Capital One Financial Corporation — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019; comparisons are primarily with Q1 2018 for operating results and December 31, 2018 for balance-sheet measures. Capital One is a diversified financial services company, with Credit Card, Consumer Banking and Commercial Banking segments.
Key financial results and condition
| Metric | Q1 2019 / March 31, 2019 | Comparable period |
|---|---|---|
| Total net revenue | $7.083 billion | $6.909 billion in Q1 2018, up 3% |
| Net interest income | $5.791 billion | $5.718 billion in Q1 2018, up 1% |
| Net income | $1.412 billion; diluted EPS $2.86 | $1.346 billion; diluted EPS $2.62 in Q1 2018 |
| Provision for credit losses | $1.693 billion | $1.674 billion in Q1 2018 |
| Net interest margin | 6.86% | 6.93% in Q1 2018 |
| Efficiency ratio | 51.83% | 51.72% in Q1 2018 |
| Return on average assets | 1.52% | 1.48% in Q1 2018 |
| Total assets | $373.2 billion | $372.5 billion at December 31, 2018 |
| Loans held for investment | $240.3 billion | $245.9 billion at December 31, 2018 |
| Deposits | $255.1 billion | $249.8 billion at December 31, 2018 |
| Borrowings | $50.4 billion | $58.9 billion at December 31, 2018 |
| Allowance for loan and lease losses | $7.313 billion; 3.04% of loans | $7.220 billion; 2.94% at December 31, 2018 |
| Common equity Tier 1 capital | 11.9% | 11.2% at December 31, 2018 |
Net interest income after the credit-loss provision was $4.098 billion, versus $4.044 billion in Q1 2018. Net charge-offs were $1.599 billion, with a 2.64% rate versus 2.59% a year earlier. The 30+ day delinquency rate was 3.40%, down from 3.84% at year-end, primarily reflecting seasonal improvement in auto and domestic card delinquencies.
Cash flow: Net cash from operating activities was $4.881 billion, investing activities $5.013 billion, and financing activities a use of $3.945 billion. Cash, cash equivalents and restricted cash for securitization investors increased $5.949 billion to $19.438 billion. These cash-flow totals should be interpreted in light of the company’s lending, deposit and securities activities.
Liquidity and funding: Liquidity reserves were $103.2 billion, up from $89.6 billion at year-end; average first-quarter liquidity coverage exceeded the 100% regulatory requirement. Deposits provided 84% of reported funding sources. Short-term borrowings fell substantially, mainly due to maturities of short-term Federal Home Loan Bank advances.
Material changes and segment performance
- Revenue rose 3% and net income rose 5% year over year. Higher interchange income—supported by 8% growth in purchase volume—and higher net interest income contributed; the latter was partly offset by lower net interest margin and the prior sale of the consumer home-loan portfolio.
- Marketing expense increased 25% to $517 million. Total non-interest expense rose 3% to $3.671 billion, partly reflecting marketing, technology and infrastructure investment; lower bankcard and regulatory fee assessments partly offset the increase.
- Credit Card: Segment net income was $751 million, up 6%. Revenue grew 3%; provision declined 5%, while expense rose 6%, including Walmart-related costs. The segment’s net charge-off rate eased to 4.90% from 5.03%.
- Consumer Banking: Net income was $468 million, up 10%. Average deposits grew 7%, while average loans fell 21%, principally reflecting the 2018 home-loan portfolio sale. The deposit interest rate increased to 1.18% from 0.80%.
- Commercial Banking: Net income fell 37% to $146 million. Provision shifted to $69 million from a $14 million benefit in Q1 2018, reflecting isolated credit deterioration and portfolio growth. Average commercial loans grew 10%.
- The company revised allocation of tax benefits for Commercial Banking segment revenue and recast the prior-period segment presentation; this change did not affect consolidated financial statements.
Outlook, risks and notable items
- Management expected higher deposit costs to weigh on net interest margin through 2019. It expected full-year 2019 marketing expense to be modestly higher than 2018, and modest adjusted operating-efficiency improvement in 2019 and 2020; the stated 2021 target was a 42% adjusted operating efficiency ratio.
- Capital One expected capital and earnings to support growth, the planned Walmart portfolio acquisition, CECL adoption and a 2019 CCAR capital-distribution request meaningfully above 2018, subject to regulatory approval.
- The Walmart agreement makes Capital One the exclusive U.S. issuer for Walmart’s cobrand and private-label card program. The company expected to acquire the existing receivables portfolio late Q3 or early Q4 2019, estimating a low-$8-billion portfolio at closing, an initial allowance of about $100 million and $225 million in 2019 one-time launch and integration expenses. Actual amounts could vary.
- CECL adoption was planned for January 1, 2020. Management expected an increase in credit-loss reserves, but said the eventual impact depended on portfolio characteristics, economic conditions and forecasts.
- Litigation-related reasonably possible losses beyond recorded reserves were estimated at approximately $1.1 billion for matters where the company could estimate them; management cautioned that actual losses could exceed its estimates. The U.K. payment-protection-insurance reserve was $105 million, with approximately $100 million of reasonably possible losses beyond the reserve.
- Capital One remained subject to an OCC anti-money-laundering consent order and was cooperating with investigations by the New York District Attorney, Department of Justice and FinCEN; a potential FinCEN resolution could include a monetary penalty. The filing also identified uncertainty around Brexit and its effects on U.K. operations.
- Other notable items: first-quarter other comprehensive income was $603 million, compared with a $472 million loss in Q1 2018. Adoption of the lease standard added a $1.9 billion lease liability and $1.6 billion right-of-use asset. The company reported no material change in its stated risk factors and concluded disclosure controls were effective.
Important facts for investors to verify
- Whether card purchase growth and interchange income remain strong, and how updated rewards-cost estimates affect revenue.
- Deposit pricing, deposit mix and net interest margin trends as funding costs rise.
- Commercial loan credit developments, allowance assumptions and subsequent delinquency and charge-off performance, particularly given the allowance build.
- Walmart acquisition timing, final portfolio size, allowance, integration costs and program execution.
- The ultimate CECL reserve and capital effects, and the outcome of the 2019 CCAR review and capital-distribution request.
- Developments in litigation, the AML investigations and the U.K. PPI claims, including whether losses exceed recorded reserves or disclosed estimates.