Capital One Financial (COF)

COF insiders are dumping shares. Whether planned or not, insiders reduced their positions by 10% during the past few months. Keep in mind that this company announced, back in February, a massive buyback program planning to redeem 10% of the total market cap. This points to the obvious strategy of the company’s management to help keep shares artificially high as they are selling. Institutions have also had the same idea and have sold off over 23 million shares during the past 6 months, effectively reducing their positions by 7%.^[1]

1. ↑ http://finance.yahoo.com/q/it?s=COF

The report released on 12th April 2008, shows a 13% increase in charge-offs since December, 2007. Moreover, you should know this: Charge-offs decline during economic expansions. We are in a totally different market condition now. Also, write-offs PEAK just prior to an economic recovery. The latest 8-K reports charge-offs are 4.11% for managed and 5.46% for national lending (credit card segment notching up to 6.54%).

Question: Wasn’t 2003 the start of the recovery? Isn’t 2008 the beginning of the decline? With all respect, I believe you should revisit Econ 101. I will not get into the fact that there is a clear uptrend going on. (Chart courtesy of Capital One investor meeting March 2007.)

Moreover, The off-balance sheet item ($49B) has a default rate of 5.8% where the base portfolio is 3.26%. The grease that keeps the wheels turning for these companies is capital. In times when money is easily available, bank-card companies utilize their customer accounts to lend money to the credit card customers. As credit card balances rise, new capital is needed to meet the consumer demand.

In order to bring in fresh capital, brokers such as Lehman, JP Morgan and Goldman Sachs (GS) raise money through note, bond and stock offerings. What do banks do? Of course if they are publicly traded they have the ability to do the same as the brokers and other companies, yet a quieter and quicker maneuver is the bring in new deposits through higher yielding savings accounts. This also helps to bring up the reserve requirements for loans issued through credit card issues and direct loans.

The simple point shows that as customers continue to look for safer alternatives and margins are squeezed as delinquencies and defaults rise, banks that do a big business within the consumer credit card arena could be hit by both problems of limited capital available to loan and ceilings on the fees they can charge for those loans.

As unemployment and credit card delinquencies rise, card issuers are on the hot seat for imposing large late fees and slamming delinquent customers with huge interest rate increases.

Delinquencies are soaring throughout the industry in concert with unemployment, which reached a 25-year high of 8.5% in March. Charge-offs, which are loans that banks have given up on, increased to an average of 8.02% in February from 4.53% a year earlier, Bloomberg reported.

Capital One reported a $111.9 million first-quarter loss on higher reserves for soured loans on Wednesday. Bank of America reported a $1.8 billion first-quarter loss in its credit-card services unit.

Lenders have tried to protect themselves with late fees, tightening credit limits and closing accounts, angering both lawmakers and consumers.

The meeting came a day after a bill to curb credit card fees and limit penalties cleared a key panel in the House of Representatives

The legislation - called the Credit Cardholders’ Bill of Rights - stops credit card issuers from imposing arbitrary interest rate increases and penalties and halts onerous billing practices. A separate version of the bill is under review in the Senate.

Legislators have expressed outrage that many card issuers have received government bailout money under the Treasury’s Troubled Asset Relief Program, essentially paid for by the U.S. taxpayers who use the cards and are saddled with the high fees.

President Obama’s economic adviser, Lawrence Summers, last weekend accused the companies of enticing consumers with aggressive marketing campaigns and deceptive interest-rate terms, encouraging them to become "addicted" to credit.

The White House specifically wants any legislation to limit issuers’ ability to charge fees when customers exceed their credit limits. Obama’s chief of staff, Rahm Emanuel, recently told House Financial Services Chairman Barney Frank that Obama also wants card issuers to offer longer terms for introductory, low teaser rates. The administration also wants card companies to apply excess payments first to balances with the highest interest rates, and to tell customers how long it will take to pay off their balances if they only make minimum payments.

The banks are saying the proposed regulations will make matters worse by raising costs, restricting credit, and ultimately hurting borrowers more.

"If the government keeps changing rules, it may make it harder for consumers to get credit," Ken Clayton senior vice president of card policy at the American Bankers Association in Washington, told Bloomberg.

"It means less credit available to vast numbers of Americans at the very wrong time," he said.

American Express Co. (AXP) and Capital One Financial Corp. (COF) fell in trading yesterday (Tuesday) after they reported overdue loans and payments increased in January. American Express, the biggest U.S. credit-card company by purchases, said defaults on loans packaged into securities rose to 8.29% from 7%, while payments at least 30 days overdue climbed to 5.28% from 4.86% in December. Capital One said that defaults rose to 7.82% and late payments reached 5.02%, Bloomberg reported.

Rising unemployment bankruptcy rates will rise will result in higher net charge-offs and lower profits.

Although historically it has done well, fierce competition with banks for higher yielding loans in a flat yield curve environment coupled with declining credit card loan growth could stifle the U.S. Card segment.

1. With only a skeleton management staff from North Fork on hand to integrate the newly acquired banks and a risk of departure of key managers, Capital One may incur short-term integration costs and be forced to ignore its unsteady U.K. card division while its hands are tied.