DBRS Comments on Capital One Financial Corporation’s 1Q13 Earnings; Senior at BBB (high)

DBRS, Inc. (DBRS) has today commented on the 1Q13 earnings of Capital One Financial Corporation (Capital One or the Company). DBRS rates Capital One’s Issuer & Senior Debt at BBB (high) with a Stable trend. For 1Q13, Capital One reported net income of $1.1 billion, up from $843 million in the prior quarter, but down from $1.4 billion a year ago.

Capital One’s financial results were impacted by the planned sale of the Best Buy partnership portfolio, as well as anticipated seasonal impacts. Loans held for investment were 7% lower sequentially at $191.3 billion primarily due to seasonal patterns, continued expected run-off in the mortgage book and the reclassification of the $7.0 billion Best Buy portfolio held for sale. During the quarter, Capital One reached an agreement with Citi to sell the Best Buy partnership portfolio for proceeds largely equal to book value, which CapOne anticipates will result in no significant gain or loss. The transaction is expected to close in 3Q13. Within the Domestic Card segment, loans declined 15% QoQ driven by the reclassification, higher customer payment rates following the holiday season and the anticipated run-off of certain HSBC branded loans. Purchase volumes, excluding HSBC, grew 5.5% reflecting good customer brand loyalty and share of customer wallet. Meanwhile, the Auto Finance and Commercial loan portfolios all grew QoQ demonstrating continued progress by Capital One to shift the loan book from lower yielding mortgages to higher yielding auto and commercial assets.

Revenue generation was respectable despite the uneven economy. Total net revenues were slightly lower QoQ at $5.5 billion reflecting seasonally lower balances and purchase volumes partially offset by higher margins. Specifically, net interest margin (NIM) expanded 19 basis points (bps) to 6.71% reflecting the positive impact of the redemption of high-cost trust preferred securities, as well as a benefit from the announced sale of the Best Buy partnership portfolio partially offset the lower day count in the quarter. In DBRS’s view, Capital One’s pre-provision earnings capacity continues to be acceptable, and is more than sufficient to absorb credit costs and generate capital. For the quarter, the Company’s pre-provision earnings improved 7% QoQ to $2.5 billion with provision expense absorbing 35% of pre-provision earnings compared to 49% in 4Q12.

Reflecting seasonal patterns, non-interest expense was 7% lower QoQ at 3.0 billion, including a 19% reduction in marketing expense, which tends to be highest in the fourth quarter. The pace of reduction in operating expenses outpaced the decline in revenues resulting in positive operating leverage. As a result, the Company’s efficiency ratio improved to 54.6% from 57.9% in the prior quarter.

Asset quality continues to be favorable supported by households hesitant to accumulate more debt and the Company’s sound servicing capabilities. Company-wide net charge-offs (NCOs) were 6 bps lower sequentially, but up 16 bps year-on-year at 2.20%. At quarter-end, 30-day plus delinquencies were 33 bps lower on a linked-quarter basis at 2.37%, but 14 bps higher than at the comparable point a year ago. Reflecting seasonality, the Domestic Card portfolio’s NCOs were 8 bps higher on a linked quarter basis at 4.43%, while the Auto Finance portfolio’s NCOs were 46 bps lower QoQ at 1.78%. DBRS notes that Domestic Card’s, NCOs and delinquencies performed better than the Company’s expected seasonal patterns. Meanwhile, the Commercial Banking portfolio continues to perform well. Specifically, NCOs were a very low 7 bps in the quarter, while the level of nonperforming loans and criticized loans improved sequentially. Overall, the Company-wide provision for credit losses totaled $885 million, a 23% reduction QoQ reflecting a $261 million allowance release partially offset by a $67 million charge related to a reserve build for unfunded commercial commitments. With loan loss reserves totaling $4.6 billion, or 2.41%of total loans held for investment, DBRS sees reserve coverage ratios as acceptable, especially given the Company’ ability to generate sold levels of income before provisions and taxes.

Capital One’s balance sheet strength remains sound. At March 31, 2013, deposits stood at $212.4 billion broadly stable QoQ. The loan book remains primarily deposit funded with the Company’s loan-to-deposit ratio improving to 90.0% compared to 96.9% in 4Q12. Capital strengthened in the quarter reflecting solid earnings retention and a 3% reduction in risk-weighted assets from the seasonal reduction in loan balances. Capital One’s Basel I Tier 1 common ratio improved 80 bps QoQ to 11.8% at March 31, 2013. From DBRS’s perspective, the quality of Capital One’s capital base improved in 1Q13 with the repayment of $3.6 billion of trust preferred securities.

In March 2013, the Federal Reserve announced its results for the Comprehensive Capital Analysis and Review (CCAR). Under the severely adverse scenario, Capital One’s Tier 1 common and leverage ratios were 6.69% and 5.23%, respectively, at their minimums. After the Federal Reserve’s non-objection to the Company’s capital plan, the Company announced an increase in its common dividend to $0.30 per share starting in 2Q13 subject to board approval.

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

[Amended on May the 23rd, 2014 to remove unnecessary disclosures.]