Why Is Capital One’s Net Interest Margin Decreasing And What Does It Mean For The Bank?

Capital One (NYSE:COF) is a financial institution which provides credit & debit cards, commercial lending and consumer lending services to its clients, and drives more than 80% of its revenues from net interest income. This makes Net Interest Margin (NIM) a key operating metrics for Capital One, as slight fluctuations in the metrics can have noticeable impact on its revenues. In Capital One’s earnings release for the third quarter (with the bank surpassing the consensus earnings estimates), it reported total revenues of $6.96 billion which in line with the figure a year ago. Notably, while Capital One’s Non-Interest Revenues improved 4% y-o-y this gain was mitigated by a 1% drop in Net Interest Income due to a 28 bps (0.28 percentage point) drop in net interest margin on a year-on-year basis.

Trefis has analyzed the change in Capital One’s Net Interest Margin and its impact on net interest income in an interactive dashboard, parts of which are highlighted below.

What Is Net Interest Margin?

Net Interest Margin is the difference between the interest income generated by the bank on its interest generating assets and the amount of interest paid out on interest bearing liabilities, relative to the amount of their total assets

Net interest margin = annualized net interest income for the period / average interest-earning assets for the period

What Happened?

• Capital One’s Net Interest Margin has decreased 28 bps from 7.01% in Q3 2018 to 6.73% in the third quarter of 2019.
• Further, the figure has decreased consecutively over the last 5 quarters.

Why Did It Happen?

• Yield on interest-earnings assets has declined, resulting in lower interest income. At the same time yield on interest-bearing liabilities has increase, resulting in higher interest expense
• Although total interest-earning assets have increased by 3% y-o-y, yield on interest earnings assets has decreased by 5 bps. This implies that Capital One is generating less interest income from its asset base compared to the year-ago period.
• Interest-bearing deposits have increased by 3% y-o-y from $275 billion in Q3 2018 to $283 billion in Q3 2019. Also, yield on interest-bearing liabilities have jumped 27 bps y-o-y. This implies that Capital One is paying much more for its deposits and other liabilities as compared to what it did last year.

So What?

• Capital One provides Commercial Banking, Consumer Banking and Card Services to its clients. This means that fluctuations in Net Interest Margin have a sizable impact on its net interest income – its single largest revenue stream as detailed in our dashboard highlighting Capital One’s Revenues.
• Its interest income dropped 1% y-o-y in the third quarter of 2019, despite 3% growth in total interest earning assets
• Further, recent Fed rate cuts is likely to put downward pressure on these rates.

Per Trefis, Capital One’s Revenues (shows key revenue components) are expected to cross $28.2 billion in 2019 – leading to an EPS of $11.09 for the year. This EPS figure coupled with a P/E multiple of 9.3x, works out to a price estimate of $103 for Capital One’s stock (shows cash and valuation analysis), which is 5% higher than the current market price.

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