DFS Discover Financial Services

Capital One Financial Corp. (COF) reported fourth-quarter 2011 earnings from continuing operations of 89 cents per share, significantly below the Zacks Consensus Estimate of $1.53.  This also compares unfavorably with $1.88 earned in the prior quarter and $2.07 recorded in the year-ago quarter.

For the full year, Capital One’s earnings per share from continuing operations was $7.03, up 5% from $6.68 in the prior year. However, earnings missed the Zacks Consensus Estimate of $7.55.

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 an extent, mitigated by higher revenues. Moreover, the company’s capital and profitability ratios showed improvement.

Capital One’s net income from continuing operations for the quarter was $411 million, down 52% from $965 million in the prior quarter and 41% from $701 million in the year-ago quarter. Adjusting for discontinued operations, Capital One’s net income came in at $407 million or 88 cents per share, compared with $813 million or $1.77 per share in the previous quarter and $697 million or $1.52 per share in the year-ago quarter.

During 2011, Capital One announced two major acquisitions, ING Direct USA, the online banking unit of Amsterdam-based ING Groep NV (ING) for $9.0 billion and HSBC Holdings Plc’s (HBC) U.S. credit card business for $32.7 billion. The company anticipates that the acquisition of ING Direct would complete in the first quarter and the acquisition of the HSBC US Card business in the second quarter. Moreover, these two acquisitions will have significant impact on its financials, especially in 2012.

Behind the Headlines

Total revenue for the reported quarter stood at $4.05 billion, down 3% sequentially but up 2% year over year. The year-over-year improvement was mainly driven by higher net interest income. Total revenue missed the Zacks Consensus Estimate of $4.14 billion.

For fiscal 2011, total revenue was $16.3 billion compared with $16.2 billion recorded in the prior year. Total revenue for the full year topped the Zacks Consensus Estimate of $16.1 billion.

Net interest income for the quarter fell 3% sequentially but improved 5% year over year to $3.18 billion. The increase was mainly due to 20% decline in total interest expenses.

Net interest margin (NIM) in the quarter fell 17 basis points (bps) sequentially but grew 2 bps year over year to 7.22%. Though NIM benefited from lower funding cost, it was more than offset by a decline in loan yields.

Non-interest income declined from $871 million in the prior quarter and $939 million from the year-ago quarter to $868 million. The fall in service charges and other customer-related fees mainly dragged down the non-interest income during the quarter.

Capital One’s operating expenses for the reported quarter surged 14% sequentially and 25% year over year to $2.62 billion, mainly due to  rise in salaries and associate benefits expenses as well as marketing expenses.

The managed efficiency ratio deteriorated to 64.64% from 55.30% in the prior quarter and 56.47% in the previous-year quarter. The increase in efficiency ratio indicates a drop in profitability.

Credit Quality

Capital One’s credit quality dipped slightly during the quarter with only allowance, as a percentage of reported loans held for investment, slipping 16 bps sequentially to 3.13%.

Net charge-off rate increased 17 bps sequentially to 2.69%. Similarly, the 30-plus day performing delinquency rate also scaled up 22 bps sequentially to 3.35%. Also, provision for loan and lease losses increased 38% sequentially to $861 million.

Capital and Profitability Ratios

Capital One’s capital and profitability ratios continued to enhance during the quarter. Tangible common equity (TCE) ratio for the quarter improved to 8.2% from 7.9% in the prior-year quarter. Also, Tier 1 risk-based capital ratio rose 20 bps year over year to 12.0%.

The company’s tangible book value per share was $34.26 as of December 31, 2011 compared with $33.82 as of September 30, 2011.

Peer Performance

One of the close peers of Capital One, Discover Financial Services (DFS) posted better than expected fourth-quarter results, with earnings marginally ahead of the Zacks Consensus Estimate. The surge in profits was driven by sales volume growth, complemented by higher interest income, reduced provision for loan losses and lower delinquency rates due to improved credit quality. The profit was also boosted by the escalated income from both direct banking and payment services business, which also drove the book value per share.

Our Viewpoint

We anticipate continued synergies from Capital One’s geographic diversification. Additionally, the resilience shown by almost all its businesses will continue to support its financials. Moreover, the recent acquisitions will improve the company’s market position in terms of deposits and assets.

However, rising operating expenses and its commercial real estate exposure will be the primary dampeners. Also, a weak loan demand, along with the impact of the new financial reform law, will suppress earnings in the near future.

Capital One currently retains a Zacks #2 Rank, which translates into a short-term ‘Buy’ rating.

 
CAPITAL ONE FIN (COF): Free Stock Analysis Report
 
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ING GROEP-ADR (ING): Free Stock Analysis Report
 
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