Capital One Financial Corporation — Q3 2015 Form 10-Q
Business context and reporting period. Diversified financial services holding company serving consumers, small businesses and commercial clients through Credit Card, Consumer Banking and Commercial Banking businesses. This filing covers the quarter and nine months ended September 30, 2015; comparisons are with the same 2014 periods unless noted. Balance-sheet comparisons are with December 31, 2014. Amounts are in U.S. dollars.
Financial performance and condition
| Metric | Q3 2015 | First 9 months 2015 | Change versus 2014 |
|---|---|---|---|
| Net interest income | $4.76 billion | $13.87 billion | +6% quarter; +5% nine months |
| Non-interest income | $1.14 billion | $3.35 billion | Approximately flat quarter; +1% nine months |
| Total net revenue | $5.90 billion | $17.22 billion | +5% in both periods |
| Provision for credit losses | $1.09 billion | $3.16 billion | +10% quarter; +30% nine months |
| Non-interest expense | $3.16 billion | $9.52 billion | +6% quarter; +7% nine months |
| Income from continuing operations, net of tax | $1.12 billion | $3.10 billion | -1% quarter; -10% nine months |
| Net income | $1.11 billion | $3.13 billion | +3% quarter; -9% nine months |
| Diluted EPS | $1.98 | $5.48 | +6% quarter; -6% nine months |
- Margins and returns: Net interest margin was 6.73% in Q3, up 4 basis points, and 6.62% for the nine months, unchanged. Total net revenue margin was 8.34% in Q3 and 8.22% year to date, down 5 and 7 basis points, respectively. The efficiency ratio was 53.56% in Q3 and 55.26% year to date; management’s full-year outlook excludes adjusting items. Return on average assets was 1.43% for Q3 and 1.33% year to date.
- Loans and credit: Loans held for investment were $213.3 billion at quarter-end, up $5.0 billion from year-end; average loans rose 6% year over year. Q3 net charge-offs were $890 million and the rate was 1.69%, up 17 basis points year over year. The 30+ day delinquency rate was 2.95%, versus 2.91% at year-end. The allowance was $4.85 billion, or 2.27% of loans, compared with $4.38 billion and 2.10% at year-end.
- Cash flow: For the first nine months, operating activities provided $9.0 billion; investing activities used $9.6 billion; financing activities provided $0.15 billion. Cash and cash equivalents ended at $6.84 billion, down $405 million from year-end. These cash-flow figures reflect a banking company’s lending, deposit and securities activity and should not be read as conventional free cash flow.
- Debt, deposits and liquidity: Deposits were $212.9 billion, up $7.4 billion from year-end. Short- and long-term borrowings totaled $42.8 billion, down from $48.5 billion; the mix shifted substantially from short-term FHLB advances toward long-term debt. Liquidity reserves were $84.4 billion, up $12.8 billion. The company reported that it exceeded the fully phased-in Liquidity Coverage Ratio requirement at September 30.
- Capital: Common Equity Tier 1 ratio was 12.1%, versus 12.5% at year-end; total risk-based capital ratio was 15.1%. Tangible common equity ratio was 9.8%, versus 9.5%. The estimated fully phased-in standardized CET1 ratio was 11.8% (a company estimate, not the reported transition-adjusted ratio).
Material changes and segment trends
- Q3 revenue growth reflected higher net interest income, supported by credit card, auto and commercial loan growth. Higher interchange income was largely offset by lower customer fees.
- Nine-month continuing-operations earnings declined as credit-loss provisions rose, including a credit card allowance build in 2015 versus an allowance release in 2014, and operating, marketing and technology costs increased. Loan growth partly offset these pressures.
- Credit Card: Q3 net income was $670 million (+7%); nine-month net income was $1.80 billion (-8%). Purchase volume rose 22% in Q3. Recent domestic card originations were seasoning, increasing Q3 charge-offs and expected future loss rates.
- Consumer Banking: Q3 net income was $273 million (-6%); nine-month net income was $830 million (-13%). Auto lending grew, while the acquired home-loan portfolio ran off; auto margin faced competitive pressure and a shift toward prime loans.
- Commercial Banking: Q3 net income was $137 million (-25%); nine-month net income was $464 million (-5%). Credit costs increased amid adverse oil-and-gas and taxi-lending conditions. Commercial nonperforming loans rose to 0.87% of segment loans from 0.34% at year-end.
Outlook, risks, contingencies and unusual items
- Management expected the 2015 full-year efficiency ratio to be around 55%, excluding adjusting items, with modest improvement in 2016. It expected Domestic Card charge-off rates in the mid-to-high 3% range in Q4 2015 and around 4% for full-year 2016, with seasonal variability; allowance additions were expected to continue.
- Management cited pressure on Consumer Banking revenue and efficiency from low deposit rates, acquired home-loan run-off, auto-loan margin compression and competition. Commercial Banking growth had slowed as the company responded to market conditions, with pricing pressure but selected specialty-industry opportunities.
- The company announced an agreement to acquire approximately $8.5 billion of healthcare-related loans and GE Capital’s Healthcare Financial Services business, with completion expected in Q4 2015 subject to customary conditions.
- The U.K. Payment Protection Insurance reserve increased by $69 million in Q3 and $78 million in Q2; the reserve for U.K. cross-sell claims was $207 million at September 30, with approximately $250 million of reasonably possible additional losses beyond the reserve.
- The company recorded $157 million of restructuring charges in Q2, including $147 million related to workforce realignment. It issued Series F preferred shares in August, raising approximately $484 million net, with a 6.20% dividend rate.
- Mortgage representation-and-warranty reserves were $632 million, down from $731 million at year-end. Management estimated approximately $1.6 billion of reasonably possible future losses beyond the reserve. Litigation, regulatory and enforcement outcomes remain uncertain and could materially affect results or cash flows.
- Other disclosed risks include investigations concerning anti-money-laundering controls and subprime auto lending, interchange litigation, interest-rate and foreign-exchange exposure, credit deterioration, regulatory changes and technology or operational disruption. A proposed FDIC deposit-insurance surcharge was under evaluation. Management reported disclosure controls were effective and no material Q3 change in internal control over financial reporting.
- Capital return: the quarterly common dividend was raised to $0.40 per share in Q2. The company had repurchased approximately $1.3 billion under its $3.125 billion 2015 program through Q3 and expected the program to run through Q2 2016, subject to market conditions, capital needs and regulatory considerations.
Important facts for investors to verify
- Whether card losses and allowance builds track management’s projected Q4 2015 and 2016 charge-off rates as recent accounts season.
- Commercial loan performance and reserve adequacy, particularly exposures to oil and gas and taxi lending.
- Actual costs and complaint trends under the U.K. PPI matter, and the range of mortgage representation-and-warranty outcomes relative to the $632 million reserve and $1.6 billion additional-loss estimate.
- Completion, financing and performance of the proposed GE healthcare-finance acquisition.
- Capital and liquidity after dividends, repurchases, preferred-stock issuance and any applicable regulatory changes; the company’s capital ratios include transition provisions, and the fully phased-in CET1 figure is estimated.