Capital One, which competes with American Express
Another issue is that the subprime meltdown is hurting Capital One's mortgage origination volume (down 13% to $6.8 billion) and the gains on sale margins it earns when it sells its loans in the secondary market. As a result, the company took some charges to reflect the lower value of the loans it holds, as well as increasing the reserve for loan repurchases. These factors contributed to the mortgage banking unit's $13 million loss for the quarter.
In Capital One's U.S. card segment, net income was down 18%, and charge-offs and delinquencies were up versus last year. Although it's easy to blame the usual culprits -- housing and subprime -- management said it believes that again, this is normalization due to the effects of bankruptcy regulation.
In addition to these issues, competition in the credit card industry has heated up. Capital One management remarked in the conference call that it was seeing competitors offer 0% teaser rates lasting more than a year on balance transfers. It was also seeing competitors offer to subprime borrowers rates that are usually only offered to prime borrowers. Management said that it won't match these competitors, instead choosing to sacrifice short-term growth and avoid future credit losses.
Despite all the current issues, I still like what I see at Capital One. For example, Capital One's mortgage originations had an average 715 FICO score and an average loan-to-value ratio of 75% -- indicating strong credit quality in originations. The worst is likely over, but even if it isn't, Capital One has probably more than adequately planned for the worst by strengthening the reserve. For the $12 billion in mortgages Capital One held for investment on its balance sheet, the average FICO score was 727 and the average LTV was 69%.
Although it's easy to understand why outsiders would be nervous about Capital One's credit quality, given the turmoil in the rest of the market, coupled with the credit normalizing taking place, I believe Capital One's conservative underwriting practices will prove to be solid. Furthermore, even at the lowered earnings guidance of $7 to $7.40 per share, Capital One is still trading at around a reasonable 10 times estimated forward earnings.
For related Foolishness:
- The Best Financial Stock for 2007: Capital One
- Capital One's Bright Future
- Fool on the Street: Capital One's Capital Strategy
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Fool contributor Emil Lee is an analyst and a disciple of value investing. He doesn't own shares in any of the companies mentioned above. Emil appreciates your comments, concerns, and complaints. The Motley Fool has a disclosure policy.