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Capital One Financial Corp.’s (COF) fourth quarter 2012 earnings of $1.41 per share significantly lagged the Zacks Consensus Estimate of $1.62. However, this was nearly 60% above the prior-year quarter earnings of 88 cents.

For 2012, Capital One reported earnings of $6.16 per share. This was below the Zacks Consensus Estimate of $6.43 and prior-year earnings of $6.80.

The quarterly results improved on a year-over-year basis. Growth in top line was partially offset by rise in operating expenses. Further, strong profitability as well as capital ratios and improving asset quality were the highlights of the quarter.

Net income from continuing operations for the fourth quarter came in at $848 million or $1.42 per share compared with $411 million or 89 cents per share in the year-ago quarter. In 2012, it stood at $3.73 billion or $6.54 per share versus $3.25 billion or $7.03 per share in 2011.

Performance in Detail

Capital One’s net revenues for the reported quarter stood at $5.62 billion, jumping 38.9% year over year. Yet, revenues were below the Zacks Consensus Estimate of $5.78 billion.

Net revenues for 2012 were $21.40 billion, surging 31.4% from $16.28 billion in 2011. Also, revenues were above the Zacks Consensus Estimate of $20.86 billion.

Net interest income for the quarter grew 42.3% from the previous-year quarter to $4.53 billion. However, net interest margin decreased 70 basis points (bps) year over year to 6.52%.

Non-interest income surged 26.3% from $868 million in the prior-year quarter to $1.10 billion in the reported quarter. The increase was mainly driven by higher service charges and other customer-related fees as well as rise in interchange fees.

Capital One’s operating expenses rose 24.3% from the prior-year quarter to $3.26 billion. The increase was largely attributable to higher salaries and associate benefits costs and merger-related expenses, partially offset by lower marketing expenses.

The managed efficiency ratio deteriorated to 57.88% from 64.64% in the prior-year quarter. The rise in efficiency ratio indicates decline in profitability.

Credit Quality

Capital One’s credit quality showed improvement during the reported quarter. Net charge-off rate declined 43 bps from 2.69% in the prior-year quarter to 2.26%.

Similarly, the 30-plus day performing delinquency rate decreased 65 bps year over year to 2.70%. Moreover, allowance, as a percentage of reported loans held for investment, came in at 2.50%, down 63 bps from 3.13% in the previous year quarter.

However, provision for credit losses jumped 33.7% year over year to $1.15 billion. The rise was largely due to an increasingly lower proportion of charge-offs related to acquired delinquent non-revolving credit card loans being absorbed by the SOP 03-3 credit mark and seasonal increase in Domestic Card portfolio.

Capital and Profitability Ratios

Capital One’s capital and profitability ratios continued to remain stable in 2012. As of Dec 31, 2012, return on average assets stood at 1.10%, up from 0.82% as of Dec 31, 2011. Similarly, return on average common equity improved to 8.44% from 5.54% in the prior period.

As of Dec 31, 2012, tangible common equity (:TCE) ratio was 7.9% compared with 8.2% as of Dec 31, 2011.

As of Dec 31, 2012, tier 1 risk-based capital ratio came in at 11.4% marginally below 12.0% as of Dec 31, 2011. The company’s tangible book value per share was $40.23 as of Dec 31, 2012 compared with $34.26 as of Dec 31, 2011.

Guidance

In 2013, Capital One anticipates average quarterly revenue levels to be almost in line with the fourth quarter of 2012. This would be driven by a modest fall in earning assets that will be offset by a steady to slightly higher net interest margin.

Moreover, the company expects non-interest expense to be about $3.1 billion per quarter in 2013, reflecting a modest decline in quarterly expenses relative to seasonally elevated operating and marketing costs in the fourth quarter of 2012.

Our Viewpoint

We anticipate continued synergies from Capital One’s geographic diversification and two of its major acquisitions – HSBC Holdings plc’s (HBC) credit card business and ING Direct USA, the online banking unit of ING Groep NV (ING). Moreover, the resilience shown by almost all its businesses will continue to support its financials. Nevertheless, exposures to commercial real estate, weak demand for loans and the impact of new financial regulations are expected to marginally dent the results in the near term.

Capital One currently retains a Zacks Rank #3 (Hold). Considering the fundamentals, we also maintain a long-term Neutral recommendation on the shares.