Capital One will need to compete aggressively with other credit card issuers to rebuild its credit card portfolio

Business Strategy and Outlook

Capital One maintains a more limited branch network than its traditional banking peers, using its online and mobile channels to acquire customers and service its accounts. The focus on online bank accounts has allowed the company to establish a national presence broader than what its narrow branch network would traditionally allow. This dynamic allows Capital One to enjoy the benefits of being a large bank without the expense of operating the branch system of a large bank. Capital One specializes in credit cards, with this segment making up more than 40% of its total loans. The bank’s remaining business mostly consists of commercial loans and auto loans through its consumer banking segment. The bank’s narrow product offering focuses its assets, giving Capital One the benefit of scale in its chosen business lines. This does have the consequence of leaving the bank undiversified as it is reliant on its credit cards and auto lending business.

Despite recent growth, Capital One’s credit card receivables are still below their 2019 highs after high payback rates during 2020-21 led to portfolio erosion. Capital One will need to compete aggressively with other credit card issuers to rebuild its credit card portfolio. Capital One has increasingly turned to the private label and co-branded credit card market to boost growth, winning the BJ’s Wholesale Club and Walmart portfolios from rival firms. While the extra growth can be seen, private label cards typically require revenue sharing agreements with the partnered merchants, reducing returns. On the other hand, high credit card paydown rates have benefited Capital One’s credit costs, with the company seeing net charge-off rates in 2022 well below the bank’s historical average, despite increased economic strain on consumers. Higher net charge-offs are expected for Capital One by 2023, 2022 should be another year of below average credit costs as the bank’s delinquency rates remain low across all loan types. Even should credit costs rise, Capital One remains in a healthy financial position, and there are no material financial strains being placed on the bank’s balance sheet.

Financial Strength

Despite its credit exposure to credit cards and auto loans, Capital One is in a strong financial position. While rising deposits and falling credit card receivables have hurt the bank’s net interest margin, the shift in the asset mix has benefited the balance sheet. At the end of March 2022, Capital One had a common equity Tier 1 ratio of 12.7%, down from its peak but still well above its long-term goal of 11%. Despite heavy reserve releases, Capital One is still well provisioned for future credit losses with its allowance for bad loans at 4.03% of existing receivables. These figures do need to be viewed in the context of Capital One’s exposure to subprime credit cards and subprime auto loans. Roughly one third of the bank’s domestic credit card portfolio is with card holders whose FICO scores were below 660, and a similar portion of its auto loans is from borrowers with FICO scores below 620. That said, the 2022 Dodd-Frank stress test results saw Capital One’s common equity Tier 1 capital ratio only fall to 10.2% under the severely adverse scenario. This is despite a projected loss rate of 20.4% on the company’s credit card portfolio and a loss rate of 13.3% on all loans in the severely adverse scenario. While Capital One does have credit-exposed assets, it is more than adequately capitalized to withstand potential credit losses.

Bulls Say’s:

Capital One’s credit card portfolio has begun to grow again, providing a boost to the company’s net interest margins and revenue growth.

Technology investments, the transition away from legacy data centers, and its reduction in the branch count should help the company reduce costs in the coming years.

Rising interest rates should provide a tailwind for Capital One’s net interest income as margins expand.

Company Profile

Capital One is a diversified financial service holding company headquartered in McLean, Virginia. Originally a spinoff of Signet Financial’s credit card division in 1994, the company is now primarily involved in credit card lending, auto loans, and commercial lending.

(Source: Morningstar)

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