With Discover acquisition, CapOne may have a card up its sleeve
William Black
Consumer Credit and Structured Finance Expert | Credit Risk Management Leader
(2.23.24) If approved, the purchase of Discover Card will vault Capital One (CapOne) to the top of the credit card leaderboard, just ahead of Chase.? But this is no garden-variety credit card portfolio acquisition.? CapOne is not only getting the $100 billion in Discover Card credit card receivables as well as a few much smaller consumer loan portfolios, but it's also getting the Discover Network, Discover's proprietary payment processing network [1]. While there are several benefits that come with ownership of a payments network, one potential advantage not extensively covered is its strategic positioning in light of the proposed Credit Card Competition Act (CCCA), currently under consideration in Congress.
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First, some context…
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The Discover Network is Discover's proprietary infrastructure through which only Discover Card transactions are routed and processed.? It operates as a distinct and competitive system to the much larger and ubiquitous Visa and MasterCard networks, which run third party member bank programs [2].?
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CapOne is already a member of the Visa and MasterCard network and has a sizable (~$115 billion) portfolio of credit cards running on both networks, so why buy a network of its own?? Simply put, it's better to be an owner than a member.? Allow me to elaborate.
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Each card purchases on the network incurs a small fee (around 1.0% - 3.0%) known as a "swipe fee."? This fee is distributed among several participants in the value chain, including the merchant bank, the issuing bank and the network operator/owner.? By owning the Discover Network, CapOne will keep for itself for any cards that run on the Discover Network. And, yes, these fees are small, but they add up when considering the billions in credit card purchase volume.
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Pending legislative bill (CCCA)…
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Despite their relatively modest size, swipe fees are not without their controversy, as they are viewed by some as an incremental cost (or "tax") ultimately borne by consumers and merchants.? Congress has taken note, and the proposed CCCA bill would impose substantial changes to the credit card ecosystem in an effort to enhance competition among networks and network members and drive down swipe fees.
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The bill would require large bank card issuers (>$100 bn in assets) to issue cards that can run on two networks, one of which cannot be either Visa or MasterCard.? In theory, this would allow the merchant to choose the more cost-effective network and, by extension, pass the savings on to consumers.? I have my doubts.? Precedent in the debit card space suggest that merchants might retain the savings rather than pass the benefit on to consumers.
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Drawing a parallel to the 2010 Durbin Amendment, which regulated debit card interchange fees, a 2015 survey conducted by the Federal Reserve Bank of Richmond indicated limited effects on retail prices.? The majority of surveyed merchants did not alter prices post-regulation, with some even increasing prices [3].??
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CapOne's strategic advantage…
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If enacted, the CCCA would provide Cap One with a competitive edge over the other card issuers who don't own their own network. While the bipartisan-supported bill faces uncertainties in the current Congressional session, its potential impact cannot be dismissed in this or future sessions.
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Additional advantages…
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Beyond economies of scale, the acquisition offers further benefits, including cross-selling opportunities and cross-brand expansion.?Cap One can leverage synergies and achieve incremental growth by cross-selling its broad array of credit card and other banking products to Discover Card cardholders. The average Discover Card cardholder generally skews older and is of higher credit quality than those in Cap One's portfolio, which may translate to more traction with consumer credit products like mortgages and auto loans, as well as other premium CapOne credit card offerings.? The deal also includes Discover's sizable online deposit business.
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Potential risks…
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However, potential downsides exist, primarily in securing regulatory approval, given concerns about industry concentration and competition.? The industry is already concentrated among just a handful of the big banks.? The top five credit card issuers in the US have over 60% of the market share.? Combined, Discover and Capital One will have close to 20% of the market as measured by receivables outstanding [4]. To address concerns, CapOne would need to demonstrate a commitment to keeping swipe fees reasonable and expanding network traffic to maximize its value. Successfully running a network requires scale and the Discover Network's place in the ecosystem is hardly assured.
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Additionally, as Capital One lacks experience in operating a network, maintaining the required technology infrastructure and retaining Discover personnel may offset some anticipated efficiency gains typically associated with portfolio acquisitions without a network component.
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Footnotes and references:
[1] Discover's 4th quarter 2023 PR. link
[2] American Express, like Discover, also owns its own payment network.
[3] Haltom, R. and Wang, Z. (December 2015). EB15-12 - Federal Reserve Bank of Richmond. Did the Durbin Amendment Reduce Merchant Costs? Evidence from Survey Results. https://www.richmondfed.org/-/media/richmondfedorg/publications/research/economic_brief/2015/pdf/eb_15-12.pdf
[4] Wallethub link.
Private Credit | Asset-Based Finance | Capital Markets | Insurance Solutions | Alternative Assets | Securitized Credit
1 年William - very interesting article and I appreciated your insight. One thing I was wondering if the regulators, in approving the merger, would require CapOne or Discover to sell off one of their business lines to minimize the anti-trust issue. If so, and if it's one of the more lucrative lines such as the payment network or cards, what would the combined company look like?
The Rule of Three comes into play again, where a smaller 3rd player is needed to keep the dominant two in check.
Exciting times ahead for Capital One with the potential acquisition of Discover Card! It's not just about climbing the credit card leaderboard; it's about strategic positioning in a rapidly evolving financial landscape. The inclusion of Discover's payment processing network could be a game-changer, especially in light of pending legislation like the Credit Card Competition Act. Looking forward to seeing how this move shapes the future of consumer credit and financial services!
Senior Vice President CardWorks Servicing
1 年William -- as usual, great insights! I have a few thoughts to add: (1) although "swipe fees" has become the accepted popular term for credit card interchange, to me it diminishes the value that has been created by these networks; kind of like calling the electric grid a "light switch" (2) IMHO, the real economic reason for interchange (apart from the network costs which as you point out aren't that large) is to create a yield on convenience use; without interchange, it would be impossible to offer an interest free grace period to consumers; (3) no doubt Capital One will find ways to significantly enhance the Discover network and, eventually, create incremental price competition to V and MC; (4) finally, the additional revenue stream from the network may help offset the looming reduction in late fees in the issuing business. Keep up the great analysis!
Consumer Credit and Structured Finance Expert | Credit Risk Management Leader
1 年Does anyone remember Discover's Ringo Starr "signature" card (circa 1995)? Does anyone remember Ringo? ??