Capital One Flexes Muscle With Stress Test

NEW YORK ( TheStreet) - A quick look at the Federal Reserve's stress test projections for Capital One ( COF), show that the company could withstand a much worse credit firestorm than the one we just emerged.

The 19 holding companies subject to the Fed's Comprehensive Capital Analysis and Review (CCAR) for 2012 were stress-tested under a severe economic scenario that included real U.S. GDP contracting "sharply through late 2012, with the unemployment rate reaching a peak of just over 13 percent in mid-2013," while also assuming "that U.S. equity prices fall by 50 percent from their Q3 2011 values through late 2012 and that U.S. house prices fall by more than 20% through the end of 2013." In addition, under the Fed's adverse scenario, "foreign real GDP growth is also assumed to contract, with growth slowdowns in Europe and Asia in 2012."

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In order to pass the stress tests, the results had to show that the group of 19's estimated Tier 1 common equity ratios would remain over 5% under the adverse economic scenario.

In order to have their capital plans approved, the companies' estimated Tier 1 capital ratios at the end of 2013 would have to be above 5%, "with all proposed capital actions through Q4 2013."

Capital One is in the midst of a major transition in its business, through its recent acquisition of ING Direct (USA), which provided the needed liquidity for the company's coming purchase of HSBC's ( HBC) $30 billion U.S credit card portfolio, for a $2.6 billion premium.

Capital One on Wednesday announced a $1.25 billion offering of common shares, to partially fund the HSBC card portfolio purchase, so it is no surprise that the company didn't include plans to raise dividends or repurchase shares during 2012, in its stress test data submission to the Federal Reserve.

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Capital One also said on Wednesday that it expected "earnings per share from continuing operations in the first quarter of 2012 of at least $2.50, inclusive of an expected bargain purchase gain of approximately $600 million, or approximately $1.15 per share, related to the ING Direct Acquisition.

The company also said it continued to "target a Tier 1 common ratio in the mid-9% range at the end of the second quarter of 2012, inclusive of the expected completion of the HSBC Acquisition," and that the Tier 1 capital ratio would be "well above 11%" at the end of the first quarter.

In the stress test results, the Federal Reserve estimates that under the regulator's adverse economic scenario, Capital One's Tier 1 common equity ratio would be 7.2%, rising to 7.8% at the end of 2012.

The Fed also estimated that under the harsh economic scenario, with much higher unemployment than the worst we saw in the last credit cycle, Capital One would post pre-tax net losses totaling $4 billion, through the end of 2013.

The Federal Reserve's projected loan losses for Capital One under the economic scenario are astronomical, including total loan losses of $19 billion, of which $13.9 billion would be credit card losses. The Fed estimated a credit card loss rate of 19.4%. That's an incredibly high rate, when compared to the company's domestic annualized loss rate of 3.84% for its managed credit card portfolios during February, and its international card loss rate of 5.43%.

So investors can take comfort that Capital One has what it takes to whether a server, and highly unlikely, credit firestorm.

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In its comments on Wednesday about the stress test results, KBW's bank research team said that "given that COF's ratio of 7.2% without any capital raise already exceeds the minimum 5% Tier 1 common ratio, it is not clear if the company necessarily needs to raise the full $1.25 billion."

KBW also said that credit card lenders fared well in the stress tests "were not surprising given the strong current levels of capital and solid business models," and that Capital One's shares, "which are trading at about 7.5x our 2013 pro forma EPS estimate of $6.77, remain compelling."

KBW analyst Sanjay Sakhrani rates Capital One "Outperform," with a $68 price target.

Capital One's shares were up 24% year-to-date, through Wednesday's close at $52.33, following a flat return in 2011.

-- 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 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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