CHICAGO--(BUSINESS WIRE)--Capital One Financial Corporation's (COF) second quarter 2016 (2Q16) earnings were down 7% sequentially due to higher provisioning in the company's domestic credit card portfolio and higher operating costs, according to Fitch Ratings.
COF's overall return on average assets (ROAA) was a still good 1.13% in 2Q16 relative to 1.23% in the sequential quarter and 1.11% in the year-ago quarter. Fitch notes that the 2Q16 ROAA still compares favorably to many regional bank peers during the quarter. However, the company's annualized return on average equity (ROE) during 2Q16 was 7.64%, which continues to be below Fitch's estimated cost of equity range for COF of between 10% to 12%.
Provision expense was the main driver of COF's earnings performance this quarter at $1.59 billion mainly due to an 18% sequential increase in the provision for credit cards. This was driven by COF's ongoing loan growth in this segment as well as higher anticipated net charge-offs (NCOs) in 2017. Higher provisions related to COF's taxi medallion portfolio (discussed below) also modestly contributed to the increase.
Credit card loans grew 5% from the sequential quarter and 11% from the year-ago quarter. NCO rates in card loans were 4.02% in 2Q16, and management expects this to increase into the low-4s in 2017. Additionally, COF also increased its auto loan allowance by $58 million due to higher subprime originations and an expected decline in used car prices from currently high levels.
COF also built an additional $60 million of reserves in its taxi medallion financing business. This business is small for COF at $854 million of loans, but nonperforming loans rose to 38% from 30% during the quarter. Pressure from ride hailing applications, particularly in the Chicago market, have impacted collateral values in this business by about 60%.
Within the energy portfolio, loans decreased by 7% due to lower borrowing bases from the spring redeterminations. Provisions were minimal after the reserve build last quarter and the total allowance for energy related loans now stands at 8.87% of funded exposure. This level increased moderately during the quarter due to the decrease in loans and is roughly in line with peers. Non-performing and criticized loans in the portfolio decreased moderately but remain elevated.
To put COF's energy exposure in context, total oil and gas loans ended the quarter at $3 billion, at only 1.3% of total company loans and 6.2% of total equity. COF's unfunded energy exposure decreased slightly to $2.7 billion due to the reductions in borrowing bases noted above.
Despite some signs of pressure across COF's various lending businesses, Fitch continues to believe this is manageable for the company within the context of its solid earnings profile.
Total revenue for COF excluding provisions was up 1% relative to the sequential quarter and up 12% relative to the year-ago quarter. This was due to higher net interest income (NII) given higher loan balances due in part to the closing of the GE Healthcare transaction as well as continued growth in credit card loans.
The net interest margin (NIM) ticked down 2 basis points relative to the sequential quarter to 6.73% at the end of 1Q16 due to high deposit costs and weaker securities yields. Relative to the year-ago quarter it is up 17 basis points due to the growth in the high-yielding credit card loan portfolio.
Non-interest income was flat relative to the sequential quarter but up 2% relative to the year-ago quarter largely driven by higher interchange net revenue. This follows trends also seen at competitors due to higher purchase volumes and due to COF's QuickSilver and Venture cards continuing to gain traction.
Non-interest expenses continue to be comparatively well controlled, though COF had a small uptick in growth expenses relative to the sequential quarter. The company's efficiency ratio remained strong at 52.7% as of the end of 2Q16.
COF's loan-to-deposit ratio was 106% which is modestly higher than the sequential quarter, and remains somewhat higher than most other regional bank peers. Fitch continues to view COF's funding profile favorably in the context of the shift over the past several years towards core deposit funding rather than wholesale borrowings.
Additionally, the company's Basel III Common Equity Tier 1 (CET1) ratio as of the end of 2Q16 was 10.9% under the standardized approach. The estimated CET1 ratio under the advanced approach remains above 8% and COF announced it no longer believes this approach will be the long-term capital constraint for the company. Fitch believes this level of capital continues to be adequate for COF's rating category.
Additional information is available at www.fitchratings.com