CAPITAL ONEFINANCIAL (NYSE: COF)

Analysts: Jing Chen, Hisham Haider Dewan, Harout Sahakian, Caleb Pierson

Company Overview

Capital One Financial, which was founded in 1993, offers various financial products and services in the United States, Canada, and UK. Through strategic mergers and acquisitions, Capital One has become one of the Nation’s top 10 largest banks based on deposits and the fourth largest issuer of Visa and MasterCard credit cards. The company has threereportable segments: Credit Card (Domestic and International), Consumer Banking, and Commercial Banking. In FY2012, the company generated revenuesof $9.1B from Credit Cards, $5.9B from Consumer Banking, and $2.3B from Commercial Banking. Capital One employs 40,000 individuals - none are covered under a collective bargaining agreement. In addition, the company has increased its dividends payments to $.30 per share over the last 3 quarters.

Current Price / Current P/E / DIV Yield / 200 Day MA / Market Cap.
$72.35 / 10.23 / 1.70% / $63.33 / $42.13B

Industry Overview

There are 5,937 FDIC insured banks in the U.S. but seven largest banks hold over 50% of the banking assets. Banks in the U.S. are regulated by Federal Reserve Bank and Federal Deposit Insurance Company. The industry faces competition from credit unions, savings & loan, and other non-banks. The industry in heavily regulated and with the creation of Dodd-Frank Act, there are higher capital requirements. Mergers and acquisitions is a frequent phenomenon as large banks acquire smaller banks to be scale assets and operations.

Financial Analysis, Projection and Valuation

Capital One had a return on assets of 1.5% which is higher than most of the competing firms. The company is well capitalized given its tier 1 capital ratio of 13.1% and total capital ratio of 15.3%. Asset quality of the firm has been improving as Nonperforming Loans to Total Loans has increased from 1.4% in 2009 to 0.5% in 2013. For residual income valuation cost of equity was estimated to be 10.964%. Gross loan was assumed to grow at 10.00% annually Provision for Loan Losses was assumed to be 2% of Gross Loan each year. Major interest rate assumptions each year are as follows:

Interest Income as % of Gross Loans / 9.73% / Interest as % of Deposits / 0.70%
Interest Income as % of Investments / 2.61% / Interest On Borrowings as % of borrowings / 2.04%

Long term ROE every year from 2019 was assumed to be 11.5% and terminal net income was assumed to grow at 2.5%. The comparable companies were chosen based on total asset, total deposit, nature of business (investment banking or commercial banking), and major business segments (credit card, consumer banking).

Residual Income / Comparable / Ben Graham
$ $77.94 / $90.60 / $78.92

Risks

The major risks of the company are increased regulation, increased loan provisioning and defaults, slow economic growth, increase in interest rate, and underperformance of the acquisitions. COF acquired credit card loan portfolio from HSBC, which has not performed up to expectation. The company may be required to write off loans from its balance sheet.

Recommendation

We recommend buying 100 Shares of NYSE:COF at Market Price. This will mean COF will be approximately 4.5% of the portfolio and be the only financial services firm in RCMP portfolio.

DECEMBER 5, 2013Page 1