2 Steps Capital One Financial Corp. (COF) Needs to Take

The second change the company should make is to leverage their deposit gathering capabilities to reduce or eliminate the need to borrow funds. In the current quarter, Capital One reported a net interest margin of 6.52%. Relative to JPMorgan at 2.4%, Bank of America at 2.35%, and Wells Fargo at 3.56%, Capital One’s margin is a big advantage.

Capital One reported their interest bearing deposits interest rate was 0.72%. At the same time, the company paid 1.87% on their “other borrowings” and 2.95% on their long-term debt. This makes no sense. If the company offered a higher rate on their interest bearing deposits, they could likely attract more than enough deposits to avoid debt financing. Even if their average interest rate rose to 1%, this would give depositors a 38.89% increase in their average rate, and cut the company’s borrowing costs significantly. Since the company’s average borrowings were over $44 billion, this is not an insignificant opportunity.

Unseen Value
It’s easy enough for investors to cast aside Capital One with their tiny yield today, but this story could change quickly. Of the banks we’ve looked at, Wells Fargo seems to offer the best combination of growth and income. Wells offers a yield of 2.8%, combined with expected EPS growth of 9.33% in the next few years. With shares selling for less than 10 times projected earnings, this seems like a good deal. By comparison, JPMorgan seems much less attractive with a lower yield (2.5%) and lower expected growth (6.45%).

Investors looking for a turnaround story might buy Bank of America. The company’s 18.76% expected growth in earnings would seem much better than Capital One’s expected growth rate of 8.23%. Both companies have similar yields, and Bank of America is more well known. The problem with this theory is Bank of America’s net interest margin of 2.35% is almost 64% less than Capital One. Bank of America will have to perform significantly better just to report the same earnings because of this handicap.

We already know that Capital One’s dividend should increase significantly this year. The bank’s superior net interest margin means they can offer higher rates to depositors and steal significant dollars from the competition if they make that choice. The company’s famous tag line is, “what’s in your wallet?” The answer might be, “profits from Capital One’s stock” if management makes these two decisions.

The article 2 Steps This Company Needs to Take originally appeared on Fool.com and is written by Chad Henage.

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