The term “widow and orphan stock” dates back to the 1930’s and is used to describe “mature companies with fat dividends” and strong market positions. Placing an estate check or life insurance payout in this asset class would provide reliable, lifetime income.
After the Fed’s recent ruling on Comprehensive Capital Analysis and Review (CCAR), you will not find many bank stocks in that category, at least for a while.
Second Quarter 2020 results are in for many banks, and today’s WSJ covers the topic in a piece titled “The Deck is Stacked Against (Credit) Card lenders.”
- Capital One COF +2.20% Financial Corp. reported another big quarterly loss Tuesday, as it set aside $2.7 billion for potential credit defaults. In light of the Federal Reserve’s new bank dividend policy, the lender now expects to slash a planned 40 cent quarterly dividend to 10 cents. There’s a potential opportunity for investors in beaten-up card lenders. But it may not pay off for a while.
This is certainly no surprise to Capital One, a credit card lender that mastered portfolio analytics early in the history of credit cards. Capital One is known for its ability to lend on the fringes of credit, price effectively, and, most importantly, collect on risky accounts.
- With Capital One’s significant reserves socked away and a dividend cut priced into the stock, it is tempting to believe that the worst might be over, especially if more stimulus is on the way to help borrowers keep making payments. Like Ally Financial, Capital One’s still-strong credit performance measures and most positive experience with forbearance programs do suggest that on present trends, credit losses may not approach the dire scenarios banks are reserved against.
Yet, credit risk is not the sole exposure. The WSJ cites interest income margins as another issue. Credit losses affect net non-interest income Here we have a problem of revolving accounts paying down their balances.
- But reserves aren’t the total earnings story. Capital One also reported a sharp drop in net interest margin, a full percentage point from the first quarter to the second quarter. One driver of that is lower interest rates. Another is that the same stimulus helping consumers avoid default is also leading some to save more and pay down credit-card debt. The bank described this as “the flip side of good credit” and a “hidden factor” in slow growth.
- Still, this dynamic puts investors in a tight spot. If government stimulus is extended, Capital One and other card lenders may not add much more to allowances, helping future earnings. But unless the economy is also concurrently picking up to drive spending and not saving—a big question mark right now—stimulus won’t fully relieve the pressure.
- As a committed consumer lender, Capital One could nab market share if its big-bank competitors are forced to be more cautious about balance sheet growth. But that is a longer-term story, and investors can expect a bumpy ride.
Capital One is typically a good tool to use when considering credit cards because of the company’s reliance; about 2/3rds of its revenue comes from that channel.
For the fixed income market, investors need to keep in mind that the current business cycle is less than smooth, though it will likely rebound as COVID-19 tempers. The problem is that the timing is still unknown and out of the market’s control.
Overview by Brian Riley, Director, Credit Advisory Service at Mercator Advisory Group
