On the earnings blowout from Capital One Financial Corp., paper from its most recent credit card deal was expected to trade at least three-to-five points inside its new issue levels. Recall that Cap One's three-year triple-As priced at 39 basis points over one-month Libor. As if they were toxic, however, the bonds were not trading as of press time last week - presumably because no one is willing to let them go, a sell-side researcher said.

"What you've got is high quality credit card paper from an issuer that is fundamentally in good shape, albeit it has suffered from headline risk," the researcher said. "Cap One's earnings have sort of quieted the naysayers."

Well, some of them, at least. Following Cap One's earning release, several skeptics emerged, noting that part of the company's strong first quarter showing was the result of lowered loan loss allowances, which freed up $85 million. Cap One reported that managed delinquencies declined to 4.97% from 5.60% in the previous quarter.

"Given the volatility of this data, we hesitate to read too much into it," write equity analysts at Goldman Sachs, who urge caution in overly embracing the name, weary of revised street estimates. Goldman did, however, raise it full-year EPS estimates by $.25 to $4.50.

Cap One said its earnings per share rose 63% over the previous year. BankStocks.com hedge fund manager Thomas Brown wrote last week that Cap One's positive first quarter "was simply a terrific performance by one of America's great companies," adding that "it marks game over' in the debate between the Capital One bulls and its legion of bears."

That said, analysts are noting that co-founder Nigel Morris has reduced his "scope of responsibilities" at Cap One, which they consider a flag, though it is apparently being interpreted in a number of different ways. One ABS analyst bullish on Cap One believes the company is continually positioning itself as an acquisition target, having visibly moved up in credit on the origination front, among other moves to improve its attractiveness to potential large banks looking to enter into or expanding their credit card businesses. Suitors named in bank research have included Barclays, JPMorgan Chase and Royal Bank of Scotland. Basically, with more than $40 billion in credit card receivables, an acquisition could instantly establish a entity as a major player in the credit card market. For Chase's part, this would almost double its managed card portfolio.

The analyst speculated that Morris' move to vice chairman from president and chief operating officer could simplify an acquisition, shedding the "co-founder situation."

"They've done a lot over the past several months to improve their image," the analyst said. "Now that their loss and delinquency numbers have come back, they become that much more attractive."

Because of its headline issues - namely portfolio transparency complaints, the memorandum of understanding with the Office of the Comptroller of the Currency, and an insider trading scandal involving the company's former CFO - Cap One, at least on the surface, paid to play in the credit card market earlier this month.

According to sources familiar with the deal, Cap One's enticing 39 basis points over Libor was a coup: luring investors, who were hesitant on the name, to do the legwork and meet with management. As a result, investors found a fundamentally sound issue, a more transparent management and spread to boot.

"It was an absolute blow-out success," one analyst said. "Having these earnings further confirms the strategy."

Meanwhile, Barclays Capital researcher Jeff Salmon sees opportunity in Cap One subprime auto paper, which has yet to tighten on the earnings news. Cap One subprime auto trades behind AmeriCredit Corp. paper, Salmon said.

"We've seen some of that paper offered and we think it's good value," Salmon said. "There's some good Cap One buys out there, especially in the subprime auto segment."

Copyright 2003 Thomson Media Inc. All Rights Reserved.


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