I learn something new from Capital One's
A loan secured by some type of collateral should have better credit quality than another without any pledged assets. That makes sense, right?
So why are mortgages, which are secured by houses, performing worse than credit card loans, which are secured by, well, nothing? Wouldn't people pay their mortgage loans before they pay their credit card bills, if only so they can stay in their houses?
Ask and ye shall receive ...
Capital One built its entire credit culture around gathering reams of data on its customers, and figuring out the patterns within. Thus, Mr. Fairbanks could query his company's decades of data to discover why more people aren't defaulting on their credit card loans.
As Fairbanks humorously put it, it doesn't seem to make sense that people would say "Honey, yes, let the house go, but by God, pay that Capital One credit card!" But according to the database, that's exactly what's happening. Among Capital One's customers who are 90 days or more delinquent on their mortgages -- in default, basically -- a whopping 70% are nonetheless current on their credit card loans. It boggles the mind.
Fairbank conjectured that these borrowers were still were doing fine in terms of employment, and wanted to stay current on any debt payments that they could. On their homes, however, many were hopelessly underwater, often with little, no, or negative equity, so they probably cut their losses.
Diverging credit quality
Alternately, credit card lenders might simply be much more stringent than their mortgage brethren when it comes to underwriting discipline. Lenders such as Capital One, Discover
Meanwhile, many now-defunct subprime mortgage lenders originated loans expressly to resell them to someone else. When their market became more competitive, credit quality slipped, and loans became increasingly toxic. Once the music stopped, many lenders were left without chairs. The current credit maelstrom reflects the consequences of that lax underwriting.
Fairbank noted Credit Suisse First Boston's estimate that 11% of subprime mortgage loans were more than 60 days delinquent, compared to Capital One's rate of 3% for its subprime credit card lenders. Fairbank also mentioned that Capital One's definition of subprime means the "upper end of subprime." Clearly, credit card lenders exercised greater underwriting discipline, perhaps because of the skin they had in the game,.
Capital One always assumes that a recession is around the corner, and it underwrites accordingly. According to its data, the economy drives credit quality, so it's better for the Capital One to sacrifice growth during the boom times if it means surviving to fight another day during recessions.
In fact, Capital One has put its money where its wallet is. The company has slowed credit card receivables growth, backed away from teaser rates and other aggressive practices when the market got too competitive, and limited its credit lines to mitigate individual credit risks -- all at the cost of additional business.
Although many of its actions have disappointed short-term investors and Wall Street analysts, I think Fairbank's strategies should protect investors during downturns and reward long-term shareholders.
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's disclosure policy believes that whatever's in your wallet, you have a right to keep it there.
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