At a glance
- The tie up between Capital One and Discover Financial appears to makes strategic sense
- The US election result will not have a bearing on the likelihood of the merger happening
- The biggest stumbling block is whether the regulators allow the deal to go ahead
Warren Buffett’s ownership of stock in a bank such as Capital One indicates the management there must be doing a good job. Earlier this week, the Virginia-based lender announced it would buy Discover Financial for £35bn.
The proposed tie-up could be one of the biggest deals in the sector since the 2008 financial crisis, creating a juggernaut that disrupts the US credit card landscape.
Capital One and Discover Financial are among the largest credit card lenders behind Citigroup and JPMorgan Chase. But the biggest prize in the deal is Discover’s payments network, which places it among the likes of Visa, Mastercard and American Express.
The network is a well-known brand in the US and reaches 70mn merchants, yet it is the smallest of the four payment networks. In 2023, by volume of payments Discover’s platform handled $550bn, far below Visa’s $6.8tn, Mastercard’s $2.8tn and American Express’s $1.35tn.
In a conference call discussing the deal, Capital One chief executive Richard Fairbank flagged his intention to help the network expand against those big names. This will be achieved by adding over 25mn Capital One cardholders and more than $175bn in purchase volumes to the network by 2027.
He added: “Scaling the network increases its value to merchants, small businesses and consumers, starting a virtuous cycle of growing acceptance in the US and abroad. This expands the network’s reach and resonance with consumers driving more spending and increasing value for merchants and cardholders alike.”
Other goals of the partnership include combining both banks’ credit card businesses and scaling up Capital One’s digital offering.
The deal is expected to complete at the end of 2024 or beginning of 2025 subject to regulatory approval.
Regulatory oversight
Analysts believe that the regulatory hurdle is important given the antitrust sentiment that has been present among US policymakers, with the Office of the Comptroller of the Currency wanting to toughen bank mergers and acquisitions rules of $50bn and above.
The OCC intends to close a loophole that says certain bank merger applications are deemed automatically approved in the US by the 15th day unless the regulator says otherwise.
Christopher Wolfe, managing director, North American banks at Fitch Ratings, says: “We are talking about two really large institutions combining and it will be interesting to see how the OCC approaches the deal given what it has laid out. It has a view on how it thinks M&A should be evaluated and this will be an interesting test case for them.”
Other bank watchers agree that the position regulators choose to take will be critical.
In a note, HSBC head of US financials research Saul Martinez wrote: “The path to approval is a key question mark as banking regulators are scrutinizing large bank transactions closely and this transaction would create a banking institution with over $600bn of assets.
“The deal also further consolidates the card issuing market. The offset in regulators’ minds could be the potential for more competition among networks.”
Despite these regulatory questions, the deal appears logical from a commercial perspective.
“Strategically, it seems to make a lot of sense and the real question is the execution. Can they get promised the benefits?” asks Wolfe.
Benefits for Capital One include obtaining customer data through ownership of the network, the associated merchant fees and economies of scale. The challenges outside regulation include the short-term risk of IT integration going wrong and the longer-term danger of service errors like wrongful billing.
Prior to the deal, legacy issues at Discover included its overcharging of merchants and a failed student loan business. Discover has publicly stated it wants to offload the student loan business, while the presentation slides for the Capital One deal call assume an exit from student lending in 2024.
Where success lies
Michal Selbka, associate director at S&P Global Ratings, writes that he expects Capital One to successfully execute the deal despite “considerable execution” risk.
It will benefit from prevailing industry trends, including market-share consolidation in consumer lending and increased digitalisation.
According to Selbka, the acquisition of Discover increases market share for Capital One’s key business area — credit cards — which accounted for about 70 per cent of total net revenues and 50 per cent of total loans in 2023.
The deal will create one of the largest card franchises in the US with Discover’s client base of higher-balance revolving borrowers and first-time credit card holders. This will complement Capital One’s more diverse spectrum of card transactors and borrowers.
For Capital One to be successful, it will have to manage its higher concentration of credit cards through conservative capital management and credit reserving policies over the next 12 to 24 months. It will take some time to see whether Capital One ultimately prevails.
“Even in the best case scenario [where] they close the deal by end of year, that is when the really hard work of putting things together starts,” says Wolfe.
“For a deal of this size I would give it six to 12 months for the integration. After that it’s more like business as usual. And then you start to see how this really comes together. So, it will be about two years to see if the acquisition works.”
