Capital One Financial Corporation — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; comparisons are generally with Q1 2017 for results and December 31, 2017 for period-end balances. Capital One is a diversified financial services company with Credit Card, Consumer Banking and Commercial Banking segments.
Financial performance and condition
| Metric | Q1 2018 / March 31, 2018 | Comparable period |
|---|---|---|
| Net interest income | $5.718 billion | $5.474 billion, Q1 2017 (+4%) |
| Non-interest income | $1.191 billion | $1.061 billion, Q1 2017 (+12%) |
| Total net revenue | $6.909 billion | $6.535 billion, Q1 2017 (+6%) |
| Provision for credit losses | $1.674 billion | $1.992 billion, Q1 2017 (-16%) |
| Net income | $1.346 billion; diluted EPS $2.62 | $810 million; diluted EPS $1.54 |
| Net interest margin / efficiency ratio | 6.93% / 51.72% | 6.88% / 52.55%, Q1 2017 |
| Net charge-offs / charge-off rate | $1.618 billion / 2.59% | $1.510 billion / 2.50%, Q1 2017 |
| Loans held for investment | $248.3 billion | $254.5 billion at Dec. 31, 2017 |
| Total assets / stockholders’ equity | $362.9 billion / $49.2 billion | $365.7 billion / $48.7 billion at Dec. 31, 2017 |
| Deposits / borrowings | $250.8 billion / $50.7 billion | $243.7 billion / $60.3 billion at Dec. 31, 2017 |
| Allowance for loan losses | $7.567 billion; 3.05% of loans | $7.502 billion; 2.95% at Dec. 31, 2017 |
| Common equity Tier 1 ratio | 10.5% | 10.3% at Dec. 31, 2017 |
Operating cash flow was $1.607 billion, investing cash flow $682 million and financing cash flow negative $2.324 billion. Cash, cash equivalents and restricted cash ended the quarter at $14.317 billion. Liquidity reserves were $98.3 billion, and the company reported that it exceeded the fully phased-in 100% liquidity coverage ratio requirement. These cash-flow figures reflect banking and lending activity and should not be read like those of a nonfinancial company.
Material changes and segment performance
- Net income rose 66% year over year, primarily from higher interest income on card and auto loan growth and yields, and a lower credit-loss provision. The provision declined mainly because the domestic card allowance build was smaller; net charge-offs nevertheless increased.
- Credit Card net income increased to $707 million from $271 million; revenue grew 8%, while provision fell 15%. Purchase volume rose 18% to $86.5 billion. The card net charge-off rate was 5.03%, nearly unchanged year over year.
- Consumer Banking net income rose to $426 million from $248 million. Auto loan growth and higher yields supported results; average home loans declined as the acquired portfolio ran off.
- Commercial Banking net income was $256 million versus $213 million. Revenue was nearly flat; reported segment revenue was affected by a tax-equivalent presentation change and the lower federal tax rate.
- Period-end loans fell $6.2 billion quarter over quarter, mainly from seasonal card paydowns and home-loan run-off, partially offset by auto and commercial growth. Deposits increased $7.1 billion.
- Other debt fell $8.2 billion, chiefly due to reduced Federal Home Loan Bank advances; securitized debt declined $1.3 billion, mainly from maturities.
Outlook, commentary and notable items
- Management expected 2018 full-year EPS growth to accelerate versus 2017, excluding adjusting items and assuming no substantial adverse change in economic or credit cycles. It expected most of the Tax Act benefit to appear in 2018, while warning that competition could absorb some benefit over time.
- Management expected a 2018 effective tax rate around 20%, plus or minus a reasonable margin of volatility; marketing expense higher than 2017; and fully phased-in CET1 to trend toward approximately 11%. It did not expect to use the remaining stock-repurchase authorization for the CCAR period ending June 30, 2018.
- Consumer Banking expected deposit rates to rise with market rates and competition, and auto charge-offs to increase gradually. The company had ceased new residential mortgage and home-equity originations and sold most mortgage servicing rights related to loans serviced for others in Q1.
- The Tax Act reduced the federal statutory rate from 35% to 21%; the continuing-operations effective tax rate was 19.2%, versus 28.3% in Q1 2017. The company said its Tax Act accounting remained subject to assessment and expected to finalize provisional amounts by December 2018.
- Early adoption of hedge-accounting guidance led to a one-time transfer of $9.0 billion of held-to-maturity securities to available-for-sale, with an after-tax $82 million increase to AOCI. The quarter also included a $173 million reclassification from AOCI to retained earnings under new tax guidance. Total other comprehensive loss was $472 million.
- Q1 restructuring charges were $19 million. The company was preparing to sell its online retail brokerage business; $1.6 billion of related customer deposits were classified as held for sale.
- Key risks include economic and credit-cycle changes, interest rates, funding access and deposit competition, regulatory and tax changes, technology and cybersecurity disruption, litigation and compliance matters, and the uncertain impact of future CECL adoption, which could increase credit-loss reserves.
- Legal and contingent exposures warrant attention: estimated reasonably possible litigation losses beyond recorded reserves were approximately $550 million, including mortgage representation-and-warranty matters; additional reasonably possible U.K. PPI losses beyond its $165 million reserve were estimated at approximately $150 million. The company also disclosed an ongoing AML investigation by New York and federal agencies and an open OCC consent order concerning AML program deficiencies.
Important facts for investors to verify
- Whether lower provision expense and improving delinquency measures persist as card originations season; monitor the card net charge-off rate, which rose year over year.
- Actual 2018 tax rate and EPS performance against management’s outlook, including the eventual finalization of provisional Tax Act accounting.
- Deposit pricing, funding costs and liquidity as interest rates and competition rise; review the reduction in FHLB advances and the composition of deposits, including brokered deposits.
- Credit performance and reserve adequacy across card and auto portfolios, and the expected balance-sheet and reserve effects of CECL adoption planned for January 2020.
- Updates to litigation, PPI and AML matters, and any material outcomes from the pending 2018 CCAR process.
- Capital ratios were preliminary pending regulatory filings; confirm final reported ratios and capital distributions. The company repurchased approximately $200 million of common stock in Q1 and paid a $0.40-per-share common dividend.