DBRS Comments on Capital One’s Q2 2009 Results, Senior at BBB (high), Trend Negative

DBRS has today commented that the ratings for Capital One Financial Corporation and its principal subsidiaries, including Capital One Bank, (collectively, Capital One or the Company) are unchanged following the Company’s announcement of its Q2 2009 financial results. DBRS currently rates Capital One Financial Corporation BBB (high). The trend on all ratings is Negative.

Today’s comment follows Capital One’s earnings release, which indicated for the quarter net income before the payment of preferred dividends of $224 million. In Q2 2009, Capital One repurchased capital issued under the U.S. Treasury Capital Purchase Program (TARP), resulting in a charge of $461.7 million. With this charge, other preferred dividends and related adjustments, Capital One reported a net loss applicable to common shareholders of $275.5 million.

During the quarter, total managed revenues increased 11% from Q1 2009 to $4.1 billion, reflecting a full quarter of contribution from the Chevy Chase Bank acquisition and an improvement in both net interest and revenue margins. Offsetting the revenue increase was a $177 million increase in non-interest expense to $1.9 billion, which was largely attributable to an $80 million FDIC special assessment and $43 million related to the inclusion of Chevy Chase Bank. Importantly, income before provisions and taxes (IBPT) a key metric for DBRS, improved 12% quarter on quarter to $2.2 billion. During negative economic and business cycles, DBRS looks to a financial institutions ability to generate sufficient IBPT to absorb increased credit costs inherit with the cycle. Given the current economic environment, DBRS considers the Company’s Q2 2009 underlying results as solid, moreover this further illustrates the strength of the Company’s franchise.

The worsening economic environment combined with the denominator effect impacted delinquency and loss trends across most of the Company’s loan book. Managed loans held for investment declined by $4.1 billion, or 2.7% to $146.2 billion. Managed charge-offs for U.S. Card, which is the largest of the Company’s loan portfolios at $64.8 billion, increased to 9.23% from 8.39% in Q1 2009. Managed 30-day plus delinquencies however, declined to 4.77% from 5.08% a quarter ago, evidencing the success in Capital One’s credit risk management efforts. Total company-wide net charges-offs at June 30, 2009 were $2.1 billion or 6.0% of managed receivables, while the total company-wide 30-day delinquency decreased slightly to 4.34%. Provision expense, on a managed basis, declined $228.1 million from the prior quarter to $1.9 billion largely attributable to the reduction in receivables. Despite the $166.2 million allowance release, at June 30, 2009, Capital One’s loan loss reserve remained at 4.8% of reported loans, up from 3.4% a year ago. Given the outlook for further increases in unemployment in the U.S., DBRS anticipates that the Company’s asset quality measures are likely to remain stressed through the remainder of 2009.

During Q2 Capital One bolstered its capital base with a $1.5 billion equity raise. At June 30, 2009, the Company reported a tangible common equity-to-tangible asset (TCE/TA) ratio of 5.7% compared with 4.8% the previous quarter. During Q2 2009 the Company’s Tier 1 capital ratio improved to 9.7% from 8.5% in Q1 2009, excluding the TARP funds. In addition to the capital raising efforts, capital ratios also benefited from the reduction in risk weighed assets.

DBRS views Capital One’s liquidity profile as well-managed and is anchored by its sizable deposit base. At quarter end deposits represented 64% of the Company’s funding base. During the quarter, total deposits declined $4.4 billion to $116.7 billion, as the Company continued to shift from higher-cost brokered deposits to lower-cost branch sourced deposits. Accordingly, Capital One’s cost of funds decreased to 2.40% in Q2 from 2.76% the previous quarter. Further enhancing Capital One’s liquidity profile is its low risk investment portfolio which totaled $38.0 billion at quarter-end. 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.

DBRS’s current ratings reflect the strength of the overall Capital One franchise, its diversified product offering and its solid retail deposit base gained from its Capital One Bank franchise as well as the recently acquired Chevy Chase Bank. The Negative trend reflects DBRS’s expectations that earnings will remain subdued as credit costs are expected to remain elevated given the stressed U.S. economy. Although DBRS has factored in a level of deterioration of asset quality metrics, continued increasing credit costs could pressure ratings; should they stress the Company’s ability to absorb credit losses out of current IBPT.

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.