Banks and other financial institutions are feeling the heat these days as interest rates have fallen, the direction of the economy is uncertain, and people who are out of work may not be able to pay on their loans.

But this isn't the first time this country has dealt with economic fallout, and since the last crisis in 2008-09, banks have worked to be more prepared for events much like the current COVID-19 pandemic and its economic fallout.

Capital One Financial (NYSE:COF) is a somewhat smaller outfit than big bank rivals such as JPMorgan Chase and Bank of America in terms of assets under management. But it has a differentiated approach to banking and is growing. How is it doing during the downturn, and is Capital One Financial a stock that investors should consider?

A couple meets a financial planner at a bank.

Image source: Getty images.

A bank with a vision

Capital One claims it is the fifth-largest U.S. consumer bank for deposits and the eighth-largest U.S. bank overall. It's fairly new on the scene, having been spun off as its own public company from Signet Financial (now part of Wells Fargo) in 1994 to be a monoline bank specializing in credit cards. Its existence was predicated on an information-based strategy to get the most benefit from technological advances being made at the time with regard to credit card transactions and management. It was the first major bank to sign onto the cloud with Amazon Web Services and it invested in strong infrastructure to support its customer-oriented products and services. 

Other than its large credit card segment, which accounts for 64% of total revenue, Capital One also now operates a consumer bank, a large auto loan division, a suite of small business services, and a smaller commercial banking division. Most of its earnings come from the interest it charges on credit card balances and loans, and it targets average working Americans.

Working from a place of strength

In the first quarter (which ended March 31) Capital One reported a $1.3 billion loss and a loss per share of $3.10. As with other banks, it was required to set aside a percentage of its funds to manage provisions for potential losses in light of the current economic atmosphere. Pre-provision earnings increased 8% to $3.5 billion, which is pretty healthy considering the situation. The bank put aside $5.4 billion, up from $1.8 billion at the end of the 2019 fourth quarter. That's a fairly high increase compared to other banks.

CFO Richard Scott Blackley talked about how the bank used a lot of modeling in figuring that number, particularly weighted to account for a projected 9.5% U.S. unemployment rate in the second quarter, which at the time must have seemed very high. Whether it was the company's large credit card segment that justified the huge increase, or just the company's overall conservative approach to handling its money, it was the right call. By the time the earnings report came out, unemployment had already spiked to 11% and is currently at 14.7% (with projections of even higher rates in the coming months).

First-quarter purchase volume on its credit cards increased 8% year over year, starting out high and then fell, decreasing at the end of the quarter by around 30% when customers were asked to maintain stay-at-home restrictions. April saw a similar decline. Those declines showed up in travel and entertainment categories as well as discretionary retail, which was in line with retail trends during the period. They were partially offset by increases in supermarket and discount, also in line with how consumers are shopping these days.

In terms of credit card delinquency, the effects of the pandemic were not yet seen in the quarter, outside of the bank's decision to build up provisions for losses and cash reserves.

Ending deposits in the consumer bank were up 6% year over year, which is similar to other large U.S. banks. Capital One is in a fine position in terms of liquidity, with reserves of $105.9 billion as of March 31, including $24.9 billion cash and cash equivalents. 

Making the right choices in good times and bad

Capital One is in a good place because of the disciplined decisions it makes during normal times. "We've also been obsessed with resilience in our choices of businesses and segments and in all of our underwriting decisions in good times and bad," CEO Richard Fairbank explained in the first-quarter conference call. The company came into being with one business (credit cards) and has branched into other segments, rounding out its product line and decreasing its overall risk for times exactly like this.

The company performed well during the financial crisis in 2008-09 and is now stronger in many ways. First, it has a stronger cash position. To deal with the increased risk of credit card defaults, it has either completely closed or scaled-down what it calls "less resilient" segments. And it has increased its positions in divisions that generate non-credit revenue.

However, Fairbank made an interesting point when he said that during the last recession, the economy was in better shape in general and card debt was the big issue. Now, Capital One is more diversified and the economy's in worse shape as companies build up greater debt. Credit cards still make up the lion's share of the bank's earnings, so he sees this as an advantage. But being diversified in general gives Capital One some cushion from any one segment pulling down the whole. Then again, if the economy tanks, banks will have trouble all around.

Capital One is a growth-oriented company whose youth and tech focus are a big plus. While it has the risks of credit card default, it has mitigated that by diversifying through other products. The share price is down about 32% year to date and is likely to remain volatile until the economy picks up. But the stock has been slowly rising since bottoming out in mid-April, rising more than 80% from its 52-week low set in late March. While the banking sector as a whole has seen greater losses than other industries and remains risky, investors might want to take a small position before the price rises further and add shares as the bank demonstrates greater strength and shows it is managing the crisis well.