Business context and reporting period
Capital One Financial Corporation is a diversified financial services company with Credit Card, Consumer Banking and Commercial Banking segments. This Form 10-Q covers the quarter and nine months ended September 30, 2019; comparisons are with the same periods in 2018 unless otherwise noted. Balance-sheet comparisons are generally with December 31, 2018.
Financial results and condition
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Total net revenue | $6.959B | $6.962B | $21.166B | $21.063B |
| Net income | $1.333B | $1.502B | $4.370B | $4.754B |
| Diluted EPS | $2.69 | $2.99 | $8.79 | $9.32 |
| Net interest income | $5.737B | $5.786B | $17.274B | $17.055B |
| Provision for credit losses | $1.383B | $1.268B | $4.418B | $4.218B |
| Non-interest expense | $3.872B | $3.773B | $11.322B | $10.770B |
- Q3 net interest margin was 6.73%, down 28 basis points; nine-month margin was 6.80%, down 6 basis points. Higher deposit costs and the U.K. PPI reserve build pressured the quarter.
- Q3 return on average assets was 1.42% versus 1.66%; return on average common equity was 9.63% versus 12.40%. The efficiency ratio rose to 55.64% from 54.19%.
- For the first nine months, operating cash flow was $12.519B, investing cash outflow $5.886B and financing cash outflow $2.585B. Cash, cash equivalents and restricted cash ended at $17.537B.
- At September 30, total assets were $378.8B; loans held for investment were $249.4B; deposits were $257.1B; and total debt and borrowings were $50.1B, down from $58.9B at year-end 2018. Equity was $58.2B.
- Liquidity reserves were $103.6B, up from $89.6B at year-end. The company’s average Q3 liquidity coverage ratio exceeded the 100% regulatory requirement.
- Common equity Tier 1 capital ratio was 12.5%, up from 11.2% at year-end. The allowance for loan and lease losses was $7.0B, or 2.82% of loans, versus $7.2B and 2.94% at year-end.
Material changes and segment performance
- Q3 net income fell 11% while revenue was essentially flat. The decline reflected a substantial U.K. PPI reserve build, higher credit provision and expenses for Walmart and technology investments. Higher interchange income and the absence of certain prior-year items partly offset these pressures.
- Credit Card earned $734M in Q3, down 29%; Consumer Banking earned $505M, up 5%; Commercial Banking earned $154M, down 16%. Commercial Banking’s provision rose amid losses on underperforming energy borrowers.
- Loans grew $3.5B from year-end, chiefly in commercial, domestic card and auto lending, partly offset by seasonal card paydowns and partnership portfolio sales. Q3 purchase volume increased 11% to $108.0B.
- Total net charge-off rate was 2.38% in Q3, down 3 basis points year over year. The 30+ day delinquency rate was 3.51%, down from 3.84% at year-end. Commercial energy credit deterioration was a notable exception to generally stable consumer credit trends.
- Deposits rose $7.4B from year-end, while other debt fell $9.4B, largely due to repayment of short-term Federal Home Loan Bank advances.
Outlook, risks and unusual items
- Management expected modestly higher full-year 2019 marketing expense than in 2018. It expected modest improvement in adjusted operating efficiency in 2019 and 2020, with a larger improvement to 42% in 2021; this is a non-GAAP measure.
- Management estimated CECL adoption on January 1, 2020 would increase credit-loss reserves by approximately 30%–40% and reduce the 2020 CET1 ratio by 13–18 basis points on a phased-in basis. These were preliminary estimates.
- Capital One launched its exclusive U.S. Walmart card program on September 24. The October 11 acquisition of approximately $8.1B of Walmart receivables was subsequent to quarter-end; management estimated an initial allowance build of about $85M. It expected approximately $225M of cumulative one-time Walmart launch costs in 2019.
- The cybersecurity incident affected approximately 100 million people in the U.S. and 6 million in Canada. The company reported $22M of Q3 net incident expense ($49M gross costs and $27M probable insurance recoveries); it expected 2019 incident costs at the low end of its $100M–$150M estimate, with some costs in 2020. Insurance coverage has a $400M limit, subject to exclusions and a deductible.
- The U.K. PPI reserve was $231M at September 30 after a $212M Q3 build; management estimated approximately $50M of reasonably possible losses beyond the reserve. Elevated claims ahead of the August 29 deadline drove the build.
- Management estimated reasonably possible litigation losses beyond recorded reserves at approximately $1.1B, while cautioning that actual losses could exceed its estimates. Cybersecurity-related class actions and inquiries, U.K. PPI litigation, and investigations involving the exited taxi-medallion lending business are among the disclosed matters. The company also remained subject to an open OCC anti-money-laundering consent order.
- The board authorized up to $2.2B of common-stock repurchases through Q2 2020; approximately $466M was repurchased in Q3. The quarterly common dividend was $0.40 per share. Future distributions remain subject to board discretion and regulatory and business conditions.
Important facts for investors to verify
- How the Walmart portfolio performs after acquisition, including actual launch costs, credit losses, revenue margin and delinquency impacts.
- Whether cybersecurity-related costs, insurance recoveries, legal proceedings or reputational effects differ materially from management’s estimates.
- Further developments in U.K. PPI claims and litigation, and whether the reserve and estimated additional exposure prove adequate.
- Commercial energy portfolio quality, charge-offs, criticized loans and reserve needs, alongside broader consumer credit trends.
- Actual CECL reserve and capital effects at adoption, and progress toward the 2021 adjusted operating-efficiency target.
- Capital One’s capacity to sustain dividends and repurchases while funding growth, managing deposit costs and maintaining regulatory capital and liquidity.