DBRS Comments on Capital One Financial Corporation’s 2Q12 Earnings; Senior at BBB (high), Stable

DBRS, Inc. (DBRS) has today commented that the ratings of Capital One Financial Corporation and its principal subsidiaries, including Capital One Bank, (collectively, Capital One or the Bank), remain unchanged following the announcement of 2Q12 earnings. DBRS rates Capital One Financial Corporation at BBB (high). The trend on all ratings is Stable.

Capital One’s quarterly results were significantly impacted by the HSBC U.S. Card business acquisition, which closed on May 1, 2012. However, on an underlying basis excluding the acquisition, the Company’s legacy businesses generated solid results underpinned by strong credit performance and a growing loan book. For 2Q12, Capital One reported pre-tax income from continuing operations of $236 million compared to $1.9 billion in the prior quarter. Results were impacted by $1.2 billion of items related to purchase accounting including allowance build for non-impaired acquired loans, finance charge reserve, credit marks on impaired loans and other items. Moreover, DBRS notes that 1Q12 results benefited from $512 million of ING acquisition-related items. Excluding acquisition items in both quarters, Capital One reported pre-tax income from continuing operations of $1.4 billion in 2Q12 compared to $1.3 billion in 1Q12.

Excluding the impact of the HSBC and ING acquisitions, net revenues were 3% higher on a linked-quarter basis at $4.4 billion. Non-interest expense, excluding the HSBC acquisition, increased 7% QoQ to $2.7 billion driven by a full quarter of ING Direct, $60 million of regulatory fines related to cross-sell activities, and $98 million due to net litigation reserves to cover interchange and other settlements in the quarter. DBRS views the underlying results as illustrating the solid momentum in Capital One’s legacy businesses, the Company’s solid earnings generation ability and the strength of its well-managed balance sheet.

Despite the uneven economic recovery in the U.S. and consumer confidence still below pre-recession levels, Capital One reported solid growth in loans across all businesses and in billed business volumes. Within the Domestic Card segment loans were 52% higher QoQ with purchase volumes expanding 33% to $41.8 billion reflecting the HSBC acquisition. In Consumer Banking, Auto Finance loans grew 7% to $25.3 billion and outpaced mortgage run-off. Lastly, Commercial Banking segment loans were 3% higher at $36.1 billion. Going forward, DBRS will look for evidence that the anticipated benefits of the recently completed ING Direct USA and HSBC U.S. credit card business acquisitions are being captured, which would allow Capital One to maintain its positive underlying earnings momentum.

Credit performance in legacy businesses continued to trend favorably demonstrating Capital One’s sound risk management and solid servicing capabilities. Within the loan book, excluding acquired loans, Company-wide NCOs declined 44 basis points (bps) sequentially and 107 bps year-on-year to 1.96%. At June 30, 2012, 30-day delinquencies were 37 bps lower on a linked-quarter basis at 2.59% and 43 bps lower than in 2Q11. Within the $71.5 billion Domestic Card portfolio, NCOs declined by 106 bps to 2.86% compared to 3.92% in 1Q12 and 4.74% a year ago. The noteworthy decline reflects the absence of charge-offs from the HSBC acquisition, which were absorbed by the credit marks established through purchase accounting. NCOs in Consumer Banking were 29 bps lower QoQ at 0.48%, largely reflecting the focus on prime auto lending and tightening of underwriting standards in the Auto Finance portfolio. The $36.1 billion Commercial Banking portfolio continues to perform well with NCOs stable QoQ at 0.19%. The provision for credit losses totaled $1.7 billion, including $1.2 billion for an allowance build for the non-impaired loans resulting from the HSBC acquisition. Within the legacy businesses, strong credit performance resulted in a $259 million reserve release. Nonetheless, reserve coverage ratios continue to be well-maintained with loan loss reserves totaling $5.0 billion, or 3.08% of total loans, excluding acquired loans.

DBRS considers Capital One’s funding and liquidity profile as well managed underpinned by its sound regional banking and leading direct deposit franchises. During the quarter, deposits declined modestly to $213.9 billion from $216.5 billion in the prior quarter. Nevertheless, despite the slight reduction in deposits and the aforementioned acquisition, Capital One’s loan-to-deposit (LTD) ratio was a very solid 94.8% at June 30, 2012.

As a result of the HSBC U.S. Card portfolio acquisition, Capital One’s Basel I Tier 1 common ratio declined to 9.9% from 11.9%. Positively, the ratio was slightly higher than the Company originally forecasted due to lower goodwill created. DBRS notes that risk-weighted assets grew 18% during the quarter to $216 billion as a result of the acquisition. With several recent acquisitions completed combined with the Company’s strong earnings generation, Capital One should rebuild capital levels going forward.

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

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations, which can be found on the DBRS website under Methodologies.

The sources of information used for this rating include company documents. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

Lead Analyst: Michael Driscoll
Approver: Roger Lister
Initial Rating Date: 17 November 2005
Most Recent Rating Update: 17 August 2011

For additional information on this rating, please refer to the linking document under Related Research.