Capital One Financial Corporation: 2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016. The filing also reports fourth-quarter results. Capital One is a diversified financial-services holding company operating through Credit Card, Consumer Banking and Commercial Banking segments.
Financial performance and position
| Metric | 2016 | Prior comparable period |
|---|---|---|
| Total net revenue | $25.5 billion | $23.4 billion in 2015; up 9% |
| Net income | $3.75 billion | $4.05 billion in 2015; down 7% |
| Diluted EPS | $6.89 | $7.07 in 2015; down 3% |
| Net interest income / margin | $20.9 billion / 6.78% | $18.8 billion / 6.66% in 2015 |
| Provision for credit losses | $6.46 billion | $4.54 billion in 2015; up 42% |
| Non-interest expense / efficiency ratio | $13.56 billion / 53.17% | $13.00 billion / 55.51% in 2015 |
| Net charge-offs / rate | $5.06 billion / 2.17% | $3.70 billion / 1.75% in 2015 |
| Loans held for investment | $245.6 billion | $229.9 billion at year-end 2015 |
| Total assets / deposits | $357.0 billion / $236.8 billion | $334.0 billion / $217.7 billion at year-end 2015 |
| Total debt and borrowings | $60.5 billion | $59.1 billion at year-end 2015 |
| Cash and cash equivalents | $10.0 billion | $8.0 billion at year-end 2015 |
| Operating cash flow | $11.9 billion | $10.1 billion in 2015 |
Net interest margin improved 12 basis points, while the efficiency ratio improved 234 basis points. Return on average assets was 1.11%, down from 1.28%; return on average common equity was 7.82%, down from 8.51%. Year-end common equity Tier 1 capital was 10.1%, versus 11.1% in 2015. The Banks met well-capitalized standards.
Liquidity reserves were $74.1 billion, up from $71.9 billion, and the Company reported that it exceeded the fully phased-in Liquidity Coverage Ratio requirement. Deposits remained the principal funding source. Cash and cash equivalents increased by $2.0 billion during the year; cash from operations was partly offset by investing outflows, including loan growth and securities purchases.
Material changes and segment performance
- Profitability: Revenue grew, led by loan growth and higher net interest income, but net income declined as credit-loss provisions rose substantially and operating and marketing costs increased.
- Credit quality: The year-end 30+ day delinquency rate rose to 3.27% from 3.00%. The allowance for loan losses increased to $6.50 billion from $5.13 billion, and allowance coverage rose to 2.65% from 2.23%.
- Credit Card: Segment net income fell to $2.16 billion from $2.35 billion. Higher loan balances and net interest income were more than offset by increased provisions; the segment’s net charge-off rate rose to 4.09% from 3.36%.
- Consumer Banking: Segment net income declined to $870 million from $1.03 billion. Auto-loan growth was offset by margin pressure, higher credit costs and runoff of the acquired home-loan portfolio.
- Commercial Banking: Segment net income was $575 million, compared with $570 million. Credit costs increased, with higher charge-offs and nonperforming loans in taxi medallion and oil-and-gas lending. The commercial nonperforming-loan rate rose to 1.53% from 0.87%.
- Funding and capital returns: Deposits grew $19.0 billion, partly from brokered deposits. Capital One repurchased about $2.1 billion of stock under its 2016 program and reduced its net share count by 47 million shares during the year.
In Q4 2016, net income was $791 million and diluted EPS was $1.45, compared with $920 million and $1.58 in Q4 2015. Q4 provision for credit losses was $1.75 billion, versus $1.38 billion a year earlier.
Outlook, risks and unusual items
- Management expected solid 2017 EPS growth, excluding adjusting items, assuming no substantial change in broader credit and economic cycles. It expected the near-term annual efficiency ratio, excluding adjusting items, to be in the 52% range, with reasonable volatility; longer-term efficiency improvement was expected to be gradual.
- Management expected the Domestic Card full-year 2017 charge-off rate to be in the mid-4% range, with quarterly variability. Consumer Banking results were expected to face pressure from auto margin declines, modestly rising auto charge-offs and continued runoff of acquired home loans.
- The Board authorized up to $2.5 billion in common-stock repurchases through the second quarter of 2017, subject to market conditions and regulatory requirements. Management’s capital-return expectations are not guarantees.
- The proposed Cabela’s card portfolio acquisition involved approximately $5.2 billion of receivables and $5.0 billion of funding liabilities. Capital One withdrew its Bank Merger Act application in January 2017 and said it could not refile until work under its OCC anti-money-laundering consent order was complete. Closing timing and approval remained uncertain.
- Capital One disclosed an open OCC AML consent order and related investigations by the New York District Attorney, Department of Justice and FinCEN. It reported progress on required remediation, but expected heightened oversight to continue.
- Mortgage representation-and-warranty reserves were $630 million; management estimated approximately $1.5 billion of reasonably possible future losses beyond the reserve. Separately, the UK cross-sell/PPI reserve was $238 million, with an estimated $300 million of reasonably possible losses beyond the reserve. Litigation loss estimates beyond recorded reserves were approximately $200 million for specified matters, excluding the identified U.S. Bank and FHFA mortgage litigation exposures. Outcomes remain uncertain.
- Other risks include seasoning-related consumer credit losses, commercial exposure to taxi medallions and energy-related borrowers, interest-rate and funding-cost changes, regulatory capital and liquidity requirements, cybersecurity and third-party technology dependence, and competition. The company noted that CECL adoption, required from 2020, could materially change credit-loss accounting; its impact was still being assessed.
Important facts for investors to verify
- Whether rising card delinquencies, charge-offs and allowance builds stabilize, and whether the 2017 Domestic Card charge-off outlook is achieved.
- The scale and pace of losses in taxi medallion and oil-and-gas portfolios, including related nonperforming loans and unfunded commitments.
- Progress under the OCC AML consent order, related regulatory findings, and the resulting timing or prospects for the Cabela’s transaction.
- Actual outcomes and reserve adequacy for mortgage representation-and-warranty claims, UK PPI remediation and other litigation.
- Whether capital, liquidity and deposit funding remain adequate as lending grows, and whether planned repurchases and dividends receive regulatory support.
Ernst & Young issued unqualified opinions on the consolidated financial statements and internal control over financial reporting; management reported no material weaknesses as of December 31, 2016.