DBRS Comments on Capital One Financial Corporation’s 3Q13 Earnings; Senior at BBB (high)

DBRS, Inc. (DBRS) has today commented on the 3Q13 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 3Q13, Capital One reported net income available to common shareholders of $1.10 billion, stable with the linked quarter, but down 6.3% from $1.2 billion a year ago. Earnings for the quarter equated to a 1.53% return on average assets and 11.00% return on average common equity, down from 1.66% and 11.97%, respectively, from the linked quarter.

Relatively flat revenues, an increase in litigation reserves, and a higher provision for credit losses drove the slight decline in Capital One’s quarterly earnings. Highlights of the quarter include net interest margin expansion, modest loan growth, and strengthening capital metrics. DBRS notes that Capital One completed the sale of its Best Buy portfolio with impacts in line with previous estimates.

Loans held for investment were up modestly to $191.8 billion reflecting growth in automobile loans and commercial banking, offset by the continued expected run-off in the mortgage book. 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 5% QoQ driving the auto lending portfolio to $30.8 billion. Meanwhile, the commercial loan portfolio grew 4%, while home loans declined 6% to $36.8 billion. Within the Domestic Card segment, loans, excluding planned run-off, were flat QoQ.

Despite the decline in average interest earning assets, total net revenues were flat QoQ at approximately $5.7 billion. Specifically, the net interest margin (NIM) expanded 6 bps to 6.89% reflecting the higher day count this quarter and a higher yield on investment securities. In DBRS’s view, Capital One’s income before provisions and taxes (IBPT) continues to be solid, and is deemed more than sufficient to absorb credit costs and generate capital. For the quarter, the Company’s IBPT from continuing operations decreased 2.9% QoQ to $2.5 billion with provision expense absorbing 34% of IBPT, compared to 30% in 2Q13.

Non-interest expense was 2.9% higher QoQ at $3.1 billion, with an increase in litigation reserves offset by a decrease in marketing expenses. The Company continues to keep control over expenses and the efficiency ratio has stayed in the mid-50% range.

Asset quality remains sound. Excluding acquired loans, Company-wide net charge-offs (NCOs) were 17 bps lower sequentially, but up 11 bps YoY at 2.29%. Delinquencies (30-day plus), excluding acquired loans, were 18 bps higher on a linked-quarter basis at 3.01%, but 14 bps lower than at the comparable point a year ago. Reflecting seasonality and the Company’s sound underwriting, the Domestic Card portfolio’s NCOs were 61 bps lower on a linked quarter basis at 3.67%. Meanwhile, the Consumer Banking portfolio’s NCOs were 35 bps higher QoQ at 0.95% representing some normalization in loss rates within this portfolio. Lastly, 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 again improved sequentially. Overall, the Company-wide provision for credit losses totaled $849 million, an 11% increase QoQ that resulted in approximately $68 million of reserve release. With loan loss reserves totaling $4.3 billion, or 2.26% 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 93% compared to 97% in 4Q12. Moreover, capital levels again strengthened in the quarter reflecting solid earnings retention and a smaller balance sheet. Specifically, Capital One’s Basel I Tier 1 common ratio improved 60 bps QoQ to 12.7% at September 30, 2013. Additionally, the Company estimates that its Basel III Tier 1 common ratio was above its expected 8% target under the advanced approach.

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

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