Capital One Financial Corporation — 2018 Form 10-K
Business context and reporting period: Diversified financial services holding company operating Credit Card, Consumer Banking and Commercial Banking businesses. This filing covers the fiscal year ended December 31, 2018; quarterly figures below refer to Q4 2018.
Financial performance and condition
- Revenue and earnings: Full-year total net revenue was $28.1 billion, up 3% from $27.2 billion in 2017. Net income was $6.0 billion, or $11.82 per diluted share, versus $2.0 billion, or $3.49 per diluted share. Income from continuing operations was $6.0 billion. Q4 net income was $1.261 billion, or $2.48 per diluted share; Q4 2017 reported a $971 million net loss, primarily reflecting Tax Act charges.
- Net interest and margins: Net interest income rose 2% to $22.9 billion, while net interest margin eased 10 basis points to 6.87%. Interest expense increased 56% to $4.3 billion, reflecting higher rates and funding costs. Total net revenue margin was 8.44%, essentially unchanged.
- Credit costs and quality: Provision for credit losses fell 22% to $5.9 billion, largely from allowance releases in domestic cards and auto loans as credit trends improved. Net charge-offs were $6.1 billion and the net charge-off rate declined to 2.52% from 2.67%. However, total 30+ day delinquencies increased to 3.84% from 3.48%, including auto delinquencies; the credit-card delinquency rate was nearly flat at 4.01%. The allowance was $7.2 billion, or 2.94% of loans.
- Expenses and tax: Non-interest expense rose 5% to $14.9 billion, with higher marketing and a legal reserve build. The effective tax rate fell to 17.7% from 61.5%; 2017 included $1.8 billion in Tax Act charges, while 2018 benefited from a $284 million tax-methodology change related to rewards costs.
- Balance sheet and funding: Total assets were $372.5 billion, up 2%; loans held for investment were $245.9 billion, down 3%, mainly after the consumer home-loan portfolio sale. Deposits rose to $249.8 billion. Borrowings were $58.9 billion, comprising $18.3 billion of securitized debt and $40.6 billion of other debt. Stockholders’ equity was $51.7 billion.
- Cash flow and liquidity: Cash from operating activities was $13.0 billion, investing activities used $15.6 billion and financing activities provided $1.8 billion. Year-end cash and cash equivalents were $13.2 billion. Reported liquidity reserves were $89.6 billion, and average Q4 liquidity coverage ratio exceeded the 100% regulatory requirement.
- Capital and shareholder returns: Common equity Tier 1 ratio was 11.2%, up from 10.3%; total capital ratio was 15.1%. The company declared $1.60 per common share in dividends and completed its $1.2 billion 2018 share-repurchase authorization. The Banks exceeded minimum capital requirements and were well-capitalized under prompt corrective action standards.
Material changes and business developments
- Capital One sold its consumer home-loan portfolio and related servicing in 2018, recording a net gain of approximately $499 million; it had previously stopped new home-loan originations. It also sold its online retail brokerage business.
- Consumer Banking loans fell with the home-loan sale, partly offset by auto-loan growth. Commercial Banking loans grew 9% at year-end; credit-card loans increased 1%.
- Credit Card segment net income rose to $3.2 billion from $1.9 billion, mainly on lower credit-loss provision and increased revenue. Consumer Banking net income rose to $1.8 billion from $1.1 billion; Commercial Banking net income rose to $889 million from $676 million, including lower losses following elevated 2017 taxi-medallion charge-offs.
- In October, Capital One acquired the Bass Pro cobrand card portfolio, adding approximately $534 million in loans at acquisition. It agreed to become Walmart’s exclusive U.S. cobrand and private-label card issuer; in January 2019 it agreed to acquire the existing Walmart receivables portfolio, expected to be approximately $9 billion at closing.
Outlook, risks and unusual items
- Management expected modest improvement in the 2019 operating efficiency ratio, excluding approximately $225 million of one-time Walmart launch and integration expenses. It estimated an initial allowance build of approximately $120 million for the acquired Walmart portfolio.
- Management expected deposit-cost increases and deposit mix changes to pressure net interest margin; it also expected further increases in Consumer Banking deposit rates and gradual longer-term increases in auto charge-offs. Management stated capital and earnings were sufficient to support growth, Walmart, CECL adoption and the potential for a meaningful 2019 capital distribution, subject to regulatory processes.
- CECL was scheduled for adoption on January 1, 2020. Capital One expected higher credit-loss reserves and a negative retained-earnings adjustment at adoption; the amount remained uncertain.
- Regulatory and legal exposure includes the open 2015 OCC anti-money-laundering consent order. Capital One paid a $100 million OCC penalty in October 2018; DOJ, FinCEN and New York authorities continued investigating, and a potential FinCEN resolution could include a penalty. Management estimated reasonably possible litigation losses beyond recorded reserves at approximately $1.1 billion, while cautioning actual losses could exceed that estimate.
- U.K. payment-protection-insurance losses were reserved at $133 million at year-end, with approximately $100 million of reasonably possible future losses beyond the reserve. The filing also identifies risks from economic deterioration, consumer credit performance, deposit competition, interest rates, cybersecurity and third-party technology providers, regulation, and Brexit uncertainty.
Important facts for investors to verify
- Whether rising auto and overall delinquency rates persist, and whether allowance releases remain appropriate as portfolios season.
- The final size, timing, integration costs and credit performance of the Walmart portfolio and card-program launch.
- The eventual CECL reserve and capital effects, and the consequences of pending capital and liquidity rule changes.
- The status and potential financial impact of the AML investigations, consent order, litigation exposure and U.K. PPI complaints before the August 2019 deadline.
- Whether deposit-cost pressure, marketing and legal expenses, and securities-portfolio repositioning affect margins and efficiency more than management expects.