Capital One Financial Corporation: Q2 2020 Form 10-Q
Reporting period: Three and six months ended June 30, 2020; comparisons are primarily with the same 2019 periods. Capital One is a diversified financial-services company operating Credit Card, Consumer Banking and Commercial Banking businesses. Results were heavily affected by the COVID-19 pandemic and credit-loss estimates.
Financial performance and position
| Metric | Q2 2020 | Prior comparable period / period-end change |
|---|---|---|
| Total net revenue | $6.56 billion | Down 8% from Q2 2019 |
| Net interest income | $5.46 billion | Down 5%; net interest margin was 5.78%, down 102 basis points |
| Provision for credit losses | $4.25 billion | Up from $1.34 billion in Q2 2019 |
| Net income (loss) | Loss of $918 million; diluted loss of $2.21 per share | Compared with net income of $1.63 billion and diluted earnings of $3.24 per share |
| Net charge-offs | $1.51 billion; 2.38% rate | Amount broadly flat; rate down 10 basis points |
| Loans held for investment | $251.5 billion at June 30 | Down $14.3 billion from December 31, 2019 |
| Allowance for credit losses | $16.8 billion; 6.69% of loans | Up from $7.2 billion and 2.71% at year-end |
| Deposits / debt | Deposits $304.2 billion; total short- and long-term debt $44.9 billion | Deposits up $41.5 billion; debt down $10.8 billion from year-end |
| Liquidity and capital | Liquidity reserves $149.1 billion; average Q2 LCR 146%; CET1 ratio 12.4% | Liquidity reserves were $90.6 billion and CET1 was 12.2% at year-end |
For the first six months, the company reported a net loss of $2.26 billion, or $5.31 per diluted share, on revenue of $13.81 billion. Net cash from operating activities was $9.22 billion; investing activities provided $5.06 billion and financing activities provided $28.54 billion. Cash, cash equivalents and restricted cash ended the period at $56.56 billion, up from $13.75 billion at the start of the period. Cash-flow figures reflect banking balance-sheet movements and should not be read as conventional free cash flow.
At June 30, total assets were $421.3 billion and stockholders’ equity was $56.0 billion. Available-for-sale securities totaled $87.9 billion, predominantly U.S. Treasury and agency securities. Common equity Tier 1 capital was 12.4%; the company reported that it exceeded applicable minimum capital requirements.
Changes and business drivers
- The loss was primarily driven by higher credit-loss provisioning amid expected economic deterioration and uncertainty. CECL adoption added $2.85 billion to reserves at adoption and reduced retained earnings by $2.19 billion; the allowance also increased through subsequent provision builds.
- Revenue fell as lower purchase activity reduced card interchange income and customer activity reduced fees. Net interest income and margin declined, partly because cash made up a larger share of interest-earning assets, despite lower funding costs.
- Q2 card purchase volume fell 16% year over year. Domestic Card loans declined as spending weakened and customers made elevated payments. Total period-end loans were down 5% from year-end, while auto and commercial loans grew.
- Reported delinquency and charge-off rates were relatively low or improved versus year-end/prior year, supported by government stimulus and payment assistance. These metrics may not yet reflect underlying borrower stress because relief programs altered payment timing and delinquency status.
- Deposits increased sharply, particularly consumer deposits, including stimulus-related savings. The company held elevated cash balances and said it expected to maintain them in the near term.
- Marketing expense fell 50% year over year in Q2 as spending was reduced; operating expense increased 8%, partly reflecting legal reserve builds. Total non-interest expense was nearly flat.
Outlook, risks and unusual items
- The filing provides no quantified earnings or revenue guidance. Management emphasized that the pandemic’s duration, economic effects and consequences for customer demand and credit losses remained uncertain.
- Customer assistance included card payment deferrals and fee waivers, auto payment extensions, customized commercial deferrals and participation in the Paycheck Protection Program. By June 30, the company had funded $1.2 billion of PPP loans. Assistance enrollments had slowed from Q1 levels, but performance after relief ends remains uncertain.
- Capital One adopted CECL in Q1 2020. Its expected-loss estimates depend on economic forecasts and assumptions, including employment, home prices and collateral values; actual credit losses may differ materially.
- Common-stock repurchases were suspended on March 13, 2020. After quarter-end, the company reduced its Q3 common dividend from $0.40 to $0.10 per share, consistent with Federal Reserve restrictions, which also capped distributions and required updated capital plans.
- Legal reserve builds were $265 million in Q2 and $310 million for the first half. Management estimated approximately $1.0 billion of reasonably possible future litigation losses beyond recorded reserves, where estimable, and cautioned actual losses could exceed estimates.
- The 2019 cybersecurity incident remains subject to consumer and securities lawsuits and regulatory inquiries. Q2 incremental incident costs were $27 million, offset by $16 million in insurance recoveries; cumulative costs were $113 million, offset by $60 million in recoveries. Management expected 2020 costs at the high end of its prior $100 million–$150 million range. August 2020 regulatory consent orders included an $80 million OCC penalty, accrued at June 30.
- The U.K. PPI reserve was $76 million at June 30, with approximately $50 million of reasonably possible future losses beyond the reserve. The company was also in discussions with FinCEN regarding an AML investigation. Rating agencies had negative outlooks as of July 23, 2020.
Important facts for investors to verify
- Whether credit-loss allowances and the 6.69% coverage ratio prove adequate as pandemic-related assistance expires and economic conditions evolve.
- How much of the observed improvement in delinquency and charge-off metrics reflects stimulus, payment deferrals or other temporary effects.
- The eventual effect of legal matters, including the cybersecurity proceedings, the accrued $80 million penalty, interchange litigation and PPI claims, on expenses and cash flows.
- Capital and dividend restrictions, the finalized stress capital buffer and the effect of continuing losses on capital at the bank subsidiaries.
- The sustainability of deposit growth and liquidity, and the impact of high cash balances and low interest rates on net interest income and margins.