Capital One Financial Corporation — Q1 2016 Form 10-Q
Reporting period: Three months ended March 31, 2016; balance-sheet comparisons are generally to December 31, 2015. Capital One is a diversified financial services company operating Credit Card, Consumer Banking and Commercial Banking businesses.
Financial performance and condition
- Revenue and earnings: Total net revenue was $6.22 billion, up 10% year over year. Net income was $1.013 billion, down 12%; diluted EPS was $1.84 versus $2.00. Net income available to common stockholders was $970 million versus $1.115 billion.
- Interest income and margins: Net interest income increased 10% to $5.056 billion; net interest margin rose 18 basis points to 6.75%. Total net revenue margin was 8.31%, up 20 basis points. The efficiency ratio improved to 51.82% from 53.99%.
- Credit costs and asset quality: Provision for credit losses rose 63% to $1.527 billion. Net charge-offs were $1.178 billion, up 34%, and the annualized net charge-off rate increased 36 basis points to 2.08%. The period-end 30+ day delinquency rate improved to 2.64% from 3.00%. The allowance for loan and lease losses was $5.416 billion, or 2.38% of held-for-investment loans, versus $5.130 billion and 2.23% at year-end.
- Cash flow: Operating activities provided $4.102 billion, compared with $1.993 billion in Q1 2015. Investing activities used $728 million, versus providing $3.071 billion; financing activities used $6.162 billion, versus $3.415 billion. Cash and cash equivalents declined $2.788 billion during the quarter to $5.235 billion.
- Balance sheet and funding: Total assets were $330.3 billion, down 1% from year-end. Held-for-investment loans were $227.6 billion, down 1%; deposits were $221.8 billion, up 2%. Short-term borrowings and long-term debt totaled $50.5 billion, down from $59.1 billion, primarily reflecting lower FHLB advances and securitized debt. Liquidity reserves were $77.2 billion, up $5.2 billion; the company said it exceeded the fully phased-in liquidity coverage ratio requirement.
- Capital and shareholder returns: The Basel III standardized common equity Tier 1 ratio was 11.1%, unchanged from year-end; the fully phased-in standardized estimate was 10.9%. The company paid $0.40 per common share in dividends and repurchased $970 million of stock during the quarter.
Material changes versus comparable periods
- Higher revenue did not translate into higher earnings: the $592 million increase in provision for credit losses and higher operating and marketing costs more than offset revenue growth. The company cited domestic card charge-offs and reserve additions, plus larger commercial credit reserves tied to oil and gas exposure.
- Credit Card revenue increased 11%, but segment net income fell 9% to $609 million as provision expense rose 60%. Purchase volume grew 19% to $68.2 billion; the card net charge-off rate rose to 4.09% from 3.48%.
- Consumer Banking net income declined 6% to $249 million. Auto loan growth and higher auto charge-offs were offset by planned acquired home-loan portfolio runoff and auto yield compression.
- Commercial Banking net income fell 57% to $67 million. Its provision for credit losses increased to $228 million from $60 million, with oil and gas and taxi medallion exposures contributing to higher credit costs and nonperforming loans.
- The December 2015 Healthcare Financial Services acquisition contributed to commercial loan growth and expenses. Q1 2016 measurement-period adjustments modestly reduced certain acquired asset values and increased goodwill; purchase accounting was expected to be finalized by June 30, 2016.
Outlook, risks and unusual items
- Management expected the Domestic Card full-year 2016 charge-off rate to be around 4%, and the 2017 rate in the low-4% range, assuming relative stability in consumer behavior, the economy and competition. Loan growth and rising expected charge-offs were expected to drive further allowance additions.
- Management anticipated approximately $160 million of bank optimization charges in 2016 and about $20 million of additional quarterly operating expense from FDIC surcharges and premium changes beginning in Q3. Despite these costs, it expected some improvement in the full-year 2016 efficiency ratio versus 2015, excluding adjusting items, with further improvement in 2017.
- Commercial credit remains a key risk: management said oil and gas conditions could require additional reserve builds and possibly higher charge-offs. Taxi medallion exposure was also identified as under pressure. Consumer Banking outlook reflects low-rate pressure on deposits, acquired home-loan runoff, auto margin compression and gradually rising auto charge-offs.
- Mortgage representation-and-warranty reserves were $613 million. The company estimated approximately $1.5 billion of reasonably possible future losses beyond reserves; it cautioned actual losses could exceed both reserves and that estimate. Favorable litigation rulings contributed to the decrease from the $1.6 billion year-end estimate.
- The U.K. cross-sell/PPI reserve was $150 million, with approximately $250 million of reasonably possible future losses beyond the reserve. The company awaited final FCA rules on PPI complaints. It also disclosed an ongoing anti-money-laundering investigation involving former commercial banking check-casher clients.
- For other litigation matters where an estimate was possible, management estimated approximately $200 million of reasonably possible losses beyond reserves, excluding specified mortgage-related cases. An adverse outcome in litigation or regulatory matters could materially affect results or cash flows in a reporting period.
- The company submitted its 2016 capital plan to the Federal Reserve on April 5, 2016; stress-test results were expected before June 30. It expected to complete the authorized stock repurchase program by the end of Q2 2016, subject to capital, market conditions and regulatory considerations.
- Management identified economic, credit, interest-rate, funding, regulatory, litigation, technology, cybersecurity, competition and execution risks as factors that could cause actual results to differ from forward-looking statements.
Most important facts for investors to verify
- Whether card losses and allowance additions track management’s 2016 and 2017 charge-off expectations, and how seasoning of recent originations affects performance.
- Further developments in oil and gas and taxi medallion credit quality, including criticized and nonperforming commercial loans and reserve adequacy.
- Actual outcomes and reserve implications for mortgage representation-and-warranty claims, U.K. PPI remediation and disclosed litigation or regulatory inquiries.
- Final HFS acquisition accounting, realized integration costs and the effect of the acquisition on commercial returns and credit quality.
- Federal Reserve CCAR results, completion of planned repurchases, and the effects of bank optimization costs and FDIC assessments on expense and efficiency trends.