Capital One remains optimistic
despite credit issues

As the effects of the US credit crisis continue to fan outwards
from the housing market, card issuer and consumer finance company
Capital One recently reported that its rate of net charge-offs on a
managed basis rose to 3.28 percent in October from 2.86 percent in
the third quarter of 2007. In response, Capital One boosted its
forecast for 2008 credit losses to between $4.9 billion and $5.5

Standard & Poor’s Ratings Services said it cut its rating on
Capital One Financial Corp to stable from positive in light of
recent developments. “The outlook revision reflects environmental
weakness and our expectations of deteriorating consumer performance
in the near to intermediate terms. This expectation is evidenced by
asset quality weakness in various consumer loan types across many
rated issuers,” said John K Bartko, a credit analyst with Standard
& Poor’s.

At an investor’s conference earlier this month, Capital One
remained optimistic that the company’s sound financial fundamentals
will allow it to bounce back and deliver strong results. However,
the management team remains aware of the risks inherent in the
current financial environment, particularly given Capital One’s
focus on card issuance to lower-income groups.

Spike in delinquency rates

Delinquency rates across the US cards industry rose more quickly
than initially expected in the third quarter. Capital One saw a
rise of over 1 percent between June and July this year, with about
half of this the result of a shift in business mix as well as the
effects of a billing change, according to Capital One’s chief risk
officer, Peter Schnall. Speaking at the investor’s conference, he
defined some of the key drivers behind this recent spike. “About a
third of the increase is simply due to normal seasonality, another
15 basis points is due to gradual changes in loan mix, as well as
the mix effects of the decline in prime revolver loan balances,” he
said. He also highlighted the impact of Capital One’s
implementation of the 25-day grace period, time between the
statement date and the due date which consumers have to settle
outstanding purchases.

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That still leaves a 20 basis point increase, which Schnall conceded
is due to other factors, including the pervasive degradation of
credit quality. “If you compared our delinquencies to competitors’,
you would see very similar trends. This doesn’t mean, however, that
we’re all seeing the same thing. For us, a piece of the increase
may be caused by highly profitable changes we made to fee and
pricing policies back in June,” he said.

Schnall noted that internal indicators at Capital One are generally
stable, as more customers are paying in full than in this period
last year, while roughly the same number are making the minimum
payment. “As far as our portfolio is concerned, the consumer is
still pretty healthy,” he concluded.

Loss expectations

Schnall also indicated that while the prior estimate of credit
losses of $4.9 billion in 2008 included normalising credit in the
card portfolio as well as a host of other factors which management
was aware of, the uncertainty in the current financial environment
made it more sensible to establish loss expectations that would
allow for both continued high delinquencies in the card business
and provide for further deterioration in the US housing

He was also quick to point out that delinquency deterioration has
been primarily concentrated within what he identifies as the ‘boom
and bust’ housing markets, most notably California and

To combat this, Capital One has tightened approval in these
challenged housing markets and limited credit line increases. The
company has also updated its credit models to reflect the changes
in the current environment. “One of the tricks of success is
keeping the models well tuned,” said Schnall. “We’ve pulled back
our least resilient programmes. We’ve reduced originations in parts
of each of our cards business segments, because we were not
comfortable with their returns, given our conservative underwriting

Capital One has reduced account attrition in its card base by 40
percent since 2002, and has significantly reduced its previous
reliance on 0 percent ‘teasers’ for customer acquisition by around
80 to 90 percent. The company is focused on purchase volume growth,
which should continue to grow more quickly than balances, resulting
in a reduction in outstanding loans in the fourth quarter of 2007.
Notably, Capital One has quadrupled the number of credit card
accounts sourced over the internet in the past two years, which
over time will produce higher returns on the company’s marketing