Capital One's Shares Are Still Cheap

NEW YORK ( TheStreet) -- Capital One Financial ( COF) is among the cheapest big bank stocks out there and the second half of 2012 looks to be relatively clean following a rocky second quarter.

Back in December I called Capital One the top bank stock pick for 2012, and the shares returned 34% through Tuesday's close at $56.47, which beats three of the "big four" U.S. banks, with the exception being Bank of America ( BAC), which returned 48% year-to-date, closing at $8.19 on Tuesday.

Rounding out the big four, shares of JPMorgan Chase ( JPM) returned 17% year-to-date, to close at $38.04 on Tuesday, while Citigroup ( C) returned 17% to close at $30.73, and Wells Fargo ( WFC) returned 27%, closing Tuesday at $34.38.

Of course, Bank of America's strong year-to-date performance follows a 58% decline during 2011, when Capital One had a flat return, that compared rather well with a 25% decline for the KBW Bank Index ( I:BKX). The index was up 21% year-to-date, through Tuesday's close at 47.47, with all but two of the 24 index components showing year-to-date gains. Citigroup's shares have been recovering from a 44% drop in 2011.

JPMorgan has bounced back from a 20% decline last year, although the shares are down 7% since May 10, when CEO James Dimon estimated $2 billion in trading losses from hedging activity by the company's Chief Investment Office. While the CIO's second-quarter trading losses ended up totaling $4.4 billion, JPMorgan reported second-quarter earnings of $5 billion. The company now expects to restart its share repurchase program in 2013.

Wells Fargo fared relatively well during 20111, with shares declining 10%, and is among the best earnings performers among large U.S. banks, with returns on average assets ranging between 1.27% and 1.40% over the past four quarters, according to Thomson Reuters Bank Insight.

Looking at current valuations, Capital One is still one of the cheapest of the large banks, relative to earnings estimates. The shares trade for 8.2 times the consensus 2013 earnings estimate of $6.92, among analysts polled by Thomson Reuters. Among the 24 components of the KBW Bank Index, only two names have lower forward price-to-earnings ratios. Citigroup trades for 6.8 times the consensus 2013 EPS estimate of $4.54, while JPMorgan Chase trades for 7.3 times the consensus 2013 EPS estimate of $5.23.

Bank of America trades at 8.9 times the consensus 2013 EPS estimate of 92 cents.

Capital One had a messy second quarter, as the company completed its purchase of HSBC's ( HBC) $27.6 billion credit portfolio and reported "an expense of $174 million to establish a finance charge and fee reserve for estimated uncollectible billed finance charges and fees and loan premium amortization expense of $63 million."

The company also was hit with $60 million in civil penalties related to credit card settlements with the Consumer Financial Protection Bureau and the Office of the Comptroller of the Currency, along with $150 million in refunds to the company's credit card customers. The two regulators had accused Capital One of failing to properly monitor third-party vendors selling add-on credit protection and credit monitoring services to credit card customers.

Capital One's second-quarter provision for credit losses was $1.7 billion, which included the establishment of a $1.2 billion allowance for loan losses on the acquired HSBC loans. The provision for credit losses increased from $573 million in the first quarter, and a provision for loan and lease losses of $343 million in the second quarter of 2011.

These items led to second-quarter earnings of $92 million, or 16 cents a share, compared to a profit of $1.4 billion, or $2.72 a share, during the first quarter, and $911 million, or $1.97 a share, during the second quarter of 2011. The first-quarter results included a bargain purchase gain of $594 million, related to the company's purchase of ING Direct (USA) from ING Groep ( ING).

Moving forward, investors would love to see a couple of "clean quarters" from Capital One, and the consensus among analysts is for the company to show profits of $1.70 a share in the third quarter, and $1.65 in the fourth quarter.

Like other major credit card lenders, Capital One reports monthly credit quality statistics, and the addition of the HSBC card portfolio, along with the second-credit marks made when the portfolio was purchased, led to sharp improvement in the company's card quality ratios, which to reverse to some extent over coming quarters, as the special reserve for the acquired HSBC loans is used up.

During July, Capital One's annualized rate of net charge-offs to average domestic card loans was 2.62%, declining from 3.41% in June, and 3.37% in July 2011. Early-stage delinquencies also declined, with loans past due 30 days or more making up 3.16% of the domestic card portfolio as of July 30, improving from 3.16% the previous month, and 3.37% a year earlier.

Capital One's average domestic credit card loans held for investment totaled $80.6 billion, increasing from $53.3 billion the previous month, because of the HSBC portfolio purchase. Net charge-offs -- loan losses less recoveries -- in the domestic card portfolio during July were $175 million, increasing from $151 million in June, but declining from $198 million a year earlier, when average domestic card loans totaled $53.8 billion.

Capital One also reported improved credit quality in its $8.8 billion international credit card portfolio, with a net charge-off rate of 4.97% during July, improving from 5.16% in June, and 6.59% in July of last year. The 30+ days delinquency rate in the international credit card portfolio improved to 4.78% in July, from 4.84% the previous month, and 5.34% a year earlier.

Capital One's shares have moved ahead nicely so far during a transformational 2012, following the drag in the second half of last year, as the regulatory approval process for the ING Direct and HSBC card portfolio acquisitions dragged on and on. The shares remain cheaply priced to forward earnings estimates, and with a strong capital base and hopefully a smooth second half to show the benefits from the two acquisitions, investors can look forward to a capital return through an increased dividend and/or share buybacks during 2013.

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

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

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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.