Capital One Financial CEO Richard Fairbank faced plenty of skepticism from big banks when he and his co-founder first pitched concepts that would revolutionize the credit card industry. Only one bank gave them a chance.
Some 35 years later, Fairbank's company could become the biggest credit card lender in America,
The proposed merger is already running into opposition from key consumer advocacy groups and Democratic lawmakers. Biden administration officials could ultimately block it. But the deal appears to be a calculated risk by Fairbank, who told analysts Tuesday that
Though some analysts are skeptical, most of them seem to like the $35.3 billion deal. They say it's an example of Fairbank pouncing when opportunity strikes.
"He'll come off as measured and somewhat laid-back, but clearly, he's fiercely competitive," said Meredith Whitney, a bank analyst who has followed Capital One since it went public in 1994. "He's been aggressive since '94, either competing or acquiring. This is a testament to that."
The true prize in the Discover purchase is not necessarily having more credit card loans than any other U.S. bank. That would just be a big side benefit. Rather, what Fairbank called the "holy grail" is being able to run Capital One's cards on Discover's payments network, rather than using Visa and Mastercard as middlemen.
Doing so would bring major savings, along
Discover, which got its start in 1985 as part of the retailer Sears, has long been viewed as a potential acquisition target for both banks and technology companies. It's built a well-known brand and a payments network that reaches 70 million merchants, which is certainly no small achievement.
But the volume of payments on that network last year, $550 billion, was far smaller than Visa's $6.8 trillion, Mastercard's $2.8 trillion, and even American Express's $1.35 trillion. By issuing cards that run on its own network, Amex has reached Fairbank's "holy grail," but its business is limited to more elite clientele.
Fairbank, who declined to comment for this story, indicated during a conference call Tuesday that one of Capital One's goals is to boost the payments volume on the Discover network. Assuming the deal closes, Capital One plans to do so partly by shifting its debit cards and, gradually, some of its credit cards, onto Discover's payment rails.
The aim is to make the Discover network a stronger competitor with Visa and Mastercard — giving the deal's architects a pro-competition argument that they can use to counter critics who argue the merger would be bad for consumers.
Opponents of the deal say it would reduce competition in credit card issuance, since it would consolidate two of the big six U.S. card lenders.
If the deal is approved, Capital One would account for 19% of U.S. credit card loans, though it would still have strong rivals in JPMorgan Chase, Bank of America, Citigroup and American Express.
The latest opponent of the deal is Rep. Maxine Waters, the top Democrat on the House Financial Services Committee. On Wednesday, Waters urged regulators to block the deal.
"For far too long, regulators rubber stamped bank merger applications, despite these mergers not being in the best interest of the public," the California Democrat said in a written statement.
The possibility that federal regulators will agree is a major risk for Capital One. Biden-era regulators, as well as the Department of Justice, have grown skeptical of bank consolidation, though they may be swayed by arguments that the deal would diminish the dominance of Visa and Mastercard.
Tom Brown, a longtime bank analyst who now runs the hedge fund Second Curve Capital, sold all of the fund's stock in Capital One on Tuesday. Regulatory uncertainty, he said, was one reason why.
"Every agency in Washington that uses the alphabet is going to be all over this deal," Brown said. "You've got a year where the people that work for Capital One are going to be uncertain about their future … so it's going to be tough to be a high-performing company."
It doesn't help that Discover has some severe regulatory issues, since fixing them would now become Capital One's problem.
After years of troubles, Discover said last year that it plans on
The problems were bad enough that Discover CEO Roger Hochschild was
New management and the regulatory "overhang" at Discover made it easier for Capital One to make a deal with a relatively good price, said Mihir Bhatia, an analyst at Bank of America. Buying Visa, Mastercard or American Express would be exceedingly expensive and infeasible, Bhatia said. Nor would it be realistic to build a rival payments network from scratch.
But if the merger goes through, Capital One will suddenly have a fully integrated payments company and direct access to Discover's valuable merchant relationships.
"It's all about the network," Bhatia said.
Saul Martinez, an analyst at the British bank HSBC, said there's "clearly strategic value" in the deal but noted that the extent of regulatory pushback is not yet clear. He also argued that scaling up Discover's business will take time and money, saying there's a "reason it's not easy to challenge Visa, Mastercard and even Amex."
"There's a lot of uncertainty," Martinez said.
It's not the first time that Capital One finds itself in the middle of a contentious merger deal. In 2011, Capital One agreed to buy the online bank ING Direct USA from the Dutch bank ING. Consumer advocates opposed the deal, and the review process took longer than expected, but the merger
The ING Direct deal was part of Fairbank's broader strategy to diversify the company's balance sheet — in that case, by gaining an online bank that bolstered its deposit platform.
Growing deposits has long been a focus for Capital One. When the company started on its credit card journey, it relied on funding through the securitization market. Its credit card loans were bundled up into securities and sold to investors.
The deals provided a fresh source of cash that enabled Capital One to make more loans, given investors' willingness to scoop up consumer debt as credit cards boomed. But the securitization market is prone to disruptions when investor confidence falters, and it's a more expensive source of funding than plain-old bank deposits, since investors require bigger payouts.
"Nothing beats old-fashioned retail deposits," Fairbank
In 2005, Capital One bought Louisiana-based Hibernia National Bank. A year later, it bought North Fork Bank in New York. And, closer to its northern Virginia headquarters, it bought Chevy Chase Bank in Maryland in 2009.
Over the years, Capital One has also diversified its revenues beyond credit cards. It made a few acquisitions in its quest to get into auto lending. It expanded into mortgages before the 2008 meltdown, dialed it back as the crisis was brewing and fully left the sector in 2017.
The consumer-focused bank also serves small businesses and larger corporate clients, including through the health care lending business it acquired in 2015 as General Electric was shrinking its sprawling empire.
The Discover deal brings Capital One "back to the beginning," since the company is looking to bolster its original credit card business, said Whitney, the veteran bank analyst.
Fairbank and his co-founder Nigel Morris' "secret sauce of credit card marketing" quickly found success, said Whitney, the CEO of Meredith Whitney Advisory Group. It helped that as a new company, they were able to build their technology from scratch, while other banks were wedded to legacy systems.
Previously, banks generally took a cookie-cutter approach to credit cards, largely charging the same interest rates without meaningfully discerning each borrowers' ability to repay or respond to more attractive offers.
Fairbank and Morris wanted to introduce a suite of cards — with different interest rate options, fees and benefits — depending on customers' preferences and credit histories.
They pitched their idea of shaking up the industry to several major banks. The only one that took them up on it was Virginia-based Signet Bank, which would soon spin off Capital One into its own company. One key driver of that success: balance transfer offers, where consumers who had large card balances elsewhere could bring them to Signet at teaser interest rates.
In 1998, a few years after the company was spun off, Fairbank told American Banker that Capital One was "really a marketing company" that sells credit cards. It also was a "massive scientific laboratory" to test the co-founders' ideas to shake up the industry, he said. The experimentation even spread into cell phone services, with the Washington Post
Discover was making its own strides at the time under then-CEO Phil Purcell, whom Fairbank said Tuesday he looked upon with "such admiration" as the company built out a network of merchants. In its credit card business, Discover executives were "the pioneers in cash back" rewards, Fairbank said.
"They created cash back before any of the rest of us thought of it," he said.
Fairbank and Morris were also "phenomenally successful," said Brown, the investor who sold his fund's Capital One stock this week. Signet's credit card portfolio would soon outperform competitors', thanks to the ideas that other banks rejected.
Brown is doubtful that Capital One's plans to shift business onto the Discover payments network will give it "significant new scale" to compete against Visa and Mastercard.
Even so, Brown admitted he was hesitant to bet against Fairbank. The 73-year-old CEO is "as smart as they get," with an ability to look ahead that's only rivaled by the likes of JPMorgan Chase CEO Jamie Dimon, Brown said.
"I never want to bet against Jamie Dimon or Rich Fairbank, but I have to do what I think is right too," he said.
