Capital One Financial Corporation — 2009 Form 10-K
Reporting period: Fiscal year ended December 31, 2009; comparisons are principally with 2008. This is an annual filing, not a standalone fourth-quarter report. Capital One operates Credit Card, Commercial Banking and Consumer Banking businesses. It acquired Chevy Chase Bank on February 27, 2009, expanding its Washington, D.C.-area banking footprint.
Financial performance and position
| Metric | 2009 | 2008 |
|---|---|---|
| Reported revenue | $12.98 billion | $13.89 billion |
| Net interest income | $7.70 billion | $7.15 billion |
| Provision for loan and lease losses | $4.23 billion | $5.10 billion |
| Income from continuing operations, net of tax | $986.6 million | $84.5 million |
| Net income (loss) | $883.8 million | $(46.0) million |
| Diluted EPS | $0.74 | $(0.21) |
| Net interest margin | 5.30% | 5.37% |
| Reported net charge-off rate | 4.58% | 3.51% |
| Managed net charge-off rate | 5.87% | 4.35% |
| Year-end deposits | $115.8 billion | $108.6 billion |
| Year-end reported loans held for investment | $90.6 billion | $101.0 billion |
| Year-end managed loans | $136.8 billion | $146.9 billion |
| Year-end total assets | $169.6 billion | $165.9 billion |
| Year-end stockholders’ equity | $26.6 billion | $26.6 billion |
Reported revenue fell about 6.5%, as non-interest income declined $1.46 billion, partly offset by higher net interest income. Lower funding costs contributed to net interest income growth: interest expense fell by about $996 million. Revenue margin declined to 8.94% from 10.44%; risk-adjusted margin fell to 5.79% from 7.83%. Return on average assets was 0.58% and return on average equity 3.71%.
Credit costs remained severe despite the lower provision, which reflected a $396.6 million allowance release in 2009 versus a $1.6 billion build in 2008. Net charge-offs rose to $4.57 billion reported and $8.42 billion managed. The year-end allowance was $4.13 billion, or 4.55% of reported loans. Managed 30-plus-day delinquencies were 4.73%, up from 4.49%; reported nonperforming assets were $1.55 billion.
Cash and cash equivalents ended the year at $8.68 billion. Cash provided by operating activities was $2.80 billion; investing activities provided $10.45 billion and financing activities used $12.05 billion. Available-for-sale securities were $38.83 billion, of which $11.9 billion was pledged. Deposits increased $7.19 billion, while year-end senior and subordinated notes were $9.05 billion and other borrowings were $11.97 billion. Management described a substantial liquidity reserve comprising cash, unencumbered securities and committed borrowing facilities. The Banks were reported as well-capitalized; the Corporation’s regulatory Tier 1 and total capital ratios were 13.75% and 17.70%.
Material changes versus 2008
- Net income recovered from a $46.0 million loss to $883.8 million, while continuing-operations income rose to $986.6 million. Common-shareholder income was $319.9 million, reflecting preferred-stock dividends and a $461.7 million accelerated discount charge when TARP preferred shares were redeemed.
- Credit deterioration continued: managed charge-off rate increased 152 basis points, and commercial and mortgage nonperforming loans rose. Lower loan balances and the allowance release reduced reported provision expense.
- Managed loans declined $10.1 billion, primarily reflecting portfolio runoff, lower consumer demand, reduced marketing and charge-offs. Reported loans declined $10.4 billion.
- Chevy Chase added approximately $13.6 billion of deposits and expanded Consumer and Commercial Banking. The acquisition consideration was $475.9 million; year-end acquired loans were carried at $7.25 billion after fair-value adjustments, and final goodwill was $1.62 billion.
- Capital One raised approximately $1.5 billion in common equity in May 2009. It redeemed the $3.55 billion TARP preferred issuance in June; the related warrants remained outstanding.
- Available-for-sale securities rose to $38.8 billion from $31.0 billion. The portfolio recorded $218.4 million of net realized gains on security sales, while servicing and securitization income declined 32.6%.
Outlook, risks and unusual items
Management’s 2010 outlook: Management expected a mid-single-digit decline in ending managed loans and a high-single-digit decline in average loans, with annual margins broadly similar to 2009 and annual revenue lower. Non-interest expense was expected to increase, marketing to return toward more normal levels, and the efficiency ratio to rise. Management saw potential for significant allowance releases as balances declined, but expected credit losses to remain high: mortgage and Commercial Banking charge-offs were expected to worsen, while other consumer charge-offs were expected to remain elevated before a gradual recovery. It forecast U.S. unemployment above 10% throughout 2010 and an 11% decline in the Case-Shiller 20-City home-price index from year-end 2009.
- Management expected first-quarter 2010 Domestic Card charge-off rates could exceed 11%, with charge-off dollars peaking around that quarter. It expected 2010 Domestic Card revenue margin in the mid-15% range, while noting the Credit CARD Act could change revenue sources and constrain pricing and fees.
- Adoption of new securitization and consolidation accounting standards on January 1, 2010 was expected to bring about $47.6 billion of loans and $44.9 billion of liabilities onto the balance sheet, add about $4.3 billion to the allowance, and reduce equity by about $3.0 billion. The filing’s pro forma estimates showed Tier 1 capital falling from 13.75% to 9.93% and Tier 1 leverage from 10.28% to 5.84%, before any transition relief.
- Mortgage representation-and-warranty reserves were $238.4 million at year-end; open repurchase requests covered about $966.2 million of original principal. The reserve excluded a portfolio-wide claim concerning roughly 30,000 loans with $1.8 billion original principal because the loss was not considered sufficiently probable and estimable. Management said ultimate losses could exceed reserves and could materially affect results.
- Other litigation included payment-protection-product class actions and a state attorney general action, as well as Visa/MasterCard interchange litigation. The filing states outcomes and potential long-term effects were uncertain.
- Regulatory uncertainty included Credit CARD Act implementation, proposed financial-sector reforms and possible interchange-fee regulation. The filing estimated that a proposed federal assessment on large financial firms, if enacted as described, could cost Capital One $154 million; it was not enacted as of the filing.
- Other notable items included an $80.5 million FDIC special assessment, $119.4 million of restructuring expense, and the 2008 $810.9 million Auto Finance goodwill impairment (none in 2009). The company reported effective internal control over financial reporting, and the auditor gave unqualified opinions on the financial statements and internal controls.
Important facts for investors to verify
- Track managed as well as reported credit metrics, especially card charge-offs, commercial real estate losses, mortgage delinquencies and allowance adequacy; acquired Chevy Chase loans were subject to purchase-accounting credit marks and excluded from some delinquency and charge-off measures.
- Assess the impact of 2010 securitization consolidation on capital, funding, reported earnings and comparability; distinguish balance-sheet expansion from underlying economic growth.
- Review the range of possible mortgage repurchase and indemnification losses, litigation developments, and whether reserves remain adequate.
- Monitor whether deposit growth and liquidity facilities can fund maturities and loan runoff at acceptable costs, including the company’s reliance on brokered deposits and securitizations.
- Compare management’s 2010 forecasts with actual loan balances, margins, expenses, credit losses and regulatory costs; the outlook is forward-looking and subject to substantial economic and regulatory uncertainty.