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The Green Sheet Online Edition

January 21, 2009 • Issue 09:01:02

Legal ease
Bankrupt banks and credit card acquiring

By Adam Atlas
Attorney at Law

You don't have to go further than the classified section of your local newspaper to know that bankruptcies create opportunities for purchasers of business units that could be profitable under new ownership.

I am not a bankruptcy attorney or financial adviser. The purpose of this article is to highlight aspects of the U.S. banking system's turmoil that affect the payments industry. I am not offering predictions or recommendations regarding investments inbanking or other businesses.

However, based upon my experience in the industry, I believe a few things are worth keeping in mind as we weather this economic storm.

Acquiring is profitable

Of all bank divisions today, the one that is perhaps most likely to continue generating revenue for banks is the division that handles credit card acquiring.

Credit card issuing, lines of credit and mortgages are troubled units inside banks today. But credit card acquiring, although smaller in dollar revenue, continues to be a relatively reliable source of cash flow.

What does this mean if a bank goes bankrupt? If a bank is forced to go out of business because of its losses on loans made to homeowners or businesses, its assets will be placed into a bankruptcy and will be open for sale to interested purchasers.

Put yourself in the shoes of a purchaser of such a bank's assets. What would you rather purchase: a portfolio of loans to individuals who cannot afford to repay them or a merchant acquiring portfolio that is generating a steady stream of residuals?

Chances are you would prefer the merchant portfolio because, subject to your ability to finance the transaction, it is likely to be a profitable purchase.

Bankrupt banks' ISOs are valuable

Conventional wisdom would tell you that the sales force of a bankrupt business is in trouble. But credit card acquiring does not work by conventional rules.

If a bank purchases a merchant portfolio through another bank's bankruptcy, the purchasing bank would be foolish not to honor the obligations of the bankrupt bank to the ISO that created the portfolio.

Again, imagine you are the purchasing bank. If you spend a few million dollars to purchase the acquiring portfolio of a bankrupt bank, and you do nothing to migrate that bank's ISOs to the new acquiring channel, will you have any realistic expectation of maintaining the portfolio you have just purchased? No.

Consequently, purchasers of merchant acquiring portfolios from bankrupt banks are going to be highly motivated to remain loyal to the sales channels that created and support those portfolios. On the flipside, to the extent that purchasers are not loyal to those sales channels, they should not expect the sales channels to be loyal to them.

Also, in a bankruptcy scenario, I cannot imagine any prudent administrator of the assets of the bankrupt bank would do anything but nurture and protect the relationships between the bank's ISOs and their merchants

I cannot predict the future; some ISOs may lose everything as a result of bank bankruptcies, but my experience suggests that despite the turmoil, ISO relationships will continue to be valuable to banks.

ISOs are tethered to merchants

The fact that ISO relationships are likely to survive a bankruptcy bespeaks one of the unwritten but evident rules of our industry: ISOs are tethered to their merchants.

Whether by contractual arrangements or by the sheer necessity to preserve residual income, ISOs will tend to remain connected to their merchant base; they will want to keep earning revenue from the portfolio, regardless of which bank services the portfolio.

Residuals are holding, sales are tough

Few ISOs or merchant level salespeople (MLSs) would survive a decrease of as much as 10 percent in their merchants' sales volume.

It is fortunate that ISOs and MLSs earn residuals based on the volume of sales their merchants carry out. The problem is that to close the same number of new merchants that they did in the past, ISOs and MLSs are having to work about three times as hard.

In other words, the cost of signing new merchants has become considerably higher, which means the residuals from merchant accounts need to be spread around more than previously.

Personal bankruptcies are up

Some ISO owners are in the terrible situation of facing personal bankruptcy for reasons not related to their businesses. The unfortunate consequence of such bankruptcies is that the creditors in the bankruptcies will become owners of the ISOs.

Given that very few creditors would know how to operate an ISO, they are likely to sell the assets of the ISO to another ISO or simply allow the portfolio to wither on the vine. This is not a personal finance advice column, so I will not discuss the ups and downs of bankruptcy; there is a lot of literature on this topic available on the Internet.

Some creditors will receive residuals

Some ISOs will have the unfortunate obligation of paying residuals to creditors of MLSs who have gone bankrupt. Such financial and legal obligations will run against the traditional loyalty that exists between ISOs and MLSs.

They will also strain the obligations of MLSs to honor the nonsolicitation and noncompetition clauses they entered into with ISOs. ISOs that find themselves in this situation should lean on the creditors to fulfill the obligations the bankrupt MLSs would otherwise have fulfilled, such as servicing the merchants.

Bankcard acquiring endures

While most feet on the street are having to work harder for the residuals they earn, merchant acquiring businesses can take some comfort in the fact that, regardless of the woes of banks, the credit card acquiring division of any bank will be seen as a valuable asset whether the bank is surviving or going bankrupt.

Often thought of as a relatively unprofitable division of bank services, merchant credit card acquiring may become one of the more durable sources of income for banks in the difficult months ahead. end of article

In publishing The Green Sheet, neither the author nor the publisher is engaged in rendering legal, accounting or other professional services. If you require legal advice or other expert assistance, seek the services of a competent professional. For further information on this article, e-mail Adam Atlas, Attorney at Law, at atlas@adamatlas.com or call him at 514-842-0886.

The Green Sheet Inc. is now a proud affiliate of Bankcard Life, a premier community that provides industry-leading training and resources for payment professionals. Click here for more information.

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