Credit Risk Considerations of the Fixed Acquirer Network Fee
Acquirer strategies vary regarding how to bill merchants for Visa’s Fixed Acquirer Network Fee (“FAN Fee”) (i.e., passing the fee through at cost or increasing the merchant’s discount rate); however, all acquirers are exposed to some level of additional credit risk unless they charge the fee in advance.
A recent survey conducted by First Annapolis of over 20 acquirers indicates that they are billing for the FAN Fee in arrears. Although the number of months in arrears varies, most acquirers are charging merchants on a one month delay (i.e., billing the merchant on May 1 based on April transaction data). As a result, acquirers are taking on credit risk equivalent to one month of FAN Fees for every merchant since Visa charges the FAN Fee to the acquirer for any merchant that processes volume during the month regardless of whether or not the acquirer collects the fee from the merchant.
When a merchant attrites to another acquirer, goes out of business, or is involuntarily terminated after performing a transaction during the month but prior to paying the fee, the acquirer may incur a loss. This is significant because the loss that results is a hard dollar loss for the acquirer, unlike the acquirer’s other fees. The FAN Fee is paid out in cash even though the acquirer has not collected from the merchant. Traditional acquirer fees, such as monthly fees or statement fees, are typically reversed when a loss occurs, meaning the accrued but uncollected revenue is written off with no impact on the acquirer’s cash position.
It is also important to note that the larger risk, in terms of frequency of loss, is in the small- to medium-sized merchant segments that are more likely to attrite. Therefore, the FAN Fee poses a greater threat to acquirers that cater specifically to these segments.
The tables illustrate how the progressive nature of the FAN Fee tables impact loss rates, making some assumptions about average portfolio attrition rates. We also assume that acquirers will only sustain a loss due to uncollected FAN Fees on 10% or fewer of their merchants, although we expect this to vary by acquirer based on their risk appetite and billing method (e.g., an acquirer has a higher probability of collecting on August 1 than on September 1 for a merchant that attrites in July). Figure 1 illustrates incremental acquirer loss rates (equal to un-recouped FAN Fee over volume) in selected tiers on outlets of varying sizes; losses are greatest on outlets with low volume and are particularly meaningful in the higher tiers.
Figure 1: U.S. Acquirer Loss Rates (FAN Fee Table 1B)
Figure 2 depicts acquirer loss rates on merchants with e-commerce volume in selected tiers of Table 2; again, loss rates are greatest on outlets with low volume.
Figure 2: U.S. Acquirer Loss Rates (FAN Fee Table 2)
We spoke to three Underwriting Managers at mid-sized acquirers about the increase in credit risk from the Visa FAN Fee. Each confirmed that it would increase overall credit risk to some extent but have not yet altered their underwriting methodology to consider the additional risk.
To illustrate the additional credit risk that acquirers incur with the introduction of the FAN Fee, we calculated a credit exposure for two merchants each with five locations and processing $200,000 annually, and also calculated the additional FAN Fee cost an acquirer would incur on each merchant. The first, a delayed-delivery furniture merchant, has a credit exposure of over $9,000 while the additional monthly FAN Fee would be $14.50 (assuming 100% card-present transactions). The second, a lower-risk restaurant merchant, would also have the same monthly FAN Fee cost of $14.50, but would only have a $7.50 credit exposure, increasing the acquirer’s monthly exposure by nearly 200%.
The key observations from this analysis suggest the following merchant types have the highest potential percentage increase in losses due to the FAN Fee:
- Low volume outlets of large merchants falling in higher tiers
- Small e-commerce merchants
- Low risk merchants that have not been previously underwritten considering exposure and for whom the FAN Fee is an increase in exposure
Going forward, acquirers should consider taking into account the additional credit exposure created by the FAN Fee when developing a process for charging their merchants and, more importantly, when they calculate the estimated credit exposure for a single merchant or think about their portfolio’s total credit risk exposure.
For more information, please contact Raymond Carter, Principal specializing in Commercial Risk, email@example.com; or Elizabeth Hooper, Analyst specializing in Merchant Acquiring, firstname.lastname@example.org
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