Plenty of ink has been spilled on Capital One’s bold move to acquire Discover Financial Services, with most of it revolving around combining two large credit card issuers and the odds of the deal securing regulatory approval.
Although these are important factors, the acquisition has several strategically critical implications that financial services leaders should consider. While our new report addresses these in greater detail, here is a quick look at two key factors.
Card Networks Are a Rare Asset
Capital One CEO Richard Fairbank stated on the investor call to discuss the deal that Discover “has created one of the rarest assets in the payment space, a global payment network at scale.” While Discover’s network ranks a distant fourth behind Visa, Mastercard, and American Express, it still offers significant benefits for a card issuer. It is difficult to envision another network coming on the market anytime soon.
Capital One’s business case models about $1.2 billion of projected network synergies. Network ownership will eliminate fees previously paid to Visa and Mastercard and create new revenue streams not subject to capital reserves or customary credit risk. It also creates direct merchant engagement, opening the door for additional opportunities for the Capital One Shopping platform.
Discover’s assets also include the PULSE debit network. Capital One indicated that, at closing, it would immediately transition its debit card portfolio (seven million cards and $60 billion of purchase volume) to Discover Debit, instantly boosting the network’s scale and credibility as an alternative to Visa and Mastercard.
The Durbin Two-Step
The deal’s impact on Capital One’s treatment under the Durbin Amendment has been somewhat overlooked. Under its current wording, Reg II in its entirety, including its cap on debit interchange, would no longer apply to Capital One-Discover debit cards once the company serves as both a card issuer and network provider. SRM estimates this annual benefit to be more than $350 million.
The benefits of acting as both issuer and network extend to the pending Credit Card Competition Act (CCCA) being championed by Sens. Dick Durbin (D-Ill.) and Roger Marshall (R-Kan.). Again, Capital One would be exempted from the CCCA’s requirement to support two unaffiliated payment card networks.
Not only would this insulate Capital One from the expense and bandwidth required to address any technology and back-office implications – not to mention potentially reduced interchange due to routing competition – it also positions the company to gain more revenue as other large (over $100 billion) issuers deal with the consequences of CCCA’s catastrophic mandate.
JPMorgan Chase’s CEO Jamie Dimon recently acknowledged that the purchase would create “an unfair advantage versus us” in debit payments and questioned, “Why should they be allowed to price debit differently than we price debit just because of a law that was passed?” While Dimon acknowledged in the same interview with CNBC that he had immense respect for Capital One’s CEO, Richard Fairbank, he stated he was not worried about the deal overall – even though, at close, the new entity would surpass JPMorgan Chase as the largest credit card issuer by loans. The investments Capital One will make leveraging the acquisition synergies are unclear, but the additional debit revenue positions the bank to create deposit value propositions that other large banks are unable to match.
The Bottom Line
The Capital One-Discover merger faces an uncertain and potentially lengthy path to approval. Nonetheless, financial services leaders should dissect its implications as if it will cross the finish line.
The impacts at the top end of the credit card issuer landscape are straightforward, but the subtler implications for network dynamics cannot be overlooked. SRM’s new report explores these major themes and considerations in greater detail.
Myron Schwarcz, Chief Product Officer, and Andrew Gordon, Senior Director, have two decades of experience in the banking industry, advising leading financial institutions on their strategic initiatives. Further inquiries may be made by emailing Myron at mschwarcz@srmcorp.com or Andrew at agordon@srmcorp.com.
