Capital One cautiously optimistic that consumer credit is stabilizing

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Capital One Financial is seeing early signs that the worsening of household balance sheets is stabilizing, according to CEO Richard Fairbank, who expressed cautious optimism about consumers' ability to stay current on their credit-card payments.

Charge-offs on Capital One's U.S. credit cards doubled in the third quarter compared with last year, as more consumers fell too far behind on their payments. But charge-offs were essentially flat with the second quarter, and monthly data shows that the increase in late payments has slowed.

The McLean, Virginia-based company is "hopeful these stabilization trends continue," Fairbank told analysts on an earnings call Thursday, though he said it's too early to "wave my arms and declare a turn."

"We happen to see some pretty positive things here, but they can also be a head fake and not be as good as they appear," Fairbank said.

Credit card lenders, including the $471 billion-asset Capital One, have been seeing steady worsening in their loan portfolios for more than a year, as the benefits of pandemic-era stimulus payments have declined and inflation has taken a toll on Americans' pocketbooks.

Consumer lenders long anticipated a so-called "normalization" from the exceedingly healthy credit metrics they saw during the pandemic. The deterioration first occurred at nonbanks that focus on subprime borrowers, but banks have also reported upticks in late payments and charged-off loans, which are now past pre-pandemic norms.

At Capital One, where U.S. credit cards make up nearly 45% of its total loans, Fairbank said Thursday that delinquencies and charge-offs are "modestly above 2019 levels."

Domestic card charge-offs jumped to 4.40% during the third quarter, twice as high as a year earlier, but roughly flat compared with the second quarter.

Bad loans are likely to rise further in the coming months as Capital One charges off credit it extended to borrowers who are delinquent today. Some 4.31% of the company's domestic card loans are at least 30 days late, up from 3.74% a quarter earlier and nearly 3% a year ago.

But Capital One executives were upbeat Thursday about the fact that delinquencies in August and September stuck to their usual seasonal trends, rather than rising more sharply.

Executives at Synchrony Financial, another major credit card company, reported this week that their cardholders have stayed resilient even as the economy slows.

Capital One executives also expressed optimism about credit trends in the auto lending business, where the company has been pulling back due to intense competition. Auto loan charge-offs jumped to 1.77% in the third quarter, up from 1.05% a year earlier, and late payments rose by a similar amount.

But the increases from the prior quarter were smaller than Capital One executives expected, and Fairbank said the auto lending sector has been stabilizing for longer than the credit card sector. Overall, Capital One is seeing "striking credit performance" in auto lending, Fairbank said, noting that tighter underwriting criteria have helped.

Auto loan originations dropped to $7.5 billion during the third quarter, down 10% from the same period last year.

Fairbank was noncommittal on whether Capital One will adopt a more aggressive posture in the auto sector as conditions improve and competitors raise the interest rates they charge.

"We're certainly on the lookout for opportunities, but I'm not here to predict an acceleration," Fairbank said. 

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Where Capital One is continuing to accelerate is in its flagship credit card business. Domestic card loans jumped 16% from the same period last year and ended the quarter at $140.3 billion.

The company also kept marketing costs elevated — at nearly $1 billion during the quarter — as it looked to entice new cardholders. It spent on rewards, travel lounges and other perks valued by the big spenders its long sought to lure.

"To win with heavy spenders, we need great servicing, jaw-dropping customer experiences — of course, great value propositions," Fairbank said. "And this takes a significant investment in upfront promotions and in marketing and in brand building."

Capital One reported higher profits during the quarter, with net income of nearly $1.8 billion compared with nearly $1.7 billion a year earlier. The company is continuing to see its net interest income rise, as the interest it collects on credit cards and other lending products outstrips a hefty jump in deposit costs.

Capital One's stock price was up 9% in mid-afternoon trading on Friday.