Capital One Earnings: Deteriorating Credit Results a Headwind as Firm Builds Reserves

Narrow-moat-rated Capital One COF reported weaker-than-expected first-quarter results as higher-than-anticipated credit provisioning and net interest margin contraction compressed the bank’s bottom line. Net revenue increased 8.9% year over year, but was down 1.5% sequentially, to $8.9 billion. Earnings per share decreased 59% year over year, and 24% quarter over quarter, to $2.31, which translates to a return on tangible equity of 10.15%. The decrease in earnings was primarily due to higher credit provisioning as the bank built up $1.1 billion in reserves.

While first-quarter earnings were weaker than we had anticipated, our thesis behind Capital One has not fundamentally changed as a result. As we incorporate these results, we do not plan to materially alter our $140 fair value estimate.

Capital One’s net interest income increased 12% year over year but was effectively flat sequentially at $7.2 billion, with the annual increase primarily due to loan growth. The loan growth was driven by its credit card business, as the company has become more conservative with underwriting in its auto loan and commercial lending segments. Average credit card receivables increased 21% from last year, compared with the bank’s commercial loans, which grew 12% year over year, and its auto loans, which were flat year over year. Capital One did see its net interest income margin fall 0.24% from last quarter to 6.6% as funding costs rose and the bank’s average cash balance increased 42% to $37 billion.

Net charge-offs continued to increase during the quarter, with firmwide defaults rising to 2.21% of average loans from 1.86% last quarter and 1.11% last year. The bank’s credit cards led the way, with net charge-offs rising to 4.06%, although this is still slightly below the bank’s historical average. On a more positive note, net charge-offs in the bank’s auto lending segment improved sequentially during the quarter, falling to 1.56% from 1.73% last quarter.