Capital One: Spoiling for a fight Once known as a subprime lender, the company wants to become a player in big banking. NEW YORK (CNNMoney.com) -- Capital One's chief executive Richard Fairbank has no qualms about going against the grain. During the last year, the 55-year-old executive has set his sights on transforming Capital One (Charts) from a well-known one-product credit card company into a diversified banking firm, ready to take on the larger banks even as competition heats up. It's a gutsy strategy and one that sets the company apart from its peers. Both MBNA and Providian, faced with stagnant growth prospects in the mature credit card industry, agreed to forgo independence last year in order to join large banks. Bank of America (Charts) acquired MBNA while Providian was snapped up by Washington Mutual (Charts) in 2005. But Capital One took the contrarian approach. Rather than become a takeover candidate - despite rampant speculation that Wachovia (Charts) was eyeing the company - Capital One became the acquirer. It purchased New Orleans-based Hibernia Corp. for $5.3 billion and most recently entered an agreement with New York-based North Fork to the buy the bank in a $14.6 billion deal. The stock has been trading in a narrow range since last year, up only 5 percent year-over-year and actually down 0.6 percent year-to-date, as investors remain cautious about Capital One's ability to execute well on the acquisitions. But with those acquisitions, analysts say Capital One is successfully reinventing itself as a broad-based financial institution, in the unique position of leveraging its strong brand name in credit cards into other areas of banking. The "What's in your wallet?" effect Call it the "What's in your wallet?" effect, after its heavy-saturation TV ad tag line. "Capital One recognizes that it's in a mature business and there's only so much more they can out of the credit card business," said Alenka Grealish, manager of the banking group and independent research and consulting firm Celent LLC. "But they have a name that's widely recognized and they've got this great platform that they can use to sell other financial products." Grealish said while Capital One relied on direct mail marketing to entice credit card consumers nationally, that strategy doesn't work as well for a company that's trying to sell mortgages or other lending products. For those needs, consumers tend to want a face-to-face relationship with an adviser. And banks need a more solid technological platform - an area Capital One excels in - to process those requests. By acquiring localized banks with branches in attractive markets such as Texas and New York, Capital One gained access to a loyal consumer base that has a direct, personalized relationship with its bankers - making it easier for Capital One to sell clients on not only its credit cards but any other lending or financial products it chooses to offer. And that localized mind set, combined with Capital One's strong technology, is exactly how Fairbank hopes to compete with larger bank entities that dwarf the company in terms of funding and scale. "If you look at the market share performance of big banks in local markets...in general the banks are systematically losing share by virtue of being out-executed in local businesses," Fairbank said at a recent industry conference. "The power of putting together a national-scale lending business with an inherently local-scale banking business is a really fantastic combination." Gaining low-cost deposits Embracing a retail bank system also provides Capital One with coveted low-cost deposits - a cheap and stable source of funds the company can use to support its lending operations. In an increasingly competitive market, having immediate access to billions of dollars in deposits is a win for the company. Hibernia provided $13 billion in deposits and North Fork - assuming the acquisition is approved by shareholders next month - would make $60 billion in deposits available to Capital One. And moving away from credit cards along also provides the company with a liquidity cushion in what's expected to be a tougher credit environment going forward, said David Hendler, analyst at CreditSights. Credit quality has been unusually benign in recent months due to the impact of last year's bankruptcy laws, which made it harder for people to file for bankruptcy. But Wall Street expects a shift down the road that could result in a spike in credit losses as more consumers default on loans. For that reason, Capital One's diversification strategy allows the company to hedge any weakness in its credit card business. "They are no longer solely dependent on one or two products," Hendler said. The company's been slowly diversifying its operations beyond the acquisitions. Capital One is currently one of largest auto lenders in the country and is growing deposits through its high-yield online banking arm - a business that's attracting high profile players such as Citigroup (Charts). But that's not to say that the company is turning its back on its subprime credit card roots. Hendler said the company may "tiptoe around subprime" after regulators challenged its controls and credit-risk determination processes in 2002, but ultimately subprime is a high-yielding business. Bank of America, for instance, said on its second quarter earnings call Wednesday that it would consider entering the subprime market down the road. For Capital One, which has been a leader in that business, it wouldn't make sense to give up on it. Hendler said he expects the company may push subprime lending as it grows more low-cost deposits with which to fund that line of business. Analysts see some challenges Still, Capital One does face some challenges as it evolves. Craig Maurer, managing director at Soleil Securities, said the company now owns a substantial mortgage portfolio at a time when the mortgage industry is under pressure from higher interest rates. But, to its credit, the company's portfolio is still a small part of its overall business as compared to other banks. Capital One is expected to report its second quarter earnings after the closing bell Thursday. Analysts expect the company to report earnings of $2.06 a share, according to earnings tracker Thomson First Call. Maurer said the company could report earnings as high as $2.24 a share, due to continued strong credit performance. But he said Capital One's main challenge going forward will be achieving the strong returns Wall Street has come to expect as it works to integrate the acquisitions. The company posted return on equity of 24.1 percent in the first quarter and return on average assets of almost 4 percent. "People have high expectations from the company," Maurer said. "Meeting those expectations will be the main challenge for them." But Maurer sees plenty of upside in the stock, which investors might consider. He has a $106 price-target on Capital One, a 22 percent jump from current levels. --------------------------------------------------------------------------- |
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