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NEW YORK — Capital One Financial announced it will acquire Discover Financial Services for $35 billion. The deal would combine two U.S. credit card companies and could revolutionize the payments industry, dominated by Visa and Mastercard. .
Under the terms of the all-stock transaction, Discover Financial shareholders will receive approximately $140 worth of Capital One stock. That’s a significant premium compared to Discover stock’s Friday closing price of $110.49.
The partnership will involve two of the largest non-bank credit card companies other than American Express: JPMorgan Chase and Citigroup. Additionally, the customers of the two companies are similar, with many Americans looking for cash back and modest travel perks compared to the premium credit cards dominated by AmEx, Citi and Chase.
“This market, which is dominated by the big players, is going to shrink a little bit over time,” said Matt Schultz, chief credit card analyst at LendingTree.
Additionally, giving Discover’s payment network a major credit card partner could once again make it a major competitor. The U.S. credit card industry is dominated by the duopoly of Visa and Mastercard, with AmEx a close third and Discover a distant fourth. It is unclear whether Capitol One will adopt the Discover payment system or if it may create a payment network that can use Discover and a second payment network like Visa in parallel.
“Our acquisition of Discover is a unique opportunity to bring together two highly successful companies with complementary capabilities and franchises to create a payments network that can compete with the largest payment networks and payment companies.” said Richard Fairbank, Chairman and CEO. Capital One said in a statement:
With the Discover acquisition, Capital One is betting that Americans will continue to use credit cards more and carry credit card balances to collect interest. Americans held $1.13 trillion in credit cards in the fourth quarter of 2023, and total household debt rose by $212 billion, an increase of 1.2%, according to the latest data from the New York Fed.
As card balances increased, consumers began paying higher interest rates. The average interest rate on bank credit cards is about 21.5%, the highest since the Federal Reserve began tracking the data in 1994.
Capital One has long had a business model that targets customers with lower credit scores than American Express or Discover, seeking customers who will maintain balances on their cards.
At the same time, the two lenders are being forced to increase their reserves to guard against the possibility of increased defaults by borrowers. After more than two years of battling inflation, many low- and middle-income Americans have used up their savings, increasingly depleted credit card balances and taken out personal loans.
The additional reserves are weighing on both banks’ profits. Last year, Capital One’s net income available to public shareholders fell 35% from 2022 as loan loss provisions rose 78% to $10.4 billion. Discover’s full-year profit was down 33.6% compared to its 2022 results as its allowance for credit losses more than doubled to $6.02 billion.
Discover customers have $102 billion in credit card balances, an increase of 13% year over year. Meanwhile, charge-off rates and 30-day delinquency rates rose.
In addition to increasing bank deposits and loan accounts, the acquisition will give Capital One access to the Discover payment processing network. Although smaller than industry giants Visa and Mastercard, the Discover network allows Capital One to generate revenue from fees charged on every merchant transaction made on the network.
Discover operates under intense regulatory scrutiny. Last summer, the company revealed that starting around mid-2007, it had been incorrectly classifying certain card accounts into the highest merchant price tier. The company also received an unrelated consent order from the Federal Deposit Insurance Corporation over its customer compliance controls.
Citigroup analysts said regulatory issues may have prompted the sale.
“While we are surprised that DFS is selling, recent regulatory challenges such as the October FDIC Consent Order and the card product misclassification issue have prompted the board to consider strategic alternatives that it did not previously have. Assuming the door may be open for consideration, analysts Alen Ciganovich and Kaili Wang wrote in a note to clients.
It is unclear whether the deal will pass regulatory review. Almost all banks issue credit cards to their customers, but few companies are first a credit card company and then a bank. Discover (formerly Sears Card) and Capital One both started as credit card companies and expanded into other financial products such as checking and savings accounts.
Consumer groups are expected to put strong pressure on the Biden administration to ensure that the deal is good not only for consumers but also for shareholders.
“Given the vertical integration of Capital One’s credit card lending with Discover’s credit card network, this transaction also raises significant antitrust concerns,” said President and Chief Executive Officer of the National Community Reinvestment Coalition. CEO Jesse Van Tol said.
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