Why Investor Concerns About Capital One’s Elevated Card Charge-Off Rates Are Justified

Charge-off rates for U.S. card lenders were notably elevated over 2017, as card loss figures began the process of normalization from the record lows they were at over 2014-15. While the trend has been evident across all major card lenders in the country, Capital One (NYSE:COF) stands out in particular with a charge-off rate in the range of 4.5-5% over the last four quarters – well above the industry average of ~3.5% for this period.

Investors reacted adversely to Capital One’s high card charge-off figures over the first half of 2017 by driving the bank’s share price down from almost $95 in the beginning of 2017 to well below $80 in Q3 2017. Although the stock has shot up to over $100 now, the rally over recent months is more attributable to anticipated gains from the Tax Act. Investor fears of a further increase in charge-off rates remain, though, as they present a sizable downside to Capital One’s valuation.

We have created an interactive model that details how changes to Capital One’s card charge-off rates impact its market price. You can modify assumptions such as earnings multiples, card balance, effective tax rate and others to see how sensitive Capital One’s shares are to its card charge-off rate. 

As detailed in the chart above, an increase in Capital One’s card charge-off rate by a single percentage point can reduce its 2018 EPS estimate by $1.60. Using Capital One’s current forward P/E ratio of 11, this represents a ~$17.50 decline in the bank’s share price – or a downside of more than 17%.

Think our estimates are off? Create your own estimates by changing the inputs in our interactive model.

We maintain a $95 price estimate for Capital One’s shares, which is about 5% below the current market price.

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