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Credit card deal faces Washington buzzsaw

THE NEWS

Capital One is buying Discover for $35 billion, a deal that will create one of the country’s biggest credit-card issuers and invite heavy scrutiny from Washington.

The companies say the merger, which would form the country’s eighth-largest bank by assets, will help it compete with bigger card companies and further Capital One’s long-held desire to be a payments giant.

LIZ’S VIEW

In the past two weeks, the following things have happened:

• The Consumer Financial Protection Bureau released a study showing that bigger credit-card issuers offer worse terms and higher fees than small ones.
• A top banking regulator announced that it would slow down merger approvals, issuing new guidelines that one top law firm called “more ambiguous, multifaceted and complex.”
• Congress scheduled a hearing on whether there’s enough competition among credit-card companies.
• Bipartisan support has grown for a bill seeking to crack the Visa-Mastercard duopoly — a move that might benefit Discover, but that Capital One has lobbied hard against.

It doesn’t seem like a great moment to be testing Washington, where anti-merger sentiment is already running hot.

That CFPB study is an almost comically frosty backdrop for this takeover, which is promising “great deals for consumers” through the heft of a combined company with more than 300 million cardholders and checkout-line hookups to 70 million merchants. No matter the industry, companies tend to justify mergers by saying that size lets them offer better terms to customers.

But the industry’s chief watchdog said — again, just four days ago — that the opposite is true for credit-card issuers. Its analysis of 150 companies found that large lenders like Capital One charge interest rates that are between 7 and 10 percentage points higher than smaller banks. Large banks also charge higher annual fees, and use their marketing muscle to pay for better placement on referral websites.

The CFPB doesn’t have an explicit veto over this takeover, but antitrust regulators do. Already, four banks control two-thirds of the U.S. card market, about the same competitive dynamic as U.S. airlines. The Justice Department just blocked the merger of JetBlue and Spirit, a combination the companies claimed would help a scrappy maverick take on the industry’s giants. At least Spirit’s flights are cheaper: Discover doesn’t even charge meaningfully less than Visa or Mastercard.

Antitrust regulators might like the idea of putting Discover’s merchant network in stronger hands to help it compete with Visa and Mastercard. I was surprised that Capital One didn’t lead with the duopoly-busting potential of this deal. If it were me, the first slide of the presentation would have been the Visa and Mastercard logos.

“There’s a story to tell that it’s both pro- and anti-competitive,” Keith Noreika, the former comptroller of the currency under President Donald Trump, told me. Regulators may see it as “beefing up a failing network to keep it going and competitive with the more dominant ones.”

Instead, executives didn’t press their case in their prepared remarks this morning and seemed unprepared for the first question to be on the deal’s regulatory hurdles. Capital One CEO Richard Fairbank said the company would be filing for the necessary approvals “in the next couple months” and moved on.

Both of these companies have found themselves in serious legal trouble in Washington in recent years. Capital One just got out of the Federal Reserve’s penalty box, four years after a major data breach, and in 2021 paid a hefty fine to Treasury for “egregious” failures to flag suspicious transactions. Discover just got into the penalty box for sweeping compliance lapses that resulted in its CEO leaving in August.

The business logic of this deal is sound enough. Capital One is strong in subprime (61% of its loans are to borrowers with credit scores of under 660) and has been chasing 800-club wealthy borrowers who might otherwise flash an Amex or Chase Sapphire. Discover is stronger in the middle, helping to fill out the barbell. And if it can grow Discover’s network of merchants, Capital One saves money on every swipe that its customers would otherwise pay to Visa or Mastercard.

But the companies appear to be underestimating the chances of a chain reaction in Washington. This deal feels like a thought experiment that escaped the lab.

Elsewhere in bank mergers: A group of white-shoe Wall Street lawyers are in talks to leave Skadden for a crosstown rival. Sven Mickisch, whose recent deals include the merger of two troubled regional banks last year and the sale (and post-collapse resale) of Leerink Partners to Silicon Valley Bank, is bringing four partners with him to Simpson Thacher, people familiar with the matter said.

For the past 40 years, BigLaw’s Wall Street practice has been largely a two-man game. Sullivan & Cromwell’s soft-spoken fixer, Rodgin Cohen, and Wachtell Lipton’s golf-pro greybeard, Ed Herlihy, have worked on nearly every bank merger and government rescue going back to the 1980s. (They were, naturally, on opposite sides of the Capital One-Discover deal announced last night.) Simpson is betting on a generational handoff. The team also includes Brian Christiansen, Bao Nguyen, Matt Nemeroff, and Tim Gaffney.

Foreign investment into China fell to a 30-year-low. Xi Jinping’s security crackdowns, office raids, and ever-more hawkish tone on Taiwan has spooked international investors, which were already rewiring their supply chains in a post-pandemic world.

“Capital is voting with its feet,” David Lubin, a senior research fellow focusing on China at Chatham House, tells Semafor.

That’s bad because Xi needs foreign money to restart his once-booming economy. Beijing is dealing with an imploding real-estate market, teetering local governments, a flailing stock market, falling domestic demand, and lousy demographics that point to decades of slower growth. As we reported from Davos last month, China sent its largest delegation since 2017 to the Swiss mountains in an attempt to woo back Westerners — a push that sits uneasily with Xi’s increasing saber-rattling in the region.

One caveat to the dismal numbers: What’s bad for geographical China “may be good for China Inc.,” Lubin said. BYD, which recently passed Tesla as the world’s biggest electric-car maker, is building new factories in Brazil, Hungary, Thailand, and Uzbekistan, foreign assets that can send money back to the mainland. That playbook worked for Japan, Lubin said, which compensates for an aging, island-bound population by investing abroad.

Reality bytes: The Biden administration promised billions of dollars to U.S. chipmakers and is starting to open its checkbook. GlobalFoundries got the first big grant yesterday, $1.5 billion for three factories in New York and Vermont. More than 160 companies have applied, including U.S. giants like Intel and Micron and foreign, but geopolitically friendly, firms from Korea and Taiwan.

Bermuda short: More bad news for 777 Partners, the investment firm whose finances are under scrutiny. After Semafor reported last week that its CFO had resigned, 777’s Bermudan insurance arm, which had bankrolled its deals for sports teams and airplanes with customers’ cash, was downgraded deep into junk territory. That will make it all but impossible to write new policies, threatening the firm’s already stretched finances just as it’s trying to pull off its flashiest deal yet, for the Premier League club Everton.

Shell game: European regulators are cracking down on foreign banks that promised, post- Brexit, to move operations from the U.K. to the continent but never really did. The central bank said in November that it “would not tolerate empty shells” executing paperwork on deals still run by executives in London. So it’s bad timing for this lawsuit, in which a Morgan Stanley trader in Germany claims he was given a fake title that “only existed on paper” to fool European regulators.

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