Core profitability measures are important 

There are two core profitability measures for a bank. The measures are net interest income and net interest margin. Net interest income is similar to gross profit for normal companies. The net interest margin is similar to the gross profit margin.

Capital One (COF) focuses on lending as a primary source of earnings. It needs to have a good pipeline of loans. These loans should lead to a growing net interest income stream. The best situation for a bank would be if the net interest income growth is accompanied by an increase in the net interest margin.

Why Capital One’s net interest margin is above the sector average

Blip in net interest income in 2014

Net interest income is like bread and butter for retail banks. Over the years, Capital One’s net interest income has been increasing. It’s in line with the increase in the bank’s loan book. However, there was a minor fall in the net interest income in 2014. In 2014, Capital One’s net interest income stood at $17.89 billion. It was $18.22 billion in 2013.

Net interest margin fell in 2014

The credit card business has high margins. Capital One entered into many new businesses since its early days. This led to falling net interest margins. However, the net interest margins still remain much higher than the sector average.

In an environment of falling net interest margins, Capital One has been able to hold on to its margins. At the end of 2014, the net interest margin was at 6.17%. This was almost double the sector-wide average net interest margins of 2.91%. This is due to Capital One’s presence in high net interest margin loans.

Wells Fargo (WFC), U.S. Bank (USB), and PNC Bank (PNC) have much lower net interest margins than Capital One. Capital One has one of the highest net interest margins among the banks in the Financial Select Sector SPDR (XLF).

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