Big Merger Plan → Big Fight
Sometimes, big plus big doesn’t just equal bigger. Thanks to outdated merger guidelines running this equation in the credit card business, it might equal biggest. But not without a fight.
Financial services company Capital One wants to acquire credit card issuer Discover in a $35 billion transaction. If successful, the combination would make the duo the largest credit card issuer in the United States, surpassing even the Wall Street megabank JPMorgan.
The top ten issuers, which include Discover and Capital One, already charge higher interest rates than cards issued by smaller banks even if the consumer has good credit. And they are harvesting interest rate margins like never before, according to a new CFPB report. If it looks like an uncompetitive market, it may be an … uncompetitive market!
Numerous financial regulation advocates oppose the proposal. Americans for Financial Reform called out the merger for its potential to raise credit card prices for consumers and constrain credit access, urging regulators to scrutinize and block the deal. Said AFR’s Patrick Woodall:
“Today’s concentrated markets and behemoth banking organizations are the result of a thirty-year run of mergers and consolidation. It is time for the banking regulators to stop rubber-stamping these transactions and stand up for consumers, communities, and a more stable financial system by blocking this takeover.”
The prospect of a new form of credit card giant has sparked bipartisan outcry on the Hill. Senator Elizabeth Warren warned that the “deal is dangerous and will harm working people.” Fellow Democrats Sen. Sherrod Brown and House Financial Services Ranking Member Rep. Maxine Waters issued their own statements. On the Republican side of the aisle, Sen. Hawley leads a call for the Department of Justice to block the merger.
AFR’s Alexa Philo highlights the Federal Reserve, FDIC, OCC and Treasury’s failure to update banking merger guidelines to preempt anticompetitive megamergers like this one. The rules are already 30 years old, and despite an update being on the table for years, regulators have yet to finalize.
“While the United States experiences a historic, bipartisan revival of the anti-monopoly movement, bank regulators have fallen badly behind in taking steps to guard against and reduce concentration in financial services,” said Philo.
The incentive for this particular merger stems from Discover’s ownership of its own card processing network and the Federal Reserve’s implementation of the Durbin Amendment. The University of Michigan’s Jeremy Kress questions the extent to which the pair would have “market power to dictate terms with merchants” as both the largest issuer and a network owner.
Also, after Congress passed the Durbin Amendment (which was about debit cards) the Fed caved to American Express lobbyists, Matt Stoller notes. It exempted Discover and other “three party networks” (as opposed to a four-party network that includes the cardholder, their bank, the merchant, their bank) from debit interchange caps. Sen. Durbin is now pushing the Credit Card Competition Act in an attempt to inject more competition into card processing.
The Washington Post foresees a “stiff antitrust review” ahead. Capital One and Discover have dismissed regulatory issues to their own investors. Interestingly, Capital One CEO Richard Fairbank makes no bones about the advantage he is seeking:
“A network is a very, very rare asset. We have always had a belief that the holy grail is to be able to be an issuer with one’s own network.”
Yes, folks, he said the quiet part out loud.
BANKING AND FINANCIAL STABILITY: Capital Requirements – Executive Accountability – Regionals – Commercial Real Estate Loans – Discriminatory Derisking?
CONSUMER: Credit Cards
CAPITAL MARKETS: Shadow Insider Trading – Human Capital
PRIVATE MARKETS: Private Fund Disclosures – Syndicated Loans – Private Equity and Pennsylvanian Coal – Private Equity and Healthcare Fraud – Private Equity, Crimes, and Groceries – Private Equity and Kids – Big Gets Bigger – Other Private Markets News
CRYPTO: Crypto “Criminal” Mismanagement
HOUSING: FHLB Promise – Built-to-Rent – Climate Resilience
CLIMATE AND FINANCE: Bluelining – Flip-Flopping – Climate and Community Banking – Carbon Credit Contracts
POLITICS AND MONEY: Crypto and Elections
Feedback? Reach us at afrnews@ourfinancialsecurity.org
BANKING AND FINANCIAL STABILITY
Capital Requirements.
House Financial’s Ranking Member Waters led 41 Democrats in urging the Fed, FDIC and OCC to hurry in finalizing the incoming Basel III “endgame” capital rules, meant to shore up the financial system’s shock cushion by directing the nation’s largest banks to hold more capital. Wrote the reps:
“Strong capital rules are the cornerstone of an effective prudential regulatory framework that promotes financial stability and the safety and soundness of our banking system … [C]apital helps shield banks from unexpected losses, preventing their failure, while serving as a source of funding that banks use, along with other sources of funds like deposits, to operate and make loans in good times and in bad…We encourage you to prioritize finalizing these rules this year to ensure we have a banking system that will promote stable economic growth without needless delay.”
Related: Truist claims it had to sell its insurance brokerage business for $15.5bn due to a “relatively weak capital position” ahead of the Basel III rules. The brokerage suggests that the sale will help with deploying “capital for organic growth and share buybacks.” Private equity firms Stone Point and CD&R, along with other co-investors, will purchase the financial group’s insurance arm.
Executive Accountability.
Sheila Bair, former chair of the FDIC and Charles Goodhart of the London School of Economics argue that, with the possibility of more bank failures on the horizon, executives need to be held accountable. Bair and Goodhart champion the RECOUP Act, working its way through the Senate, which would vest regulators with the authority to claw back two years’ worth of executive compensation and levy penalties against those executives. They cite how executives at SVB, First Republic and Signature took reckless risks by adding low-yield securities and loans to their banks’ balance sheets, then failed to hedge that risk.
Regionals.
New York Community Bancorp has been experiencing turbulence ever since it posted unexpected losses from commercial real estate loans in its end-of-January earnings. This period of rockiness at a regional has prompted officials from the OCC, FDIC and state banking agencies to ask regional lenders across the country whether they’ve felt any shock from NYCB. Some calls centered on liquidity and deposit flows, and others on customer sentiment.
Commercial Real Estate Loans.
Other banks have also piled up issues with commercial real estate loans. Around two dozen US banks now have portfolios of commercial real estate loans that may bring more scrutiny from federal regulators, due to rapidly piling debt on office buildings, retail storefronts, and other property worth three times more than their total capital. More scrutiny would likely lead to regulators pressuring banks to increase reserves. At the largest banks, loan loss provisions have grown larger than their loss reserves, following a “sharp increase in late payments linked to offices, shopping centres and other properties.”
Discriminatory Derisking?
Previously, the NYT reported that JPMorgan was closing down bank accounts without warning, in order to “de-risk” in alignment with anti-money laundering rules. A group of lawmakers led by Sen. Warren is concerned this may be happening in a way that “disproportionately affects Muslim Americans and other minority communities.”
CONSUMER
Credit Cards.
A new survey released by the CFPB has found that large banks charge higher interest rates on credit cards than smaller banks and credit unions. The largest 25 percent of card issuers charge consumers interest rates 8 to 10 points higher than smaller banks and credit unions for the same service. The difference can cost consumers a difference of $400 to $500 a year. The trouble doesn’t stop there: large issuers also offered worse credit scores, APRs over 30%, and annual fees almost $100 higher than smaller card issuers.
Card issuers doubled the interest rate from 2013 to 2023. In total, major issuers charged $105 billion in interest, making it the leading cost of a card to consumers.
CAPITAL MARKETS
Shadow Insider Trading.
A biotechnology executive discovered Pfizer would soon purchase his employer. He bought stock in a rival pharmaceutical company and made $120,000. Now, he’ll go on trial for what his defense calls a first-of-its-kind case to do with “shadow insider trading.” On its face, it may not seem like the typical insider trading: the exec didn’t buy his own company’s shares, and didn’t have insider info on the rival. But the SEC contends that, due to a company policy that barred employees from using material nonpublic information to trade on other company’s shares and the fact that he placed the trades on his work computer only seven minutes after he learned about the acquisition, the stock buys were illegal.
Human Capital.
Americans for Financial Reform issued a letter urging the SEC to propose a rule requiring public companies to make human capital management disclosures as soon as possible. The letter, sent to SEC Chair Gary Gensler, notes that previous rules passed in 2020 are “woefully inadequate” and do not protect investors:
“The continuing opacity of public companies’ human capital management practices puts investors— including workers saving for retirement — at risk. Effective human capital management is essential to long-term value creation and therefore material to evaluating a company’s prospects. With 90% of S&P 500 value attributed to intangibles (the majority of which include and/or are derived from human capital), investors are lacking information critical to their ability to make informed decisions about their investments”
Human capital disclosures are essential to ensuring investors have the proper information needed to make decisions about their investments. The letter is backed by 16 additional signatories.
PRIVATE MARKETS
Private Fund Disclosures.
Regulators have already passed a rule ensuring more disclosure to information collected by private funds over Form PF and Form CPO, two forms that disclose assets filed to the SEC and CTC respectively, that will give greater visibility and early warning signs to regulators overseeing the $21 trillion industry. AFR calls for more data to be collected on private funds, and urges the SEC to consider additional amendments on Form PF to require firms to disclose their individual loans, as well as additional rules to boost transparency in the private funds sector.
“The private fund industry has grown to become one of the largest parts of our financial system, and oversight and regulation of the industry urgently needs to catch up,” said Andrew Park, senior policy analyst at AFR. “The increased data collection in this rule is a useful step, but there is much more the SEC can and should do.”
Syndicated Loans.
A few weeks ago, Financial Justice described what was at stake in Kirschner v. JP Morgan, a case that was possibly bound for the Supreme Court: investor protections in the $3trn syndicated loan market. The outcome of the case hinged on whether syndicated loans – parcels of loans chopped up and sold to investors in a form that resembled securitizations – were loans or securities. The Second Circuit Court of Appeals called them loans, denying investors the safety of securities regulations. Now, SCOTUS has opted not to hear the case.
Private Equity and Pennsylvanian Coal.
For years, private equity firms – at one point, the megafirm Carlyle Group, and eventually Knighthead Management – kept running the declining Homer City Generating Station, Pennsylvania’s largest coal-fired power plant and one of its largest polluters. Over the years, it ran afoul of numerous environmental regulations, from outputting an excess of respiratory-irritating sulfur dioxide to dumping wastewater infused with toxic selenium into creeks.
For a time, the plant had been on a steady decline. In the six years preceding 2023, it ran at only around 20% of its capacity. By April last year, it was staffed by a skeleton crew of 129 employees. When it closed in July, the 1,500 residents who lived nearby and had come to rely on the plant to provide jobs were “left in dire straits” as the workers who remained were given 90 days’ notice. Wrote the Penn Capital-Star:
“For some industry observers and analysts, the Homer City station stands as a cautionary tale regarding the growing role of private equity…While banks have increasingly pulled back from financing fossil fuels, notorious for their damage to the environment, private equity has helped keep the coal industry alive. In the case of Homer City, the plant’s private equity owners kept a failing company operating for another six years — as it further polluted the environment and extended the power sector’s reliance on coal.”
Private Equity and Healthcare Fraud.
Bloomberg reports the Justice Department will zero in on private equity’s role in causing healthcare fraud, as “the department’s civil investigators are increasingly noticing private equity, venture capital, and other investing sources influencing medical provider behavior.”
Private Equity, Crimes, and Groceries.
In 2022, AFR raised the alarm on the private equity megafirm Cerberus and its move to loot and then merge its Albertsons chain of grocery stores with Kroger. Still pending, if the merger goes through, Albertsons would take on a massive debt burden, putting workers and their retirement funds at risk. Meanwhile, shareholders would receive a special dividend. A few months ago, Kroger defended the proposed acquisition by touting its association with four local growers, one of which had ties to an “alleged human trafficking kingpin” that subjected migrant workers to “modern-day slavery.” Now, it’s surfaced that there is possible criminal activity at work, namely an effort to suppress wages and break unions.
Private Equity and Kids
Private equity’s interested in the childcare sector, hoping to take advantage of high demand, low startup costs and the opportunity to receive government funds as some states like Vermont invest more money into and expand eligibility for the service. If private equity’s presence in nursing homes (worse health outcomes leading to deaths, lower quality care, more violations) is any indication, their entry into childcare facilities may be cause for concern.
“Children get hurt in child care; children occasionally go missing from a care facility; every year, some children die in day cares. If private-equity firms can structure their relationship to day-care centers as they have nursing homes, families may have little recourse should they encounter a serious problem,” The Atlantic suggests.
Big Gets Bigger.
The private equity sector is experiencing an “unprecedented era of consolidation and the emergence of mega-managers,” EY reports. Some industry players foresee a contraction from over 11,000 firms racing for acquisitions to around a mere 100 “significant ones” over the next decade. Already, in Europe, private equity funds with over $1bn assets under management (AUM) raised 82% of all capital raised on the continent in 2023. The piece takes the examples of General Atlantic’s acquisition of Actis, BlackRock’s deal with Global Infrastructure Partners and Wendel Group’s grab-up of IK Partners as a sign of the large getting larger.
Other Private Markets News.
Fundraising. Last year, private equity fundraising numbers ran up slowly, but they ran high. Buyouts Insider says 2023 represented the slowest year for fundraising since the 2008 financial crisis, but the $559bn pulled in by firms was the “third-largest infusion of capital into the industry on record.”
Returns. Over the past two years, payouts by private equity firms to their investors have fallen. The decline coincides with a paradigm shift in how limited partners (the investors in question) measure the performance of their general partners (the private equity firms). The relied-upon metric used to be internal rate of return (IRR), a measure of “gains on future cash flows.” These days, it’s distributed to paid-in capital (DPI), a measure of cash generated versus what’s invested. Since 2021, DPIs have dropped 49%.
A London Airport. Carlyle Group will take control of London Southend Airport, a small international airport east of London, after the finalization of a debt-for-equity swap. The airport will assume and work to cancel Carlyle’s debt in exchange for the megafirm becoming its owner.
CRYPTO
Crypto “Criminal” Mismanagement.
Swiss authorities raided the high-profile crypto hedge fund Tyr Capital Partners after one of its investors, a fund called TGT, accused it of “criminal” mismanagement over losses incurred by the collapse of the crypto exchange FTX. The hedge fund is “alleged to have ignored an internal risk limit and investor warnings over its exposure to FTX.” TGT claimed it flagged concerns about the exchange’s financial health shortly before its failure, though the investor only attempted to withdraw its assets from FTX on the day of the exchange’s bankruptcy.
Reminder: FTX began to fail in late 2022. Its founder, Sam Bankman-Fried, would later be found guilty on several counts related to fraud and conspiracy after using the exchange to siphon customer funds to a different crypto hedge fund, Alameda Research.
HOUSING
FHLB Promise.
The Consumer Federation of America (CFA) suggests the Federal Home Loan Banks, a government-sponsored system of financial institutions initially designed to lend to other banks to provide them capacity to make home loans, has not fulfilled its promise to promote affordable housing. Rather, since its founding in the 1930s, “it has since evolved to focus on best serving the financial interests of its members rather than on addressing the dire housing needs of our country.” Investigations find that 42% of the FHLBs’ 6,400 members haven’t even originated a mortgage in the last five years. Loans instead went to already wealthy financiers and ailing banks, like SVB, First Republic and Signature shortly before their collapses.
CFA recommends that FHLB members kick up 20% of their net income to affordable housing programs (as opposed to the currently mandated 10%), “renew” their mission beyond that mandated giving, and pilot new housing programs through the FHLB system.
Built-to-Rent.
Investment in built-to-rent communities, those neighborhoods of single-family homes managed by the likes of private equity-backed corporate landlords that are constructed to rent from the outset, is gaining steam, as the sector becomes more attractive to “powerhouse investors.” This month, Pretium Partners, backing property manager Progress Presidential, raised $1bn this month to acquire built-to-rent homes. In the background: single-family rents were rising more than apartment rents by November 2023.
Climate Resilience.
The Department of Housing and Urban Development (HUD) will award $73.5mn in new loans and grants to “support extensive energy efficiency and climate resilience renovations” at ten HUD-assisted multifamily properties servicing 1,400 low-income families.
CLIMATE and FINANCE
Bluelining.
AFR’s Jessica Garcia explains how bluelining – the practice by which financial institutions might raise prices or withdraw from markets deemed environmentally risky – is intensifying an insurance crisis, disproportionately so in low-income and other formerly redlined (that is, discrimination based on race) communities:
“One of the many consequences of redlining still being experienced today, relates to decades of disinvestment in housing and critical infrastructure for redlined communities. With poor building conditions, fewer or substandard sewers, levees, trees, and green spaces that could protect communities from climate-related hazards, particularly flooding and heat, these communities are more vulnerable to climate change.”
In a separate blog post, Garcia calls on institutions to invest in climate resilience, be involved in “managed retreat” and relocation efforts, and encourage lower emissions development in more resilient areas.
Flip-Flopping.
Major asset managers JPMorgan, State Street and Pimco pulled out of the climate-focused industry coalition Climate Action 100+, BlackRock scaled back its commitment to the group, and Bank of America walked back a promise to stop financing coal projects. Ostensibly, it’s the result of a monthslong campaign of Republican backlash against ESG (environmental, social, governance) investing. “The political cost has heightened, the legal risk has heightened,” said one sustainable-business consultant. You can brush up on why ESG investment protects workers, communities and the planet, all while putting public retirement money to work, here.
Climate and Community Banking.
The Environmental Defense Fund (EDF) explains how natural events intensified by manmade climate change can impact community banking. (It’s one of a three-part series of blogs exploring how climate-related financial risks can influence the market – one on property insurance here, and another on housing and mortgages here.) Disasters can send shockwaves through the banking system by “damaging banking infrastructure, destroying collateral, and causing borrowers to default on loans.” Often, smaller banks that service more local economies or communities suffer the most. When Hurricane Sandy hit New York, local credit unions were unable to provide for over 14,000 people, many of which were without access to cash or the ability to pay their bills in the aftermath.
The EDF also highlights a few regulatory actions that mark a step toward more fully addressing climate-related financial risks, like the OCC, FDIC and Fed’s principles of climate risk management, the National Credit Union Administration’s research on climate risks and its membership of FSOC’s Climate-related Financial Risk Committee.
Carbon Credit Contracts.
Americans for Financial Reform Education Fund submitted comments to the Commodity Futures Trading Commission in support of its proposed guidance on the listing of voluntary carbon credit contracts:
“First, the Commission should strengthen and finalize this guidance as soon as possible. Second, the Commission should continue dialogue with [designated contract markets] DCMs on the risks of [voluntary carbon credit] VCC derivatives and the underlying [voluntary carbon markets] VCM throughout the process of translating the statutory Core Principles for DCMs to this evolving class of derivatives to monitor developments and determine if further guidance is necessary. Finally, the Commission should monitor for, and intervene robustly, in cases of nonadherence to the Core Principles following this guidance for VCC derivative contracts”
POLITICS and MONEY
Crypto and Elections.
The triplet team of PACs backed by crypto cash – Fairshake, Defend American Jobs, and Protect Progress – have continued spending to influence races and prop up industry allies. Defend American Jobs recently spent $1.5mn on West Virginia Gov. Jim Justice’s bid for Senate. Fairshake’s taken interest in California’s Senate primary. And pro-crypto Republicans are trying to replace Sens. Warren (a crypto attorney named John Deaton) and Brown (a former car dealer named Bernie Moreno, endorsed by Club for Growth).