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Member Banks See Windfall in Visa IPO

Laurie Kulikowski

Visa's initial public offering next week could raise up to $18 billion, but the real winners stand to be its member banks and underwriters.

In a worrisome U.S. economic environment, the banks stand to make a tidy sum selling shares back to the San Francisco-based credit card payments company. Banks struggling to maintain capital levels as the credit crunch holds tight and losses from residential mortgage loans intensify especially welcome the opportunity.

And while some market participants have expressed doubt that the IPO could live up to its lofty expectations in a down market, the more than 40 underwriters -- many of them the same banks expected to record large gains from the IPO -- are doing all they can to make sure the deal is successful.

The banks "certainly have a lot of interest in it going public," says Nicholas Einhorn, research analyst at Renaissance Capital, which runs the Web site IPOhome.com. "If there are liquidity issues at these bigger banks they have a lot of interest in pushing it out sooner. Because they basically own the whole company they have a lot of say in when Visa goes public."

Visa has more than 16,000 financial institution customers and operates the world's largest electronic payments network. The company, like rival MasterCardMA, which had its own successful IPO in 2006, makes its money on transaction fees and does not hold customers' credit card debt on its balance sheet, making it an attractive property during the credit crunch.

Prior to a restructuring completed last year, Visa was organized as multiple associations by country. So-called member banks owned shares in the various associations. It now operates under one holding company with the exception of Visa Europe.

Visa, which will trade under the ticker symbol "V," plans to sell 406 million Class A shares at $37 to $42 a pop, according to a filing with the Securities and Exchange Commission. The proceeds from the IPO could top $18 billion, if shares of Visa are priced at the very top of the indicated range. The company is expected to price shares after the market closes on Wednesday and begin trading on Thursday, observers say.

While the proceeds expected from the deal are gargantuan, Visa itself will only see a small portion.

Visa plans to use about $10 billion of the IPO proceeds to redeem shares owned by the so-called member banks. The largest owners -- JPMorgan ChaseJPM, Bank of AmericaBAC, National CityNCC, CitigroupC, U.S. BancorpUSB and Wells FargoWFC -- plan to initially sell about 30% of their stakes.

JPMorgan Chase -- one of Visa's largest customers along with BofA -- said it expects a gain of roughly $1.2 billion before taxes in the first quarter. Charlie Scharf, Chase's head of retail, is also on Visa's board of directors.

Bear Stearns analyst David Hilder estimates that BofA would have an initial gain of $545 million, if the stock is priced at $39.50 (minus fees), the midpoint of the $37 to $42 a share price range Visa indicated. Under these terms, Nat City would get a boost of $380 million, while Citi would have a gain of $261 million, Hilder says. Two other large banks -- U.S. Bancorp and Wells Fargo stand to gain $241 million and $238 million, respectively, according to a recent note.

The gains would provide a nice boost to capital levels, analysts say.

Using JPMorgan Chase's projected gain as a basis, Andrew Marquardt, an analyst at Fox-Pitt, Kelton Cochran Caronia Waller, estimated that the Cleveland-based Nat City could see a 19-basis point improvement to its current Tier 1 capital of 7.99%, according to an industry note this week. Marquardt is using Tier 1 levels that have been adjusted for recent capital raises at some banks, including Nat City.

On the other hand, Citi would have the least improvement to capital levels, Marquardt wrote. The New York banking titan would add just 1 basis point to its Tier 1 capital level of 8.67%.

Besides the redemption of shares, Visa will deposit $3 billion of the proceeds into an escrow account to cover any legal expenses and fees pertaining to several ongoing lawsuits and its November settlement with American ExpressAXP. AmEx alleged that Visa, MasterCard and a host of big banks conspired to keep the company out of the bank-issued credit card business.

Visa still faces a similar antitrust suit with Discover Financial ServicesDFS.

But perhaps the biggest pieces of remaining litigation are 50 class action and individual complaints filed since 2005 on behalf of merchants against Visa, regarding so-called interchange fees. The suits allege the involvement of Visa, MasterCard and member banks in the setting of default interchange rates violated federal and state antitrust laws. The plaintiffs in the litigation are "seeking damages for alleged overcharges in merchant discount fees," Visa's filing says.

More than $50 billion is at stake if the merchants are successful, according a recent article by the Legal Times on Law.com.

That leaves just $3 billion of the proceeds to be used to grow the business. And there are plenty of areas to grow.

Michael Kon, an analyst at Morningstar, notes many countries outside the U.S. are just beginning to convert from cash to plastic payment methods, and transactions will also start moving through mobile phones.

"All of this requires a lot of investment," he says.

While Visa's outlook is generally optimistic, the company isn't totally immune to downward economic trends. A significant downturn of consumer spending could take its toll on Visa and MasterCard as the two get paid through fees garnered by customer transactions. Plus it remains to be seen how Visa's remaining litigation plays out.

"Obviously the timing is perfect for the [banks] because many of them need the capital, but I don't think that was the trigger for the entire process," Kon says. "The process started a few years ago when Visa U.S. started to negotiate with several Visa organizations to get together to merge and go public. The trigger for that were the legal liabilities -- the banks wanted to limit those liabilities."

Banks are also eager to breathe life into the dismal IPO market this year. If Visa's IPO does well, it could encourage other companies sitting on the sidelines to enter the market, helping underwriting fees overall, observers say.

The top eight underwriters -- JPMorgan Chase, Goldman SachsGS, BofA, Citi, HSBC, Merrill LynchMER, UBS and WachoviaWB -- will receive the lion's share of the fees. Fees could be roughly $480 million if shares trade at the midpoint price of $39.50. Visa is currently estimating a 3% fee, according to the prospectus.

"It's not the best time to go public with what's happening in the market, but MasterCard's stock has been holding up pretty well compared to some of the other financial services companies and that's basically at the end of the day [Visa's] No. 1 benchmark," Kon says. "It has a more positive event for the market itself because it definitely might change some of the mood in the IPO market."