Break Up Bank of America if Capital One Deal Falters (Update 3)

Updated with market lose informtion and a statement from Capital One.

NEW YORK ( TheStreet) -- What are they afraid of?

After seven months, three public hearings giving voice to pious "consumer advocates" who say that allowing Capital One to become the seventh largest U.S. banking company through its agreement to purchase ING Direct (USA) from ING Groep ( ING) would be such a terrible thing, the Federal Reserve again failed to rule on the deal, even following Monday's special and delayed meeting on the subject.

How much further information could the Federal Reserve's Board of Governors possibly need?

It would appear that the Fed is afraid of its own shadow on this one. After all, if the Fed were to determine that Capital One -- which would have roughly $298 billion in total assets if the ING Direct (USA) deal were completed -- were to pose such a dire threat to the U.S. economy, being "too big to fail," then it would be forced to explain why it doesn't advocate the breakup of Bank of America ( BAC), JPMorgan Chase ( JPM), Citigroup ( C), Wells Fargo ( WFC), U.S Bancorp ( USB), Bank of New York Mellon ( BK), which would still be larger than Capital One.

Oh wait - I forgot. Investment banks Goldman Sachs ( GS) and Morgan Stanley ( MS) are technically bank holding companies that gather deposits. They would also have larger balance sheets than the combined Capital One, so they must also be considered dire threats by the consumer advocates and possibly by the new, craven Fed.

The Fed might also need to revisit its decision to quickly approve Wells Fargo's acquisition of the troubled Wachovia at the end of 2008. What a terrible deal that was to the U.S. economy.

Such "systemic risk."

Not only did the Wells Fargo/Wachovia combination lower systemic risk by preventing a possible failure for Wachovia and more expense for the government, the combined company has been performing quite well.

Among the "big four" U.S. banks, Wells Fargo has had, by far, the strongest and most consistent earnings performance over the past year, with a return on average assets (ROA) ranging between 1.1% and 1.27% over the past five quarters, according to HighlineFI.

Let's not forget that the Fed's vacillation on the Capital One/ING Direct (USA) deal also affects Capital One's agreement to purchase HSBC's ( HBC) U.S. credit card portfolio, for which it needs the liquidity boost from the ING Direct deal.

Investors reacted calmly, considering the overall weakness in financial names, with Capital One's shares sliding only 1% to close at $47.98.

Despite the Fed's continued delay, FBR analyst Scott Valentin still believes that Capital One's ING Direct and HSBC card deals will be approved, although he did say on Tuesday that "the delays are increasing investor anxiety given the myriad of outcomes (potential non-approval of the transaction, additional capital and/or other restrictions/requirements)."

Valentin says that Fed "approval of the ING Bank acquisition is key to COF generating significant EPS growth in 2013 via asset mix-shift, rotating out of lower yielding ING Bank, FSB assets and into higher yielding HSBC credit card portfolio assets.

Isn't a better-earning Capital One good for the United States?

A Capital One spokesperson said "this is a thoughtful and deliberate process and we appreciate the thoroughness of the Fed's review. We look forward to their final decision and the positive impact the acquisition will have on our customers, associates, shareholders and our communities."

Capital One's shares have now returned 13% year-to-date. The shares trade for 1.4 times tangible book value, according to HighlineFI, and for eight times the 2012 consensus earnings estimate of $5.81, among analysts polled by Thomson Reuters.

Of course, that consensus estimate factors-in the approval of the ING Direct and HSBC deals.

Valentin is behind the consensus, estimating that Capital One will earn $5.58 a share in 2012, but his 2013 EPS estimate of $7.05 is ahead of the consensus estimate of $6.71.

The analyst reiterated his "Outperform" rating for Capital One, with a $60 price target.

Even if the ING Direct (UA) and HSBC card deals are not approved by the Fed, investors should keep a close eye on Capital One. The company is a solid earnings performer, with ROA ranging from 0.81% to 2.05% over the past five quarters.

And the shares will clearly be in play after the Fed's inability to come to a timely merger approval decision.

Interested in more on Capital One? See TheStreet Ratings' report card for this stock.

-- Written by Philip van Doorn in Jupiter, Fla.

To contact the writer, click here: Philip van Doorn.

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Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.

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