One of the most important things when it comes to evaluating a bank stock is its deposit base. Good banks have low-cost deposit bases and customers that don't leave the bank at the first sign of higher yield elsewhere. Low-cost deposits are a cheap source of funding banks can use to fund loans or buy bonds and make money on the spread.
While they may not be thought of as traditional banks, credit card companies like Capital One (COF 0.93%) do hold bank charters. But pure-play credit card lenders are rarely known for their strong deposit bases because they issue high-yielding loans, so deposit costs are less important than loan growth and managing credit quality.
Still, a credit card company with a very strong deposit base would be a deadly combo. While Capital One is not a league leader or anything in the banking industry, I've been impressed at how the bank has been building its deposit base. Here's why.
Dealing with the difficult environment
The best kind of deposits a bank can gather are non-interest-bearing deposits, which they would pay no interest on. Now, credit card lenders aren't really focused on those, but the goal is to grow core deposits that cost less than the Federal Reserve's overnight borrowing rate -- the federal funds rate -- and that reprice slower on the way up.
The federal funds rate ended 2022 inside a range of 4.25% and 4.50%. Capital One at the end of the year had $332 billion of deposits, more than $300 billion of which were in interest-bearing deposits in Q4. The average rate paid on all of these deposits in the fourth quarter was 1.82%. Now that's up significantly from 1% in the third quarter, but remember how much the Fed raised rates in Q4, and it's still well below the federal funds rate.
Another thing you can examine to assess a bank's deposit base is its deposit beta, which essentially looks at how much a bank will raise its deposit costs in response to a rise in the federal funds rate. Most banks are starting to see their betas climb more aggressively than in the past because the Fed has never done this many rate hikes in this short of a time period.
Capital One CFO Andrew Young said on the company's most recent earnings call that its company-wide beta in the fourth quarter was about 35%, which is pretty good. Young added that the ending beta for the company in the last rate-hiking cycle was 41%, although this time around it will likely exceed that.
Still, I like the fact that Capital One is really committed to organically improving its deposit base. CEO Richard Fairbank noted on its earnings call that the company has invested heavily in its digital capabilities so it can really provide an excellent bank account product. "Our growth story is not just about savings accounts, but it's very much about checking accounts as well," he added, referring to accounts associated with lower-cost deposits. The bank had success in the fourth quarter when looking at its interest-bearing deposit costs versus its peers.
| Company | Interest-Bearing Deposit Costs 9/30/22 | Interest-Bearing Deposit Costs 12/31/22 |
|---|---|---|
| Capital One | 1% | 1.82% |
| Ally Financial (ALLY 0.76%) | 1.58% | 2.53% |
| Discover Financial Services (DFS 0.27%) | 1.53% | 2.55% |
| Synchrony Financial (SYF 1.96%) | 1.66% | 2.52% |
| Citigroup (C 1.38%) | 1.21% | 2.10% |
Data source: Company financial statements
Hope for continued growth
I'm not here to tell you that Capital One has an elite deposit base per se or is even close to the likes of JPMorgan Chase or Bank of America, which have impressively accomplished gathering cheap consumer deposits on a massive scale.
But I do think the company has had success in building a good deposit base in a segment of banking that doesn't focus on deposits as much as traditional lenders. My hope is that Capital One continues to build a stronger low-cost deposit base because a good credit card lender with a great deposit base would drive a much higher valuation.
