Capital One Financial Corporation — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2016. Capital One is a diversified financial services company, with Credit Card, Consumer Banking and Commercial Banking segments.
Financial performance and condition
- Q2 revenue and earnings: Total net revenue was $6.254 billion, up 10% year over year. Net income was $942 million, up 9%; diluted EPS was $1.69 versus $1.50.
- First-half results: Revenue was $12.474 billion, up 10%; net income was $1.955 billion versus $2.016 billion. Diluted EPS was $3.52 versus $3.51.
- Net interest: Q2 net interest income was $5.093 billion, up 12%, and net interest margin was 6.73%, up 17 basis points. Non-interest income was $1.161 billion, up 2%.
- Credit costs and expenses: Q2 provision for credit losses rose 41% to $1.592 billion. Non-interest expense was $3.295 billion, essentially flat. The efficiency ratio improved to 52.69% from 58.30%.
- Cash flow, first half: Operating cash flow was $6.568 billion; investing cash flow was negative $8.918 billion; financing cash flow was $1.476 billion. Cash and cash equivalents declined $874 million to $7.149 billion.
- Balance sheet at June 30: Assets were $339.1 billion; loans held for investment were $234.6 billion; deposits were $221.1 billion; total debt was approximately $59.2 billion; and stockholders’ equity was $48.1 billion.
- Credit and capital: Allowance for loan losses was $5.881 billion, or 2.51% of loans. Q2 net charge-off rate rose to 2.01% from 1.64%, while 30+ day delinquency declined to 2.79% from 3.00% at year-end. Common equity Tier 1 ratio was 10.9%.
- Liquidity: Liquidity reserves were $69.2 billion, down from $71.9 billion at year-end. The company reported exceeding the fully phased-in Liquidity Coverage Ratio requirement.
Material changes versus comparable periods
- Q2 earnings increased as loan growth supported net interest income and higher card purchase volume lifted interchange income. These gains were partly offset by substantially higher credit-loss provision.
- First-half earnings declined modestly: higher credit-loss provision and increased marketing, operating and technology costs more than offset revenue growth.
- Loan growth reflected auto, commercial and credit card portfolios, including the acquired Healthcare Financial Services business; acquired home loans continued to run off. Purchase accounting for the HFS acquisition was finalized in Q2, recognizing approximately $9.2 billion of assets, including $8.2 billion of loans.
- Credit deterioration was concentrated in seasoning credit card growth and Commercial Banking’s oil and gas and taxi medallion exposures. Commercial nonperforming loan rate rose to 1.59% from 0.87% at year-end.
Outlook, risks and unusual items
- Management expected Domestic Card’s full-year 2016 charge-off rate to be around 4%, and the 2017 rate in the low-4% range, assuming relative stability in consumer behavior, the economy and competition. Loan growth and rising charge-offs were expected to require further allowance additions.
- Management expected acquired home-loan runoff, auto margin compression and gradually rising auto charge-offs to weigh on Consumer Banking revenue and earnings. Commercial credit pressure remained focused on oil and gas and taxi medallion lending.
- Management expected some improvement in the full-year 2016 efficiency ratio versus 2015, excluding adjusting items, despite approximately $160 million of expected 2016 bank-optimization costs and higher FDIC-related expenses in the second half.
- The Federal Reserve did not object to the 2016 capital plan. The board authorized up to $2.5 billion of common-stock repurchases from Q3 2016 through Q2 2017; timing and amount remain discretionary. The quarterly common dividend was $0.40 per share.
- Mortgage representation-and-warranty reserve was $614 million. Management estimated approximately $1.5 billion of reasonably possible future losses beyond the reserve. Other litigation matters were estimated to have approximately $200 million of reasonably possible losses beyond reserves, excluding specified mortgage cases.
- U.K. payment-protection and other cross-sell remediation reserve was $176 million; reasonably possible future losses beyond that reserve were estimated at approximately $250 million. The company added $54 million to the reserve in Q2, primarily reflecting a higher claims-rate assumption.
- The Q2 included a gain related to the exchange of Capital One’s Visa Europe ownership interest with Visa Inc. The filing also describes pending mortgage-related litigation, an AML investigation involving former check-casher clients, and the reversal of approval of a proposed interchange class settlement; outcomes remain uncertain.
- Risks highlighted include credit losses, economic and interest-rate changes, regulatory and litigation developments, funding-market access, competition, technology or security disruption, and execution of digital and operating plans. Management reported effective disclosure controls and no material Q2 change in internal control over financial reporting.
Most important facts for investors to verify
- Whether card and auto charge-offs, allowance builds and commercial oil-and-gas and taxi-medallion losses develop in line with management’s assumptions.
- Whether loan growth and HFS integration generate sustainable returns while acquired home loans run off and auto margins remain pressured.
- The adequacy of reserves and potential ultimate exposure for mortgage representation-and-warranty claims, U.K. PPI remediation and other litigation.
- Capital, liquidity and deposit trends, including execution of the authorized repurchase program and the effect of regulatory requirements.
- Whether the reported improvement in efficiency and the stated charge-off outlook are achieved; these are forward-looking expectations, not guarantees.