2nd UPDATE: Capital One 1Q Net Up 38% On Bargain Purchase Gain

Capital One Financial Corp.'s (COF) first-quarter profit rose 38% as a gain tied to the bank's acquisition of ING Direct boosted its bottom-line results and net charge-offs improved.

The company, which transformed itself from a credit-card lender to a bank just before the financial crisis hit, benefited along with many of its peers in recent months as credit losses declined and delinquency rates eased.

A stronger loan portfolio helped drive Capital One's profits higher earlier in 2011, though the credit improvements have showed some signs of slowing in recent months.

Capital One is buying HSBC Holdings PLC's (HBC, 0005.HK, HSBA.LN) U.S. credit-card operations, which includes about $30 billion in loans, for $2.6 billion. The deal would make Capital One the third-largest issuer of the private-label credit card companies. The company last month unveiled plans to offer $1.25 billion of its common stock to help fund the HSBC acquisition.

In February, Capital One completed its acquisition of ING Direct USA from ING Groep NV (ING, INGA.AE) in a deal valued at $9 billion.

Executives said the integration of ING Direct is moving forward and Capital One is on track to complete the acquisition of the HSBC business in the current quarter. However, the company warned that over time its overall card charge-offs could rise because HSBC typically has seen higher loss rates than Capital One.

"Despite the noise associated with the short-term and medium-term impacts, we expect that the synergies in ongoing operations of the HSBC U.S. card business will drive a significant and sustainable increase in domestic card earnings," Richard Fairbank, chairman and chief executive of Capital One, said during an earnings conference call Thursday.

For the latest quarter, Capital One posted a profit of $1.4 billion, or $2.72 a share, up from $1.02 billion, or $2.21 a share, a year earlier. Excluding the impact of a "bargain purchase" gain related to the ING Direct acquisition, earnings were $1.56 a share in the latest period. The gain of $594 million was previously expected and largely driven by a decline in long-term interest rates, Chief Financial Officer Gary Perlin said.

Total revenue increased 21% to $4.94 billion.

Analysts polled by Thomson Reuters expected a $1.39 per-share profit and $4.37 billion in revenue.

Shares were up 1.6% at $54.80 after market close. Capital One's stock is up 28% since the start of the year.

The credit-card industry overall has performed well over the last two years as consumers aggressively paid down debt, leading to lower delinquencies and net charge-offs. Capital One has benefited from the trend, though it has seen write-offs tick up in recent months, and some analysts predict its credit losses to edge higher as it integrates the HSBC business.

Moody's Investors Service expects Capital One to be the "worst performer" in terms of charge-offs this year of the six largest credit-card issuers, the ratings agency said last week, citing the bank's HSBC acquisition. The HSBC business contains some loans made to "subprime" borrowers, or those with tarnished credit, and store cards, which tend to perform slightly worse than general-purpose credit cards.

But the delinquency rate for its U.S. credit cards was 3.25%, down from 3.59% a year earlier and down from 3.66% in the fourth quarter. The net charge-off rate was 3.92%, down from 6.2% a year earlier and down from 4.07% in the fourth quarter.

Analysts at Macquarie said they have concerns about Capital One's recent growth from portfolio acquisitions.

"We are not against these card purchases and expect them to be accretive," they wrote in a research note last week. "However, credit is at risk to underperform the peer group, given the collateral mix includes higher subprime and retail collateral."

But Capital One "could see higher than peer card loan growth due to their new private-label card strategy as they are well positioned to pick off expiring deals from larger players," Don Fandetti, an analyst for Citigroup Inc., wrote in a research note last month.

Loan growth has been stagnant for credit-card lenders, partly due to consumers' unwillingness to take on new debt. But some issuers, including Capital One and American Express Co. (AXP), have started to see expansion.

Capital One's U.S. credit-card loans increased 5.1% from a year earlier to $53.2 billion but were down 6.1% from the fourth quarter.

While improving credit has allowed credit-card lenders to boost profits by releasing reserves and recording smaller provisions for future loan losses, analysts expect that trend to wane this year as issuers pursue loan growth.

Capital One recorded a provision of $573 million, up from $534 million a year earlier, but down from $861 million in the fourth quarter.

Lenders are likely to pull back marketing investments, which increased significantly for many card issuers last year, as expenses tied to losses increase.

Capital One's marketing expenses were $321 million in the first quarter, up 16.3% from a year earlier but down 23.6% from the fourth quarter.

The net charge-off rate for all loans, including auto, international cards and other categories, was 2.04%, down from 3.66% a year ago and from 2.69% the previous quarter. Charge-offs are loans banks don't expect to be able to collect. The overall delinquency rate was 2.23%, compared with 3.07% in the year-ago period and 3.35% in the previous quarter.

-By Andrew R. Johnson and Nathalie Tadena, Dow Jones Newswires, 212-416-3214; [e-mail]