COF

Capital One Financial Corp. 10-Q Summary

Business Context and Reporting Period

This filing is a Quarterly Report on Form 10-Q for Capital One Financial Corporation for the period ended September 30, 2005. Capital One is a diversified financial services company operating through three primary segments: U.S. Card, Auto Finance, and Global Financial Services. The company markets credit cards, consumer loans, auto financing, and deposit products. As of the reporting date, the company had 49.2 million accounts and $84.8 billion in managed loans outstanding.

Key Financial Metrics

Income Statement (Three Months Ended Sept 30, 2005 vs. 2004):

• Net Income: $491.1 million (2005) vs. $490.2 million (2004).
• Diluted Earnings Per Share (EPS): $1.81 (2005) vs. $1.97 (2004), a decrease of 8%.
• Total Revenue: $2.50 billion (2005) vs. $2.31 billion (2004).
• Net Interest Income: $910.2 million (2005) vs. $775.4 million (2004).
• Provision for Loan Losses: $374.2 million (2005) vs. $267.8 million (2004).
• Non-Interest Expense: $1.37 billion (2005) vs. $1.31 billion (2004).

Balance Sheet (Sept 30, 2005 vs. Dec 31, 2004):

• Total Assets: $60.42 billion (2005) vs. $53.75 billion (2004).
• Net Loans: $37.40 billion (2005) vs. $36.71 billion (2004).
• Allowance for Loan Losses: $1.45 billion (2005) vs. $1.51 billion (2004).
• Total Liabilities: $49.39 billion (2005) vs. $45.36 billion (2004).
• Stockholders' Equity: $11.04 billion (2005) vs. $8.39 billion (2004).
• Cash and Cash Equivalents: $4.60 billion (2005) vs. $1.41 billion (2004).

Cash Flow (Nine Months Ended Sept 30, 2005):

• Net Cash Provided by Operating Activities: $1.84 billion.
• Net Cash Used for Investing Activities: $(1.93) billion.
• Net Cash Provided by Financing Activities: $3.29 billion.

Material Changes and Drivers

Revenue Growth: Total revenue increased 8% year-over-year for the quarter, driven by a 17% increase in net interest income and a 4% increase in non-interest income. Net interest income growth was fueled by a 10% increase in average earning assets and higher loan yields.

Provision for Loan Losses: The provision increased 40% to $374.2 million. This increase was primarily due to:

• Gulf Coast Hurricanes: An additional $28.5 million build in the allowance for loan losses and a $15.6 million write-down of retained interests.
• Bankruptcy Legislation: Anticipated spike in bankruptcies prior to the October 17, 2005, effective date of the Bankruptcy Abuse Prevention and Consumer Protection Act resulted in an additional $27.0 million allowance build and a $48.0 million write-down of retained interests.
• Portfolio Growth: A 10% growth in the reported loan portfolio.

EPS Dilution: While net income remained flat, diluted EPS declined due to an increase in the share count resulting from the issuance of 10.4 million shares in May 2005 to settle forward purchase contracts related to mandatory convertible debt securities.

Segment Performance:

• U.S. Card: Net income increased to $481.8 million, driven by higher revenue and lower provision for loan losses despite hurricane and bankruptcy impacts.
• Auto Finance: Reported a net loss of $7.7 million for the quarter, down from $55.3 million in the prior year, due to increased provisions and expenses offsetting revenue growth from acquisitions and originations.
• Global Financial Services: Net income decreased slightly to $81.9 million, impacted by deteriorating credit quality in the U.K. and higher provisions.

Guidance, Outlook, and Risks

2005 Full Year Guidance:

• Diluted EPS: Expected to be in the lower end of the $6.60 to $7.00 range, inclusive of the Hibernia acquisition.
• Managed Loan Growth: Expected to be approximately 12% for 2005 (excluding Hibernia).
• Marketing Investment: Expected to be approximately $1.4 billion for 2005 (excluding Hibernia).
• Charge-offs: Management expects a one-time rise in the fourth quarter managed net charge-off rate of 50 to 100 basis points due to bankruptcy filings, estimating a quarterly rate of approximately 5% for Q4 2005.

Key Risks and Contingencies:

• Hibernia Merger: The $5.2 billion merger with Hibernia Corporation was delayed to November 16, 2005, due to Hurricane Katrina impacts. Risks include integration challenges and potential losses from hurricane damage to Hibernia's assets and operations.
• Legal Proceedings: The company is a defendant in antitrust lawsuits regarding interchange fees and exclusionary practices involving MasterCard and Visa. Management believes it has meritorious defenses but cannot determine the long-term financial impact.
• Bankruptcy Legislation: Uncertainty remains regarding the full financial impact of the spike in bankruptcy filings preceding the new legislation.
• Securitization: The company relies heavily on off-balance sheet securitizations for liquidity. A significant reduction in these markets could require alternative, potentially more expensive, funding sources.

Investor Verification Checklist

• Verify the impact of the delayed Hibernia merger closing on Q4 2005 earnings and integration costs.
• Monitor the actual Q4 2005 net charge-off rate against the management estimate of 5% to assess the accuracy of bankruptcy loss projections.
• Review the status of the MasterCard/Visa antitrust litigation for any updates on potential liability or settlement terms.
• Assess the sustainability of the Auto Finance segment's profitability given the Q3 loss and increased provision expenses.
• Confirm the company's ability to maintain liquidity and funding costs if securitization markets tighten.