DFS Discover Financial Services

Capital One Financial Corp. (COF) reported first-quarter 2012 earnings of $1.56 per share, outpacing the Zacks Consensus Estimate of $1.40.  This also compares favorably with 88 cents earned in the prior quarter and $2.21 recorded in the year-ago quarter.

Considering the impact of a bargain purchase gain related to the ING Direct USA acquisition, Capital One reported net income of $1.4 billion or $2.72 per share in the reported quarter. The company completed the acquisition of ING Direct, online banking unit of Amsterdam-based ING Groep NV (ING), during the quarter. This acquisition is accretive to the company’s first-quarter results.

Higher net increase income and fee income were major contributors to the better-than-expected Capital One results. This was further augmented by the ING Direct acquisition, which positively impacted the company’s financials. However, higher operating expenses slightly marred the earnings. Moreover, during the quarter, credit quality exhibited significant improvement and capital and profitability ratios remained stable.

Performance in Detail

Total revenue for the reported quarter stood at $4.94 billion, surging 22% sequentially and 21% year-over-year. The improvement was mainly driven by higher net interest and non-interest incomes. Total revenue also surpassed the Zacks Consensus Estimate of $4.35 billion.

Net interest income for the quarter grew 7% sequentially and 9% year-over-year to $3.41 billion. The increase was mainly driven by substantially higher loans held for investment, including past-due fees.

Net interest margin in the quarter fell 102 basis points (bps) sequentially and 104 bps year over year to 6.20%. The drop primarily resulted from ING Direct's lower yielding assets and higher cash balances.

Non-interest income climbed from $868 million in the prior quarter and $942 million from the year-ago quarter to $1,521 million. Inclusion of bargain purchase gain of $594 million related to ING Direct acquisition accounted for the significant rise.

Capital One’s operating expenses for the reported quarter dropped 4% sequentially but climbed 16% year over year to $2.50 billion. Lower marketing expense was the primary reason for the sequential decline. The year-over-year increase was mainly due to rise in salaries and associate benefits expenses as well as marketing expenses.

The managed efficiency ratio improved to 50.74% from 64.64% in the prior quarter and 52.96% in the previous-year quarter. The decline in efficiency ratio indicates an increase in profitability.

Credit Quality

Capital One’s credit quality showed significant improvement during the quarter with allowance, as a percentage of reported loans held for investment, slipping 79 bps sequentially and 189 bps year over year to 2.34%. Likewise, net charge-off rate also declined from 2.69% in the prior quarter and 3.66% in the year-ago quarter to 2.04%.

Moreover, the 30-plus day performing delinquency rate declined 112 bps sequentially and 84 year over year to 2.23%. However, provision for loan and lease losses decreased 33% sequentially but marginally climbed 7% to $573 million.

Capital and Profitability Ratios

Capital One’s capital and profitability ratios continued to elevate during the quarter. Tangible common equity (TCE) ratio for the quarter was 8.2%, in line with the prior quarter and up from 7.3% in the prior-year quarter. As of March 31, 2012, tier 1 risk-based capital ratio rose 190 bps sequentially and 300 bps year over year to 13.9%.

The company’s tangible book value per share was $39.37 as of March 31, 2012 compared with $34.26 as of December 31, 2011 and $29.47 as of March 31, 2011.

Peer Performance

One of the close peers of Capital One, Discover Financial Services (DFS) posted better-than-expected first-quarter results, with earnings surpassing 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. Further, ING Direct was accretive to the company’s financials, immediately upon closing. Moreover, we believe that the pending acquisition of HSBC Holdings Plc’s (HBC) U.S. credit card business will boost its top line and improve its 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 #3 Rank, which translates into a short-term ‘Hold’ rating.

 
CAPITAL ONE FIN (COF): Free Stock Analysis Report
 
DISCOVER FIN SV (DFS): Free Stock Analysis Report
 
HSBC HOLDINGS (HBC): Free Stock Analysis Report
 
ING GROEP-ADR (ING): Free Stock Analysis Report
 
To read this article on Zacks.com click here.
 
Zacks Investment Research