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Bankstocks.com  Jul 27  Comment 
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The store credit card giant just encountered a major bump in the road to growth.


Capital One Financial Corp. (NYSE: COF) is a diversified financial services company and is one of the largest credit card companies in the United States. Established in 1988, Capital One emerged as a Fortune 500 company within a decade by aggressively growing its credit card service through analytical, data-centric approach that helped grab credit card market share and slash its costs. Following its success in the credit card market, it has branched out to become a major player in retail banking, auto finance, mortgage lending, and other financial services. The company generated $13.0 billion in revenue in 2009 with an operating margin of 2.46%.[1]

Business Overview

Established in 1995 as a credit card company, Capital One emerged as a diversified financial services Fortune 500 company within a decade by aggressively growing its credit card service into one of the largest in the nation. Following its success in the credit card market, it has branched out to become a major player in retail banking, auto finance, and other financial services.

Business & Financial Metrics

In 2009, COF realized a net income of $883.7 million on $13.0 billion in revenue. Total revenues decreased by 6.54% from 2008 in accord with a slowing global economy. Net interest income is Capital One's primary revenue driver, as net interest income accounted for $7.70 billion, or 61.3% of total revenue, in 2009. Non-interest income from sources like interchange and service charges totaled $5.29 billion for the same year. COF's net gain in 2009 represented a reversal from 2008, when the company lost $79.7 million.

Business Segments

Capital One has three segments: Credit Card, Commercial Banking, and Consumer Banking.

  • Credit Card: This segment includes COF's domestic consumer and small business card lending, domestic national small business lending, national closed end installment lending and international card lending businesses in Canada and the United Kingdom.
  • Commercial Banking: This segment includes operations related to lending, deposit gathering and treasury management services to commercial real estate and middle market customers. The Commercial Banking segment also includes the financial results of a national portfolio of small ticket commercial real estate loans.
  • Consumer Banking: This segment includes all branch-based lending and deposit-gathering activities for small business customers as well as COF's branch-based consumer deposit gathering and lending activities, national deposit gathering, consumer mortgage lending, servicing activities and national automobile lending.

Trends & Forces

Information-Based Strategy

Driving Capital One's success and efficiency has been its innovative "Information-Based Strategy" (IBS). With a wealth of data from its 50 million consumer and business accounts, Capital One analyzes its profitability down to the individual customer level and tracks the behavior of its customers in order to statistically analyze micro-segments of the consumer market.

Capital One has used IBS to great effect in the credit card division both in creating revenues and in cutting costs. Capital One has been able to innovate intelligently and rapidly by testing new marketing strategies on small groups before engaging in full-scale marketing. This approach allows the company to predict results of rolling out new products and rapidly scale up successful new promotion schemes before competitors have a chance to copy. IBS has also provided a high level of product customization. Capital One redefined the credit card industry in the 1990s with its personal pricing and credit line sizing, achieving low risk and default rates through personalized pricing. Setting price and line size for individual customers, Capital One took the most profitable business from competitors using aggregate pricing schemes and has consistently had the highest credit card profit margins among competitors.

Since IBS is one of the company's main competitive advantages, Capital One will continue to rely on it as the company expands into other financial territories. The success of IBS points to the existence of informational returns to scale in consumer lending, allowing large financial players to reap information-based efficiencies from market share consolidation.

Consumer Credit Quality

When customers do not pay their debts, credit card companies write off, or "charge off", the delinquent balances as operating losses. Card companies typically expect yearly loss rates of a few percentage points, and Capital One has an average 4% net charge-off rate. Consumer credit quality is cyclical and is highly correlated with economic performance indicators, especially unemployment and bankruptcy rates.

In the wake of August's U.S. mortgage market difficulties, in August 2007 Capital One announced that it is closing its mortgage lending segment,

Economies of Scale

The card industry is characterized by economies of scale. Fixed costs, like advertising and IT expenses, need to be spread over a wide base of customers. Once a card company hits critical mass, incremental returns can rise quickly. In addition, in an industry that relies on having a lot of information to price risk and decrease customer spending, having more accounts translates into an information advantage.

Interest Rates

Capital One borrows money at short-term rates and lends to its customers at a higher rate, profiting from the margin. Net interest income accounts for about 65% of Capital One’s total revenues. Capital One's revenues are not highly sensitive to interest rate changes. The company estimates that a 200 basis point change in interest rates will only affect total revenues by 2%.


Card companies owe their large profits in part to tactics that have been under widespread criticism. The industry has recently come under scrutiny for its employment of confusing billing practices buried in impenetrable fine print. For example, a single late payment may trigger a large rise in interest rates, and payments received on the due date may still incur a steep late fee if received after 4:00pm and even 12:00pm in some cases.

In January 2007 the U.S. Senate held hearings to determine whether or not to introduce legislation punishing card companies for preying on consumers, with executives from Bank of America (BAC), J P Morgan Chase (JPM), and Citigroup (C) on hand to defend industry practices. Capital One has recently declared that it is voluntarily simplifying its fee structure to avoid antagonizing customers as it makes building brand loyalty a priority.

On the other hand, legislation can also change the lending environment to credit card companies' advantage. A tightening of bankruptcy laws in late 2005 led to a temporary spike in bankruptcy rates due to early filing followed by a sustained lower level of bankruptcy rates, leading to a lower level of charge-offs across the industry. This one-time "shake-off" has been followed by a very gradual return to previous levels.

Real Estate Financing Substitution

During good real estate market performance, the "home equity effect" may reduce credit card revenues. Under these conditions consumers choose to refinance mortgages and borrow against home equity instead of higher-interest borrowing on plastic.


Capital One competes with credit card companies like American Express, and Discover. Capital One aims to beat its competitors in operational efficiency by maintaining lower net charge-off rates and higher returns on its credit card loans.


  1. COF 2009 10-K pg. 48  
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