Is the Worst Over for Capital One Financial?

Capital One Financial (NYSE: COF) has struggled through net losses in the past two quarters. The COVID-19 pandemic has meant lower spending on the bank’s credit cards, high provision of credit losses due to recession-related economic hardships, and 0% interest rates — a triple whammy.

The bank’s stock price has taken a major hit, down about 32% this year. But the good news for investors is that it has gained almost 20% since its recent lows in July. You may be wondering if it is safe to go back in the water. Is the worst over for Capital One?

A man staring at a laptop with his hand on his face, looking stressed out.

Image source: Getty Images.

What’s in their wallet?

Capital One is the ninth-largest bank in the U.S., with $383 billion in assets under management as of June 30, and one of the four largest credit card issuers in the U.S. The credit card business is in fact Capital One’s primary source of revenue, making up roughly 64% of its income.

Credit card revenue was down about 8% to $4.2 billion in the second quarter year over year, due to the pandemic. Loan balances were down 4% to $107.3 billion, and purchase volumes were down 16% to $90.1 billion in the quarter. As would be expected during a recession, the declines were related to people cutting back on spending and paying down their balances. The company also cut back on marketing expenses to hold the line on spending, but it did have a negative effect on sales.

It also has smaller consumer and commercial banking businesses, both of which had revenue losses. Overall, revenue was down about 10%.

Overall, the company reported a net loss of $918 million in the second quarter, down from a $1.6 billion net gain a year ago. This follows a $1.3 billion loss in the first quarter of this year. The losses stem from a huge $4.2 billion allocation for credit losses, including a $2.7 billion reserve build. The reserve build allocated $1.7 billion for credit card losses, $668 million for auto loan losses, and $330 million for commercial loan losses. Overall, the provision for credit losses is 68% higher than the second quarter, and it follows a $5.4 billion allocation in the first quarter.

This provision is far more than competitors like Toronto-Dominion Bank, PNC Financial, and Goldman Sachs have set aside, mainly because credit card loans typically have higher default and delinquency rates than bank loans. This is due to the fact that people typically give credit card payments lower priority during hard times than mortgages, car payments, and other loans. 

The losses have forced Capital One to reduce its dividend from $0.40 per share to $0.10 per share in the third quarter.

From worse to bad

Capital One is well-capitalized to navigate the downturn, as its common equity tier 1 ratio — a measure of a bank’s ability to withstand shocks — rose slightly to 12.4% year over year in the second quarter. This is well above the Federal Reserve’s capital requirement of 10.1%. Its cash position is also strong, with $149 billion in cash, cash equivalents, and securities and a liquidity coverage ratio of 146%, well above the 100% baseline requirement.

Capital One’s profitability over the next few quarters is going to come down to the credit allowance, as it is hit harder than most competitors by this. And the credit allowance is tied to economic conditions, which are not expected to improve much.

S&P Global forecasts $1.3 trillion in credit losses in 2020, which is twice the amount in 2019. In 2021, the picture improves somewhat, but S&P still anticipates $800 billion in credit losses, up about 33% from 2019 levels.

So, has Capital One seen the worst of it? Probably, but conditions are still not great for banks or credit card issuers. It doesn’t look like there will be enough of an improvement over the short term to warrant a buy. The recovery for banks will take a bit longer, and you can find better stocks out there right now. 

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Dave Kovaleski has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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