2012 Debit Issuer Study

Steve Sievert Executive Vice President, PULSE

November 29, 2012

Executive Summary

Study Overview

PULSE commissioned Oliver Wyman to conduct the 2012 Debit Issuer

Study, the definitive assessment of the debit card industry

– Based on primary research with 57 financial institutions (FIs), drawn from

across FI types and sizes, geographies and network affiliation

– Conducted in April and May 2012

– Sample includes ~87 million debit cards and is representative of the market

Segment Label Participants

Large banks (Top 60) LB 26

Credit unions CU 15

Community banks CB 16

Total 57

Segment Participants

Regulated

(≥ $10 BN in assets)

27

Exempt (< $10 BN in assets) 30

Total 57

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Summary of Key Findings

While debit growth remains strong, issuers report profound changes to their

business as a result of Regulation II

– For regulated issuers (≥ $10 billion in assets), how they manage their debit

business has fundamentally shifted

Important changes in terms of the overall attractiveness of debit, the relative

importance of different transaction types, and interest in debit rewards and GPR

prepaid cards

– Many issuers were affected by the requirement to participate in at least two

unaffiliated networks

Issuers report on how they make their network selection decisions and how the

dynamics within the transaction routing market are still playing out

– Certain fundamentals of the debit business remain true, post-Reg II

For exempt issuers, economics and the importance of debit has been relatively

unaffected, to date

For all issuers, debit growth remains robust and managing fraud is a challenge

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Summary of Key Findings (cont’d)

New technologies and business models are generating considerable

interest among issuers

– 47% of issuers indicate that they would like to pilot mobile payments (to enable

their debit “cards” in a mobile wallet)

However, of issuers that have tested it, interest has waned

– Most issuers are aware of Visa and MasterCard rule changes designed to

promote EMV (chip card) adoption; however, very few debit issuers plan to

migrate to EMV debit cards

Issuers cite certain costs and uncertain benefits

– Will merchants adopt?

– Will the dates stick?

– How much fraud will be eliminated versus pushed to other venues?

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What Changed with Regulation II’s

Interchange Cap Provision

5

Regulation II is shifting how regulated issuers manage debit business Exempt issuers report no material change to their business, so far

Pre-Reg II strategy Post-Reg II strategy

Overall interest in

the debit business

Fast-growing, high-margin fee

business

Focus on growth through increasing

Penetration, Activation and Usage

Significant reduction in debit revenue and

contribution

Less enthusiasm to grow debit spend

PIN vs. signature Promote signature debit, since

higher interchange rate more than

offsets the higher costs

Same interchange rate cap for signature and PIN

Promote PIN debit, since it now has a better

margin (as a result of lower costs)

Business debit Highest per-txn contribution margin

One of the top three growth

opportunities within debit

Revenue declined by 87%

Business debit is now unprofitable on a per-

transaction basis for some issuers

Ticket size and

performance

metrics reporting

Grow large-ticket transactions to

capture more revenue/transaction

Revenue and margin tracked on a

bps of dollar volume basis

Grow small-ticket transactions, since revenue is

now primarily driven by number of transactions

(not spend)

Revenue and margin tracked on a dollar per

transaction basis

Rewards Use rewards as a lever to grow

debit usage and profitability

Significantly lower interest in issuer-funded

rewards programs, given shrinking top-line

GPR cards Limited interest in GPR prepaid

cards; greater opportunities

elsewhere

More issuers offer – and are interested in offering

– GPR prepaid cards (exempt from the

interchange cap under certain conditions)

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As required by Reg II, interchange rates dropped for regulated issuers

Note: Pre-Reg II refers to interchange rates reported by respondents for the period Jan-Sep 2011 (also referred to as pre-Oct 2011), while post-Reg II refers to interchange

rates for the period Oct-Dec 2011 (also referred to as post-Oct 2011)

Consumer signature interchange Consumer PIN interchange

144 bps

64 bps

143 bps 137 bps

144 bps

73 bps

72 bps

51 bps

85 bps 85 bps 74 bps

56 bps

Pre-Reg II Post-Reg II

Interchange rate ($ per txn) Interchange rate ($ per txn)

Overall interest in debit business

Ticket

size $36 $34 $36

Ticket

size $42 $39 $42

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18.3 $0.23 12 = $51 per

active

card per year

Transaction mix Blended

interchange rate

($ per transaction)

Monthly

transactions

per active

card

×

Gross interchange

revenue per active

consumer card

×

Interchange rate

($ per transaction)

Debit interchange revenue per consumer card for

regulated issuers is now 45% less than that for exempt issuers

Average gross interchange revenue per active consumer card Regulated vs. exempt issuers

Re

gu

late

d

Ex

em

pt

Months

per year

Note: Numbers may not add up as shown in chart due to rounding

1. Up 6% from $87 per active card per year from the 2011 Study

18.7 $0.41 12 = $92 per

active

card per year1

×

Gross interchange

revenue per active

consumer card

×

Overall interest in debit business

$0.33

$0.46

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Regulated issuers now prefer PIN debit over signature

■ Historically, many issuers preferred

signature transactions

– Many issuers had marketing or

rewards strategies in place to

promote signature transactions

Post-Reg II, a PIN transaction is more

profitable to a regulated issuer than a

signature transaction

– Average gross contribution margin is

$0.11 per signature vs. $0.18 per PIN

transaction

– Due to the interchange cap imposed

by Reg II, the signature-centric

approach has been abandoned by

many regulated issuers

“We need to move from signature to

PIN. We may have some sweepstakes

for PIN transactions.”

– Regulated FI

“We are promoting PIN debit over

signature as a cost-savings play.”

– Regulated FI

“We have been aggressive with

contacting customers with phone and

direct mail to promote PIN.”

– Regulated FI

Many regulated issuers are

employing various tactics to increase

their share of PIN transactions

PIN vs. signature

9

Relative share of PIN and signature debit transactions

has remained steady, but might change post-Reg II

2011 PIN/signature

transaction mix

Trends in PIN/signature

transaction mix

PIN vs. signature

10

Business signature debit was significantly impaired by Reg II

Business signature interchange rates

231 bps

26 bps

241 bps 215 bps

232 bps

40 bps

Pre-Reg II Post-Reg II

Business debit

Note:, Pre-Reg II refers to interchange rates reported by respondents for the period Jan-Sep 2011 (also referred to as pre-Oct 2011), while post-Reg II refers to interchange

rates for the period Oct-Dec 2011 (also referred to as post-Oct 2011)

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$0.39

Business debit interchange revenue per card for

regulated issuers is 85% less than that for exempt issuers

Average gross interchange revenue per active business card Regulated vs. exempt issuers

Note: Numbers may not add up to 100% because of rounding

1. Up 7% from $273 per active card per year from the 2011 Study

14.1 $0.25 12 = $43 per

active

card per year

Transaction mix Blended

interchange rate

($ per transaction)

Monthly

transactions

per active

card

×

Gross interchange

revenue per active

business card

×

Interchange rate

($ per transaction)

Re

gu

late

d

Ex

em

pt

Months

per year

16.3 $1.49 12 = $291 per

active

card per year

×

Gross interchange

revenue per active

business card

×

Business debit

$0.33

$1.80

12

The debit market is expanding at the low-end,

with small-value transactions displacing cash

Ticket size distribution

Mean = $38

Median = $19

Ticket size & performance

metrics reporting

13

Regulated issuers now prefer low-value debit transactions

Interchange rates have shifted from largely ad-valorem based (bps on

dollars) to largely per-transaction based (dollars per transaction)

– As a result, the realized interchange rate (in bps) on small-value transactions is

now higher

– Some costs – network fees and fraud losses – are calculated based on ticket size

Smaller-ticket purchases now have higher margins

“More income is made by growing

transactions, we need to improve our

small-ticket penetration”

– Regulated FI

“Large-ticket signature purchases now

cost more than we receive in

interchange revenue”

– Regulated FI

Ticket size & performance

metrics reporting

14

Interest in issuer-funded rewards programs is waning

Planned changes in current rewards program % of issuers

65% of all

issuers do

not plan to

have a

rewards

program

81% of

regulated

issuers do

not plan

to have a

rewards

program

Rewards

15

More issuers now offer GPR prepaid, attracted by higher

interchange rate and ability to meet specific customer needs

Percent of issuers offering GPR cards1

1. For regulated issuers, reloadable cards are exempt from the cap only if the following three conditions are met: a. There is no overdraft facility; b. At least one ATM

transaction is free a month; c. The funds can only be accessed through the card (i.e., no ACH-based bill pay)

Prepaid card sales growth

projections for 2012

13%

GPR Cards

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What Changed with Regulation II’s

Network Exclusivity Provision

17

Many issuers needed to change their debit card

network participation in order to comply with Reg II

Overall card mix Debit card counts as of December 2011

Cards only participate in

affiliated networks

Must change

• Add an unaffiliated network

Signature-only cards

5%

Must change

• Add an unaffiliated PIN network

PIN-only cards

11% Cards only participate in one

PIN network

Must change

• Add another PIN network

• Add an unaffiliated signature network

Cards participate in (at least) two PIN

networks

No change required

Dual function cards

84% Cards already participate in (at

least) two unaffiliated networks

No change required

Network exclusivity provision

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Many issuers expressed concern with how the

market for network transaction routing is evolving

Will transactions shift from a lower cost network to a higher cost network?

Will networks lower interchange rates to try to attract merchant/acquirer

routing?

Issuers concerns with loss of routing control

“Within days, half of our volume migrated

over to the new PIN network. The shift was

much faster than what we expected.”

“We used to have a lot more control over how our transactions are routed, but now post-

Durbin we don’t have that level of control anymore.”

“We don't have any control over the

merchant’s routing and we don't know how

it will impact our income and expense.”

Network exclusivity provision

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Certain Fundamentals are Unchanged

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Exempt

issuers’

interest in

debit

Debit economics for exempt issuers have not been significantly impacted

by Reg II – at least, not to date – and hence their view of debit is relatively

unaffected by it – Interchange has declined by 0-3%, as compared to 30-60% for regulated issuers

– Exempt issuers are focused on improving debit performance metrics, rewards

programs and growing the business

Debit

growth

Consumer usage of debit continues to grow strongly; growth in 2011

exceeded issuers’ expectations

Issuers expect the positive trend to continue

Fraud as a

key

challenge

Fraud continues to be one of the top challenges facing the industry,

impacting both regulated and exempt issuers

Issuers expect fraud rates to remain steady or increase in the future; few

predict declines

Outlook for

debit

All issuers agree that regulatory pressure and fraud are the biggest

challenges to their debit business

Exempt issuers see more growth opportunities in the debit business;

regulated issuers show greater interest in cost reduction opportunities

Market characteristics that did not change post-Reg II

21

Debit usage continues to grow

Key debit performance metrics in 2010 and 2011

Consumer

Business

2010 2011

Debit growth

22

Consumer debit growth in 2011 exceeded issuers’ expectations

PIN transaction growth in 2011 Projected vs. actual

Signature transaction growth in 2011 Projected vs. actual

Debit growth

Projected Actual

23

Issuers believe that the positive trend will continue

Transaction growth projections in 2012

Debit growth

Consumer

24

Fraud remains a major challenge, with

data breaches as the primary source of fraud

Signature debit and PIN debit loss rates In bps per $

Primary sources of fraud1

Note: “Data breaches/compromises” include counterfeit cards/card compromise, as well as network, processor and merchant breaches. “Other” includes international fraud,

breaches by family/friends and false client disputes (“first-party fraud”)

1. Does not sum to 100% because issuers indicated multiple fraud sources

Fraud as a key challenge

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7.50 bps 7.50 bps

8.06 bps

1.26 bps

5.24 bps

7.50 bps 7.50 bps

8.06 bps

0.80 bps 0.99 bps

1.26 bps 0.99 bp

54% of issuers expect signature debit fraud rates to

increase in the future; 37% expect PIN debit fraud rates to increase

Fraud loss ratio predictions1 Signature debit

Fraud loss ratio predictions1

PIN debit

1. Time horizon for predictions is two years (2012-2013)

Fraud as a key challenge

Increase Stay the same Decrease

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All issuers report that regulatory pressure and

fraud are the biggest challenges to their debit business

Key challenges for 2012 % of issuers

“Ongoing regulatory pressure

around overdraft is also a big

challenge.”

– Exempt FI

“ A decreased profit margin means

a much smaller tolerance for

increases in fraud for us.”

– Regulated FI

Outlook for debit

27

Regulated issuers will

remain less interested

in rewards

Exempt issuers see more opportunities

Key opportunities for 2012 % of issuers

Cost reduction is a bigger

priority for regulated issuers

after Reg II

“We are trying to cut processing

fees, plastic costs, paper

statements, etc. This is an

enterprise-wide challenge.”

– Regulated FI

“We have implemented a

merchant-funded debit rewards

program in hopes to increase

activation.”

– Exempt FI

Outlook for debit

28

Beyond Reg II, issuers are most attentive to

two new developments: mobile payments and EMV

Mobile

payments

Mobile payments allow consumers to use their mobile devices for

transactions at the POS

– Cardholders link card payment information to a mobile device and use the

mobile device to initiate a payment

Several solutions to mobile payments, utilizing different technologies,

currently exist in the market

Many issuers view mobile payments as the natural next step after

mobile banking

EMV

EMV (Europay, MasterCard, Visa) is the chip-based payments

standard used to store card data as mandated by EMVCo

EMV features improved security, which will reduce card-present

transaction fraud

EMV should also enhance card acceptance outside the U.S. (where

chip cards are prevalent)

EMV could potentially allow multiple transaction types to be supported

on one card (e.g. combining debit and credit)

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Many express interest in participating in mobile payments pilots

Mobile payments pilot participation

There is limited participation in mobile

payments pilot programs, but strong

interest

– Large banks are the most active in

participating in pilots

– Some issuers have initiated employee

pilots

Some issuers who have participated

in pilots have been unsatisfied, often

due to the absence of indicative

results

Mobile payments

30

Most issuers are familiar with networks’ EMV rule

changes and expect the transition to be challenging

Issuers’ familiarity with EMV mandates % of issuers

“We are waiting for developments and

question whether the deadline will be

pushed back.”

– Community bank

“Much needs to be addressed at a

processor level before banks can

adequately determine their individual EMV

strategy.”

– Large bank

“We are concerned about merchant

participation and the results from the lack

thereof when implemented.”

– Credit union

EMV

31

Issuers are taking a “wait-and-see” approach to adopting EMV

“The top merchants may go

through a full transformation, but

most merchants will move slowly.

Merchants are worried about

investing too much initially and

then experiencing a rule change.

Most people will adopt a wait-and-

see approach.”

– Large bank

“We will be issuing our

platinum/international cards next

year. We will slowly migrate to

standard issue as the market

adjusts to EMV acceptance.”

– Community bank

Issuers’ plans to issue EMV cards % of issuers

EMV

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Summary

Debit growth continues to be strong despite profound changes to debit as

a result of Reg II

– Regulated issuers are investing less in debit and are pursuing different tactics

than in the past (e.g. scaling back or discontinuing rewards programs,

promoting PIN over signature)

– The environment doesn’t seem to have changed for exempt issuers. Debit

economics are similar – for now

– The requirement to participate in at least two unaffiliated networks resulted in

major shifts in PIN network affiliations, routing dynamics are still playing out

New technologies are generating significant interest among issuers.

Mobile payments and EMV are generating the usual mix of emotions

associated with change – excitement, skepticism and trepidation

– Issuers who have tested mobile payments are not particularly enthusiastic, but

many issuers are still interested in piloting the technology

– Very few issuers plan to migrate to EMV, largely driven by certain costs and

uncertain benefits

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Questions?

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Thank You

salesperson@pulsenetwork.com

pulsenetwork.com

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