In its monthly credit card delinquency and charge-off report filed with the SEC this Monday, Capital One Financial (NYSE:COF) revealed a further deterioration in its credit card portfolio for November from that in October.  The announcement by Capital One was largely expected, considering the slowing economy. Its competitors Discover Financial Services (NYSE:DFS) and American Express (NYSE:AXP) also reported a small increase in their net charge-off rates.  Moreover, in October, Capital One had foretold an increase in credit card charge-off rates in the months to come as a direct result of its acquisition of HSBC’s (NYSE:HBC) U.S. card business (see Capital One Reports Profitable Quarter; Warns Of Higher Future Charge-Offs).
We maintain a $61 price estimate for Capital One’s stock, which is at a premium of less than 5% to the current market price.
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Capital One’s business model relies heavily on its card operations – something made obvious by the chart above which suggests that cards contribute nearly two-thirds of its total value. An increase in the bank’s credit card delinquencies/charge-off rates is therefore a cause for concern as it can significantly affect its value. While delinquent loans are those which have not received a repayment in at least 30 days, charge-offs represent loans the bank believes it can no longer recover.
Capital One’s net charge-off rate figure for its card business in the U.S. increased from 3.93% in September to 4.25% in October to 4.46% in November. The international card business fared worse, with the net charge-off rate jumping from around 4.5% in September and October to 8.4% in November.
Delinquency rates for the U.S. card business has also slowly crept up over the months, from 3.5% in September to 3.7% in November.
No doubt the economic uncertainty has a role to play in the worsening of Capital One’s loan quality over recent months. But a more important factor is the actual quality of loans Capital One acquired from HSBC. In its earnings release statement for Q3 2012, Capital One noted that charge-offs on its card portfolio will be higher going forward as credit card loans by the erstwhile HSBC cards business were given out on comparatively relaxed norms. ((Q3 2012 Earnings Press Release, Capital One Press Releases, Oct 18 2012))
We capture the impact of charge-offs on Capital One’s share value through our forecast for the size of its credit card provisions, as higher charge-offs will automatically result in higher provisions. As you can see by making changes to the chart below, Capital One’s estimated share price falls by nearly 10% if we assume that provisions will remain at the current level of about 3.75% of outstanding loans over the rest of our forecast period. This just goes on to show how sensitive the bank’s share value is to the underlying quality of its loan portfolio as well as to its ability to recover its loans.Notes:
- 8-K Filing, SEC Website, Dec 17 2012 [↩]
- Credit-Card Losses Inch Up for Some Lenders in November, Fox Business, Dec 17 2012 [↩]