Saturday, July 25, 2009

Capital One's (COF) Earnings Fantasy

Capitol One SHOULD HAVE reported a net LOSS of $120 million.

Capital One's stockd higher Friday after the Company released earings which were better than expected. They reported net income of $220 million, not including charges related to paying back TARP. Technically the market should care about those charges but I'll let that one slip by. MORE important, COF created their net income out of thin air by reducing their provision for loan losses. They reduced this accounting charge by $345 million from the amount they used the 1st quarter, DESPITE the fact that their total charge off rate spiked up to 9.3% in the 2nd quarter from 7.3% in the 1st quarter and from 6.07% in the 2nd quarter of 2008. If they had just held their provision for losses flat, they would have reported at net loss of $120 million (they will tell your their managed assets declined, HOWEVER, their charge-off rates more than offset this and their NET assets were basically flat, so strike that b.s. from the record).

The charge-off trend is not COF's friend. If anything, they should have INCREASED the amount they "provision" for loan losses, rather than decrease that amount, especially since they "provision" rate is about 1/2 of the actual charge-off rate. IN FACT, investors should penalize COF for not being a lot more conservative in this area of accounting. They even said in their conference call that they expect higher charge-offs in the future, so why do analysts let them get away with this crap?

In their explanation, Capital One wraps a loosely spun story around their reduction in loan loss provision for Q2. Don't believe it. If anything, analysts should be all over that - but they won't be. In another troubling trend, the default rates across all of their lending at their Chevy Chase bank subsidiary have spiked higher again. Another no-friend trend for COF. These business lines include commericial real estate, auto loans and home mortgages. And everyone knows that the charge-offs in credit cards are accelerating higher.

I would imagine that if I took the time to pour over the 10Q when they file it, I would find that is in much worse financial condition than is presented in their fictitious quarterly earnings report and I could decimate their "higher" Tangible Common Equity calculation, which they proudly strutted to analysts and I'm sure is based on more fantasy.

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