The recent struggles in the banking industry have brought down the valuations of most bank stocks. That has created a lot of bargains in the sector, particularly among the larger players. But not all of these discounted banks are good buys. To be a bargain, there has to be some upside value.
Among the larger banks, there is one stock in particular that might not be the bargain it seems to be (at least not right now): Capital One Financial (COF -1.95%). While there could be some long-term value here, given the current environment, it might not be the best time to jump in. Here's why.
A dirt cheap valuation
Capital One Financial is the ninth-largest bank in the country with $472 billion in assets as of March 31. It is most familiar as one of the largest issuers of credit cards in the U.S. About 44%, or $137 billion, of its $309 billion in total loans last quarter was for credit cards.
The stock price is down about 6% year to date and is trading at about $87 per share. Over the past 12 months as of May 8, it has lost about 26% of its value. Currently, the stock has an extremely low price-to-earnings ratio of 6 and it is trading below book value, with a price-to-book ratio of 0.71.
That means that the stock price is lower than the value of its assets on the books. These are signs of a deeply discounted stock.
Historically, Capital One has been very cyclical, tied to the movements of the economy and markets. That is primarily because of its large concentration of credit card assets. When the economy is strong and markets are up, it typically outperforms the market -- more people are spending, unemployment is low, and credit quality is good.
But when the economy is weak or in a recession, and markets are down, Capital One typically trails the market because spending declines and delinquencies rise. Last year, for example, the stock was down about 35%, worse than the Nasdaq or S&P 500.
So, as we look ahead, there are some signs that there could be challenges for Capital One in the near term.
Deteriorating credit quality
Capital One released its first-quarter earnings a couple of weeks ago, and there were a few ominous signs. For one, credit quality is deteriorating, and net charge-offs and delinquencies rose year over year.
The net charge-off rate -- unpaid loans that have been charged off as losses -- jumped to 2.11%, up from 1.86% in the fourth quarter and 1.11% in the first quarter a year ago. Also, the 30-day delinquency rate for its credit card business jumped to 3.86%, from 3.46% in the fourth quarter and 2.38% a year ago.
According to research from TransUnion, serious credit card delinquencies are forecast to rise in 2023. This is likely due to expectations by many economists that there could be a recession, while unemployment is expected to tick up, partly as a result of aggressive interest rate hikes by the Federal Reserve.
Capital One may be more vulnerable to delinquencies compared to the other leading issuers, because it typically caters more to consumers with lower credit scores.
In the first quarter, Capital One allocated about $2.8 billion for credit losses, up from $2.4 billion in the fourth quarter and $677 million in the year-ago quarter. This trend should persist and lead to the company to set aside higher provisions for credit losses over the next few quarters, and that will take a further bite out of earnings.
Overall, Capital One is an extremely cheap stock, but as a company that could be more exposed to an economic downturn than other large banks, there are probably better bargain banks out there right now.
