There’s really nothing wrong with the shares of Capital One Financial (COF) that a stronger U.S. economy, a more confident U.S.consumer, and an interest rate increase–or two–from the Federal Reserve wouldn’t fix.
It’s just that I don’t see any of these in the cards in the near term–December at the earliest for a move by the Federal Reserve. And the Fed seems to be deep into holding the course until it can collect some evidence that inflation is a real danger (especially with an election looming.)
I bought shares of Capital One for my Jubak Picks portfolio back on December 10, 2015, when it looked like the Fed might actually deliver not just a December interest rate increase but two more increases in 2016. That would have given banks a big boost toward higher net interest margins on their capital and would have been a sign that the Fed was optimistic about the U.S. economy.
If those interest rate increases aren’t pending and if faith in the economy seems increasingly a matter of faith and not data, I think it’s time to call this buy “premature” and sell these shares. Shares of Capital One are up 18% from the June 27 low as of the close today, August 18. (But my position in these shares is still down 13.66% since that December purchase.) That recent gain brings them pushing up against the 200-day moving average at $69.57 and to a position near the top of their recent volatility range as sketched by the Bollinger Bands indicator. The stock has shown a recent pattern of lower highs with the shares failing to reach the April 26 high of $75.91 or the May 27 high of $73.83. The July 14 high was $68.85. By all these measures Capital One is starting to look, if not expensive, at least stretched.
The bank’s second quarter results fed into my decision to sell because they show a bank that is itself acting as if it sees dangers in the economy. For the second quarter, Capital One reported operating earnings of $1.76 a share, slightly below the Wall Street consensus at $1.86.
The miss was largely the result of a build in reserves as the bank added $465 million to the money it has put aside for troubled loans and credit card accounts. $298 million went toward reserves for the bank’s big U.S. credit card business, but the bank also set aside $58 million largely for its subprime auto loan portfolio.
The caution evidenced in the results as of the end of June looked well founded when the bank reported on July operations recently. Credit losses in its international credit card business rose 12 basis points to 3.64%. Credit losses were down 12 basis points from June but up 76 basis points year over year. Dollar delinquencies rose 18 basis points as percentage of loans from June. Credit card loss rates historically improve in the second quarter at Capital One and then increase again in the fourth quarter.
In its second quarter earnings call bank management said that it expects to see margin compression in the second half of the year driven by declining margins on auto loans and by the current and continuing low level of interest rates. (In July credit losses from auto loans increased by 25 basis points to 1.71% from June. That’s only a tick higher than the 1.70% rate of credit losses in June 2015.
Wall Street analysts have been lowering their earnings estimates for the third and fourth quarters of 2016. The consensus estimate of $2.08 for the third quarter 30 days ago is now down to 1.96 a share. For the fourth quarter the consensus estimate of 30 days ago at $1.70 has crept lower to $1.66 a share.
I still like the bank’s credit card business as a driver of future revenue growth but I just think the current interest rate environment makes it very hard for the bank to generate earnings growth from this business.
Time to review these shares when Fed policy clearly turns toward higher interest rates.