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To: patron_anejo_por_favor who wrote (213261)	1/9/2003 9:24:24 AM
From: orkrious	Respond to of 436258

Capital One Rally Flouts Feds' New Focus By Peter Eavis Senior Columnist 01/09/2003 07:04 AM EST thestreet.com The news from the capital may not be as good as some Capital One (COF:NYSE - news - commentary - research - analysis) investors believe. Showing Washington's nervousness at the explosive growth in loans to people with impaired credit, federal banking authorities announced guidelines Wednesday that are designed to keep credit card lenders from using "inappropriate" practices that engulf borrowers in more and more debt. The long-awaited guidance from the Federal Financial Institutions Examination Council, which represents four federal banking regulators, didn't hit credit card lender stocks because the regulators used language that was softer than the market had been expecting. Capital One, a credit card lender that could be especially vulnerable to the new guidance, jumped $3.21, or 10%, to $35.41, on Wednesday. But a close reading of the guidance shows that the feds are still very keen on preventing lenders from increasing borrowers' debt levels by adding unpaid fees and charges to the balance of the loan, a practice known as negative amortization. The regulators want to restrict negative amortization because it can "increase credit risk and mask" the amount of defaulted loans at card lenders. Regulators face heat from Congress when banks collapse because taxpayers have to pay for the refund of federally insured deposits. Many credit card companies use bank deposits to fund their loans. Risk Factors After reviewing the FFIEC's draft guidelines released in August last year, Detox concluded that Capital One's earnings were highly exposed to the proposed new guidance. While the language may have been tempered in the final guidelines, Capital One's outlook is no less at risk. When asked for comment, a Capital One spokeswoman emailed a research note by a Banc of America Securities analyst that said the new guidance "looks innocuous on first read." Caren Mayer, the author of the note, asserted that investors had been worried that the regulators would prohibit overlimit fees, which the guidance did not do. But a second read suggests that the regulators, in code, could be singling out Capital One for special attention. How so? Well, there is a good case to be made that Capital One's earnings rely heavily on late and overlimit fees from loans to people with poor credit histories, known in the industry as subprime borrowers. Capital One's disclosure is very poor on its fees -- something the bulls on the stock fail to acknowledge. But work done by Bill Ryan of Portales Partners, an analyst with an enviable record of spotting broken lending models at financial companies, estimated that Capital One's late and overlimit fees were more than three times its pretax profits in the third quarter. Around 40% of the lender's loans are subprime. Given these insights, it would appear to some that Capital One systematically strives to maximize fees, which, in turn, may lead to significant amounts of negative amortization. The following passage from the new guidance strongly implies that regulators are unequivocally committed to stamping out such a business model: "The pitfalls of negative amortization are magnified when subprime accounts are involved, and even more so when the condition is prolonged by programmatic, recurring overlimit fees and other charges that are primarily intended to increase recorded income for the lender rather than enhance the borrowers' performance or their access to credit." Bill Me Later So how will this hurt Capital One? Negative amortization can occur when minimum payments are less than the amount owed in fees and finance charges in a given billing period. Therefore, the new rules could force Capital One to increase its minimum payments or chop its fees. The former would lead to higher defaults and the latter would slam revenue and earnings. In weighing who is right in the Capital One debate, investors also should remember that in July, the lender announced that the Federal Reserve and the Office of Thrift Supervision had asked it to enter an "informal memorandum of understanding." That is effectively a request by the regulators that Capital One address issues that concerned it. The memo led to higher regulatory capital and increases to the bad loan reserve, as well as a commitment to improve management. The FFIEC guidance also set new guidelines for setting up reserves for troubled loans.