Capital One Financial Corporation — Q3 2009 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2009; unaudited. Capital One is a diversified financial services company, with Credit Card, Commercial Banking and Consumer Banking segments. Comparisons below are with the corresponding 2008 periods unless stated otherwise. Dollar amounts are in U.S. dollars.
Financial performance and position
- Q3 earnings: Continuing-operations income was $469 million, up 22%; net income was $426 million, up from $374 million. Diluted EPS was $0.94 versus $1.00, reflecting a larger share count; diluted EPS from continuing operations was $1.03 in both periods. Q3 included a $44 million after-tax loss from discontinued GreenPoint mortgage operations.
- Nine-month earnings: Continuing-operations income was $613 million versus $1.481 billion; net income was $538 million versus $1.376 billion. Net loss available to common shareholders was $26 million, including $564 million of preferred dividends and discount accretion associated with preferred stock outstanding during the period.
- Revenue and margins: Q3 reported total revenue was $3.603 billion, up 3%, as net interest income rose to $2.051 billion from $1.807 billion, more than offsetting lower non-interest income ($1.552 billion versus $1.697 billion). Nine-month revenue was $9.658 billion, down 10%, principally because servicing and securitization income fell. Q3 reported net interest margin was 5.64% versus 5.42%; reported revenue margin was 9.91% versus 10.51%.
- Credit costs: Q3 provision for loan and lease losses was $1.173 billion versus $1.094 billion. Reported net charge-off rate was 4.53% versus 3.53%; managed rate was 6.00% versus 4.30%. At September 30, the allowance was $4.513 billion, or 4.66% of reported loans. Managed delinquency rate was 4.55%, versus 3.99% a year earlier.
- Balance sheet and funding: Total assets were $168.5 billion; reported loans held for investment were $96.8 billion and managed loans were $141.1 billion. Total deposits were $114.5 billion, senior and subordinated notes $9.2 billion, and other borrowings $12.1 billion. Cash and cash equivalents were $4.1 billion; available-for-sale securities were $37.7 billion, of which $11.4 billion were pledged. Stockholders’ equity was $26.2 billion.
- Cash flow, nine months: Operating activities provided $3.1 billion and investing activities provided $5.4 billion; financing activities used $13.2 billion. Cash and cash equivalents decreased $4.6 billion to $4.1 billion.
- Capital and liquidity: The company reported Tier 1 capital of 11.89%, total capital of 15.73% and Tier 1 leverage of 9.19%; both bank subsidiaries were classified as well-capitalized. Available funding included $7.7 billion of unused committed securitization conduits and $12.1 billion of FHLB advance availability, subject to collateral and other conditions.
Material changes versus comparable periods
- Net interest income improved in Q3 as deposit and borrowing costs fell, while loan interest income was lower. Non-interest income declined, especially securitization-related income and customer fees; securities-sale gains contributed to other income.
- Credit deterioration continued: Q3 reported charge-offs rose 29% in dollars year over year, and nonperforming loans increased to $1.334 billion from $655 million. Commercial Banking nonperforming loans rose notably, with weakness concentrated in construction and small-ticket commercial real estate.
- Managed loans at period end fell $6.3 billion, or 4.3%, year over year, including declines in credit card and auto balances. Deposits increased year over year, substantially reflecting the February acquisition of Chevy Chase Bank; Q3 deposits then declined $2.2 billion from the prior quarter as higher-cost balances ran off and the U.K. deposit business was sold.
- The February 2009 Chevy Chase Bank acquisition added scale and deposits, and contributed $8.0 billion of acquired loans at September 30. Its purchase accounting remains preliminary; goodwill was revised upward by $147 million in Q3 to approximately $1.6 billion.
- Commercial Banking recorded a Q3 net loss of $130 million, compared with $72 million income a year earlier, as sharply higher credit provisions outweighed revenue growth. Consumer Banking income increased to $185 million from $33 million; Credit Card income declined to $292 million from $357 million.
Outlook, risks and unusual items
- Management expected continued pressure on profitability from the recession. Its outlook assumed unemployment would reach the low-10% range in Q1 2010 and remain elevated through much of 2010, and home prices would fall about 42% peak to trough.
- Management expected Domestic Card charge-off rates to rise in Q4, despite an estimated 60-basis-point benefit from a smaller effect of OCC minimum-payment changes. It expected charge-off dollars to peak within one to two quarters, while rates could keep rising as balances contract. Domestic Card revenue margin was expected to remain above 16% in Q4 and moderate modestly in 2010.
- Management expected managed loans to decline through the rest of 2009 and into 2010, with weaker spending, loan demand, charge-offs and portfolio run-off. It anticipated lower-cost retail deposits would continue replacing more expensive wholesale funding.
- Securitization accounting: SFAS 166 and 167, effective for Capital One beginning January 1, 2010, could require consolidation of some previously off-balance-sheet entities. The company warned this could increase assets and regulatory capital needs and adversely affect results. It cited $44.3 billion of credit card receivables in QSPEs, including $41.3 billion backed by securities held by external investors, and $4.8 billion of mortgage receivables considered at risk for consolidation.
- Mortgage claims and litigation: GreenPoint’s reserve for repurchase and indemnification claims was $171 million, while open repurchase requests covered about $840 million of original loan principal. The reserve excludes a portfolio-wide claim involving approximately 30,000 loans with $1.8 billion original principal; the company said the ultimate loss could not be reasonably estimated and reserves may prove inadequate. Interchange-fee and other litigation outcomes also remain uncertain.
- Other exposures: The Credit CARD Act imposes new limits on card rates, fees and practices, with most provisions effective in 2010; management said the eventual industry impact remained uncertain. The company also disclosed elevated commercial real estate and construction credit risk, mortgage servicing valuation sensitivity, and potential securitization early-amortization and funding risks. The FDIC imposed higher assessments, including a one-time $81 million special assessment in Q2.
- Unusual items: Capital One redeemed $3.555 billion of preferred stock during 2009 and issued $1 billion of 10.25% trust preferred securities. A U.S. Tax Court decision and IRS examination developments reduced unrecognized tax benefits; Q3 included a $30 million discrete tax benefit.
Key facts for investors to verify
- Whether credit losses, delinquencies and commercial real estate exposures continue to worsen, and how much of reported credit metrics is affected by acquired-loan accounting and the Chevy Chase credit mark.
- Whether the $4.513 billion allowance and the $171 million GreenPoint reserve adequately reflect future credit losses, repurchase claims and litigation outcomes.
- The actual balance-sheet, capital and funding effects of adopting SFAS 166 and 167, including any required consolidation of securitization entities.
- Whether loan runoff, card purchase volumes, securitization income and the expected Q4 Domestic Card margin develop as management projected.
- How much liquidity is available after pledged collateral, facility conditions and deposit flows, and the implications of the company’s negative credit-rating outlooks.