6th-largest Bank in the US, Discover Financial will Acquired by US Credit Card Company Capital One

Sixth-largest bank in the US, Discover Financial will be received by Capital One in an all-stock deal worth $35.3 billion.

US consumer lender Capital One, supported by Warren Buffett, announced on Monday that it will pay $35.3 billion in all-stock prices to acquire Discover Financial Services, a provider of credit cards.

The goal of the partnership, which will unite the two biggest credit card firms in the US, is to create “a payments network that can compete with the largest payments networks and payments companies,” according to a statement from Capital One’s chairman and CEO, Richard Fairbank.

Other US-based payment networks include American Express, Visa, and Mastercard.

For every Discover share, shareholders will receive 1.0192 Capital One shares. In comparison to Discover’s closing price on Friday, it represents a 26.6% premium.

As per the statement, upon completion, shareholders of Capital One will hold 60% of the combined company, whereas shareholders of Discover will own roughly 40%.

According to Nilson, Discover is the sixth-largest player in the US credit card market by volume as of 2022, and Capital One, valued at $52.2 billion, is the fourth largest.

Capital One Financial announced that it would purchase Discover Financial Services for $35 billion. This would combine two of the country’s credit card companies and could potentially upend the Visa and Mastercard-dominated payments sector.

Discover Financial Services is expected to be acquired by Capital One Financial for $35.3 billion in all stock.

Discover shareholders would receive 1.0192 Capital One shares for every Discover share under the terms of the agreement, or around 26% more than Discover’s Friday closing price of $110.49. The companies stated that they anticipate the deal closing in late 2024 or early 2025, at which point shareholders of Capital One would own 60% of the combined company and shareholders of Discover would own 40%.

Discover Financial shareholders will receive Capital One shares valued at approximately $140 as part of the terms of the all-stock transaction. Compared to the $110.49 at which Discover shares closed on Friday, that represents a sizable premium.

With the notable exception of American Express, the agreement unites JPMorgan Chase and Citigroup, two of the biggest credit card companies that aren’t banks. Additionally, it unites two companies whose clientele is essentially similar: Americans typically seeking low-cost travel rewards or cash back in lieu of the premium credit cards offered by AmEx, Citi, and Chase.

Capital One’s credit card offerings and deposit base would be expanded through the merger of the two companies, which rank among the biggest credit card issuers in the United States. In June of last year, the company acquired the digital concierge service Velocity Black, a premium credit card and luxury market platform.

Capital One intends to maintain the Discover brand even though it currently uses the Visa and Mastercard networks.

“This marketplace that’s dominated by the big players is going to shrink a little bit more now,” said Matt Schulz, chief 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.

Capital One is wagering that Americans will continue to use credit cards more frequently and maintain balances on those accounts in order to earn interest by purchasing Discover. According to the most recent data from the New York Federal Reserve, as of the fourth quarter of 2023, Americans owed $1.13 trillion on credit cards, and total household debt balances rose by $212 billion, or 1.2%.

Customers are paying higher 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.

The 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 they are also taking out personal loans and increasing their credit card debt.

The profits of both banks have been affected by the additional reserves. Capital One’s net income available to common shareholders fell by 35% in 2022 compared to the previous year, and the company’s provisions 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 profit to drop 33.6% from its 2022 results.

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 acquisition, Capital One would gain access to the Discover payment processing network in addition to increasing bank deposits and loan accounts. Even though Discover is smaller than Visa and Mastercard, two of the biggest names in the industry, 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 company revealed last summer that it had mistakenly placed some card accounts in its highest merchant pricing tiers, starting about mid-2007. Additionally, the Federal Deposit Insurance Corporation issued an unrelated consent order to the company regarding its customer compliance management.

Citigroup analysts speculate that the sale might have been prompted by regulatory issues.

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 formerly known as the Sears Card, began as credit card companies before branching out into other financial services like checking and savings accounts.

It is anticipated that consumer advocacy groups will exert significant pressure on the Biden Administration to ensure that the agreement benefits both shareholders and consumers.

“The proposed transaction is rather out of sync with the times. But big banks don’t worry too much about consumers and they are always out to reduce competition,” said Carter Dougherty with Americans for Financial Reform.

Since comparable acquisitions in the financial sector are rare, Schiff predicted that the Capital One-Discover agreement will have a significant impact on merger activity in the industry as a whole.

“It’s a good example of the risk we’re seeing in the market, where the competing interests from regulators for increased control and rigor balance against the competitive demands that are being made quite clearly, in terms of the overall market,” Schiff said.

The acquisition takes place at a time when Discover is under growing pressure from new leadership and regulatory scrutiny. In December 2023, Michael Rhodes was named the company’s current CEO.

With a 1.7% decline in shares for the year, Discover’s market valuation is now $27.63 billion. With a $52.2 billion market valuation, Capital One’s shares have increased 4.6% in 2024.

One of the biggest agreements announced this year would be the merger of Capital One and Discover. In January, Synopsys revealed plans to acquire Ansys for $35 billion, while on February 12, Diamondback Energy revealed plans to acquire privately held oil and gas producer Endeavor Energy for $26 billion.

Details of the Deal

For every Discover share, shareholders will receive 1.0192 Capital One shares, representing a 26.6 percent premium over Discover’s Friday closing price.

As per the official statement, after the merger is completed, shareholders of Capital One will own 60% of the combined company, while shareholders of Discover will hold approximately 40%.

According to Nilson, Capital One, with a $52.2 billion market valuation as of 2022, is the fourth-largest participant by volume in the US credit card market. Currently, Discover is ranked sixth in the market.

Regulatory Landscape and Democratic Pressure

According to Capital One, the acquisition is expected to receive regulatory approval in late 2024 or early 2025.

According to the report, the transaction is anticipated to be closely examined, especially since US President Joe Biden’s administration is still committed to boosting competition in a number of industries, including banking. In an executive order from 2021, the administration emphasized its focus on bank deals.

Professor of business law at the University of Michigan and former expert in Federal Reserve bank merger oversight, Jeremy Kress, told Reuters that they anticipate strong opposition to this deal and increased regulatory scrutiny.

Democratic progressives have long opposed bank consolidation because it increases systemic risk and hurts consumers by restricting lending. Pressure to take stricter measures against these kinds of transactions has recently increased on regulators in response to deals that attempted to save failing lenders, like JPMorgan’s purchase of First Republic Bank.

Discover and Capital One Assets

Discover was the 27th-largest US bank with approximately $150 billion in assets, according to Federal Reserve data from December. Capital One was the ninth-largest bank with $476 billion in assets. According to Fed data, the combined company is expected to rank as the sixth-largest bank in the United States after the merger is completed.

Despite certain credit card business areas being shared by both companies, Discover is a significant credit card processor in the United States. The transaction takes place at the same time that the Consumer Financial Protection Bureau (CFPB) is putting more of an emphasis on credit card fees in terms of regulations.

CFPB’s Concerns and Discover’s Regulatory Challenges

Under the leadership of merger skeptic Rohit Chopra, the CFPB raised concerns about competition in the US credit card market by pointing to a report that showed lower interest rates that small banks and credit unions were offering in the first half of 2023.

In response to legal challenges, Discover revealed a review of credit card accounts that were mistakenly categorized starting in mid-2007. As part of an October consent order with the Federal Deposit Insurance Corp., Discover also committed to improve consumer compliance.

Discover and Capital One both reported lower fourth-quarter profits; Discover’s drop was 62 percent, while Capital One’s was 43 percent.

Deals involving financial firms are often hindered by regulatory obstacles, such as supervisory issues. However, legal experts have indicated that regulators may be more accommodating when the target company has regulatory issues and the acquiring entity has a clean regulatory history.

Based on Federal Reserve data from December that ranked insured US banks, Discover was the 27th largest US bank by assets, with nearly $150 billion in assets; Capital One ranked ninth with $476 billion in assets.

According to Fed data, the combined company would rank as the sixth-largest US bank.

Discover is one of the four main US credit card processors, along with Visa, Mastercard, and American Express, which facilitate credit card payments. Although the two companies overlap in some areas of the credit card business, Discover is a potentially valuable source of fees for Capital One.

Additionally, the agreement would be made at a time when credit card fees are coming under more regulatory scrutiny and are the focus of stringent new regulations that the Consumer Financial Protection Bureau is proposing.

This agency, which has influence over bank transactions and is headed by merger skeptic Rohit Chopra, raised competition concerns in the US credit card market last week.

According to a report, small banks and credit unions generally offered lower interest rates than the top 25 credit card issuers in the first half of 2023, for all credit score ranges.

The top 10 issuers by average credit card outstandings accounted for 83% of credit card loans in 2022, according to a prior CFPB report, which continued the decline from 87% in 2016.