Wisconsin bank navigates to greater interchange income

The first step in maximizing interchange income for Horicon Bank was to try to get a clear sense of revenue and expenses from its interchange programs. Getting that clear sense, however, was like trying to look into the heart of a black hole, said Mark Nelson, senior vice president and chief information officer at the Horicon, Wis.-based bank.

Nelson and a colleague at the $609 million bank began a project to maximize income and build products around interchange in 2012. “At the time we only offered debit cards,” Nelson said. “We had a bunch of cards but we weren’t making a lot of money on it.”

Interchange bills are phenomenally granular, Nelson said. “The vendors break out things by fractions of a cent,” he said. “They break things out so much that it was hard to get an apples-to-apples comparison and tell exactly what was happening.”

To establish a reliable comparison, Nelson requested information from banking peers. “We began talking with fellow bankers at meetings and conferences and within our core processing group,” he said. “Since they were noncompeting banks, we were able to gather data on our program from the standpoint of revenue and expenses; we then could benchmark our business. We found we were below our peers for revenue and expenses.”

Since Nelson began the project a year before the bank’s vendor contracts were up for renewal, he was free to change vendors as needed. “We decided we needed to create a competitive situation between vendors,” he said. “Since vendors have breakage fees and de-conversion fees, we strategized to diminish that.”

Nelson sent requests for proposals to three networks and processors.  The bank evaluated the information received and brought in a consultant – Ryan Rackley of Cornerstone Advisors, Scottsdale, Ariz. –  to verify their findings.  “It was a big decision to change providers and we didn’t want to make the wrong decision,” Nelson said.

Cornerstone Advisors has maintained data from every processing and network contract it has helped negotiate since in 2002. “It has gotten more complicated to get a straight price. Service providers have obtained more leverage in contract negotiations,” Rackley said. “Each provider’s pricing methodology is different from the next and they are different on purpose. We help make sure the price is competitive.”

Cornerstone analysis gave Nelson the verification he needed. Horicon Bank switched to SHAZAM as its processor and network in 2013. It also signed up directly with a new card provider, rather than working with SHAZAM’s provider; that change also reduced cost.

“Over five years, we expect to gain $1 million just in cost savings,” Nelson said. “We were at $10,000 to $20,000 per month in interchange income. Now we are at net $45,000 per month. The biggest contributor to lower cost was the processing relationship.”

While the benefits are there, Nelson said banks need to be ready for a sizeable project if they set out to maximize interchange income. “We decided to put some elbow grease into it; it wasn’t easy,” he said. “There have been some hang-ups to switching vendors and getting new cards out, but it has definitely paid off.”


Building usage among customers

While banks reduce their cost of running interchange programs by managing vendor contracts, they cannot negotiate the interchange fee they receive, Rackley said. “There is a formula for interchange; it is typically a percentage of the dollar sale,” he said. “The way to increase interchange revenue is by influencing card holder behavior. Banks do so through rewards programs and marketing campaigns where the goal is larger higher ticket items.”

Both Nelson and Rackley agreed that signature transaction fees are converging with PIN transaction fees. “The gap used to be significant between signature and PIN,” Rackley said. “That gap has gotten smaller and smaller.”

The first step for banks working to increase the frequency and ticket-size of customers’ card usage is to analyze their card portfolio’s metrics and compare them to peers and best in class banks, Rackley said.

The key metrics are:

  • Number of transactions and ticket spend
  • Penetration rate for the bank’s customer base
  • Ratio of debits to check usage
  • Card activation by customers and usage over a 90 day period
  • Pin usage versus signature.

In terms of the ratio of debits to check usage, Rackley said banks will want a high ratio − higher than 100 percent.

If a bank finds a metric does not stack up next to peers, it has identified an area of opportunity, Rackley said. “If you see average ticket spend is low, you can create rewards to encourage bigger ticket spending,” he said. “It is absolutely critical to know the levers to increasing interchange to correctly spend your marketing dollars.”

It is attractive for banks to choose longer term contracts with vendors because it decreases the cost. “Banks should also look at functionality and the level of integration with the processors system, for example, and the bank’s other systems,” he said.

An example of functionality is the ability to update a customer name and address for a card through the bank’s system rather than through a third party application. “It can become a problem, for example, for a customer to walk into a bank and have the service person need 15 different applications to help the customer,” Rackley said.