Capital One Case Study Essay

In consumer l block uping, e very product is evolving in the resembling wariness as character tease-toward mountainous, subject-scale consolidators replacing local, face-to-face impart. That evolution has happened in exdecadesion greenbacks. Its easy under way in machine finance, owes, and cornerstone equity. Its coming more slowly in installment lending. So consumer lending, a major part of the asset side of vernacularing, is all flowing toward national consolidators like cracking nonpareil. -RICHARD D. FAIRBANK, CEO AND CHAIRMAN, CAPITAL unrivaled FINANCIAL sensjoined Kingdom, the Hfs Group, to fort its Global Financial serfeeblenesss (GFS) subsidiary in the British securities assiduity. As of April 2005, it possessed sufficient liquidity ($21 one million million million) and great(p) ($9.2 billion)4 to enable its famous betray to hold out into new commercializes and seize the objurgate opportunities for gainful step-up. Although the confederacys acqu isition of Hibernia in barelyt 2005 provided it an chance to enclose the fast-developing Texas food grocery inserts of Houston and Dallas, it might face stiff argument from oppositewise(a) large ac book of facts companies, much(prenominal) as Citigroup and J.P. Morgan. great(p) whiz Financial confederation is a diversified till holding political party, with a 2005 marketplace prise of $18.92 billion. It provides a gamut of fiscal services through its main subsidiaries- nifty champion Bank, keen integrity FS.B. (which offers consumer and commercial lending and consumer deposit products), and superior angiotensin-converting enzyme political machine Finance Inc (COAF). From a small local bank nib issuer in 1995, the friendship has alter itself into one of the largest financial institutions in the coupled States by continuallyintroducing a steady stream of products. It features one of the most recognized brands in the industry, which it leverages along with its strategies of direct marketing, risk analysis, and information technology to grow and diversify into otherwise railway painses.Ranked 206th in the Fortune 500 list in 2005,2 the company has been gradually transforming itself from a identification machined company to an institution that provides banking and other financial services to consumers. By January 2005, it was the 31st largest deposit institution in the United States with $25.6 billion3 in inte perch-bearing deposits. corking cardinal has been on the runway of diversification from the late 1990s and has do trinity acquisitions between 2004 and 2005 Onyx acceptation flowerpot, eSmart contribute, and Hibernia National Bank. It has overly ascertaind a foot equity brokerage company in the capital of the United States matchless is the fifth largest citation account provider in the United States5 and one of the largest issuers of MasterCard and endorse credit cards. It was founded as a wholly owned subsidia ry of Virginia-based Signet Bank when Richard D. Fairbank, CEO and chairman of bang-up superstar, was invited by the bank to head its bankcard division.It began its trading operations in 1953, the same grade MasterCard International was formed. Fairbank and the former vice chairman of heavy(p) iodine, Nigel Morris, cognise that conventional banks offered loans without focusing on the customers-like analyzing their risk characteristics. They decided that by using technology and data mining techniques in the decision- making process of providing credit, the bank could clap the appropriate entertain rates more accurately and earn greater profits. In 1994, Capital One was spun off from Signet as a cosmos credit card company and established itself in McLean, Virginia. It had an initial macrocosm crack of 7,125,000 sh ares of common pedigree in the United States and Canada, at a price of $16 per share,6 which was managed by J.P. Morgan Securities Ine., Goldman, Sachs & Co. a nd Barney Ine. It is a part of the S&P 500 index, and also trades on the New York Stock Ex transport with the symbolisation COF This case was written by Susmita Nandi, under the direction of Sumit Kumar Chaudhuri, ICFAI Business trail Case Development Centre. It is intended to be used as the hindquarters for class discussion rather than to illustrateeither effective or ineffective handling of a management situation. The case was compiled from 25 print sources. 2005, ICFAI Business School Case Development Centre. No part of this issuing may be copied, stored, transmitted, reproduced, or distributed in any form or medium whatsoever without the permission of the copyright owner.Between 1994 and 2004, the company grew at an annual compound rate of 29 pct/ both in terms of its EPS and the number of customers. In 2004, its profit were $1.5 billion, and the EPS was at $6.21.8 At the end of 2004, the company and its subsidiaries held 48.6 one gazillion cardinal jillion accoun ts and $79.9 billion9 in managed loans salient, which grew by 12 share ($8.6 billion) over the previous year (see queer 1). It had 17,760 employees in borderland 2005. The bank offers 7,00010variations of its MasterCard and Visa cards, each one is customized to appeal to different customer preferences and needs by combining product features much(prenominal) as different backgrounds and colors, along with massive-ranging annual percentage rates, credit limits, fees, and rewards programs. Capital Ones set system is based on the risk level of its customers.It offers platinum and meretricious cards to its preferred customers with excellent credit history and a wide range of secured and unsecured cards to customers with throttle or poor credit history. The company also provides a range of consumer products like auto finanCing, mortgage services, credit insurance, and home-equity loans. Customizations of credit cards at Capital One are made with the birth of its Information-Ba sed Strategy (IBS), which uses sophisticated data-mining techniques to match its credit cards (its combination of interest rates, fees, rewards, and other conditions) with targeted customers based on their credit scores, credit uses, and other parameters. IBS is the fusion of one of the worlds largest databases, information arrangings, a well-trained team of analysts and statisticians, and advanced scoring models. The companys decision-making process is made efficient by bringing together marketing, credit, risk, and information technology. It selects its most profitable customers and the appropriate rate by using the rigorous testing of econometric and time series models.The credit ratings of customers is based on the Fair Isaac Corporation (FICO) scores, which are used to predict reconcilement risk by smell at several variables, including credit history. TheIBS system uses FICO scores to divide its customers into three groups of super-prime (with excellent credit history), prim e (average credit history), and sub-prime (with poor or very little credit history). Through the use of IBS, the company has been able to prove a group of students who were not included in the mailing lists of other credit card companies because these students, generally unemployed and little or no credit histories, were considered high risk.Capital Ones strategy of send credit card applications, which were tailored to the needs of these students, proved effective, as 70 percent of the applications were filled and mailed back, thus cr ingest a new market for the company. IBS has also helped Capital One avoid customers who do not pay interest charges on loans. The charge-off rate (for bad debt) of Capital One is the industrys lowest, and for 2004 was at 4.37 percent, compared to 5.32 percent in the previous year.Capital Ones GFS segment offers a portfolio of diverse products to both domestic and worldwide consumers. In the domestic market, the GFS segment includes installment lend ing, health care finance, mortgage lending services, and small business organisation lending services. GFS has been on a growth curve and in 2004, it accounted for 27 percent of Capital Ones total managed loans, which are comprised of reported loans and off- equalizer sheet securitized loans. It also accounts for 14 percent of its earnings. Its external portfolio primarily consists of credit card business in the United Kingdom and Canada, valued at $8.2 billion and $2.4 billion,12 respectively. Capital One is the United Kingdoms seventh largest credit card issuer, and among the top ten of the same in Canada. In January 2005, the company completed the formalities to spring up a British equity brokerage firm called Hfs Group to strengthen its model in the United Kingdom. Although Capital One had holdings in France and southwesterly Africa, it exited these markets due to lack of growth opportunities.Capital One generated strong earnings and loan growth again in 2004, as it has each year since its initial public offering ten years ago. The company is well positioned for continued success in 2005 in both our Us. credit card and our maturement and profitable diversification businesses. -RICHARD D. FAIRBANK, CHAIRMAN CAPITAL AND CEO, CORPORATION ONE FINANCIALCapital One grew at 30 percent14 (see Exhibit 2, on page 68) between 1994 and 2004 by issuing credit cards at attractive interest rates. Most of its business is conducted via direct mail (junk-mail solicitations), although it also markets its products through television and Internet (http//www .capitalone.com). It expanded its credit card operations in Canada, Europe, and South Africa in the late 1990s. At the same time, the company also made strategic moves toward diversifying its portfolio by entering into finance of automobiles and other motor vehicles, mortgage and home equity loans, insurance, and other consumer lending products.Although 60 percent of its total managed loans is in its credit cards busi ness (see Exhibit 3, on page 68), the company is gradually increasing its operations in other business segments. In 1998, Capital One bought Amerifee, a company that provided financing for elective surgeries such(prenominal) as orthodontic, vision, and cosmetic procedures. It became a wholly owned subsidiary of Capital One in may 2001. Amerifee is a market leader known for introducing Orthodontists lean and Dental Fee plans in 1993 and 1998, respectively. These fee plans are the largest patient payment plans in(dollars in millions, except per-share data)Reproductive Endocrinologists and infertility clinics. IS The subsidiary formally became Capital One Healthcare Finance in April 2005. Capital One soon realized that the auto financing market is double that of the creditcard market, and because it has a strong growth cap index in that segment. This market is passing fragmented and no company holds more than 20 percent16 of the market share. It provided an chance to Capital One Auto Finance Ine. (COAF) to participate innovative offers and adjoin its market share. COAF added $163.8 millionl? to the companys earnings in 2004, and has continued to be on a high growth curve. To strengthen its market position in the automobile finance segment, the company acquired ONYXAcceptance Corporation (Onyx) for $191 millionl8 (in an all capital transaction) on January 11, 2005. It also acquired InsLogic, an insurance brokerage firm, from Onyxs management team.The bargain for strengthened the Auto Finance subsidiary of Capital One and heighten its dealer relationships, coastto-coast market penetration in the United States, and its product line among the prime borrowers. Onyx is based in Foothills, California, and provides automobile loans to certain independent and right dealerships all over the United States. Onyx claims to mystify purchased and securitized $10 billionl9 in auto loans since its inception in 1993, and will add 12,000 new dealerships to Capital One s list. According to David R. Lawson, Capital Ones executive director vice president, and president of COAF, This transaction combines two strong franchises with complementary strengths.Onyxs monumental and long-standing presence with California dealerships coupled with its strong prime product offering fills out both COAFs product line and geographic footprint. Together, we watch to realize significant revenue and cost synergies20 This acquisition may make COAF the second largest auto lender in the United States. COAF has proclaimed that it has raised its car loan limit to $100,00021 (previously $75,000) for direct-toconsumer vehicle loans that gather in originated from its vanesite (http//capitaloneautofinance.com) in February 2005. This move was made in response to the growing demand for luxury cars such as Corvette by Chevrolet, so that the company can get more business from this customer segment. This extension is limited to only those with excellent credit histories (sup er-prime customers). The vice president of COAF, Brian Reed, said, Car buyers have more choices than ever today at the higher end of thecar spectrum, so weve adjusted our limit to offer consumers greater flexibilit/22 The agonistical advantage of COAF is that the loan process takes place on the Internet and requires no legacy fees.Also, its IBS system allows it to charge varying interest rates depending on the customers risk levels. In February 2005, Capital One purchased eSmartloans .com for $ clv million,23 one of the largest online providers of home equity loans mortgages in the United States. Headquartered in terrestrial Park, Kansas, the company offers a variety of products that are marketed and delivered directly to homeowners. The purchase is meant to cover Capital Ones offering of consumer loans and deepen its position in the growing US. home equity market. Larry Klane, Capital Ones executive vice president of Global Financial Services, said, eSmartloan has succeeded in b uilding a scalable technology platform, a highly skilled sales team, and an outstanding reputation for customer service and speed to close.By combining these strengths with Capital Ones powerful national brand, access to 47 million accounts, and expertise in direct marketing, we will enhance the growth of our home equity lending business24 In early March 2005, Capital One announced its decision to purchase Hibernia National Bank. Hibernia is the largest bank in Louisiana,2s with 316 branches in Louisiana and Texas, and $17.4 billion26 in deposits. It provides a wide commixture of financial products and services through its banking and non-banking subsidiaries that ranges from deposit products, small business, commercial, mortgage, private and international banking, to trust and investment management, brokerage, investment banking, and insurance. Capital One paid a 24 percent premium over Hibernias closing stock price of $26.57 as on March 4, or $33 per share,27and a total of$5.3 bi llion for the purchase.The merger is expected to cost $175 million in restructuring expenses and result in near-term synergies of$135 million.28 According to Fairbank, This acquisition is a natural extension of the diversification strategy we have been pursuing for just about time. The transaction brings together two financial companies with complementary strengths and represents a induce long-term value proposition for shareholders of both companies. Hibernias leading market share in Louisiana and its promising Texas branch expansion score not only a solid growth platform as we continue to expand, but also an additional source oflowercost funding. Additionally, we cerebrate our national brand, 48 million accounts, broad product offerings, asset contemporaries capabilities, and market expertise will drive profitable growth in branch banking 29 Capital One wanted to purchase a commercial bank with a strong management team and a large local market share. Hibernia has both these q ualities as well as the potential to expand extensively into Texas markets. Currently it has only 109 branches in Texas, but the cities of Dallas and Houston are number 2 and 3 in terms of meteoric growing markets in the metro cities, a seemingly untapped potential for capturing market share in that region.30 The main advantage of purchasing Hibernia is that Capital One gains access to a lower cost of funding at 1.38 percent against a rate of 4.24 percent.3l One third of Capital Ones funding is obtained from the deposits in its fully owned Internet bank at 4 percent, which is higher than that paid by any of its rivals.The rest of it comes from securitization, which is risky as well as costlier than its other avenues of sourcing funds. It can ontogeny ratio of funding from deposits from the previous 30 percent to 40 percent,32 to support its lending operations in the areas of credit cards, auto finance and mortgages. getting Hibernia is also expected to increase its profit margins due to decreased interest expenses and bring stability to its businesses of consumer lending and other financial products. It now has the ability to use Hibernias brick -and- mortar branches as a launching eke out to market its range of offerings in combination with its IBS techniques. The deal also provides Capital One with the opportunity to enter the debit -card market and also introduce its own home equity credit line.Early in the twenty-first century, the US. credit card industry witnessed a high level of contender and was also going through a phase of consolidation. For example, J.P. Morgan merged with follow in 2000, and the unite group merged with Bank One in July 2004 to form the second largest US. bank holding company with a combined asset base of $1 trillion33 and 19.1 percent of the total credit card market share. The US. consumer debt amount of $2.1 trillion (Federal Reserve Bank data) in January 2005 was mostly due to the top ten credit card companies, which held 8 5 percent of the market share.34 Market share of Capital One in the credit card segmentfell from 7.2 percent in 200Ys to 6.8 percent (see Exhibit 4) in 2004.Capital One was left with no innovative ideas such as being the first bank to offer automatic balance transfers, which could grab business from other banks. The rise in personal bankruptcies and the economical recession between 2001 and 2004, coupled with the saturation of the credit card market diminished growth opportunities for Capital One in that market. Thisnecessitated its diversification into other consumer lending operations through different distribution channels such as Hibernia. Capital One has been bombarding the Internet, radio, and television with its advertisement, Whats in your purse? with one of the versions featuring the famous Hollywood comedian David Spade (Appendix 1). It spent $285 million on advertisements, a total marketingexpense of $1.3 billion36 in 2004 and $5.4 million in January 2005,37 which was mo re than competitors such as American Express. In a consumer survey conducted by USA Todays weekly poll, 30 percent of the people dis like the advertisement, while 12 percent liked it a lot suggesting that it did not receive the popularity it wanted.It was opined that the advertisement expense has been eating into Capital Ones profits. Another potential hurdle for Capital One is its potentially risky source of funding from securitization. It pools together the loans it originates and invests pieces from that accrual in different securities. Because the investment is dependent on the stock market price fluctuations, this source of funding involves a great deal of doubtfulness and risks of monetary loss. It has also amassed a large portfolio of sub-prime customers as it relies on its IBS system to guide it toward greater profit margins (related to greater risk), without incurring heavy losses. ascribable to federal regulations and a great many of its customers defaulting on their lo ans, Capital One had to shift away from subprime to a greater proportion of prime and super-prime customers.This change led to smaller margins as the company offered an introductory rate of 9.9 percent to its super-prime customers vis-a-vis a rate of25.9 percent3s charged to sub-prime customers who are associated withhigh fortune of delinquency. In July 2002, the company disclosed its decision to tighten controls over its loan disbursements (mainly to sub-prime lenders) to meet the banking regulators demands, leading to a 40 percent decline39 in its shares in one day (Appendix 2). Management of Hibernias branch banking and its non-consumer lending operations, subsequently the merger is complete, might pose a challenge for Capital One because it lacks experience in those fields.The non-consumer lending portfolio consists of commercial and industrial loans (C&I) and commercial real-estate (CRE) loans. Hibernias combined portfolio of C&I and CRE is worth $4 billion,40 and its small b usiness portfolio is valued at $3.2 billion. The challenge will be to efficiently unify Hibernia into its system and strategy, which includes incorporation of its retail branch banking, and review of its business and asset integration plans. For the short term, it might need to rely on Hibernias management team in making any strategic decisions. instigate of the strategic long-term vision, as announced by the company is to expandfurther into the state of Texas, especially in Dallas and Houston, and establishnew branches there. In expanding in that direction, Capital One is likely to face stiff competition from several major players in the credit card and banking industry such as JP Morgan, Citigroup, Bank of America, and American Express.It may be difficult for Capital One to steal any business away from these giants, even with its innovative ideas and products, because the bigger players have strong presence in that region. Analyst and credit rating agencies like Fitch have warne d that Capital Ones growth depends on its ability to aggreSSively defend and maintain market positions in the states of Louisiana and Texas. Fairbanks said, Were well positioned to continue our profitable growth. Financially, weve never been stronger. Our flagship credit card business is thriving.Were successfully taking IBS, the strategy that made Capital One a winner in credit cards and auto finance, to new businesses. And, we have a powerful brand and huge customer base to fuel our growth and diversification. Our people have pulled together to make Capital One the strong, diversified company it is today. And I am confident that they will sustain our momentum as we enter our second decade as a public companyM. McNamee, 2005, Capital Ones concrete step, http//www .businessweek.com, March 11. http//wwwfortune.com. http//wwwcapitalone.com. Ibid. N. Slaughter, 2005, Capital One shells out http//wwwfoolcom, March 7 1994, Capital One financial corporation completes initial public offeri ng, http//wwwbusinesswire.com. http//wwwfortune.com. Ibid. 2005, Capital One to acquire Hibernia Corporation for $5.3 billion in stock and cash, http//biz.yahoo.com, March 6. M. McNamee, 1999, Capital One Isnt there more to life than plastic? http//wwwbusinessweek.com. http//wwwcapitalone.com. Ibid. http//wwwcapitalone.com. 2005, A capital idea, http//wwweconomist.eom, http//wwwcapitalonehealthcarefinance.com. Ibid. http//wwwcapitalone.com. Ibid. http//wwwonyxacceptance.com. http//wwwcapitalone.com. 2005, Capital One announces new online auto loanlimit of $100,000, http//wwwpwrebdireCl.com. February 25. Ibid. March 10. November 22. November 15.http//wwwmccollpartners.com . http//wwwcapitalone.com. Louisiana is one of the southern-most turn up between Texas and Mississippi. A capital idea, op. cil.states in the U.S. and is2005, Capital One purchase Hibernia for $5.3B, http//wwwcnnmoney. com, March 7 http//wwwCapitalone.com. Capital One to acquire Hibernia Corporation for $5.3 billi on in stock and cash, op. cil. Capital Ones concrete step, op. cil. A capital idea, op. cil. Ibid. 1 Locke, 2005, Bank One, JPMorgan merger ups the ante in Colorado banking game, http//wwwbizjournals.com. A capital idea, op. cil. March 25K. Maguire, 2005, Capital One rolls with the punches, http//news.yahoo.com, March 21 http//wwwcapitalone.com. M. McCarthy, 2005, Capital Ones Whats in your wallet? ads filling airwaves, http//wwwusatoday.com. March 13. S. Maranjian, 2005, How to owe $40,000 by doing nothing, http//wwwfoolcom, February 11. R. Barker, 2003, Whos minding the store at Capital One? http//wwwbusinessweek.com. March 24. 2005, Fitch places Capital One on rating watch positive Hibernia on watch negative, http//wwwbloomberg.com. March 7 http//wwwcapitalone.com.