Capital One’s Decision To Exit Mortgage Origination Business Will Add Value On Multiple Fronts

by Trefis Team
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Capital One
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In what comes as the latest indicator of the secular shift in the country’s mortgage industry over recent years, Capital One (NYSE:COF) recently announced that it is shuttering its mortgage origination unit. With the Fed’s ongoing rate hike driving mortgage rates higher, Capital One concluded that it will no longer be able to keep up with the competition in a profitable manner – prompting the abrupt exit.

We believe that the decision is a good one for Capital One in the long run. As we have pointed out on many occasions in the past, Capital One’s sizable mortgage business is essentially a by-product of its overall strategy of growing through big-ticket acquisitions – with the current mortgage unit becoming a part of the bank’s card-focused business model after its acquisition of ING Direct’s U.S. operations. Capital One never aimed to grow the unit, as is evidenced by the steady decline in its mortgage portfolio over the years.

With its decision to stop originating more mortgages, Capital One will be able to run off its existing mortgage business at an accelerated rate over subsequent quarters. While the resulting reduction in workforce will save the bank millions of dollars in operating expenses, it will also free up more capital for the bank to focus on its core competency of credit card loans.

We are currently in the process of updating our $96 price estimate for Capital One’s stock to factor in the newly announced change.

See our full analysis for Capital One

Stricter regulatory requirements, coupled with an overall slowdown in the mortgage industry since 2012, reduced the appeal of the once-lucrative mortgage business for banks, and non-banking financial institutions have quickly grown in size and numbers to fill in the gap left by the banks. Notably, just four of the ten largest mortgage lenders in the country are now banks – something that can be explained by the fact that most of the banks (including banking giants Bank of America and Citigroup) had to shrink their mortgage operations considerably in the wake of the sub-prime mortgage crisis. The largest gainer from this ongoing trend has been Quicken loans, which now has a market share of nearly 5% in terms of mortgage originations, and is second only to industry leader Wells Fargo in terms of outstanding mortgages.

As seen in the chart below, Capital One’s mortgage portfolio has shrunk steadily over the years, as the bank originated far less mortgages over a period compared to what borrowers repaid. The mortgage division was never a strategic growth area for the bank, which is why the bank was letting the portfolio it acquired from ING Direct to run off. With the recently announced plan, the mortgage portfolio will shrink at a rapid rate going forward – a change we are incorporating into our analysis.

Incidentally, this is the second time Capital One is choosing to exit the mortgage business, with the bank also doing so in mid-2007 when the sub-prime mortgage crisis came to light. At that time, Capital One had acquired a mortgage business (GreenPoint Mortgage) as a part of a bigger acquisition (of North Fork Bancorp in late 2006). However, the reason for exiting the business is understandably different now from what it was ten years ago.

Capital One’s decision to discontinue mortgage origination operations will result in a reduction in the bank’s total headcount by 905. Besides this, the bank is also shedding 200 jobs at one of its customer support centers. Taken together, this represents a reduction in more than 1,100 jobs at Capital One over coming months – just over 2% of  its total employee strength of 50,400 at the end of Q3 2017. As the bank reported employee compensation expenses of $1.5 billion in Q3 2017, a 2% reduction in this figure translates to cost savings of roughly $30 million each quarter. Now Capital One’s consumer banking business reports around $200 million in fee income each quarter – a figure that includes fees from deposits, auto loans, mortgages as well as other retail loans. As deposits and mortgages contribute the most to these fees, it would be safe to assume that mortgage origination brings in between 10-15% of this fee figure. This translates to $20-30 million in fees from mortgage originations in a quarter. As the cost savings are higher than the range of potentially lost revenues, the move should have a positive impact on margins for Capital One’s consumer banking operations going forward.

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