As the youngster in the credit-card game a few years ago, Capital One was at a decided disadvantage. The Richmond, Virginia-based bank, born in 1995 as a spin-off of Signet Bank, had no demonstrated ability to weather a recession. It also had an undiversified and cyclical asset base, which would put it in a precarious position if such a recession led to a capital crunch.
"Here we were this brand-new bank with no stand-alone funding," recalls CFO David Willey, who took a much-needed break recently to hike part of the Appalachian Trail. "So much of our balance sheet was short-term loans--fine at the time, but when you looked at where we were ratings-wise, in the triple B area, a downgrade would have been catastrophic," he adds. "While the odds [of a downgrade] were low, we desperately needed to craft a financial strategy to manage our liquidity."
This he did, designing and implementing a liquidity risk- management policy ensuring that funding constraints did not rob Capital One of self-determination. For his effort, Willey is being recognized with a CFO Excellence Award in the Risk Management category. "The first job of a CFO or treasurer is not to run out of money," says Willey, barely out of breath from his morning hike. "Funding is the lifeblood of a financial services company. It must be available when needed, to pursue opportunities as they arise and protect the company in times of turmoil," he says. "Fortunately, I believe we've tackled such liquidity concerns."
So do the rating agencies. Last summer, Capital One was upgraded a notch by both Moody's and Duff & Phelps, and previously was hiked to a double Bplus by Standard & Poor's. "I used to have trouble sleeping, worrying about credit risk and liquidity," says Willey. "Now I sleep just fine."
A Legacy of Innovation
Capital One is something of a maverick in the credit card business. Its innovativeness is probably a legacy from former parent Signet Bank, which issued the first MasterCard in 1953. But its customer credit card strategy is all its own, says Tony Smith, bank analyst at Donaldson, Lufkin & Jenrette Inc. "The raison d'être behind Capital One's business model is its information-based approach," he explains. Rigorous scientific testing of customer preferences allows the company "to offer the right product to the right customer at the right time and the right price. And the end result is higher acceptance rates and lower attrition levels."
For Willey, who joined Signet Bank in 1989, one year after it introduced the bank-card division that later became Capital One, protecting the company's access to capital is imperative. So after the initial public offering in 1995, one of Willey's first tasks as Capital One's treasurer--and now as CFO--was to challenge the bank's risk management and capital markets groups to devise an integrated liquidity risk- management strategy. He did that by establishing four specific objectives: a world-class debt investor relations (IR) program; improved liquidity risk analytical tools; enhanced capability in the retail deposit market; and a position as a top-tier issuer in the securitization market.
For example, the company's dedicated IR team was repositioned to focus on the debt side as well as on equity. The core of the team's approach is providing solid information. "Dave is very proactive when it comes to meeting with investors in conference settings or at one-on-one intimate lunches," says Smith. The effort bodes well for Capital One's main liquidity goal, he adds. "Through a series of disciplined approaches, particularly with respect to cultivating new investors, Dave has broadened and deepened the company's funding flexibility."
Meat and Potatoes
But building a world-class IR team was nothing compared with creating appropriate analytical tools to manage Capital One's liquidity risks. "We had to start from scratch," says Willey. "At the time of the IPO, we were really nowhere. Treasury was me and another guy."
To get the ball rolling, Capital One introduced a stress- based scenario system--dramatizing a particular funding disaster and the steps required to survive it. Its moderate- stress scenario, for example, calls for finance to maintain the ability to pursue all strategies in the event it loses access to new unsecured, wholesale funding for a year.
The strategy paid off during the liquidity crunch in the autumn of 1998. "The unsecured, wholesale markets practically dried up, and we felt it would take us longer than normal to execute a term securitization deal," recalls Willey. "Fortunately, the events bore a striking resemblance to our moderate- stress scenario. We were actually able to access the funding markets when others could not." In early November of that year, they raised $750 million through the sale of asset- based securities.
Nigel Morris, Capital One's president and chief operating officer, says such preparedness is crucial to the company. "Dave and his team have worked very hard to build an architecture to manage the boring side of the balance sheet," he says. "They have ensured, through their scenario-based analyses, that our edifice is strong enough to withstand difficult economic times."
Banking On Deposits
The third piece of the integrated strategy called for enhancing Capital One's retail deposit-taking capabilities. The company entered this business in the third quarter of 1997 upon purchasing J.C. Penney's $1 billionplus retail deposit business. It grew deposits, using proprietary technology and the Internet, from $2.3 billion in the second quarter of 1999 to $5.3 billion in the second quarter this year.
Since the retail deposit market is inversely correlated to the wholesale capital markets, Capital One also obtains a natural hedge. This offset was apparent during the aforementioned liquidity crunch in 1998, when the bank received a huge inflow in retail deposits. "The rating agencies view this as very positive," Willey contends.
Smith backs him up. "By offering both credit cards and deposits on its Web site, and successfully segmenting the market according to customer needs, Capital One has created a diversified risk portfolio, essentially removing interest rate risk," he says.
Capital One's last liquidity risk management goal was to reposition itself as a top-tier issuer in the securitization market. In early 1999, the bank kicked off a new securitization strategy with an alternative credit card structure, using Class C notes to tap into institutional investor demand and expand its investor base.
The new structure improved spreads, resulting in a funding cost savings of approximately $1.5 million for 1999 transactions. A broader investor base has been garnered, particularly among U.S. investors. "The achievement of top-tier status will provide a greater ease of issuance in good market conditions," says Willey. "And it will give us greater access to funding during times of market disruptions."
All this good news is great for both Capital One and for Richmond, a city that has watched a parade of its top firms march down the merger aisle. "Capital One is leading the charge here for other companies trying to figure out how to operate in the New Economy," says Tayloe Negus, manager of business development in Arthur Andersen's Richmond office and the organizer of a local CFO group that meets bimonthly to discuss business issues.
Negus, in fact, nominated Willey, a member of the CFO group, for the CFO Excellence Award, even though Willey is not a client. "Dave is extremely smart and sophisticated, yet very laid-back, the kind of guy who knows his way around, in the office and out of it," says Negus.
Are these the kinds of qualities that are useful for someone hiking the Appalachian Trail? "Obviously, I don't have time to walk the whole thing," says Willey. "I'm taking it in segments."