Irish Eyes Frown on Capital One

In other words, the company exists not to supply credit that can be paid back on time, but to supply credit that can't.

No Capital One fan has really dared to rebut the penalty-fee argument. Capital One consistently masks the true level of fees it receives by burying fee data in lines of its income statement that include other items.

When a lender relies so heavily on fees, it often happens that its borrowers' outstanding principal rises even after they've made minimum payments. That's because the minimum payment is exceeded by the newly added penalty fees. When balances don't go down for this reason, it's called negative amortization. Capital One avoids helpful disclosure on negative amortization. When asked on a conference call in January about negative amortization, Capital One CFO Gary Perlin conspicuously didn't say how many of its accounts were affected.

The added problem for Capital One is that banking regulators have introduced new lending guidelines that are designed to reduce negative amortization in the banking industry. The banking authorities dislike the practice in principle, because it traps borrowers. Regulators at both the federal and state levels are feeling pressure from politicians and groups who believe negative amortization is usurious.

Regulators also dislike negative amortization because it also helps banks mask the true level of bad loans. If borrowers had to make minimum payments that were high enough to actually pay down their balances, many of them would default because the payments would be too high. In the buoyant credit environment of the past seven years, bad loans haven't been a big problem, but a crunch could be far worse than expected at a lender that has a lot of loans on its books with negative amortization.

And it is absolutely certain now that Capital One can forget about any continued lenience from its main banking regulator, the Federal Reserve. The last thing the Fed wants is Capital One using low-cost funds raised at Hibernia being used to fund a penalty-fee model. If the regulatory threat has not been too much to worry about up to now, it will be now after the proposed Hibernia deal.