Capital One Shuts Down Mortgage Unit, Shifting Attention To More Profitable Areas

Those who have said the mortgage market’s survivors will thrive due to fewer competitors are certainly right, but as the Capital One (COF) announcement last night shows, even those that could survive might not even try to do so. The company has decided to shut down its GreenPoint wholesale mortgage unit and cut 1,900 jobs as a result. The secondary mortgage market is to blame, as Capital One is one of many banks that can no longer sell mortgages at profitable prices to investors in order to fund new originations.

Despite the headlines that will undoubtedly result from this news, let’s go through what it actually means for Capital One in dollar terms. GreenPoint was hardly in shambles before this announcement. After losing $12.6 million in Q1, the division actually earned a profit of $2.6 million in Q2, and management was assuming a breakeven year in 2007. During the second quarter, wholesale mortgages represented an immaterial 0.3% of Capital One’s net income. For the first half of 2007, the unit’s $10 million loss negatively impacted the company’s earnings by only 0.7%.

Why the rush to shut down Greenpoint then? I was actually surprised they didn’t halt new originations for a while to see how the secondary market shaped up in coming months, but given that there were 1,900 jobs within GreenPoint, and the odds of it generating any significant earnings in the short or intermediate term was essentially zero, it does make sense that Capital One management decided it was not a good use of resources to continue to fund the division. Why not just save a ton of money and cut the thing loose now?

Interestingly, even in 2006 when the mortgage market was great, GreenPoint only earned$138.5 million. That’s a lot compared with this year, but even then it contributed only about $0.33 to Capital One’s earnings of more than $7 per share. As you can see, even in good times GreenPoint might not be missed all that much, especially if the company can reallocate that money into higher return projects, which I suspect it can.

And keep in mind that this decision does not mean that Capital One is no longer in the mortgage market. They will still be loaning money to home buyers in the form of new mortgages and home equity loans through their local banking operations. They simply decided to halt the wholesale business in order to have more control over their loan operations.

All in all, this decision sets Capital One up nicely heading into 2008. The mortgage pressures on earnings will be lifted meaningfully, much of the merger related charges and other restructuring charges will be behind them (2007 was an integration and transition year), and the yield curve has steepened somewhat in recent weeks, so the company’s margins should improve.

Given that Capital One is still slated to earn more than $7 per share this year before one-time special charges related to the GreenPoint closing and merger-related charges will decline in 2008 as cost savings are further realized, I would not be surprised to see an earnings per share number meaningfully above $8 next year, (perhaps even approaching $9). In addition, after the company’s current $3 billion buyback is completed (it is more than half done), I would expect a new “bank-like” stock dividend put into place as well. In such a case, Capital One stock should no longer be anywhere near the current $66 quote.

Full Disclosure: Long shares of Capital One at the time of writing

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One Thought on “Capital One Shuts Down Mortgage Unit, Shifting Attention To More Profitable Areas

  1. I also thought about it like this: Clearly there is massive over capacity in mortgage origination, which is why we’re seeing so many of the eventual survivors cutting headcounts. COF could have done the same thing and taken a much smaller charge, but by focusing it at Greenpoint, they’re able to take a bigger (non-cash portion) charge, which will improve their ROE going forward.

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