Should Investors Be Worried About Capital One’s Private Label Card Losses?

by Trefis Team
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The latest issue of Equifax’s National Consumer Credit Trends Report revealed that private label card delinquencies jumped 57 basis points from the figure in March 2017 to reach 4.65% in March 2018 – the highest since 2013. As one of the five largest private label card issuers in the U.S., Capital One (NYSE:COF) will definitely be negatively impacted by these higher card losses. But as we detail in our interactive model for Capital One, the impact on the card-focused bank shouldn’t be significant enough to be a concern for investors.

You can modify assumptions such as Capital One’s card balance, card charge-off rate, net margin as well as earnings multiples to see how sensitive Capital One’s share price is to each of these key metrics. We maintain a $107 price estimate for Capital One’s stock, which is about 15% ahead of the current market price.

See our full analysis for Capital One

Elevated Charge-Off Rates

Charge-off rates for U.S. card lenders have notably been elevated since early 2017, as card loss figures began the process of normalization from the record lows they saw over 2014-2015. While this trend has been evident across all major card lenders in the country, Capital One stands out in particular with a charge-off rate in the range of 4.5-5% over the last five quarters – well above the industry average of about 3.5% for this period. We expect Capital One’s overall card charge-off rate to remain largely around current levels going forward.

Notably, the ongoing shift in consumer preference toward online shopping has led to higher delinquencies for private label cards, as they are mostly issued by retail chains in partnership with card lenders. Equifax stated that as some of these retail chains have gone bankrupt or out of business, some consumers believed that they wouldn’t have to repay their loans outstanding. This, coupled with generally higher risk associated with private label cards and an upward trend in delinquencies in general, has contributed to the rising private label delinquency rate.

The five largest issuers of private label cards are Synchrony, Alliance Data, Capital One, Citigroup and Wells Fargo. While private-label cards form substantially all of the lending portfolios for Synchrony and Alliance Data, their proportion in the loan portfolios for the three banks is extremely small. For Capital One, private label cards represent between 5-10% of its total card loan portfolio. Accordingly, even if these loan losses unexpectedly jump by 100 basis points (i.e. 1 percentage point), the effective impact on Capital One’s total card charge-off rate will only be between 5-10 basis points. More importantly, as many of these card partnerships include a loss-sharing agreement between the company and the lender, the effective impact on the charge-off rate will be even smaller.

Impact Of Delinquencies On Capital One Would Be Minimal

For our analysis, we assume that Capital One’s loan provisions would increase by 10 basis points due to extremely high private-label card losses – which is the upper end of the likely range. This should raise Capital One’s total card provisions for the year by ~$115 million from our original estimate of $6.48 billion to $6.6 billion – an increase of less than 2%.

Although Capital One’s top line will remain unaffected by the higher card charge-offs, revenues net of provisions would be reduced due to the increased card loan provisions, as shown below:

As operating expenses would not be affected by the higher card loan provisions, the lower net revenue figure would result in a small reduction in Capital One’s net margin from our original estimate of 22% to 21.9%. The net impact of all these factors would be to decrease Capital One’s EPS figure for 2018 slightly to $9.63 from our original estimate of $9.73.

Using the new EPS figure, and a forward P/E multiple of 11x (which we believe is appropriate for Capital One), we arrive at an estimate of $106 for Capital One’s shares – which is slightly below our previous estimate of $107. But as detailed earlier, this represents the maximum impact on Capital One from increased private label delinquencies – leading us to conclude that the actual impact will be immaterial to investors in the bank.

In case you disagree with any of our forecasts, feel free to modify them in our interactive model to come up with your own forecast for Capital One

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