There has been an unprecedented wave of consolidation in the U.S. payment processing industry this year, with two major core processors acquiring the two largest merchant acquirers, and two of the largest remaining payment technology companies agreeing to merge. In January, Fiserv agreed to acquire First Data for $22 billion in stock, also assuming $17 billion in debt. Two months later, Worldpay sold itself to FIS for $34 billion in stock and cash, in addition to assuming $9 billion in debt, about a year after closing its merger with Vantiv. Finally, Global Payments agreed in May to a $21.5 billion merger with TSYS.

While these transactions have been heavily reported, a few additional thoughts may be worth sharing, especially since the wave of processor and payment technology company consolidation seems likely to roll on for some time.

Economies of Scale

Each of these three deals has promised significant recurring cost savings, but these may be partially offset by restructuring and integration costs arising from consolidation. Moreover, these savings may be limited by the complementary nature of the platforms and services provided by the parties to each deal – particularly with respect to the first two transactions noted above.

Even if the promised cost synergies are ultimately achieved, it is not clear that they will compensate for comparatively low growth in the issuer-processing and core-processing businesses, or for margin compression in the ultra-high-volume end of the merchant-processing business.

However, there may be cost-savings relating to the development or acquisition of technology as larger entities expand their ability to cross-subsidize internal R&D or act as quasi-monopsonists. Greater scale may also offer the ability to add new payment rails such as the Real-Time Payment product from The Clearing House or the just-announced Federal Reserve real-time payment and settlement option, once it is commercially available.

Integration

The survivor/successor entities will offer combinations of core processing, issuer processing, merchant processing and related services. This is clearly in response to financial institutions’ and merchants’ increasing demand for universal payment solutions for both acceptance and disbursement.

Migration to digital platforms for business services such as accounting and sales also makes integrated payment services important for the acquisition and retention of processing clients.

In addition, ease of access to large pools of consumer and merchant data will facilitate the integrated entities’ provision of ancillary financial services, such as point-of-sale financing and merchant-linked offers. As discussed below, there will also be expanded opportunities for on-us, off-network processing for financial institutions.

All this said, it remains unclear whether and to what extent any resulting cost savings will be passed on to financial institutions or merchants, given the reduction in competition and the need to show the Street the economic rationale behind the deals.

Possible Takeaways for Banks

A real concern for the banking industry is that consolidation in the payments sector will increase processors’ bargaining power, potentially leading to higher prices in the medium and long term, reduced responsiveness and further reduced customization.

As with the post-IPO networks, banks may find themselves working closely with entities that see themselves in part as the banks’ competitors – especially for the payments business of big merchants. It may be useful to view the recent wave of processor consolidation as part of a larger trend that also encompasses, for example, Bank of America’s discontinuance of its joint venture with First Data – or perhaps the processor-side and bank-side trends should be viewed as antithetical.

Notwithstanding the general negative impact on the banking industry, certain partner banks should benefit from payments consolidation, as payment technology companies increasingly become the customer interface for payments and related financial services. On the other hand, we would expect increased regulatory scrutiny of bank vendor management and diligence obligations.

While we do not see the FDIC or the other federal banking agencies moving aggressively to cut back on the scope of FinTech-bank partnerships, this is always a possibility, particularly if significant issues begin to emerge as a result of these partnerships. More likely, at least in the interim, federal banking agencies will continue to exercise a significant degree of control over scrutiny of third-party vendor relationships involving payments entities and are likely to question banks about payment partner relationships in which a bank has significant dependency but little control.

Similarly, as the payments industry further consolidates, bank examiners will become increasingly focused on banks’ contingency planning to assure continuity of service if the payments partner encounters a problem that interferes with or restricts its ability to provide payment services.

Possible Takeaways for Networks

As mentioned, consolidation between issuing and acquiring platforms provides the opportunity for greater disintermediation of payment networks through “on-us” transactions. (Obviously, this is also a takeaway for banks interested in diverting transaction volume off the networks – or perhaps just in threatening to do so.)

The vast volumes of data available to processing conglomerates may allow them to act as payment facilitators, underwriting and submitting transactions on behalf of many more merchants, if individual submerchant limits are raised. Networks’ refusal or delay in raising such limits could be perceived as anticompetitive.

Takeaways for Merchants

Prices to merchants may decrease in the short term as the new processing conglomerates seek to take on FinTechs. However, we should expect relative prices to rise in the medium and long term as the industry continues to consolidate.

Merchants, of course, will be looking for ways to extract greater value, efficiency and other potential benefits (customer information, datasets and analysis, etc.) from their payments providers. Absent the ability to gain other benefits to offset increasing prices, merchants may turn to other possible solutions, including regulatory -- and/or renewed legislative -- relief for escalating costs.

As with financial institutions, service levels from merchant processors, as well as their willingness to customize offerings, may decrease in the short term as they seek to implement cost savings. However, we believe market participants such as Evo and similar competitors likely will seize the opportunity that this presents.

Conclusion

We look forward to readers’ thoughts on these matters. We will continue to monitor developments in this area and will report back from time to time.