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Wednesday, January 23, 2008

Capital One CEO: "Managing as if Recession is here"

by Calculated Risk on 1/23/2008 05:48:00 PM

Quote of the day from Capital One CEO Richard Fairbank:

"Simply put, we're acting divisively and aggressively to manage the company for the benefit of shareholders in the face of cyclical economic head winds. We're pulling back on loan growth, focusing on our most resilient businesses and closely manage credit with the insight and experience we have garnered in prior economic downturns. ... We are managing the company as if a recession was already here.”
Here are some excerpt from the conference call. Note that according to Capital One, in the 1991 recession, the credit quality statistics for credit cards led the unemployment rate by 6 months.
"By intuition -- I certainly believe that some of what we're seeing is early read on economy worsening that may be preceding [economic] metrics. I really do believe that that is going on. I do think, though, we're also seeing a -- a really consumer-led worsening, which in some ways is certainly very different than the kind of sequential dynamics of what happened in the '91 recession."
Capital One is tightening lending standards for auto loans (sounds like the auto industry is in for a really tough year):
"Charge-offs and delinquencies in auto finance have followed expected seasonal patterns in 2007, and continued to worsen from 2006 levels. The combination of rising charge-offs and allowance has driven overall 2007 auto finance results that are clearly unacceptable. We took decisive action to refocus and reposition the auto business through improved performance and a return to better profitability and financial returns. Our actions result in a significant growth pullback and a focus on loans with better credit characteristics across the risk spectrum. We have scaled back our dealer prime business to those with better credit and profitability performance. We focused on originating loans with better credit characteristics by tightening underwriting and steering our originations up market within both the subprime and prime parts of the market. We stopped originating loans to the riskiest subsegments. We're exiting the riskiest 25% of subprime originations from the third quarter and earlier time periods. We have -- this resulted in dramatic improvement in average FICO scores in our prime originations. Today the average FICO scores are 30 points better than prime originations from the fourth quarter of 2006 and 70 points better than prime originations from the fourth quarter of 2005. We were also able to increase pricing on fourth quarter originations as competitive supply decreased. Thus, while originations continued to grow in October and November, the loans we originated had both better credit profiles and higher pricing. As we continued to pull back in December, originations declined by about 25% from run rates in the first two months of the quarter. Despite our confidence in the improved credit characteristics, profitability and resilience of the loans we're now originating and despite the reduction, prudence leads us to scale back our auto business even more given the cyclical credit challenges in 2008. Ramp down origination volumes with origination run rates down significantly by the second quarter of the year. This should result in a decline in auto loan balances in 2008, with further migration to higher quality loans within both prime and subprime."
emphasis added
An answer to a question on the auto business (and the impact of the housing bust):
"If I were to comment in general, there has been some industry risk expansion in the auto space, and one of the worries that we have always one of the bad things that can happen is an overly good credit environment, such as we had in 2006. And in some sense, all of the industry is paying the consequences of, you know, in a sense of overconfidence in what we saw, and I think we mentioned several times over the last -- course of the last year. There has been some risk expansion pretty much across the boards in the auto space, and it becomes a little bit -- the table stakes for playing. It's hard to say if people structure products that way, we weren't going to offer them that way. That doesn't mean you just go out and does what everybody else does. The good thing that is happening now is that practices and pricing are becoming -- and product structures are becoming more sensible, and this is basically positioning this industry to be healthy on the other side of this. The other big insight in the auto space is the house market correction markets, which is basically 25% of the country -- and 25% of our portfolio has certainly taken it on the chin the most.
More Q&A:

Okay. And the follow-up, Rich, I know there has been a lot of discussion about credit trends, particularly in auto, and specifically within the high HPA markets. Can you talk a little bit about how the credit card experience looks in those markets?

Capital One

"The credit card experience is very similar to what we're seeing in auto…this is very much across all of our consumer lending businesses, we see this sort of -- if you will, the kind of HPA effect that is commonly seen. But I do want to say also that this is not -- this is not an issue where our customers with mortgages are having unique problems, because actually we find renters and home owners tend to be following very similar patterns. It's just that renters and home owners, in all of our consumer lending businesses -- renters and home owners together in the -- in the challenged housing price markets are degrading in parallel and together. "
The Fed talks frequently with various CEOs to gauge the economy. If Bernanke (or someone at the Fed) is hearing this from other CEOs, no wonder there was an emergency rate cut.