This Is Capital Ones Most Impressive Accomplishment

What Capital One has accomplished over the course of its 20-year existence is rare among diversified financial services companies.

Most firms its size start by accumulating low-margin consumer or commercial deposits before expanding into higher-margin businesses like credit cards.

But Capital One approached it from the opposite direction. It started life as a stand-alone credit card company in 1995 and then expanded into online and branch banking. It's now the eighth largest traditional bank in the United States when measured by assets.

The only other company I'm aware of that's been able to match this was Commercial Credit, a one-time Baltimore, Maryland-based consumer lender that transformed into Travelers Group in the 1980s and 90s before merging with Citicorp in 1998 to form Citigroup.

It was an incredible run to be sure, spearheaded by the legendary financier Sandy Weill, but it's one that Capital One is well on its way toward replicating.

If you look at Capital One's business today, the evidence of its former concentration in credit cards is still apparent.

More than 40% of its loans relate to credit cards. That compares to 11.1%, 7.1%, and 3.5% at Bank of America, US Bancorp, and Wells Fargo, respectively.

You may think this isn't a great thing. After all, credit card loans are second to none in terms of default rates.

In this year's stress test, the Federal Reserve assumed that 13.1% of all credit card loans would default if the economy experiences another economic downturn akin to the financial crisis. The next riskiest category, commercial real estate loans, were projected to default at a rate of 8.6%. Residential mortgages weighed in at only 3.6%.

But the upside to this risk is that credit card loans pay a significantly higher rate of interest, which means that Capital One's asset portfolio generates more income on a relative basis than a traditional lender.

Its yield on earning assets in the second quarter was 7.14%. That was more than twice the 3.42% yield of its closest competitor, US Bancorp. And the difference is even greater when you look at Capital One's largest rivals,as you can see in the figure below.

The net result is that Capital One's unusual path into the regional banking space gives it unique exposure to both tremendous profit potential as well as elevated credit risk. Done right, this is a model that will continue to produce industry-beating returns for years to come.

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John Maxfield has no position in any stocks mentioned. The Motley Fool recommends Bank of America and Wells Fargo. The Motley Fool owns shares of Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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