CAPITAL ONE FINANCIAL CORP annual report, FY2014

Capital One Financial Corporation — 2014 Form 10-K

Reporting period: Fiscal year ended December 31, 2014; filed February 24, 2015. Capital One is a diversified financial services company with Credit Card, Consumer Banking and Commercial Banking segments. The figures below are in U.S. dollars; unless otherwise noted, amounts are in billions.

Financial performance and condition

Metric20142013Change
Total net revenue$22.290$22.384Approximately flat
Net interest income$17.818$18.106Down 2%
Non-interest income$4.472$4.278Up 5%
Provision for credit losses$3.541$3.453Up 3%
Net income$4.428$4.121Up 7%
Diluted EPS$7.59$6.89Up 10%
Net interest margin6.67%6.80%Down 13 bps
Efficiency ratio54.64%55.19%Improved 55 bps
Return on average assets1.48%1.46%Up 2 bps

For fourth-quarter 2014, net income was $999 million and diluted EPS was $1.73, versus $852 million and $1.43 in fourth-quarter 2013. Fourth-quarter provision for credit losses was $1.109 billion.

  • Cash flow: Operating activities provided $9.304 billion; investing activities used $15.991 billion; financing activities provided $7.638 billion. Cash and cash equivalents increased $951 million to $7.242 billion.
  • Loans and credit: Loans held for investment rose 6% to $208.3 billion. Net charge-offs were $3.414 billion, or 1.72% of average loans, down from $3.934 billion and 2.04%. The 30+ day delinquency rate was 2.91%, versus 2.96%. The allowance for loan and lease losses was $4.383 billion, or 2.10% of loans, compared with $4.315 billion, or 2.19%.
  • Funding and liquidity: Deposits were $205.5 billion; short-term borrowings and long-term debt totaled $48.5 billion. Reported liquidity reserves were $71.6 billion, including cash, securities and available borrowing capacity.
  • Capital: The Basel III Standardized Approach common equity Tier 1 ratio was 12.46% at year-end, and the Tier 1 leverage ratio was 10.77%. Capital ratios use a different methodology from 2013, so direct comparison with the prior-year Tier 1 common ratio is not appropriate. The Banks exceeded applicable well-capitalized requirements.

Material changes and segment performance

  • Higher net income reflected lower funding costs, reduced non-interest expense and a substantially improved mortgage representation-and-warranty result. These benefits were partly offset by lower net interest income associated with the 2013 Best Buy portfolio sale and increased marketing.
  • Credit Card generated $2.479 billion of net income, down from $2.615 billion. Year-end card loans increased 6% to $85.9 billion; purchase volume rose 12% to $224.8 billion. The card net charge-off rate improved to 3.46% from 4.15%.
  • Consumer Banking net income fell to $1.195 billion from $1.451 billion, reflecting deposit-spread and auto-margin pressure and runoff of acquired home loans. Auto originations grew 20% to $20.9 billion; year-end auto loans rose 19% to $37.8 billion.
  • Commercial Banking net income declined to $659 million from $731 million. Loans grew 13% to $50.9 billion, but provision expense rose from a prior-year benefit to $93 million as the segment built its allowance. Commercial loan yields faced competitive pressure.
  • Other income improved to $90 million from a $443 million loss, primarily due to lower funding costs and the absence of a prior-year charge associated with redemption of trust preferred securities.

Outlook, risks and unusual items

  • 2015 outlook: Management expected full-year revenue growth, driven by average loan growth, and higher marketing and operating expenses. The expected efficiency ratio was 53.5%–54.5%, excluding non-recurring items. Management expected quarterly efficiency to vary with timing and business activity.
  • Credit and business outlook: Domestic Card quarterly charge-off rates were expected in the mid-to-high 3% range, with seasonality and newer loan growth likely to raise losses and allowance needs. Management was cautious about auto underwriting, pricing and used-vehicle values; it expected low rates to continue pressuring retail banking returns. Commercial loan growth was expected to slow amid intense competition.
  • Capital returns: Capital One repurchased approximately $2.0 billion of common stock in 2014 under a $2.5 billion program and expected to complete the program in first-quarter 2015. The quarterly common dividend was $0.30 per share. Future distributions remain subject to regulatory approval, capital conditions and board discretion.
  • Mortgage claims: The representation-and-warranty reserve fell to $731 million from $1.172 billion after $408 million of realized losses and settlements. Management estimated approximately $2.1 billion of reasonably possible future losses beyond the reserve; actual losses could exceed both the reserve and estimate. The estimate is highly uncertain and depends on claims, litigation, loan performance, recoveries and economic conditions.
  • Other contingencies: Management estimated reasonably possible future losses of approximately $250 million for certain litigation matters, excluding specified mortgage-related cases. The U.K. cross-sell/PPI reserve was $116 million. The filing also describes government inquiries concerning anti-money-laundering controls and subprime auto lending, among other litigation and regulatory matters.
  • Regulatory and operating risks: New capital, liquidity, stress-testing and conduct requirements could increase costs or constrain distributions and lending. The company entered Basel III Advanced Approaches parallel run in January 2015 and was subject to the phased-in U.S. liquidity coverage ratio. Risks also include credit deterioration, low or changing interest rates, competitive pressures, cybersecurity and service-provider disruptions. Capital One reported prior denial-of-service incidents that temporarily affected online services.
  • Unusual accounting and comparability: The Best Buy card portfolio sale was completed in 2013; no significant acquisition or disposition occurred in 2014. The company adopted proportional amortization accounting for qualified affordable-housing investments retrospectively, recasting prior periods. The filing states that this reduced 2013 net income by $38 million and 2012 net income by $25 million.

Ernst & Young issued unqualified opinions on the consolidated financial statements and internal control over financial reporting; management reported no material weakness in internal control.

Important facts for investors to verify

  • Review the drivers and sustainability of earnings growth, particularly card purchase-volume growth, funding costs, marketing investment and the decline in net interest margin.
  • Assess whether improving card credit metrics persist as loan growth seasons, and monitor auto charge-offs, commercial allowance builds and the effect of acquired-loan accounting on reported credit measures.
  • Evaluate the mortgage representation-and-warranty reserve and the $2.1 billion estimate of possible additional losses, including developments in the identified lawsuits and claims pipeline.
  • Track progress against 2015 revenue, expense and efficiency-ratio expectations, as well as completion of the share-repurchase program and regulatory capital distribution approvals.
  • Confirm liquidity and capital under changing regulatory requirements, and monitor the effects of rate movements, deposit competition and operational or cybersecurity incidents.