Risk Profile Punishes Capital One
Soaring losses, slowing growth and a debt-laden capital structure have crushed Metris' stock this year, but its second quarter was worse than even the bears had expected. The setback came a day after Capital One, one of the nation's most highly regarded lenders, shocked investors Tuesday evening by revealing that 40% of its loan book is made up of loans to borrowers with patchy credit histories -- a far higher share than analysts had estimated. Capital One had previously declined to break out the share of these so-called subprime loans, something this column had complained about.
The reports stunned an otherwise upbeat market Wednesday. Metris stock dived 38% to $3.77 and Capital One skidded 34% to $33.72. Other lenders slumped as well, with Household (HI - Get Report) dropping 10% to $41.57 and little-regarded Providian (PVN) sliding 16% to $3.40.
The bad news will strengthen the view that U.S. lenders did far too much subprime lending when that risky enterprise looked profitable. The credit card issuers are now paying the consequences, as more borrowers than expected encounter difficulties in repaying their loans.
Jam and PreservesMetris executives moved into self-preservation mode Wednesday by repeatedly asserting on a conference call that the company had solid long-term prospects and that its balance sheet was strong. But by any yardstick the company's prospects aren't good. As losses increase -- they jumped to 15% of the total loan book in the second quarter -- Metris will have to add more to its reserve, which punishes profits.
Quality, Job OneAt first blush, Capital One's selloff would seem odd, given its increase in earnings guidance for 2002 and the fact that it beat profit expectations. But numbers weren't as clean as usual. For example, Capital One allowed its marketing expense to drop $33 million from the prior quarter. If it had kept marketing at the prior quarter number, earnings would've been 9 cents lower. As for guidance, credit card earnings are relatively easy to manufacture, due to the fact that the accounting method used in the industry allows fast-growing lenders to book big profits upfront. And Capital One's explanation Tuesday about how it intends to keep increasing earnings appeared inconsistent to some observers. The company said that it intends to keep adding loans to highly creditworthy customers but also conceded that this market segment is getting increasingly competitive. A company spokeswoman responded: "We still have a large amount of opportunities in the marketplace." Also, now that the company has revealed its subprime loan book to be higher than market estimates, analysts will probably start to up bad loan forecasts. The other jarring revelation in Capital One's release Tuesday was the requirement from regulators that the company improve its systems. The lender was long been considered a leader in technology. The company spokeswoman responded that Capital One's data-mining IT that it uses to find profitable borrowers is excellent, adding that the regulatory agreement concerns "internal government structures." Capital One's "memo of understanding" with the regulators also increases expenses for Capital One. The higher bad loan reserves required by the regulators almost certainly pushed up the provision expense in the second quarter, and the cost of upgrading systems will also add to overhead.
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