DBRS Morningstar Revises Capital One’s Trend to Stable from Negative; Confirms Ratings at A (low)

DBRS, Inc. (DBRS Morningstar) confirmed the ratings of Capital One Financial Corporation (Capital One or the Company), including its Long-Term Issuer Rating of A (low) and Short-Term Issuer Rating of R-1 (low). At the same time, DBRS Morningstar confirmed the ratings of its banking subsidiaries, Capital One Bank (USA), National Association and Capital One, National Association (the Banks). The trend for all long-term ratings has been revised to Stable from Negative. The Intrinsic Assessment (IA) for the Banks is ‘A’, while the Support Assessment remains SA1. The Company’s Support Assessment is SA3 and Capital One’s Long-Term Issuer Rating is positioned one notch below the Banks’ IA.

KEY RATING CONSIDERATIONS
The ratings confirmation and revision of the ratings trend to Stable reflect the Company’s resilient earnings generation and solid credit performance, despite the substantial challenges caused by the Coronavirus Disease (COVID-19) induced economic downturn. The ratings also reflect the Company’s strong franchise, distinct and highly profitable business model, disciplined credit risk management, strong and diversified funding profile, and sound capitalization. The ratings also consider Capital One’s revenue concentration, the notable exposures to subprime customer segments in its credit card and auto loan portfolios, as well as the highly competitive environment for these consumer lending sectors.

The Stable trend reflects our expectation that Capital One’s operating results will continue to improve with the widespread lift of the pandemic-related restrictions and the accompanied economic growth. The Stable trend also contemplates that credit performance will gradually trend towards normalized levels from the latest multi-year low levels.

RATING DRIVERS
A more diversified revenue stream, including an increased fee income contribution, while upholding strong profitability metrics, would result in an upgrade of the ratings. Conversely, a substantial decline in earnings, reflecting a weakening of the Company’s revenue generation ability, or a sustained deterioration in asset quality metrics would lead to a downgrade of the ratings.

RATING RATIONALE
Capital One has a solid franchise, with strong brand recognition, operating a regional banking company coupled with a national consumer lending franchise. The Company is the third largest U.S. general purpose credit card issuer, the fourth largest private label credit card issuer, and one of largest online direct banking institutions by deposits in the U.S. The Company’s franchise is also supported by its technology focus and ongoing investments in digital infrastructure. In 2020, Capital One was highly ranked in various J.D. Power customer satisfaction studies related to its small business and national banking businesses, as well as for its mobile applications.

Capital One’s earnings power is underpinned by solid earnings generation that benefits from its diverse product offering and its highly profitable credit card businesses. On the other hand, a constraint on the Company’s earnings power is that fee-based income is more limited compared to peer banks, accounting for just 18% of net revenue in 2020, relative to the similarly rated peer average of approximately 28%. Despite the challenging operating environment in 2020, due to the coronavirus pandemic and the associated substantial increase in loan loss provisions, the Company remained profitable on an annual basis delivering a net income of $2.4 billion. For 1Q21, Capital One reported strong net income of $3.3 billion, which benefited from a sizeable reserve release. We expect the Company’s operating earnings trajectory to improve in 2021 as consumers’ credit card spending rebounds while strong economic growth from pent up demand should facilitate higher loan balances. The Company’s continuing digitalization efforts have enhanced its operating efficiencies resulting in further progress improving its adjusted efficiency ratio (defined as adjusted non-interest expenses as a percentage of adjusted total net revenue) to 51.7% in 2020 from 52.7% in 2019 (and down from 54.3% in 2015). While marketing spend was curtailed by 29% in 2020, it increased by 2% year-over-year (YoY) in 1Q21 and we anticipate further growth as the Company resumes building its portfolio while expanding its franchise presence.

The Company has a good risk profile supported by a disciplined and effective credit risk management with a through-the-cycle underwriting approach coupled with appropriate portfolio management capabilities. Capital One’s credit performance has been strong since the onset of the pandemic-induced fallout, benefiting from the government’s stimulus payments and other support measures, as well as by the Company’s loss mitigation and risk management initiatives. Total net charge-offs (NCOs) of $740 million in 1Q21 have declined substantially from recent periods resulting in an annualized NCO rate of 1.21%. Similarly, at 2.54%, the NCO rate for the domestic credit card portfolio in 1Q21 was near historic lows, and stood slightly below the peer average. Meanwhile, the 30+ day delinquency rate for the total loan portfolio was also low at 1.98% at March 31, 2021. Even with a sizeable reserve release, loan loss reserves remain substantial at 5.77% of loan balances as the Company anticipates credit performance reversion towards historical averages over time. We expect a gradual but manageable credit deterioration to occur in the intermediate term driven by the growing portfolio, the lifting of the early-pandemic credit tightening, as well as the removal of stimulus.

Capital One’s funding and liquidity profile is strong, stemming from its regional deposit franchise, accompanied by national online deposit gathering capabilities, as well as from its access to diverse funding sources. The Company’s deposit funding of $310.3 billion is mostly comprised of consumer deposits and accounted for 89% of its total funding, at March 31, 2021, while senior unsecured debt, asset backed securitizations and other short term debt accounted for the remainder of funding. Capital One maintains a strong liquidity position with high-quality liquid assets as evidenced by the liquidity coverage ratio (LCR) of 135% in 1Q21, that is well above of the minimum requirement of 100%. At March 31, 2021, the Company had cash and cash equivalents of $50.5 billion, unencumbered investment securities of $99.2 billion and pledged collateral to the Federal Reserve’s discount window and the FHLB with a combined total available borrowing capacity of nearly $41 billion.

The Company has sound capitalization given its risk profile and earnings generation capacity. Capital One’s common equity Tier 1 (CET1) ratio was 14.6% at March 31, 2021, up 90 basis points from YE20, remaining above its target CET1 ratio of 11% and well above the regulatory threshold of 10.1%, including the stress capital buffer requirement. Capital One has historically demonstrated a solid ability to improve its capital position through flexible capital management and access to capital markets. The Company repurchased approximately $490 million of shares during 1Q21 while its share repurchases for 2Q21 are expected to be capped at $1.7 billion due to the Fed's extension of the pertinent earnings rules. Further, in 1Q21, the Company restored its quarterly dividend to $0.40 per share from $0.10 per share.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at: https://www.dbrsmorningstar.com/research/373262.

The Grid Summary Grades for Capital One Financial Corporation are as follows: Franchise Strength – Strong/Good; Earnings Power – Strong/Good; Risk Profile – Good; Funding & Liquidity – Strong; Capitalization – Strong/Good.

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

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (June 8, 2020), which can be found on our website under methodologies and criteria: https://www.dbrsmorningstar.com/research/362170/global-methodology-for-rating-banks-and-banking-organisations.
Other applicable methodologies include DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 3, 2021):
https://www.dbrsmorningstar.com/research/373262/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

The primary sources of information used for this rating include Company Documents and S&P Global Market Intelligence. DBRS Morningstar considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This rating was not initiated at the request of the rated entity.

The rated entity or its related entities did not participate in the rating process for this rating action. DBRS Morningstar did not have access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

This is an unsolicited credit rating.

Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are under regular surveillance.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com.

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