Capital One price target revised to $48
Stricter lending requirements have led to a marked improvement in the bank's credit quality.
We have revisited our analysis of Capital One (COF) in light of economic conditions and the company's performance. Capital One is the fifth largest bank in the U.S. and competes with American Express (AXP), Discover Financial (DFS), Bank of America (BAC) and JPMorgan Chase (JPM).
In October, Capital One reported a strong third quarter net income of $865 million, which was up 5.7% from the same period in the prior year, but down 8.5% from the prior quarter (we've excluded income from discontinued operations in our analysis). Our updated price estimate for Capital One of $48 is about 5% ahead of the current market price.
We have rolled back changes to our Capital One model which reflected its acquisition of the online banking unit of ING, since the deal has not yet been approved by regulators. We do still expect the acquisition to be approved in the first half of this year.
Credit card balances continue to decline
Since the 2008 global economic crisis, credit card issuers have been very cautious in giving out loans. Card issuers have closed risky accounts, cut credit limits on millions of accounts, and tightened lending standards to cut their risk of defaults and late payments. The demand for credit has also decreased as borrowers are working hard to pay down balances in order to avoid high interest rate penalties. Capital One's outstanding credit card balance has declined sharply in the last three years, from $79 billion in 2008 to $62 billion in 2011.
We remain optimistic about the long-term growth potential of Capital One's credit card loans, which would get a big boost if regulators approve the acquisition of ING's online banking unit.
Default rates drastically reduced
Stricter lending requirements have led to a marked improvement in Capital One's credit quality. Continued improvement in credit performance, including reduced delinquency rates, lower bankruptcy losses and higher recoveries, contributed to a significant reduction in the company's provisions for loan losses.
As a result of the reduction in charge-offs, Capital One released $1.1 billion in allowances in the first nine months of 2011. This caused the provisions as a percentage of total loans to drop to 2.7% in 2011 from 5% in 2010. From 2012 onward, we expect it to be around 4%.
Dividend payout affected by tighter regulations
The Federal Reserve is conducting a stress test on large banks and has restricted them from increasing dividends. Capital One's request to increase its dividend was turned down by the Fed in Q1 2011.
We believe that it will be difficult for Capital One to increase its dividends in the next couple of years because of the tighter regulations and also because of its planned acquisitions of the credit card business of HSBC and ING's online banking unit.
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