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On Mar 6, 2013, we downgraded Capital One Financial Corp. (COF - Analyst Report) to Underperform based on the company’s lower-than-expected fourth quarter 2012 results and elevated operating expenses. Moreover, the company has delivered an average negative surprise of 15.1% over the past 4 quarters.

Why the Downgrade?

On Jan 17, Capital One’s announced its fourth quarter 2012 earnings of $1.41 per share, which substantially lagged the Zacks Consensus Estimate of $1.62. Further, net revenue for the reported quarter stood at $5.62 billion, below the Zacks Consensus Estimate of $5.78 billion.

Estimates over the past 60 days have also been declining with the Zacks Consensus Estimate for 2013 going down 5.6% to $6.61 per share. The Zacks Consensus Estimate for 2014 also declined significantly (down 7.3% to $6.85 per share). With the Zacks Consensus Estimates for both 2013 and 2014 going down, the company now has a Zacks Rank #5 (Strong Sell).

Causes of Concern

Increasing operating expenses remain a key concern for Capital One at this point. Though expense management initiatives have significantly helped the company offset higher credit losses in the last few years, operating expenses have been continuously mounting. In 2012, operating expenses rose roughly 28% from the previous year to $11.9 billion.

Further, stringent capital, liquidity and leverage ratio requirements under the financial reform law are expected to restrict Capital One’s ability to pursue business opportunities and further increase costs. Also, sluggish economic recovery remains a drag on its asset quality.

Stocks That Warrant a Look

While we prefer to avoid Capital One shares until we see signs of improvement in the company's performance, other financial institutions that are worth considering include – BankUnited, Inc. (BKU - Analyst Report), Fifth Third Bancorp (FITB - Analyst Report)and State Street Corporation (STT - Analyst Report).  BankUnited carries a Zacks Rank #1 (Strong Buy) whereas Fifth Third and State Street carry a Zacks Rank #2 (Buy).

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