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Federal Reserve Fights Durbin Ruling

While many investors and bankers breathed a sigh of relief that the Federal Reserve raised the interchange fee cap considerably from its initial proposal, large banks reported significant declines in fee revenue after the rules were implemented during the fourth quarter of 2011.

Bank of America (BAC - Get Report) said in January 2012 that "the implementation of new interchange fee rules in the fourth quarter of 2011 as a result of the Durbin Amendment... reduced revenue by $430 million."

JPMorgan Chase (JPM - Get Report) saw its fourth-quarter 2011 noninterest revenue in its consumer and business banking segment decline by 7%, "driven by lower debit card revenue reflecting the impact of the Durbin Amendment, partially offset by increased deposit-related fees."

Wells Fargo (WFC) said in January 2012 that its fourth-quarter 2011 "Card fees declined $333 million from third quarter due to a $365 million decline in debit interchange fees partially offset by improved credit card fee revenue."

Since Judge Leon said in his ruling that merchants should have the freedom to select a payment processor for every single debit card transaction, shares of Visa (V - Get Report) underperformed those of MasterCard (MA - Get Report) over the succeeding weeks, since Visa has a much larger market share.

But implementing the judge's order would not only be difficult for the Fed, it would create a whole new can of worms for banks, since many debit cards are only designed to work on one payment network. Millions of new debit cards would have to be issued, and many banks would also have to implement significant systems changes.

KBW analyst Sanjay Sakhrani last week advised investors to load up on shares of Visa, since they had declined 7% from July 30 through Aug. 14, while MasterCard was up 5%.

In a note following the Fed's announcement of the appeal, Sakhrani on Wednesday called the regulator's action "incrementally positive new," since it "took some wind out of the sales" for a possible refund by banks of interchange fees the judge finds excessive.

"This action should likely lengthen the process to get to some sort of finality, which not only increases the probability of a more favorable outcome (i.e., given the appellate court will take fresh look at the case) but also give the industry time to plan for any contingencies in an adverse scenario," he wrote. Sakhrani continues to rate both Visa and MasterCard "outperform."

Sterne Agee analyst Greg Smith has neutral ratings on Visa and MasterCard, and in a note on Wednesday wrote that although the Fed's appeal "provides some near-term relief of pressure on Visa and MasterCard (more so on Visa given its higher debit market share), the overhang will drag on and likely create consternation as we move closer to a decision on the appeal."

-- Written by Philip van Doorn in Jupiter, Fla.

>Contact by Email.

Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.
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