We have reaffirmed our Neutral recommendation on Capital One Financial Corp. (COF) after a thorough review of its second-quarter 2011 earnings results and the upcoming acquisitions of ING Direct USA, the online banking unit of Amsterdam-based ING Groep NV (ING) and HSBC Holdings Plc’s (HBC) U.S. credit card business that would enhance the company’s position in terms of deposits and assets, as well as be significantly accretive to its financials.
Capital One’s second quarter earnings from continuing operations were substantially ahead of the Zacks Consensus Estimate. The results primarily improved due to increased revenues and a lower provision for loan losses ensuing from an improved credit performance. However, increase in operating expenses was the downside.
In August this year, Capital One announced a definitive agreement to acquire HSBC’s U.S. credit card business for $32.7 billion. The completion of the agreement would enhance the company’s card business and is likely to bring high teens GAAP as well as operating earnings per share for Capital One in 2013.
This acquisition is a strategic fit for the company as HSBC’s U.S. credit card business has a proven track record and generates more than half of its revenue from credit cards. The deal will definitely improve the credit card franchise of the company.
Earlier in June, Capital One had announced a deal to buy ING Direct USA in a stock-cum-cash transaction valued at $9.0 billion. The deal would catapult the company to the fifth position from the present eighth, in terms of deposits in the U.S.
At present the deal is facing hurdles from the Federal Reserve enquiry regarding the concerns that it would heighten the risks to the financial system of a new "too big to fail" institution. Yet the combined entity is expected to create a valuable banking franchise, which would reap benefits from a large number of banking branches in high-growth markets.
On the flip side, though there has been a substantial improvement in credit quality for Capital One over the last few quarters, we expect it to remain under pressure as the current state of the economy is expected to persist for a while.
Additionally, increasing non-interest expense remains a key concern at this point. Though expense management initiatives have significantly helped Capital One in offsetting higher credit losses in the last few years, non-interest expense has been continuously increasing. We expect increasing marketing opportunities to keep non-interest expense elevated through 2011.
Currently, Capital One retains a Zacks #3 Rank, which translates into a short-term Hold rating.
CAPITAL ONE FIN (COF): Free Stock Analysis Report
HSBC HOLDINGS (HBC): Free Stock Analysis Report
ING GROEP-ADR (ING): Free Stock Analysis Report
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