What's in Capital One's Wallet?

Yet analysts expect Capital One to survive on its own.

"Fairbanks is an independent-minded CEO," said David A. Hendler, senior U.S. financial services analyst at CreditSights, an independent research firm in New York. "He's very entrepreneurial. I don't think he's ready to put the baby up for adoption yet."

Edwin Groshans, who follows Capital One for Fox-Pitt, Kelton Inc. in New York, credits Capital One with recognizing two years ago that it needed not only to diversify its product offerings, but also its borrowing. One force driving independent card companies to merge with large branch banks is the banks' access to cheaper funding sources, such as certificates of deposit, checking and savings accounts.

"They were way ahead of the curve in terms of seeing the balance-sheet problems," Groshans said. "The Hibernia deal is a good first step. They will now have a piece of what they need to move forward. The other credit card companies weren't looking to do what Capital One has done."

Capital One is paying $5.3 billion for Hibernia. The New Orleans-based company has $22 billion in assets, more than 300 branches in Louisiana and Texas, and $17.1 billion of customer deposits.

Like most financial institutions, Capital One's basic business proposition is "the spread," the difference between what it charges its borrowers in interest and what it pays for money. As a stand-alone credit card company, Capital One funds its customer credit card balances through bond sales, by packaging and selling credit card balances to investors, and by selling wholesale certificates of deposit. All those forms of funding are more expensive than bank deposits.

In its most recent quarter, Hibernia paid only 2.13 percent on average for its interest-bearing deposits, while the yield on its loans was 6.21 percent. The average cost of Capital One's $26 billion deposits was 4.24 percent, while the yield on its loan portfolio was 12.45 percent. And so the logic of the merger: The melding of Hibernia's much cheaper deposits with Capital One's much higher loan yields will, over time, make the balance sheet throw off more profits.

Analyst Groshans does not think Capital One is through with bank acquisitions either.

"Hibernia is not enough to fix their balance sheet issues," he said. "While we don't think they need a national branch-bank franchise, they do need to bulk up on the retail deposits a bit more. We would not be surprised if in 2006 or 2007 they buy another bank in Texas or Florida."

At the same time, Capital One is shopping for businesses that, like credit cards in the early 1990s, are highly fragmented with no dominant players. For instance, more than 93 percent of all credit card debt at the end of 2003 was held by the top 10 largest credit card issuers. The top 10 auto lenders, on the other hand, held only 53 percent of the market; the top 10 home equity lenders held only 42 percent of that market.

By applying the same marketing strategies that worked so well in credit cards, Fairbank believes Capital One has a shot at being a national player in such non-card businesses.

But the record of specialized financial services companies becoming diversified, national companies is not good, according to Hendler.

"You haven't seen a 'monoline' issuer become a bank and grow from there to become a national powerhouse," he said. "They don't have the easiest path of growth to do that. It's an unrealistic scenario, with a low probability of success."

Fairbank, a strategy consultant before he went into the credit card business in 1988, said he thinks Capital One has all the requisite tools to make his diversification strategy work. Fairbank said "being an endgame player" in consumer banking will require a deposit base fueled by local branches, a nationally recognized brand, and multiple national consumer lending lines of business.

"I can't prove we're going to be different, but I'd rather be where we are than where a lot of the banks are," he said. "I like our chances."

Hendler added that Capital One has repeatedly proved its doubters wrong. Over the past 10 years, it has gone through regulatory problems, a chief financial officer's insider trading, a disastrous foray into cell phones, allegations that it was charging improperly high fees and faced cutthroat competition from card issuers who copied Capital One's tactics.

"This is a company that has nine lives," Hendler said. "It has hit potholes, but it has always rebounded."