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The financial crisis that has been erupting in the U.S. and Europe over the course of this year will have profound long term effects on the acquiring business and on ISOs specifically. The purpose of this article is to highlight the key areas where our industry can expect change. This re-ordering of the financial world will be a permanent change to the way business is done in the U.S., and its effects will be felt at all levels of the economy over time. In truth, it's still too soon to know exactly what has happened, let alone what it all means. Even now, leaders in finance and government are still working out how this crisis evolved. The roots are so complex and theoretical that even the sharpest minds on Wall Street are dazed and confused. Many are still stunned to the point of speechlessness at the rapidity and severity of the changes on Wall Street.
While it may look like the crisis popped out of nowhere, it's been building for about 10 years, and possibly more, until the financial system reached the breaking point. Who knew a year ago that we would see giants of the financial world like Bear Stearns and Lehman Brothers disappear completely from the financial landscape? This year, we have witnessed the most breathtaking and far-reaching reordering of our financial system since the Great Depression.
But the world won't come to an end as a result of all these events. Life will go on, of course, but things are going to be different from here. Anticipating the changes and adapting your business to the new future will be the key to prosperity in the new paradigm for American business at all levels.
ISOs and acquirers will feel these differences in the coming months and years. There are four key areas for the industry in the coming months and years.
Assest Valuations
We have seen a resetting of financial valuations for assets of almost every kind from homes to cars to loans to stocks — almost every asset class has had its value adjusted down - and some violently so. Think sale prices of SUVs and the companies who make them if you want to ponder the fate of a sector of the U.S. economy that was, until recently, a major employer and reservoir of value. New and used SUVs are selling for less and less every day. The companies that make them are headed for the graveyard of American business. Other asset classes, like commodities, have also reset dramatically. Oil fell from nearly $140 a barrel to below $80 at the time of this writing. Expect the same from real estate, including housing, retail and office properties.
I think we can also expect a downward adjustment in valuations for merchant contracts and portfolios. They simply are not going to be worth what they were worth several years ago. And there are good reasons for that adjustment. Consumer spending will be weak in the coming months (at least), and therefore merchant attrition will increase as merchants deal with lower revenues. Many merchants will go out of business. That's not good for our industry of course, and heightens the sense of risk in the business. That heightened sense of risk in the quality of merchant residuals will act to depress valuations.
For along time, valuations in our market have included a sense of optimism about growth that now appears to be at least delayed and perhaps non-existent. In fact, our industry may be in for its first experience with a shrinking customer base and revenue.
Consumer Spending
Expect consumer spending to be flat to down. Last year's holiday retail season was a bust, and this year's will probably be worse. Consumers have stretched to the limit in recent years. For at least the last five years, the economy has grown largely due to expanding consumer credit in the form of increased loans using house values as collateral. Both home purchase loans and home equity loans have inflated our recent growth rates as consumers found credit easy to obtain. That credit inflation drove up house prices. The resetting of those house prices to something nearer the historical norms was the proximate cause of the current credit crisis.
Consumers not only leveraged their houses to the limit, but also found that credit cards were readily obtainable and an easy way to finance purchases. Used judiciously, credit cards are a wonderful financial management tool. But when spending gets out of control, theyÕre a cancer on the consumer and the fastest road to financial ruin yet invented.
A credit fueled expansion like the one we have had in the last 5 years won't be turned around until all the bills are paid. Consumers need to pay down debts on houses and credit cards. That's a painful process and one that takes time. We didn't get in to this mess overnight and we won't get out of it overnight. Consumers will reduce their debts in a variety of ways, some through paying it down monthly using excess income. Others will pay it all at once through asset sale (see above about reduced asset values, ouch.) Some will reduce their debts through bankruptcy or other means of repudiation. Recent changes in bankruptcy laws make this choice more difficult and painful than in years past, but it's still an option when debts become overwhelming.
In short, expect consumers to retreat to buying staples and looking for bargains. WalMart, Target and other retailers of that type will do well in this environment. Neiman Marcus and other expensive luxury goods retailers are likely to suffer. Hardest hit of all will be retailers whose products are seen as trendy, unnecessary and/or overpriced (Abercrombie and others). For them, it may well be the end of the road.
Already this year, we have seen the bankruptcies of major retailers like Sharper Image and Mervyn's. They won't be the last as retail shakes out. Who's next? Keep your eyes on the business pages. I think that by the middle of 2009, after this holiday seasons has come and gone, weÕll see 'ther retailers fall — and perhaps some big ones.
Availability of Credit for Business and Consumers
Credit of any kind - business or consumer — is going to be harder to get, more tightly underwritten (meaning lower risk profile for the lender) and more expensive. Let's talk about each one separately.
Business lenders will take a number of months at least, and possibly a year to get their feet back under them. This year, especially the last half, has been so topsy-turvy for business lenders that most are just catching their breath. Even the ones who are left standing with solid balance sheets have been reluctant to lend because of uncertainty about the environment. Over the last six months, banks have been reluctant to lend to one another due to uncertainty about the stability of their counter party.
That sense of risk is reflected in the interest rate banks charge for loans to each other, which has been at historic highs. If banks don't have confidence in each other, they won't have confidence in businesses either.
In addition, and more profoundly, there has been an erosion of credit quality in the United States that has taken almost 50 years to play out. Today, there are only 7 companies in the U.S. with a AAA credit rating. (In 1980 there were at least 32 non-financial companies rated AAA). And one of them, General Electric, had to borrow $5 billion from Warren Buffet and agree to pay a 10% dividend FOREVER to get it. For GE, thatÕs junk rates. What that means is that no one believes that any borrower is worth making a loan to anymore. And when that happens, lending stops.
Combine these problems in banking with the asset price adjustment phenomenon mentioned above, and no banker knows whether the collateral he's lending against will be worth loan value in the future. It's a terrible dilemma and one that will likely make bankers all over the world hesitant for quite some time.
Consumers are also likely to find credit harder to come by in the coming years. Already, credit card companies have been cutting back on credit limits and reducing their marketing efforts. They simply could not continue growing in the way they had been over the last 10 years. Many credit card companies resorted to marketing to consumers who had weak credit ratings and are now paying the price. But, making a loan to someone who can't pay it back is not a good business model in this climate. Unfortunately, many good credit quality consumers will be caught in a downdraft as well. Young people without a credit history will have difficulty establishing the track record they need to make large purchases later, such as a house or a car.
Every kind of consumer debt will be negatively affected it this cycle— house loans, car loans, credit cards, student loans —simply every means of borrowing money will become more difficult and more expensive.
None of that is good for the economy in general. As credit deflates, so will consumer spending. As credit card usage weakens, so will the revenues in acquiring and the ISO business.
Flight to Quality
There will be a general flight to quality in the coming years. Just as the banks will be looking for quality borrowers and credit card issuers will be looking for quality consumers who can pay their bills, so will merchants be looking for quality financial institutions to process their credit cards. Credit card volumes have become too large a slice of total merchant revenues for merchants to take the financial stability of their processing bank for granted.
If this credit crisis shows us one thing, it demonstrates that there are a select number of large banks which are instrumental to the national if not the world economy. Those institutions will never be allowed to fail. JP Morgan Chase, Bank of America, Citibank and a handful of others will be in business a century from now. But the same is not true for the majority of the other 16,000 financial institutions in the U.S. Most of them are not large enough to be considered essential to the U.S. economy. If they fail, bank regulators have procedures in place to force the sale of that institution to another bank and move on. Depositors are covered to the first $250,000 and that's it.
How would a merchant be treated in case his FI collapsed? Harshly, it seems. Merchants would be considered unsecured creditors if their processing bank (or the bank their ISO uses) collapsed. There's no legal obligation for any other company (VISA, MasterCard, the FDIC, etc.) to make the merchant whole. If small merchants knew that their revenue was at risk for bank failure, they would opt for a known name bank that can't fail. If merchants take time to think through the issues, they will avoid community banks and choose a name bank for their processing.
The crisis we're all living through isn't over, and its affects are only now beginning to be apparent. We'll all be noticing the changes in the coming years and many of them will be profound. 
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