Capital One Profits Surge

By Greg Sushinsky | July 12, 2011 AAA

Capital One Financial Corp. (NYSE:COF), known for its credit card business, saw its second quarter net income surge. The company was able to release a large amount of loan loss reserves as net charge offs fell dramatically year-over-year. Capital One also announced a stock offering which will partially fund its acquisition of ING Direct's US online banking unit. (To help better determine if the purchase of ING was the right move, check out Analyzing An Acquisition Announcement.)

TUTORIAL: Mergers and Acquisitions

Improved Results Continue
Revenue for the quarter was $4 billion, while net interest income was $3.1 billion. Net income rose to $911 million from $608 million in the second quarter a year ago. Earnings per share increased to $1.97 from $1.33 in the same period. The net charge off rate was 2.91%, down dramatically from the year ago figure of 5.35%. This enabled the company to release $579 million from its loan loss reserves, which one analyst said added 81 cents to the earnings per share.

First quarter net income in 2011 was $1.0 billion or $2.21 per share, so that is the sequential context for Capital One's earnings. The net charge off rate in the first quarter was 75 basis points higher, 3.66%. Progress continues to be dramatic in the lowering of the net charge off rates as customers are doing better at paying their credit card bills and loans. Provision expense was $343 million, which was $191 million less than the previous quarter, the first quarter of 2011. The domestic card segment saw a slight decline as $200 million growth in revolving card balances was offset by $500 million run-off in installment loans, which are included in the card segment. (For more on financial institution, see Analyzing A Bank's Financial Statements.)

Other Financials
Capital One was tucked in among the group of big banks, including Citigroup (NYSE:C), JP Morgan Chase (NYSE:JPM), Bank of America (NYSE:BAC) and Wells Fargo (NYSE:WFC), which are reporting earnings this week and next. While the market was bracing for potentially mediocre earnings from the big name banks, Capital One has managed to mine its credit card niche well. The credit card business was a nightmare during and after the recession, as consumers were pressured on all sides by unemployment, falling housing values and credit constraints, yet Capital One was able to survive and move forward in what is a more narrowly focused and less diverse business model than the larger banks.

Adding ING
Capital One is not strictly limited to the credit card business, as it does the usual consumer lending for autos and homes, as well as commercial lending. However, its fate rises and falls with its credit card portfolio. Its acquisition of ING Direct's US online banking operation for $9 billion will be partially financed by a $2 billion stock offering. The company feels this acquisition will be a game changer, as it allows entry into a turnkey franchise with potential growth. Although online banking is getting more crowded with other banks, the acquisition should provide synergy for Capital One with its heavy dose of consumers as its customer base. Capital One is also remaining highly visible. Its spending on marketing and advertising, including its oft-seen TV commercials, reached $329 million in the second quarter.

Capital One Stock
Investors might argue that none of the financials are the place to be right now. Although the market didn't like Capital One's report, likely due to the stock offering, its share price was trading at around $51, less than 10% off its 52-week high. The ING integration will be no slam dunk, but think back to the depths of the recession when the credit card business looked like the worse possible place to be. Now the credit card business is a good place to be - if you execute it like Capital One does. (If you are interested in how banking has changed over time, check out The Evolution Of Banking.)

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