Started. We've got the main event here. So we have Capital One, where we have Rich Fairbank, founder and CEO, Andrew Young, the CFO. Capital One announced a transformative deal to buy Discover last week, just in time for our conference. All right? I know you did just for my conference. But I'm happy they're here. So congrats on the deal again. But maybe you could just talk, Rich, about the value of the network for a company like Capital One.
Okay. Thank you, Sanjay. Great to be here, again. And thanks everybody for joining us today and those listening in on the webcast. So, well, obviously the timing of this meeting is a good one, given our big announcement last week. You know, there's lots of reasons that we're extremely excited about the possibilities with Discover. But kind of at the centerpiece of the strategic excitement is the network. And let me just talk a little bit about why that is. So, you know, from the founding days of our company, we've been very focused on the payments business as we felt it's the tip of the spear of how technology and information are gonna change financial services. So in many ways, what Capital One did over the years is build an information-based payments company.
But there was always one sort of gap, you know, very big gap, sort of, in what you'd normally have if you built a full payments company, and that was the network. There are a very small number of networks. So all of us, you know, built our business, and it was it was certainly very successful, but with an intermediary between us and the merchants, the intermediary, of course, being, you know, Visa and Mastercard. Buying a network allows us to go direct to the merchant. There's just many, many benefits of going direct. In fact, we had independently been so focused on leveraging the sort of 100 million customers that we had to help merchants drive more sales, reduce fraud, and also create customized solutions and deals and offerings for our customers that we had already independently really leaned into this.
Things like Capital One Shopping, for example, is an example of very much that direct merchant kind of relationship. So when this opportunity came along, this was just a giant and rare asset to accelerate the direct relationship model with merchants. It also is beneficial, sort of economically beneficial, in terms of vertical integration and the ability to capture the portion of the value chain that otherwise, you know, goes to the networks. So that was beneficial. And it was also allowed Capital One to, you know, expand into a new business, which had been really quite well-developed by Discover, which is to be a network for other banks. In fact, they have 4,500 banks who are on their PULSE network. So that's an interesting business opportunity.
And then when you pull all the way up and think about the revenue model of a network, it is revenues that are not associated directly with lending. So in terms of sort of the stability, resilience, and value of those, I think it's. There's some extra benefits there.
So, you know, we just had Visa and Mastercard here this morning. I'm just curious how you guys expect Visa and Mastercard to react to the deal. Have you guys talked to them?
Yes. You know, one of our first calls after the announcement was to Visa and to Mastercard. We have been partners, really, since the founding of Capital One. They've been great partners for us. You know, I think there's every reason to believe they will continue to be great partners for Capital One. I think they're amazing companies. They have built a breathtaking global, you know, tech-based payment company. You know, there's a lot of ways that they add value to other networks and other banks across the system. So, I think we'll continue to be partners with them. We can talk about it in a bit, about how we've our plans of sort of moving volume over time onto the Discover Network.
Yeah. Maybe we get into that a little bit. Why not move all the business over to the Discover Network?
So, Discover, I wanna just start with sort of savoring the extraordinary story of what Discover did in its 40-year journey to build a network. Because building a network at with yourself sort of as the sole issuer is a really tough thing to do. Creating a network, of course, has the chicken-and-egg problem. As you're building one, you show up with a merchant and say, "I need to add you to the network." And you say the merchant says, "How many customers do you have?" "Well, not too many, but this is where you come in." The same thing, of course, on the other side for getting customers. This is why it's a very tough thing to do, to build a network. Over the years and on the back, really, originally of the Sears franchise, Discover created this extraordinary network.
And even though they're relatively slow, you know, low-scale compared to the giant networks, they were able to really go out and build nearly universal acceptance in the United States and have then built some international acceptance, built a brand, and have come an amazing way, given the big issue that they faced, which is just not enough scale. Because this is a network business is a very scale-driven business. So really, I think a lot of the appeal of the Capital One acquisition is to be able to add a whole bunch more scale to the network and to allow them to achieve things that otherwise they were not able to do.
But along the way, you know, when you think about what people say, "Why doesn't Capital One just pick up all the volume and move it over there?" That would certainly create a lot of scale on this network. As extraordinary as Discover's journey has been, there are some important realities also about where they are in that journey. But let me start at the place that they are the farthest along, which is on the debit side of the business. So they made a brilliant, extraordinary acquisition in 2005 of the PULSE network. This is a PULSE PIN debit network. It was a national network. And it has international ATM. A lot of that overseas as well.
So, by doing that, they then added a fully national PIN network to their existing signature network 'cause their credit card network is essentially a signature network for credit and debit. So now they had a sort of full-range debit network. And, you know, testament to the strength of that is the 4,500 banks that are also on that. So when we look at this, we say that right off the bat, without really any changes on the Discover side, we can move our entire debit business into this fully developed network. And, so that's the first step. That adds, obviously, important volume and helps accelerate, you know, get the flywheel going. Here's where Discover isn't as far along as it would love to be, even though I'm amazed how far they got. And that is on the, with respect to, the brand, as it relates to acceptance.
So let me start with the reality of acceptance. When we were considering doing this deal, we went out and conducted our own market research to, you know, 'cause we had understood that acceptance is nearly universal as a reality. We wanted to know what people thought about that. So we looked at two groups. What do Discover customers think about acceptance, and what do non-customers think? Strikingly, Discover customers, who were the ones who would really experience it, they are very pleased with, you know, their embrace of the acceptance and sort of answers to the question, "Do you find it's accepted everywhere you need to pay?" They are right there with Visa and Mastercard customers, really, just right up there in the very high 90s. Here's the other striking thing, though. For non-customers, there was a significant gap in the perception of acceptance.
Now, any brand person will tell you that, "Give me a great reality, and I'll bring you a brand consistent with that reality." It's a really tough thing to do the opposite of that. So we're thrilled that they have a great reality 'cause that's the really tough thing to build. But we need to bring our Capital One's, you know, marketing muscle and sort of brand into building the perception of the network catch up to the reality of the network. The other thing, consistent with our journey at Capital One to continue to stretch up market, we'd love to take the perception of the brand up market, a little bit more, as well. The other thing on our to-do list is international acceptance. In some countries, it's really quite strong.
Some countries, it's really not so great. So we need to work on that through, you know, putting partnerships and other things together. So in the meantime, while we work on that, we've identified an important amount of credit card business that we can move over to help, again, give a kickstart on the scale, get the flywheel going. And the more that we build the brand and build the international side of the business, we'll continue to move more volume over. And in that way, we take this network that's pretty small, trying to compete against the big guys, and give it a better chance.
Great. Maybe we could shift gears on the regulatory side to the approval process. Where are we in the process from here, like, and, could you also talk about antitrust? 'Cause that comes up quite a bit as well.
Okay. So the bank mergers have a process. It's the bank merger application process. And it is an application to the regulators, the Fed and the OCC. We do not file an application, an HSR filing with the antitrust regulators. So that's different from what in most industries is done. So what our banking regulators do as part of the application process, they consult with the antitrust division of the Justice Department. And then based on that consultation, they add that to their consideration. And ultimately, the banking regulators render their decision. You know, just a comment with respect to sort of the competitive aspects of this deal. From a network point of view, there are really four major networks out there. The Discover Network is the little one by far.
It's kind of about the third of the size of American Express, way, way smaller than the other two. So, the ability to take some of Capital One's scale and hopefully, over time, an increasing amount of Capital One's scale really sort of gives this network a chance to be more competitive with the giant network players out there. On the credit card side, we are Capital One is third in purchase volume. After this deal, Capital One will be third in purchase volume. They're big players out there. But, you know, we certainly get some scale benefits there. And then if you think about the other scale perspective is on the banking side, Capital One is in deposits 10th. Discover is 26th. So putting these together is still gonna create an institution that's less than a fifth the size of the biggest.
Great. So Rich, you guys have placed a big emphasis on acquiring spenders. Discover's more revolver. How do you get comfortable with that strategy?
So, you know, the way the credit card business works is, spending and revolving are very much part of, you know, how the product works. So, you know, we have a lot of spending, and we have a bunch of revolving at Capital One. Discover has a bunch of spending and a bunch of revolving there as well. The thing that I have been vocal about over the years is my preference to avoid what I call high-balance revolvers. Now, a high-balance revolver, I'm not talking about the amount of balances they have, say, with us. Or it is the collective amount of balances or, or indebtedness that they have across their credit card, all their credit cards. And our reason for this is pretty simple. And I think there's an intuitive logic to it.
And it's just that these customers, while they may be paying on time all the time, they're just not as resilient when the times get tough. And intuitively, I think anybody can understand that. But we've empirically validated that in the great, global financial crisis, for example. So we have been very vocal about trying to minimize the exposure to high-balance revolvers. No one can have none of them because I can book a customer who, you know and they can be their first card. And then they can load up on lots of cards. And suddenly, I have a high-balance revolver. But anyway, in our efforts, we have managed to have by quite a gap the lowest proportion of our balances coming from high-balance revolvers. When we looked at Discover, they are middle of the pack in the industry with respect to this.
So they have more than we have. But it's really, I think, you know, certainly at a manageable level. And our blended average is still gonna be at the lower end for the industry. So those were the cautions I've been vocal about.
Yeah. Okay. Great. I guess I don't know if this one's for you, Rich or Andrew, but, like, you guys are assuming higher-than-model credit loss estimates for Discover relative to consensus. I mean, where do you expect their losses to go? 'Cause I know they've expected them to flatten out and sort of improve as we get through the year.
Yeah. So, we so we, of course, the thing with great interest, when we went into this deal was to try to get all the credit data, all the vintage curves, and sort of build our own models on where credit losses could go over time. And I wanna say, by the way, they have a history of building an amazing franchise with respect to credit. Lately, the credit losses have gotten higher than they expected. So for all of us, we wanted to look in and just say, you know, "Where do we think they're going from here?" The way, you know, the key thing we do is we look at the vintage curves of every, you know, cohort of originations. And we just look at the height of them, the patterns, the trajectories.
And that's how we, and other things as well. But that's how we make our projections. Out from where we sat, our projections for 2024 were right on top of where the street is with respect to Discover's credit losses. We noticed, the street estimates, the IBES, which had 2025 losses, dropping pretty precipitously. And we, as put into our models, the 2025 full-year number being just about where 2024 is, in other words, sort of more of a plateau than a peak and coming right down. And the reason we did that just relates to the, the 2021, 2022, 2023 vintages not having hit their peak yet. And so, that, we think, is a little bit more how the dynamics will work. No one's got a crystal ball, by the way. We, we could be wrong. And then, but here's the key thing.
You know, then on the other side of that, we assume in our models that things improve from there. And we're big believers in the quality of the long-term credit of this portfolio.
Anything to add?
No.
No? All right. Cool. Operating expense synergies, they seem conservative. You guys talked about net. Those are net numbers too. Maybe you just elaborate on that.
Yeah. You're, you're right, Sanjay, that they are net. So just as a reminder for the audience, we've assumed 26% operating expense synergies in the deal outside of, of marketing. That is a little over $1.3 billion. And, we thought about it through diligence in really three buckets, the first being retail and card are two businesses that, of course, we have massive scale in, bringing those, those businesses into our portfolio. Once we get through synergies or sorry, integration and, those businesses are running on our systems through our processes, we can take much more of a, I'll call it a marginal cost type approach to those businesses. The other businesses, the second category, the other businesses, including the network, where we don't have overlap you know, our starting assumption was we are not going to get synergies from those businesses.
The third category, though, is where do we believe we are going to be investing as we get through integration? Rich talked about the network. We see opportunities to further strengthen the enterprise. And so that third bucket becomes a dissynergy as we think about it. And so when we combine the gross net synergies in the retail and card businesses with the dissynergies, the investments we plan on making, you bring those together, and it gets you to that 26% number.
How recurring are the investments? Is it add-on to that question?
Well, there are two parts to it. One is we will be making investments through the integration phase. So we quoted the $2.8 billion of integration cost that.
Right.
Covers everything at close all the way through, you know, two years to bring them into our systems. A portion of that $2.8 billion is to make targeted investments. But when we're talking about the synergy number, that is a run-rate operating expense sort of synergy P&L from 2027 and beyond.
Okay. Got it. Another one for you, maybe, Andrew. Could we just talk about Tangible Book Value dilution? I'd love to just maybe you could just be more precise on the number for us.
Sure. Well, look, there's a number of metrics through which to evaluate a deal. I would highlight that most of them in this deal, you know, stand alone to create a really compelling financial and strategic case. The tangible book value, given that we're buying a company that has a higher price to book, and we're paying a premium for that, while I can't quote a precise number of what the ultimate dilution is going to be until we get to close at the end of 2024, it certainly will be dilutive on a tangible book value basis. Now, the corollary to that, the important corollary is we are paying a premium for a business that trades at a high price to book. The reason they trade at a high price to book is it generates a very high ROTCE, return on tangible common equity.
And so that's just as a standalone company, they generate a high ROTCE. As we bring in the synergies, the effective ROTCE of combining the two companies is even greater. And so as you look at, you know, valuations of companies, there's an incredibly strong correlation between, you know, price to book and ROTCE. And so while we're gonna have a lower amount of tangible book, we are gonna have a much higher ROTCE. And then the other thing and some other metrics that we highlighted in the investor presentation we did last week is you can also think about the tangible book and ROTCE in a cross-multiplication sort of way where the output of that is earnings. And we are two companies that have historically traded at relatively similar PEs.
And so when we look at the accretion on an EPS basis, we highlighted double-digit adjusted accretion in 2026, mid-teens in 2027, and then a return on invested capital in 2027 that's 16% and growing from there. So I think when you couple all of those things with the tangible book value dilution piece, you know, in aggregate, thinking about the value that is created here both strategically and financially, you know, we feel incredibly good about the transaction.
Anything to add, Rich?
no.
No? Cool. So when we look at, like, the pro forma efficiency ratio for the combined company, I think we get to somewhere in the high 30s before synergies. How much improvement can you achieve with the synergies on a combined basis?
I think my answer here, Sanjay, is similar a bit to the one that I just gave. You know, if you look at Discover on a standalone basis, they have an operating efficiency that historically has been below Capital One. So the sheer act of bringing the two companies together, lowers the, you know, combined efficiency or gets us to a combined efficiency ratio that is below where Capital One is on a standalone basis. We feel incredibly confident in our ability to achieve the synergies both on the revenue side and on the cost side. And so when we bring that together, you know, we would expect to have an operating efficiency that is, you know, net inclusive of those benefits over time.
That's part of, you know, what makes the deal so financially attractive to us is being able to operate in an efficiency ratio that's lower than where we are and reaping the benefits not only of how they operate as a company standalone but adding to that the synergies we're confident in achieving.
Just to summarize what I'm hearing, you guys are saying you can do that while making the necessary investments that you need to, to achieve the goals that you need to with the network and the business. Correct?
Yeah, that's what we tried to put, all that, those assumptions into our model. And in this case, it really is a, there's two different dynamics going on. And in some ways, it mirrors the whole journey of Capital One. And that is that we for a lot of companies, the way they, they drive their efficiency is through, just continuing to cut costs out all the time and cut your way to greatness. In many ways, the story of Capital One has been to invest our way and leverage technology to be able to drive more growth and at the same time drive efficiency.
So, what we're investing in on the other side of this is, you know, on the regulatory side, you know, they have already given a big number that they are assuming in terms of, you know, to deliver on all the regulatory requirements. You know, we are making the assumption this is, you know, will be a really significant amount of work. We won't inherit their enforcement action, but we inherit very much the, you know, the same challenge and necessity to really bring them to a very different, you know, place with respect to compliance and risk management.
Now, I think we're in a great position to do it because over the years, we've built the tech, the infrastructure, the technology, the talent, the processes, and the governance to be able to do scalable risk management at a high level. But one of those contra-synergies Andrew talked about was an assumption on our part of taking even more investment, more cost into the regulatory and compliance side. You also heard us talk about investing in leaning into the network on the brand side. And of course, we will be over time, you know, taking their more traditional technology and moving so much of that into the modern technology infrastructure. Most of those costs are really directly in the integration expenses.
So on the other side of this, we'll be a company that continues to invest and still, I think, generates very significant efficiency benefits.
Great. I wanna talk about the compliance and regulatory issues that Discover had previously flagged. How are you guys thinking about those? And how does that play out after the acquisition in terms of the consent orders?
So again, you know, we sort of take over what needs to be done without carrying the actual enforcement actions. But one benefit that we have, I think it would be more it well. First thing I wanna say is I think it's a very challenging thing to take on, you know, significant in the set of enforcement actions like this and what comes along with that. And it's part of a journey that, you know, pretty much every bank has gone through. And so, I start by saying we assume it is a lot of work. We assume that it, you know, it's even more than people who are in the middle of it think it may be just because, you know, I remember how it was for us in the past.
You know, these can be very big undertakings. The great thing is we are mostly buying businesses we're already in. Therefore, we have the compliance and risk management, infrastructure, governance processes not just as a company but also in those businesses. So I don't think this is necessarily a thing of going and taking every issue that exists there and fix each individual one, although there'll certainly be that. But it's a matter of trying to take it and bring it into the scalable risk management, infrastructure and process at Capital One. But we still assume, you know, we just take the mindset that says, "Whatever people think it is, we'll take the over," 'cause I think that is so often how it works in things like this. They do have a network business.
We are not in the network business. We don't have an existing compliance, you know, infrastructure on that side. So that one we'll have to build a little bit more from the ground up. But collectively, you know, we're taking just intuitively the over in terms of cost and time to fully get that done. But we put those into our financial assumptions. And then, you know, we'll try to be happy on the other side of that estimate.
Okay. I have one last one here. Maybe you know, this is a question I get a lot from investors, 'cause you've done such a fabulous job over your time at Capital. Just wondering how much more time you wanna give to Capital One since you've been so successful at it. Maybe, maybe you could just talk about what your plans are, 'cause you've now embarked on a pretty big investment here.
Well, thank you.
You'd like to keep it fun is what it is, right?
Oh, well, thank you. Well, listen, I grew up with parents who, you know, always they were very successful in their own ways. Well, very successful just overall. But what I loved is that their chase for success was not for success itself, but it was for the love of the game, for doing something great. And so always, for me, this has been, you know, from the moment I came up with the idea for Capital One one afternoon. The funny thing is it took one afternoon, chatting with somebody who's in the credit card industry and saying, you know, "How does that industry work?" I remember that afternoon thinking, "Oh my gosh, this is the" you know, "They're this industry is based on an extrapolation of how traditional banking worked, face-to-face, judgmentally driven.
But actually, truly, this is a massive information-based technology business. Hence the insight that let's go build an information-based technology company that does banking competing against banks who use information and technology, but it's not who they are. So from sort of that founding notion and feeling kind of almost like a, you know, like a sort of religious conversion on that day of believing, "Oh my gosh, this is gonna be where the world goes," I went all in. And we pulled together a great team going all in to chase this dream. And ever since we've been on this quest, for me, it has been just incredibly energizing and satisfying. And so over the years, as we've gotten bigger and bigger, people ask me nowadays, "What's it like at Capital One?
And why don't you just at some point, you know, retire from this?" And I say, "You know what this reminds me of? It reminds me of the founding days of Capital One because we look out there. We see the world is changing, rapidly. We try to identify where winning is, and we work backwards from that. And we have spent years putting the pieces together of our technology, transformation, the businesses that we have built, franchise, and the customer loyalty that we've generated over time. And I think Capital One is incredibly well-positioned to do great things going forward. And I'm as excited as I've ever been. I feel like the founding days when there's so much to do and so many reasons maybe this won't work. But, I'm all in in the pursuit of this.
And, you know, I, you know, there are no guarantees in business. But for me, this is a quest that's got some of its best days ahead of it. And I really look forward to being a part of that.
All right. Well, thank you for the answer. We probably have time for a couple of questions. There's a question right there. And then there's one over there. So maybe him first and then back over here.
With the Discover Rails driving China UnionPay, is that an impact into your thought process or how you might drive that in the future?
That's something we really, you know, don't have a lot of particular insight at this point.
1 right over here.
Thank you, Rich. On the network side, 10 years from now, say 20 years from now, where do you think you'll see more value? Or from the credit network, you know, maybe gaining credit card market share, maybe opening up the network and taking on new issuers, or on the debit side where maybe you have greater deposit market share or maybe you just benefit from the Durbin loophole and keep increasing debit spend?
Right. Well, first of all, I wanna say that your term Durbin loophole. I really think that's very much a misnomer. It's just, it's not covered. It's not by design not covered under the regulations there. You know, I think in the near term, the opportunity on the debit side is bigger because Discover has a fully developed debit network. And we can move all our business over there. And, it's also very much helps us on the building of our national bank. Just a comment there that we have built at Capital One a digital-first national bank. It's a unique thing. You've got the direct players who have savings banks. Then you have the banks with branches on every corner.
Capital One has built a unique digital-first, full-service banking business where almost everything you can do in a branch, we built it to be available digitally. And so with that capability, we then put in thin physical distribution, including iconic cafés and iconic locations, in 22 of the top 25 metropolitan areas. So we have kind of built the pieces of what we believe is kind of the bank of the future. And we have been leaning in really hard, growing that organically. So this acquisition and the ability to have our own network is very helpful on that quest. With respect to what will be most impactful over the long term, I certainly look at the size of our credit card business relative to the debit and certainly hope that over time, the greater impact will be on the credit card side.
The timing and yeah, basically, the timing of how much we continue to build volume on that network is really gonna depend on how fast we can address some of the brand perception and international acceptance issues. And, as you can imagine, we'll be leaning into that. We'll be doing lots of tests along the way to really understand where our customers are and where the market's brand perceptions are about this network. And then we'll continue to make our choices along the way. What one thing we are pleased with is we don't like a lot of times, if you think of the history of Capital One, we have a lot of times declared, "Winning is over there, and we're going over there." And occasionally, it's been a big leap to get there.
The most striking example is when we really, in the 2000s, said, "We really believe that we have to transform to a bank balance sheet. We don't trust capital markets-based funding." And so we bought banks, in order to get resilience, a balance sheet. And so that was a little bit more of a leap. And we asked our investors to take that leap with us. This one is gonna be a grab walk, if you will, lifting one leg, or arm or whatever they're called at a time. And because each, you know, along the way, we're gonna move what it makes economic sense and what will be sure-footed from a customer reaction point of view. And so we've got this destination over time of more and more business on the on the Discover Network.
But we're gonna basically crawl-walk our way there sure-footedly because, you know, along the way, we're gonna move what it makes economic sense and what will be sure-footed from a customer reaction point of view. And so we've got this destination over time of more and more business on the Discover Network. But we're gonna basically crawl-walk our way there sure-footedly.
All right. We're gonna have to end it right there. Thank you, Rich.
Thank you.
Andrew, thank you.
Thanks, Andrew.