New York - Beleaguered credit card issuer Capital One Financial circled the wagons last week at the JPMorgan 2003 Financial Services Conference, held at the firm's corporate headquarters here in New York. The event took place one day after the resignation of its CFO amid insider trading charges. Company officials reiterated that the Wells notice filed by the Securities & Exchange Commission was not aimed at the company or any of its executive staffers and that it was "at the seam" in its strategic turnaround plan.
If anything, it was an awkward situation. Fresh news that former Executive Vice President and CFO David Willey had audience members on the edge of their seats, yet little was said about this development that had already not been stated publicly. Officials did say that despite the two major blows landed, "we have gotten out in front of the regulatory challenges." There was one caveat to this statement: Cap One had yet to hire an Enterprise Risk Manager, despite its being mandated in last year's Memorandum of Understanding.
The key to the turnaround lies in Cap One's ability to shift into a higher credit quality borrower base, while maintaining its total portfolio size in the coming year. This plan was mapped out to a packed house of investors by Steve Linehan and Jeff Norris of the Capital One Treasury department.
Cap One's Fico distribution is currently bar-belled, with 39.8% of accounts sub 660 and 36.7% greater than 710, both a touch higher than the industry average. The middle ground, or the range between 661 and 710, which makes up the remaining 23.6% of its U.S. credit card portfolio, is not being targeted heavily. "Those borrowers are not superprime, but with the competition for their business, they are priced like superprime," noted Norris.
To address the steadily increasing charge-offs in the subprime credit card portfolio, Linehan expects losses to trend higher, peaking at the "mid to high 6-percent area" versus the most recently reported 6.21%. As the accounts reach their first year of seasoning, however, Linehan said he expects losses to drop 50 to 75 basis points in the second half of 2003, and leveling off in the "low 6 percent" area.
Next Linehan addressed portfolio growth, a driving factor in the rising charge-offs Cap One is expecting. The slowdown of subprime will be cut to a 10 to 15% pace, which, according to Linehan, will be offset by the company's planned move into prime and super-prime segments. Prime and super-prime growth is expected in the 25% area during Cap One's recovery.
While this drastic shift in strategy may cause concerns, investor relations manager Norris said that the diversification strategy it has employed in recent years is starting to pay dividends. While in previous years, the lower-margin up-in-credit cards, overseas credit card and adjacent lending strategies, such as auto and installment loans, were supported by the core business. They now account for $300 million in net income.
The diversification businesses have grown significantly in the past four years, in the red in 2000 and 2001, net income was positive in 2001, accounting for $109 million. The viability of these operations comes at just the right time, as Norris pointed out. "Growth in underserved markets is not rewarded right now in the capital markets."
Cap One will target cardholders of its core, "no hassle" product line with new debt products. Its auto-lending strategy is centered on the "direct" concept of avoiding the reverse auctions most independent auto lenders use to purchase receivables. Two-thirds of the sub-prime auto portfolio is backed by direct-to-consumer loans and losses for these accounts are about half of those typically seen in non-prime auto pools, Norris added.
Another concern among corporate debt and equity investors is Cap One's ability to pay off debt coming due. On this front, Linehan claims it is "well positioned." Term maturities for 2003 are concentrated in the second half of the year, with $400 million of debt and $3 billion of ABS scheduled to mature late in the year. All of its ABS obligations due in the second half come due in the fourth quarter.
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