CAPITAL ONE FINANCIAL CORP annual report, FY2015

Capital One Financial Corporation — FY2015 Form 10-K

Business context and reporting period. This annual report covers the fiscal year ended December 31, 2015; selected fourth-quarter results are also noted. Capital One is a diversified financial services holding company operating through Credit Card, Consumer Banking and Commercial Banking segments. It completed the acquisition of GE Capital’s Healthcare Financial Services business on December 1, 2015, adding approximately $9.2 billion of assets, including $8.3 billion of loans.

Financial performance and position

Revenue and earnings: Total net revenue was $23.4 billion, up 5% from $22.3 billion in 2014. Net income was $4.05 billion, down 9%; diluted EPS was $7.07, down from $7.59. Income from continuing operations was $4.01 billion versus $4.42 billion.
Fourth quarter: Net income was $920 million and diluted EPS was $1.58, compared with $999 million and $1.73 in Q4 2014. Net interest income was $4.96 billion; provision for credit losses was $1.38 billion.
Interest income and margins: Net interest income increased 6% to $18.83 billion, largely on loan growth. Net interest margin was 6.66%, essentially unchanged from 6.67%; total net revenue margin eased to 8.29% from 8.34%.
Credit costs and expenses: Provision for credit losses rose 28% to $4.54 billion. Non-interest expense increased 7% to $13.00 billion, including higher operating and marketing costs, technology and infrastructure investment, GE acquisition costs, and $150 million of severance and site-closure charges. The efficiency ratio worsened to 55.51% from 54.64%.
Returns: Return on average assets declined to 1.28% from 1.49%; return on average common equity fell to 8.51% from 10.08%.
Cash flow: Operating activities provided $10.13 billion; investing activities used $29.73 billion, including $9.31 billion net cash paid for acquisitions; financing activities provided $20.38 billion. Cash and cash equivalents ended the year at $8.02 billion.
Balance sheet and funding: Total assets were $334.0 billion, up 8%. Loans held for investment rose 10% to $229.9 billion. Deposits increased 6% to $217.7 billion. Borrowings were $59.1 billion, up from $48.5 billion, including $16.2 billion of securitized debt and $42.9 billion of other debt.
Credit quality: Net charge-offs were $3.70 billion and the rate rose to 1.75% from 1.72%. The 30-plus-day delinquency rate increased to 3.00% from 2.91%. The allowance for loan and lease losses rose to $5.13 billion; coverage was 2.23% of loans, versus 2.10%.
Capital and liquidity: The Basel III standardized common equity Tier 1 ratio was 11.1%, down from 12.5%; total capital ratio was 14.6%. The Banks met well-capitalized standards. Liquidity reserves were $71.9 billion, and the company reported exceeding the fully phased-in LCR requirement at year-end.

Material changes versus 2014

Loan growth, including the GE Healthcare acquisition, increased revenue and total assets; the acquired home-loan portfolio continued to run off.
Higher domestic credit-card provisions reflected loan growth, seasoning of newer balances and expected rising charge-offs. Commercial provisions also rose, notably in oil and gas and taxi-medallion lending.
Credit Card segment net income fell to $2.35 billion from $2.48 billion; Consumer Banking fell to $1.03 billion from $1.20 billion; Commercial Banking fell to $570 million from $659 million.
Net income was partly supported by $38 million of income from discontinued operations, primarily reflecting a favorable reduction in the legacy mortgage representation-and-warranty reserve. The company also issued $1.47 billion of preferred stock and repurchased $2.44 billion of common stock during the year.

Outlook, risks and unusual items

Outlook: Management expected 2016 revenue growth driven by loan growth and some improvement in the full-year efficiency ratio versus 2015, with further improvement in 2017, excluding adjusting items. Domestic Card charge-offs were expected to be around 4% in 2016 and in the low-4% range in 2017, with seasonal variation.
Segment commentary: Management expected card delinquencies and charge-offs to remain under upward pressure as newer balances season. Consumer Banking faced low-rate deposit returns, home-loan runoff and auto-margin pressure from a shift toward prime lending and competition. Commercial Banking growth was slowing; oil-and-gas and taxi-medallion exposures remained areas of concern, with possible further criticized/nonperforming loans, allowance builds and charge-offs.
Contingencies: The U.K. PPI reserve was $176 million at year-end after a $147 million 2015 build; reasonably possible additional losses were estimated at approximately $250 million. Mortgage representation-and-warranty reserves were $610 million, with approximately $1.6 billion of reasonably possible losses beyond the reserve. Management cautioned actual losses could exceed these estimates.
Regulatory and legal matters: In July 2015, Capital One entered an OCC consent order concerning its anti-money-laundering program and former check-cashing clients; it reported progress on required improvements and expected continued oversight. The filing also describes ongoing mortgage repurchase litigation and other proceedings; reasonably possible litigation losses beyond reserves were estimated at approximately $200 million for matters other than specified mortgage cases.
Other risks: Key exposures include consumer and commercial credit deterioration, energy and taxi-medallion lending, interest-rate and funding conditions, regulatory capital and liquidity requirements, litigation, cyber and technology disruption, competition, and execution and integration risks.

Most important facts for investors to verify

Whether rising card charge-offs and the related reserve build develop in line with management’s 2016–2017 expectations.
Credit trends and loss estimates for oil-and-gas and taxi-medallion commercial exposures, including the effect of the GE Healthcare loan portfolio.
Whether PPI remediation costs and mortgage representation-and-warranty claims remain within recorded reserves and disclosed possible-loss estimates.
How loan growth, funding costs and regulatory capital/liquidity requirements affect margins, efficiency and the capacity for dividends and repurchases.
The GE Healthcare acquisition’s final purchase accounting and subsequent contribution to Commercial Banking results; the filing states purchase accounting was not yet final.

The company’s consolidated financial statements received an unqualified audit opinion. Management reported effective internal control over financial reporting; the acquired GE Healthcare business was excluded from that year-end control assessment.