Last month, over 99% of the stockholders of Capital One and Discover formally approved the merger of the two firms. But rumors recently emerged from unnamed sources in the Department of Justice (DOJ) that the merger might be considered anti-competitive due to the relatively large share of the so-called “sub-prime” credit card market held by the two companies. This would be a mistake, as the evidence shows the merger would be good for all consumers—especially those with lower credit scores.
By expanding access to credit and strengthening competition in the consumer financial market, the merger would reduce obstacles for millions of younger, minority, and other excluded consumers to gain access to credit cards and bank accounts on competitive terms. The new administration has signaled that it wants to make sure that its merger policy works for working class families. Permitting Capital One and Discover to join forces will enable them to better serve subprime consumers across the board.
Under traditional antitrust analysis, this merger barely raises an eyebrow. Yes, the combined entity would be the sixth-largest bank by assets, but it would hold only 3% of all domestic assets. It would also be the third-largest credit card issuer by purchaser volume, after JPMorgan Chase and American Express, but there are thousands of credit card issuing banks in the United States and even the largest issuers only have a modest percentage of all volume. Most significant, the combination of Capital One’s marketing and underwriting savvy with Discover’s existing processing network will make Discover a more viable competitor to Visa, MasterCard, and Amex. In both banking and credit card operations, the combined entity’s scale and innovative approach could drive improvements both directly for its customers and indirectly for customers of other banks, who would be driven to provide competitive offerings. In short, the merger is likely to be pro-competitive.
As noted, rumors have surfaced that some DOJ antitrust lawyers have raised concerns that the merger would create excessive concentration in the “subprime” credit card market, i.e., the roughly 16% of all U.S. consumers with a credit score below 660. It is important to note that the DOJ’s role is advisory, as the merger will be reviewed by bank regulators, not the DOJ antitrust division. Regardless, these concerns are unfounded. Capital One and Discover have specialized in providing services to customers with lower credit scores in different ways and the combination will enable them to leverage their combined expertise to serve those customers better. For example, it will be able to use Capital One’s algorithms to identify customers of Discover who, in spite of having low credit scores, are lower risk, and offer those customers loans at preferential rates.
This highlights the reality of “subprime” credit: it is not a separate credit card “market” because the individuals classified as “subprime” are dynamic, as many subprime consumers improve their credit and gain access to prime cards while those with higher credit scores hit bumps in the road and move in the opposite direction. Using data from 2014 and 2015, Fair Isaac found within a six month period 19% of all credit card accounts improved their credit scores by more than 20 points while 14% decreased by more than 20 points. Thus, as much as 1/3 of customers significantly change their credit status every six months.
In any case, the Bank Policy Institute estimates the merged firm would account for a little less than 30% of subprime credit card balances in the United States, concluding that “If the subprime consumer segment of the credit card market merits separate scrutiny, our analysis indicates that the segment is highly competitive and would remain so even after the proposed merger.”
Most major card issuers have focused on catering to wealthier, high-spend, and low risk consumers that require less effort to underwrite and serve and lower capital reserve requirements. Capital One gained its market share in “subprime” over time through its data-driven strategy and ability to better-identify diamonds in the subprime rough than competitors. This has enabled the company to identify lower-risk individuals in (otherwise) higher-risk groups, thereby serving otherwise underserved consumers, while limiting default risk. It also provides opportunities for these consumers to migrate toward a lower-risk category by gradually increasing the size of their credit lines as they demonstrate creditworthiness.
The combination of Capital One and Discover will almost certainly increase access to credit for people with low credit scores, thereby enabling them to get onto the first rung of the credit ladder and to build (or rebuild) their credit. It should thus be considered a good outcome for the new Administration, with its increased attention to the effects of mergers on working class Americans.
