It's been a rough few weeks for Capital One Financial (COF 0.16%). It's a credit card company as well as a bank, and both types of business have been under fire. Banks are struggling with liquidity, while creditors are dealing with rising delinquencies. It's no wonder Capital One's stock price is down more than 13% just since its July peak, and more than 40% below its 2021 high.
This weakness, however, is ultimately a buying opportunity for investors who understand Capital One's business and can see the bigger picture. The worst-case scenario is already priced in, and then some.
Capital One is under the microscope
Don't misunderstand. There are risks. Chief among them is the risk of the unknown. Capital One even acknowledges as much, choosing to not give credit-performance guidance with its most recent quarterly report. In the meantime, its 30-day delinquencies on credit card loans grew from 2.42% of the loan portfolio a year ago to 3.77% as of the end of last quarter, while charge-offs jumped from $845 million in the second quarter of 2022 to nearly $2.2 billion for the quarter ending in June. Capital One is also being required by the Federal Reserve to raise its so-called "stress capital" levels from 3.1% of assets to 4.8% following recently administered stress tests of the nation's biggest banks. The increase suggests the bank and credit card lender would have a tougher time handling economic turbulence than it would have a year ago.
It's possible, however, to be so distracted by the numbers that you end up losing sight of the non-quantifiable factors that work in a company's favor.
Chief among these overlooked bullish factors right now is the timing of Capital One's charge-offs versus its net recoveries on bad debt.
See, most lenders (and credit card lenders in particular) quickly follow up on charge-offs with partial recoveries by selling those soured loans to collection agencies. The full amount of these loans is never recouped, but these lenders get these bad loans off their books and out of the way.
Capital One does things a bit differently. As CEO Rich Fairbank explained during Q2's earnings call:
There is one effect that is increasing our loss rate that is probably more pronounced for Capital One, at least for a time, which is related to our recovery. Past charge-offs are the raw material for future recoveries, and we just lived through three years of very low charge-offs. So, our recoveries will be unusually low in the short to medium term. This is a larger headwind for us than for most others because we tend to have meaningfully higher recovery rates than the industry average and because we tend to work our own recoveries, so they tend to come in over time, not all at once, which happens in a debt sale.
In other words, this company seemingly isn't offsetting rising charge-offs with rising recoveries, and likely won't be able to anytime soon. It will ultimately recover more of its rising charge-offs than other credit card lenders, however, further down the road.
Another key factor dialing back Capital One shareholders' overall risk is the company's recent efforts to shed what could become problematic loans to businesses looking for office space. One of these deals took shape just a few days ago, in fact, with Capital One selling $1 billion worth of office loans to Fortress Investment Group in mid-August.
Also note that even though the bank is touting the sell-off as their effort to dial back risk, Capital One is also tightening its lending standards in adjustment to the changing quality of the credit market, but not pointing that fact out.
Patience will eventually pay off
Capital One isn't wholly immune to the predictable fallout from the economic headwinds currently blowing. It's suffering losses on loans. The unrealized losses on the bonds it's holding to form its asset base are also forcing the bank to keep more of its cash protected rather than put to work in the form of riskier loans.
With shares priced at less than 9 times this year's expected per-share earnings of $11.67, though -- and priced at less than 8 times next year's projected per-share profits of $13.40 -- the market's mostly ignoring the measures this bank has been taking (and continues taking) to defend itself from this tricky economic environment.
To this end, the analyst community is calling for healthy sales and earnings growth at least through 2025. Once it becomes clear Capital One isn't in quite the dire straits it's presumed to be in, don't be shocked to see the stock start perking up again.
