Capital One Financial Corp. gained a more diverse funding source to sustain its lending business when it bought North Fork Bancorporation last week, a purchase that will reduce its reliance on the securitization market. Even so, the bank will be able to sustain its credit card ABS volume by tapping into credit card receivables from its newly acquired unit, say capital market sources.
Although the deal will lessen Capital One's dependence on asset-backed securities as an overall proportion of its funding mix, according to market sources, it might not necessarily translate into dramatically less Capital One ABS paper in the market. Capital One, which is the fourth-largest issuer of credit-card ABS in the U.S., behind Citigroup, Banc of America and JPMorgan Chase, will be able to tap into North Fork's retail banking and mortgage customer bases to market its own card product, which has more brand recognition, and a portion of the incremental loans could be securitized as well. This would mitigate some of the reduction in ABS funding, said Mark Girolamo, managing director and corporate bond analyst at Barclays Capital.
As for Melville, N.Y.-based North Fork, some capital markets professionals did not foresee, at least for the time being, that Capital One would rush to securitize its mortgage portfolio. Although North Fork did buy mortgage specialist GreenPoint Financial Corp., which has completed a few securitizations backed by Alt-A and home equity loans, North Fork itself did not directly securitized its mortgage portfolio, according to Rod Dubitsky, who heads Credit Suisse's ABS research group. Still, others recall that Capital One has wanted to get into the home equity lending business, so North Fork's large mortgage portfolio might offer an attractive source of capital to fund a home equity lending operation.
The ABS market gave the nod to the cash and stock transaction. Valued at $14.6 billion and expected to close in the fourth quarter, the deal is expected to make Capital One Financial Corp. one of the 10 largest banks in the United States, in terms of deposit accounts and managed loans. It also becomes the third-largest depository institution in the New York metropolitan area, behind JPMorgan Chase and Citigroup.
"The latest purchase shows that Capital One is continuing its strategy to diversify its businesses, funding sources and more importantly earning stream," noted Credit Suisse analysts in their Market Tabs research note issued last week. After the acquisition, analysts expect Capital One's U.S. credit card business to contribute 51% of its net income after tax, as opposed to the 88% it would have contributed pre-merger, according to a presentation to investors last week.
From a capital markets standpoint, the deal further reduced Capital One's reliance on brokered deposits and securitization to help fund its credit card business. The former monoline bank saw off-balance sheet securitizations decline to 33% in 2005, compared to 46% in 2001, according to a research note from Barclays Capital. Brokered deposits, large-denomination sums that often resemble certificates of deposit, can be costly for banks because they require higher interest-rate payouts to account holders.
Capital market professionals now predict that Capital One's future credit card ABS deals are going to look a lot better to rating agencies and investors, once its announced buyout of North Fork Bancorporation furnishes the former credit card monoline bank with more diverse capital sources. Standard & Poor's put Capital One's BBB' paper on ratings watch for a possible upgrade. Moody's Investors Service put several of Capital One's A3' paper on ratings watch for a possible upgrade.
When rating agencies look at credit card ABS enhancements, they often scrutinize the originators' business model and reward sound operators by requiring less stringent credit enhancement, said Rajat Bhu, vice president of ABS research at Credit Suisse. Capital One was rewarded earlier this year already because it diversified its funding sources and maintained solid performance in its Capital One Multi-Asset Execution Trust, or COMET. Strong portfolio performance - specifically stable and below-industry average charge-offs, improved delinquencies and stronger payment trends - reduced credit enhancement on class A senior bonds to 17%, from 18.75%; class B to 8% from 8.75%; and class C to 1% from 1.5%. Barclays attributed the significant decline in charge offs to the Bankruptcy Reform Act of 2005, which holds consumers partially responsible for paying off their debts when they file for bankruptcy protection from creditors, according to Juliet Jones, an associate director at Barclays Capital.
On the management level, North Fork's small business and retail banking expertise is so thorough that Capital One is offering incentive agreements to retain the New York's bank's management. North Fork CEO John Kanas will become head of Capital One's banking division.
One aspect of the deal - that it came so quickly after Capital One acquired New Orleans-based Hibernia Corp. - did take the market by surprise and stirred up some passing concerns of integration risk. The merits of the North Fork Bancorporation deal, however, have generally won over capital markets professionals. Capital One mitigated its integration risk in this deal by choosing companies whose operations did not overlap with its own and convincing key North Fork executives to stay with the merged company. All in all, Capital One has gotten a turnkey operation, says Girolamo, which makes for smoother sailing ahead.
"This is definitely a good transaction for Capital One and North Fork," he said. "They have complimentary franchises, with little overlap and some excellent cross-selling opportunities."
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