Capital One Financial (COF)

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WHAT HAS CHANGED?

Latest Earnings

In Q1 2020, Capital One’s reported revenues of $7.2 billion, which was 2% less than the previous year. This could be attributed to a 10% y-o-y drop in Non-Interest Revenues, followed by a 1% decrease in Net Interest Income. Further, provision for credit losses doubled to $5.4 billion due to expected losses on outstanding loans.

Impact of coronavirus outbreak

Capital One’s stock has suffered as states and countries are on lockdown, which would negatively impact consumer demand. People aren’t meeting friends and colleagues for drinks, lunch, or dinner; they are not going to movies, amusement parks, vacation trips, and are refraining from any non-essential expenditure. As the credit card giant derives most of its revenues from card business, it could suffer losses due to lower consumer demand and an expected spike in loan default rates. While the results for Q1 2020 were on the similar lines, we believe the company’s results for Q2 will further confirm this reality with a drop in revenues across all the segments.

POTENTIAL UPSIDE & DOWNSIDE TO TREFIS PRICE

Below are key drivers of Capital One’s value that present opportunities for upside or downside to the current Trefis price estimate for the bank:

Credit Cards

  • Provisions % of Outstanding Credit Card Loans: Capital One’s credit card provisions increased from 4.7% of the outstanding loan portfolio in 2007 to 8.3% in 2009 before declining to 3% by 2011. Major acquisitions pushed this figure to 5.1% for 2012 before Capital One’s decision to run-off/sell some of the loan portfolios helped provisions to fall to below 3.5% in 2014 before jumping to 5.9% by 2017. In FY 2018, it reported provisions of 4.5% which we estimate to normalize at around 5% over our forecast period, should the division perform worse than expected in coming years, the provisions could increase to 6%. If that were to occur, there would be a downside of 16% to the Trefis price estimate. On the other hand, if the bank focuses on improving the credit quality of its loan portfolio, and the provisions reduce to 4% of the loans over the same period, then this would represent a 16% upside to the Trefis price estimate.
  • Net Interest Yield on Credit Card Balances: Capital One’s net interest yield on its credit card portfolio has remained around 13% over recent years, and we forecast it to stay at that level over the rest of the forecast period. However, if the yield figure falls to 12% for this period, then there would be a downside of about 8% to the current price estimate.

BUSINESS SUMMARY

Capital One is one of the largest banks in the United States, whose banking and non-banking subsidiaries market a variety of financial products and services. The corporation’s principal subsidiaries include Capital One Bank (USA) and National Association (COBNA) which currently offer credit and debit card products, other lending products, and deposit products; and Capital One, National Association (CONA) which offer a broad spectrum of banking products and financial services to consumers, small businesses and commercial clients.

Big-Ticket Acquisitions

In June 2011, Capital One bought the American banking operations of ING Direct for $9 billion, which significantly boosted Capital One’s consumer and commercial loan portfolio.

Capital One also agreed to buy the United States credit card business of HSBC Holdings for $2.6 billion, which boosted Capital One’s credit card loans by more than $30 billion. The company is also expected to realize cost saving of about $350 million from the business combination.

In late 2015, Capital One acquired GE’s healthcare financing unit - adding $8.5 billion in healthcare loans to its total portfolio.

SOURCES OF VALUE

The Credit Cards division is the primary source of value for Capital One for the following reasons.

Largest revenue contributor

Capital One’s Credit Card division accounted for 64% of the firm’s total revenues in 2018 compared to 26% from the Consumer Loans division and 10% from the Commercial Loans division.

KEY TRENDS

Rise in Prime Loan Interest Rates Will Benefit Capital One

As a result of the economic downturn, the U.S. government decreased the prime loan interest rate (the interest rate that commercial banks charge their most credit-worthy customers) from levels of around 8.25% in late 2007 to 3.25% in 2008. The prime rate remained at this level for more than seven years, before a series of rate hikes by the Fed brought this figure to its current level of 5.50%. As economic conditions improve, interest rates will eventually return to historical levels, at which point Capital One’s revenues will be positively impacted.

Fast Growth in Electronic, Cashless Payment Solutions

Capital One also operates in the cashless payment solution market. This includes payments using credit cards. The market for such transactions is growing at a rapid pace. Consumers are moving toward cashless transactions in large numbers, particularly in international markets where credit and debit cards are becoming more prevalent. We expect significant growth in this segment in the near future as more customers and merchants embrace credit/debit card payment solutions.

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