Read the case study below and make an overview that summarizesthe following component for your report:
1- a. Identify the executives from Capital One who you expect to be in your audience. What can you establish about the key members of Fairbank’s management team?
2-Your report and overview should address the following key strategic issues, followed by a recommendation:
a. Conduct an External Environmental Analysis, and identify key environmental forces that have immediate strategic implications for Capital One.
b. Conduct an Internal Environmental Analysis, and identify the capabilities and weaknesses within Capital One that have immediate strategic implications.
c. Basedon your analysis of the external and internal environments what would be your recommendation to the Chairman?
3. Based on these strategic inputs, define Capital Ones business-level and corporate-level strategies, and evaluate their potential for continued success.
4. Assess Capital One’s international position.
5. Evaluate the strategic fit of Capital One’s recent acquisitions, and discuss the key strategic issues raised by the company’s acquisition strategy.
6. Based on your complete analysis, recommend actions for Capital One to sustain growth and ensure maximum performance and value for shareholders.
7. Discuss the ethical ramifications of sub-prime lending at high interest rates, (discuss pros and cons).
Capital One: The American Credit card Companys Growth Strategies
Susmita Nandi, Sumit Kumar Chaudhuri
ICFAI University
In consumer lending, every product is evolving in the same direction as credit cardstoward large, national-scale consolidators replacing local, face-to-face lending. That evolution has happened in credit cards. Its well under way in auto finance, mortgages, and home equity. Its coming more slowly in installment lending. So consumer lending, a major part of the asset side of banking, is all flowing toward national consolidators like Capital One.
Richard D. Fairbank,
CEO and Chairman,
Capital One Financial Corporation1 Capital One Financial Corporation is a diversified bank holding company, with a 2005 market value of $18.92 billion. It provides a gamut of financial services through its main subsidiariesCapital One Bank, Capital One F.S.B. (which offers consumer and commercial lending and consumer deposit products), and Capital One Auto Finance Inc (COAF). From a small local bankcard issuer in 1995, the company has transformed itself into one of the largest financial institutions in the United States by continually introducing a steady stream of products. It features one of the most recognized brands in the industry, which it leverages along with its strategies of direct marketing, risk analysis, and information technology to grow and diversify into other businesses. Ranked 206th in the Fortune 500 list in 2005, 2 the company has been gradually transforming itself from a credit card company to an institution that provides banking and other financial services to consumers. By January 2005, it was the 31st largest deposit institution in the United States with $25.6 billion3 in interest-bearing deposits. Capital One has been on the path of diversification from the late 1990s and has made three acquisitions between 2004 and 2005: Onyx Acceptance Corporation, eSmartloan, and Hibernia National Bank. It has also acquired a home equity brokerage company in the United Kingdom, the Hfs Group, to strengthen its Global Financial services (GFS) subsidiary in the British market. As of April 2005, it possessed sufficient liquidity ($21 billion) and capital ($9.2 billion)4 to enable its famous brand to expand into new markets and seize the right opportunities for profitable growth. Although the companys acquisition of Hibernia in March 2005 provided it an opportunity to enter the fast-developing Texas markets of Houston and Dallas, it might face stiff competition from other large credit companies, such as Citigroup and J.P. Morgan.
Capital One: The Background
Capital One is the fifth largest credit card provider in the United States5 and one of the largest issuers of
MasterCard and Visa credit cards. It was founded as a wholly owned subsidiary of Virginia-based Signet Bank when Richard D. Fairbank, CEO and chairman of Capital One, was invited by the bank to head its bankcard division. It began its operations in 1953, the same year MasterCard International was formed. Fairbank and the former vice chairman of Capital One, Nigel Morris, realized that traditional banks offered loans without focusing on the customerslike analyzing their risk characteristics. They decided that by using technology and data mining techniques in the decision-making process of providing credit, the bank could charge the appropriate interest rates more accurately and earn greater profits. In 1994, Capital One was spun off from Signet as a public credit card company and established itself in McLean, Virginia. It had an initial public offering of 7,125,000 shares of common stock in the United States and Canada, at a price of $16 per share,6 which was managed by J.P. Morgan Securities Inc., Goldman, Sachs & Co. and Barney Inc. It is a part of the S&P 500 index, and also trades on the New York Stock Exchange with the symbol COF.
Between 1994 and 2004, the company grew at an annual compound rate of 29 percent, 7 both in terms of its EPS and the number of customers. In 2004, its earnings were $1.5 billion, and the EPS was at 6.21.8 At the end of 2004, the company and its subsidiaries held 48.6 million accounts and $79.9 billion9 in managed loans outstanding, which grew by 12 percent ($8.6 billion) over the previous year (see Exhibit 1). It had 17,760 employees in March 2005. The bank offers 7,00010 variations of its MasterCard and Visa cards, each one is customized to appeal to different customer preferences and needs by combining product features such as different backgrounds and colors, along with varied annual percentage rates, credit limits, fees, and rewards programs. Capital Ones pricing strategy is based on the risk level of its customers. It offers platinum and gold cards to its preferred customers with excellent credit history and a wide range of secured and unsecured cards to customers with limited or poor credit history. The company also provides a range of consumer products like auto financing, mortgage services, credit insurance and home-equity loans. Customizations of credit cards at Capital One are made with the support of its Information-Based Strategy (IBS), which uses sophisticated data-mining techniques to match its credit cards (its combination of interest rates, fees, rewards, and other conditions) with targeted customers based on their credit scores, credit uses, and other parameters. IBS is the fusion of one of the worlds largest databases, information systems, a well-trained team of analysts and statisticians, and advanced scoring models. The companys decision-making process is made efficient by bringing together marketing, credit, risk, and information technology. It selects its most profitable customers and the appropriate rate by using the rigorous testing of econometric and time series models. The credit ratings of customers are based on the Fair Isaac Corporation (FICO) scores, which are used to predict payment risk by looking at several variables, including credit history. The IBS system uses FICO scores to divide its customers into three groups of super-prime (with excellent credit history), prime (average credit history), and sub-prime (with poor or very little credit history). Through the use of IBS, the company has been able to locate a group of students who were not included in the mailing lists of other credit card companies because these students, mostly unemployed and little or no credit histories, were considered high risk. Capital Ones strategy of sending credit card applications, which were tailored to the needs of these students, proved effective, as 70 percent of the applications were filled and mailed back, thus creating a new market for the company. IBS has also helped Capital One avoid customers who do not pay interest charges on loans. The charge-off rate (for bad debt) of Capital One is the industrys lowest, and for 2004 was at 4.37 percent, compared to 5.32 percent in the previous year. Capital Ones GFS segment offers a portfolio of diverse products to both domestic and international consumers. In the domestic market, the GFS segment includes installment lending, health care finance, mortgage lending services, and small business lending services. GFS has been on a growth curve and in 2004, it accounted for 27 percent of Capital Ones total managed loans, which are comprised of reported loans and off-balance sheet securitized loans. It also accounts for 14 percent of its earnings. Its international portfolio primarily consists of credit card business in the United Kingdom and Canada, valued at $8.2 billion and $2.4 billion, respectively. Capital One is the United Kingdoms seventh largest credit card issuer, and among the top ten of the same in Canada. In January 2005, the company completed the formalities to acquire a British equity brokerage firm called Hfs Group to strengthen its position in the United Kingdom. Although Capital One had holdings in France and South Africa, it exited these markets due to lack of growth opportunities.
Growth Strategies
Capital One generated strong earnings and loan growth again in 2004, as it has each year since its initial public offering ten years ago. The company is well positioned for continued success in 2005 in both our U.S. credit card and our growing and profitable diversification businesses.
Richard D. Fairbank,
Chairman and CEO,
Capital One Financial Corporation
Capital One grew at 30 percent14 (see Exhibit 2, on page 68) between 1994 and 2004 by issuing credit cards at attractive interest rates. Most of its business is conducted via direct mail (junk-mail solicitations), although it also markets its products through television and Internet (http://www.capitalone.com). It expanded its credit card operations in Canada, Europe, and South Africa in the late 1990s. At the same time, the company also made strategic moves toward diversifying its portfolio by entering into financing of automobiles and other motor vehicles, mortgage and home equity loans, insurance, and other consumer lending products. Although 60 percent of its total managed loans is in its credit cards business (see Exhibit 3, on page 68), the company is gradually increasing its operations in other business segments.
In 1998, Capital One bought Amerifee, a company that provided financing for elective surgeries such as orthodontic, vision, and cosmetic procedures. It became a wholly owned subsidiary of Capital One in May 2001. Amerifee is a market leader known for introducing Orthodontists Fee and Dental Fee plans in 1993 and 1998, respectively. These fee plans are the largest patient payment plans in the sectors of Orthodontics and Dentistry. In 2001, it pioneered the Family Fee plan, which was specifically designed for treatment of infertility and are offered through Reproductive Endocrinologists and infertility clinics.
The subsidiary formally became Capital One Healthcare Finance in April 2005.
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Capital One soon realized that the auto financing market is double that of the credit card market, and therefore it has a strong growth potential in that segment. This market is highly fragmented and no company holds more than 20 percent of the market share. It provided an opportunity to Capital One Auto Finance Inc. (COAF) to introduce innovative offers and increase its market share. COAF added $163.8 million to the companys earnings in 2004, and has continued to be on a high growth curve. To strengthen its market position in the automobile finance segment, the company acquired ONYX Acceptance Corporation (Onyx) for $191 million (in an all cash transaction) on January 11, 2005. It also acquired InsLogic, an insurance brokerage firm, from Onyxs management team. The purchase strengthened the Auto Finance subsidiary of Capital One and enhanced its dealer relationships, coast to-coast market penetration in the United States, and its product line among the prime borrowers. Onyx is based in Foothills, California, and provides automobile loans to certain independent and franchise dealerships all over the United States. Onyx claims to have purchased and securitized $10 billion in auto loans since its inception in 1993, and will add 12,000 new dealerships to Capital Ones list. According to David R. Lawson, Capital Ones executive vice president, and president of COAF, This transaction combines two strong franchises with complementary strengths. Onyxs significant and long-standing presence with California dealerships coupled with its strong prime product offering fills out both COAFs product line and geographic footprint. Together, we expect to realize significant revenue and cost synergies. This acquisition may make COAF the second largest auto lender in the United States. COAF has announced that it has raised its car loan limit to $100,000 (previously $75,000) for direct-to-consumer vehicle loans that have originated from its Website (http://capitaloneautofinance.com) in February 2005.
This move was made in response to the growing demand for luxury cars such as Corvette by Chevrolet, so that the company can get more business from this customer segment. This extension is limited to only those with excellent credit histories (super-prime customers). The vice president of COAF, Brian Reed, said, Car buyers have more choices than ever today at the higher end of the car spectrum, so weve adjusted our limit to offer consumers greater flexibility. The competitive advantage of COAF is that the loan process takes place on the Internet and requires no legacy fees. Also, its IBS system allows it to charge varying interest rates depending on the customers risk levels. In February 2005, Capital One purchased eSmartloans.com for $155 million,23 one of the largest online providers of home equity loans mortgages in the United States. Headquartered in Overland Park, Kansas, the company offers a variety of products that are marketed and delivered directly to homeowners. The purchase is meant to broaden Capital Ones offering of consumer loans and deepen its position in the growing U.S. home equity market. Larry Klane, Capital Ones executive vice president of Global Financial Services, said, eSmartloan has succeeded in building a scalable technology platform, a highly skilled sales team, and an outstanding reputation for customer service and speed to close. By combining these strengths with Capital Ones powerful national brand, access to 47 million accounts, and expertise in direct marketing, we will enhance the growth of our home equity lending business. In early March 2005, Capital One announced its decision to purchase Hibernia National Bank. Hibernia is the largest bank in Louisiana,25 with 316 branches in Louisiana and Texas, and $17.4 billion in deposits. It provides a wide assortment of financial products and services through its banking and non-banking subsidiaries that ranges from deposit products, small business, commercial, mortgage, private and international banking, to trust and investment management, brokerage, investment banking, and insurance. Capital One paid a 24 percent