Will the Capital One-Uncover merger be authorized? A information to the problems

Capital One - Discover
Capital One says it might probably assist make Uncover a stronger competitor to Visa and Mastercard. The deal’s critics query that assertion and fear that the mixed firm could be a bank card large, notably within the subprime section.


The ultimate final result of the largest financial institution deal since 2008, Capital One’s blockbuster buy of Uncover Monetary Companies, is anybody’s guess.

It could possibly be blocked by U.S. banking regulators. The merger-skeptical Division of Justice might sue to dam the tie-up, very like it did within the failed merger of JetBlue and Spirit airways. Or the deal would possibly get authorized regardless of issues from antitrust hawks.

Critics argue that the merger would create an enormous bank card firm, restrict choices for subprime debtors and fail to place a significant dent available in the market energy of Visa and Mastercard.

Capital One argues that the deal doesn’t pose anti-competitive issues, saying that it could nonetheless face intense competitors from JPMorgan Chase, American Categorical, Citigroup and different heavyweights.

The McLean, Virginia-based firm additionally contends that the merger would enhance competitors within the funds market, the rails by which debit and bank card funds get processed. Uncover’s community has lengthy lagged behind these owned by Visa and Mastercard, and Capital One says its large buyer base could make Uncover a stronger competitor. 

Figuring out which facet’s arguments prevail will take months, involving in depth analyses of overlap within the particular markets the place Capital One and Uncover compete. The battle might finally transfer to a courtroom, the place economists would argue over the definition of these markets and to what extent they’d stay aggressive.

“You possibly can’t do it within the summary,” mentioned Lawrence White, a New York College professor who focuses on monetary regulation and antitrust points. “All of it comes right down to: What does the info inform us?” 

Step one in answering these questions got here final month, when Capital One filed its formal merger software with its two principal regulators, the Federal Reserve and the Workplace of the Comptroller of the Forex. 

Under is an summary of what is forward and the important thing questions that can drive whether or not the merger will get authorized.

The method

Regulators on the Fed and OCC will evaluate Capital One’s software within the coming months, they usually’re more likely to maintain public hearings on the deal. 

These hearings might show contentious, given the opposition from some Democratic lawmakers and a few key neighborhood teams. The Nationwide Neighborhood Reinvestment Coalition, which unsuccessfully fought Capital One’s final main merger in 2012, rapidly got here out towards the deal.

As regulators weigh approving the merger, they will contemplate whether or not it poses dangers to monetary stability, if it advantages the “comfort and wishes” of communities and every financial institution’s compliance with guidelines that guard towards shoppers’ laundering cash.

However the actual motion will seemingly come when financial institution regulators analyze whether or not the deal makes markets roughly aggressive. Those that oppose the deal say regulators have lengthy taken a lax method, utilizing high-level metrics to review market focus relatively than narrower ones. 

President Joe Biden’s administration is, on the very least, sympathetic to these arguments. Months into his presidency, Biden issued an government order calling for a government-wide evaluate of antitrust insurance policies, calling out “extreme market focus” in a number of industries. 

“It is an attention-grabbing check of the all-of-government method of Biden’s government order,” Harry First, an antitrust regulation professor at New York College, mentioned of the deal.

Financial institution regulators have been considerably gradual to conduct their very own overhauls, however momentum has picked up lately. 

In January, performing Comptroller of the Forex Michael Hsu proposed some modifications and referred to as for regulators to “formulate a brand new framework for assessing competitors.” A brand new proposal from the Federal Deposit Insurance coverage Corp., which does not have a say within the Capital One merger, would make it tougher for larger banks to merge.

However maybe essentially the most notable voice in overhauling financial institution merger insurance policies has been Jonathan Kanter, the assistant lawyer common who’s answerable for the DOJ’s antitrust division.

DOJ And Federal Trade Commission Hold Annual Spring Enforcers Summit
Jonathan Kanter, the assistant lawyer common answerable for the Division of Justice’s antitrust division, has mentioned that the division will focus extra intently on how financial institution mergers “might have an effect on competitors for various buyer segments.”

Al Drago/Bloomberg

Beneath financial institution merger insurance policies, the DOJ submits a evaluate of “aggressive elements” to the banking businesses that approve or deny mergers. In a speech final 12 months, Kanter laid out an overhaul going down on the DOJ to make sure these critiques take into consideration “in the present day’s market realities.” 

The Biden administration’s revision to DOJ tips for financial institution mergers has but to be launched, and the final replace got here in 1995. However final 12 months the DOJ up to date its tips for different firms, and advocates need the DOJ to apply its more durable framework to the Capital One-Uncover deal.

Quite than focusing totally on overlaps in deposit bases and department footprints, the DOJ will focus extra intently on how mergers “might have an effect on competitors for various buyer segments,” Kanter mentioned in his speech final 12 months. That lens might show vital as regulators weigh whether or not the mixed firm’s subprime borrower base leaves these clients with fewer choices.

The Fed and OCC can select to approve the deal even when the DOJ flags main issues. But when the banking regulators greenlight the merger, the Justice Division nonetheless has the flexibility to sue inside 30 days in an effort to dam the deal on anti-competitive grounds.

The DOJ hasn’t fought a financial institution merger in many years. However the company’s willingness to take action appears heightened, if its latest spate of court docket circumstances in different sectors is any information. Although the DOJ has a combined observe file of late, it scored a significant victory in January when a federal decide nixed the JetBlue-Spirit deal.

“Throughout each trade, not simply banking, this DOJ has been much more aggressive, much more interventionist,” mentioned Jennifer Rie, a senior litigation analyst at Bloomberg LP who focuses on antitrust points.

Bank card issuance

The primary product supplied by each firms is the bank card. 

Capital One had the fourth most bank card balances excellent final 12 months, whereas Uncover was tied with Financial institution of America because the fifth largest card issuer, in accordance with a Capital One investor presentation. If the companies merge, Capital One would turn into the most important bank card lender within the nation, outpacing JPMorgan Chase and accounting for 19% of excellent U.S. card loans.

That quantity alone doesn’t set off main crimson flags. Beneath new merger tips the DOJ issued for a number of sectors in 2023, the company mentioned a merger can elevate monopoly issues if the corporate’s post-merger market share is greater than 30%. 

And the pure heft of Capital One’s opponents means that bank card holders will proceed to have choices. The checklist of opponents consists of Chase, American Categorical, Financial institution of America, Citi and U.S. Bancorp. 

Plus, Capital One would hold its present spot because the third largest card firm by buy quantity, behind Chase and Amex.

“The bank card trade is extremely aggressive and dynamic,” Capital One wrote in a submitting to regulators, including that it’ll “proceed to face many vital opponents” even after the merger. That checklist consists of 1000’s of banks and credit score unions that subject bank cards, even when their particular person scale is way smaller than large banks’.

The deal’s critics, nonetheless, are pointing to the 2 firms’ comparatively giant portfolios of subprime bank cards. They argue that financial institution regulators and the DOJ ought to outline the bank card market extra narrowly to give attention to debtors with subprime credit score scores, who have a tendency to hold balances relatively than repay their borrowings every month.

“They are going to turn into the largest total, however particularly available in the market for individuals who use their bank card to borrow,” mentioned Elena Botella, a former chief in Capital One’s subprime card enterprise who now works on the progressive group Omidyar Community. 

Loans to subprime debtors made up 32% of Capital One’s U.S. bank card portfolio final 12 months and 20% of Uncover’s, in accordance with securities filings from every firm.

Capital One’s share is considerably bigger than that of different giant card issuers. Chase’s subprime playing cards comprise 14% of its whole portfolio, and the comparable determine at Citi is round 20%.

That sort of high-level evaluation does not take into consideration a number of nuances, resembling whether or not debtors have had subprime scores for a very long time or not. Financial institution regulators and the DOJ would have entry to way more element, together with knowledge on different kinds of subprime lending past bank cards, as they weigh the deal’s aggressive impacts.

If the DOJ chooses to combat the merger, narrower definitions of the bank card or client lending markets might function closely.

“There’s nothing that stops the DOJ from defining a market … that is narrower than simply all potential bank card holders,” mentioned Rie, the Bloomberg authorized analyst.

White, the NYU professor, mentioned Capital One might defend itself in court docket if it thinks regulators’ analyses do not adequately outline the market. From there, it could be as much as a decide to find out whether or not the federal government overstepped.

In its merger software, Capital One wrote that the Fed and OCC have acknowledged that “any marketplace for bank card issuing is nationwide in scope, intensely aggressive and never concentrated,” pointing to a number of financial institution regulatory evaluations centered on bank cards.

The corporate additionally pointed to the trade’s “dynamism, innovation and competitors,” with varied options that present bank card issuers supply to customers, in addition to new entrants and competitors from nonbank lenders. 

If the DOJ does slender its focus to subprime lending, it should contemplate that there are different “types of credit score” out there, past simply bank cards, mentioned Fred Ashton, a contest economics analyst on the American Motion Discussion board, a center-right assume tank. Borrowing choices for subprime customers embrace private loans, payday loans, auto title loans and newer types of credit score from purchase now/pay later firms.

“A bank card does not simply compete with different bank cards,” Ashton mentioned, including that the DOJ would seemingly wish to “slender the market definition as finely as they’ll, however not so tremendous that it is unrealistic.”

Funds networks

The main driver of the deal is what Capital One CEO Richard Fairbank has referred to as “the holy grail” — having the ability to run not less than a few of Capital One’s playing cards on Uncover’s networks. 

Capital One has lengthy needed to undergo two dominant middlemen — Visa and Mastercard — for the processing of funds that clients make on their playing cards. Switching would reserve it vital quantities of cash.

Uncover has constructed up an enormous community of retailers that settle for its playing cards, however amid lagging fee volumes, it has did not take market share from Visa and Mastercard. It additionally trails Amex — which, like Uncover, points bank cards that run by itself community.

In its submitting with regulators, Capital One mentioned the Uncover deal will make funds networks extra aggressive. The financial institution argues that its heft and huge buyer base could make Uncover a extra formidable competitor to Visa and Mastercard.

The deal will “promote competitors by deconcentrating these extremely concentrated markets, over which Visa and Mastercard tower,” Capital One acknowledged in its software. It’s “essentially the most viable likelihood to maintain and develop the Uncover funds community,” the financial institution added.

Critics of the deal query that assertion, saying that Capital One is simply planning to shift a portion of its bank cards to Uncover and doesn’t have a concrete plan to meaningfully change Uncover’s trajectory.

“There’s simply no actual path for Uncover to start to compete with Visa and Mastercard, as a result of it definitely does not compete now,” mentioned Shahid Naeem, a senior coverage analyst on the American Financial Liberties Undertaking, a progressive antitrust group. “It is only a actually robust argument to take at face worth.”

Uncover processed some $550 billion in funds in the USA in 2023, far beneath Mastercard’s $2.84 trillion and Visa’s $6.8 trillion. Capital One says it plans to shift greater than $175 billion in buy volumes by 2027, an quantity that Naeem says is way too small to make a distinction.

The comparatively gradual method towards shifting Capital One’s bank card debtors is partly as a result of customers wrongly consider that Uncover playing cards aren’t broadly accepted in the USA. Capital One will work on altering that misperception by its “advertising and marketing muscle,” Fairbank mentioned at a convention in February.

However Uncover is clearly missing in its acceptance by worldwide retailers. Shifting all of Capital One’s bank card holders onto the Uncover community instantly might backfire, as travel-heavy clients notice their playing cards are not as broadly accepted.

“The timing of how a lot we proceed to construct quantity on that community is absolutely going to depend upon how briskly we are able to handle a few of the model notion and worldwide acceptance points,” Fairbank mentioned.

As an alternative of transferring all of its playing cards instantly, the shift is “going to be a crab stroll,” or lifting one leg at a time, Fairbank mentioned.

Jeremy Kress, a professor on the College of Michigan, worries that Capital One might finally cost retailers more cash for utilizing the Uncover community, as not accepting the largest U.S. card firm could be dangerous to retailers’ companies. 

“Might that give Capital One the flexibility to jack up service provider charges to make use of its bank card community? I feel that is a risk,” Kress mentioned. “If that could be a threat, it is one which the DOJ and the banking businesses are going to must take into consideration.”

Charges might additionally turn into a degree of rivalry on the debit card facet. Uncover has lengthy been exempt from the caps on debit card interchange charges that Congress handed in 2010 below the so-called Durbin modification to the Dodd-Frank Act. Capital One would get hold of Uncover’s exemption if the merger goes by.

Capital One has mentioned that it plans to shift all of its debit-card enterprise to Uncover’s community, which might reserve it tons of of tens of millions of {dollars} by slicing out the intermediary.

However the removing of the Durbin modification’s value cap might additionally give Capital One an incentive to boost charges on retailers, argued Naeem, the American Financial Liberties Undertaking analyst, in a report on the merger.

JPMorgan Chase CEO Jamie Dimon raised issues about Capital One getting an exemption from the Durbin modification in a February interview with CNBC. Whereas his principal level was that regulators ought to permit the mixed firm to compete within the market, he additionally mentioned that Capital One would achieve an “unfair benefit versus us” in debit playing cards.

“After all, I’ve an issue with that,” Dimon mentioned. “, like why ought to they be allowed to cost debit completely different than we value debit simply due to a regulation that was handed?”

Jeff Norris, a prime Capital One government, mentioned at a convention final month that the financial institution is not envisioning any value modifications on the Uncover community.

Elevating costs and probably angering retailers wouldn’t essentially be in Capital One’s finest pursuits, mentioned Ashton, the American Motion Discussion board analyst. In a February report, he wrote that the deal will “inject competitors” into the funds market.

“Whereas the deal would, actually, create a much bigger financial institution, the extra essential impact could be the seemingly creation of a viable different to Visa and Mastercard’s prominence within the funds community market that might yield extra favorable phrases to retailers whereas increasing entry to Uncover’s community,” Ashton wrote. 

Visa and Mastercard’s pricing energy has been the supply of a long-running feud between the Justice Division and the 2 firms. Final month, Visa and Mastercard agreed to decrease their interchange charges as a part of a settlement with retailers throughout the nation.

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