As one research report put it, the reaction to news that regulators had begun to scrutinize Capital One Financial is handling the subprime loans in its portfolio was "swift and unforgiving," sending Cap One stock down 33%, while unsecured debt widened up to 250 basis points for five-year paper. Although the reaction in the asset-backed market was significantly less drastic, with spreads widening seven to 10 basis points on the news, many thought the cheapening of Capital One's fixed-income securities was an over-reaction on the part of the investment community.

While heightened regulatory supervision among credit card issuers has been a precursor to more severe actions lately, this announcement was viewed by some as a buy opportunity for Capital One equity, debt securities and ABS.

Both Moody's Investors Service and Standard & Poor's announced they were leaving unsecured debt ratings unchanged at Baa3' and BB+', respectively. Meanwhile, Fitch Ratings put its BBB+' rating on watch negative.

Following the news, Lehman Brothers released a comment saying it expected widening of three to five basis points for five-year triple-A paper, and single-A subs were seen moving 10 to 15 basis points. Lehman's assessment was a little on the conservative side, as spreads moved slightly wider than initial predictions.

"The capital markets are a fickle place these days - fickle beyond reason." quipped researchers at Banc One ABS. A company announces that it had good earnings and that it will comply with the desires of banking regulators and it loses 40% of its market capitalization."

Barclays Capital unsecured debt research called the widening an "unwarranted knee-jerk reaction, providing an exceptional opportunity to invest" in Capital One debt. JPMorgan Securities research notes that "news of a slowdown in growth rates (will) likely put pressure on equity valuations; however slower growth and higher capital are consistent with a stronger credit history."

Reports as of late Thursday quoted triple-A rated 2002-4 A class paper, which priced May 31 at 14 basis points over one-month Libor, had widened to 20 over Libor. Single-A B paper, with a 50 basis point over Libor coupon, was quoted in the high 90 basis point area over Libor and triple-Bs were in the low 200 area over Libor, out from pricing at 155 basis points over.

As was widely reported last week, Capital One agreed with the Federal Reserve Board and the Office of Thrift Supervision to four issues relating to capital reserve requirements, reserve allowances for loan losses, finance charge reserves and procedural, systems and control concerns. (See chart)

Capital One added that it was already in compliance with three of the four regulatory recommendations, with the exception of the suggestion to update its internal risk management systems and technological, information and documentation controls. Also, asset quality was better than expected, with net charge-offs at 4.36%, and delinquencies at 4.45%. Net income increased 37%.

Oddly, Capital One - which always traded cheap to comparable monoline credit card issuers primarily because of a perceived lack of disclosure - was not obliged to reveal the memorandum of understanding (MOU) and it is not even legally binding.

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