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Capital One Hits a Subprime Snag

Some worry earnings will be hit by mortgage delinquencies.

Some investors are biting their nails over mortgage risk at

Capital One Financial

(COF) - Get Capital One Financial Corporation Report


Shares have lost 10% of their value over two months as investors fret that its $14 billion acquisition of residential lender North Fork Bank could put a damper on earnings. The selling started in earnest after once-highflying lenders




New Century


warned of rising defaults. New Century subsequently collapsed into bankruptcy.

Capital One hasn't reported any damage so far, but the lender is set to report first-quarter earnings on Thursday. Analysts expect the credit card giant to make $1.99 a share, down from $2.86 a share last year, on revenue of $4.11 billion.

Investors are also worried that the meltdown in subprime mortgages -- home loans made to buyers with poor credit histories -- will spread. Defaults and delinquencies have already started to spike in the so-called Alt-A category, which covers loans made to borrowers with good credit scores but without full documentation. Now the concern is that the deterioration could start to creep into other asset classes, such as auto and credit cards -- two big components of Capital One's $146 billion managed-loan portfolio.

"Given recent turmoil in the subprime mortgage sector, Alt-A loans have faced greater scrutiny by secondary market investors, seemingly driving pricing and gain-on-sale margins much lower," writes Bradley Ball, an analyst at Citigroup. "We would also expect overall origination volumes to fall as the company will likely take a more cautious underwriting stance. Since Capital One seeks to sell its mortgage loans immediately in the secondary market, non-interest income will likely be affected in the first quarter."

Capital One didn't have much of a mortgage business before it bought North Fork in December. North Fork, through its subsidiary of GreenPoint Mortgage, brought Capital One $32 billion of residential and commercial mortgage loans. While the majority of those loans were made to so-called prime borrowers -- those with good credit histories -- North Fork also was a significant Alt-A mortgage lender.

Alt-A loans include option adjustable-rate mortgages, negative amortization loans and other nontraditional loans. According to North Fork's third-quarter earnings report -- its last full quarter as an independent bank -- about 32% of North Fork's $9.5 billion originations were option ARMs, Alt-A and other jumbo specialty loans.

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The decline in Alt-A loans has already hit shares of lenders such as






. Shares of IndyMac are off 35% this year, while Countrywide's stock has slid 20.5%.

Last year IndyMac and Countrywide were the top two Alt-A issuers, according to

Inside Mortgage Finance

. Capital One is now the No. 7 Alt-A mortgage originator through its acquisition of North Fork.

Investors' nervousness at the growing mortgage problem could be well-founded.

As a number of subprime lenders have folded in recent months, several companies conceded that earnings will be hurt by falloff in the Alt-A sector.

Late last month,

M&T Bank

(MTB) - Get M&T Bank Corporation Report

surprised investors with an earnings warning related to its Alt-A business. The Buffalo company said first-quarter earnings will be reduced by $11 million, or 10 cents a share, because of unfavorable market conditions including a lack of liquidity in the industry that reduced its ability to sell the loans in the quarter.

American Home Mortgage


slashed its earnings guidance earlier this month as the market for the securitization of subprime loans diminishes. The Melville, N.Y., firm also said a disproportionate share of its nonperforming loans are repurchased Alt-A loans. It said it has ceased offering those types of Alt-A loans that have resulted in a high proportion of its repurchases.

"GreenPoint would originate and sell a meaningful portion of their production," says Gerard Cassidy, an analyst at RBC Capital Markets who covered North Fork. But "bids for the product just aren't there like they used to be. It is going to cause some discomfort for Capital One, of course, but it's something that they'll manage."

Craig Maurer, an analyst at Calyon Securities, says he is not overly worried.

Capital One expects to "to get less than 3% of their earnings from the mortgage business," says Maurer, who has a buy rating on the stock. "I view it as an opportunity."