DBRS Confirms Capital One Financial Corporation at A (low); Trend Stable

DBRS, Inc. (DBRS) confirmed the ratings of Capital One Financial Corporation (Capital One or the Company), including its Long-Term Issuer Rating of A (low) and Short-Term Issuer Rating of R-1 (low). At the same time, DBRS confirmed the ratings of its banking subsidiaries, Capital One Bank (USA), National Association and Capital One, National Association (the Banks). The trend for all ratings is Stable. The Intrinsic Assessment (IA) for the Banks is A, while the Support Assessment remains SA1. The Company’s Support Assessment is SA3 and Capital One’s Long-Term Issuer Rating is positioned one notch below the Banks’ IA.

KEY RATING CONSIDERATIONS
The Company’s ratings and Stable trend reflect the strength of the Capital One franchise and its distinct, highly profitable business model, which includes a large national credit card lending platform, a significant regional banking operation and a large online direct bank that provides substantial deposit funding, as well as other consumer and commercial banking products and services.

The ratings also consider the Company’s solid financial results, its strong and proven risk management and sound balance sheet. With a peer-leading net interest margin and disciplined expense management, Capital One’s earnings generation is robust and provides significant capacity to absorb credit losses, while still allowing for investment in the franchise and technology, including the Company’s ongoing digitization efforts. Constraining the rating is the Company’s consumer-heavy loan portfolio, including sizeable exposures to subprime borrowers in both credit cards and auto, which represents an outsized exposure to the U.S. consumer as compared to most large regional banks. In DBRS’s view, the recently announced sale of the residential mortgage portfolio, while freeing up balance sheet capacity, also further concentrates the loan portfolio in unsecured lending.

RATING DRIVERS
DBRS views the current ratings as well-placed. Over the longer-term, greater diversification of revenues, including a more significant non-interest income contribution and a reduced reliance on credit cards in the loan mix could have positive rating implications. Conversely, a substantial decline in earnings, reflecting a permanent weakening of revenue generation ability, or a significant amount of asset quality deterioration could lead to negative rating actions.

RATING RATIONALE
For 2017, Capital One reported net income of $2.0 billion, down from $3.9 billion in 2016, as the impact of the Tax Act included charges of $1.9 billion primarily stemming from a revaluation of net deferred tax assets. Absent this charge, results were flat year-over-year as a strong 11% increase in revenues was offset by higher provisions for credit losses, as well as higher expenses.

Higher net interest income has been driven by growth in the domestic credit card and auto loan portfolios, as well as an increase in yields, reflecting higher interest rates. The increase in operating expenses stemmed from loan growth, continued investments in technology and infrastructure, and restructuring activities, including branch closures, as Capital One looks to reduce expenses to accelerate its digitization efforts. Higher loan loss provisioning reflected higher charge-offs in the domestic credit card portfolio, as newer vintages begin to season. Most recently in 1Q18, Capital One reported net income of $1.3 billion, an increase from the linked-quarter, as seasonally lower marketing and operating expenses and lower provision for credit losses were partially offset by modestly lower revenues and an increase in provisioning for credit losses.

DBRS continues to view Capital One’s asset quality as sound and net charge-off levels, while increasing, as remaining manageable and reflective of credit card portfolio growth. Importantly, DBRS sees the Company’s loan loss reserves, which stood at $7.6 billion, representing 3.03% of total loans held for investment at March 31, 2018, as sufficient, particularly given the Company’s strong ability to generate capital organically through earnings. The Company sold the majority of its taxi medallion lending portfolio, which had been experiencing elevated losses due to their declining values.

Capital One’s balance sheet remains sound, underpinned by ample liquidity and deposit funding, as well as a solid capital position, all of which provide support to current ratings. Additionally, Capital One’s common equity Tier 1 ratio was 10.5% at March 31, 2018, up from 10.3% at YE17. Following guidance from regulators, management has increased its targeted CET1 capital ratio to 11%. The loan sale should allow the Company to quickly get to this level and allow for buyback activity.

Headquartered in McLean, Virginia, Capital One reported $362.9 billion in assets at March 31, 2018.

The Grid Summary Grades for Capital One are as follows: Franchise Strength – Strong/Good; Earnings Power – Strong/Good; Risk Profile – Good; Funding & Liquidity – Strong; Capitalisation – Strong.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The applicable methodology is Global Methodology for Rating Banks and Banking Organisations (May 2017), which can be found on our website under Methodologies.

The primary sources of information used for this rating include company documents and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

Lead Analyst: John Mackerey, Vice President – Global FIG
Rating Committee Chair: Michael Driscoll, Managing Director, Head of NA FIG – Global FIG
Initial Rating Date: 17 November 2005
Last Rating Date: 2 August 2017

The rated entity or its related entities did not participate in the rating process for this rating action. DBRS did not have access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

This is an unsolicited credit rating.

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