Capital One Financial Earnings: Slower Growth and Higher Expenses

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Capital One Financial (NYSE: COF) released its second quarter earnings on Thursday, and the markets weren't impressed. After missing estimates on the top and bottom lines, shares dropped by nearly 5% after hours. Here's what you need to know about Capital One's quarter, and where the bank may find growth in the future.

The big numbersCapital One generated $5.67 billion in revenue, shy of the $5.76 billion analysts had hoped for. The miss was even worse on the bottom line, as the company produced net income of $1.50 per share ($863 million total), which translated to $1.78 per share when adjusted for certain items.

Analysts had expected $1.97 per share in earnings, and comparisons to the company's results in recent quarters may look alarming at first glance. Net income was more than $300 million greater in both the first quarter of 2015 and the same quarter last year even though revenue was lower during both of those quarters, so it's only natural to wonder what happened.

A closer lookUpon closer inspection, the earnings miss was due to a combination of significantly higher expenses and sluggish growth in many areas of the business.

Let's start with the credit card division, which is the largest and perhaps the most well-known part of Capital One's business. This was a bright spot of the quarter. Outstanding credit card loans were up 10% year-over-year and purchase volume increased by 22%. Credit quality also increased, with the net charge-off rate, 30-day delinquency rate, and the nonperforming loan rate all dropped over the past year.

However, most of Capital One's other businesses struggled to grow. For example, auto loans and bank deposits were up just 1% and total consumer loans were flat from the same quarter last year.

The commercial banking business performed slightly better, with 6% and 5% year-over-year loan and deposit growth, respectively, but charge-offs and nonperforming loans both increased.

In all, the bank's revenue grew 4% year-over-year, which actually wasn't too bad when compared with many other banks. For example, Wells Fargo's revenue increased by just 1% from the second quarter of 2014, and Bank of America's increased by less than 2%.

All of the revenue growth was more than offset by increased expenses, which is the main reason for the drop in net income. Total non-interest expense grew by 11% year-over-year, including a 16% increase in marketing expense and a 12% rise in operating expenses. To be fair, the higher operating expenses included a $147 million restructuring charge and a $41 million reserve build, but this only accounts for some of the difference.

It doesn't take a mathematician to realize that when your expenses grow by 11% and your revenue grows by 4% you're going to make less money, and that's exactly what happened here.

Future growth opportunitiesHaving said all of that, Capital One still has a thriving credit card business and could be worth a look if the stock continues to fall post-earnings. CEO Richard Fairbank said in the bank's press release that Capital One continues "to see growth opportunities across our businesses, particularly in Domestic Card."

As a final point to consider, although spending increased significantly, it's not an entirely bad thing. As I mentioned, a large chunk of it went toward building reserves, which won't necessarily translate to losses. And more importantly, the largest area of increased spending (percentage-wise) was marketing.

The marketing effort seems to be doing the trick in terms of increased credit card business, a move that could pay off over the long run. Credit card business has somewhat of a "delayed fuse" -- banks like Capital One generally spend money recruiting new card members, and earn money down the road when customers use the cards, so don't be too discouraged by the fact that marketing spending was disproportionate to growth.

In a nutshell, Capital One's earnings report wasn't good. But, bear in mind that bad quarters don't necessarily imply a broken business, so don't be dismissive of Capital One based on this earnings report alone. We'll just have to wait and see if the company's increased spending pays off in the long run.

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