Key Takeaways
- Capital One’s $35.3 billion acquisition of Discover Financial stands to shake up the financial services industry, making the combined company a major player in credit cards.
- The company could displace JPMorgan Chase as the dominant credit card lender, based on current card loan data.
- With a boost in investment from Capital One, Discover could better take on Visa and Mastercard, which are the dominant credit card brands in the U.S.
- The deal, however, will face regulatory hurdles.
The proposed $35.3 billion merger of Capital One (COF) and Discover Financial (DSF) stands to shake up the competitive landscape in the U.S. credit card market.
The combination of the two financial services providers, which executives hope will be completed by early next year pending regulatory and shareholder approval, could result in JPMorgan Chase (JPM) being displaced from its perch as the leader in credit card lending. At the same time, Capital One investments in Discover Financial, the number four payments network after Visa (V), Mastercard (MA) and American Express (AXP), would boost its ability to compete with the credit card giants.
“The deal from a qualitative perspective would be a great fit for Capital One in our view given the scarcity value of a major US credit card network and (Capital One’s) technological prowess that could potentially unlock additional value of the network for its branded card business and for its retail partner credit card business,” Citi analysts wrote in a note Tuesday.
Capital One shares, after falling early in Tuesday’s session following the news late Monday that the company had offered a 27% premium to acquire Discover, ended 0.1% higher at $137.39.
The combined company would immediately jump to the top of the list of U.S. credit card lenders, based on current data. Capital One and Discover together hold $267 billion in credit card loans versus JPMorgan’s $211 billion. (see chart below)
“JPM looks to become a banking payments leader, but the (Capital One/Discover) deal could create a new strategic threat depending on how (Capital One) will use the (Discover) payment network,” Wells Fargo analysts said in a report Tuesday. “On the other hand, JPM will still have the advantage of its 5,000 branch network, which drives 1/4 of card growth.”
JP Morgan declined to comment for this story.
Visa, Mastercard May Have to Give Concessions
As for the potential impacts on Mastercard and Visa, Capital One currently has deals with the two big credit card companies and is unlikely to outright abandon them, at least in the short-term, in part because Discover has less of an international presence.
“We expect any transition away from (Visa/Mastercard) would likely be slow,” the Wells Fargo analysts said, noting that both credit card providers signed agreements with Capital One in the past two years. “Acknowledging Discover’s network is much smaller generating 2% the volume as (Visa/Mastercard) globally, it gives Capital One the optionality to negotiate away from (or price-down) the global networks over time, in our view.”
Analysts at Jefferies noted that Mastercard is more exposed to any changes than Visa is, as Capital One represents 16% of Mastercard’s U.S. purchase volume while the bank only accounts for 4% of Visa’s volume.
“We’re skeptical there will be any meaningful disruption to credit volumes,” Jefferies said in a research note Tuesday, noting that Discover’s weaker brand, especially among high-spending cardholders, will make it difficult for Capital One to move the credit portfolios issued on the Mastercard and Visa networks to Discover.
“Ultimately, (Capital One) gets some pricing concessions from (Mastercard) and (Visa) on domestic processing/licensing fees from the threat of migrating volumes, but we’re skeptical of any far-reaching impacts beyond that,” Jefferies said in the note.
Regulatory Risks to Deal Approval Exist
The deal faces regulatory hurdles before it could close.
“We expect a significant amount of regulatory scrutiny given we have not seen a bank merger of this size in several years, excluding forced mergers of failing banks,” investment bank Piper Sandler said in a research note Monday.
Ben Johnson, chief operating officer at the Innovative Payments Association, of which Discover is a member, said that bank regulators will be focused on risks posed to the banking system while the Federal Trade Commission and Justice Department may be concerned about unacceptable consolidation in the credit card lending market. “This is not going to be a fast consolidation,” he told Investopedia in a phone interview.
From Johnson’s perspective, this acquisition wouldn’t take away a competitor, in Discover, from payments but rather would bolster the weakest performer.
Peter Conti-Brown, a professor of financial regulation at The Wharton School of the University of Pennsylvania, said in a message to Investopedia that there may be differences among the various regulatory agencies that will have to pipe in on the decision, including the Options Clearing Corporation, the Federal Reserve, the Federal Deposit Insurance Corporation and the Department of Justice.
“These agencies mostly see mergers in similar ways, but not completely,” Conti-Brown said.