Capital One Financial Corporation — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016; comparisons are to the corresponding 2015 periods unless noted. Capital One is a diversified financial services company, with Credit Card, Consumer Banking and Commercial Banking segments. Amounts below are in U.S. dollars.
Financial performance and condition
| Metric | Q3 2016 | First nine months 2016 | Comparison |
|---|---|---|---|
| Total net revenue | $6.46 billion | $18.94 billion | Up 10% in both periods |
| Net interest income | $5.28 billion | $15.43 billion | Up 11% in both periods |
| Provision for credit losses | $1.59 billion | $4.71 billion | Up 45% and 49%, respectively |
| Income from continuing operations, net of tax | $1.02 billion | $2.98 billion | Down 9% and 4%, respectively |
| Net income | $1.01 billion | $2.96 billion | Down 10% and 5%, respectively |
| Diluted EPS | $1.90 | $5.42 | Down 4% and 1%, respectively |
| Net interest margin | 6.79% | 6.76% | Up 6 and 14 basis points, respectively |
| Net charge-off rate | 2.10% | 2.06% | Up 41 and 38 basis points, respectively |
Higher loan balances, including credit card and commercial loans and loans from the Healthcare Financial Services acquisition, supported revenue growth. Increased credit provisions and operating costs more than offset that growth. Interchange income rose with purchase volume; customer fees declined, partly following the exit of legacy Domestic Card payment protection products. The Q3 efficiency ratio was 52.02%, compared with 53.56% a year earlier.
Segment net income, Q3 / nine months: Credit Card $555 million / $1.65 billion (down 17% / 8%); Consumer Banking $244 million / $750 million (down 11% / 10%); Commercial Banking $191 million / $396 million (up 39% / down 15%). Credit Card results faced higher charge-offs and allowance building. Commercial Banking’s Q3 improvement reflected revenue growth and a lower provision, while nine-month results were affected by losses in taxi medallion and oil and gas lending.
Balance sheet and funding at September 30, 2016: Assets were $345.1 billion; loans held for investment were $238.0 billion, up $8.2 billion from year-end 2015; deposits were $226.0 billion, up $8.3 billion; total borrowings were $59.8 billion; and stockholders’ equity was $48.2 billion. The allowance for loan and lease losses was $6.26 billion, or 2.63% of loans, versus $5.13 billion and 2.23% at December 31, 2015. The 30+ day delinquency rate was 3.04%, up 4 basis points from year-end.
Cash flow, nine months: Operating activities provided $9.86 billion; investing activities used $15.18 billion; financing activities provided $6.39 billion. Cash and cash equivalents ended the period at $9.09 billion. Liquidity reserves were $76.7 billion, and the company reported exceeding the fully phased-in liquidity coverage ratio requirement.
Capital: The company’s Basel III Standardized Approach common equity Tier 1 ratio was 10.6%, down from 11.1% at December 31, 2015; total capital ratio was 14.7%. The company and its banks exceeded applicable regulatory thresholds, and the banks were classified as well-capitalized. These September ratios were preliminary. The company issued $583 million of Series G preferred stock during the quarter.
Material changes and outlook
- Loan growth was concentrated in auto, commercial and credit card portfolios; the acquired home loan portfolio continued its planned run-off. Average loans held for investment increased 12% year over year in Q3.
- Management attributed higher credit costs to the seasoning and subprime mix of recent card growth, rising card losses, and adverse conditions in taxi medallion and oil and gas lending. Commercial nonperforming loans rose to 1.50% from 0.87% at year-end.
- Management expected the full-year 2016 efficiency ratio, excluding adjusting items, to be substantially below 2015 despite a significant seasonal Q4 expense increase. The near-term annual efficiency ratio was expected in the 52% range, with reasonable volatility; gradual longer-term improvement was anticipated.
- Management expected Domestic Card charge-offs of about 4.15% for 2016 and in the mid-4% range for 2017. It expected seasoning-related upward pressure on card delinquencies and charge-offs to peak in 2016 and diminish in 2017.
- Management cautioned that Consumer Banking revenue, efficiency and net income would be pressured by auto margin compression, modestly rising auto charge-offs and mortgage run-off. It said Commercial Banking credit pressure remained concentrated in oil and gas and taxi medallion loans.
- Capital One had repurchased about $1.2 billion under its authorized $2.5 billion 2016 buyback program through Q3 and expected to complete the program by Q2 2017; repurchases could be suspended. Common dividends were $0.40 per share in Q3.
- On October 3, 2016, after quarter-end, the company announced a proposed Cabela’s card-operations acquisition and exclusive card partnership. The proposed purchase included about $5.2 billion in receivables and other assets and $5.0 billion in funding liabilities; closing remained subject to customary conditions, regulatory approvals and Cabela’s stockholder approval. The filing noted OCC consideration of the company’s progress under a previously disclosed consent order.
Risks, contingencies and unusual items
- Mortgage representation-and-warranty reserves totaled $632 million. Management estimated approximately $1.5 billion of reasonably possible future losses beyond the reserve; actual losses could exceed both the reserve and this estimate. Favorable litigation rulings reduced the estimate from $1.6 billion at year-end.
- U.K. payment protection insurance and other cross-sell reserves were $221 million, including a $63 million Q3 addition following FCA consultation; management estimated about $250 million of reasonably possible future losses beyond the reserve.
- Management estimated approximately $200 million of reasonably possible future litigation losses beyond recorded reserves for certain matters, excluding specified mortgage-related cases. The interchange class settlement was vacated on appeal in June 2016, leaving the outcome uncertain. The company also reported cooperating with authorities investigating anti-money-laundering matters involving former commercial banking clients.
- Other exposures include potential GreenPoint manufactured-housing clean-up calls involving approximately $420 million of assets, expected to begin from 2017 through 2019; management said reasonably possible future losses were not significant based on its current estimate.
- Risks highlighted by the filing include credit deterioration, economic and interest-rate changes, funding access, regulation and litigation, technology and operational disruption, cybersecurity, competition, and the accuracy of estimates and risk models. Management reported no material change to the risk factors in its 2015 Form 10-K.
Most important facts for investors to verify
- Whether rising card charge-offs and the allowance build track management’s stated 2016–2017 expectations, and how credit performance develops as recent originations season.
- Loss trends, risk ratings and reserve adequacy in taxi medallion and oil and gas portfolios, including the effect on commercial nonperforming loans.
- Whether the proposed Cabela’s transaction receives approvals and closes on the disclosed terms, and the implications of the OCC consent-order review.
- Developments in mortgage representation-and-warranty claims, PPI remediation, interchange litigation and the AML investigation, including any changes to recorded reserves or reasonably possible losses.
- Capital and liquidity levels after buybacks, dividends, preferred issuance and potential acquisition funding; confirm final regulatory capital ratios when filed.
- Whether loan growth, operating costs and investment spending support management’s efficiency outlook, particularly after the anticipated Q4 seasonal expense increase.