Capital One Financial Corporation — Q2 2015 Form 10-Q
Business context and reporting period. Capital One is a diversified financial services holding company serving consumers, small businesses and commercial clients through Credit Card, Consumer Banking and Commercial Banking businesses. This unaudited report covers the three and six months ended June 30, 2015; comparisons are with the corresponding 2014 periods, except balance-sheet comparisons, which are with December 31, 2014. Amounts below are in U.S. dollars.
Financial performance and condition
| Metric | Q2 2015 | Q2 2014 | First half 2015 | First half 2014 |
|---|---|---|---|---|
| Total net revenue | $5.672 billion | $5.468 billion | $11.319 billion | $10.838 billion |
| Net interest income | $4.537 billion | $4.315 billion | $9.113 billion | $8.665 billion |
| Provision for credit losses | $1.129 billion | $704 million | $2.064 billion | $1.439 billion |
| Non-interest expense | $3.307 billion | $2.979 billion | $6.356 billion | $5.911 billion |
| Income from continuing operations, net of tax | $852 million | $1.204 billion | $1.986 billion | $2.328 billion |
| Net income | $863 million | $1.194 billion | $2.016 billion | $2.348 billion |
| Diluted EPS | $1.50 | $2.04 | $3.51 | $4.00 |
- Revenue increased 4% in both the quarter and first half. Net interest margin was 6.56% in Q2 and 6.57% for the first half, broadly stable year over year.
- Profitability declined as credit-loss provisions and expenses rose faster than revenue. Q2 return on average assets was 1.11%, versus 1.64%; return on average common equity was 7.30%, versus 11.09%. The efficiency ratio increased to 58.30% from 54.48%.
- Credit quality indicators were mixed: the consolidated net charge-off rate was 1.64% in Q2, down 3 basis points year over year, while the allowance for loan and lease losses increased to $4.676 billion from $4.383 billion at year-end. The 30+ day delinquency rate was 2.65%, down from 2.91% at year-end. Commercial nonperforming loans rose to 0.90% of that portfolio from 0.34%, with deterioration concentrated in certain oil-and-gas and transportation exposures.
- At June 30, loans held for investment were $209.7 billion, deposits $208.8 billion, total assets $310.5 billion, borrowings $45.8 billion and stockholders’ equity $46.7 billion. Loans grew $1.4 billion and deposits $3.2 billion from year-end; borrowings declined $2.7 billion.
- First-half operating cash flow was $4.348 billion, investing cash outflow was $4.471 billion and financing cash inflow was $37 million. Cash and cash equivalents declined $86 million to $7.156 billion. Liquidity reserves were $77.4 billion, up $5.8 billion from year-end.
- Common equity Tier 1 ratio was 12.1% (12.5% at year-end); total risk-based capital ratio was 15.1%. The company reported an estimated 11.8% fully phased-in standardized CET1 ratio. The banks were reported well-capitalized under applicable prompt corrective action requirements.
Material changes and segment results
- Credit Card: Q2 revenue rose 5% to $3.478 billion, while net income fell 31% to $463 million. Loan growth supported revenue, but allowance building and higher marketing and operating costs weighed on earnings. Purchase volume rose 22% to $68.6 billion.
- Consumer Banking: Q2 revenue increased 2% to $1.640 billion and net income declined 13% to $291 million. Auto loan growth was partly offset by acquired home-loan runoff, higher credit costs and operating expenses.
- Commercial Banking: Q2 revenue rose 8% to $589 million and net income was $172 million, compared with $171 million. Higher loan and fee revenue was partly offset by increased credit provisions.
- Across the company, the credit-loss provision rose 60% in Q2 and 43% in the first half, reflecting allowance builds in card, auto and commercial portfolios; in 2014, improved credit outlook had supported allowance releases. Non-interest expense rose 11% in Q2, including restructuring charges, technology and infrastructure investment, and marketing.
- The company changed derivative and related cash-collateral balance-sheet presentation to net presentation from January 1, 2015, retrospectively recasting prior periods. Management said there was no impact on income or operating cash flows.
Outlook, risks and unusual items
- Management expected full-year 2015 efficiency ratio to be around 55%, excluding non-recurring items, and did not expect much improvement in 2016. It anticipated strong revenue growth from lending, higher credit provisions pressuring net income, and pre-provision earnings growth broadly in line with revenue growth.
- Management expected Domestic Card charge-off rates near 3% at the Q3 seasonal low, rising to the mid-to-high 3% range in Q4 and higher in 2016 as newer balances season; allowance additions were expected to continue. Consumer Banking outlook cited low-rate pressure on deposit returns, acquired home-loan runoff, slower auto growth and auto margin compression. Commercial Banking growth was slowing in response to market conditions.
- The Board authorized up to $3.125 billion of common-stock repurchases through Q2 2016; approximately $625 million had been repurchased through Q2. The quarterly common dividend increased from $0.30 to $0.40 per share. Repurchases and dividends remain subject to capital, market and regulatory considerations.
- Unusual items included $157 million of restructuring charges, including $147 million related to workforce realignment; a $78 million increase in the U.K. Payment Protection Insurance reserve; and a favorable mortgage representation-and-warranty reserve adjustment. The U.K. PPI reserve was $160 million at quarter-end; management warned actual losses could materially exceed its estimate, including because the effect of the Plevin ruling remained uncertain.
- The mortgage representation-and-warranty reserve was $636 million, down from $731 million at year-end. Management estimated approximately $1.6 billion of reasonably possible additional losses beyond the reserve, while cautioning actual losses could exceed both the reserve and estimate. Other litigation matters had an estimated $250 million of reasonably possible losses beyond recorded reserves, excluding specified mortgage-related matters included in the $1.6 billion estimate.
- In July 2015, the company entered into an OCC consent order concerning deficiencies in its former check-cashing group’s anti-money-laundering program and said remediation was underway. It also reported subpoenas and investigations concerning AML controls and subprime auto lending; the filing does not quantify a clear potential financial exposure for these matters.
- Key sensitivities include economic conditions, consumer and commercial credit losses, interest and foreign-exchange rates, regulatory and capital requirements, funding access, technology and operational disruption, and litigation and customer-remediation outcomes. Management said disclosure controls were effective and reported no material Q2 change in internal control over financial reporting.
Important facts for investors to verify
- Whether card and auto loan growth translates into sustainable earnings as charge-off rates and allowance needs rise.
- Developments in commercial oil-and-gas and transportation credit quality, including the rise in nonperforming commercial loans.
- The adequacy and sensitivity of the U.K. PPI and mortgage representation-and-warranty reserves, and the assumptions underlying possible additional losses.
- Progress and potential consequences of the OCC AML consent order, related investigations, and subprime auto inquiries.
- Capital levels and regulatory approval, timing and execution of the remaining repurchase authorization and future dividends.
- The filing provides first-half cash-flow figures; investors should distinguish operating cash flow from the modest net change in cash and from liquidity reserves.