Capital One Financial Corporation — Q1 2012 Form 10-Q
Reporting period: Three months ended March 31, 2012; balance-sheet comparisons are generally to December 31, 2011. Capital One is a diversified financial services company with Credit Card, Consumer Banking and Commercial Banking segments. Results include approximately six weeks of ING Direct operations following its February 17 acquisition. The HSBC U.S. credit card acquisition closed May 1, after quarter-end.
Financial performance and position
| Metric | Q1 2012 | Comparable period / change |
|---|---|---|
| Total revenue | $4.935 billion | Up 21% from Q1 2011 |
| Net interest income | $3.414 billion | Up 9% from Q1 2011 |
| Net interest margin | 6.20% | 7.24% in Q1 2011 |
| Provision for credit losses | $573 million | Up 7% from Q1 2011 |
| Non-interest expense | $2.504 billion | Up 16% from Q1 2011 |
| Income from continuing operations, net of tax | $1.505 billion | Up 46% from Q1 2011 |
| Net income / diluted EPS | $1.403 billion / $2.72 | $1.016 billion / $2.21 in Q1 2011 |
| Operating cash flow | $1.466 billion | $1.869 billion in Q1 2011 |
Reported results included a $594 million ING Direct bargain purchase gain and $162 million income from a Visa stock sale; management reported net income of $809 million, or $1.56 per diluted share, excluding the bargain purchase gain. The effective tax rate was 19.0%, principally affected by the non-taxable acquisition gain. Discontinued operations produced a $102 million after-tax loss, primarily related to legacy mortgage repurchase costs.
Credit quality improved: the net charge-off rate was 2.04%, versus 3.66% a year earlier; 30+ day delinquencies were 2.69% at quarter-end, versus 3.95% at year-end. These measures benefited partly from acquired-loan accounting; excluding acquired loans, the charge-off rate was 2.40% and 30+ day delinquency rate was 3.57%. The allowance for loan and lease losses fell to $4.06 billion from $4.25 billion; coverage was 2.34% of loans, versus 3.13% at year-end.
Quarter-end total assets were $294.5 billion, loans held for investment $173.8 billion, deposits $216.5 billion and stockholders’ equity $37.0 billion. The ING Direct acquisition contributed approximately $40.4 billion of loans and $84.4 billion of deposits at acquisition. Total liquidity reserves were $83.3 billion, up from $35.8 billion at year-end. Total short- and long-term debt, including securitized obligations, was $32.9 billion, down from $39.6 billion. Tier 1 common capital ratio rose to 11.9% from 9.7%; tangible common equity ratio was 8.2%, unchanged.
Material changes and segment results
- Acquisitions and scale: ING Direct materially expanded Consumer Banking, assets, deposits and investment securities. Total assets rose 43%, loans 28% and deposits 69% from year-end. Excluding ING Direct loans, total loans declined 2%, largely due to seasonal card paydowns.
- Revenue and margins: Net interest income increased with higher average assets, but net interest margin declined 104 basis points year over year as lower-yielding acquired assets and temporary cash balances diluted returns. Lower funding costs partly offset this pressure.
- Segment earnings, year over year: Credit Card net income was $566 million, down 12%, reflecting higher marketing and merger costs and a $75 million customer-refund reserve. Consumer Banking earned $224 million, up 4%, with acquisition-related revenue and expense growth. Commercial Banking earned $210 million, up 30%, supported by revenue growth and lower credit costs.
- Capital actions: Equity issuances included shares issued to ING sellers and public offerings/forward-sale settlement; the company also issued $1.25 billion of senior notes. These actions supported acquisition financing and strengthened reported capital ratios.
Outlook, risks and unusual items
- Management expected modest overall loan growth despite underlying growth in Auto Finance, Commercial Banking and Domestic Card, citing run-off of acquired and legacy portfolios.
- The May 1 HSBC acquisition was expected to have a significant second-quarter impact, including a substantial short-term negative effect on earnings and capital, principally from a significant allowance build. Management expected longer-term earnings and capital-generation benefits, while noting integration costs and intangible amortization over several years.
- Management anticipated ING Direct home-loan run-off and legacy mortgage run-off to weigh on Consumer Banking loan volumes. It expected generally steady Commercial Banking performance, with possible quarterly credit-metric fluctuations.
- Mortgage representation-and-warranty reserves were $1.101 billion, up from $943 million at year-end. Q1 mortgage repurchase-loss provision was $169 million, including $95 million related to a GSE settlement paid after quarter-end. The company estimated reasonably possible additional losses beyond reserves could reach $1.5 billion; actual losses could be higher.
- Other disclosed exposures include material mortgage repurchase litigation, including U.S. Bank, DBSP and FHLB of Boston matters; management estimated a $50–$175 million high end of possible losses for other litigation matters, excluding those mortgage matters. The filing emphasizes uncertainty in outcomes and reserve estimates.
- Other unusual items included a $355 million cumulative mark-to-market loss on ING Direct-related interest-rate swaps through termination, of which $78 million was recorded in Q1 2012. The filing also identifies customer-refund exposure tied to certain card cross-selling practices.
- Key risks include economic and credit conditions, integration and realization of acquisition benefits, interest-rate and funding-market changes, regulatory developments, litigation and mortgage claims, and the accuracy of acquisition fair-value estimates. No specific EPS or revenue guidance was provided.
Important facts for investors to verify
- How HSBC’s acquired portfolio performs, the allowance build required, and the near-term impact on earnings and capital.
- Whether credit improvement persists after seasonality and acquired-loan accounting effects are separated from legacy portfolio trends.
- The adequacy of the $1.101 billion mortgage representation-and-warranty reserve and developments in the disclosed litigation and potential additional losses.
- Underlying earnings excluding the $594 million bargain purchase gain and other notable items, including the Visa stock-sale income and discontinued mortgage losses.
- Integration costs, expense growth, margin trends and the durability of deposit funding and liquidity following the acquisitions.