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On Apr 25, 2013, we upgraded our recommendation on Capital One Financial Corp. (COF - Analyst Report) to Neutral from Underperform. Our decision rests on Capital One’s better-than-expected first quarter earnings. However, rising expenses and weak demand for loans are causes of concern.

Why the Upgrade?

Capital One’s first-quarter 2013 earnings of $1.79 per share came in nearly 27% above the prior-quarter earnings of $1.41. The results benefited from a decline in operating expenses, partially offset by lower top line. Moreover, strong profitability and capital ratios as well as continued improvement in asset quality were the other highlights for the quarter.

The Zacks Consensus Estimate for 2013 has gone up 0.6% to $6.53 per share and it inched up just 0.1% to $6.73 per share for 2014. With the Zacks Consensus Estimates for both 2013 and 2014 modestly going up, Capital One currently carries a Zacks Rank #3 (Hold).

The Federal Reserve’s approval of Capital One’s capital plan under the Comprehensive Capital Analysis and Review (CCAR) for a 500% hike in its dividend to $0.30 per share further endorses the company’s strong capital position. Further, Capital One’s geographically diversified loan portfolio, acquisition spree and solid credit card businesses are expected to improve its financials going forward.

However, increased operating expenses, immense pressure on credit quality and stringent capital, liquidity and leverage ratio requirements under the financial reform law are expected to restrict Capital One’s ability to pursue business opportunities.

Other Stocks to Consider

Banking stocks that are performing better than Capital One and worth a look include State Street Corp. (STT - Analyst Report), Fifth Third Bancorp (FITB - Analyst Report) and Credit Acceptance Corp. (CACC - Snapshot Report). All these carry a Zacks Rank #2 (Buy).

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