Capital One to Acquire Discover Financial Services in $35 Billion Deal, Potentially Shaking Up Payments Industry
In a surprising move that could have far-reaching implications for the payments industry, Capital One Financial has announced its plans to acquire Discover Financial Services in a $35 billion deal. This acquisition brings together two of the nation’s largest credit card companies and has the potential to disrupt the industry currently dominated by Visa and Mastercard.
Under the terms of the all-stock transaction, Discover Financial shareholders will receive Capital One shares valued at nearly $140, a significant premium to the closing price of Discover shares. This deal marks the union of two major credit card companies that are not banks, with the exception of American Express. It also brings together two companies whose customers share similar preferences for cash back or modest travel rewards, setting them apart from premium credit cards dominated by AmEx, Citi, and Chase.
The acquisition is expected to shrink the market dominance of the big players in the credit card industry. Matt Schulz, chief credit card analyst at LendingTree, believes that this consolidation will have a significant impact on the industry landscape. “This marketplace that’s dominated by the big players is going to shrink a little bit more now,” Schulz stated.
One of the key advantages of this deal is that it will give Discover’s payment network a major credit card partner, potentially making it a formidable competitor once again. Currently, the U.S. credit card industry is largely controlled by the Visa-Mastercard duopoly, with American Express in a distant third place and Discover even further behind in fourth place. It remains uncertain whether Capital One will adopt the Discover 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, “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’s decision to acquire Discover is based on its belief that Americans will continue to increase their credit card usage and maintain balances on their accounts to collect interest. Recent data from the New York Federal Reserve shows that in the fourth quarter of 2023, Americans held $1.13 trillion on their credit cards, with aggregate household debt balances increasing by $212 billion. As consumers accumulate higher card balances, they are also subject to higher interest rates, with the average rate on a bank credit card reaching its highest level since 1994 at approximately 21.5%.
Capital One has traditionally targeted customers with lower credit scores who are more likely to carry a balance on their cards. This strategy sets them apart from American Express and Discover, which cater to customers with higher credit scores. However, both Capital One and Discover have had to increase their reserves in anticipation of potential borrower defaults. The economic challenges faced by lower- and middle-income Americans, including rising inflation and depleted savings, have led to increased credit card balances and personal loans. These additional reserves have impacted the profitability of both banks, with Capital One’s net income available to common shareholders declining by 35% in 2023, and Discover’s full-year profit sinking by 33.6%.
Aside from the boost in 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 from fees charged for every merchant transaction processed through the network.
Discover has faced regulatory scrutiny in recent years, which may have influenced its decision to sell. Last summer, the company disclosed misclassification issues with certain card accounts and received a consent order from the Federal Deposit Insurance Corporation regarding customer compliance management. Analysts speculate that these regulatory challenges prompted the board to consider strategic alternatives, leading to the sale.
The deal’s regulatory approval remains uncertain, and consumer groups are expected to pressure the Biden Administration to ensure that the acquisition benefits both consumers and shareholders. Jesse Van Tol, president and CEO of the National Community Reinvestment Coalition, highlights the potential anti-trust concerns arising from the vertical integration of Capital One’s credit card lending with Discover’s credit card network.
The acquisition of Discover Financial Services by Capital One has the potential to reshape the payments industry. By bringing together two major credit card companies, this deal introduces a new player that could challenge the dominance of Visa and Mastercard. As the regulatory process unfolds, it will be interesting to see how this acquisition shapes the future of the credit card industry and impacts consumers and shareholders alike.