Calling the recent mortgage market meltdown "an unexpected shock to the system," Capital One Financial Corp.'s chief executive said he is nonetheless confident about the long-term strategy of his move into retail banking.
The tougher environment prompted the company last month to shutter mortgage origination operations acquired in its recent deal for North Fork Bancorp, a deal it had framed as a strategic coup less than a year ago.
"There is a paradox to the situation," said Richard Fairbank, who is also the $145 billion-asset McLean, Va., company's chairman. "We bought a bank in order to have a stronger balance sheet to reduce our exposure to capital markets disruptions," he said, but the "meltdown in the mortgage industry" was "unexpected."
Mr. Fairbank spoke last week about
Commenting on the mortgage crisis, he said, "This is the first time that I've been through such a cycle. When the second wave hit, we were left with the choice of massively putting loans on our balance sheet or shutting it down. We didn't feel that we were in the position to underwrite the risk in order to hold it." He added, "It's a lot harder to ride the cycle down when the destination on the other side is so unclear."
Mr. Fairbank, who describes himself as a longtime skeptic of national mortgage origination platforms, said he pursued the $13.2 billion deal for North Fork to bolster Capital One's funding base and reduce its reliance on securitizations.
"We didn't want to rely on one asset class," he said. "The reason why we made our move is really being played out in the marketplace right now."
He said he had had lingering reservations about running a mortgage business, calling it "the only argument against" buying North Fork. The deal closed Dec. 1. However, he said, Capital One tried to make it work, tightening standards last year and cutting GreenPoint's staff by 20% when the market became more volatile in March.
Mr. Fairbank said he finally became persuaded last month that Capital One should quit the wholesale mortgage business after further deterioration in the capital markets and growing evidence that the nonconforming-mortgage business, in which GreenPoint was a major alternative-A originator, would never return to form. Through midyear the mortgage division had posted a $10 million loss, compared with a $34 million gain a year earlier while it was part of North Fork. Capital One retained a $50 billion servicing portfolio from GreenPoint along with the unit's small-ticket commercial lending platform.
GreenPoint has become a costly case of irony, causing Capital One to twice trim its 2007 earnings guidance. The company expects $860 million in charges tied to closing the platform and the firing of 1,900 employees, which is scheduled to happen by yearend. It also is in the midst of a companywide cost-cutting effort announced in June that is expected to cut 2,000 jobs and cost $200 million.
Mr. Fairbank said the company has completed several infrastructure projects and no longer needs as many people. "Cost-cutting is a never-ending exercise," he said, "and a key way to create value is to be more efficient."
Capital One had originally projected that the mortgage business would generate up to 15% of the $275 million in bottom-line synergies it expected.
"Obviously, those synergies have evaporated," Mr. Fairbank said, though he remains convinced that Capital One will benefit from the bank-acquisition strategy that began with the purchase of Hibernia Corp. of New Orleans in 2005.
Though the company will be pressed to offset the loss of GreenPoint, he said, he believes that it can still realize the North Fork synergies by late next year through other means.
For one, Mr. Fairbank said, the company's issuance of $1.5 billion in senior notes on Sept. 4 might not have gone so well in current market conditions — at least not at favorable terms — without the ratings it obtained because it has a banking platform. Since Capital One last issued notes, in March 2005, Moody's Investors Service has raised its rating for the company to A3, from Baa3, and Standard & Poor's hiked its rating to BBB-plus, from BBB-minus.
Having dealt with the GreenPoint issue, Capital One must now deal with its fledgling bank division, where it is just months away from integrating North Fork's more than 350 branches. The unit is contending with more than the mortgage meltdown. Some of its problems stem from an unfavorable yield curve. Capital One decided before the deal closed to delay the branch conversion until early 2008, and it has pared back a branch expansion.
Last month, John A. Kanas, the former North Fork chairman and chief executive who was running Capital One's banking business, relinquished his post earlier than expected. Before departing, Mr. Kanas said in an American Banker interview that his employer lacked "a well-defined strategy that they're ready to put their shoulder behind aggressively."
Mr. Fairbank on Wednesday said that Capital One does have a strategy for banking, which is led now by Lynn Pike, a former Bank of America Corp. executive who succeeded Mr. Kanas. The focus is to steer the more than 5 million Capital One cardholders who live in the bank's geographic territories into the branch network. "We will rely on our name recognition and consumer orientation," he said.
Capital One will offer more "competitively priced" consumer products, he said. Though it is accepting applications for and servicing credit cards and auto loans in its branches, he said, such offerings "are not being aggressively peddled" in the former Hibernia branches, and there are limits on what North Fork can offer until the branches are converted. He said that the company would more aggressively market consumer products by mid-2008, if not sooner, and that he is confident the existing work force can be trained to sell more consumer products.
Mr. Fairbank said the banking division remains a top priority at Capital One and that most of the 2,000 job cuts announced in June are coming from the company's corporate offices and other business lines. The only cuts to be made in the bank division are the ones that were previously included in the company's plan for combining the two banks that it bought. "In the case of North Fork, it was already a very efficient bank," he said.
He has no plan to expand with more bank acquisitions, Mr. Fairbank said, even if it would connect the Hibernia footprint in Louisiana and Texas to North Fork's New York stronghold. "There is no need to be truly national in branch banking … , and we certainly don't feel a need to connect the north and the south," he said.
Craig Maurer, an analyst at Credit Agricole SA's Calyon Securities, said Capital One is making the right choices, though he said questions about North Fork will linger throughout next year. "Closing GreenPoint eliminates what would have been a distraction over the next six to 12 months," he said in an interview. "Most people felt that they overpaid for North Fork and that they should have had better vision" about the mortgage business. "We'll see how things go after they rebrand North Fork. That's the real litmus test."
Analysts are also watching credit quality within Capital One's other businesses, such as credit cards and auto lending, where chargeoffs and nonperforming assets are in the rise. The company also raised some eyebrows by announcing that it had stopped courting prime cardholders to focus on subprime ones.
Meanwhile, it has attributed most of the credit-quality changes to "normalizing" credit trends after the enactment of bankruptcy reform in October 2005 and forecast that chargeoffs should remain below historical highs through the rest of this year.
Mr. Fairbank would not provide guidance beyond this year, though he said that credit quality for now "is coming in right on top of projections" and that the meltdown in subprime mortgages "doesn't seem to have significantly spread into the other consumer credit businesses."
Scott Valentin, an analyst at Friedman, Billings, Ramsey Group Inc., said that he is not overly concerned about Capital One's credit card changes. "They only want the most profitable customers," he said in an interview. "Their ability to price risk appropriately is very good, and they're cautious about extending large credit lines."
This puts the focus even more on banking. "This is still a company in transition," Mr. Maurer said. "I'm not afraid that the bank division is going to fail, but it's clearly where they lack the most in expertise and where they have the most hurdles ahead of them."
