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 subsidiary, Capital One, National Association (the Bank). The trend for all ratings is Stable. The Intrinsic Assessment (IA) for the Bank 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 Bank’s IA.
KEY RATING CONSIDERATIONS
The ratings reflect the Company’s strong franchise, earnings power resiliency and highly profitable business model, disciplined credit risk management, diversified funding profile and sound capitalization. The ratings also reflect the Company’s elevated revenue and loan concentration to consumer lending; particularly the highly competitive credit card and auto loan sectors including a sizeable exposure to consumer subprime credit segments. While the recent termination of the Walmart cobranded program and the transfer to another issuer is a temporary setback for Capital One (though a characteristic part in the cobranded/private label card issuing space), it is not expected to occur for at least another year and a half. Further, since it accounted for just 3% of total earnings in 2022, the impact to the Company’s bottom line results is expected to be manageable while growth in other cobranded or general purpose portfolios should provide a partial mitigant.
The Stable trend reflects our expectation that the Company will continue to deliver resilient operating results despite the anticipated economic slowdown and the reversion to normalized credit metrics while maintaining sound balance sheet fundamentals. Nonetheless, a contraction or prolonged slowdown in U.S. economic activity coupled with a high interest rate environment could present downside risks to our expectations.
Over the longer term, further diversification of revenues, entailing an increased contribution of fee income while generating solid risk-adjusted profitability, would result in an upgrade of the ratings. Conversely, a sustained weakening in the Company’s earnings and/or a prolonged deterioration in asset quality metrics would lead to a downgrade of the ratings.
Franchise Combined Building Block (BB) Assessment: Strong / Good
The Company has a solid franchise with strong brand recognition that includes a regional bank, an online direct bank and a national consumer lending franchise. Capital One is the third largest U.S. credit card issuer, one of largest U.S. auto loan providers and the ninth largest U.S. bank by assets (at year-end 2022). The Company’s franchise is also supported by its focus on technology and digital oriented developments that enhance customer satisfaction. Indeed, the Company has consistently achieved high rankings on various customer satisfaction studies. Capital One was ranked first in the J.D. Power 2022 U.S. National Banking Satisfaction Study for a third consecutive year while it was also ranked first in other J.D. Power studies for U.S. online banking and U.S. mobile app satisfaction.
Earnings Combined Building Block (BB) Assessment: Strong / Good
Capital One’s earnings power is strengthened by solid earnings generation through its diversified loan portfolio, improving operating efficiencies and the highly profitable credit card business segment. Nonetheless, the Company’s fee-based income, that accounted for 21% of net revenue in 2022, is more limited compared to peer banks and thereby revenue is more reliant on the inherent cyclicality of lending activity and the rate environment. For 2022, the Company reported net income of $7.4 billion, notably lower from the $12.4 billion generated in 2021, mainly due to loan loss reserve additions relative to sizeable reserve releases in the prior year. Nonetheless, income before provisions and taxes (IBPT), after adjusting for one-time items, was strong, totaling $15.0 billion, up 7% year-over-year (YoY). For 1Q23, adjusted IBPT of $4.0 billion was up 9% YoY, as revenue growth was essentially offset by higher expenses. Over the coming quarters, operating results should benefit from the solid loan growth registered over the past year along with the Company’s expected stability or modest improvement in operating efficiency but partially offset by the credit normalizations’ impact on both revenue and costs.
Risk Combined Building Block (BB) Assessment: Good / Moderate
The Company’s risk profile is supported by a disciplined and through-the-cycle underwriting approach coupled with appropriate and effective portfolio management capabilities. However, Capital One’s consumer loan portfolio that accounted for nearly 70% of its loan book has a higher exposure to subprime credit than its bank peer group. On the other hand, the Company’s exposure to the commercial office space is limited, accounting for just 1.2% of total loans held for investment at March 31, 2023.
As anticipated and consistent with other banks, most credit performance metrics have essentially reverted back to normalized levels. For the domestic credit card portfolio, at March 31, 2023, the 30+ day delinquency rate of 3.66% reached pre-pandemic levels, while the net charge-off (NCO) rate of 4.04% in 1Q23 was still below the 5.04% rate in 1Q19, although given the delinquency trends it is likely to approach these levels over the near-term. For the auto loan portfolio, the 30+ day delinquency rate remains below pre-pandemic levels while for the commercial banking portfolio the nonperforming loans ratio has exceeded these levels. Meanwhile, loan loss reserves at 4.64% of loan balances at March 31, 2023, stood above the levels of the day one ratio upon the implementation of CECL across all its business segments. While we anticipate credit performance metrics to deteriorate further in the coming quarters, we expect the overall asset quality to remain manageable in the absence of a sharp or prolonged economic contraction.
Funding and Liquidity Combined Building Block (BB) Assessment: Good
Capital One’s funding and liquidity profile is solid, underpinned by its defensible regional deposit franchise and national online deposit gathering capabilities along with access to other funding sources. The Company’s deposit funding of $349.8 billion is mostly comprised of consumer deposits which accounted for 88% of its total funding, at March 31, 2023, while senior unsecured debt, asset backed securitizations, and other short term debt accounted for the remainder of funding. Notably, in 1Q23, Capital One’s deposits increased by 5% from the linked quarter due to the growth in retail deposits, while the portion of insured deposits increased to 78% from 76% at YE22.
Capital One maintains a strong liquidity position with high-quality liquid assets as evidenced by the liquidity coverage ratio (LCR) of 148% in 1Q23, well above the minimum requirement of 100% while at March 31, 2023, the Company and the Bank exceeded the net stable funding ratio (NSFR) rule requirement. The Company also had cash and cash equivalents of $46.5 billion, unencumbered investment securities of $74.3 billion (approx. 97% U.S. Agency and Treasuries) and pledged collateral to the Federal Reserve’s discount window and the FHLB with an aggregate available borrowing capacity of nearly $37 billion.
Capitalisation Combined Building Block (BB) Assessment: Strong / Good
The Company’s capitalization is sound given its risk profile and underlying earnings generation capacity. Capital One’s common equity Tier 1 (CET1) ratio was 12.5% at March 31, 2023, unchanged from YE22, remaining above its target CET1 ratio of 11% and well above the regulatory well-capitalized threshold, including the stress capital buffer requirement. After including the unrealized losses in AOCI to the CET1 ratio, the expected impact is 200 bps resulting in a CET1 ratio of 10.5%. The Company has historically demonstrated a solid ability to improve its capital position through flexible capital management and access to capital markets. Capital One repurchased approximately $150 million of shares during 1Q23, following $4.8 billion of share repurchases in 2022, while the quarterly dividend of $0.60 per share remained unchanged during 2022 and in 1Q23.
Further details on the Scorecard Indicators and Building Block Assessments can be found at https://www.dbrsmorningstar.com/research/414500
ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental/ Social/ Governance factor(s) that had a significant or relevant effect on the credit analysis
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 (May 17, 2022).
All figures are in U.S. Dollars unless otherwise noted.
The principal methodology is the Global Methodology for Rating Global Methodology for Rating Banks and Banking Organisations https://www.dbrsmorningstar.com/research/398692/global-methodology-for-rating-banks-and-banking-organisations (June 23, 2022). In addition DBRS Morningstar uses the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings https://www.dbrsmorningstar.com/research/396929/ dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings in its consideration of ESG factors.
The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.
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.
The 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, management 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.
The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are under regular surveillance.
For more information on this credit or on this industry, visit www.dbrsmorningstar.com.
140 Broadway, 43rd Floor
New York, NY 10005 USA
Tel. +1 212 806-3277