Capital One Financial Corporation — Q3 2010 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2010. Capital One is a diversified financial services company operating Credit Card, Consumer Banking and Commercial Banking businesses.
Financial performance and condition
| Metric | Q3 2010 / September 30, 2010 | Comparison and context |
|---|---|---|
| Revenue | $4.016 billion | Down 12% from Q3 2009 managed revenue of $4.585 billion. Nine-month revenue was $12.209 billion, down 2% from $12.467 billion managed revenue. |
| Net income | $803 million; diluted EPS $1.76 | Q3 2009 net income was $394 million and diluted EPS $0.87. Nine-month net income was $2.046 billion, versus $508 million in 2009; 2009 common shareholders reported a $56 million loss after preferred dividends and discount accretion. |
| Net interest income / margin | $3.109 billion; 7.21% | Nine-month net interest income was $9.434 billion and margin 7.13%. Margin benefited from lower funding costs and higher loan yields. |
| Provision for loan and lease losses | $867 million | Nine-month provision was $3.069 billion, down from $3.386 billion reported in 2009. The allowance declined during 2010 as credit indicators improved. |
| Net charge-offs / delinquencies | Charge-off rate 4.82%; 30+ day performing delinquency rate 3.71% | Charge-off rate declined from 5.36% in Q2 2010; delinquency rate declined from 3.81% in Q2 and 4.73% at year-end 2009. Management believed charge-offs peaked in Q1 2010. |
| Assets, loans and deposits | Total assets $196.9 billion; loans held for investment $126.3 billion; deposits $119.2 billion | Loans fell 8% from year-end 2009; deposits rose 3%. Comparisons are affected by the accounting consolidation described below. |
| Liquidity and debt | Liquidity reserves $38.4 billion; securitized debt $29.5 billion; other debt $14.8 billion | Cash and cash equivalents were $4.9 billion. Deposits were the company’s largest funding source; other borrowings declined from $17.1 billion at year-end 2009. |
| Capital | Tier 1 risk-based capital ratio 11.13%; Tier 1 common equity ratio 8.21%; TCE ratio 6.6% | Tier 1 risk-based and Tier 1 common ratios rose 120 basis points from Q2 2010. Capital One and both banks were reported as well-capitalized. |
| Cash flows, nine months | Operating +$8.020 billion; investing +$5.950 billion; financing −$17.713 billion | Cash and cash equivalents declined $3.743 billion to $4.942 billion. Cash-flow presentation changed with securitization consolidation. |
Material changes and comparability
- Effective January 1, 2010, new consolidation standards brought most credit-card securitization trusts, one installment-loan trust and certain mortgage trusts onto the balance sheet. Capital One added $41.9 billion of assets and $44.3 billion of related debt and recorded a $2.9 billion after-tax reduction to retained earnings.
- Because adoption was prospective, 2010 reported results are not directly comparable with 2009 reported results. The filing generally compares 2010 reported results with 2009 managed results; revenue and line-item comparisons reflect this basis, while net income was the same on reported and managed bases.
- Mortgage representation-and-warranty reserves rose to $836 million from $238 million at year-end 2009, following estimation refinements and increased claims activity. Nine-month 2010 repurchase-loss provision was $644 million; Q3 provision was $16 million.
- Capital One acquired a legacy Sony Card portfolio with $807 million of loans in September. It also completed a clean-up call on an installment-loan securitization and deconsolidated certain mortgage trusts after selling retained interests.
Outlook, management commentary and risks
- Management expected loan balances to bottom over the next few quarters, stabilize and begin modest growth in 2011, subject to economic demand. It expected securitized debt to decline to about $27 billion by year-end 2010.
- Management expected revenue margins to decline as unusually favorable card credit performance and low promotional-rate balances normalized; marketing expense was expected to rise toward more normal levels. Pre-provision earnings were expected to decline heading into 2011 and stabilize in 2011. The allowance was expected to continue declining near term.
- Capital ratios were expected to decline into Q1 2011 as consolidation-related regulatory capital phase-in continued, but management expected the Tier 1 risk-based ratio to remain above well-capitalized minimums. Management expected to reach the proposed Basel III minimum common-equity ratio, including the conservation buffer, in 2011.
- Risks included a fragile recovery, persistently high unemployment, housing-market weakness and foreclosure-process disruption, changing CARD Act and Dodd-Frank requirements, interchange-fee regulation, and potential funding or credit-market stress.
- Mortgage repurchase exposure remains uncertain. Open repurchase requests covered about $1.6 billion of original loan principal. The $836 million reserve largely related to GSE and active insured-securitization claims; the filing said it could not determine a meaningful range of reasonably possible losses above the reserve.
- Material matters included GreenPoint litigation over alleged repurchase obligations for mortgage portfolios, payment-protection and credit-card interest-rate class actions, overdraft-fee litigation, and an SEC investigation focused largely on auto-loan loss-reserve methods in certain 2007 quarters. The filing did not provide a meaningful loss range for several of these matters.
- Management reported effective disclosure controls and internal control over financial reporting, while noting a material change associated with Chevy Chase systems integration. The filing reported no material change to the previously disclosed risk factors.
Investor verification priorities
- Confirm comparisons use the appropriate basis—2010 reported versus 2009 managed—and account for the January 2010 consolidation and retained-earnings charge.
- Track the allowance for loan losses, allowance releases, charge-offs and delinquencies, including whether improvement persists as loan balances and credit conditions change.
- Assess the adequacy of the $836 million mortgage representation-and-warranty reserve against future requests, litigation outcomes and any activation of currently inactive investors.
- Monitor CARD Act and Dodd-Frank implementation, interchange-fee developments, and the expected impact on fees, revenue margins and capital requirements.
- Verify progress on loan stabilization, the expected decline in securitized debt, deposit funding and the capital-ratio phase-in; management outlook is forward-looking and may not be achieved.