Capital One (COF) Posts a 90% Drop in Profits Due to Increased Loan Reserves

Shares of Capital One Financial (COF: Charts, News) slumped this week after the bank reported that its second quarter profit plunged 90%, from $1.97 per share in the prior year quarter to 16 cents per share, due to an acquisition that forced it to massively increase its loan-loss reserves.

Analysts had forecast the bank to earn $1.46 per share. Meanwhile, revenue rose 27% to $5.06 billion, exceeding analyst estimates. Daily Chart
Over the past seven years, CEO Richard Fairbank has spent over $28 billion on diverse acquisitions, all aimed at expanding beyond the bank's credit card business, which comprises over half of the bank's revenue. These purchases include the 2012 acquisition of ING Direct USA and HSBC Holdings' U.S. card business. The acquisition of HSBC loans triggered the large increase in loan loss reserves that nearly canceled out its earnings per share this quarter. CFO Gary Perlin had warned about this on June 13. "This expense should consume most or all of one quarter's normal income," he stated. During the quarter, the bank's loan loss provision increased to $1.7 billion, with $1.2 billion allocated towards the HSBC loans. Capital One acquired a total of $27.6 billion in loans from HSBC. Fairbanks assured investors regarding the bank's initially alarming numbers. "While second-quarter results reflect significant purchase accounting impacts and other items," he commented, "the strong underlying performance of our businesses continues to demonstrate that we're well positioned to deliver sustained shareholder value." Through these acquisitions, Capital One has become the sixth-largest U.S. commercial bank by deposits. While the bank's stock has held up well compared to its industry peers, shedding 27% over the past five years, new regulatory measures in the United States threaten to end the stock's 30% year-to-date rally. On Wednesday, Capital One agreed to pay $210 million in a settlement alleging that the bank's third party vendors had engaged in the deceptive marketing of credit card "add-on" products, such as credit monitoring and payment protection, in order to boost its revenue. Capital One agreed to refund between $140 million to $150 million to 2 million affected customers, as well as $60 million in penalties to the Consumer Financial Protection Bureau and the Office of the Comptroller of Currency. Since becoming aware of the vendors' misconduct in late 2011, Capital One has been anticipating the charges, and already set aside $75 million last quarter for a possible settlement. This quarter, it set aside an additional $41 million. The bank has stated that it did not acknowledge the $24 million in revenue gained from these "add-on" products in its second quarter earnings. "We are accountable for the actions that vendors take on our behalf,' stated Ryan Schneider, president of the card business. "These marketing calls were inconsistent with the explicit instructions we provided to agents for how these products should be sold." However, that $210 million settlement may only be the tip of the iceberg for Capital One. Last week, Capital One, Visa V, Mastercard MA, and other financial firms agreed to a final settlement of a seven-year old price-fixing case regarding card-swipe fees. High card swipe fees - a primary source of revenue for credit card companies - have often been seen as detrimental to merchants. Merchants have attempted to fight back with higher surcharges for different credit card companies, to limited success. Morgan Stanley analysts believe that these charges, which have yet to be determined, could cut the bank's annual EPS by as much as 8%. During the second quarter, its core credit card business posted flat growth, while auto loans rose 7% and commercial-banking loans increased by 3%. However, total deposits slid $2.6 billion from the previous quarter. As with other banks, net interest margin is being squeezed by record low interest rates, dropping 0.16 percentage points to 6.04%. Shares of Capital One trade a 9 times forward earnings with a 5-year PEG ratio of 0.98. The bank pays a quarterly dividend of 5 cents per share, an anemic 0.36% yield at current prices. Other News About COF Consumer Agency Fines Capital One For Card Marketing Capital One's massive credit card arm gets hit by a big settlement. Capital One Profit Plunges on Higher Provisions Capital One's bottom line slides 90%. Other Stocks in the News American Express Revenue Misses On Weaker Spending American Express earnings show weak consumer sentiment. GM Pension Fund to Sell Private Equity Assets to China - Report GM finally resolves its pension problem with an unusual solution. Copyright 2012 by, Inc. InvestorGuide has no control over the sites we link to, is not affiliated with these sites, and cannot take responsibility for their quality or suitability. The news, analysis, commentary and profile information is not meant to be comprehensive, and the data provided is not guaranteed to be accurate. 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Published on Jul 20, 2012
By Leo Sun
Leo Sun
Leo Sun is a freelance finance writer and position trader. He focuses on a combination of value and momentum investing, with a strong interest in the trading philosophies of Warren Buffett and Peter Lynch. Leo also has experience writing articles to help small business owners acquire loans and manage their finances. He regularly contributes to the Stock of the Day analysis.

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