Capital One, Little Credit

So what was so distressing about the fourth quarter? Even Capital One bulls couldn't quite get over the size of marketing spending in the quarter. Capital One spent $511 million in the fourth quarter alone on marketing -- a sum even CEO Richard Fairbank labeled "eye-popping." In the year-earlier fourth quarter, Capital One spent $317 million. Nor did the 2004 quarter's big spend translate into strong loan or new accounts growth. Bill Ryan, analyst at New York brokerage Portales Partners, says that each net new account costs "an incredible $379." (Portales rates Capital One a sell, and Portales doesn't do investment banking.)

One has to assume the marketing spending was defensive, since the company didn't warn that it was coming. Perhaps in the latter part of 2004, it felt pressure from Citigroup (C Quote) and J.P. Morgan Chase (JPM Quote) and spent like crazy to snatch customers. Of course, marketing spending will dip in the first quarter from the fourth, and it's possible that accounts growth will be higher than expected. However, if Capital One is being forced to massively up marketing spending for most of 2005, it will make the $6.92 consensus estimate almost impossible to achieve.

Even if conditions in the credit card market stayed like they are today, Capital One would clearly get clobbered by its rivals. But conditions are likely to get worse on other fronts.

First, Capital One is going to feel gradually more pressure from regulators to rein in the use of penalty fees. One massive advantage under which Capital One has operated is that it is regulated by the Federal Reserve, which has taken a more lenient stance on late and overlimit fees than another federal banking regulator, the Office of the Comptroller of the Currency.

However, over time, it's fair to assume that the Fed will tighten standards as well, especially as larger banks are softening their penalty-fee practices. One thing the OCC really wants to limit is a credit card borrower's outstanding principal increasing even after minimum payments are made because the lender has slapped on high penalty fees. This is called negative amortization. Asked on the conference call how Capital One might respond to pressure from regulators to limit negative amortization, CFO Gary Perlin said that "we believe our minimum payment practices are very appropriate and that we are in compliance with" regulatory guidance. However, on the call, Perlin conspicuously didn't supply data showing how many of its accounts were in negative amortization.