Incorporated: 1995
NAIC: 522210 Credit Card Issuing; 551111 Offices of Bank Holding Companies
Capital One Financial Corporation, a holding company, is perhaps best known for its inventive advertising of its credit card products. But it was Capital One's creative use of information technology that helped it rapidly grow to one of the largest providers of MasterCard and Visa in the world. During its short history, the company has expanded not only beyond U.S. boundaries but into a variety of consumer financial products and services.
Richard D. Fairbank and Nigel W. Morris began building the foundation for Capital One in 1988 under the auspices of Richmond, Virginia-based Signet Bank. In the mid-1980s, Fairbank recognized what he perceived as a missed opportunity by the credit card industry. He called on Morris, a fellow consultant at Strategic Planning Associates (later named Mercer Management Consulting), to help construct a more integrated and scientific approach to marketing bank cards. Fairbank and Morris's plan would allow companies to fine-tune card product and pricing strategies for individual customers through a decision-making structure blending together marketing, credit, risk, operations, and technology functions. The pair pitched the idea to more than 20 national retail banks before Signet signed on and gave Fairbank and Morris the green light to develop the plan. They intended to revolutionize Signet's credit card business, which dated back to the early 1950s and operated in traditional banking fashion.
Citibank had stepped outside the box, when it turned to a direct mail campaign to push its credit cards, a move that was quickly copied by other major commercial banks. Yet, the credit card products themselves remained unremarkable. Interest rates hovered between 18 and 20 percent. In the mid-1980s nonbanking entities offered some new spins to consumer credit. The Discover Card, a Sears, Roebuck and Co. product, introduced the annual rebate. Travel and entertainment card marketer American Express Co. rolled out the Optima card with a 15 percent rate.
Fairbank and Morris envisioned a credit card industry revolution, beginning with Signet's $1 billion credit card operation. "We warned them that this would require virtually starting over, rebuilding a very different company," Fairbank told American Banker in September 1998. "We had to create a culture that was very nonhierarchical and challenged everything." But their dreams were almost scuttled by the real estate woes of the late 1980s, when losses forced Signet to seriously consider sinking the endeavor.
The introduction of the balance transfer offer in 1991 saved the day for Fairbank and Morris. Credit card users along with their existing credit card debt were lured to Signet with introductory or "teaser" offers below the 19.8 percent rate typically offered to middle-income customers. "The genius of Morris and Fairbank was to burrow deep into the spending habits and lifestyles of these so-called prime customers to find the better bets, then offer them various rates based on their various risks," remarked Bernard Condon in an article for Forbes in April 2001. Other credit card issuers were quick to catch on--Citibank, MBNA Corporation, and First USA, Inc. among them. Consumers' mailboxes were flooded with offers. Fairbank and Morris countered by using their technological know-how to tap into the subprime market, seeking out the best possible risks among customers not typically offered cards, those with no or slightly flawed credit histories.
Signet's credit card operation quickly became its most profitable enterprise. Citing the need to concentrate on its core businesses, the regional banking operation decided to spin off its credit card portfolio. The new unit was called Oakstone Financial Corporation--so named to reflect "its financial strength and stability," according to Fairbank, who would be chairman and CEO. A $16 per share initial public offering (IPO) in late 1994 led the way to the complete separation of the credit operation in February 1995. Renamed Capital One Financial Corporation, the newly formed company ranked as one of the top ten credit card issuers in the country, with more than five million credit card customers. Since the up and comers in the industry used tactics similar to Capital One to bring in new accounts, keeping customers became a crucial issue. Again relying on its massive information base and on employees trained as retention specialists, Capital One could quickly determine the best possible rate for a customer shopping around for a deal on interest rates. Capital One wanted to keep the customer's credit balance in the fold while maintaining the necessary financial return on that account.
As Capital One grew so did the number of delinquencies in the consumer credit industry. The trend had a negative effect on card issuers' stock value. But, according to American Banker, some analysts saw Capital One's Information-Based Strategy (IBS) as a significant advantage. IBS could be used to market a wide array of financial services products beyond credit cards, which gave Capital One a leg up on less technically advanced monoline companies.
Capital One's system for analyzing risk and making marketing decisions, however, came at a price. The building and maintenance of such a detail-rich system required significant capital. Additional output came when it was time to put the system to use and send out those credit card offers. In 1994, Capital One followed just behind Citibank in terms of sheer volume of solicitations. That year the card industry as a whole sent out 2.4 billion solicitations at a cost of nearly $500 million in postage alone, reported Forbes.
By early 1996, Capital One had shifted away from its dependence on teaser rates to generate new business. According to American Banker, new marketing efforts included: cobranded/affinity, secured, and "joint account" cards. The company had been losing customers to competitors offering higher ceilings on loan balances and accounts with no annual fee. Capital One aimed at boosting its revenue in new ways. With secured cards, for example, people with flawed credit histories were required to put down deposits in order to get a line of credit.
In mid-1996, Capital One received federal approval to set up a thrift operation, Capital One FSB. The action allowed, among other things, Capital One to retain and lend out deposits on secured cards. The thrift charter also opened the way for financial activities, such as automobile installment loans. Also in 1996, Capital One expanded internationally, entering the United Kingdom and Canada.
According to a June 1997 article in Chief Executive, Capital One served nine million customers and held $12.6 billion in credit card receivables. Capital One's success gained it a position on the Standard & Poor's 500. The company's return on assets exceeded 20 percent each year since going independent. Stock price rose above the $100 mark in 1998.
As envisioned by founders Fairbank and Morris, Capital One moved into new markets. America One Communications Inc., a wireless business subsidiary, was the country's only direct marketer of cellular phone service. With the purchase of Summit Acceptance Corp. in 1998, Capital One entered the automobile finance business. The Dallas-based subprime lending company held $260 million in managed loans. Fairbank told American Banker, "We feel we can bring the capability of risk management and more sophisticated marketing methodology into an industry that right now is in a depressed condition, with a lot of companies having run into credit problems."
The hitherto glowing reports by Capital One dimmed somewhat in 1999. America One was smacked with loses related to a wireless communication price war, forcing Capital One to rethink its strategy in that arena. In addition, subprime credit card issuers were being hurt by rising interest rates in mid-1999, but Capital One said that it had already been going after more affluent superprime borrowers, attempting to balance out its loan portfolio. Fairbank and Morris also had turned their attention to the Web. Capital One had held back while other card issuers were eager to log on. But once they decided to make the move, Fairbank and Morris believed, according to Business Week, Capital One's culture of innovation would help them catch up and even surpass more established Internet players.
Capital One began a concerted effort to boost brand recognition in 2000. According to the company, brand awareness was just 61 percent in June 1999. Many customers did not even know Capital One was an entity separate from Visa and Mastercard. In an all-out effort to be seen as a national brand, "What's in your wallet?" advertisements began showing up on the airwaves. There were promotions, too. In Chicago, for example, commuters were handed plastic cards alerting them to Capital One's online services and offering a chance to win a free computer.
Since its IPO, Capital One had more than quadrupled its earnings, according to Forbes, growing to $470 million in 2000 on credit card receivables of $30 billion. The industry itself had expanded rapidly. U.S. credit card debt hit $3 trillion, nearly twice the amount of four years earlier. Capital One held just 4 percent of total card loans. To keep up its growth rate Capital One needed to keep bringing in new accounts.
"Getting new customers is crucial not just to goose the company's earnings but to keep the charge-off ratio at a low 4%. An important subtlety about this ratio, not well understood by most investors, is that it mixes chronological apples and oranges," explained Condon in Forbes. Bad loans, when compared with current loans outstanding, rather than loans outstanding when the borrower stopped paying, resulted in a different slant on the company's current financial situation.
A key to Capital One's success to this point, and to its credibility among investors, had been its ability to find customers in higher risk segments with the best credit outlook. Were there enough of those good credit risks out there to continue to drive credit card growth? Could Capital One succeed in other financial service niches?
Capital One dropped out of the wireless phone service business in 2000 but expanded its financial service offerings in 2001. In May, Capital One acquired AmeriFee Corporation. The Massachusetts-based company made consumer loans for elective medical and dental procedures. Then in October, PeopleFirst Inc., the largest online provider of direct motor vehicle loans, was purchased.
Capital One's marketing blitz, which continued in 2001, included sponsorship of college football's Florida Citrus Bowl. In addition, a "No-Hassle" Platinum Card was launched. Brand recognition reached 92 percent by December.
Overall, Capital One's reputation on Wall Street and within the industry remained solid. During 2001, the company ranked high on a number of "best places to work" lists. The company was also proud of its commitment to community. Following the September 11 attacks on the United States, thousands of Capital One employees volunteered to set up phone systems and then receive calls for the largest telethon in history, helping raise money for disaster relief.
In the midst of all this, some competitors in the credit card industry had begun a downward spiral. Preceding the events of September 11, Capital One's own stock took a beating in reaction to lowered estimates by Providian Financial. Some analysts felt that Providian's troubles were indicative of problems ahead for the industry as a whole. Capital One, like Providian, had a large number of riskier, but higher margin, subprime loans in its portfolio.
The economy soured post-9/11, but Capital One held its own. In 2001, the sixth largest credit card issuer in the United States reached its seventh consecutive year of 20 percent-plus annual earnings growth despite the economic recession, rising unemployment, and fears of more terrorist attacks, observed American Banker in January 2002.
Capital One revealed, about mid-July 2002, that the Federal Reserve Board and the Office of Thrift Supervision had taken informal action regarding the company's infrastructure. Capital One agreed to add to its loan-loss reserves and change the way it reported revenue on uncollectible finance charges and fees. Regulators were cracking down on card issuers in an effort to tighten account management standards. In addition, to the dismay of investors, Capital One revealed that the subprime segment of its credit card accounts was larger than previously understood.
To regain the confidence of regulators and investors, Capital One planned to pull back on the subprime while building up the prime and superprime credit card lending segments. A greater emphasis was to be placed, as well, on personal installment and auto loans and the consumer loan business outside the United States. But more negative news came in October 2002, when Capital One announced that it anticipated a drop-off in growth and a jump in the chargeoff rate. Wall Street was not impressed.
Principal Subsidiaries
Capital One Bank; Capital One, F.S.B.; Capital One Bank (Europe) plc (U.K.).
Principal Competitors
MBNA Corporation; Citigroup Inc.; First USA, Inc.; Providian Financial Corporation; Household International, Inc.; Metris Companies Inc.
Further Reading
Bloom, Jennifer Kingson, "Capital One Says It's Riding a Tech Revolution," American Banker, September 9, 1998, p. 6A.
Buss, Dale, "Brand Builders: Raising Capital," Brandweek, November 19, 2001, pp. 16+.
Cline, Kenneth, "Card Issuer Capital One Sets Up Thrift to Widen Scope," American Banker, July 8, 1996, pp. 1+.
Condon, Bernard, "House of Cards," Forbes, April 2, 2001, p. 77.
Fickenscher, Lisa, "Capital One Begins to Move Beyond Teaser Rates," American Banker, April 9, 1996, p. 14.
"Isn't There More to Life Than Plastic?," Business Week, November 22, 1999, p. 173.
Kingson, Jennifer A., "4Q Earnings: Capital One Boasts Banner Year," American Banker, January 17, 2002, p. 16.
Kuykendall, Lavonne, and W.A. Lee, "3Q Earnings: Monoline Stocks Drilled," American Banker, October 17, 2002, p. 1.
Lee, W.A., "Are None Immune in Card Crackdown?," American Banker, July 18, 2002, p. 1.
Leuchter, Miriam, "Capital One: Fanaticism That Works," US Banker, August 2001, p. 24.
Martin, Zack, "Capital One Makes Big Push to Become National Brand," Card Marketing, December 2000, pp. 1+.
Mathews, Gordon, "Fear of Delinquency Prompts Jitters About Capital One," American Banker, August 15, 1995, p. 24.
Millman, Gregory J., "Plastic Meltdown," Institutional Investor, December 2001, pp. 105+.
Novack, Janet, "The Data Edge," Forbes, September 11, 1995, pp. 148+.
Shook, David, "A Slower-Growing But Safer Capital One," Business Week Online, October 4, 2002.
"The Technology Bank," Chief Executive (U.S.), June 1997, pp. 12+.
Winig, Eric, "Providian News Sends Capital One Stock South," Washington Business Journal, September 7, 2001, p. 7.
— Kathleen Peippo
