DBRS Comments on Capital One Financial Corporation’s 2Q13 Earnings; Senior at BBB (high)

DBRS, Inc. (DBRS) has today commented on the 2Q13 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 2Q13, Capital One reported net income available to common shareholders of $1.10 billion, up 5% from $1.05 billion earned during the linked quarter, and up significantly from $93 million a year ago. Earnings for the quarter equated to a 1.66% return on average assets and 11.97% return on average common equity, up from 1.51% and 11.23%, respectively, from the linked quarter.

Capital One’s financial results were favorably impacted by positive operating leverage, a reduction in provision expense, and $123 million in earnings related to the held-for-sale accounting treatment for the BestBuy partnership portfolio. The 2Q13 results also included a $183 million (pre-tax) charge for mortgage representation and warranty expense.

Loans held for investment were relatively flat at $191.5 billion in line with seasonal patterns, continued expected run-off in the mortgage book, and growth in automobile loans. However, Capital One continues to make progress shifting the loan book from lower-yielding mortgage loans to higher-yielding auto and commercial assets. Specifically, auto loan originations were up 19% QoQ resulting in a 5% increase in the auto lending portfolio to $29.4 billion. Meanwhile, the commercial loan portfolio grew 4%, while home loans continued to run-off as expected, declining 7% to $39.2 billion. Within the Domestic Card segment, loans, excluding planned run-off, increased modestly QoQ reflecting seasonal patterns. Purchase volumes, excluding HSBC acquired loans, outpaced the industry growing 9%, reflecting good customer brand loyalty and share of customer wallet. DBRS sees the solid underlying loan growth evidencing the benefits of Capital One’s focus on investing in certain more profitable market segments.

Despite the decline in average interest earning assets, total net revenues were slightly higher QoQ at $5.6 billion. Specifically, the net interest margin (NIM) expanded 12 basis points (bps) to 6.83% reflecting the higher day count this quarter and credit card yield improvement. In DBRS’s view, Capital One’s income before provisions and taxes (IBPT) continues to be solid, and is more than sufficient to absorb credit costs and generate capital. For the quarter, the Company’s IBPT from continuing operations improved 2% QoQ to $2.6 billion with provision expense absorbing 30% of IBPT compared to 35% in 1Q13.

Non-interest expense was modestly higher QoQ at $3.1 billion, with slight increases in most categories. The pace of increase in revenues outpaced operating expenses resulting in positive operating leverage. As a result, the Company’s efficiency ratio improved 29 bps to 54.26%.

Asset quality continues to trend favorably. Excluding acquired loans, Company-wide net charge-offs (NCOs) were 23 bps lower sequentially, but up 50 bps YoY at 2.46%. Delinquencies (30-day plus), excluding acquired loans, were 7 bps lower on a linked-quarter basis at 2.83%, but 24 bps higher than at the comparable point a year ago. Reflecting seasonality and the Company’s sound underwriting, the Domestic Card portfolio’s NCOs were 15 bps lower on a linked quarter basis at 4.28%. Meanwhile, the Consumer Banking portfolio’s NCOs were 18 bps lower QoQ at 0.60% supported by historically low charge-offs in Auto Finance. With used car values softening in recent months, DBRS expects some normalization in loss rates within this portfolio. Lastly, the Commercial Banking portfolio continues to perform well. Specifically, NCOs were a very low 4 bps in the quarter, while the level of nonperforming loans improved sequentially. Overall, the Company-wide provision for credit losses totaled $762 million, a 14% reduction QoQ that resulted in approximately $200 million of reserve releases. With loan loss reserves totaling $4.4 billion, or 2.30% of total loans held for investment, DBRS sees reserve coverage ratios as acceptable, especially given the Company’s ability to generate sold levels of IBPT.

Capital One’s balance sheet strength remains sound. Indeed, the loan book remains primarily deposit funded with the Company’s loan-to-deposit ratio at 91% compared to 96.9% in 4Q12. Moreover, capital levels again strengthened in the quarter reflecting solid earnings retention and net unrealized gains on AFS securities, which more than offset growth in risk-weighted assets. Capital One’s Basel I Tier 1 common ratio improved 30 bps QoQ to 12.1% at June 30, 2013. Additionally, the Company estimates that its Basel III Tier 1 common ratio was approximately 8.5%, above its expected 8% target.

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

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