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Merchant Litigation Settlement May Hurt Capital One (COF) Earnings

 March 08, 2012 02:33 PM

A potential settlement to the ongoing merchant litigation against: Visa, Inc. (NYSE:V), Mastercard, Inc. (NYSE:MA) and banks may include a temporary cut to credit interchange, and could negatively impact Capital One Financial Corp. (NYSE:COF).

The pace of the class action lawsuit filed by US merchants in 2005 against Visa, MasterCard, and their issuing banks appears to have picked up. Recent events, including the setting of a tentative trial date in September '12, as well as implied and explicit estimates from Visa and Mastercard of potential monetary settlement amounts have increased investor interest in better understanding the impacts of potential case outcomes.

[Related -Visa (V) Call Options Look For Rebound]

"To date, we believe most of this focus has been on potential litigation impacts relative to V and MA, but based on our analysis, we believe card issuers (especially COF) might face greater risks from litigation then the card networks," Jefferies analyst Jason Kupferberg wrote in a note to clients.

Meanwhile, a settlement is a better option in large antitrust cases such as this one considering the risks and costs associated with trial.

"Based on our checks and recent disclosures by V and MA, we believe an overall monetary settlement of $6-10B is plausible," the analyst added.

[Related -Mastercard Inc (MA) Q3 Earnings Preview: What To Expect?]

A key potential component of a settlement might be a temporary cut to US credit interchange rates Capital One is estimated to have earned about 15 percent of its trailing twelve-month (TTM) revenues as gross credit interchange. As a result, a temporary cut to credit interchange as part of any merchant litigation settlement would likely have a direct and material impact on Capital One.

Capital One reported an average of $53.5 billion in domestic card receivables for 2011, which represents both on balance sheet and securitized balances. According to the company's master trust filings, the 2011 average balance outstanding in the trust was $39.9 billion, or 75% of the total. Master trust data also reported gross interchange of $1.9 billion in 2011.

"A 33% cut to credit interchange for one year would reduce our FY'12 EPS estimate for COF by 15% to $4.61 and our FY'13 EPS estimate by 12% to $5.70," said Kupferberg, who has a "hold" rating on Capital One shares.

The assumption of a 33 percent cut in credit interchange for one year would result in about $673 million or 3 percent in lost revenue from the analyst's fiscal 2012 revenue estimate of $26 billion.

Wall Street expects Capital One to earn $5.78 a share on revenue of $19.6 billion for 2012, according to analysts polled by Thomson Reuters.



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