Capital One Hit With New Sell Rating

Piper Jaffray said in a note Wednesday that Capital One Financial Corp. COF is stuck in a cyclical downtrend, marked by intense competition eroding margins and credit loss rates continuing to move back toward historical levels.

As such, Piper Jaffray initiated coverage of Capital One with a Sell rating and a $81 price target.

Ballooning Credit Loss Rates

Analyst Kevin Barker believes credit card losses, which have accelerated faster than the company's peers, stem from both the Growth Math, which the firm offered as reason, as well as other factors. The company defined Growth Math as the upward pressure on net charge offs resulting from to a period of high new loan growth.

Barker noted that since 2013, Capital One has loosened its credit standards from 31 percent exposure to sub-660 FICO clients to 36 percent as of the fourth quarter of 2016. The analyst believes the company will raise its 2017 domestic card NCO guidance again after bumping it up already once this year.

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Margin Woes

Despite higher rates and loosening underwriting standards, Piper Jaffray noted that margins have not expanded. The firm noted that the net interest margin, or NIM, remained subdued, due to rising debt costs, an elevated loan/deposit ratio and above-average deposit betas.

The firm clarified that the net interest margin has grown only 9 basis points to 6.88 percent since the Fed began tightening rates.

"While we believe COF is building one of the better deposit gathering franchises, the near-term headwinds on asset yields from intense competition will likely keep margins capped," the firm said.

Unrealistic Street Estimates

The firm noted that the Street estimates for Capital One appear too high. The firm estimates earnings per share of $7.84 for 2018 and $8.30 for 2019. This compared to the Street estimates of $8.40 for 2018 and $9.55 for 2019. The firm attributed the variance to its low net interest income and NIM estimates.

The firm is of the view that heavy competition in the credit card industry and increasing deposit betas will temper any tailwinds from higher short-term rates. Given the fact that the company has struggled to grow core earnings in recent years, the firm thinks the Street expectations for 11 percent earnings per share growth in 2018 and 14 percent in 2019 as overly optimistic.

With the stock is trading in the upper range of its historical forward P/E, the firm believe Capital One shares are set up to underperform until valuation is better aligned or risk-adjusted returns improve.

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