Business context and reporting period
Capital One Financial Corporation filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2017. The diversified financial services company operates Credit Card, Consumer Banking and Commercial Banking businesses, with activities in the U.S., U.K. and Canada. Comparisons below are year over year unless otherwise noted.
Financial performance and condition
| Metric | Q2 2017 | Six months 2017 |
|---|---|---|
| Total net revenue | $6.704 billion, up 7% | $13.239 billion, up 6% |
| Net interest income | $5.473 billion, up 7% | $10.947 billion, up 8% |
| Provision for credit losses | $1.800 billion, up 13% | $3.792 billion, up 22% |
| Net income | $1.036 billion, up 10% | $1.846 billion, down 6% |
| Diluted EPS | $1.94, up 15% | $3.49, down 1% |
| Net interest margin | 6.88%, up 15 bps | 6.88%, up 14 bps |
| Efficiency ratio | 50.92%, improved 177 bps | 51.73%, improved 52 bps |
Q2 income from continuing operations was $1.047 billion; six-month income from continuing operations was $1.842 billion. Average loans held for investment rose 5% in Q2 and 6% for the half year. Net charge-offs were $1.618 billion in Q2 and $3.128 billion year to date; the corresponding rates were 2.67% and 2.59%, respectively. The allowance for loan and lease losses was $7.170 billion, or 2.93% of loans, at June 30, up from $6.503 billion and 2.65% at year-end.
At June 30, total assets were $350.593 billion, deposits $239.763 billion and stockholders’ equity $49.137 billion. Other debt was $31.596 billion and securitized debt obligations were $18.358 billion. Total borrowings, including securitized debt obligations, were approximately $49.954 billion. Cash and cash equivalents were $6.715 billion. Liquidity reserves totaled $85.309 billion, up from $74.076 billion at year-end; the company reported that it exceeded the fully phased-in liquidity coverage ratio requirement. Operating cash flow for the first six months was $7.023 billion, investing cash flow was negative $4.295 billion and financing cash flow was negative $8.206 billion. Cash, cash equivalents and restricted cash ended the period at $7.015 billion.
Common equity Tier 1 capital was 10.7% under the Basel III Standardized Approach with transition provisions, versus 10.1% at year-end. The company’s Q2 return on average assets was 1.20%; return on average common equity was 8.59%.
Material changes versus comparable periods
- Q2 net income increased as higher loan interest income and interchange income more than offset increased credit-loss provisions, funding costs and operating expenses. For the first half, net income declined as higher credit provisions, operating expenses and interest expense outweighed revenue growth.
- Net charge-off rates increased year over year, notably in domestic credit cards (5.02% for Q2 versus 4.02%) and Consumer Banking (1.25% versus 0.83%). Management cited seasoning and growth in recent card vintages, auto-loan growth and lower used-car auction prices, and higher commercial losses in oil-and-gas and taxi-medallion lending.
- Loans held for investment were $244.302 billion, down $1.284 billion from year-end, reflecting seasonal card paydowns and acquired home-loan runoff, partly offset by auto, card and commercial growth. Deposits increased $2.995 billion; total debt declined as FHLB advances fell.
- Commercial Banking six-month net income rose to $359 million from $205 million, partly reflecting a lower credit-loss provision and allowance release. Credit Card six-month net income fell to $824 million from $1.093 billion.
Outlook, risks, contingencies and unusual items
- For 2017, management expected an efficiency ratio in the 51% range, excluding adjusting items, and EPS growth of 7%–11%, excluding adjusting items, assuming no substantial change in broader credit and economic cycles. Expectations exclude potential effects of the anticipated Cabela’s acquisition.
- Management expected the 2017 Domestic Card charge-off rate in the high 4% range to around 5%, with quarterly variability. Auto charge-off rates were expected to rise gradually; a change in charge-off practices was expected to add 15–20 bps to annualized auto charge-off rates from Q3 2017 into 2018. Commercial credit pressures were expected to remain concentrated in oil-field services and taxi medallions.
- The board authorized up to $1.85 billion of share repurchases for Q3 2017 through Q2 2018. It had repurchased approximately $2.2 billion under the preceding $2.5 billion authorization through Q2 2017. The quarterly common dividend was $0.40 per share.
- The Federal Reserve did not object to the 2017 capital plan but required a revised plan by December 28, 2017 to address weaknesses in the capital-planning process. An objection to the resubmission could restrict future capital distributions.
- The proposed Cabela’s card-portfolio transaction was restructured: Synovus was to acquire certain World’s Foremost Bank assets and liabilities and then sell the credit-card assets and related liabilities to Capital One. Closing remained subject to customary conditions, including regulatory approval of Synovus’s acquisition and completion of the Cabela’s–Bass Pro merger; parties could terminate if conditions were not met by October 3, 2017.
- Mortgage representation-and-warranty reserves were $521 million; management estimated approximately $1.3 billion of reasonably possible future losses beyond reserves. Separately, reasonably possible litigation losses beyond reserves were estimated at approximately $200 million, excluding the mortgage claims included in the prior estimate. Management cautioned that actual losses could exceed these estimates.
- Other notable exposures include a $315 million U.K. payment-protection-insurance reserve and approximately $200 million of reasonably possible future PPI losses beyond the reserve; a $42 million liability for GreenPoint manufactured-housing clean-up-call obligations, with assets subject to calls of about $410 million; and investigations concerning former commercial-bank check-casher clients and the AML program. Capital One remained subject to a 2015 OCC consent order concerning AML deficiencies.
- A second-quarter change in the estimated charge-off treatment for certain consumer loans resulted in approximately $48 million of auto net charge-offs. Management said this increased Q2 auto and total Consumer Banking charge-off rates by 38 bps and 26 bps, respectively; excluding the change, the respective rates were 1.32% and 0.99%.
- Key uncertainties include consumer and commercial credit deterioration, economic and interest-rate changes, funding-market access, regulatory and legal developments, technology and cybersecurity disruption, and the impact of rewards competition and operating costs. The filing reported no material change to previously disclosed risk factors.
Important facts for investors to verify
- Whether card and auto credit losses continue to rise as recent loan vintages season, and how charge-off practice changes affect reported trends.
- Whether allowance growth is adequate relative to loss expectations, particularly for domestic credit cards and auto loans.
- Progress on the revised capital plan, regulatory capital levels, and the timing and execution of the $1.85 billion repurchase authorization.
- Actual outcomes and reserve adequacy for mortgage representation-and-warranty claims, PPI remediation, AML matters and GreenPoint clean-up calls.
- Whether the Cabela’s transaction closes on its stated terms and within the contractual deadline.
- Cash-flow and funding trends: bank cash-flow statement movements, deposit mix and costs, debt maturities, and the availability of liquidity reserves.