Capital One's Bright Future

In the U.S., the company is now the fourth-largest Visa and MasterCard (NYSE: MA) issuer; it's also No. 2 in non-captive auto lending, No. 2 in small-business credit cards, and No. 3 in Small Business Administration loans.

Card issuers operate with mostly fixed-cost structures. They have to advertise to promote their brand and attract customers, build expensive technology infrastructure to handle back-office duties such as account maintenance, and hire staff to perform duties such as credit risk management and customer service. As a result, marginal costs, or the cost of adding an additional customer, are minimal. All the card issuer has to do is print out a piece of plastic and mail it to the customer. Clearly, the credit card business is a game of scale.

Data can also be used to figure out things such as how to lower customer-acquisition costs. Thus, scale becomes a virtuous cycle for credit card companies.

Capital One wisely went down a different route in purchasing Hibernia and North Fork (NYSE: NFB), two well-run regional banks. Regional banks have historically provided better customer service and taken market share from the national banks. In the past five years, the smallest banks (the 31st largest and lower) have seen their deposit market shares rise an average of 4% annually, whereas the largest five banks have had their share contract by 4% annually. By using a regional banking strategy, Capital One can use a growing base of low-cost deposits to fund its credit-card and consumer-lending business rather than raise debt in expensive capital markets. In 2005, Capital One had to pay 4.14% to its depositors and 6.18% to its debtholders.

I've thought for a while now about why people insist on banking locally and borrowing nationally. My theory is that it simply comes down to whether you're handing over your money or receiving it. I know that when I'm paying out money, I want a face-to-face relationship to make sure I know whom I'm giving my money to. However, when someone's giving me money, I just want the best deal. In college I had a summer job with Ditech. I remember thinking that borrowers around the country probably had no idea that I was sitting in a building in Costa Mesa, Calif., processing what might be the most important financial transaction in their life. The borrowers probably didn't care, as long as they got their money at a low interest rate. For this reason, I believe that Capital One's strategy is the correct one and will pay off in spades in the future.