Capital One Financial Corporation — Q2 2009 Form 10-Q
Business context and reporting period
Unaudited results cover the quarter and six months ended June 30, 2009, compared with the same 2008 periods. Capital One provides consumer and commercial lending, credit cards, auto finance, and banking and deposit services. The February 27 acquisition of Chevy Chase Bank expanded its Washington, D.C.-area branch and deposit base; its results were included from the acquisition date and assigned to “Other” pending segment reallocation.
Financial performance and position
| Metric | Q2 2009 | Comparable period / change |
|---|---|---|
| Reported revenue | $3.18 billion | Down 5.1% from Q2 2008 |
| Net interest income | $1.95 billion | Up 12.7%; net interest margin 5.14%, down 11 bps |
| Provision for loan losses | $934 million | Up $105 million year over year |
| Income from continuing operations | $230 million | Down 50.2% |
| Net income | $224 million | Versus $453 million |
| Net income available to common shareholders | Loss of $276 million; diluted EPS loss of $0.65 | Included $500 million of preferred dividends and accelerated discount accretion related to TARP preferred-share redemption |
| Six-month operating cash flow | $3.14 billion | Versus $2.50 billion |
Reported non-interest income fell 24.1% to $1.23 billion, mainly because servicing and securitization income declined. Non-interest expense rose 5.6% to $1.92 billion; the company cited Chevy Chase costs and an $80.5 million special FDIC assessment, partly offset by lower marketing expense. For the first half, net income was $112 million versus $1.00 billion, and common-shareholder loss was $452 million versus income of $1.00 billion.
At June 30, total assets were $171.9 billion, deposits $116.7 billion, senior and subordinated notes $10.1 billion, other borrowings $13.3 billion, and stockholders’ equity $25.3 billion. Cash and cash equivalents were $4.8 billion; available-for-sale securities were $37.7 billion, including $12.0 billion pledged. The allowance for loan and lease losses was $4.48 billion, or 4.84% of reported loans. Six-month financing cash flow was negative $8.76 billion, primarily reflecting the preferred-share redemption and other funding and capital transactions.
Material changes versus prior periods
- Credit quality weakened: Q2 reported net charge-off rate rose to 4.66% from 3.24%; managed rate rose to 6.00% from 4.15%. Reported 30-day-plus delinquency reached 4.04%, versus 3.43%; managed delinquency was 4.34%, versus 3.64%.
- Reported loans held for investment were $101.1 billion, up $4.0 billion year over year, while managed loans were $146.3 billion, down $1.0 billion. Management cited tighter underwriting, portfolio exits, lower spending and higher charge-offs.
- Deposits were $116.7 billion, up $24.3 billion year over year, partly reflecting the Chevy Chase acquisition. In Q2, management said deposits decreased $4.4 billion from Q1 as higher-cost funding rolled off. Interest-bearing deposit cost was 2.17% at period end, versus 2.64% at December 2008.
- Net interest income increased, helped by lower funding costs and a larger securities portfolio, but the reported net interest margin declined year over year. Non-interest income was pressured by lower securitization revenue and customer fees.
- Capital One issued $1.5 billion of common stock in May and redeemed its $3.1 billion TARP preferred shares for approximately $3.57 billion, including accrued dividends. It also issued $1.0 billion of senior notes and $1.5 billion of subordinated notes. The company and its banks were described as well-capitalized; regulators’ stress-test assessment found no need for additional Tier 1 capital or Tier 1 common equity under the more-adverse scenario.
Outlook, risks and unusual items
- Management expected continued profitability pressure and further deterioration in credit performance. Its economic assumptions included U.S. unemployment of about 10.3% by year-end 2009 and a roughly 42% peak-to-trough decline in the Case-Shiller 20-City home-price index.
- Management expected U.S. Card charge-offs to rise through 2009, including an estimated 120-basis-point Q3 increase from portfolio shrinkage and OCC minimum-payment practices. It also expected higher Auto Finance delinquencies and charge-offs in the second half, declining managed loans, and a full-year U.S. Card revenue margin slightly below 15%.
- The Credit CARD Act and related rules could reduce card revenue and yields, increase compliance costs, and require changes to account-management practices. Proposed financial regulatory reforms and possible interchange-fee legislation were additional uncertainties.
- New securitization accounting standards, effective January 1, 2010, were expected to require consolidation of at least some previously off-balance-sheet entities. Capital One reported approximately $44.5 billion of credit-card receivables in QSPEs and warned that consolidation could require additional capital, whose availability and terms were uncertain.
- Q2 included $10.0 million of credit-related investment-security impairment in earnings and $149.2 million of impairment in other comprehensive income before tax. Available-for-sale securities had $1.09 billion of gross unrealized losses. Management warned that further deterioration could result in additional impairment.
- Other notable exposures include payment-option mortgage and securitization risks, GreenPoint representations-and-warranties claims, card interchange and fee litigation, and contingent credit commitments. The filing does not quantify a clear ultimate loss value for the principal litigation matters.
- Subsequent events: Capital One sold approximately $1.2 billion of U.K. deposits in July, issued $1.0 billion of trust preferred securities at 10.25%, and completed the Chevy Chase Bank merger into CONA. The filing reported negative outlooks from the listed credit-rating agencies.
Important facts for investors to verify
- Track reported and managed charge-offs, delinquencies, allowance coverage, and performance of acquired Chevy Chase loans; acquired-loan accounting and credit marks affect comparability.
- Reconcile GAAP reported results with management’s managed-loan measures, including securitization adjustments, and assess the effect of declining securitization income and retained-interest valuation changes.
- Assess the capital, balance-sheet and funding consequences of adopting the 2010 securitization-consolidation standards, including the potential treatment of the $44.5 billion QSPE portfolio.
- Check subsequent credit performance against management’s charge-off, loan-volume and revenue-margin expectations, and monitor funding costs, liquidity facilities and rating outlooks.
- Evaluate the final Chevy Chase purchase-price allocation, integration costs, and any developments in the disclosed litigation, guarantees and other contingencies.