Capital One, one of the nation’s leading financial institutions, has announced its plans to acquire Discover Financial Services in a groundbreaking deal worth $35 billion. This acquisition is set to not only bring together two major credit card companies but also potentially disrupt the payments industry, which is currently dominated by Visa and Mastercard.
Under the terms of the agreement, shareholders of Discover Financial will receive Capital One shares valued at nearly $140, a significant premium compared to the closing price of Discover shares. This merger will unite two of the largest credit card companies that are not banks, with the exception of American Express. Both Capital One and Discover cater to similar customers, primarily Americans who seek cash back or modest travel rewards. This sets them apart from premium credit cards offered by AmEx, Citi, and Chase.
The acquisition is expected to have a significant impact on the credit card industry, which is currently dominated by Visa and Mastercard. Matt Schulz, chief credit card analyst at LendingTree, believes that this deal will lead to a contraction in the market share of the major players. Additionally, it will give Discover’s payment network a major credit card partner, potentially positioning it as a formidable competitor once again.
The U.S. credit card industry has long been dominated by Visa and Mastercard, with American Express trailing behind in third place and Discover in fourth place. It remains uncertain whether Capital One will adopt Discover’s payment system or establish a parallel payment network that allows the use of both Discover and another network like Visa.
Richard Fairbank, the chairman and CEO of Capital One, expressed his enthusiasm for the acquisition, stating that it presents a unique opportunity to combine the strengths and capabilities of both companies. He envisions building a payments network that can rival the largest players in the industry.
Capital One’s decision to acquire Discover reflects its belief in the continued growth of credit card usage among Americans. In the fourth quarter of 2023, Americans held a staggering $1.13 trillion on their credit cards, with aggregate household debt balances increasing by $212 billion. As consumers accumulate credit card debt, they are also subject to higher interest rates. The average interest rate on a bank credit card currently stands at approximately 21.5%, the highest it has been since 1994.
Capital One has traditionally targeted customers who maintain balances on their credit cards, focusing on individuals with lower credit scores compared to American Express and Discover. However, both lenders have had to increase their reserves in anticipation of potential borrower defaults. Many lower- and middle-income Americans have depleted their savings due to inflation and are increasingly relying on credit cards and personal loans.
This emphasis on reserves has impacted the profitability of both banks. Capital One’s net income available to common shareholders declined by 35% in 2023, while Discover’s full-year profit sank by 33.6%. Discover’s customers currently carry $102 billion in credit card balances, a 13% increase from the previous year. Unfortunately, charge-off rates and delinquency rates have also risen.
In addition to bolstering deposits and loan accounts, the acquisition will grant Capital One access to Discover’s payment processing network. Although smaller than Visa and Mastercard, the Discover network will enable Capital One to generate revenue through transaction fees charged for every merchant transaction conducted on the network.
Discover has faced increased scrutiny from regulators in recent times. Last summer, the company revealed that it had misclassified certain card accounts into its highest merchant pricing tiers since mid-2007. Additionally, it received a consent order from the Federal Deposit Insurance Corporation regarding its customer compliance management. Analysts speculate that these regulatory issues may have influenced Discover’s decision to sell.
The deal’s regulatory approval is uncertain, as it raises concerns about potential anti-trust violations due to the vertical integration of Capital One’s credit card lending and Discover’s credit card network. Consumer groups are expected to exert pressure on the Biden Administration to ensure that the acquisition benefits both consumers and shareholders.
In conclusion, Capital One’s acquisition of Discover Financial Services marks a significant development in the credit card industry. By bringing together two major credit card companies, this deal has the potential to disrupt the dominance of Visa and Mastercard. It remains to be seen how this acquisition will shape the future of the payments industry and whether it will receive regulatory approval.