Business context and reporting period
Capital One Financial Corporation filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2018. It is a diversified financial services company operating through Credit Card, Consumer Banking and Commercial Banking segments.
Financial performance and condition
- Third-quarter results: Net revenue was $6.96 billion, essentially unchanged year over year. Net income rose 36% to $1.50 billion; diluted EPS increased 40% to $2.99. Net interest income was $5.79 billion, up 2%, while non-interest income fell 8% to $1.18 billion.
- Nine-month results: Net revenue increased 4% to $21.06 billion; net income rose 61% to $4.75 billion and diluted EPS rose 66% to $9.32. The effective tax rate declined to 21.6% from 28.8%, primarily reflecting the federal tax-rate reduction.
- Credit costs and margins: Provision for credit losses declined 31% to $1.27 billion in Q3 and 25% to $4.22 billion year to date, mainly due to allowance releases in domestic credit card and auto. Q3 net charge-off rate was 2.41%, down 20 basis points year over year. Net interest margin was 7.01%, down 7 basis points; total net revenue margin was 8.43%, down 25 basis points.
- Balance sheet and liquidity: Total assets were $362.9 billion and loans held for investment were $238.8 billion at quarter-end. Deposits totaled $247.2 billion, up $3.5 billion from year-end; borrowings were $52.2 billion, down $8.1 billion. Liquidity reserves were $94.7 billion, up from $84.3 billion at year-end; the company reported its Q3 liquidity coverage ratio above the 100% requirement.
- Capital: Common equity Tier 1 ratio was 11.2%, compared with 10.3% at year-end; total capital ratio was 15.2%. The company and both banks exceeded applicable minimum capital requirements.
- Cash flows: For the first nine months, operating activities provided $9.0 billion, investing activities used $5.9 billion and financing activities used $5.9 billion. Ending cash, cash equivalents and restricted cash was $11.6 billion. These banking-company cash flows include substantial loan, securities and funding movements.
Material changes versus comparable periods
- Q3 earnings growth was driven principally by lower credit-loss provision and higher net interest income; higher marketing expense, a legal reserve build and a securities impairment partly offset gains.
- Consumer home-loan portfolio sales substantially reduced loans held for investment. The Q3 sale of substantially all remaining consumer home loans generated a $99 million gain; second-quarter sales had generated approximately $400 million in net gains, including a $46 million credit-loss benefit.
- Credit Card net income rose to $1.04 billion in Q3, supported by lower provision and loan growth; purchase volume increased 15% to $97.5 billion. Consumer Banking net income rose to $482 million, while Commercial Banking net income rose to $204 million.
- The company repurchased approximately $569 million of common stock in Q3 under a $1.2 billion program authorized through Q2 2019. Common dividends were $0.40 per share for the quarter.
Outlook, commentary, risks and unusual items
- Management expected the 2018 corporate effective tax rate to be around 22% before discrete items and full-year operating efficiency to be roughly flat versus 2017, net of adjusting items. It expects gradual long-term efficiency improvement, principally from digital productivity and growth.
- Management expected Q4 marketing expense to be well above typical seasonal levels, continued increases in deposit costs and resulting pressure on net interest margin. It also expected auto charge-off rates to rise gradually over the longer term.
- Capital One announced a long-term Walmart U.S. credit-card program agreement, with exclusivity beginning August 1, 2019. The Bass Pro co-brand portfolio acquisition closed October 5, 2018, after quarter-end, adding approximately $534 million of card loans at acquisition.
- A $200 million intent-to-sell impairment on investment securities drove net securities losses in Q3; reported securities losses were $196 million for the quarter. Higher rates also contributed to unrealized losses in available-for-sale securities and cash-flow hedges.
- The company accrued a $100 million AML civil penalty in Q3, agreed in October 2018 to resolve the monetary component of an OCC consent order, and remained subject to related agency investigations. Management estimated reasonably possible litigation losses beyond reserves of approximately $750 million, including mortgage representation-and-warranty exposure; outcomes remain uncertain.
- The U.K. payment protection insurance reserve was $118 million at quarter-end, with approximately $100 million of reasonably possible future losses beyond the reserve. Other disclosed risks include credit deterioration, interest-rate and deposit-cost pressure, regulatory changes, litigation, competition, and operational, technology and cybersecurity risks.
Important facts for investors to verify
- Whether credit quality and allowance releases remain sustainable, particularly in domestic card and auto, and how to interpret the higher Consumer Banking delinquency rate following home-loan sales.
- The composition and subsequent development of the $750 million estimated reasonably possible litigation losses, the $100 million AML penalty and PPI exposure.
- Whether deposit-cost increases, elevated Q4 marketing and other operating expenses affect margins and the full-year efficiency outlook.
- The actual results and financial impact of the Walmart program and post-quarter Bass Pro acquisition.
- Potential effects of the $200 million securities impairment, rising-rate-related AOCI losses and implementation of CECL, which the company planned to adopt in 2020 and said could increase credit-loss reserves.