Capital One (NYSE: COF) seeks growth with addition of Discover (NYSE: DFS), but danger lurks
Capital One (NYSE: COF), the fourth largest US credit card issuer, has received regulatory blessing to acquire the sixth biggest, Discover Financial Services (NYSE: DFS), for $35 billion.
Capital One is trying to take advantage of the explosive growth in credit-card usage, as cash and checks go the way of the dinosaur, and transactions migrate to the digital world. Household credit card balances totaled $1.21 trillion in the fourth quarter, up 4% from the prior quarter and 7% from a year earlier.
Capital One commenced as Signet Financial in 1988 and turned into Capital One in 1994. The founders were pioneers in using statistical analysis to create customized credit card offers for different customer demographics.
It started as just a credit-card lender. But in 2005 it became the first monoline credit card issuer to get into consumer and commercial banking with the purchase of Hibernia National banks. Capital One has grown to become the No. 9 bank in the country in terms of assets.
It has gained notoriety for its celebrity ads that have included actor Samuel L. Jackson, ex-basketball star Charles Barkley, movie director Spike Lee and actress Jennifer Garner.
History of Discover
Discover was created by Sears, then the biggest US retailer, in 1986. Sears sought to create one-stop financial shopping for its customers after purchasing Dean Witter Reynolds securities brokerage and Coldwell Banker real estate brokerage in 1981. Sears also owned a bank.
Discover was one of the first cards to offer rewards, including cashback. That helped it gain a large national consumer base. Retailers liked it because it didn’t charge any fee to them.
However, the Sears connection proved to be a problem. It turned out consumers weren’t looking for one-stop financial service at the place where they bought their undergarments. And some retailers were resistant to accept a card issued by a major competitor.
Sears spun off Discover as part of Dean Witter Reynolds in 1993. The public company was taken over by Morgan Stanley in 1997. And the investment bank spun Discover off in 2007. Discover has its own credit card network, which is the financial infrastructure that facilitates transactions between merchants and card issuers.
An attraction for Capital One
That makes it a competitor to Mastercard (NYSE: MA) and Visa (NYSE: V). And it was undoubtedly part of the attraction for Capital One, as it gives the bank another revenue stream. To be sure, Mastercard and Visa dominate that market. They are the top two credit card brands, with more than 30% of the global market each, compared to 1% for Discover.
Capital One and Discover together will be the third biggest card issuer by purchase volume, behind No. 1 JPMorgan Chase (NYSE: JPM) and American Express (NYSE: AXP). They will push Citigroup (NYSE: C) down to fourth. Bank of America (NYSE: BAC) is fifth.
A merger creating that kind of scale in a growing market seems like a good thing. But Capital One will face a tougher operating environment. The 30-day delinquency rate for credit-card loans hit 3.5% in the fourth quarter, the highest level since the Philadelphia Fed began tracking it in 2012.
The payments system is also a very competitive space, so don’t go too crazy over the merger.
