Capital One Financial Corporation — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; balance-sheet comparisons are generally against December 31, 2016. Capital One is a diversified financial services holding company operating in Credit Card, Consumer Banking and Commercial Banking. Unless noted, amounts are in U.S. dollars.
Financial performance
- Revenue and earnings: Net interest income rose 8% year over year to $5.474 billion; non-interest income fell 9% to $1.061 billion. Total net revenue increased 5% to $6.535 billion. Net income was $810 million, down 20%; diluted EPS was $1.54, down from $1.84. Continuing-operations income was $795 million.
- Drivers and margins: Net interest margin increased to 6.88% from 6.75%, supported by loan growth, higher yields and home-loan runoff. Total net revenue margin was 8.21%, versus 8.31%. The efficiency ratio increased to 52.55% from 51.82%.
- Credit costs: Provision for credit losses rose 30% to $1.992 billion; net charge-offs increased 28% to $1.510 billion. The net charge-off rate increased to 2.50% from 2.08%, primarily reflecting seasoning of recent domestic card growth. The allowance for loan and lease losses was $6.984 billion, or 2.90% of loans, up from $6.503 billion and 2.65% at year-end.
- Expenses and taxes: Non-interest expense increased 7% to $3.434 billion, including higher personnel and operating costs, technology and infrastructure investment, FDIC costs and U.K. PPI reserve activity. The effective tax rate on continuing operations fell to 28.3% from 30.7%, partly due to tax credits and benefits from adopting share-based payment accounting guidance.
- Cash flow: Net cash provided by operating activities was $3.163 billion, compared with $4.102 billion a year earlier. Investing activities provided $2.078 billion, versus $728 million used in Q1 2016; financing activities used $7.933 billion, versus $6.219 billion used. Cash, cash equivalents and restricted cash ended at $9.801 billion, down from $12.493 billion at the start of the quarter.
- Loans, funding and liquidity: Average loans held for investment grew 7% year over year to $241.5 billion, while period-end loans fell 2% from year-end to $240.6 billion, largely from seasonal card paydowns and acquired home-loan runoff. Deposits were $241.2 billion, up $4.4 billion from year-end. Total borrowings were $48.4 billion, down 20%, principally due to lower FHLB advances. Liquidity reserves increased to $87.6 billion from $74.1 billion; the company reported meeting the fully phased-in liquidity coverage requirement.
- Capital and shareholder returns: Common equity Tier 1 ratio was 10.4%, compared with 10.1% at year-end; total capital ratio was 14.7%. The company paid $0.40 per common share and repurchased $218 million of shares during the quarter. It had repurchased approximately $2.2 billion of the $2.5 billion authorized under its program through Q1-end.
Material changes and segment results
- Credit Card: Revenue rose 5% to $4.084 billion, but net income fell 56% to $271 million. Provision for credit losses increased 60% to $1.717 billion; the segment’s net charge-off rate rose to 5.02% from 4.09%. Purchase volume increased 7% to $73.2 billion.
- Consumer Banking: Revenue increased 6% to $1.712 billion and net income was essentially unchanged at $248 million. Auto originations rose 20% to $7.025 billion; average auto loans grew, while home loans continued to run off. The segment’s net charge-off rate rose to 1.19% from 1.04%.
- Commercial Banking: Revenue increased 11% to $724 million and net income rose to $213 million from $67 million. Results benefited from a credit-loss provision release of $2 million, compared with a $228 million provision in Q1 2016, reflecting lower exposure and improved performance in oil and gas and taxi-medallion portfolios.
- Companywide 30+ day delinquency declined to 2.92% from 3.27% at year-end, attributed mainly to seasonal improvement. Allowance increases in card and auto portfolios more than offset a commercial allowance release.
Outlook, risks and unusual items
- Management expected a 2017 annual efficiency ratio in the 51% range, excluding adjusting items, with a reasonable margin of volatility. It expected 2017 EPS growth of 7%–11%, excluding adjusting items, assuming no substantial change in broader credit and economic cycles.
- Management expected the 2017 Domestic Card charge-off rate in the high 4% range to around 5%, with quarterly variability. Auto charge-offs were expected to rise gradually and auto growth to moderate. Commercial credit pressures were expected to remain concentrated in oil-field services and taxi-medallion lending.
- U.K. PPI: The reserve increased to $324 million from $238 million at year-end after the FCA set an August 29, 2019 complaint deadline and issued final rules. Q1 included a $99 million reserve addition; reasonably possible losses beyond the reserve were estimated at approximately $200 million.
- Mortgage representations and warranties: The reserve declined to $516 million from $630 million, mainly due to favorable legal developments. Management estimated reasonably possible losses beyond the reserve at approximately $1.4 billion. It cautioned actual losses could exceed both recorded reserves and that estimate.
- Legal and regulatory matters: The filing estimated approximately $200 million of reasonably possible losses beyond reserves for certain other litigation matters where an estimate was possible; actual losses could be higher. Capital One remained under an OCC consent order concerning AML program deficiencies and was cooperating with investigations by government agencies related to former commercial check-casher clients. The filing stated no material change to previously disclosed risk factors.
- Other contingencies: A $40 million liability was recorded for potential mandatory clean-up calls on discontinued manufactured-housing securitizations, which could require acquisition of up to approximately $420 million of receivables and other assets. The company also disclosed substantial unfunded credit commitments; contractual commitments totaled $350.7 billion, including $320.4 billion in credit-card lines.
- Cabela’s transaction: Capital One withdrew its Bank Merger Act application in January 2017 after concluding approval was unlikely before the parties’ October 3, 2017 termination date. On April 17, after quarter-end, it agreed to acquire Cabela’s credit-card assets and related liabilities from Synovus following Synovus’s acquisition of certain Cabela’s assets and liabilities. Completion remained subject to customary conditions and the Cabela’s–Bass Pro merger.
- Management identified economic conditions, consumer credit losses, interest rates, funding access, regulation, litigation, technology and cybersecurity, and execution of growth and cost plans among factors that could cause results to differ from forward-looking expectations.
Most important facts for investors to verify
- Whether card losses and allowance needs continue to rise as recent loan growth seasons, and whether actual Domestic Card charge-offs align with management’s 2017 range.
- Whether auto credit performance and used-car values develop as assumed, and whether commercial exposures in oil and gas and taxi medallions improve or deteriorate.
- Progress in resolving U.K. PPI complaints and the adequacy of the $324 million reserve and approximately $200 million estimated additional reasonably possible exposure.
- Developments in mortgage repurchase litigation and whether actual representation-and-warranty losses remain within the recorded $516 million reserve and estimated $1.4 billion additional possible losses.
- Completion, timing and economics of the revised Cabela’s card-portfolio transaction, including outstanding approvals and closing conditions.
- Capital and liquidity levels, the effects of share repurchases and dividends, and cash flow trends; regulatory capital ratios reported for March 31 were preliminary.