting U.S. Bancorp's card fee revenues in the years to come, there will also be a notable increase in the total volume of merchant transactions processed by the bank going forward. Taken together, the deal sure looks like a great step forward for U.S. Bancorp.

US Bancorp Merchant Transactions

At Trefis, we maintain a $35 price estimate for U.S. Bancorp's stock, which is around 10% above its current market price.

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