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Capital One Gains from Acquisitions

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Capital One Financial Corp.’s (COF - Free Report) third quarter 2012 earnings of $2.01 per share significantly surpassed the Zacks Consensus Estimate of $1.75. Also, this substantially outpaced the prior-quarter earnings of 16 cents.

Results improved on the back of augmented revenue, which was driven by the full quarter impact of the acquisitions of HSBC Holdings plc’s credit card business and ING Direct USA – online banking unit of ING Groep NV (ING - Free Report) . Further, lower operating costs and robust profitability as well as capital ratios were the highlights of the quarter. Yet, substantial deterioration in the asset quality was the primary dampener.

Net income from continuing operations came in at $1.19 billion or $2.03 per share compared with $193 million or 33 cents per share in the prior quarter.

Performance in Detail

Capital One’s total revenue for the reported quarter stood at $5.78 billion, jumping 14.4% sequentially. The surge was largely due to the full-quarter impact of the HSBC credit card loans acquired in the second quarter and a lower non-principal reserve build. Moreover, total revenue was above the Zacks Consensus Estimate of $5.54 billion.

Net interest income for the quarter grew 16.4% from the previous quarter to $4.64 billion. Likewise, net interest margin in the quarter increased 93 basis points (bps) sequentially to 6.97%.

Non-interest income surged 7.8% from $1.05 million in the prior quarter to $1.14 billion in the reported quarter. The increase was mainly due to the full-quarter impact of the HSBC credit card acquisition.

Capital One’s operating expenses declined 3.1% sequentially to $3.05 billion. The fall was largely attributable to a decrease in charges for legal and regulatory matters as well as lower merger-related and marketing expenses, partially offset by the full-quarter impact of the HSBC credit card acquisition.

The managed efficiency ratio improved to 52.66% from 62.16% in the prior quarter. The fall in efficiency ratio indicates improvement in profitability.

Credit Quality

Capital One’s credit quality showed considerable deterioration during the reported quarter. Net charge-off rate rose 22 bps from 1.53% in the prior quarter to 1.75%. Similarly, the 30-plus day performing delinquency rate increased 48 bps sequentially to 2.54%. Moreover, allowance, as a percentage of reported loans held for investment, came in at 2.54%, up 7 bps from 2.47% in the previous quarter.

However, provision for credit losses decreased 39.5% sequentially to $1.01 billion. The decline was driven by a significantly lower HSBC-related allowance build.

Capital and Profitability Ratios

Capital One’s capital and profitability ratios continued to elevate during the quarter. Tangible common equity (TCE) ratio for the reported quarter was 8.2%, up from 7.4% in the prior quarter.

As of September 30, 2012, return on average assets stood at 1.60% compared with 0.26% in the last quarter. Similarly, return on average common equity improved to 12.33% in the reported quarter from 2.06% in the previous quarter.

As of September 30, 2012, tier 1 risk-based capital ratio came in at 12.7% improving from 11.6% as of June 30, 2012. The company’s tangible book value per share was $40.17 as of September 30, 2012 compared with $35.67 as of June 30, 2012.

Our Viewpoint

We anticipate continued synergies from Capital One’s geographic diversification and the two major recent acquisitions. Moreover, the resilience shown by almost all its businesses will continue to support its financials. Nevertheless, in the near term, exposures to commercial real estate, weak demand for loans and the impact of new financial regulations are expected to marginally dent the results.

Capital One currently retains a Zacks #3 Rank, which translates into a short-term Hold rating. Considering the fundamentals, we also maintain a long term ‘Neutral’ recommendation on the shares.

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