Capital One’s deal disquiet puts rage in arbitrage

Discover Financial Services

21/03/2025 17:00

The author is a Reuters Breakingviews columnist.  The opinions expressed are his own.

By Stephen Gandel

NEW YORK, March 21 (Reuters Breakingviews) - Merger arbitrageurs overplayed their Trump card. Hedge funds that bet on pending deals rapidly narrowed the gap between Discover Financial Services’ DFS.N share price and the value of a $35 billion takeover offer from Capital One Financial COF.N after Donald Trump’s presidential election victory. The sellers’ stock has now plunged 20% on renewed regulatory fears. Financiers gambling on what they assume conservatives will do rather than what Republicans actually say are bound to encounter more pain.

Announced a year ago, the all-stock deal would form the largest U.S. credit card issuer. Antitrust enforcers under then-President Joe Biden were bound to be skeptical. On November 5, as Americans headed to the polls, Discover’s share price was roughly 10% below Capital One’s offer.

That snapped to 6% the next day, eventually falling under 3%. Bankers happily predicted that President Trump would slash red tape and encourage deals. He dismantled the Consumer Financial Protection Bureau, signaling easing lender regulation.

Yet on Monday, news service Capitol Forum reported that Department of Justice staff are concerned that the merger locks up too much of the credit card market among low-credit-score borrowers. As of 2024’s end, Capital One and Discover together held $67 bln of so-called subprime loans, roughly 30% of the $220 billion outstanding from all card lenders, Jefferies analysts reckon.

There were plenty of reasons for caution. The combined market share grazes a red-flag threshold under guidelines repeatedly affirmed by incoming trustbusters. Conservatives have blasted credit-card companies, with Trump proposing a 10% cap on interest rates during the campaign. Even worse, the president's family business sued Capital One for “debanking” the real-estate developer by closing its corporate accounts in the wake of the January 6 riot at the U.S. Capitol.

There is still reasonable hope. The Federal Reserve and the Office of the Comptroller of the Currency effectively lead reviews of lender tie-ups. DOJ staff recommendations do not guarantee lawsuits. The companies could sell their portfolio - Jefferies pegs Discover’s subprime holdings at about $20 billion. And Capital One could attempt to settle with Trump, much as fellow merger candidate Paramount Global PARA.O is trying to do.

Yet it’s remarkable that hedge funds ever got so comfortable. Even temporary stock swings can force traders out of positions. Several funds blew up underestimating the last administration; merger arbitrage notched a 5.6% return in 2024, according to industry tracker HFR, dead-last among event-driven strategies. Now, investors have already been wrong-footed twice by Trump after being caught in late January by Hewlett Packard Enterprise’s HPE.N blocked $14 billion acquisition of Juniper Networks JNPR.N. The hope of a long-sought reversal of fortune risks leading Wall Street into an even more bitter reckoning.

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CONTEXT NEWS

Staff reviewing Capital One Financial’s planned $35 billion acquisition of Discover Financial Services at the Department of Justice are concerned that the merger could harm competition in lending to subprime borrowers, news service Capitol Forum reported on March 17.

Shares of Discover fell on the news, and are now 20% below their peak in February.

Investors' confidence in Discover deal wanes https://reut.rs/4hEfLaU

 (Editing by Jonathan Guilford and Pranav Kiran)

 ((For previous columns by the author, Reuters customers can click on GANDEL/ stephen.gandel@thomsonreuters.com))