Card Spending Gives Capital One Charged Q2 Results

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Capital One (NYSE:COF) had some good news to share with investors in its earnings results as the banking group saw its pre-tax income for the period cross $1.8 billion, a 5.5% improvement over Q2 2012 and almost 11% higher than Q1 2013, on the back of better credit conditions that prevailed during the period. [1] Charge-off rates for its domestic card business fell to the lowest level since the bank acquired HSBC’s card business last year, allowing Capital One to set aside sequentially lower cash as provisions this quarter. Card purchase volumes also jumped nearly 13% quarter-on-quarter allowing the bank to earn more fee revenues.

Investors responded to the strong results by buying Capital One’s shares, leading to a jump in share prices from under $67 to almost $70 apiece. While the price has settled around $69 now, we believe that the improving quality of Capital One’s loan portfolio as demonstrated by falling charge-off and delinquency rates should allow the bank to unlock considerably more value for investors.

Capital One will also be returning $1 billion to investors through a share repurchase program that was approved by its board earlier this month. In view of these positive developments, we have updated our price estimate for Capital One’s stock from $59 to $72.

See our full analysis for Capital One

Credit Card Charge-offs No Longer A Source of Concern

One of the unwanted side-effects of Capital One’s acquisition of HSBC’s (NYSE:HBC) U.S. card business was a notable increase in charge-off rates for the bank’s credit card business. This is because credit card loans by the erstwhile HSBC unit were not given out on similarly stringent terms that Capital One employs. This was the inherent trade-off in the deal – while the acquisition boosted the credit card portfolio and also brought in cost synergies, the overall charge-off rate on loans (and hence the corresponding provisions) will remain higher than their historical levels. To put things in perspective, Capital One’s charge-off figure shot up from 3.22% in Q3 2012 to 4.32% in Q4 2012, although the credit conditions in the country were fairly constant between these quarters.

Q1 2011 Q2 2011 Q3 2011 Q4 2011 Q1 2012 Q2 2012 Q3 2012 Q4 2012 Q1 2013 Q2 2013
Charge-off rate 6.13% 5.06% 4.23% 4.30% 4.14% 3.13% 3.22% 4.32% 4.45% 4.36%

Capital One’s charge-off rates only increased to 4.45% – raising fears that the acquired portfolio may remain a source of problems for the bank for quite some time to come. remain on the high side. But the figures for this quarter have mitigated that fear to a good extent, as charge-off rates fell to 4.36%, allowing provisions for the credit card business to decline to $713 million from $743 million last quarter and the much higher $1.7 billion in the same quarter last year.

Auto Loans Help Total Loan Portfolio Grow

Capital One originated $4.5 billion in auto loans this quarter, increasing the size of auto loans outstanding to $29.4 from the $27.9 billion figure for last quarter. The reducing focus on mortgage lending and other retail lending becomes evident from the sequential decline in loans outstanding for both these categories.

The credit card portfolio remain largely unchanged at $78.3 billion, with an increase in domestic card loans nullified by a reduction in international card loans.

On the commercial banking front, growth remains strong with total commercial loans reaching $40.8 billion at the end of Q2 2013 compared to $39.1 billion at the end of last quarter. Growth was registered by the bank’s commercial real-estate as well as commercial & industrial loan portfolios.

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Notes:
  1. Capital One Reports Second Quarter 2013 Net Income of $1.1 billion, or $1.87 per share, Capital One Press Releases, Jul 18 2013 []
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