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As if you needed another reason to get short Capital One Financial (NYSE:COF). For purposes of this discussion, I am going to ignore the Credit Card portfolio and its accelerating delinquencies and charge offs. I am going to ignore the HELOCs. I am going to ignore the exposure to the collapsing UK housing market. I am going to ignore the Auto Finance portfolio, which is more than likely the next “shoe to drop”, to borrow CNBC's overused phrase. I hate to pile it on, but this should not be a $40 stock.

A quick history lesson for anyone not familiar with the history of Capital One, The Bank. Just before Katrina hit New Orleans in 2005, COF announced the agreement to purchase Hibernia Bank, a midsize commercial bank from Louisiana and Texas. I think COF's timing on the Hibernia deal is a good metaphor for their excursion into retail banking. In early 2006, COF announced the purchase of North Fork Bank (NFB), of Melville NY. NFB was the leading bank on Long Island in market share and was rapidly growing in the New York City market. NFB focused on growing deposits through its network of Private Bankers, many of whom focused on the NYC real estate market. NFB also owned Greenpoint Mortgage, a top-10 national mortgage lender based in California that specialized in Alt-A. Needless to say, Greenpoint was closed in late 2007.

Back to those Private Bankers... And the NYC real estate market... For a non-Money Center Bank, NFB was very successful with gathering deposits from Property Managers and Property Owners. The Private Bankers and Commercial Lenders were the driver behind that growth. Now, COF is losing these Relationship Managers to other local banks in a big way. Seven Private Banking teams left COF for Signature Bank (SPLY) alone in the last year. (see SBNY Q1 conference call transcript, pg 2 last sentennce and PR Newswire for more recent defections)

Now, looking at the last quarter's numbers, deposits grew 4.7B. On the surface, that is a pretty damn good number considering the conversion of the NFB branches to the Capital One Bank name recently. But, a big part of this 4.7B in deposit growth was hot money brought in by insanely high rates on CDs through the online direct bank. (5.35% as of today, Countrywide doesn't even have to pay that much). Unfortunately, Capital One Bank doesn't break out deposit or loans regionally on their 10Q. (I am not saying there is anything suspicious on the Q, it just makes our job a lot harder) Lower cost local banking deposits grew less than 1B. If you look at the northern franchise deposits (NFB) vs. the southern franchise deposits (Hibernia), I would bet that that the net 900M growth in deposits came from the commodity-rich Louisiana and Texas market, rather than the northern franchise with its headwinds in losing key relationship managers and a merger-related name change.

So, we have a bank that is:

  1. Losing relationship managers in NY. This is very bad.
  2. Geographically exposed to a recessionary NY economy.
  3. Geographically exposed to a commodity boom. (sounds good, but I don't think it is)
  4. Faces additional merger integration risk.

Going forward, Capital One Bank is stuck between a rock and a hard place. They are going to have to stem the tide of RM's leaving. That is going to be expensive. They are going to have to replace the RM's who left. That is going to be expensive. They have a NY economy that is suffering, partially due to the layoffs in the financial industry. The probability of a commodity bust is exponentially high, directly affecting the southern franchise. That could KILL credit metrics for the local banking segment and accelerate losses. The CEO sold a ton of stock in late May.

For these reasons, along with those in my first paragraph, I own a few put spreads on COF. Apparently I am in good company, someone went out and piled into the September and October puts, trading 6x open interest on Thursday according to Pete Najarian on Fast Money. I have no position in SBNY because of their exposure to CDOs, but if they get that cleaned up this quarter, SBNY could be a screaming buy.

Disclosure: Author holds a short position in COF and no position (currently) in SBNY. 

 

 

Source: Capital One: A Different Short Case