Capital One Financial Corporation (COF) — Q3 2017 Form 10-Q
Reporting period: Three and nine months ended September 30, 2017; balance-sheet comparisons are generally against December 31, 2016. Capital One is a diversified financial-services company with Credit Card, Consumer Banking and Commercial Banking segments.
Financial performance
| Metric | Q3 2017 | Change vs. Q3 2016 | First 9 months 2017 | Change vs. 2016 |
|---|---|---|---|---|
| Total net revenue | $6.985 billion | +8% | $20.224 billion | +7% |
| Net interest income | $5.700 billion | +8% | $16.647 billion | +8% |
| Provision for credit losses | $1.833 billion | +15% | $5.625 billion | +20% |
| Non-interest expense | $3.567 billion | +6% | $10.415 billion | +5% |
| Income from continuing operations, net of tax | $1.137 billion | +12% | $2.979 billion | Approximately flat |
| Net income | $1.107 billion | +10% | $2.953 billion | Approximately flat |
| Diluted EPS | $2.14 | +$0.24 | $5.63 | +$0.21 |
Q3 net interest margin was 7.08%, up 29 basis points year over year; total net revenue margin was 8.68%, up 37 basis points. The efficiency ratio improved to 51.07% from 52.02%. Q3 return on average assets was 1.28%, and return on average common equity was 9.40%.
Reported operating cash flow for the first nine months was $10.091 billion; investing cash flow was negative $11.745 billion and financing cash flow was negative $2.051 billion. Cash, cash equivalents and restricted cash decreased $3.705 billion to $8.788 billion. These cash-flow figures include restricted cash held for securitization investors.
Balance sheet, funding and credit
- Total assets were $361.4 billion; loans held for investment were $252.4 billion, up $6.8 billion from year-end. Growth in auto and domestic card loans, including the Cabela’s portfolio, was partly offset by seasonal card paydowns and home-loan runoff.
- Total deposits were $239.1 billion, up $2.3 billion. Other debt was $42.4 billion and securitized debt obligations were $17.1 billion. Total short- and long-term borrowings were $59.5 billion, down $1.0 billion from year-end.
- Liquidity reserves were $77.4 billion, up $3.3 billion; the company said it exceeded the fully phased-in Liquidity Coverage Ratio requirement. Available FHLB borrowing capacity was $9.3 billion, with $8.1 billion of Federal Reserve Discount Window capacity.
- Common equity Tier 1 capital ratio was 10.7%, up from 10.1% at year-end; total capital ratio was 14.8%. The company and its banks exceeded applicable minimums, and the banks were well-capitalized under prompt corrective action rules. September ratios were preliminary.
- Net charge-offs were $1.606 billion in Q3, and the annualized net charge-off rate rose to 2.61% from 2.10%. The 30+ day delinquency rate was 3.24%, down 3 basis points from year-end. The allowance for loan and lease losses increased to $7.418 billion, or 2.94% of loans, from $6.503 billion, or 2.65%.
Material changes and segment performance
- Q3 revenue growth reflected loan growth, higher yields amid rising interest rates, higher interchange income and securities-sale gains. Higher credit-loss provisions, funding costs and operating expenses partly offset these gains. The effective tax rate on continuing operations fell to 28.3% from 32.8%.
- Credit Card Q3 revenue increased 7% to $4.305 billion and net income rose 3% to $572 million. For the first nine months, segment net income fell 15% to $1.396 billion as credit provisions rose 27% to $4.580 billion.
- Consumer Banking Q3 revenue increased 10% to $1.841 billion and net income rose 30% to $316 million. Auto loans grew 11% from year-end, while home loans declined 13%. Auto credit losses increased, including amid lower used-car auction prices.
- Commercial Banking Q3 revenue increased 4% to $739 million, while net income declined 6% to $179 million. Taxi-medallion losses and continued credit pressures in taxi medallion and oil-field-services lending remain areas to monitor.
- On September 25, Capital One completed the Cabela’s credit-card portfolio acquisition. It added approximately $5.7 billion of card loans; the purchase price was $3.2 billion net of cash and restricted cash acquired. Purchase accounting was still expected to be finalized by December 31, 2017.
Outlook, risks and unusual items
- Management expected the 2017 efficiency ratio, excluding adjusting items, to be in the low 51% range; 2017 EPS growth excluding adjusting items of 7%–11%; and solid EPS growth in 2018. These expectations assumed no substantial change in broader credit and economic cycles.
- Management expected the 2017 Domestic Card charge-off rate at the high end of the high-4% range to around 5%. It expected auto charge-offs to rise gradually and auto growth to moderate; commercial credit pressure to remain concentrated in oil-field services and taxi medallions.
- The board authorized up to $1.85 billion of share repurchases from Q3 2017 through Q2 2018. Repurchases may be suspended; the company paid a $0.40 common dividend per share in Q3.
- The Federal Reserve did not object to the 2017 capital plan but required a revised plan by December 28, 2017 to address weaknesses in the capital-planning process. An objection to the resubmitted plan could restrict later capital distributions.
- Hurricane-related estimated losses contributed to allowance building. The filing also cites seasoning and growth in recent card vintages, auto-loan losses and used-car price declines as credit risks.
- Mortgage representation-and-warranty reserves were $401 million; management estimated approximately $550 million of reasonably possible future losses beyond the reserve. U.K. payment-protection-insurance reserves were $298 million, with approximately $200 million of reasonably possible future losses beyond the reserve. Management estimated approximately $250 million of reasonably possible losses beyond reserves for other specified litigation matters; outcomes remain uncertain.
- Other notable exposures include an open anti-money-laundering investigation and an OCC consent order concerning AML-program deficiencies. The company was cooperating with investigative agencies. On October 10, 2017, after quarter-end, Capital One assumed certain GreenPoint manufactured-housing securitization clean-up-call obligations and received approximately $37 million; the filing said the transaction would be reflected in Q4.
- Key broader risks include credit deterioration, interest-rate movements, regulatory and legal developments, technology or cybersecurity disruption, execution of growth and digital strategies, funding-market access, and natural disasters. Management reported no material change to the risk factors in its 2016 Form 10-K.
Important facts for investors to verify
- Whether rising card and auto charge-offs, portfolio seasoning and the enlarged allowance develop in line with management’s expectations.
- How the Cabela’s acquisition affects card revenue margins, delinquencies, charge-offs and purchase accounting after integration.
- Whether the 2017 and 2018 EPS outlook is achieved, including the effect of any “adjusting items” and changes in economic or credit conditions.
- Progress on the revised capital plan due December 28, 2017, and any consequences for capital distributions or repurchases.
- Updates to mortgage representation-and-warranty, U.K. PPI, interchange, AML and other legal exposures, including actual losses compared with reserves and reasonably possible estimates.
- Liquidity and funding trends, including deposit costs, borrowings, regulatory liquidity compliance and the impact of higher interest rates on earnings and economic value of equity.