Capital One Financial Corporation — Q1 2015 Form 10-Q
Reporting period: Three months ended March 31, 2015. Capital One is a diversified financial services company operating through Credit Card, Consumer Banking and Commercial Banking segments.
Financial performance and condition
| Metric | Q1 2015 | Prior period / change |
|---|---|---|
| Total net revenue | $5.647 billion | $5.370 billion, up 5% year over year |
| Net interest income | $4.576 billion | $4.350 billion, up 5% |
| Net interest margin | 6.57% | 6.62%, down 5 basis points |
| Provision for credit losses | $935 million | $735 million, up 27% |
| Non-interest expense | $3.049 billion | $2.932 billion, up 4% |
| Income from continuing operations, net of tax | $1.134 billion | $1.124 billion, up 1% |
| Net income | $1.153 billion | $1.154 billion, approximately flat |
| Diluted earnings per common share | $2.00 | $1.96, up 2% |
| Efficiency ratio | 53.99% | 54.60%, improved 61 basis points |
| Net charge-offs / rate | $881 million / 1.72% | $931 million / 1.92% |
Revenue gains reflected loan growth and higher interchange fees. Increased credit-loss provisions and operating and marketing expenses offset much of that improvement. The allowance for loan and lease losses was $4.405 billion, or 2.16% of loans held for investment, versus $4.383 billion and 2.10% at year-end 2014.
Operating cash flow was $1.993 billion, investing cash flow was $3.071 billion and financing cash flow was negative $3.415 billion. Cash and cash equivalents increased $1.649 billion to $8.891 billion. These cash-flow figures reflect the company’s banking and lending activities and should be considered alongside the balance sheet.
At March 31, total assets were $306.2 billion, loans held for investment were $204.0 billion, deposits were $210.4 billion and stockholders’ equity was $45.7 billion. Borrowings totaled $41.0 billion, down 15% from December 31, primarily as short-term FHLB advances declined. Liquidity reserves were $83.0 billion, up from $71.6 billion; the company reported exceeding the fully phased-in Liquidity Coverage Ratio requirement.
Capital remained strong: the Basel III Standardized Approach common equity Tier 1 ratio was 12.46%, unchanged from year-end; the estimated fully phased-in ratio was 12.1%. The company reported a 9.22% supplementary leverage ratio.
Material changes and segment performance
- Credit Card: Revenue rose 5% to $3.482 billion, while net income was unchanged at $668 million. Purchase volume increased 21% to $57.4 billion; the segment’s net charge-off rate improved to 3.48% from 4.02%.
- Consumer Banking: Net income declined 19% to $266 million. Auto-loan growth and higher expenses were partly offset by the planned run-off of acquired home loans; higher provisions contributed to the earnings decline.
- Commercial Banking: Net income increased 13% to $155 million, supported by loan growth and fee income, partly offset by a larger allowance build. Management cited portfolio-specific commercial credit risks.
- Average loans held for investment increased 6% year over year to $205.2 billion, although period-end loans fell 2% from year-end, primarily from seasonal card paydowns and acquired home-loan run-off.
- The 30+ day delinquency rate fell to 2.58% from 2.91% at year-end, which management attributed primarily to seasonality. The allowance build and credit-loss provision were higher than in Q1 2014, when the company recorded allowance releases in certain portfolios.
Outlook, risks and unusual items
- Management expected full-year 2015 revenue growth versus 2014, driven by average loan growth. It expected the efficiency ratio near the high end of 53.5%–54.5%, or possibly modestly above, excluding non-recurring items, partly due to planned marketing and operating investment.
- For Domestic Card, management expected near-term charge-off rates at the lower end of its previously communicated mid-to-high 3% range, potentially in the low 3% range at the seasonal third-quarter low; it expected growth and seasoning to push the rate to the mid-to-high 3% range in Q4 and higher in 2016. Growth was also expected to require allowance additions.
- Management cautioned that auto-loan returns on new originations were below portfolio-wide returns and said it was monitoring pricing, underwriting, used-vehicle prices and competition. Low interest rates were expected to continue pressuring deposit-business returns.
- The mortgage representation-and-warranty reserve declined to $673 million from $731 million. Management estimated reasonably possible future losses beyond the reserve at approximately $2.1 billion; actual losses could exceed both the reserve and that estimate. The estimate is subject to substantial legal, claim-volume, loan-performance and housing-market uncertainty.
- Other legal and regulatory matters included an anti-money-laundering investigation involving certain commercial banking customers, subpoenas concerning subprime auto lending, and mortgage repurchase litigation. Management estimated approximately $200 million of reasonably possible litigation losses beyond reserves for other matters, excluding specified mortgage litigation covered in the mortgage estimate; outcomes could be material in a reporting period.
- The Board authorized up to $3.125 billion of common-share repurchases from Q2 2015 through Q2 2016 and raised the quarterly common dividend from $0.30 to $0.40 per share beginning in Q2 2015. Repurchases remain subject to market conditions, growth opportunities and capital needs and may be suspended.
- Effective January 1, 2015, the company retrospectively changed presentation of certain qualifying derivative assets and liabilities to a net basis. The filing states this affected balance-sheet presentation, not income or operating cash flows.
Important facts for investors to verify
- Whether loan growth, especially in auto and Domestic Card, translates into durable revenue and earnings after marketing, operating costs, credit losses and required allowance builds.
- Whether card and consumer delinquency improvements persist beyond seasonal effects, and how charge-offs develop as newer loan balances season.
- The adequacy of the $4.405 billion loan-loss allowance and the assumptions behind the $2.1 billion estimate of possible mortgage representation-and-warranty losses beyond reserves.
- Developments in the AML, subprime auto, mortgage repurchase and other legal matters, including any changes in reserves or reasonably possible loss estimates.
- Execution of the announced dividend increase and repurchase authorization, and the effect of distributions on capital and liquidity.
- Regulatory capital calculations during the Basel III Advanced Approaches parallel run; management noted that capital requirements under that approach could exceed those under the Standardized Approach.