Business context and reporting period
Capital One Financial Corporation filed this unaudited Form 10-Q for the quarter ended June 30, 2013. The diversified financial services company reports Credit Card, Consumer Banking, and Commercial Banking segments. Comparisons are affected by the 2012 ING Direct and U.S. HSBC card acquisitions.
Financial results and condition
- Second-quarter results: Total net revenue was $5.64 billion, up 12% year over year. Net income was $1.12 billion, or $1.87 diluted EPS, versus $93 million, or $0.16, a year earlier. Continuing-operations net income was $1.24 billion.
- First six months: Revenue was $11.19 billion, up 12%; net income was $2.18 billion, or $3.65 diluted EPS, up from $1.50 billion, or $2.72.
- Interest income and margins: Second-quarter net interest income rose 14% to $4.55 billion; net interest margin increased to 6.83% from 6.04%. For the first half, net interest income rose 23% to $9.12 billion and margin increased to 6.78% from 6.24%. Management attributed margin improvement mainly to lower funding costs.
- Credit costs and expenses: Provision for credit losses was $762 million in Q2, down 55%, and $1.65 billion in the first half, down 27%. Non-interest expense was $3.06 billion in Q2, down 3%, but $6.09 billion for six months, up 8%, reflecting acquisition-related operating costs and intangible amortization.
- Profitability: Q2 return on average assets was 1.66%, return on average common equity 11.97%, and efficiency ratio 54.26%. The filing notes changes to its common-equity return measures in 2013.
- Balance sheet: At June 30, total assets were $296.5 billion, loans held for investment $191.5 billion, deposits $209.9 billion, and stockholders’ equity $41.0 billion. Versus December 31, 2012, assets fell 5%, loans 7%, and deposits 1%; equity rose 1%.
- Credit quality: The allowance was $4.41 billion, down 15%, with coverage of loans held for investment at 2.30% versus 2.50%. The reported 30+ day delinquency rate improved to 2.71% from 3.09%; the net charge-off rate was 2.03% in Q2 versus 1.53% a year earlier. Management cautioned that acquired-loan accounting affects comparability of credit metrics.
- Capital, debt, and liquidity: Basel I Tier 1 common ratio was 12.06%, up from 10.96% at year-end; total risk-based capital ratio was 14.67%. Total short- and long-term borrowings were $36.2 billion, down from $49.9 billion. Liquidity reserves fell 18% to $50.3 billion, primarily because cash declined; deposits remained the company’s largest funding source.
- Cash flows, first half: Operating activities provided $5.63 billion and investing activities $3.73 billion; financing activities used $15.77 billion. Cash and cash equivalents declined $6.41 billion to $4.65 billion. These bank cash flows are affected by lending, securities, deposits, and debt transactions.
Material changes versus comparable periods
- Q2 earnings improved sharply from 2012, principally because 2012 included a $1.2 billion provision for acquired card loans and a $174 million finance-charge and fee reserve charge. The first half of 2012 also included a $594 million ING Direct bargain purchase gain and $162 million from a Visa stock sale; these did not recur in 2013.
- Card purchase volume increased 12% in Q2 and 20% in the first half. However, reported card charge-off rates rose year over year, partly reflecting timing and acquisition-related denominator effects; card delinquencies improved from year-end.
- Loans held for investment declined partly because approximately $7 billion of Best Buy card loans moved to held for sale. Commercial loans grew 5% from year-end and consumer auto balances grew, while acquired home loans and certain card balances ran off.
- Rising interest rates drove a roughly $2.0 billion swing in available-for-sale securities from a $1.1 billion net unrealized gain at year-end to an $827 million net unrealized loss at June 30. First-half other comprehensive loss was $1.53 billion.
Outlook, commentary, risks, and unusual items
- Management expected average interest-earning assets and full-year average loan balances to decline in 2013. It forecast approximately $10 billion of pre-provision net income, $11 billion of operating expense, and $1.5 billion of marketing expense, with estimates subject to reasonable variation and excluding potential non-recurring items.
- Management expected about $9.5 billion of acquired mortgage run-off, $2 billion of run-off in certain acquired card loans, and the expected third-quarter sale of approximately $7 billion of Best Buy loans, partly offset by auto and Commercial Banking growth. It cited intensifying auto and commercial-and-industrial competition.
- The Board raised the quarterly common dividend to $0.30 per share. A July 2 authorization for up to $1 billion of buybacks was conditional on closing the Best Buy portfolio sale and Federal Reserve approval; completion was expected in Q3. These were post-quarter developments.
- Mortgage representation-and-warranty reserves rose to $1.16 billion from $899 million. Management estimated approximately $2.5 billion of reasonably possible additional losses beyond the reserve; actual outcomes could exceed both the reserve and estimate. Other litigation matters were estimated to involve approximately $250 million of reasonably possible future losses, excluding specified mortgage litigations.
- Ongoing costs from the closed GreenPoint mortgage business produced a $119 million after-tax Q2 discontinued-operations loss. The filing also describes PPI complaints and reserves, interchange and other litigation, overdraft and payment-protection claims, and new patent and TCPA lawsuits.
- Risks include credit deterioration, interest-rate and securities valuation changes, mortgage repurchase claims, competition, acquisition integration, regulatory changes, and the phased implementation of Basel III. A July 31, 2013 court ruling required the Federal Reserve to reconsider permitted debit interchange amounts; the financial effect was uncertain.
Important facts for investors to verify
- How much of earnings growth reflects sustainable operating performance versus the unusually high 2012 acquired-card provision and other comparison items.
- Credit trends, especially card charge-offs, auto losses, and delinquency measures adjusted to exclude acquired loans.
- Progress and final terms of the Best Buy portfolio sale, associated loan run-off, and the conditional $1 billion repurchase authorization.
- Adequacy of the $1.16 billion mortgage representation-and-warranty reserve and the possible additional exposure, including litigation developments.
- Liquidity and capital effects of securities unrealized losses, rising rates, Basel III implementation, and planned dividends or repurchases.