DBRS Confirms Capital One at BBB (high), Trend Revised to Negative

DBRS has today confirmed the ratings for Capital One Financial Corporation and its principal subsidiaries, including Capital One Bank, (collectively, Capital One or the Company), including its Issuer & Senior Debt rating of BBB (high). Today’s rating confirmation is based on Capital One’s strong liquidity and funding profile, solid capital base and resilient franchise. Concurrently, the trend has been revised to Negative from Stable.

Today’s revision in the rating trend takes into account DBRS’s perspective that the U.S. consumer will experience ongoing and escalating stress through 2009 and considers the likely impact on Capital One’s earnings prospects, in light of the Company’s earnings release and net loss of $111.9 million for the first quarter of 2009. The Company’s loss reflects the impact on its business of slowing U.S. consumer spending, a $119 million write-down of its interest-only strip asset, and continuing pressure on its net interest margin. Also included in the loss is a $124 million build to the loan loss reserve. DBRS recognizes the Company’s efforts to build provisions given expectations for continued credit losses. At March 31, 2008, Capital One’s loan loss reserve totaled $4.6 billion representing 4.8% of reported loans, up from 3.3% a year ago.

During the quarter total revenue on a managed basis declined by 6% to $3.7 billion, as U.S. consumers reduced their spending activity. Pressure on disposable income and concerns regarding employment prospects have led U.S. consumers to reduce spending on non-core expenses and become more defensive. Also driving the decline in total revenue was a decrease in non-interest income of $197 million on reduced overlimit and late fees as consumers managed their balances more carefully. Although Capital One reported a loss, DBRS considers the Company’s income before provisioning and taxes (IBPT) for the quarter of $2.0 billion, on a managed basis, as indicative of its core earnings capacity. However, DBRS is concerned that the deteriorating credit trends revealed by Capital One (and other market participants with substantial consumer exposures) in the past couple of quarters, if sustained into 2009, will stress the Company’s ability to absorb credit losses out of current IBPT.

The ongoing deterioration in the U.S. economy during the quarter drove net charge-offs higher. Managed charge-offs increased by 0.54% this quarter to 5.52%. Managed 30-day plus delinquencies, however, improved in the first quarter by 13 basis points (bps) to 4.36% from 4.49% at year end. While DBRS views the improvement in delinquencies positively, DBRS is also mindful that there is a seasonality component to the improvement, as borrowers utilize tax refunds and other measures to reduce debt levels. However, a continuation of this trend (reduction in 30-day delinquencies) would be viewed very positively; as DBRS believes early stage delinquencies are a leading indicator of future credit performance. Nonetheless, given its outlook for a prolonged recession in the U.S., DBRS anticipates that the Company’s asset quality measures are likely to weaken further in 2009 sustaining negative pressure on earnings.

Capital One continues to maintain sound capital ratios. At March 31, 2008, the Company reported a tangible common equity-to-tangible asset (TCE/TA) ratio of 4.78%, which reflects an increase of 20 bps from the Chevy Chase Bank acquisition adjusted pro-forma TCE/TA ratio at year end 2008. The Company’s Tier 1 capital ratio was 11.4% and 8.5% without the $3.55 billion in TARP funds received.

DBRS considers Capital One’s liquidity profile as solid, well-managed and greatly enhanced by its growing deposit base. Capital One continues to build its deposit base, which benefited from the $14.0 billion of retail deposits gained in the Chevy Chase Bank acquisition. Total deposits increased by $12.0 billion in the quarter to $121.1 billion. Moreover, Capital One continues to replace more expensive wholesale funding in favor of lower rate retail deposit funding. DBRS views this replacement positively, because retail deposits are traditionally more sticky, while the lower cost should enhance margins at a time when margins are being pressured. Further, Capital One’s liquidity profile is bolstered by its available liquidity, which increased by $5.0 billion during the quarter to approximately $45.0 billion. Moreover, while Capital One is eligible to participate in the various government liquidity programs, including the Term Asset-Backed Securities Loan Facility (TALF), Temporary Liquidity Guarantee Program (TLGP) and the Commercial Paper Funding Facility (CPFF), the Company has not participated in these programs.

The Negative trend reflects DBRS’s expectations that credit costs will continue to increase through 2009 for Capital One as the U.S. economy remains distressed and U.S. consumers reduce spending. Although DBRS has factored in a level of deterioration of asset quality metrics, continued increasing credit costs could pressure ratings; especially should increasing levels of provisions reduce the Company’s ability to protect its franchise, which underpins the rating. DBRS considers Capital One’s diversified product offering and its solid funding profile gained from its Capital One Bank and recently acquired Chevy Chase Bank franchises. However, Capital One’s sizable exposure to the US consumer adds to its vulnerability in this economic downturn, whose depth and duration remain uncertain.

Notes:

All figures are in U.S. dollars unless otherwise noted.

The applicable methodologies are Rating Finance Companies in the United States, Rating Banks and Bank Holding Companies Operating in the United States, and Enhanced Methodology for Bank Ratings – Intrinsic and Support Assessments, which can be found on our website under Methodologies.

This is a Corporate (Financial Institutions) rating.