Capital One Outlook Lowered by Moody's Amid Coronavirus Scare

As the coronavirus-induced economic slowdown weakens creditworthiness of borrowers, Capital One Financial Corporation COF and its bank subsidiaries’ outlook has been downgraded to negative from stable by Moody’s Investors Service — the rating services arm of Moody's Corporation MCO.

However, ratings of the company along with its subsidiaries have been affirmed. Capital One and its subsidiaries’ senior long-term unsecured debt ratings have been affirmed at Baa1. The long-term deposit rating of the subsidiaries has been affirmed at A1.

Rationale Behind the Rating Affirmation

The strength in Capital One’s credit card business along with its solid liquidity and funding profile is the main reason for the ratings affirmation.

Capital One’s credit card segment continues to show strength. In first-quarter 2020, Domestic Card, which accounted for more than 91% of the Credit Card net revenues, reflected rise in loans held for investment and increasing purchase volumes on a year-over-year basis.

Moreover, its subsidiaries have a well-established branch network along with a leading direct banking platform. The banks’ strong liquidity position also protects it against any severe disruption in the funding markets.

Reason Behind the Outlook Downgrade

Per Moody’s, Capital One will likely face significant strain on its credit quality and earnings in the coming quarters in case the downturn, resulted from the coronavirus outbreak, lasts longer than expected.

This is because the pandemic has already started to result in a contraction in the U.S. economy. Moreover, because of the lockdown, business activities have come to a halt and unemployment levels will likely rise rapidly within the United States.

As a result of these, creditworthiness of borrowers will weaken, forcing banks to significantly increase allowances. Loan delinquencies and charge-offs will also increase significantly.

These are expected to hurt Capital One’s earnings and asset quality because the bank has high exposure to industries that are hit hardest by the slowdown such as commercial and consumer lending.

So, as the bank’s ability to absorb unexpected losses reduces, its profitability will weaken.

In first-quarter 2020, Capital One recorded a significant rise in provision for credit losses on a year-over-year basis to $5.42 billion. The rise was due to the economic uncertainty due to the pandemic, and deterioration in the oil and gas industry.

Also, net charge-off rate increased 8 bps year over year to 2.72%.

Notably, even S&P Global Ratings has revised the outlook downward for Capital One from stable to negative. The rating agency lowered outlooks of 13 banks, including Capital One, Ally Financial ALLY, East West Bancorp EWBC and others.

What Could Lead to an Upgrade in Ratings?

Capital One’s outlook could be upgraded if the risks associated with the pandemic decreases, resulting in an improvement in operating conditions that Moody's expects would allow the firm to return to pre-coronavirus crisis profitability, asset quality and capital levels within the next 2-3 years.

What Could Lead to a Downgrade?

The outlook could be downgraded further if the bank’s capitalization weakens materially, such as tangible common equity to risk weighted assets falls and remains below 10% or if its asset performance is weaker than Moody's currently expects, given the present economic environment.

Conclusion

Deteriorating credit quality remains a major near-term concern for Capital One. While a solid liquidity position, strength in credit card and online banking businesses, efforts to expand inorganically, and rise in loan demand are expected to aid revenues; lower interest rates amid the Federal Reserve's accommodative policy stance will likely hamper growth to some extent.

Shares of the company have lost 39.8% over the past six months compared with a decline of 42.6% for the industry.

Currently, Capital One carries a Zacks Rank #4 (Sell).

You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

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Moodys Corporation (MCO) : Free Stock Analysis Report
 
Capital One Financial Corporation (COF) : Free Stock Analysis Report
 
East West Bancorp Inc (EWBC) : Free Stock Analysis Report
 
Ally Financial Inc (ALLY) : Free Stock Analysis Report
 
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