Morningstar DBRS Confirms Capital One Financial Corporation at A (low); Stable Trend

DBRS, Inc. (Morningstar DBRS) confirmed its credit ratings on 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, Morningstar DBRS confirmed the credit ratings of its banking subsidiary, Capital One, National Association (the Bank). The trend for all credit ratings is Stable. The Intrinsic Assessment (IA) for the Bank 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 Bank's IA.

KEY CREDIT RATING CONSIDERATIONS
The credit ratings reflect the Company's strong franchise, resilient earnings, disciplined credit risk management, diversified funding profile, and sound capitalization. The credit ratings also reflect the Company's elevated revenue and loan concentration to the highly competitive credit card and auto loan sectors including a sizable exposure to consumer subprime credit segments. The credit ratings also consider the pending acquisition of Discover Financial Services (Discover), which, once completed, will enable Capital One to become an even more formidable player in the U.S. credit card space. While Capital One has historically integrated acquired companies successfully, there remains integration risk and a chance for a lackluster realization of merger expectations. Morningstar DBRS views the December 2024 acquisition approval from the office of the Delaware State Bank Commissioner and the most recent approval from both companies' shareholders as presenting a notable progress for the Company toward the acquisition while awaiting the remaining approvals from the Federal Reserve and the Office of the Comptroller of the Currency. As a result of the pending regulatory approvals, both companies disclosed in their recent filings that per the merger agreement the outside date for the closing of the transaction has been automatically extended to May 19, 2025. The filings also disclosed ongoing litigations to prevent the merger, which both Capital One and Discover claim are without merit.

The Stable trends reflect our expectation that Capital One will maintain sound balance sheet fundamentals and generate resilient bottom-line results. The key downside risks to our expectations are a notable weakening in the labor markets, as well as persistent inflationary pressures, which adds further stress on U.S. consumers, especially in the subprime sector.

The Bank's Intrinsic Assessment of "A" has been assigned at the midpoint of the IA Range, as Morningstar DBRS views Capital One's credit fundamentals and performance as commensurate with those of similarly rated peers.

CREDIT RATING DRIVERS
Over the longer term, the credit ratings would be upgraded if the Company sustains solid operating results and balance sheet fundamentals while successfully integrating Discover and achieving acquisition expectations. Conversely, a sustained weakening in the Company's earnings generation and asset quality metrics or a poorly executed integration of Discover would result in a downgrade of the credit ratings.

CREDIT RATING RATIONALE
Franchise Combined Building Block Assessment: Strong/Good
Capital One has a solid franchise stemming from the strong brand recognition of its national consumer lending and online deposit platform franchises as well as from its regional banking operations. The Company is the third-largest U.S. credit card issuer, one of the largest auto loan providers in the U.S., and the ninth-largest U.S. bank by assets. Capital One's customer-oriented and technology-focused approach has enabled it to consistently achieve high rankings in various customer satisfaction surveys. Indeed, Capital One was ranked first in the J.D. Power 2024 U.S. National Banking Satisfaction Study for a fifth consecutive year while it was also highly ranked in other J.D. Power studies in the U.S. for small business, online banking, and credit card and mobile app satisfaction. With the anticipated completion of the Discover acquisition, the Company is expected to further entrench its franchise in the U.S. credit card industry as the largest card issuer while expanding into U.S. payment network space.

Earnings Combined Building Block Assessment: Strong/Good
Capital One's earnings power is supported by solid earnings generation through its diverse loan book, including its highly profitable credit card portfolio, as well as from improving operating efficiencies. That said, Capital One's fee-based income contribution to total revenue is comparably lower relative to its more diversified peer banks and thereby its spread oriented revenue streams are more correlated to the interest rate cycle and lending activity. In 2024, the Company reported net income of $4.8 billion, down slightly from the prior year, as it was affected by $234 million of Discover integration expenses and $826 million of allowance build related to the Walmart credit card program agreement termination. Pre-tax, pre-provision earnings (adjusted for one-time items) totaled $18.0 billion in 2024, up from $16.8 billion in 2023, as the operating efficiency (defined as adjusted operating expenses as a percentage of total net revenue) further improved to 42.4% in 2024 from 43.5% in 2023. Capital One's profitability is expected to improve over the medium term as it achieves expense synergies from the Discover acquisition and revenue boost from the integration of Discover's high net interest margin credit card portfolio.

Risk Combined Building Block Assessment: Moderate
Capital One's risk profile is underpinned by a disciplined credit risk management approach embedded in its underwriting and portfolio management capabilities. The Company's sizable consumer loan portfolio, which accounted for 73% of its total loan book at December 31, 2024 (YE2024), has higher exposure to subprime credit segments relative to its bank peer group. Nonetheless, upon the completion of the merger, the asset quality of the combined credit card portfolio is expected to improve moderately as Discover's portion of outstanding loan receivables associated with subprime borrowers is lower than Capital One's domestic card portfolio (20% at Q3 2024 versus 31% at YE2024, respectively). Over the past year, the Company's credit performance metrics have indicated signs of stabilization for both consumer and commercial loan portfolios. At YE2024, the 30-plus day delinquency rate for domestic credit cards was 4.53% down 8 basis points (bps) year-over-year (YOY), compared with 2.9% (flat YOY) for the peer group of the top card issuers, while for auto loans the 30-plus day delinquency rate declined 39 bps YOY to 5.95%. The nonperforming loan ratio for the commercial banking portfolio has been largely stable over the past few quarters. Of note, the 30-plus day delinquency rate for Discover's credit card portfolio also improved YOY.

Funding and Liquidity Combined Building Block Assessment: Good
The Company has a solid funding profile encompassing broad funding sources and a defensible deposit base attained from its branch-based regional franchise along with its national online deposit gathering capabilities. The integration of Discover's online deposit franchise, with its historically good reputation for customer service, will augment the Company's deposit base and franchise. At YE2024, approximately 85% of Discover's $107.0 billion deposit base was composed of direct-to-consumer deposits with the remainder brokered deposits. At YE2024, Capital One's deposits of $313.4 billion (88% of which are consumer deposits) increased by 4% YOY and 3% from the linked quarter and accounted for 89% of total funding. The Company also retains access to unsecured debt, asset backed securitizations, and short-term borrowings that collectively provide diversity and flexibility to its funding mix. The Company has sound levels of high-quality liquid assets to meet its short-term funding needs as indicated by the liquidity coverage ratio (LCR) of 155% in Q4 2024, that is well above of the minimum requirement of 100%. At YE2024, liquidity reserves of $123.8 billion included $43.2 billion in cash and cash equivalents, a sizable, unencumbered investment securities portfolio and FHLB eligible loans.

Capitalization Combined Building Block Assessment: Strong/Good
Capital One has sound capitalization supported by strong capital generation through earnings. The Company's common equity Tier 1 (CET1) ratio was 13.5% at YE2024, well above the regulatory minimum requirement of 10.0%, including the stress capital buffer. Capital One has historically demonstrated a consistent ability to improve its capital position through accessing the capital markets and/or by adapting flexible capital management. The Company repurchased approximately $553 million shares of its common stock in 2024, following $600 million of share repurchases in 2023. The Company's quarterly dividend of $0.60 per share was unchanged during 2024, as dividend increase restrictions remain because of the pending merger with Discover.

Further details on the Scorecard Indicators and Building Block Assessments can be found at https://dbrs.morningstar.com/research/448338.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factors that had a significant or relevant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (August 13, 2024) https://dbrs.morningstar.com/research/437781

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 4, 2024) https://dbrs.morningstar.com/research/433881. In addition, Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (August 13, 2024) https://dbrs.morningstar.com/research/437781 in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

The primary sources of information used for these credit ratings include Morningstar Inc. and company documents. Other sources include Morningstar DBRS and Company documents. Morningstar DBRS considers the information available to it for the purposes of providing these credit ratings was of satisfactory quality.

The credit rating initiated at the request of the rated entity.

The rated entity or its related entities did not participate in the credit rating process for this credit rating action.

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

This is an unsolicited credit rating.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS' trends and credit ratings are under regular surveillance.

For more information on this credit or on this industry, visit https://dbrs.morningstar.com.

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