Time for Margin Expansion at Capital One
The company should finally realize the benefits of its growth strategy this year.
Capital One Financial (COF) has seen impressive loan growth over the past four years, expanding credit card loans at a compound annual growth rate of more than 9%. However, it has not been able to turn that loan growth into meaningfully higher revenue or earnings. Net revenue after provisions has grown less than 1% each year while credit provisions have more than doubled. In 2017, pretax income stood 14% lower than in 2013. This has caused investors to question the company’s strategy and credit quality of new credit card loans.
We believe that Capital One’s rising charge-offs should not be viewed as indications of danger or the next lending debacle. Rather, the charge-offs should be considered necessary investments in building a high-quality, seasoned book of profitable credit card holders. Unlike other consumer loans, charge-offs on credit card holders typically happen early in the relationship. In addition, it is unlikely that any bank will be able to match the credit quality on credit card originations from before 2014, because credit lending standards were much higher after the financial crisis. In fact, it would be more surprising to us if credit card losses hadn’t risen over the past few years. When looking for value creation in credit card issuers, we believe investors need to spend less time looking at the quarter-to-quarter income statements, which are noisy, and more time studying the balance sheet, as the assets being created are long-lived and will generate returns many quarters into the future.
Colin Plunkett does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.