According to Fitch Ratings, Capital One Financial's (COF) 2Q'12 earnings were noisy due to the June 2012 closing of the company's acquisition of HSBC's domestic card business. Because of purchase accounting, provisioning for the new receivables, and some other items, COF's 2Q'12 net income dropped to $92 million, or a 0.26% return on assets (ROA).
In 2Q'12 COF completed the HSBC acquisition noted above, which added approximately $32 billion of credit card receivables to COF's balance sheet. However, in the quarter, merger and purchase accounting costs were significant as COF increased its provision expense to $1.2 billion to build the reserve for the non-impaired HSBC loans as well as $133 million of merger related costs.
Additionally, COF was also impacted by various regulatory and legal settlements during the quarter. Specifically, the company had an additional $180 million of provision expense related to mortgage representation and warranty claims, $98 million of litigation reserve to cover its recent interchange settlement, $101 million of expenses related to settlement and remediation of its cross-selling litigation in its domestic card business, and an $82 million accrual related to UK PPI the latter of which jointly reduced revenue and increased expenses.
While Fitch would note that some of these expenses are one time in nature, others such as the representation and warranty expense have weighed on earnings for the last few quarters and may continue to do so going forward. Additionally, Fitch would also expect COF to continue to incur integration and merger related expenses over the remainder of the year as it continues to integrate HSBC's card business as well as ING Direct's deposit business into its operations. As such, Fitch expects earnings to remain noisy over the remainder of the year.
Absent the effects of the HSBC deal, COF's legacy loan growth was very modest as some growth in commercial loans and decent growth in auto-lending offset the continued run-off of mortgage loans, which COF had acquired with the closing of the ING Direct acquisition earlier in the year. Fitch expects continued mortgage loan run-off over the balance of the year, to be in part offset by potential growth in commercial and auto lending, the latter of which has remained relatively strong.
The company's overall net interest margin (NIM) dipped to 6.04% as lower asset yields in the domestic card business related to purchase accounting more than offset improved funding costs from a full quarter's impact of ING's Direct deposit business in COF's total results.
COF's credit quality has remained reasonably good. Net charge-off (NCO) rates declined across almost all loan categories, 30-day plus performing delinquencies rates and non-performing asset rates similarly declined among most loan categories, other than in auto lending were there was a modest up-tick in both. Fitch notes that COF's domestic credit card asset quality is nearing a cyclical low, and would expect this to increase to more normalized levels over time, particularly as the HSBC business, including its private label cards, are brought into the fold.
The company's Tier 1 common ratio was 9.9% as of 1Q12, which was within Fitch's expectations. Fitch would expect COF to continue to build capital over the remainder of the year.
Additional information is available at www.fitchratings.com.
Justin Fuller, CFA, +1-312-368-5472
70 W. Madison Street
Chicago, IL 60602
Meghan Neenan, CFA, +1-212-908-1221
Brian Bertsch, +1-212-908-0549