DBRS, Inc. (DBRS Morningstar) 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 Morningstar 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 ratings confirmation reflects the Company’s strong franchise, distinct and highly profitable business model, disciplined credit risk management, diversified funding profile, and sound capitalization. The ratings also consider Capital One’s revenue concentration, the sizeable exposures to subprime customer segments in its credit card and auto loan portfolios, as well as the persistently heightened competition for these consumer lending sectors.
The Stable trend reflects our expectation that Capital One will continue to maintain sound balance sheet fundamentals and generate resilient bottom-line results, even as credit performance gradually reverts towards more normalized levels. We expect the strong U.S. labor market, healthy consumer balance sheets and growing consumer spending to be supportive of the Company’s operating results. Nevertheless, weakening economic conditions caused by persistent inflationary pressures or a spillover from the current geopolitical developments in Europe present key downside risks to our expectations.
Greater diversification of revenues, including a more substantial non-interest income contribution while maintaining solid risk-adjusted returns, would lead to a ratings upgrade. Conversely, a substantial weakening in the Company’s earnings generation capacity and/or a sustained material deterioration in asset quality metrics would result in a ratings downgrade.
Franchise Combined Building Block (BB) Assessment: Strong / Good
Capital One has a solid franchise stemming from the strong brand recognition of its national consumer lending and online deposit platform franchises as well as from its regional banking operations. The Company is the third largest U.S. credit card issuer and one of largest auto loan providers in the U.S. The Company’s customer and technology focused approach has enabled it to be consistently highly ranked in multiple customer satisfaction studies. Indeed, Capital One was ranked first in the J.D. Power 2021 U.S. National Banking Satisfaction Study for a second consecutive year while it was also highly ranked in other J.D. Power studies for U.S. credit card and U.S. mobile app satisfaction. Over the past year, the Company has expanded its domestic credit card portfolio with the addition of new co-branded and private label relationships and enhanced product offerings while it endeavors to make further inroads in the high-spender travel oriented credit card segments with the launch of a new premium credit card, travel portal and the inaugural opening of its proprietary airport lounge.
Earnings Combined Building Block (BB) Assessment: Strong / Good
The Company’s earnings power has been supported by solid earnings generation and a peer-leading net interest margin driven from its highly profitable credit card business as well as from improving operating efficiencies. On the other hand, Capital One’s fee-based income contribution to revenue is proportionally lower relative to its banking peers and thereby its reported earnings are more correlated to interest rate cycles and lending activity. In 2021, the Company reported net income of $12.4 billion, significantly higher than the $2.7 billion earned in 2020 as sizeable reserve releases continued to boost the bottom line. Nonetheless, income before provisions and taxes (IBPT), after adjusting for one-time expenses and gains, were also solid totaling $14.0 billion in 2021, up 6% year-over-year (YoY) despite the substantial increase in marketing spend to support business growth initiatives. The adjusted operating efficiency ratio (defined as adjusted operating expenses as a percentage of adjusted total net revenue) improved to 44.7% from 46.0% in 2020. For 1Q22, adjusted IBPT of $3.4 billion was essentially flat YoY as strong revenue growth was mostly offset by higher expenses. Over the next year, we anticipate the Company’s earnings to benefit from an expanding net interest margin, as well as continued growth in credit card loans and purchase volume driven by its product refinements and the pent-up demand for in-person activities and experiences including travel, entertainment and dining.
Risk Combined Building Block (BB) Assessment: Good / Moderate
Capital One’s good risk profile is underpinned by credit risk management capabilities and expertise attained through its long track record of credit underwriting and life-cycle portfolio management, the effectiveness of which has been demonstrated through multiple economic environments. Nonetheless, the Company’s higher exposure to subprime consumer segments relative to its bank peer group, elevates the overall risk profile. Like most banks, the Company’s credit performance metrics remain better than pre-pandemic levels, but are expected to gradually normalize. Despite reserve releases, loan loss reserves remain strong at 4.03% of loan balances at March 31, 2022. The consumer loan portfolio continues to be supported by the strong labor market and consumers’ excess savings accumulated through the pandemic. The net charge-off (NCO) rate of the domestic credit card portfolio was 2.12% in 1Q22, down from 2.54% in 1Q21 (and from 5.04% in 1Q19) while the 30+ day delinquency rate was 2.32% at March 31, 2022, up 8 basis points YoY but easily below the 3.7% range seen in the quarters leading up to the pandemic. Similarly, the Company’s auto loan and commercial banking portfolios have registered solid credit trends. Overall, the total NCO rate was a very manageable 1.11% in 1Q22.
Funding and Liquidity Combined Building Block (BB) Assessment: Good
The Company has a solid funding profile supported by broad funding sources and a defensible deposit base derived from its branch-based regional franchise along with its national online deposit gathering capabilities. As of March 31, 2022, Capital One’s deposit funding of $313.4 billion (primarily consumer deposits), accounted for 87% of total funding. The Company also maintains consistent access to unsecured debt, asset backed securitizations and short-term borrowings that provide further diversity and flexibility to its funding mix. Of note, the Company and its banking subsidiaries exceeded the net stable funding ratio (NSFR) rule requirement at March 31, 2022. Capital One’s liquidity position is solid with cash and cash equivalents of $26.8 billion, unencumbered investment securities of $81.1 billion as well as pledged collateral to the Federal Reserve’s discount window and the FHLB with a combined total available borrowing capacity of $41.5 billion, of which $4.1 billion was utilized as of March 31, 2022. Further, the Company has sound levels of high-quality liquid assets to meet its short term funding needs as indicated by the liquidity coverage ratio (LCR) of 140% in 1Q22, that is well above of the minimum requirement of 100%.
Capitalization Combined Building Block (BB) Assessment: Good
Capital One has sound capitalization bolstered by its strong earnings generation ability. The Company’s common equity Tier 1 (CET1) ratio was 12.7% at March 31, 2022, comfortably above both the regulatory minimum requirement of 7.0%, including the stress capital buffer, and higher than its target CET1 ratio of 11%. The Company has presented a consistent ability to improve its capital position through accessing the capital markets and/or by adapting flexible capital management. Following $7.5 billion of share repurchases in 2021, Capital One repurchased another $2.4 billion during 1Q22. Subsequently, in April 2022, the Company’s Board of Directors authorized an additional $5 billion of share repurchases beginning in 3Q22.
Further details on the Scorecard Indicators and Building Block Assessments can be found at https://www.dbrsmorningstar.com/research/397381.
Social (S) Factors
The S factor has changed from the prior rating disclosure. The Social factor does not affect the ratings or the trend assigned to Capital One. As a result of the Company’s cybersecurity incident that was announced in 2019, the sub-factor Data Privacy and Security was relevant to the ratings of Capital One, but did not affect the ratings or the trend assigned to Capital One. The Company agreed to a settlement for $190 million with the parties of the U.S. consumer class action cases related to the cybersecurity incident, which was covered by the Company’s legal reserve for this matter. In February 2022, a U.S. federal court preliminarily approved the class action settlement. As a result, we view the uncertainty related to the Company’s long-term financial health has been substantially diminished in regard to this cybersecurity incident.
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.
All figures are in U.S. dollars unless otherwise noted.
The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (July 19, 2021): https://www.dbrsmorningstar.com/research/381742/global-methodology-for-rating-banks-and-banking-organisations.
Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (May 17, 2022):
The primary sources of information used for this rating include Morningstar, Inc. and Company Documents. DBRS Morningstar considers the information available to it for the purposes of providing this rating was of satisfactory quality.
This rating was not initiated at the request of the rated entity.
The rated entity or its related entities did not participate in the rating process for this rating action. DBRS Morningstar 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.
Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are under regular surveillance.
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