Irish Eyes Frown on Capital One

In a presentation that explained the deal, Capital One said that its interest-bearing liabilities cost 4.24% and its deposits 4.15%. But after the Hibernia deal, it estimates that its interest-bearing liabilities will fall in cost to 3.70% and its deposit cost will drop to 2.98%. Given that marketing is such a massive cost for Capital One, any fall in the price of its funding is welcome. The other positive thing about this deal is that Capital One gains entry into branch banking in markets that are somewhat underserved by banks, particularly Texas.

However, nothing about the deal is likely to change the huge flaw that will ultimately cause Capital One to crater: its heavy use of late and over-limit fees. History shows again and again that lending companies that use punitive tactics don't do well over time. Two good examples come to mind. First, the old Conseco, which charged insufferably high interest rates on loans for mobile homes. The company filed for bankruptcy in late 2002 primarily because of problems in its lending arm. Second, there was Household International, a huge and often ruthless consumer lender that ended up getting bought by the U.K.'s HSBC (HBC Quote) at the end of 2002 when it went through a weak patch.

A Capital One fan could argue that because the Hibernia deal means lower-cost funds, the company can reduce its reliance on penalty fees on the asset side, and thus maintain margins. In theory, that could happen -- but that underestimates just how dependent Capital One is on hitting its borrowers with fees.

Bill Ryan, consumer finance analyst at New York-based Portales Partners, estimates that between 100% and 200% of Capital One's pretax earnings come from fees. Ryan has a hold rating on the stock, and his firm hasn't done investment banking with Capital One.