Capital One Financial Corporation — 2012 Form 10-K
Reporting period: Fiscal year ended December 31, 2012. This is an annual filing; selected fourth-quarter results are also reported. Amounts are in U.S. dollars unless noted.
Business context and reporting period
Capital One is a diversified financial-services holding company operating in Credit Card, Consumer Banking, and Commercial Banking. In 2012 it completed two major acquisitions: ING Direct, adding approximately $40.4 billion of loans and $84.4 billion of deposits, and HSBC’s U.S. card business, adding approximately $27.8 billion of card receivables and 27 million active accounts. Acquisition accounting, integration costs, and the timing of these deals materially affected comparisons with 2011.
Financial performance and position
| Metric | 2012 | 2011 |
|---|---|---|
| Total net revenue | $21.396 billion | $16.279 billion |
| Net interest income | $16.589 billion | $12.741 billion |
| Net interest margin | 6.50% | 7.27% |
| Provision for credit losses | $4.415 billion | $2.360 billion |
| Non-interest expense | $11.946 billion | $9.332 billion |
| Income from continuing operations, net of tax | $3.734 billion | $3.253 billion |
| Net income | $3.517 billion | $3.147 billion |
| Net income available to common stockholders | $3.487 billion | $3.121 billion |
| Diluted EPS | $6.16 | $6.80 |
| Net charge-offs / rate | $3.555 billion / 1.89% | $3.771 billion / 2.94% |
| 30+ day delinquency rate at year-end | 3.09% | 3.95% |
| Efficiency ratio | 55.83% | 57.33% |
| Return on average assets / equity | 1.30% / 10.00% | 1.63% / 11.38% |
Fourth-quarter 2012 net income was $843 million, versus $407 million in fourth-quarter 2011; fourth-quarter net income available to common stockholders was $825 million. Fourth-quarter net interest income was $4.528 billion, provision for credit losses $1.151 billion, and non-interest income $1.096 billion.
- Balance sheet: Total assets were $312.9 billion, loans held for investment $205.9 billion, deposits $212.5 billion, and stockholders’ equity $40.5 billion at year-end. Loans and deposits rose 52% and 66%, respectively, largely due to acquisitions.
- Cash flow: Operating cash flow was $9.060 billion; investing cash flow was negative $17.987 billion, including acquisition outflows; financing cash flow was $14.147 billion. Cash and cash equivalents ended the year at $11.058 billion.
- Liquidity and debt: Liquidity reserves were $61.2 billion, including $11.1 billion cash and $50.2 billion of unencumbered available-for-sale securities. Short-term borrowings and long-term debt totaled $49.9 billion, including $21.1 billion short-term borrowings. Securitized debt was $11.4 billion.
- Capital: Basel I Tier 1 common, Tier 1 risk-based, and total risk-based capital ratios were 11.0%, 11.3%, and 13.6%, respectively. Both bank subsidiaries were reported well-capitalized.
- Segments: 2012 net income from continuing operations was $1.530 billion for Credit Card, $1.363 billion for Consumer Banking, and $835 million for Commercial Banking. Credit Card earnings fell from $2.277 billion, while Consumer and Commercial Banking earnings increased from $809 million and $595 million, respectively.
Material changes versus prior period
- Revenue grew 31% and net income grew 12%, but diluted EPS declined from $6.80 to $6.16, reflecting a substantially higher weighted-average share count following equity issuance and acquisition consideration.
- Net interest margin fell 77 basis points to 6.50%, primarily reflecting the larger share of lower-yielding ING Direct assets, acquisition-related premium amortization, and lower asset yields. Management attributed part of the funding benefit to lower-cost deposits.
- Credit-loss provision increased 87%. A $1.2 billion initial allowance for acquired revolving card receivables was a major component. The allowance for loan and lease losses ended at $5.156 billion, up from $4.250 billion; its ratio to loans fell from 3.13% to 2.50%, partly because many acquired loans were recorded using expected-cash-flow accounting without an allowance unless expected collections later deteriorated.
- Non-interest expense rose 28%, including higher operating and integration costs, $336 million of merger-related expense, and $609 million of intangible amortization. The HSBC card acquisition generated $334 million of purchased-card-relationship amortization.
- The $594 million ING Direct bargain purchase gain boosted 2012 non-interest income. It was nonrecurring and excluded from management’s illustrative acquisition pro forma results.
- Reported credit quality improved, but acquired-loan accounting affects delinquency and charge-off comparability. Management also noted that acquired-loan credit marks absorbed losses in some quarters; the 2012 reported net charge-off rate was 2.34% excluding certain acquired loans accounted for on expected cash flows.
Outlook, risks, contingencies, and unusual items
- 2013 outlook: Management expected average interest-earning assets and average loan balances to decline, with approximately $18 billion of ending loan run-off or sales, including about $9 billion of acquired mortgage run-off, $7 billion from the planned Best Buy portfolio sale, and $2 billion of other acquired card run-off. Management expected modestly higher net interest margin than in 2012, overall non-interest expense of approximately $12.5 billion, and marketing expense of approximately $1.5 billion.
- Best Buy: In February 2013 Capital One agreed to sell the approximately $7 billion Best Buy card portfolio to Citi and end the partnership early. Closing was expected in the third quarter of 2013, subject to conditions; the company expected proceeds near book value and no significant gain or loss.
- Mortgage representations and warranties: The recorded reserve was $899 million at year-end. Management estimated reasonably possible future losses beyond the reserve at approximately $2.7 billion, up from $1.5 billion at year-end 2011; actual losses could exceed both the reserve and estimate. The filing describes multiple mortgage repurchase and insurer/investor lawsuits.
- Other legal and regulatory exposure: The company reported 2012 consent orders with the OCC and CFPB concerning vendor sales of payment-protection and credit-monitoring products, and orders concerning Servicemembers Civil Relief Act compliance and third-party management. The filing also describes interchange, overdraft, card-rate, and other litigation. Management estimated approximately $150 million of reasonably possible losses for certain other litigation matters, excluding specified mortgage cases included in the mortgage estimate.
- Acquisition and portfolio actions: Capital One redeemed $3.65 billion of trust preferred securities on January 2, 2013. It also completed an exchange in February 2013 in which approximately 80% of COBNA’s 8.80% subordinated notes due 2019 were exchanged for new 3.375% subordinated notes due 2023.
- Risks and regulation: Key disclosed risks include weak economic conditions, credit losses, low interest rates and a flat yield curve, deposit competition, acquisition integration, operational and cyber disruption, regulatory compliance costs, capital and liquidity rules, and concentrated commercial exposure in the New York metropolitan area. Capital One became subject to Basel II Advanced Approaches rules at year-end 2012 and expected to enter a parallel run in 2015; management cited uncertainty about future capital requirements.
- Other unusual item: A $39 million allowance was recorded for Hurricane Sandy exposure. Management identified loan-loss estimates, fair values, mortgage reserves, rewards reserves, and tax assets as significant judgment areas. Auditors issued unqualified opinions on the financial statements and internal control; management reported no material weakness.
Most important facts an investor should verify
- How much 2012 earnings growth depended on the $594 million bargain purchase gain, acquisition timing, and other one-time or acquisition-related accounting effects.
- Underlying credit performance excluding acquired loans and how the $1.2 billion acquired-card allowance and acquired-loan credit marks affect reported credit metrics and future provisions.
- The adequacy and sensitivity of the $899 million mortgage reserve and the approximately $2.7 billion reasonably possible loss estimate, including developments in litigation and new claims.
- Whether management’s 2013 assumptions for loan run-off, Best Buy sale completion, margin, expenses, and growth in Auto, Domestic Card, and Commercial Banking were achieved.
- Capital and liquidity under final Basel III and Basel II rules, stress tests, and regulatory limits on dividends or other capital distributions.