Capital One Financial Corp. was a credit card monoline, then a specialty finance lender, and perhaps soon it will become a retail bank.
The fourth-largest U.S. credit card company has long said that its efforts to become a diversified financial services provider could include the establishment of physical branches, but recently it has been talking up the idea with more gusto. Some outsiders have read that as a sign that it may pursue an acquisition to get there.
"Really, the one channel that we do not have a presence in at this point is physical branches," Richard D. Fairbank, Capital One's chief executive, said in an interview Wednesday. The eight-year-old McLean, Va., company "brings significant advantages to the table that will be somewhat differentiated from existing retail banks."
For one thing, with 46 million accounts and $67 billion of managed loans spread throughout the country, "we have far more customers in the footprint of most banks than the banks do," he said.
There is another element to its thinking. Retail deposits would help remedy what analysts see as Capital One's main weakness: its high cost of funds.
"Branch banks' strength in generating low-cost deposits is a natural complement to Capital One's strength in generating high-quality loans" and is an advantage unavailable to non-deposit-based institutions like his company, Mr. Fairbank acknowledged.
Its continued expansion into areas such as auto financing and installment loans, as well as its shift toward superprime card accounts, have put pressure on the margins, and its cost of debt capital, raised largely through securitization, has put it at a disadvantage against banks.
"As we continue to diversify on the asset side into businesses with thinner margins than credit cards, then a natural complement to that strategy is to diversify our sources of funding," Mr. Fairbank said. "And nothing beats old-fashioned retail deposits."
One analyst, who asked not to be named, said Mr. Fairbank "understands that somehow, some way, he has to get rid of the company's Achilles' heel, either by partnering with someone with a lower cost of funds or by creating a source of its own."
And the idea, floated for some time, that Capital One might sell itself to a large bank issuer like Citigroup Inc. or Bank One Corp. appears to have been dispelled. Now it is Capital One that appears to be in the buying mood.
Last week at its annual debt and equity conference in New York, Mr. Fairbank readied investors for an acquisition - or at least the idea of one.
Capital One has tended to acquire rather than form start-ups in business lines that stretch its expertise. For example, it set up its own installment loan unit but acquired an auto financing firm when it entered those markets.
"Where there is a compelling acquisition opportunity, we have tended to choose" that route, Mr. Fairbank said Wednesday.
At the end of the third quarter, Capital One had $21 billion of deposits, which generated about 30% of its funding. It markets various savings products, including certificates of deposit and money market accounts, through channels like direct mail and through some partner institutions.
"I want to stress that in some ways, Capital One already does what retail banking's all about," Mr. Fairbank said.
So far it has not elaborated on what or when it wants to buy. Analysts say it could easily use its reserves to buy a bank with $1 billion or $2 billion of assets.
"Historically, Capital One has kept its eye on taking a small position and growing from there," said Chris Brendler of Legg Mason Wood Walker Inc. "But branch banking is not exactly a leverageable business, like auto finance, so they could be looking to make a bigger acquisition for this market."
Some say they are not convinced the move would be beneficial. "We are somewhat puzzled by the company's view that a costly branch based deposit business is attractive," David Hochstim, a Bear Stearns & Co. analyst, wrote in an Oct. 31 report. He also wrote that a renewed emphasis on subprime card lending could bring a bigger return to shareholders than a foray into retail banking.
Mr. Fairbank would not elaborate on his plans Wednesday, saying it is "premature to speculate about the size or timing" of any future deal at this point. In the meantime, analysts' guesses range from the next six months to two years. Theoretically, they say, Capital One can make an acquisition while its 16-month-old memorandum of understanding with regulators is still in place.
"I think he was pretty clear that this is a longer-term strategy, although there seems to be a bit of misinterpretation [among investors] about just how soon it would happen," Mr. Brendler said. Capital One's management "is trying to manage expectations a little better than it has in the past." It "wants to put this out now and get investors used to it."
Since Mr. Fairbank's presentation last week, Wall Street has been adjusting to the idea.
"We believe the clear message is that Capital One is poised to buy a branch-based distribution system over the near to intermediate term," Bradley Ball, a Prudential Equity Group Inc. analyst, wrote in a research note Monday. "While we believe such a move may cement Capital One's future as an independently viable financial services firm, it would likely carry several additional risks - including credit, interest rate, and regulatory - and would dilute the company's 'monoline' franchise - likely depressing long-term growth, returns, and valuation."
Mr. Fairbank's "vision for the future of Capital One (beyond the next 2-3 years) remains somewhat vague," Mr. Ball wrote. "It is still unclear what the company will look like when the transformation" from a credit card issuer to a diversified financial institution is complete.
"We have tried to be very clear with the Street about where we're going and we have systematically, one piece at a time, moved toward" its broader goal, Mr. Fairbank said. Since "retail banking is one of the last frontiers, to complete that destiny we would have to fill in that missing piece."
He also said the retail bank market has more room for a newcomer than the card market.
"The credit card business is, in my mind, a more consolidated market, more dominated by the endgame players," he said. "There is a lot of evolutionary space still to work with" in retail banking. "I don't want to underestimate the strength of the competition," but Capital One's operating scale, in particular its direct mail and credit infrastructure, and its increasingly popular brand should translate well to the branch business.
