An Aug. 15 Business article about Capital One Financial Corp. misspelled the company's name in some references. (Published 8/16/2005)
Richard D. Fairbank may be the person most responsible for the boom in consumer debt.
Teaser rates. Balance-transfer offers. Blizzards of direct-mail pitches. Credit terms tailored toward almost anyone, regardless of financial status. All those ideas, common now not only in the credit card business, but also in home mortgages and other forms of consumer lending, were first put to use at the company Fairbank co-founded, McLean-based Capital One Financial Corp.
Since it was spun out of a mid-size Virginia bank in 1995, Capital One has become the nation's second-largest independent credit card company, and the fifth-largest overall. Capital One's democratization of lending -- the idea that almost anyone can get an unsecured loan on some terms -- made it a prime mover in the rise of American consumer credit in the 1990s.
Credit card and auto-loan debt in the United States totals more than $2 trillion, a 24 percent increase in five years that has worried consumer advocates but bolstered the profits of companies like Capitol One.
It earned more than $1.5 billion last year, and more than $1 billion so far this year. And it has become a household name with the help of frequent television commercials featuring comedian David Spade and a horde of barbarians lampooning its competitors.
But Fairbank is only getting started. Driven in part by the tapped-out credit card market and tightening profit margins in that business, Capital One is on an ambitious and risky campaign to become a diversified, national financial services company.
College loans, small-business loans, mortgages, home equity loans, insurance, installment loans and auto lending figure prominently in Capital One's future. In about two weeks, Capital One expects to close on its purchase of Hibernia Corp., making it the only credit card company to purchase a major branch-banking operation.
"The leaders in any business make their moves before they have to, from a position of strength," Fairbank, Capitol One's chairman and chief executive, said in an interview Friday. "I guess my definition of bad leadership is when one is making moves when others are making you do it. That's why we made the decision years ago. When [stand-alone] credit card companies were a wildly successful business model, we made a conscious choice to be more than a credit card company."
Capital One's efforts to diversify reflect some unfavorable market realities, or, in Fairbank's words, "absolutely inexorable trends." Profitability has been squeezed by the tough competition for customers. At the same time, borrowing costs for credit card companies -- the money borrowed from the capital markets to fund their customers' credit card balances -- have inched up along with the rise in short-term interest rates.
Over the past 20 years, financial services companies had splintered into single-focus providers like Capitol One's credit card operation. Now, though, consumers are showing increasing interest in bundled financial services. As with cable, phone and Internet service, the holy grail in consumer banking today is the "relationship," in which one company can provide lending, deposit and even investment services under one roof.
While Capital One has been buying non-credit card businesses, its chief independent competitors have gone in the opposite direction: selling out. MBNA Corp., the largest independent credit card issuer, and Providian Financial Corp. this summer both agreed to multibillion-dollar buyouts by major banking companies.
MBNA Corp. is going to Bank of America Corp. for $35 billion, and Providian is going to Washington Mutual Inc. for $6.45 billion. A third large independent credit card company, Metris Companies Inc. , agreed this month to be bought by multinational bank HSBC Finance Corp. for $1.6 billion. The mergers are expected to close later this year or next, leaving Capital One alone among major credit card issuers that are not controlled by much-larger banks.
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."