Capital One's Revenues Shine

| About: Capital One (COF)
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Capital One Financial Corp.’s (NYSE:COF) first quarter earnings from continuing operations of $1.58 per share were substantially better than the Zacks Consensus Estimate of 59 cents. This also compares favorably to a net loss of 38 cents in the year-ago period.

Results for the quarter benefited over the prior-year quarter primarily from increased revenues and lower provision for loan losses. Also, resilience and strong profitability of almost all of its businesses has acted as positive catalysts in this downturn and credit turmoil. However, an increase in operating expenses was the downside.

Excluding the loss from discontinued operations, Capital One’s GAAP net income came in at $336.3 million or $1.40 per share, compared to a net loss of $172.3 million or 44 cents in the earlier quarter.

Behind the Headlines

Total managed revenues for the quarter decreased 1.8% sequentially but improved 14.8% year-over-year to $4.3 billion as the increased margin was partially offset by a 2.9% decline in average loans.

Managed net interest margin (NIM) increased 20 basis points (bps) sequentially and 121 bps on a year-over-year basis to 7.10%. The sequential increase in NIM was driven by a 17-bp decrease in cost of funds and a 3-bp increase in loan yields.

Net interest income decreased 1.8% sequentially but improved 17.4% year-over-year to $3.2 billion. Non-interest income decreased 11.5% sequentially but improved 7.7% year-over-year to $1.1 billion.

Managed provision for loan losses decreased 20.0% sequentially and 30.7% year-over-year to $1.5 billion. The sequential decrease in managed provision for loan losses was driven by lower charge-offs and an allowance release of $566 million.

Capital One’s operating expenses for the reported quarter decreased 3.5% sequentially but increased 6.5% year-over-year to $1.7 billion. The managed efficiency ratio decreased to 43.07% from 43.85% in the prior quarter and 46.25% in the prior-year quarter.

Average total deposits for the quarter increased 2.6% over the prior quarter to $117.5 billion.

Questions Regarding Credit Quality

Capital One’s credit quality remained mixed during the quarter. Allowance as a percentage of reported loans held for investment increased 134 bps sequentially to 6.29%. Managed net charge-offs decreased 7.8% sequentially but increased 1.4% year-over-year to $2.0 billion. The net charge-off rate has improved 35 bps sequentially to 6.35%. The 30-plus day performing delinquency rate decreased 53 bps sequentially to 4.46%.

Evaluation of Capital and Profitability Ratios

Capital One’s tangible common equity (TCE) ratio for the quarter was 5.53%, down from the prior quarter level of 6.30%. The Tier 1 risk-based capital ratio decreased 300 bps relative to the prior quarter to an estimated 9.6%, and continues to stay above the regulatory well-capitalized minimum.

Tangible book value per share of common stock was $22.86 as of Mar 31, 2010, compared to $27.72 as of Dec 31, 2009 and $23.91 as of Mar 31, 2009.

We anticipate continued synergies from Capital One’s geographic diversification and expense management initiatives. The repayment of bailout money and the warrants sell-off by the Treasury augur well for investors as the company is now free from government intervention and pay restrictions. However, its commercial real estate exposure will remain a drag. We also believe the weakening demand for new loans and the pressure on credit quality will restrict earnings in the near future.

Comparison with Competitor

Rival card company American Express (NYSE:AXP) also reported its first quarter results concurrent with Capital One’s earnings release after the market closed on Apr 22, 2010. AmEx’s first-quarter earnings from continuing operations of 73 cents per share were 10 cents ahead of the Zacks Consensus Estimate. This also compares favorably with earnings of 32 cents in the prior-year quarter.