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We have retained our Neutral recommendation on Capital One Financial Corp. (COF - Analyst Report) following the detailed analysis of its first-quarter 2012 earnings results. Further, the acquisition of HSBC Holdings plc’s U.S. credit card business strengthened our view. This buyout is expected to enhance the company’s position in terms of deposits and assets, as well as be significantly accretive to its financials.
In May 2012, Capital One closed the HSBC Holdings Plc’s U.S. credit card business deal, which was announced in August 2011. The company paid $31.3 billion in cash, including $2.5 billion premium for credit card receivables acquired, to HSBC. Following the acquisition, the company assumed $28.2 billion of credit card receivables and $0.6 billion in other net assets.
This acquisition is a strategic fit for the company as HSBC’s U.S. credit card business has a proven track record. In addition to this, HSBC generates more than half of its revenue from credit cards. This deal will definitely improve Capital One’s credit card franchise.
Moreover, Capital One reported first-quarter 2012 earnings from continuing operations of $1.56 per share, substantially outpacing the Zacks Consensus Estimate of $1.40. This also compared favorably with 88 cents earned in the prior quarter and $2.21 recorded in the year-ago quarter.
Considering the impact of a bargain purchase gain related to the ING Direct USA acquisition, Capital One reported net income of $1.4 billion or $2.72 per share in the reported quarter. The company also completed the acquisition of ING Direct, online banking unit of Amsterdam-based ING Groep NV (ING - Snapshot Report), during the quarter. This acquisition is accretive to the company’s first-quarter results.
Higher net interest and fee income were major contributors to the better-than-expected results. This was further augmented by the ING Direct acquisition, which positively impacted the company’s financials. However, higher operating expenses slightly marred its earnings. Moreover, during the quarter, credit quality exhibited significant improvement; however capital and profitability ratios remained stable.
On the flip side, increasing non-interest expense remains a key concern at this point. Though expense management initiatives have significantly helped Capital One to offset higher credit losses in the last few years, non-interest expense has been continuously increasing. Operating expenses declined sequentially in the first quarter, but it was up on a year-over-year basis. We expect the integration of current acquisitions and the company’s focus on organic growth through improved loan portfolio and enhanced client base, will keep non-interest expense elevated through 2012.
Recently, the Federal Reserve unveiled a series of capital proposals with an aim to ensure that the U.S. banks maintain a solid capital position and become resilient in stressful times. As per the proposals, the banks would be required to maintain a total tier 1 ratio of 7%, which is well above the current requirement of about 2%. Although Capital One has a strong liquidity position and expects to meet these stringent requirements, it will be less flexible with respect to business investments and lending volumes.
We believe that the risk-reward profile of Capital One is currently balanced; hence, we have reiterated our Neutral recommendation on its shares. Capital One currently retains its Zacks #3 Rank, which translates into a short-term ‘Hold’ rating.