Capital One (COF 0.25%) is one of the biggest credit card lenders in the United States, and it focuses more on this type of lending than most of its commercial banking peers do. In this Fool Live video clip from our Nov. 16, 2020, Industry Focus show, host Jason Moser and Fool.com contributor Matt Frankel, CFP, discuss why the credit card business can be so attractive.
Matt Frankel: In Capital One's case, their deposit portfolio is enough to cover their entire lending operation. They have some higher-yield savings accounts, which let's face it, right now, still are not very high yield. I want say I read their average deposit, pay something about 0.8% right now. When you have that and you have a credit card that's charging 16%, the challenge is loaning credit cards to people or giving credit cards to people who are going to be able to pay them back.
Jason Moser: That's a good point. We're living in a time now where we've seen a lot of news recently with FICO scores. They've adjusted how those FICO scores are tallied and we've seen the average FICO score go up, which obviously opens up a bigger lending base, more people are able to get cards and access to lending.
Matt Frankel: It is. Some lenders are pumping the brakes on credit card lending right now, which is totally understandable given the uncertainty that's been going on. Most credit card lenders don't publish their specific approval guidelines. We want a 720 credit score and we want to see this much income and things like that. But in general, when times get tough, it becomes tougher to get a credit card where a lender might normally want like a 700 score, they might want to 740 now or something to that effect. So that could have a little bit to do with why Capital One's credit card portfolio has dropped a little bit. But their core competency is credit card lending. It's a riskier type of lending. Before the pandemic happened, the net charge-off rate in their loan portfolio was about 2.6%. That's elevated compared to other banks. Most are well under 1% in normal times. The credit card side of the portfolio was 4.3%. Meaning every $100 they loan out as credit card loans, they're not going to get back about $4.30 of it. But when you're making $15 on that $100 credit card loan, losing four dollars is a reasonable cost of doing business.
Jason Moser: Sure.
Matt Frankel: The problem is when you get the pandemic or recession or any tough times like we're seeing in 2020, when unemployment spikes, people run into trouble paying their debts and that 4.3% or 4% charge-off rate can easily spike to the double-digits. We saw this in the financial crisis where most credit card lenders had peaked default rates in the 10% to 12% range. That can make your profit margin disappear really quickly. It's a riskier form of lending, but it's higher profit when, one, it's done well, and two, when times are going well. It's a different animal. I mentioned that the net revenue margin was 15.8% on their credit card business. Net interest margin, that's after paying everything including losses and things like that. The net interest margin was almost 7% at the end of 2019. Most banks are happy with the net interest margin in the 3% ballpark. That's where Bank of America (BAC +0.02%) and JPMorgan Chase (JPM 0.26%) run. So Capital One is twice as profitable and that's not just their credit card business, that's the entire lending operations.
Jason Moser: Wow.
Matt Frankel: That's a pretty impressive cost advantage.
