Capital One’s third quarter earnings were relatively good as the company delivered a 1.43% return on average assets (ROAA), up from the sequential quarter which was impacted by a large restructuring charge, but down 8 basis points from the year-ago quarter.
Fitch Ratings notes similarly, return on average equity (ROAE) was 9.54% for 3Q15, up from 7.30% sequentially, but down from 10.12% year over year. While Fitch considers this a good result, it is also below our range of estimates for the company’s long-term cost of equity assumption.
It is noteworthy that this quarter also included a $69 million build of litigation reserves relative to the company’s U.K. Payment Protection Insurance (PPI) reserve. The build last quarter was $78 million.
For the industry, PPI insurance was supposed to cover a consumer’s debt payments if they were not employed, but in many cases these policies were alleged to have been mis-sold and are now creating a liability for the sellers.
COF’s total net revenue expanded 4% sequentially and 5% from the year over year. This was the result of higher net interest income (NII) in 3Q15 relative to both periods, as non-interest income was flat relative to both periods.
The NII growth was due to higher loan balances, largely the result of growth in domestic credit card receivables, which grew 4% sequentially and 12% year over year.
As the company continues to run-off its legacy acquired mortgage loans, the growth in the higher yield card receivables noted above as well as one extra day in the quarter helped to push up the company’s net interest margin (NIM), which ticked up to 6.73% in 3Q15, versus 6.56% sequentially quarter and 6.69% year over year.
It is noteworthy that COF’s purchase volume was up strongly again, climbing 2% sequentially and 22% year over year. However, despite this strong purchase volume, net interchange fees were down 2% sequentially and only up 6% year over year.
Fitch believes much of the interchange generated from purchase volume continues to fund rewards programs. Across the industry the competition related to customer rewards programs remains high. Fitch believes that this dynamic helped keep non-interest income flat.
Overall non-interest expense was down 4% sequentially, but up 6% year over year. Given the revenue growth as well as the reasonably good expense management the efficiency ratio improved to 53.56% in 3Q15. While Fitch expects management to remain vigilant on expenses through the balance of the year and into 2016, we believe the efficiency ratio may modestly tick-up.
Overall provision expense was $1.09 billion, down 3% sequentially but up 10% year over year.
Compared to 2Q15, the story is mixed, with lower provisioning in credit cards due to still better-than-expected credit performance partially offset by higher provisioning in the company’s commercial portfolio, which has been impacted by weakness in COF’s taxi medallion portfolio and energy lending portfolio.
The growth in provision relative to a year ago was due to growth in overall card balances, growth in auto balances, and the modest credit deterioration in the commercial portfolios noted above.
Despite some of the issues in the commercial portfolio, overall credit metrics remain good with an overall net charge-off (NCO) rate of 2.96%. In addition, the commercial portfolio’s the non-performing loan rate was 0.87%, higher versus the year-ago period, but still a good result.
Fitch continues to believe that overall credit metrics for COF – as well as the rest of the industry – remain near a cyclical trough and would expect some reversion in credit metrics over time. Other than the aforementioned areas in COF’s commercial portfolio, we are also cautious on some eventual deterioration auto loans for COF as well as the rest of the industry.
COF’s liquidity position is good and continues to evolve. While deposit growth has begun to moderate, total deposits in 3Q15 still increased by 1% sequentially and 3% year over year.
The company’s loan-to-deposit ratio ticked up to 100%, which is higher than some peer institutions. During the quarter, COF used some wholesale funding as well as deposits to fund its loan growth. Over time, as COF continues to gather deposits, Fitch would expect this ratio to modestly improve (i.e. to decline).
Additionally, Fitch believes the company to be in early compliance with the Liquidity Coverage Ratio (LCR) as well.
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