Capital One Financial Corporation (COF) — Q3 2014 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2014. Capital One is a diversified financial services company operating through Credit Card, Consumer Banking and Commercial Banking. Comparisons below are with the corresponding 2013 period unless noted. The 2013 Best Buy card portfolio sale affects comparability.
Financial performance and condition
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Total net revenue | $5.64B | $5.65B | $16.48B | $16.84B |
| Net interest income | $4.50B | $4.56B | $13.16B | $13.68B |
| Provision for credit losses | $993M | $849M | $2.43B | $2.50B |
| Non-interest expense | $2.99B | $3.11B | $8.90B | $9.12B |
| Net income | $1.08B | $1.11B | $3.43B | $3.27B |
| Diluted EPS | $1.86 | $1.84 | $5.86 | $5.46 |
- Q3 net interest margin was 6.69%, down 20 basis points year over year; total net revenue margin was 8.39%, down 15 basis points. Q3 efficiency ratio improved to 52.93% from 55.02%.
- For the first nine months, operating cash flow was $7.70B, investing cash flow was negative $8.09B, and financing cash flow was positive $243M. Cash and cash equivalents were $6.15B at September 30.
- At September 30, total assets were $300.2B; loans held for investment were $201.6B; deposits were $204.3B; borrowings were $42.2B; and stockholders’ equity was $44.0B. Liquidity reserves totaled $77.6B, up from $69.7B at year-end 2013.
- Capital ratios included a 12.73% common equity Tier 1 ratio, 13.31% Tier 1 risk-based ratio and 15.24% total risk-based ratio. The company cautions that the new Basel III-based 2014 ratio is not directly comparable with the 2013 Basel I measure. Estimated fully phased-in Basel III common equity Tier 1 ratio was 11.8%.
- Credit indicators improved year over year: Q3 net charge-off rate fell to 1.52% from 1.92%; 30+ day delinquency rate was 2.76% at September 30 versus 2.96% at year-end 2013. The allowance was $4.21B, or 2.09% of loans, down from 2.19% at year-end; it increased during Q3 as loan growth and delinquencies raised expected losses.
Material changes and management commentary
- Q3 net income declined 2%, while nine-month net income increased 5%. Nine-month improvement reflected lower mortgage representation-and-warranty provisions, lower expenses and funding costs, and improved credit; lower net interest income partly offset these benefits.
- Credit Card net income fell 10% in Q3 to $624M, with lower revenue following the Best Buy portfolio sale and a higher credit-loss provision. Consumer Banking net income declined 16% to $289M, primarily on retail deposit spread compression. Commercial Banking net income rose 12% to $182M in Q3, supported by loan growth, but fell 9% for the nine-month period as provisions shifted from a prior-year release to a build.
- Commercial Banking loans grew 11% from year-end to $49.8B, led by commercial and industrial and commercial real estate lending. Auto loan originations rose 14% in Q3; auto loans increased as acquired home loans ran off.
- Management continued to expect approximately $10B of 2014 pre-provision earnings, excluding non-recurring items. It forecast higher Q4 2014 operating expenses and marketing, and higher full-year 2015 expenses and marketing, reflecting growth, digital investment and regulatory costs. Management expected 2015 revenue growth from average loan growth and a 2015 efficiency ratio of 53%–54%, excluding non-recurring items.
- Management expected Domestic Card charge-off rates to rise seasonally in Q4 2014 and Q1 2015, with quarterly 2015 rates in the mid-to-high 3% range; loan growth was expected to drive allowance additions. Auto returns were expected to decline but remain attractive; low rates were expected to pressure retail banking. Commercial competition was expected to slow 2015 growth and pressure margins.
Risks, contingencies and unusual items
- Mortgage representation-and-warranty reserve was $1.08B at September 30, down from $1.17B at year-end. Management estimated approximately $2.3B of reasonably possible additional losses beyond the reserve; actual losses could exceed both the reserve and that estimate. The estimate depends on uncertain litigation outcomes, claims, loan performance and recoveries.
- Other litigation matters with estimable reasonably possible losses were estimated at approximately $250M, excluding specified mortgage matters included in the estimate above. Significant matters included interchange-fee litigation, mortgage repurchase suits, overdraft litigation and TCPA claims. The company also disclosed New York investigations concerning check cashing/anti-money-laundering controls and subprime auto lending. Management stated that adverse outcomes could materially affect results or cash flows in a particular period.
- The UK cross-sell/PPI reserve was $167M. An updated refund calculation led to a $23M Q3 reserve addition, offset by payments and foreign-exchange movements.
- New liquidity rules required a phased-in liquidity coverage ratio; management expected to meet the initial January 2015 requirement. The company noted that holding more qualifying liquid securities could reduce investment yields.
- After quarter-end, on October 31, 2014, Capital One issued Series D preferred depositary shares, receiving approximately $484M net proceeds. The filing also described planned common-stock repurchases of up to $2.5B through Q1 2015; approximately $1.5B had been repurchased through Q3.
Most important facts for investors to verify
- Whether loan growth and marketing investments translate into the projected 2015 revenue growth and efficiency ratio.
- Domestic Card credit trends, including the expected charge-off increase and allowance builds.
- The sensitivity of earnings and capital to mortgage representation-and-warranty claims and litigation beyond recorded reserves.
- Commercial loan growth, competitive margin pressure, and the performance of auto lending as returns and yields decline.
- Liquidity-rule compliance, funding costs, capital actions and the effect of share repurchases and preferred issuance on capital.
- Reported earnings comparability: the Best Buy sale, discontinued mortgage operations, acquired-loan accounting and the 2014 accounting-method change for affordable-housing investments.