Capital One's (COF) multibillion-dollar acquisitions of ING Direct and HSBC's U.S. credit card portfolio are underperforming expectations.
On Thursday after the market closed, the McLean, Va., bank issued profit guidance for 2013 that underwhelmed investors. Capital One said it expects to earn, on average, the same amount per quarter that it made in last year's fourth quarter. Those quarterly results missed analyst forecasts.
One factor in the fourth quarter was a rising provision for credit losses, driven in part by the HSBC acquisition. Analysts also questioned the company's ability to retain or replace the retailing partners inherited from that deal. Capital One's stock price dropped nearly 8% in midday trading Friday.
"I think people are disappointed with the earnings power with these two deals," said Mike Taiano, an analyst with Telsey Advisory Group.
Capital One also said the HSBC and ING deals created $2.5 billion less in goodwill - the amount by which a purchase price exceeds the value of identifiable assets - than it originally anticipated.
During a conference call with analysts Thursday, Capital One Chief Executive Officer Richard Fairbank stood firmly behind the deals.
"As for both ING Direct and HSBC, we continue to believe that they are both financially and strategically compelling, and we are as excited about the acquisitions as we were the day we announced them," Fairbank said. "This is true even though the acquisition impacts will play through our 2013 financials differently than expected at announcement back in 2011."
The ING deal was designed to give Capital One a cheap source of funding, while the HSBC purchase was intended to provide a pool of high-yielding assets.
Capital One paid a $2.6 billion premium for the $30 billion card portfolio and $9 billion for Dutch giant ING's U.S. online banking unit. To get the ING acquisition approved by regulators, the company had to go through an arduous process, overcoming the objections of community activists who charged that the new company would add to systemic risk.
Analysts gave differing assessments Friday of the two acquisitions, both of which were announced in 2011 and closed last year.
Sanjay Sakhrani, an analyst with Keefe, Bruyette & Woods, trimmed his 2013 and 2014 earnings estimates for Capital One on Friday. Though he maintained his bullish stance on the stock, Sakhrani indicated some concern about Capital One's ability to integrate the two acquisitions.
"Clearly a large part of the value creation story is based on the success or lack thereof for management to integrate the acquisitions of HSBC's U.S. card portfolio and ING Direct," Sakhrani wrote in a research note. "At this point, it still appears like it was the right move to make these acquisitions."
But Scott Valentin, an analyst with FBR Capital Markets, doubts that the two acquisitions are to blame for Capital One's diminished earnings power. He notes that Capital One had posted stronger results in the third quarter of 2012, after both deals had closed. "I think investors are frustrated with the volatility quarter to quarter," Valentin says.
Capital One's credit card delinquencies have been higher than those of some competitors, driven in part by the HSBC portfolio, which includes store-branded cards, generally considered riskier than general-purpose cards.
In the fourth quarter, the company made a $1.2 billion provision for credit losses, up $137 million from the previous quarter.
In addition, many of the contracts with HSBC's onetime retail partners have expired, prompting some concerns about Capital One's ability to renew those relationships.
"We have a very selective strategy," Fairbank told analysts Thursday, referring to the renewal of existing retail contracts and the pursuit of new ones. "We're going to make sure that we do this on terms that really work."
Capital One's share of credit card loans outstanding has stagnated recently, but Fairbank said that is no problem, since the company courts cardholders who generally pay their bills in full each month more than those who tend to carry balances.
"We're also very focused on finding customers who are not intense, balance-hungry customers, but who represent great long-term customers," he said. "That's been our strategy for years, and I think it's worked very well."
The focus on convenience users is designed to provide a shield against downturns in the economy, according to Valentin.
Fairbank contrasted Capital One's approach with those of certain competitors, though he didn't single out any by name.
"You have a number of competitors who have, I think, kind of altered the mix of how they're pursuing the business," he said. "Some competitors that are just really focusing on going right after the top of the market, and some competitors that have been focused on the prime revolver segment and doing a lot of heavy activity there in the sort of teaser rate, high-balance revolver segment."
Citigroup (C) said Thursday that it is only about halfway through its efforts to revamp its credit cards business. Discover (DFS) said in December that balance transfers helped it increase its business in the fiscal quarter that ended in November, but hurt its yield.