Car Jam? Capital One Loan Customers Draw Scrutiny

Capital One (COF Quote), the go-go consumer lender, is maddeningly vague about where its eye-popping growth is coming from. But if rivals are to be believed, a good chunk of it is being generated by making car loans at aggressive terms to borrowers with tainted credit histories.

The Falls Church, Va.-based lender has long posted gaudy growth rates in its credit card portfolio. But over the past year, it has substantially increased the amount of auto loans it makes, concentrating on people with iffy credit.

If, as alleged, the terms of Capital One's car loans are too burdensome for shaky borrowers, these debtors could default and push up bad-loan-related loss rates. This would be something of an upset, because investors have credited Capital One with careful lending policies.

Of course, if Capital One could show that its impressive earnings aren't reliant on loans to financially strapped borrowers, the stock could rally strongly. But the company declines to publicly divide up its loan book according to the creditworthiness of its debtors. In the post-Enron environment, such caginess does not go down well.

In the face of this opacity, investors will tend to assume the worst. And that might start to be justified, going by industry mutterings about Capital One's auto loans.

"We look at the terms of Capital One's loans and we don't think they're doing smart business," comments a Texas-based senior executive at a rival finance company. This person thinks Capital One's loans are as "aggressive" as those currently being made by AmeriCredit (ACF Quote) and Household (HI Quote), which are also perceived by skeptics to be expanding their auto loan books too quickly.

Capital One didn't comment beyond producing a J.D. Power survey that appears to show the interest rate on Capital One loans being lower than on AmeriCredit and Household auto lending. It was down $3.68 late Tuesday, to $47.58, a slide of 7.18%.

Kicking the Tires

Capital One's loan book grew 53% in 2001 to $45 billion, enabling the company to post 31% earnings growth for the year. By contrast, the auto loan portfolio, excluding an acquisition, grew $2.1 billion, or a smoking 175%, to $3.3 billion last year. This jump accounts for 13% of the $15.7 billion rise in total loans last year. Not a small number.

Capital Idea? Looking for signs at Capital One

But could that growth come at a cost? The Texas lending exec thinks it might. He claims the most dangerous feature of Capital One's loans is their allegedly large monthly payments. This person says he's seen Capital One loans that require payments of $500 to $600 a month. His company is reluctant to go over $450 per month, he says. "Making a small minimum payment on a credit card is a lot different from paying out over $500 a month," he observes.

At the same time, Capital One is charging interest rates in the 12%-16% range, generally below market and confirming the single data point Capital One provided. In addition, its loans are for longer time periods, this person claims.

So why is the monthly payment higher? Because Capital One is granting bigger loans on more expensive cars, says the lending executive. He claims Capital One loans can be as high as $17,000 to $18,000, compared with an average of $13,000 at his company. And he adds: "Capital One appears to be doing considerably more loans on new cars than us." The ratio at his firm is 85% used to 15% new. One more key claim: He says Capital One is requiring lower fees from dealers than his firm.

To Be Sure

It's possible that Capital One knows exactly what it's doing and is bringing its famed marketing prowess to this area of lending. In fact, it could have important data on lenders that others simply don't have, giving it a competitive edge. The bears have been wrong on this stock before.

But in the aftermath of Enron, Capital One's habit of not disclosing sought-after details of its borrowers' creditworthiness is unlikely to wash. Capital One merely says that, going by the dollar amounts of loans outstanding, borrowers with excellent credit, the so-called superprime segment, are the largest group. Next comes people with good credit histories, or prime borrowers, then those with a record of nonpayment, or the subprime segment. Investors would like to know the exact size of each group to get a better idea of how Capital One produces its soaring profits.

The bears wonder whether the growth is being achieved through low-margin superprime or through potentially risky subprime, or a combination of both. And in this new hypersensitive market environment, Capital One can't expect investors to wait forever.