In a deal that would combine two of the country’s credit card businesses and perhaps upend the payments sector, which is primarily controlled by Visa and Mastercard, Capital One Financial, announced that it will purchase Discover Financial Services for $35 billion.
The owners of Discover Financial will receive shares of Capital One, valued at approximately $140, as part of the terms of the all-stock deal. That represents a sizable premium above the closing price of $110.49 for Discover shares on Friday.
With the significant exception of American Express, the agreement unites JPMorgan Chase and Citigroup, two of the biggest credit card firms that aren’t banks. Additionally, it unites two businesses whose clientele is essentially similar: Americans typically seeking low-cost travel rewards or cash back instead of the premium credit cards offered by AmEx, Citi, and Chase.
Laptops 1000The major firms’ controlled market will now contract even further, according to Matt Schulz, principal credit card analyst at LendingTree.
Additionally, it will provide Discover’s payment network with a significant credit card partner, which may resurrect the network as a major rival. The Visa-Mastercard monopoly dominates the U.S. credit card market, with Discover coming in even further behind and AmEx coming in third. Uncertainty surrounds Capitol One’s potential adoption of Discover or the possibility of establishing a payment network that would enable Discover to be used in tandem with a second payment network, such as Visa.
Chairman and CEO of Capital One Richard Fairbank said in a statement, “Our acquisition of Discover is a singular opportunity to bring together two very successful companies with complementary capabilities and franchises, and to build a payments network that can compete with the largest payments networks and payments companies.”
Capital One is wagering that Americans would continue to use credit cards more frequently and maintain balances on such accounts to earn interest by purchasing Discover. According to the most recent figures from the New York Federal Reserve, as of the fourth quarter of 2023, Americans owed $1.13 trillion on credit cards, while total household debt levels rose by $212 billion, or 1.2%.
Customers are paying greater interest rates in addition to accruing larger credit card balances. Approximately 21.5% is the highest interest rate on a bank credit card since the Federal Reserve began keeping track of the data in 1994.
For a considerable amount of time, Capital One has been pursuing consumers with lower credit scores than American Express or even Discover to attract balance-carrying customers.
Laptops 1000The two lenders have had to increase their reserves in response to the potential for an increase in borrower defaults. Many Americans in lower and middle-income brackets have exhausted their savings after fighting inflation for over two years, and many are also taking out personal loans and increasing their credit card debt.
The profitability of both banks has been affected by the higher reserves. Capital One’s net income accessible to common shareholders fell by 35% in 2022 compared to the previous year, and the company’s reserves for loan losses increased by 78% to $10.4 billion. Discover’s provisions for credit losses more than doubled to $6.02 billion, which caused its full-year earnings to drop 33.6% from its 2022 figures.
The $102 billion in credit card balances that Discover’s customers are carrying represent a 13% increase from the previous year. Concurrently, there has been an increase in the charge-off and 30-day delinquency rates.
Through the deal, Capital One would get access to the Discover payment processing network in addition to increasing bank deposits and loan accounts. Even while Discover is smaller than Visa and Mastercard, two of the biggest names in the business, it will still allow Capital One to make money from fees associated with each merchant transaction that occurs on the network.
Regulators have been closely monitoring Discover’s operations. The business revealed last summer that it had mistakenly placed some card accounts in its top merchant pricing tiers, starting about mid-2007. Additionally, the Federal Deposit Insurance Corporation issued an ancillary consent order to the corporation regarding its customer compliance management.
Citigroup analysts speculate that the transaction might have been spurred by regulatory problems.
Analysts Arren Cyganovich and Kaili Wang wrote to clients, “We are surprised that DFS would sell, but suppose that its regulatory challenges, like its recent October FDIC consent order and the card product misclassification issue, may have opened the door for the board to consider strategic alternatives that it may not have in the past.”
Whether the deal will pass regulatory scrutiny is unknown. Customers can get credit cards from almost any bank, but not all businesses are banks first and credit card companies second. Both Capital One and Discover, which was once known as the Sears Card, began as credit card firms before branching out into other financial services including checking and savings accounts.
It is anticipated that consumer advocacy groups would exert significant pressure on the Biden Administration to ensure that the agreement benefits both shareholders and consumers.
The National Community Reinvestment Coalition’s president and CEO, Jesse Van Tol, stated, “The deal also poses massive anti-trust concerns, given the vertical integration of Capital One’s credit card lending with Discover’s credit card network.”
