Capital One Financial: The Latest Casualty of the Mortgage Crisis

Every week there seems to be another mortgage malaise casualty and this week it was Capital One Financial (COF).

From Reuters:

Capital One Financial Corp on Monday said it will eliminate 1,900 jobs and shut down a wholesale mortgage unit it acquired less than a year ago, as it struggles with the U.S. housing downturn.

The closure of GreenPoint Mortgage Inc. will result in an $860 million charge, or $2.15 per share, and Capital One slashed its 2007 earnings forecast. Shares fell in after-market trading but then rose as investors cheered the company's exit from an increasingly risky business.

[...]

"GreenPoint has run into unforeseen circumstances that are beyond its control," said Richard Fairbank, chairman and chief executive at Capital One.

The company now expects 2007 profit of $5.00 per share. The company had previously forecast earnings toward the low end of the range of $7.00 to $7.40 per share.

Based on the most recent data I could pull-up, Capital One’s TTM net earnings were about $2.4 billion, so the $860 million charge is equivalent to about 35.83% of its TTM net earnings. As we can see from COF’s slashing of its earnings forecast, the closure of GreenPoint Mortgage will decrease 2007’s forecasted earnings by about 1/3rd as well.

Before investors go rushing to Capital One’s shares expecting that the worse is over now that they’ve shuttered their subprime mortgage unit, I’d like to remind them of the following:

1) The “Rise” reported in the Reuter’s article was approximately $0.02

2) Since the beginning of the “mortgage crisis”, has there been a single lender that only released a single bit of bad news, OR has the pattern been that a single instance of bad news is nearly always followed by several more negative announcements? At the moment, I believe we’re only seeing the weakness in one subprime unit; Capital One offers ARMs, HELOCs and low documentation loans which could begin hurting earnings at any minute. After all, ARMs are hurting prime and subprime lenders, Alt-A lenders are dropping like flies and Countrywide reported problems with its prime HELOCs nearly a month before its current troubles surfaced.

3) Cutting your profit outlook for the year by 1/3rd is nothing to gloss over. Whilst COF has implemented various cost cutting initiatives that will help mute the impact of the charge, the decline in profit will undoubtedly hurt COF’s expansion efforts, in the form of buying regional banks as both a diversification tactic and as a source of cheap deposits.

4) Capital One is also a subprime credit card lender, and whilst they saw strong results from their credit card business last quarter, delinquencies are increasing.

5) Capital One has exposure to the subprime auto loan business and in its last quarterly report, noted a significant decrease in the profitability of its auto lending business as a whole (prime and subprime). Profits within the auto lending segment dropped by nearly 60% and the provision for lending losses increased by roughly 143%. During Q1 of last year, auto lending constituted 17% of net income and for the most recent quarter it constituted 5%. Now, COF’s other business units more than made up for the decline in auto lending, but it’s still a cause for concern. It’s also worth noting that Capital One securitizes a great deal of its subprime auto loans; considering the current state of the market, it’s safe to say that it’s going to be more expensive for that unit to operate, even if the profit declines and loan default trend were to reverse.

For now, I would maintain a “wait and see” outlook on Capital One as it has two additional subprime dominoes that could indeed fall, as well as possible weakness in its mortgage business overall. While I believe that COF will weather this storm, I think that the stock will become even cheaper in the next 3-6 months due to weakness in its credit card, auto lending and home lending businesses.

Disclosure: The Author doesn’t own a position in Capital One and hopes that disclosing this won’t cause the Huns from the COF commercials to come swooping down on him and force him to purchase the stock: “What’s in your portfolio?”