We have reaffirmed our Neutral recommendation on Capital One Financial Corp. (COF) after a thorough review of its fourth-quarter 2011 earnings results. Further, the acquisition of ING Direct USA, the online banking unit of Amsterdam-based ING Groep NV (ING) coupled with approval of acquiring HSBC Holdings plc‘s (HBC) U.S. credit card business strengthened our view. The acquisitions are expected to enhance the company’s position in terms of deposits and assets, as well as be significantly accretive to its financials.
In August 2011, Capital One announced a definitive agreement to acquire HSBC’s U.S. credit card business for $32.7 billion. The completion of the agreement would enhance the company’s card business and is likely to bring high teens GAAP as well as operating earnings per share for Capital One in 2013.
This acquisition is a strategic fit for the company as HSBC’s U.S. credit card business has a proven track record and generates more than half of its revenue from credit cards. The deal will definitely improve the company’s credit card franchise.
In February 2012, Capital One wrapped up the ING Direct USA deal – announced in June 2011. For Capital One, the deal will create a valuable banking franchise for taking advantage of the large number of branch banking in attractive high-growth markets and to gain from an online banking franchise with a national reach. Additionally, ING Direct, with about 7.7 million customers in its kitty, would further enhance the company’s market share in the online banking sector.
However, Capital One reported fourth-quarter 2011 earnings from continuing operations of 89 cents per share, substantially trailing the Zacks Consensus Estimate of $1.53. This also compared unfavorably with $1.88 earned in the prior quarter and $2.07 in the year-ago quarter.
The year-over-year results were adversely impacted by an increase in operating expenses and higher provision for loan and lease. However, these negatives were, to some extent, mitigated by higher revenues. Moreover, the company’s capital and profitability ratios showed considerable improvement.
Further, though there has been a substantial improvement in credit quality for Capital One over the last few quarters, we expect it to remain under pressure as the current state of the economy is expected to persist for a while.
Additionally, increasing non-interest expense remains a key concern at this point. Though expense management initiatives have significantly helped Capital One in offsetting higher credit losses in the last few years, non-interest expense has been continuously increasing. We expect the integration of current acquisitions and focus on organic growth through improvement in loan portfolio and enhancement of new client base will keep non-interest expense elevated through 2012.
Currently, Capital One retains a Zacks #3 Rank, which translates into a short-term Hold rating.
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