Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

September 30, 2011 For the quarterly period ended September 30, 2011

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission File No. 1-13300

 

 

CAPITAL ONE FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   54-1719854

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

1680 Capital One Drive,

McLean, Virginia

  22102
(Address of Principal Executive Offices)   (Zip Code)

Registrant’s telephone number, including area code:

(703) 720-1000

(Former name, former address and former fiscal year, if changed since last report)

(Not applicable)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)    Yes  ¨    No  x

As of October 31, 2011, there were 459,677,105 shares of the registrant’s Common Stock, par value $.01 per share, outstanding.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

          Page  

PART I—FINANCIAL INFORMATION

     1   

Item 1.      

  

Financial Statements

     69   
  

Condensed Consolidated Statements of Income

     69   
  

Condensed Consolidated Balance Sheets

     70   
  

Condensed Consolidated Statements of Changes in Stockholders’ Equity

     71   
  

Condensed Consolidated Statements of Cash Flows

     72   
  

Notes to Consolidated Financial Statements 

     73   
  

Note   1—Summary of Significant Accounting Policies

     73   
  

Note   2—Acquisitions

     75   
  

Note   3—Discontinued Operations

     77   
  

Note   4—Investment Securities

     78   
  

Note   5—Loans

     86   
  

Note   6—Allowance for Loan and Lease Losses

     108   
  

Note   7—Variable Interest Entities and Securitizations

     110   
  

Note   8—Goodwill and Other Intangible Assets

     120   
  

Note   9—Deposits and Borrowings

     124   
  

Note 10—Derivative Instruments and Hedging Activities

     127   
  

Note 11—Stockholders’ Equity

     133   
  

Note 12—Earnings Per Common Share

     134   
  

Note 13—Fair Value of Financial Instruments

     135   
  

Note 14—Business Segments

     146   
  

Note 15—Commitments, Contingencies and Guarantees

     149   

Item 2.      

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”)

     1   
  

Summary of Selected Financial Data

     1   
  

Introduction

     4   
  

Executive Summary and Business Outlook

     6   
  

Critical Accounting Policies and Estimates

     11   
  

Consolidated Results of Operations

     13   
  

Business Segment Financial Performance

     20   
  

Consolidated Balance Sheet Analysis and Credit Performance

     33   
  

Off-Balance Sheet Arrangements and Variable Interest Entities

     52   
  

Risk Management

     52   
  

Liquidity and Capital Management

     53   
  

Market Risk Management

     60   
  

Supervision and Regulatory Developments

     63   
  

Accounting Changes and Developments

     63   
  

Forward-Looking Statements

     63   
  

Supplemental Tables

     66   

Item 3.      

  

Quantitative and Qualitative Disclosures about Market Risk

     161   

Item 4.      

  

Controls and Procedures

     161   

PART II—OTHER INFORMATION

  

Item 1.      

  

Legal Proceedings

     162   

Item 1A.  

  

Risk Factors

     162   

Item 2.      

  

Unregistered Sales of Equity Securities and Use of Proceeds

     162   

Item 3.      

  

Defaults upon Senior Securities

     162   

Item 5.      

  

Other Information

     162   

Item 6.      

  

Exhibits

     162   

SIGNATURES

     163   

INDEX TO EXHIBITS

     164   

 

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Table of Contents

INDEX OF MD&A TABLES AND SUPPLEMENTAL TABLES

 

Table

  

Description

  

Page

 

  

MD&A Tables:

  

1

  

Consolidated Financial Highlights (Unaudited)

     1   

2

  

Business Segments Results

     5   

3

  

Average Balances, Net Interest Income and Net Interest Yield

     14   

4

  

Rate/Volume Analysis of Net Interest Income

     16   

5

  

Non-Interest Income

     18   

6

  

Non-Interest Expense

     19   

7

  

Credit Card Business Results

     22   

7.1

  

Domestic Credit Card Business Results

     24   

7.2

  

International Credit Card Business Results

     26   

8

  

Consumer Banking Business Results

     28   

9

  

Commercial Banking Business Results

     31   

10

  

Investment Securities

     33   

11

  

Loan Portfolio Composition

     35   

12

  

30+ Day Delinquencies

     37   

13

  

Aging of 30+ Day Delinquent Loans

     38   

14

  

90+ Day Delinquent Loans Accruing Interest

     38   

15

  

Nonperforming Loans and Other Nonperforming Assets

     39   

16

  

Net Charge-Offs

     40   

17

  

Loan Modifications and Restructurings

     41   

18

  

Allowance for Loan and Lease Losses Activity

     44   

19

  

Allocation of the Allowance for Loan and Lease Losses

     45   

20

  

Unpaid Principal Balance of Mortgage Loans Originated and Sold to Third Parties Based on Category of Purchaser

     47   

21

  

Open Pipeline All Vintages (all entities)

     49   

22

  

Changes in Representation and Warranty Reserve

     51   

23

  

Allocation of Representation and Warranty Reserve

     51   

24

  

Liquidity Reserves

     53   

25

  

Deposits

     53   

26

  

Expected Maturity Profile of Short-term Borrowings and Long-term Debt

     55   

27

  

Borrowing Capacity

     56   

28

  

Senior Unsecured Debt Credit Ratings

     56   

29

  

Capital Ratios Under Basel I

     57   

30

  

Risk-Based Capital Components Under Basel I

     58   

31

  

Interest Rate Sensitivity Analysis

     62   

  

Supplemental Tables:

  

A

  

Reconciliation of Non-GAAP Measures and Calculation of Regulatory Capital Measures

     66   

B

  

Reconciliation of Basel III Capital Measures

     68   

 

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Table of Contents

PART I—FINANCIAL INFORMATION

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) should be read in conjunction with our unaudited condensed consolidated financial statements and related notes in this Report and the more detailed information contained in our 2010 Annual Report on Form 10-K (“2010 Form 10-K”). This discussion contains forward-looking statements that are based upon management’s current expectations and are subject to significant uncertainties and changes in circumstances. Please review “Forward-Looking Statements” for more information on the forward-looking statements in this Report. Our actual results may differ materially from those included in these forward-looking statements due to a variety of factors including, but not limited to, those described in this Report in “Part II—Item 1A. Risk Factors,” in our 2010 Form 10-K in “Part I—Item 1A. Risk Factors” and in Exhibit 99.5 to our Current Report on Form 8-K filed on July 13, 2011.

 

 

SUMMARY OF SELECTED FINANCIAL DATA

 

Below we provide selected consolidated financial data from our results of operations for the three and nine months ended September 30, 2011 and 2010, and selected comparative consolidated balance sheet data as of September 30, 2011, and December 31, 2010. We also provide selected key metrics we use in evaluating our performance.

Table 1: Consolidated Financial Highlights (Unaudited)

 

    Three Months Ended September 30,     Nine Months Ended September 30,  
(Dollars in millions)       2011             2010             Change             2011             2010             Change      

Income statement

           

Net interest income(1)

  $ 3,283      $ 3,109        6   $ 9,559      $ 9,434        1

Non-interest income

    871        907        (4     2,670        2,775        (4
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

    4,154        4,016        3        12,229        12,209          **   

Provision for loan and lease losses(1)

    622        867        (28     1,499        3,069        (51

Non-interest expense

    2,297        1,996        15        6,714        5,843        15   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations before income taxes

    1,235        1,153        7        4,016        3,297        22   

Income tax provision

    370        335        10        1,174        948        24   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations, net of taxes

    865        818        6        2,842        2,349        21   

Loss from discontinued operations, net of taxes(2)

    (52     (15     247        (102     (303     (66
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

  $ 813      $ 803        1   $ 2,740      $ 2,046        34
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Common share statistics

           

Earnings per common share:

           

Basic earnings per common share

  $ 1.78      $ 1.78        **   $ 6.02      $ 4.53        33

Diluted earnings per common share

    1.77        1.76        1        5.95        4.49        33   

Weighted average common shares outstanding:

           

Basic earnings per common share

    456.0        452.5        1        455.2        451.9        1   

Diluted earnings per common share

    460.4        456.6        1        461.0        456.0        1   

Dividends per common share

    0.05        0.05        **        0.15        0.15        **   

Stock price per common share at period end

    39.63        39.55        **        39.63        39.55        **   

Total market capitalization at period end

    18,075        17,900        1        18,075        17,900        1   

 

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Table of Contents
     Three Months Ended September 30,     Nine Months Ended September 30,  
     2011     2010     Change     2011     2010     Change  

Average balances

            

Loans held for investment

   $ 129,043      $ 126,307        2   $ 127,360      $ 129,565        (2 )% 

Interest-earning assets

     177,710        172,473        3        175,147        176,332        (1

Total assets

     201,611        196,598        3        199,616        200,931        (1

Interest-bearing deposits

     110,750        104,186        6        109,552        104,119        5   

Total deposits

     128,268        118,255        8        126,102        118,095        7   

Borrowings

     37,366        45,910        (19     39,107        52,044        (25

Stockholders’ equity

     29,316        25,307        16        28,202        24,498        15   

Performance metrics

            

Purchase volume(3)

   $ 34,918      $ 27,039        29   $ 96,941      $ 77,533        25

Revenue margin (1) (4)

     9.35     9.31     4 bps      9.31     9.23     8 bps 

Net interest margin (1) (5)

     7.39        7.21        18        7.28        7.13        15   

Net charge-off rate (1) (6)

     2.52        4.82        (230     3.02        5.41        (239

Return on average assets(7)

     1.72        1.66        6        1.90        1.56        34   

Return on average equity(8)

     11.80        12.93        (113     13.44        12.78        66   

Non-interest expense as a % of average loans held for investment(9)

     7.12        6.32        80        7.03        6.01        102   

Efficiency ratio(10)

     55.30        49.70        560        54.90        47.86        704   

Effective income tax rate

     29.96        29.05        91        29.23        28.75        48   
     September 30,
2011
    December 31,
2010
    Change                    

Balance sheet (period end)

            

Loans held for investment

   $ 129,952      $ 125,947        3      

Interest-earning assets

     174,308        172,024        1         

Total assets

     200,148        197,503        1         

Interest-bearing deposits

     110,777        107,162        3         

Total deposits

     128,318        122,210        5         

Borrowings

     34,315        41,796        (18      

Total liabilities

     170,770        170,962        **         

Stockholders’ equity

     29,378        26,541        11         

Tangible common equity (“TCE”)(11)

     15,425        12,558        23         

Credit quality metrics (period end)

            

Allowance for loan and lease losses

   $ 4,280      $ 5,628        (24 )%       

Allowance as a % of loans held for investment

     3.29     4.47     (118 )bps       

30+ day performing delinquency rate(12)

     3.13        3.52        (39      

30+ day delinquency rate

     3.81        4.23        (42      

Capital ratios

            

Tier 1 common equity ratio(13)

     10.0     8.8     120 bps       

Tier 1 risk-based capital ratio(14)

     12.4        11.6        80         

Total risk-based capital ratio(15)

     15.4        16.8        (140      

Tangible common equity ratio (“TCE ratio”)(16)

     8.3        6.9        140         

 

** Change is less than one percent.
(1) 

Interest income was reduced by $206 million and $421 million in the third quarter and first nine months of 2011, respectively, for amounts earned by Kohl’s Department Stores (‘Kohl’s”). The reduction in the provision for loan and lease losses attributable to Kohl’s was $236 million for the first nine months of 2011. Loss-sharing amounts attributable to Kohl’s reduced net charge-offs by $39 million and $80 million in the third quarter and first nine

 

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Table of Contents
  months of 2011, respectively. The expected loss reimbursement from Kohl’s netted in our allowance for loan and lease losses was approximately $156 million as of September 30, 2011. See “Note 2—Acquisitions” for additional information.
(2) 

Discontinued operations reflect ongoing costs related to the mortgage origination operations of GreenPoint’s wholesale mortgage banking unit, GreenPoint Mortgage Funding, Inc. (“GreenPoint”), which we closed in 2007.

(3) 

Consists of credit card purchase transactions for the period, net of returns. Excludes cash advance transactions.

(4) 

Calculated based on annualized total revenue for the period divided by average interest-earning assets for the period.

(5) 

Calculated based on annualized net interest income for the period divided by average interest-earning assets for the period.

(6) 

Calculated based on annualized net charge-offs for the period divided by average loans held for investment for the period. Average loans held for investment include purchased credit-impaired loans acquired as part of the Chevy Chase Bank acquisition.

(7) 

Calculated based on annualized income from continuing operations, net of tax, for the period divided by average total assets for the period.

(8) 

Calculated based on annualized income from continuing operations, net of tax, for the period divided by average stockholders’ equity for the period.

(9) 

Calculated based on annualized non-interest expense, excluding restructuring and goodwill impairment charges, for the period divided by average loans held for investment for the period.

(10) 

Calculated based on non-interest expense, excluding restructuring and goodwill impairment charges, for the period divided by total revenue for the period.

(11) 

Tangible common equity is a non-GAAP measure consisting of total assets less assets from discontinued operations and intangible assets. See “Supplemental Tables—Table A: Reconciliation of Non-GAAP Measures and Calculation of Regulatory Capital Measures” for the calculation of this measure and reconciliation to the comparative GAAP measure.

(12) 

See “Consolidated Balance Sheet Analysis and Credit Performance—Credit Performance—Nonperforming Assets” for our policies for classifying loans as nonperforming by loan category.

(13) 

Tier 1 common equity ratio is a non-GAAP measure calculated based on Tier 1 common equity divided by risk-weighted assets. See “Liquidity and Capital Management—Capital Management” and “Supplemental Tables—Table A: Reconciliation of Non-GAAP Measures and Calculation of Regulatory Capital Measures” for additional information, including the calculation of this ratio and non-GAAP reconciliation.

(14) 

Tier 1 risk-based capital ratio is a regulatory measure calculated based on Tier 1 capital divided by risk-weighted assets. See “Liquidity and Capital Management—Capital Management” and “Supplemental Tables—Table A: Reconciliation of Non-GAAP Measures and Calculation of Regulatory Capital Measures” for additional information, including the calculation of this ratio.

(15) 

Total risk-based capital ratio is a regulatory measure calculated based on total risk-based capital divided by risk-weighted assets. See “Liquidity and Capital Management—Capital Management” and “Supplemental Tables—Table A: Reconciliation of Non-GAAP Measures and Calculation of Regulatory Capital Measures” for additional information, including the calculation of this ratio.

(16) 

Tangible common equity ratio (“TCE ratio”) is a non-GAAP measure calculated based on tangible common equity divided by tangible assets. See “Supplemental Tables—Table A: Reconciliation of Non-GAAP Measures and Calculation of Regulatory Capital Measures” for the calculation of this measure and reconciliation to the comparative GAAP measure.

 

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INTRODUCTION

 

Capital One Financial Corporation (the “Company”) is a diversified financial services holding company with banking and non-banking subsidiaries that offer a broad array of financial products and services to consumers, small businesses and commercial clients through branches, the internet and other distribution channels. Our principal subsidiaries include:

 

   

Capital One Bank (USA), National Association (“COBNA”), which currently offers credit and debit card products, other lending products and deposit products; and

 

   

Capital One, National Association (“CONA”), which offers a broad spectrum of banking products and financial services to consumers, small businesses and commercial clients.

The Company and its subsidiaries are collectively referred to as “we,” “us” or “our” in this Report. CONA and COBNA are collectively referred to as the “Banks” in this Report.

We had $130.0 billion in total loans outstanding and $128.3 billion in deposits as of September 30, 2011, compared with $125.9 billion in total loans outstanding and $122.2 billion in deposits as of December 31, 2010.

Our revenues are primarily driven by lending to consumers and commercial customers and by deposit-taking activities, which generate net interest income, and by activities that generate non-interest income, including the sale and servicing of loans and providing fee-based services to customers. Customer usage and payment patterns, credit quality, levels of marketing expense and operating efficiency all affect our profitability. Our expenses primarily consist of the cost of funding our assets, our provision for loan and lease losses, operating expenses (including associate salaries and benefits, infrastructure maintenance and enhancements and branch operations and expansion costs), marketing expenses and income taxes.

Our principal operations are currently organized, for management reporting purposes, into three major business segments, which are defined based on the products and services provided or the type of customer served: Credit Card, Consumer Banking and Commercial Banking. The operations of acquired businesses have been integrated into our existing business segments.

 

   

Credit Card: Consists of our domestic consumer and small business card lending, national small business lending, national closed end installment lending and the international card lending businesses in Canada and the United Kingdom.

 

   

Consumer Banking: Consists of our branch-based lending and deposit gathering activities for consumers and small businesses, national deposit gathering, national automobile lending and consumer home loan lending and servicing activities.

 

   

Commercial Banking: Consists of our lending, deposit gathering and treasury management services to commercial real estate and middle market customers. Our middle market customers typically include commercial and industrial companies with annual revenues between $10 million to $1.0 billion.

Certain activities that are not part of a segment are included in our “Other” category.

Table 2 summarizes our business segment results, which we report based on income from continuing operations, net of tax, for the three and nine months ended September 30, 2011 and 2010. We provide a reconciliation of our total business segment results to our consolidated results using generally accepted accounting principles in the U.S. (“U.S. GAAP”) in “Note 14—Business Segments” of this Report.

 

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Table 2: Business Segment Results

 

     Three Months Ended September 30,  
     2011     2010  
     Total  Revenue(1)     Net Income  (Loss)(2)     Total  Revenue(1)     Net Income  (Loss)(2)  
(Dollars in millions)    Amount     % of
Total
    Amount     % of
Total
    Amount     % of
Total
    Amount     % of
Total
 

Credit Card

   $ 2,720        65   $ 663        76   $ 2,605        65   $ 631        77

Consumer Banking

     1,285        31        190        22        1,142        28        175        21   

Commercial Banking

     415        10        145        17        355        9        39        5   

Other(3)

     (266     (6     (133     (15     (86     (2     (27     (3
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total from continuing operations

   $ 4,154        100   $ 865        100   $ 4,016        100   $ 818        100
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

     Nine Months Ended September 30,  
     2011     2010  
     Total  Revenue(1)     Net Income  (Loss)(2)     Total  Revenue(1)     Net Income  (Loss)(2)  
(Dollars in millions)    Amount     % of
Total
    Amount     % of
Total
    Amount     % of
Total
    Amount     % of
Total
 

Credit Card

   $ 7,844        64   $ 1,924        68   $ 8,072        66   $ 1,688        72

Consumer Banking

     3,699        30        692        24        3,451        28        785        33   

Commercial Banking

     1,202        10        435        15        1,088        9        67        3   

Other(3)

     (516     (4     (209     (7     (397     (3     (191     (8
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total from continuing operations

   $ 12,229        100   $ 2,842        100   $ 12,214        100   $ 2,349        100
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) 

Total revenue consists of net interest income and non-interest income.

(2) 

Net income (loss) for our business segments reflects income from continuing operations, net of tax.

(3)

Includes the residual impact of the allocation of our centralized Corporate Treasury group activities, such as management of our corporate investment portfolio and asset/liability management, to our business segments as well as other items as described in “Note 14—Business Segments.”

 

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EXECUTIVE SUMMARY AND BUSINESS OUTLOOK

 

Financial Highlights

We reported net income of $813 million ($1.77 per diluted share) in the third quarter of 2011, with each of our three business segments contributing to our earnings. In comparison, we reported net income of $911 million ($1.97 per diluted share) in the second quarter of 2011 and net income of $803 million ($1.76 per diluted share) in the third quarter of 2010. Net income totaled $2.7 billion ($5.95 per diluted share) for the first nine months of 2011, compared with net income of $2.0 billion ($4.49 per diluted share) for the first nine months of 2010.

Our capital levels continued to increase during the third quarter of 2011, with total stockholders’ equity up $2.8 billion from year-end 2010. Our Tier 1 risk-based capital ratio under Basel I was 12.4% and our Tier 1 common equity ratio, a non-GAAP measure, was 10.0% as of September 30, 2011, both up 60 basis points from the end of the second quarter of 2011, reflecting strong internal capital generation as well as the continued decline in the amount of disallowed deferred tax assets. Based on our current understanding of the Basel III framework, which has not been implemented by the U.S. banking agencies and is subject to change, we estimate that our Tier 1 common equity ratio was 10.1% as of September 30, 2011. Our stockholders’ equity and capital ratios do not reflect any impact from the equity forward sale agreements executed in July 2011 referenced below, as they have not been settled in whole or in part as of the date of this Report. We present the calculation of our regulatory capital ratios and a reconciliation of our supplemental non-GAAP capital measures below under “Supplemental Tables.”

Our strategies and actions are designed to deliver profitable long-term growth through the acquisition and retention of franchise-enhancing customer relationships across our businesses. We believe that franchise-enhancing customer relationships produce strong long-term economics through low credit costs, low customer attrition and a gradual build in loan balances and revenues over time. Examples of franchise-enhancing customer relationships include rewards customers and new partnerships in our Credit Card business, long-term retail deposit customers in our Consumer Banking business and primary banking relationships with commercial customers in our Commercial Banking business. We intend to grow these customer relationships by continuing to invest in our bank infrastructure to allow us to provide more convenient and flexible customer banking options, including a broader range of fee-based and credit products and services, by leveraging our direct bank customer franchise with national reach and by continued marketing investments to further strengthen our brand. We believe our actions have created a well-positioned balance sheet and strong capital and liquidity levels which have provided us with investment flexibility to take advantage of attractive opportunities and adjust, where we believe appropriate, to changing market conditions.

As previously announced, in June 2011, we entered into a definitive agreement with ING Groep N.V., ING Bank N.V., ING Direct N.V., ING Direct Bancorp, collectively, the Sellers, under which we will acquire substantially all of the Sellers’ ING Direct business in the United States (“ING Direct”), in exchange for $6.2 billion in cash and approximately 55.9 million shares of our common stock, subject to certain adjustments. We continue to expect the ING Direct acquisition to close in late 2011 or early 2012, subject to customary closing conditions, including certain governmental clearances and approvals. In the third quarter of 2011, we closed a public underwritten offering of our senior notes, from which we received total proceeds of approximately $3.0 billion, and a public underwritten offering of 40 million shares of our common stock at a price per share of $50.00, subject to forward sale agreements. After underwriter’s discounts and commissions, the net proceeds to us from the equity offering will be at an initial forward sale price per share of $48.50. The forward sale price is subject to adjustment under the forward sale agreements. We have not received any proceeds from this public offering of our shares of common stock yet. Under the terms of the forward sale agreements, we must settle the forward sale agreements on or before February 15, 2012. We expect to settle the forward sale agreements entirely by physical delivery of shares of common stock in exchange for cash proceeds from the forward purchasers of approximately $1.9 billion based on the initial forward price. However, we may, subject to certain conditions, elect cash or net share settlement of all or a portion of our obligation to deliver shares of common stock. We expect to

 

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use the net proceeds from the debt and equity offerings, along with cash sourced from our current liquidity, to fund the $6.2 billion in cash consideration payable in connection with the ING Direct acquisition.

In addition to the pending ING Direct acquisition, we announced in August 2011 that we had entered into a purchase agreement with HSBC Finance Corporation, HSBC USA Inc. and HSBC Technology and Services (USA) Inc. (collectively, “HSBC”), to acquire substantially all of the assets and assume liabilities of HSBC’s credit card and private-label credit card business in the United States for a premium estimated at $2.6 billion as of June 30, 2011. We currently expect the HSBC acquisition to close in the second quarter of 2012, subject to customary closing conditions, including certain governmental clearances and approvals.

We took several actions during the quarter to manage the anticipated impact of the pending ING Direct acquisition on our market risk exposure and regulatory capital requirements. Since the date we entered into the agreement to acquire ING Direct, interest rates have declined substantially, and our current estimate of the fair value of the ING Direct net assets and liabilities has increased correspondingly. In order to capture some of the anticipated benefits to regulatory capital on the closing date attributable to this decline in interest rates, in August 2011, we entered into various pay-fixed/receive-floating interest-rate swap transactions with a total notional principal amount of approximately $23.8 billion. These swap transactions are designed to mitigate the effect of a rise in interest rates on the fair values of a significant portion of the ING Direct assets and liabilities during the period from when we entered into the swap transactions to the anticipated closing date of the ING Direct acquisition in late 2011 or early 2012. Although the interest-rate swaps represent economic hedges, they are not designated for hedge accounting. Accordingly, changes in the fair value are recorded in earnings. Our results for the third quarter of 2011 include a mark-to-market loss of $266 million related to these interest-rate swaps, which was attributable to a decline in interest rates as of the end of the quarter. Changes in the fair value of these interest-rate swaps will continue to be recorded in earnings until the swaps are terminated. We also sold approximately $6.4 billion of investment securities, consisting predominantly of agency mortgage-backed securities (“MBS”). We recorded a gain of $239 million on the sale of these securities, which largely offsets the mark-to-market loss recognized on the interest-rate swaps. We will continue to evaluate market conditions and may take additional balance sheet management actions, such as entering into similar swap transactions or selling additional investment securities, to manage the anticipated impact of the pending ING Direct and HSBC acquisitions on our market risk exposure and regulatory capital requirements. For additional detail, see “Market Risk Management” section of this Report and “Note 10—Derivative Instruments and Hedging Activities.”

Below are additional highlights of our performance for the third quarter and first nine months of 2011. These highlights generally are based on a comparison to the same prior year periods. The changes in our financial condition and credit performance are generally based on our financial condition and credit performance as of September 30, 2011, compared with our financial condition and credit performance as of December 31, 2010. We provide a more detailed discussion of our financial performance in the sections following this “Executive Summary and Business Outlook.”

Total Company

 

   

Earnings: Our earnings of $813 million in the third quarter of 2011 increased by $10 million, or 1%, from the third quarter of 2010, while our earnings of $2.7 billion for the first nine months of 2011 increased by $694 million, or 34%, from the first nine months of 2010. The increase in net income for each period was primarily attributable to significantly lower credit costs due to improvements in loan credit quality. The increase in net income for the first nine months of 2011 also reflected a substantial reduction in the provision for mortgage repurchase losses for legacy mortgage-related representation and warranty claims. These factors were partially offset by higher operating expenses related to our recent acquisitions and increased marketing expenditures.

 

   

Total Loans: Period-end loans held for investment increased by $4.0 billion, or 3%, during the first nine months of 2011, to $130.0 billion as of September 30, 2011, from $125.9 billion as of December 31, 2010. The increase was primarily attributable to the additions of the $3.7 billion private-label credit card loan

 

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portfolio of Kohl’s in the second quarter of 2011 and the $1.4 billion credit card loan portfolio of Hudson’s Bay Company (“HBC”) in the first quarter of 2011, as well as growth in our auto finance, commercial and revolving domestic card balances. Excluding the impact of the addition of the Kohl’s and HBC portfolios, total loans decreased by $1.1 billion, or 1%, in the first nine months of 2011, due to the continued expected run-off of installment loans in our Credit Card business and legacy home loans in our Consumer Banking business, other loan paydowns and charge-offs. The impact from these factors more than offset the strong purchase volume growth across the Domestic Card business, a significant increase in auto loan originations and steady loan growth in our Commercial Banking business.

 

   

Charge-off and Delinquency Statistics: Net charge-off rates continued to decline during the third quarter of 2011. The net charge-off rate decreased to 2.52%, from 2.91% in the second quarter of 2011 and 4.82% in the third quarter of 2010. The net charge-off rate was 3.02% for the first nine months of 2011, a decrease of 239 basis points from the first nine months of 2010. The 30+ day delinquency rate was 3.81% as of September 30, 2011, compared with 3.57% as of June 30, 2011, and 4.23% as of December 31, 2010. As overall credit trends are stabilizing after almost two years of rapidly declining charge-offs, our quarterly credit metrics are increasingly driven by seasonal patterns.

 

   

Allowance for Loan and Lease Losses: We reduced our allowance by $208 million in the third quarter of 2011 and by $1.3 billion in the first nine months of 2011 to $4.3 billion as of September 30, 2011. In comparison, we reduced our allowance by $624 million in the third quarter of 2010 and by $2.0 billion in the first nine months of 2010. The significant reductions in our allowance releases in the third quarter and first nine months of 2011 from the same prior year periods reflect the impact of stabilizing credit trends. While our net-charge off rate improved by 239 basis points in the first nine months of 2011, compared with the same prior year period, the allowance coverage ratio fell by only 118 basis points to 3.29% as of September 30, 2011, from 4.47% as of December 31, 2010.

 

   

Representation and Warranty Reserve: Our representation and warranty reserve totaled $892 million as of September 30, 2011, compared with $816 million as of December 31, 2010. This reserve relates to our mortgage loan repurchase exposure for legacy mortgage loans sold by our subsidiaries to various parties under contractual provisions that include various representations and warranties. The reserve reflects losses as of each balance sheet date that we consider to be both probable and reasonably estimable. We recorded a provision for this exposure of $72 million and $153 million in the third quarter and first nine months of 2011, respectively, compared with a provision of $16 million and $644 million in the third quarter and first nine months of 2010, respectively.

Business Segments

 

   

Credit Card Business: Our Credit Card business generated net income from continuing operations of $663 million and $1.9 billion in the third quarter and first nine months of 2011, respectively, compared with net income from continuing operations of $631 million and $1.7 billion in the third quarter and first nine months of 2010, respectively. The improvement in credit performance was the primary driver of the improvement in our Credit Card business, resulting in a significant decrease in the provision for loan and lease losses. The provision decrease for the first nine months of 2011 was partially offset by an increase in non-interest expense attributable to increased operating and integration costs related to the acquisitions of the credit card loan portfolios of Sony, HBC and Kohl’s and increased marketing expenditures. New account originations have continued to grow in our Credit Card business.

 

   

Consumer Banking Business: Our Consumer Banking business generated net income from continuing operations of $190 million and $692 million in the third quarter and first nine months of 2011, respectively, compared with net income from continuing operations of $175 million and $785 million in the third quarter and first nine months of 2010, respectively. The increase in net income for the third quarter of 2011 was primarily due to revenue growth resulting from improved loan margins attributable to an increase in average loan yields, coupled with a decrease in the cost of funds. The decrease in net income for the first nine months of 2011 reflected the impact of the absence of a one-time pre-tax gain of $128 million recorded in

 

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the first quarter of 2010 from the deconsolidation of certain option-adjustable rate mortgage trusts and an increase in the provision for loan and lease losses due to growth in auto loans. These factors were partially offset by an increase in total revenue due to a shift in our loan product mix toward higher priced auto loan originations, coupled with deposit growth resulting from our continued strategy to leverage our bank outlets to attract lower cost deposit funding. Strong growth in auto loan originations during the third quarter and first nine months of 2011 has more than offset the continued run-off in legacy home loans.

 

   

Commercial Banking: Our Commercial Banking business generated net income from continuing operations of $145 million and $435 million in the third quarter and first nine months of 2011, respectively, compared with net income from continuing operations of $39 million and $67 million in the third quarter and first nine months of 2010, respectively. The improvement in results for our Commercial Banking business reflected an increase in revenues, a decrease in non-interest expense and a decrease in the provision for loan and lease losses due to the improvement in credit quality. As a result of this improvement, we reduced our allowance for loan and lease losses and recorded a negative provision for loan and lease losses of $10 million and $43 million in the third quarter and first nine months of 2011, respectively. In comparison, we recorded a provision for loan and lease losses of $95 million and $395 million in the third quarter and first nine months of 2010, respectively, related to our Commercial Banking business. We continued to experience steady loan growth in our Commercial Banking business, with loan demand expanding beyond refinancing to include demand for new credit to finance growth for our commercial customers.

Business Environment and Recent Developments

Recent Business and Regulatory Developments

The challenging economic environment intensified during the third quarter of 2011, due to concerns about the U.S. debt ceiling and subsequent downgrade of the U.S. debt, the continued elevated U.S. unemployment rate and the European debt crisis. These concerns resulted in increased economic uncertainty and market volatility. We have continued to monitor our portfolio credit performance for signs that these difficult market conditions are causing deterioration in our credit results. Our credit metrics are stabilizing with normal seasonality re-emerging after a long period of cyclical improvement. We believe actions we made in underwriting and managing our business through the recession, including focusing on our most resilient businesses, have continued to drive our strong credit performance. In addition, our recent partnerships and acquisitions have contributed to new account originations and a continued increase in purchase volumes in our Credit Card business.

Recent Acquisitions and Related Developments

During the past several years, we have explored opportunities to acquire financial services companies and financial assets and enter into strategic partnerships as part of our growth strategy. Our financial strength and flexibility and our experience in the credit card and direct banking businesses are key factors that we believe have enabled us to take advantage of our recent investment opportunities, including the acquisition of HBC’s existing credit card loan portfolio in the first quarter of 2011, the acquisition of Kohl’s existing credit card loan portfolio in the second quarter of 2011 and our pending acquisitions of ING Direct and HSBC’s U.S. credit card business. We continue to evaluate and anticipate engaging in additional strategic partnerships and selected acquisitions of financial institutions and other financial assets, including credit card and other loan portfolios. We may issue common stock or debt in connection with future acquisitions, including in public offerings, to fund such acquisitions.

Business Outlook

We discuss below our current expectations regarding our total company performance and the performance of each of our business segments over the near-term based on market conditions, the regulatory environment and our business strategies as of the time we filed this Report. The statements contained in this section are based on our current expectations regarding our outlook for our financial results and business strategies. Our expectations take into account, and should be read in conjunction with, our expectations regarding economic trends and

 

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analysis of our business as discussed in “Part I—Item 1. Business” and “Part I—Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our 2010 Form 10-K. Certain statements are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual results could differ materially from those in our forward-looking statements. Forward-looking statements do not reflect (i) any change in current dividend or repurchase strategies, (ii) the effect of any acquisitions, divestitures or similar transactions or (iii) any changes in laws, regulations or regulatory interpretations, in each case after the date as of which such statements are made. See “Forward-Looking Statements” in this Report, “Item 1A. Risk Factors” in our 2010 Form 10-K and the risk factors set forth in Exhibit 99.5 to our Current Report on Form 8-K filed on July 13, 2011, for factors that could materially influence our results.

Total Company Expectations

Our third quarter results continue to demonstrate the impact of our strategy to deliver profitable long-term growth through the acquisition and retention of franchise-enhancing customer relationships across our businesses. We believe we remain well-positioned to win in the marketplace and deliver shareholder value. We expect that the combined acquisitions of ING Direct and the HSBC U.S. credit card business will deliver attractive financial results in the near-term and put us in an even stronger position to enhance and sustain the value we can deliver to our customers, our communities and our shareholders over the long-term. We believe strong earnings will enable us to maintain strong capital levels and trajectory and that deep access to deposits will bolster our already-strong liquidity. Based on recent trends, including modest loan growth, and our targeted initiatives to attract new business and develop franchise-enhancing customer relationships, we believe the period of shrinking loans during the recession has come to an end. We expect modest year-over-year growth in ending loan balances in 2011. Although we expect an increase in period- end loans, we expect that average loan balances for 2011 will be comparable to average loan balances for 2010 given the lower loan balance starting point in 2011. Following the completion of the planned acquisitions of ING Direct and the HSBC U.S. credit card business, we expect our loan growth rate trajectory will be muted by the larger base of loans and the expected run-off of several of our legacy and acquired business loan portfolios.

Business Segments Expectations

Credit Card Business

We believe that our Domestic Card loan balances reached a low point in the first quarter of 2011. We expect seasonal loan growth in the fourth quarter of 2011. We believe we remain well positioned to gain market share in the new level playing field resulting from the CARD Act. We believe the credit results in our Domestic Card business are stabilizing and exhibiting expected seasonal patterns.

Consumer Banking Business

In our Consumer Banking business, we expect that auto originations and returns will remain strong and drive growth in auto loans for 2011. We expect that the continuing run-off of the legacy home loan portfolio will largely offset the growth in auto loans. We believe we have reached a cyclical low point for auto finance charge-offs. We expect that the auto finance charge-off rate will increase in the fourth quarter of 2011, driven by seasonal patterns. Over the long run, competitive factors and moderation in auction prices for used vehicles is likely to create higher charge-off rates.

Commercial Banking Business

In our Commercial Banking business, we believe that the worst of the commercial credit downturn is behind us and there is positive credit performance trajectory. However, we continue to expect some quarterly uncertainty and variability in commercial charge-offs and nonperforming loans. We have been growing commercial loans with lower credit risk and expect further modest growth to continue in the fourth quarter of 2011.

 

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CRITICAL ACCOUNTING POLICIES AND ESTIMATES

 

The preparation of financial statements in accordance with U.S. GAAP requires management to make a number of judgments, estimates and assumptions that affect the reported amount of assets, liabilities, income and expenses in the consolidated financial statements. Understanding our accounting policies and the extent to which we use management judgment and estimates in applying these policies is integral to understanding our financial statements. We provide a summary of our significant accounting policies in “Note 1—Summary of Significant Accounting Policies” of our 2010 Form 10-K.

We have identified the following accounting policies as critical because they require significant judgments and assumptions about highly complex and inherently uncertain matters and the use of reasonably different estimates and assumptions could have a material impact on our reported results of operations or financial condition. These critical accounting policies govern:

 

   

Fair value

   

Allowance for loan and lease losses

   

Asset impairment

   

Representation and warranty reserve

   

Revenue recognition

   

Derivative and hedge accounting

   

Income taxes

We evaluate our critical accounting estimates and judgments on an ongoing basis and update them as necessary based on changing conditions. The use of fair value to measure our financial instruments is fundamental to the preparation of our consolidated financial statements because we account for and record a significant portion of our assets and liabilities at fair value. Accordingly, we provide information below on financial instruments recorded at fair value in our consolidated balance sheets. We also discuss below refinements we made in the third quarter of 2011 in determining the estimated amount of uncollectible finance charges and fees for credit card loans. Management has discussed our critical accounting policies and estimates with the Audit and Risk Committee of the Board of Directors.

Fair Value

Fair value is defined as the price that would be received for an asset or paid to transfer a liability in an orderly transaction between market participants on the measurement date (also referred to as an exit price). The fair value accounting guidance provides a three-level fair value hierarchy for classifying financial instruments. This hierarchy is based on whether the inputs to the valuation techniques used to measure fair value are observable or unobservable. Fair value measurement of a financial asset or liability is assigned to a level based on the lowest level of any input that is significant to the fair value measurement in its entirety. The three levels of the fair value hierarchy are described below:

 

Level 1:

   Quoted prices (unadjusted) in active markets for identical assets or liabilities.

Level 2:

   Observable market-based inputs, other than quoted prices in active markets for identical assets or liabilities.

Level 3:

   Unobservable inputs.

The degree of management judgment involved in determining the fair value of a financial instrument is dependent upon the availability of quoted prices in active markets or observable market parameters. When quoted prices and observable data in active markets are not fully available, management judgment is necessary to estimate fair value. Changes in market conditions, such as reduced liquidity in the capital markets or changes in secondary market activities, may reduce the availability and reliability of quoted prices or observable data used to determine fair value.

 

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We have developed policies and procedures to determine when markets for our financial assets and liabilities are inactive if the level and volume of activity has declined significantly relative to normal conditions. If markets are determined to be inactive, it may be appropriate to adjust price quotes received. When significant adjustments are required to price quotes or inputs, it may be appropriate to utilize an estimate based primarily on unobservable inputs.

Significant judgment may be required to determine whether certain financial instruments measured at fair value are included in Level 2 or Level 3. In making this determination, we consider all available information that market participants use to measure the fair value of the financial instrument, including observable market data, indications of market liquidity and orderliness, and our understanding of the valuation techniques and significant inputs used. Based upon the specific facts and circumstances of each instrument or instrument category, judgments are made regarding the significance of the Level 3 inputs to the instruments’ fair value measurement in its entirety. If Level 3 inputs are considered significant, the instrument is classified as Level 3. The process for determining fair value using unobservable inputs is generally more subjective and involves a high degree of management judgment and assumptions.

Our financial instruments recorded at fair value on a recurring basis represented approximately 20% of our total assets of $200.1 billion as of September 30, 2011, compared with 22% of our total assets of $197.5 billion as of December 31, 2010. Financial assets for which the fair value was determined using significant Level 3 inputs represented approximately 2% of these financial instruments (less than 1% of total assets) as of September 30, 2011, and approximately 2% of these financial instruments (less than 1% of total assets) as of December 31, 2010.

We discuss changes in the valuation inputs and assumptions used in determining the fair value of our financial instruments, including the extent to which we have relied on significant unobservable inputs to estimate fair value and our process for corroborating these inputs, in “Note 13—Fair Value of Financial Instruments.”

Key Controls Over Fair Value Measurement

We have a governance framework and a number of key controls that are intended to ensure that our fair value measurements are appropriate and reliable. Our governance framework provides for independent oversight and segregation of duties. Our control processes include review and approval of new transaction types, price verification and review of valuation judgments, methods, models, process controls and results. Groups independent from our trading and investing functions, including our Valuations Group and Valuations Advisory Committee, participate in the review and validation process. The Valuation Advisory Committee includes senior representation from business areas, our Enterprise Risk Oversight division and our Finance division.

Our Valuations Group performs monthly independent verification of fair value measurements by comparing the methodology driven price to other market source data (to the extent available), and uses independent analytics to determine if assigned fair values are reasonable. The Valuations Advisory Committee regularly reviews and approves our valuation methodologies to ensure that our methodologies and practices are consistent with industry standards and adhere to regulatory and accounting guidance.

Revenue Recognition

We recognize finance charges and fees on credit card loans when the amounts are billed to the customer and include these amounts in the loan balance, net of the estimated uncollectible amount of finance charges and fees. Our process for estimating the uncollectible amount of billed finance charges and fees is consistent with the process we use to estimate the allowance for incurred principal losses on our credit card loan receivables.

We determine the adequacy of the uncollectible finance charge and fee reserve on a quarterly basis, primarily based on the use of a roll-rate methodology. We refine our estimation process and key assumptions used in

 

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determining our loss reserves as additional information becomes available. In the third quarter of 2011, we revised the manner in which we estimate expected recoveries of finance charge and fee amounts previously considered to be uncollectible. Our revised recovery assumptions better reflect the post-recession pattern of relatively low delinquency roll-rates combined with increased recoveries of finance charges and fees previously considered uncollectible. This reduced the uncollectible finance charge and fee reserves by approximately $83 million as of September 30, 2011, and resulted in a corresponding increase in revenues of $83 million in the third quarter of 2011. We also applied these revised assumptions to the estimated recovery of principal charge-offs in determining our allowance for loan and lease losses. The revision, however, had an insignificant impact on the overall determination of our allowance for lease and loan losses as of September 30, 2011.

For additional information on our critical accounting policies and estimates, see “Part II—Item 7. MD&A—Critical Accounting Policies and Estimates” of our 2010 Form 10-K.

 

 

CONSOLIDATED RESULTS OF OPERATIONS

 

The section below provides a comparative discussion of our consolidated financial performance for the three and nine months ended September 30, 2011 and 2010. Following this section, we provide a discussion of our business segment results. You should read this section together with our “Executive Summary and Business Outlook” where we discuss trends and other factors that we expect will affect our future results of operations.

Net Interest Income

Net interest income represents the difference between the interest income and applicable fees earned on our interest-earning assets, which include loans held for investment and investment securities, and the interest expense on our interest-bearing liabilities, which include interest-bearing deposits, senior and subordinated notes, securitized debt and other borrowings. We include in interest income any past due fees on loans that we deem are collectible. Our net interest margin represents the difference between the yield on our interest-earning assets and the cost of our interest-bearing liabilities, including the impact of non-interest bearing funding. We expect net interest income and our net interest margin to fluctuate based on changes in interest rates and changes in the amount and composition of our interest-earning assets and interest-bearing liabilities.

Table 3 below presents, for each major category of our interest-earning assets and interest-bearing liabilities, the average outstanding balances, interest income earned or interest expense incurred, and the average yield or cost for the three and nine months ended September 30, 2011 and 2010.

 

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Table 3: Average Balances, Net Interest Income and Net Interest Yield

 

    Three Months Ended September 30,  
    2011     2010  
(Dollars in millions)   Average
Balance
    Interest
Income/
Expense(1)
    Yield/
Rate
    Average
Balance
    Interest
Income/
Expense(1)
    Yield/
Rate
 

Assets:

           

Interest-earning assets:

           

Consumer loans:(2)

           

Domestic(3)

  $ 88,995      $ 2,828        12.71   $ 89,530      $ 2,767        12.36

International

    8,703        354        16.27        7,342        302        16.45   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total consumer loans(3)

    97,698        3,182        13.03        96,872        3,069        12.67   

Commercial loans(3)

    31,345        368        4.69        29,435        378        5.13   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans held for investment

    129,043        3,550        11.00        126,307        3,447        10.92   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Investment securities

    37,189        264        2.84        39,872        347        3.48   

Other interest-earning assets:

           

Domestic

    10,711        18        0.67        5,793        20        1.38   

International

    767        3        1.56        501        1       0.80   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total other interest-earning assets

    11,478        21        0.73        6,294        21        1.33   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-earning assets(4)

  $ 177,710      $ 3,835        8.63   $ 172,473      $ 3,815        8.85
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash and due from banks

    1,742            2,014       

Allowance for loan and lease losses

    (4,488         (6,803    

Premises and equipment, net

    2,731            2,709       

Other assets

    23,916            26,205       
 

 

 

       

 

 

     

Total assets

  $ 201,611          $ 196,598       
 

 

 

       

 

 

     

Liabilities and equity:

           

Interest-bearing liabilities:

           

Deposits

  $ 110,750      $ 294        1.06   $ 104,186      $ 358        1.37

Securitized debt obligations:

           

Domestic

    14,734        73        1.98        25,928        159        2.45   

International

    3,744        16        1.71        4,822        32        2.65   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total securitized debt obligations

    18,478        89        1.93        30,750        191        2.48   

Senior and subordinated notes

    10,519        84        3.19        8,677        72        3.32   

Other borrowings

    8,369        85        4.06        6,483        85        5.24   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-bearing liabilities

  $ 148,116      $ 552        1.49   $ 150,096      $ 706        1.88
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Non-interest bearing deposits

    17,518            14,069       

Other liabilities

    6,661            7,126       
 

 

 

       

 

 

     

Total liabilities

    172,295            171,291       

Stockholders’ equity

    29,316            25,307       
 

 

 

       

 

 

     

Total liabilities and stockholders’ equity

  $ 201,611          $ 196,598       
 

 

 

       

 

 

     

Net interest income/spread(4)

    $ 3,283        7.14     $ 3,109        6.97
   

 

 

   

 

 

     

 

 

   

 

 

 

Interest income to average interest-earning assets

        8.63         8.85

Interest expense to average interest-earning assets

        1.24            1.64   
     

 

 

       

 

 

 

Net interest margin

        7.39         7.21
     

 

 

       

 

 

 

 

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Table of Contents
    Nine Months Ended September 30,  
    2011     2010  
(Dollars in millions)   Average
Balance
    Interest
Income/
Expense(1)
    Yield/
Rate
    Average
Balance
    Interest
Income/
Expense(1)
    Yield/
Rate
 

Assets:

           

Interest-earning assets:

           

Consumer loans:(2)

           

Domestic(3)

  $ 88,129      $ 8,194        12.40   $ 92,476      $ 8,563        12.35

International

    8,741        1,056        16.11        7,526        903        16.00   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total consumer loans(3)

    96,870        9,250        12.73        100,002        9,466        12.62   

Commercial loans(3)

    30,490        1,084        4.74        29,563        1,116        5.03   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans held for investment

    127,360        10,334        10.82        129,565        10,582        10.89   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Investment securities

    39,684        893        3.00        38,979        1,037        3.55   

Other interest-earning assets:

           

Domestic

    7,388        49        0.88        7,216        58        1.07   

International

    715        10        1.86        572        2        0.47   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total other interest-earning assets

    8,103        59        0.97        7,788        60        1.03   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-earning assets(4)

  $ 175,147      $ 11,286        8.59   $ 176,332      $ 11,679        8.83
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash and due from banks

    1,851            2,214       

Allowance for loan and lease losses

    (5,058         (7,623    

Premises and equipment, net

    2,722            2,719       

Other assets

    24,954            27,289       
 

 

 

       

 

 

     

Total assets

  $ 199,616          $ 200,931       
 

 

 

       

 

 

     

Liabilities and equity:

           

Interest-bearing liabilities:

           

Deposits

  $ 109,552      $ 923        1.12   $ 104,119      $ 1,125        1.44

Securitized debt obligations:

           

Domestic

    18,214        281        2.06        31,275        548        2.34   

International

    3,827        61        2.13        5,092        96        2.51   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total securitized debt obligations

    22,041        342        2.07        36,367        644        2.36   

Senior and subordinated notes

    8,910        211        3.16        8,731        211        3.22   

Other borrowings

    8,156        251        4.10        6,946        265        5.09   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-bearing liabilities

  $ 148,659      $ 1,727        1.55   $ 156,163      $ 2,245        1.92
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Non-interest bearing deposits

    16,550            13,976       

Other liabilities

    6,205            6,294       
 

 

 

       

 

 

     

Total liabilities

    171,414            176,433       

Stockholders’ equity

    28,202            24,498       
 

 

 

       

 

 

     

Total liabilities and stockholders’ equity

  $ 199,616          $ 200,931       
 

 

 

       

 

 

     

Net interest income/spread(4)

    $ 9,559        7.04     $ 9,434        6.91
   

 

 

   

 

 

     

 

 

   

 

 

 

Interest income to average interest-earning assets

        8.59         8.83

Interest expense to average interest-earning assets

        1.31            1.70   
     

 

 

       

 

 

 

Net interest margin

        7.28         7.13
     

 

 

       

 

 

 

 

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(1)

Past due fees included in interest income totaled approximately $303 million and $249 million for the three months ended September 30, 2011 and 2010, respectively, and approximately $793 million and $893 million for the nine months ended September 30, 2011 and 2010, respectively.

(2)

Interest income on credit card, auto, home and retail banking loans is reflected in consumer loans. Interest income generated from small business credit cards also is included in consumer loans.

(3) 

In the first quarter of 2011, we revised previously reported interest income on interest-earning assets and average yield on loans held for investment for 2010 to conform to the internal management accounting methodology used in our segment reporting. The interest income and average loan yields presented reflect this revision. The previously reported interest income and average yields for the third quarter of 2010 were as follows: domestic consumer loans ($2,846 million and 12.72%); total consumer loans ($3,148 million and 13.00%); and commercial loans ($299 million and 4.06%). The previously reported interest income and average yields for the first nine months of 2010 were as follows: domestic consumer loans ($8,691 million and 12.53%); total consumer loans ($9,594 million and 12.79%); and commercial loans ($988 million and 4.46%).

(4)

Interest income was reduced by $206 million and $421 million in the third quarter and first nine months of 2011, respectively, for amounts earned by Kohl’s.

Table 4 presents the variance between our net interest income for the three months ended September 30, 2011 and 2010, and for the nine months ended September 30, 2011 and 2010, and the extent to which the variance was attributable to: (i) changes in the volume of our interest-earning assets and interest-bearing liabilities or (ii) changes in the interest rates of these assets and liabilities.

Table 4: Rate/Volume Analysis of Net Interest Income(1)

 

     Three Months Ended September 30,
2011 vs. 2010
    Nine Months Ended September 30,
2011 vs. 2010
 

(Dollars in millions)

   Total
   Variance  
    Variance Due to     Total
   Variance  
    Variance Due to  
       Volume         Rate           Volume         Rate    

Interest income:

            

Loans held for investment:

            

Consumer loans

   $ 113      $ 26      $ 87      $ (216   $ (299   $ 83   

Commercial loans

     (10     24        (34     (32     35        (67
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans held for investment, including past-due fees

     103        50        53        (248     (264     16   

Investment securities

     (83     (22     (61     (144     18        (162

Other

     —          12        (12     (1     2        (3
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest income

     20        40        (20     (393     (244     (149
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest expense:

            

Deposits

     (64     21        (85     (202     56        (258

Securitized debt obligations

     (102     (65     (37     (302     (230     (72

Senior and subordinated notes

     12        15        (3     —          5        (5

Other borrowings

     —          22        (22     (14     42        (56
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest expense

     (154     (7     (147     (518     (127     (391
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

   $ 174      $ 47      $ 127      $ 125      $ (117   $ 242   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1)

We calculate the change in interest income and interest expense separately for each item. The change in net interest income attributable to both volume and rates is allocated based on the relative dollar amount of each item.

 

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Our net interest income of $3.3 billion for the third quarter of 2011 increased by $174 million, or 6%, from the third quarter of 2010, driven by a 2% (18 basis points) expansion in our net interest margin to 7.39% and a 3% increase in average interest-earning assets.

 

   

Net Interest Margin: The increase in our net interest margin in the third quarter of 2011 was primarily attributable to a reduction in our cost of funds, which was partially offset by a decline in the yield on our interest-earning assets. Our cost of funds continued to benefit from the shift in the mix of our funding to lower cost consumer and commercial banking deposits from higher cost wholesale sources. In addition, the prevailing low interest rate environment, combined with our disciplined pricing, contributed to the decrease in our average deposit interest rates.

 

   

Average Interest-Earning Assets: The increase in average interest-earning assets in the third quarter of 2011 was attributable to the additions of the existing HBC credit card loan portfolio of $1.4 billion in the first quarter of 2011 and the $3.7 billion Kohl’s credit card loan portfolio in the second quarter of 2011, coupled with growth in auto loan originations, commercial loans and revolving credit card purchase volumes. The impact of these factors more than offset the continued run-off of businesses that we exited or repositioned, including our installment, home loan and small-ticket commercial real estate loan portfolios.

Our net interest income of $9.6 billion for the first nine months of 2011 increased by $125 million, or 1%, from the first nine months of 2010, driven by a 2% (15 basis points) expansion in our net interest margin to 7.28%, which was partially offset by a 1% decrease in average interest-earning assets.

 

   

Net Interest Margin: The increase in our net interest margin in the first nine months of 2011 reflected the benefit from the improvement in our cost of funds, as we shifted the mix of our funding to lower cost consumer and commercial banking deposits from higher cost wholesale sources and the decline in deposit interest rates as a result of the overall interest rate environment. The decrease in yield on interest-earning assets was attributable to a reduction in late payment fees resulting from the Federal Reserve guidelines regarding reasonable fees that went into effect in the third quarter of 2010 and the addition of the Kohl’s portfolio. Under our partnership agreement with Kohl’s, we share a fixed percentage of revenues, consisting of finance charges and late fees. We report revenues related to Kohl’s credit card loans on a net basis in our consolidated financial statements, which has the effect of reducing the yield on our average interest-earning assets. The impact of these factors was partially offset by the run-off of lower margin installment loans, a reduced level of new accounts with low introductory promotional rates, and an increase in the recognition of billed finance charges and fees due to the improvement in credit performance as well as the change we made in the third quarter of 2011 in our estimation of non-principal recoveries used in determining our uncollectible finance charge and fee reserve.

 

   

Average Interest-Earning Assets: The decrease in average interest-earning assets in the first nine months of 2011 reflected the continued run-off of businesses that we exited or repositioned, including our installment, home loan and small-ticket commercial real estate loan portfolios, which more than offset the impact of modest revolving credit card loan growth and the addition of the existing HBC credit card loan portfolio of $1.4 billion in the first quarter of 2011 and the addition of the existing Kohl’s private-label credit card loan portfolio of $3.7 billion in the second quarter of 2011.

Non-Interest Income

Non-interest income consists of servicing and securitizations income, service charges and other customer-related fees, interchange income (net of rewards expense) and other non-interest income. The servicing fees, finance charges, other fees, net of charge-offs and interest paid to third party investors related to our consolidated securitization trusts are reported as a component of non-interest income. We also record the provision for mortgage repurchase losses related to continuing operations in non-interest income. The “other” component of non-interest income includes gains and losses on derivatives not accounted for in hedge accounting relationships

 

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and gains and losses from the sale of investment securities, which we generally do not allocate to our business segments because they relate to centralized asset/liability and market risk management activities undertaken by our Corporate Treasury group.

Table 5 displays the components of non-interest income for the three and nine months ended September 30, 2011 and 2010.

Table 5: Non-Interest Income

 

     Three Months Ended September 30,     Nine Months Ended September 30,  
(Dollars in millions)        2011             2010             2011             2010      

Servicing and securitizations

   $ 12      $ 13      $ 35      $ (3

Service charges and other customer-related fees

     542        496        1,527        1,577   

Interchange

     321        346        972        991   

Net other-than-temporary impairment

     (6     (5     (15     (62

Provision for mortgage repurchase losses(1)

     3        (16     (5     (211

Other(2)

     (1     73        156        483   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total non-interest income

   $ 871      $ 907      $ 2,670      $ 2,775   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1)

We recorded a total provision for mortgage repurchase losses of $72 million and $16 million for the three months ended September 30, 2011 and 2010, respectively, and $153 million and $644 million for the nine months ended September 30, 2011 and 2010, respectively. The remaining portion of the provision for repurchase losses is included in discontinued operations.

(2)

“Other” for the three and nine months ended September 30, 2011 includes a gain of $239 million recognized on the sale of investment securities and a mark-to-market derivative loss of $266 million related to interest-rate swaps we entered into in August 2011 to partially hedge the interest rate risk of the net assets associated with the pending ING acquisition.

Non-interest income of $871 million for the third quarter of 2011 decreased by $36 million, or 4%, from non-interest income of $907 million for the third quarter of 2010. The decrease in non-interest income for the third quarter of 2011 reflects the net impact of two significant items recorded during the quarter resulting from actions taken to reposition our balance sheet and manage the anticipated impact of the pending ING Direct acquisition on our market risk exposure and regulatory capital requirements.

First, in August 2011, we entered into various pay-fixed/receive-floating interest-rate swap transactions with a total notional principal amount of approximately $23.8 billion. Since the date we entered into the agreement to acquire ING Direct, interest rates have declined substantially, and our current estimate of the fair value of the ING Direct net assets and liabilities has increased correspondingly. These swap transactions are intended to capture some of the anticipated benefits to regulatory capital on the closing date attributable to this decline in interest rates and designed to mitigate the effect of a rise in interest rates on the fair values of a significant portion of the ING Direct assets and liabilities during the period from when we entered into the swap transactions to the anticipated closing date of the ING Direct acquisition in late 2011 or early 2012. Although the interest-rate swaps represent economic hedges, they are not designated for hedge accounting. Accordingly, changes in the fair value are recorded in earnings. We recognized a mark-to-market loss of $266 million on these interest-rate swaps in the third quarter of 2011, which was attributable to the decline in interest rates as of the end of the quarter. Changes in the fair value of these interest-rate swaps will continue to be recorded in earnings until the swaps are terminated.

Second, we sold approximately $6.4 billion of investment securities, consisting predominantly of agency MBS, during the third quarter of 2011. We recorded a gain of $239 million on the sale of these securities. The combined impact of the mark-to-market derivative loss and the gain on the sale of investment securities accounted for $27 million of the reduction in non-interest income in the third quarter of 2011.

 

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Non-interest income of $2.7 billion for the first nine months of 2011 decreased by $105 million, or 4%, from non-interest income of $2.8 billion for the first nine months of 2010. This decrease was primarily due to the absence of a one-time pre-tax gain of $128 million recorded in the first quarter of 2010 and net gains on the sale of securities in 2010.

We provide additional information on the reserve for representation and warranty claims below in “Consolidated Balance Sheet Analysis and Credit Performance—Potential Mortgage Representation and Warranty Liabilities.”

Provision for Loan and Lease Losses

We build our allowance for loan and lease losses through the provision for loan and lease losses. Our provision for loan and lease losses in each period is driven by charge-offs and the level of allowance for loan and lease losses that we determine is necessary to provide for probable credit losses inherent in our loan portfolio as of each balance sheet date. Our provision for loan and lease losses declined by $245 million to $622 million in the third quarter of 2011 and by $1.6 billion in the first nine months of 2011 to $ 1.5 billion, relative to the same prior year periods. The decrease in the provision was largely driven by a substantial decline in net charge-offs across all of our business segments, reflecting the improvement in the credit performance of our loan portfolio. The net charge-off rate was 2.52% and 3.02% for the third quarter and first nine months of 2011, respectively, compared with 4.82% and 5.41% for the third quarter and first nine months of 2010, respectively. As charge-offs declined, we recorded an allowance release of $208 million and $1.3 billion in the third quarter and first nine months of 2011, respectively. Our allowance releases have been significantly lower in 2011 relative to 2010, reflecting a stabilization of the improvement in credit trends.

See “Consolidated Balance Sheet Analysis and Credit Performance—Allowance for Loan and Lease Losses” for a discussion of changes in our allowance for loan and lease losses and details of our provision for loan and lease losses and charge-offs by loan category for the three and nine months ended September 30, 2011 and 2010.

Non-Interest Expense

Non-interest expense consists of ongoing operating costs, such as salaries and associated employee benefits, communications and other technology expenses, supplies and equipment, occupancy costs and miscellaneous expenses. Marketing expenses also are included in non-interest expense. Table 6 displays the components of non-interest expense for the three and nine months ended September 30, 2011 and 2010.

Table 6: Non-Interest Expense

 

     Three Months Ended September 30,      Nine Months Ended September 30,  
(Dollars in millions)        2011              2010              2011              2010      

Salaries and associated benefits

   $ 750       $ 641       $ 2,206       $ 1,937   

Marketing

     312         250         917         650   

Communications and data processing

     178         178         504         512   

Supplies and equipment

     143         129         402         381   

Occupancy

     122         135         359         371   

Other(1)

     792         663         2,326         1,992   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total non-interest expense

   $ 2,297       $ 1,996       $ 6,714       $ 5,843   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1)

Consists of professional services expenses, credit collection costs, fee assessments and intangible amortization expense.

Non-interest expense of $2.3 billion for the third quarter of 2011 was up $301 million, or 15%, from the third quarter of 2010. Non-interest expense of $6.7 billion for the first nine months of 2011 was up $871 million, or 15%, from the first nine months of 2010. The increase reflects the recognition of expense of $60 million and $90 million in the third quarter and first nine months of 2011, respectively, for contingent payments related to

 

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acquisitions and partnership agreements. In addition, our operating costs have increased due in part to the integration of the recent acquisitions of the Sony, HBC and Kohl’s loan portfolios, as well as higher marketing costs. We have expanded our marketing efforts to attract and support targeted customers and new business volume through a variety of channels. We provide additional information on contingent payment arrangements in “Note 15—Commitments, Contingencies and Guarantees.”

Income Taxes

We recorded an income tax provision based on income from continuing operations of $370 million (30.0% effective income tax rate) in the third quarter of 2011, compared with an income tax provision of $335 million (29.1 % effective income tax rate) in the third quarter of 2010, and $1.2 billion (29.2% effective income tax rate) for the first nine months of 2011, compared with $948 million (28.8% effective income tax rate) for the first nine months of 2010.

We recorded tax benefits of $98 million in the first nine months of 2011, which were related to the release of a valuation allowance against certain state deferred tax assets and net operating loss carryforwards and the resolution of certain tax issues and audits. We monitor the status of our deferred tax assets on a regular basis. The release of the deferred tax valuation allowance reflects our projected ability to utilize the deferred tax assets to offset future taxable income based on our achieving sustained profitability in certain tax jurisdictions. We recorded tax benefits of $71 million in the first nine months of 2010, which were related to adjustments for the resolution of certain tax issues and audits.

Our effective income tax rate excluding the benefit from these discrete tax benefit items was 31.7% and 30.9% for the first nine months of 2011 and 2010, respectively. The higher effective income tax rate for the first nine months of 2011 was primarily attributable to the recognition of expense for non-deductible contingent payments related to certain acquisitions.

We provide additional information on items affecting our income taxes and effective tax rate in our 2010 Form 10-K under “Note 18—Income Taxes.”

Loss from Discontinued Operations, Net of Tax

Loss from discontinued operations reflects ongoing costs, which primarily consist of mortgage loan repurchase representation and warranty charges, related to the mortgage origination operations of GreenPoint’s wholesale mortgage banking unit, which we closed in 2007. We recorded a loss from discontinued operations, net of tax, of $52 million and $102 million in the third quarter and first nine months of 2011, respectively. In comparison, we recorded a loss from discontinued operations, net of tax, of $15 million and $303 million in the third quarter and first nine months of 2010, respectively.

The increase in the loss from discontinued operations in the third quarter of 2011 was attributable to the recognition of an additional provision for mortgage repurchase losses due to an increase in repurchase activity with respect to certain uninsured investors. The decrease in the loss from discontinued operations in the first nine months of 2011 was attributable to a significant reduction in the provision for mortgage repurchase losses. We provide information on our reserve for representation and warranty claims in “Consolidated Balance Sheet Analysis and Credit Performance—Potential Mortgage Representation and Warranty Liabilities.”

 

 

BUSINESS SEGMENT FINANCIAL PERFORMANCE

 

Our principal operations are currently organized into three major business segments, which are defined based on the products and services provided or the type of customer served: Credit Card, Consumer Banking and Commercial Banking. The operations of acquired businesses have been integrated into our existing business segments.

 

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The results of our individual businesses, which we report on a continuing operations basis, reflect the manner in which management evaluates performance and makes decisions about funding our operations and allocating resources. Our business segment results are intended to reflect each segment as if it were a stand-alone business. We use an internal management and reporting process to derive our business segment results. Our internal management and reporting process employs various allocation methodologies, including funds transfer pricing, to assign certain balance sheet assets, deposits and other liabilities and their related revenue and expenses directly or indirectly attributable to each business segment. We may periodically change our business segments or reclassify business segment results based on modifications to our management reporting methodologies and changes in organizational alignment. Certain activities that are not part of a segment, such as management of our corporate investment portfolio and asset/liability management by our centralized Corporate Treasury group are included in the “Other” category. See “Note 20—Business Segments” of our 2010 Form 10-K for information on the allocation methodologies used to derive our business segment results.

We summarize our business segment results for the three and nine months ended September 30, 2011 and 2010 in the tables below and provide a comparative discussion of these results. We also discuss changes in our financial condition and credit performance statistics as of September 30, 2011, compared with December 31, 2010. See “Note 14—Business Segments” of this Report for a reconciliation of our business segment results to our consolidated U.S. GAAP results. Information on the outlook for each of our business segments is presented above under “Executive Summary and Business Outlook.”

Credit Card Business

Our Credit Card business generated net income from continuing operations of $663 million and $1.9 billion in the third quarter and first nine months of 2011, respectively, compared with net income from continuing operations of $631 million and $1.7 billion in the third quarter and first nine months of 2010, respectively. The primary sources of revenue for our Credit Card business are net interest income and non-interest income from customer and interchange fees. Expenses primarily consist of ongoing operating costs, such as salaries and associated benefits, communications and other technology expenses, supplies and equipment, occupancy costs and marketing expenses.

Table 7 summarizes the financial results of our Credit Card business, which is comprised of the Domestic Card and International Card operations, and displays selected key metrics for the periods indicated. Our Credit Card business results for 2011 reflect the impact of the acquisitions of the existing portfolio credit card loan portfolios of Kohl’s and HBC. The results related to the Kohl’s loan portfolio, which totaled approximately $3.7 billion at acquisition on April 1, 2011, are included in our Domestic Card business. The results related to the HBC loan portfolio, which totaled approximately $1.4 billion at acquisition on January 7, 2011, are included in our International Card business.

Under the terms of the partnership agreement with Kohl’s, we share a fixed percentage of revenues, consisting of finance charges and late fees, with Kohl’s, and Kohl’s is required to reimburse us for a fixed percentage of credit losses incurred. Revenues and losses related to the Kohl’s credit card program are reported on a net basis in our consolidated financial statements. The revenue sharing amounts earned by Kohl’s are reflected as an offset against our revenues in our consolidated statements of income, which has the effect of reducing our net interest income and revenue margins. The loss sharing amounts from Kohl’s are reflected as a reduction in our provision for loan and lease losses in our consolidated statements of income. We also report the related allowance for loan and lease losses attributable to the Kohl’s portfolio in our consolidated balance sheets net of the loss sharing amount due from Kohl’s.

Interest income was reduced by $206 million and $421 million in the third quarter and first nine months of 2011, respectively, for amounts earned by Kohl’s. Loss sharing amounts attributable to Kohl’s reduced charge-offs by $39 million and $80 million in the third quarter and first nine months of 2011, respectively. In addition, the

 

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expected reimbursement from Kohl’s netted in our allowance for loan and lease losses was approximately $156 million as of September 30, 2011. The reduction in the provision for loan and lease losses attributable to Kohl’s was $236 million for the first nine months of 2011.

We provide additional information on the acquisition of the existing credit card loan portfolios of Kohl’s and HBC in “Note 2—Acquisitions.”

Table 7: Credit Card Business Results

 

    Three Months Ended September 30,     Nine Months Ended September 30,  
(Dollars in millions)       2011        

    2010    

        Change             2011             2010             Change      

Selected income statement data:

           

Net interest income

  $ 2,042      $ 1,934        6   $ 5,873      $ 6,024        (3 )% 

Non-interest income

    678        671        1        1,971        2,048        (4
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

    2,720        2,605        4        7,844        8,072        (3

Provision for loan and lease losses

    511        660        (23     1,270        2,600        (51

Non-interest expense

    1,188        978        21        3,604        2,894        25   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations before income taxes

    1,021        967        6        2,970        2,578        15   

Income tax provision

    358        336        7        1,046        890        18   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations, net of tax

  $ 663      $ 631        5   $ 1,924      $ 1,688        14
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Selected performance metrics:

           

Average loans held for investment

  $ 62,371      $ 61,391        2   $ 61,889      $ 63,314        (2 )% 

Average yield on loans held for investment(1)

    14.84     14.65     19 bps      14.45     14.74     (29 )bps 

Revenue margin(2)

    17.44        16.97        47        16.90        17.00        (10

Net charge-off rate(3)

    4.23        8.16        (393     5.13        9.30        (417

Purchase volume(4)

  $ 34,918      $ 27,039        29   $ 96,941      $ 77,533        25
    September 30,
2011
    December 31,
2010
    Change                    

Selected period-end data:

           

Loans held for investment

  $ 62,030      $ 61,371        1      

30+ day delinquency rate(5)

    3.87     4.29     (42 )bps       

Allowance for loan and lease losses

  $ 2,915      $ 4,041        (28 )%       

 

(1) 

Average yield on loans held for investment is calculated by dividing annualized interest income for the period by average loans held for investment during the period. In preparing our Report on Form 10-Q for the first quarter of 2011, we determined that beginning in the second quarter of 2010, our management accounting processes excluded certain accounts that should have been included in the calculation of the average yield on loans held for investment. The mapping error was limited to the average yields on loans held for investment for our Credit Card business and had no impact on income statement amounts or the yields reported for any of our other business segments or for the total company. The previously reported average loan yield for our Credit Card business was 14.27% and 14.48% for the three and nine months ended September 30, 2010, respectively.

(2)

Revenue margin is calculated by dividing annualized revenues for the period by average loans held for investment during the period for the specified loan category.

(3)

The net charge-off rate is calculated by loan category by dividing annualized net charge-offs for the period by average loans held for investment during the period for the specified loan category.

(4)

Consists of purchase transactions for the period, net of returns. Excludes cash advance transactions.

 

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(5) 

The delinquency rate is calculated by loan category by dividing 30+ day delinquent loans as of the end of the period by period-end loans held for investment for the specified loan category. The 30+ day performing delinquency rate is the same as the 30+ day delinquency rate for our Credit Card business, as credit card loans remain on accrual status until the loan is charged-off.

Key factors affecting the results of our Credit Card business for the third quarter and first nine months of 2011, compared with the third quarter and first nine months of 2010 included the following:

 

   

Net Interest Income: Net interest income increased by $108 million, or 6%, in the third quarter of 2011, due in part to a 2% increase in average loan balances coupled with an increase in the average yield on loans held for investment. The growth in average loan balances reflect the additions of the HBC and Kohl’s portfolios, which were partially offset by the continued expected run-off of the installment loan portfolio. The average yield for the third quarter of 2011 reflects the benefit from a revision we made in the third quarter of 2011 in estimating non-principal recoveries to determine the uncollectible finance charge and fee reserve, which we discuss above in “Critical Accounting Policies and Estimates.” This revision accounted for approximately $83 million of the increase in net interest income. Net interest income decreased by $151 million, or 3%, in the first nine months of 2011, reflecting the impact of a 2% decline in average loan balances. The expected run-off of the installment loan portfolio was the primary driver of the decline in average loan balances in the first nine months of 2011, more than offsetting modest revolving card loan growth and the additions of the HBC and Kohl’s portfolios. The decrease in the average loan yields in the first nine months of 2011 reflects the impact of the Kohl’s revenue-sharing agreement.

 

   

Non-Interest Income: Non-interest income was relatively stable in the third quarter of 2011, compared with the third quarter of 2010. Non-interest income, however, decreased by $77 million, or 4%, in the first nine months of 2011. The decrease in the first nine months of 2011 reflects the impact of contra-revenue amounts recorded in the second quarter of 2011, including a provision of $52 million for anticipated refunds to U.K. customers related to retrospective regulatory requirements pertaining to payment protection insurance (“PPI”) in our U.K. business and the recognition of expense of $21 million related to the periodic adjustment of our customer rewards points liability to reflect the estimated cost of points earned to date that are ultimately expected to be redeemed. These decreases were partially offset by higher interchange fees during the first nine months of 2011, attributable to increased purchase volume from our higher spend customer segments.

 

   

Provision for Loan and Lease Losses: The provision for loan and lease losses related to our Credit Card business decreased by $149 million in the third quarter of 2011, to $511 million and by $1.3 billion in the first nine months of 2011, to $1.3 billion. The significant reduction in the provision was primarily attributable to the continued improvement in credit performance, including reduced delinquency rates, lower bankruptcy losses and higher recoveries. As a result of the reduction in charge-offs and improvement in the net charge-off rate, we recorded an allowance release for the Credit Card business of $178 million and $1.1 billion in the third quarter and first nine months of 2011, respectively.

 

   

Non-Interest Expense: Non-interest expense increased by $210 million, or 21%, in the third quarter of 2011 and $710 million, or 25%, in the first nine months of 2011. The increase was attributable to increased operating and integration costs related to the acquisitions of the credit card loan portfolios of Sony, HBC and Kohl’s, coupled with increased marketing expenditures. We have expanded our marketing efforts to drive new business volume through a variety of channels.

 

   

Total Loans: Period-end loans in our Credit Card business increased by $659 million, or 1%, in the first nine months of 2011, to $62.0 billion as of September 30, 2011, from $61.4 billion as of December 31, 2010. The increase was primarily attributable to the acquisitions of the Kohl’s credit card portfolio of $3.7 billion and the HBC credit card portfolio of $1.4 billion, which were partially offset by the continued run-off of the installment loan portfolio and seasonal paydowns from year-end levels.

 

   

Charge-off and Delinquency Statistics: Net charge-off and delinquency rates continued to improve in the third quarter and first nine months of 2011. The net charge-off rate decreased to 4.23% and 5.13% in the

 

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third quarter and first nine months of 2011, respectively, from 8.16% and 9.30% in the third quarter and first nine months of 2010, respectively. The 30+ day delinquency rate decreased to 3.87% as of September 30, 2011, from 4.29% as of December 31, 2010. The improvement in the net charge-off and delinquency rates reflects the impact of improved credit quality across our credit card portfolio, tighter underwriting standards implemented over the last several years, and ongoing normalization of credit performance in the portfolio.

Domestic Credit Card Business

Table 7.1 summarizes the financial results for Domestic Card and displays selected key metrics for the periods indicated. Domestic Card accounted for 86% of total revenues for our Credit Card business in both the third quarter and first nine months of 2011, compared with 87% in both the third quarter and first nine months of 2010. Because our Domestic Card business currently accounts for the substantial majority of our Credit Card business, the key factors driving the results for this division are similar to the key factors affecting our total Credit Card business.

Table 7.1: Domestic Card Business Results

 

    Three Months Ended September 30,     Nine Months Ended September 30,  
(Dollars in millions)   2011     2010     Change     2011     2010         Change      

Selected income statement data:

           

Net interest income

  $ 1,753      $ 1,691        4   $ 5,011      $ 5,291        (5 )% 

Non-interest income

    588        575        2        1,755        1,753          ** 
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

    2,341        2,266        3        6,766        7,044        (4

Provision for loan and lease losses

    381        577        (34     798        2,348        (66

Non-interest expense

    972        844        15        2,970        2,522        18   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations before income taxes

    988        845        17        2,998        2,174        38   

Income tax provision

    351        301        17        1,065        775        37   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations, net of tax

  $ 637      $ 544        17   $ 1,933      $ 1,399        38
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Selected performance metrics:

           

Average loans held for investment

  $ 53,668      $ 54,049        (1 )%    $ 53,148      $ 55,788        (5 )% 

Average yield on loans held for investment(1)

    14.62     14.40     22 bps      14.18     14.57     (39 )bps 

Revenue margin(2)

    17.45        16.77        68        16.97        16.84        13   

Net charge-off rate(3)

    3.92        8.23        (431     4.94        9.43        (449

Purchase volume(4)

  $ 31,686      $ 24,858        27   $ 87,780      $ 71,359        23
    September 30,
2011
    December 31,
2010
        Change                        

Selected period-end data:

           

Loans held for investment

  $ 53,820      $ 53,849        **      

30+ day delinquency rate(5)

    3.65     4.09     (44 )bps       

Allowance for loan and lease losses

  $ 2,409      $ 3,581        (33 )%       

 

** Change is less than one percent.
(1)

Average yield on loans held for investment is calculated by dividing annualized interest income for the period by average loans held for investment during the period. As indicated above, in preparing our Report on Form 10-Q for the first quarter of 2011, we determined that beginning in the second quarter of 2010, our management accounting processes excluded certain accounts that affected the calculation of the average yield on loans held for investment for our Credit Card business. The previously reported average loan yield for our Domestic Credit Card business was 13.95% and 14.25% for three and nine months ended September 30, 2010, respectively.

 

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(2) 

Revenue margin is calculated by dividing annualized revenues for the period by average loans held for investment during the period for the specified loan category.

(3)

The net charge-off rate is calculated by loan category by dividing annualized net charge-offs for the period by average loans held for investment during the period for the specified loan category.

(4)

Consists of purchase transactions for the period, net of returns. Excludes cash advance transactions.

(5) 

The delinquency rate is calculated by loan category by dividing 30+ day delinquent loans as of the end of the period by period-end loans held for investment for the specified loan category. The 30+ day performing delinquency rate is the same as the 30+ day delinquency rate for our Credit Card business, as credit card loans remain on accrual status until the loan is charged-off. The September 30, 2011 30+ day delinquency rate for Domestic Card reflects the impact of a revision in the way we estimate recoveries in determining the uncollectible amount of finance charges and fees, which resulted in an increase of 11 basis points as of September 30, 2011. See “Critical Accounting Policies and Estimates” above for additional information.

Domestic Card generated net income from continuing operations of $637 million and $1.9 billion in the third quarter and first nine months of 2011, respectively, compared with net income from continuing operations of $544 million and $1.4 billion in the third quarter and first nine months of 2010, respectively.

The increase in Domestic Card net income from continuing operations in the third quarter of 2011, compared with the third quarter of 2010 was driven by: (1) an increase in total revenue attributable to a benefit of approximately $78 million in the third quarter of 2011 from the revision we made in the way we estimate recoveries in determining the uncollectible amount of finance charges and fees; (2) a significant reduction in the provision for loan and lease losses due to the improvement in credit performance metrics, including decreases in delinquency and charge-off rates; and (3) an increase in non-interest expense attributable to higher operating and integration costs related to the acquisitions of the credit card loan portfolios of Sony and Kohl’s, coupled with increased marketing expenditures.

The increase in Domestic Card net income from continuing operations in the first nine months of 2011, compared with the first nine months of 2010 was driven by: (1) a decline in total revenue attributable to lower average loan balances and a decrease in average loan yields as a result of reduced fees and the impact of the addition of the Kohl’s loan portfolio; (2) a significant reduction in the provision for loan and lease losses due to the improvement in credit performance metrics, including decreases in delinquency and charge-off rates; and (3) an increase in non-interest expense attributable to increased operating costs associated with higher purchase volumes and higher legal expenses and increased marketing expenditures.

International Credit Card Business

Table 7.2 summarizes the financial results for International Card and displays selected key metrics for the periods indicated. International Card accounted for 14% of total revenues for our Credit Card business in the third quarter and first nine months of 2011, compared with 13% in both the third quarter and first nine months of 2010.

 

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Table 7.2: International Card Business Results

 

    Three Months Ended September 30,     Nine Months Ended September 30,  
(Dollars in millions)   2011     2010     Change         2011             2010           Change    

Selected income statement data:

           

Net interest income

  $ 289      $ 243        19   $ 862      $ 733        18

Non-interest income

    90        96        (6     216        295        (27
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

    379        339        12        1,078        1,028        5   

Provision for loan and lease losses

    130        83        57        472        252        87   

Non-interest expense

    216        134        61        634        372        70   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations before income taxes

    33        122        (73     (28     404        (107

Income tax provision

    7        35        (80     (19     115        (117
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations, net of tax

  $ 26      $ 87        (70 )%    $ (9   $ 289        (103 )% 
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Selected performance metrics:

           

Average loans held for investment

  $ 8,703      $ 7,342        19   $ 8,741      $ 7,526        16

Average yield on loans held for investment(1)

    16.24     16.40     (16 )bps      16.09     16.02     7 bps 

Revenue margin(2)

    17.42        18.47        (105     16.44        18.21        (177

Net charge-off rate(3)

    6.15        7.60        (145     6.31        8.28        (197

Purchase volume(4)

  $ 3,232      $ 2,181        48   $ 9,161      $ 6,174        48

Selected period-end data:

   
 
September 30,
2011
  
  
   

 

December 31,

2010

  

  

      Change           

Loans held for investment

  $ 8,210      $ 7,522        9      

30+ day delinquency rate(5)

    5.35     5.75     (40 )bps       

Allowance for loan and lease losses

  $ 506      $ 460        10      

 

(1)

Average yield on loans held for investment is calculated by dividing annualized interest income for the period by average loans held for investment during the period. As indicated above, in preparing our Report on Form 10-Q for the first quarter of 2011, we determined that beginning in the second quarter of 2010, our management accounting processes excluded certain accounts that affected the calculation of the average yield on loans held for investment for our Credit Card business. The previously reported average loan yield for our International Credit Card business was 16.62% and 16.16% for the three and nine months ended September 30, 2010, respectively.

(2)

Revenue margin is calculated by dividing annualized revenues for the period by average loans held for investment during the period for the specified loan category.

(3)

The net charge-off rate is calculated by loan category by dividing annualized net charge-offs for the period by average loans held for investment during the period for the specified loan category.

(4)

Consists of purchase transactions for the period, net of returns. Excludes cash advance transactions.

(5)

The delinquency rate is calculated by loan category by dividing delinquent loans as of the end of the period by period-end loans held for investment for the specified loan category. The 30+ day performing delinquency rate is the same as the 30+ day delinquency rate for our Credit Card business, as credit card loans remain on accrual status until the loan is charged-off.

Our International Card division generated net income from continuing operations of $26 million in the third quarter of 2011 and a net loss of $9 million in the first nine months of 2011, compared with net income from continuing operations of $87 million and $289 million in the third quarter and first nine months of 2010, respectively.

The decrease in International Card net income from continuing operations in the third quarter of 2011, compared with the third quarter of 2010 was driven by: (1) an increase in the provision for loan losses due to the addition of

 

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the HBC loan portfolio and lower allowance releases relative to the same prior year periods and (2) an increase in non-interest expense attributable to increased operating costs associated with HBC associates who joined us as a result of the acquisition. These factors were partially offset by an increase in non-interest income attributable to higher loan balances.

The International Card net loss from continuing operations in the first nine months of 2011, compared with net income in the first nine months of 2010 was driven by: (1) a decrease in non-interest income due to the contra-revenue provision of $52 million recorded in the second quarter of 2011 for the anticipated refunds to U.K. customers related to retrospective regulatory requirements pertaining to PPI insurance in our U.K. business; (2) an increase in the provision for loan losses due to the addition of the HBC loan portfolio and lower allowance releases relative to the same prior year periods; and (3) an increase in non-interest expense attributable to increased operating costs associated with HBC associates who joined us as a result of the acquisition. These factors were partially offset by an increase in interest income attributable to higher loan balances.

Consumer Banking Business

Our Consumer Banking business generated net income from continuing operations of $190 million and $692 million in the third quarter and first nine months of 2011, respectively, compared with $175 million and $785 million in the third quarter and first nine months of 2010, respectively. The primary sources of revenue for our Consumer Banking business are net interest income from loans and deposits and non-interest income from customer fees. Expenses primarily consist of ongoing operating costs, such as salaries and associated benefits, communications and other technology expenses, supplies and equipment and occupancy costs.

Table 8 summarizes the financial results of our Consumer Banking business and displays selected key metrics for the periods indicated.

 

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Table of Contents

Table 8: Consumer Banking Business Results

 

    Three Months Ended September 30,     Nine Months Ended September 30,  
(Dollars in millions)         2011                 2010             Change         2011         2010         Change    

Selected income statement data:

           

Net interest income

  $ 1,097      $ 946        16   $ 3,131      $ 2,777        13

Non-interest income

    188        196        (4     568        674        (16
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

    1,285        1,142        13        3,699        3,451        7   

Provision for loan and lease losses

    136        114        19        272        52        423   

Non-interest expense

    853        757        13        2,351        2,180        8   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations before income taxes

    296        271        9        1,076        1,219        (12

Income tax provision

    106        96        10        384        434        (12
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations, net of tax

  $ 190      $ 175        9   $ 692      $ 785        (12 )% 
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Selected performance metrics:

           

Average loans held for investment:

           

Auto

  $ 19,757      $ 17,397        14   $ 18,851      $ 17,479        8

Home loan

    11,126        13,024        (15     11,537        14,002        (18

Retail banking

    3,979        4,669        (15     4,127        4,840        (15
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total consumer banking

  $ 34,862      $ 35,090        (1 )%    $ 34,515      $ 36,321        (5 )% 
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Average yield on loans held for investment

    9.83     9.28     55 bps      9.65     9.07     58 bps 

Average deposits

  $ 88,266      $ 78,224        13   $ 86,375      $ 76,818        12

Average interest rate on deposits

    0.95     1.18     (23 )bps      0.98     1.21     (23 )bps 

Core deposit intangible amortization

  $ 32      $ 36        (11 )%    $ 100      $ 110        (9 )% 

Net charge-off rate(1)(2)

    1.32     1.79     (47 )bps      1.30     1.77     (47 )bps 

Automobile loan originations

  $ 3,409      $ 2,439        40   $ 8,890      $ 5,547        60

 

$88.26661 $88.26661 $88.26661 $88.26661 $88.26661 $88.26661

Selected period-end data:

   
 
September 30,
2011
  
  
   

 

December 31,

2010

  

  

      Change           

Loans held for investment:

           

Auto

  $ 20,422      $ 17,867        14      

Home loan

    10,916        12,103        (10      

Retail banking

    4,014        4,413        (9      
 

 

 

   

 

 

   

 

 

       

Total consumer banking

  $ 35,352      $ 34,383        3      
 

 

 

   

 

 

   

 

 

       

30+ day performing delinquency rate(1)(3)

    4.01     4.28     (27 )bps       

30+ day delinquency rate(1)(3)

    5.57        5.96        (29      

Nonperforming loan rate(1)(4)

    1.88        1.97        (9      

Nonperforming asset rate(1)(5)

    2.04        2.17        (13      

Allowance for loan and lease losses

  $ 620      $ 675        (8 )%       

Deposits

    88,589        82,959        7         

Loans serviced for others

    18,624        20,689        (10      

 

(1) 

Average loans held for investment used in the denominator in calculating net charge-off, delinquency and nonperforming loan and nonperforming asset rates includes the impact of loans acquired as part of the Chevy Chase Bank acquisition, which were considered purchased credit-impaired (“PCI”) loans. However, we separately track and report PCI loans and exclude these loans from our net charge-off, delinquency, nonperforming loan and nonperforming asset rates.

 

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(2)

The net charge-off rate is calculated by loan category by dividing annualized net charge-offs for the period by average loans held for investment during the period for the specified loan category. The net charge-off rate, excluding loans acquired from Chevy Chase Bank from the denominator, was 1.51% and 2.11% for the three months ended September 30, 2011 and 2010, respectively, and 1.50% and 2.10% for the nine months ended September 30, 2011 and 2010, respectively.

(3) 

The delinquency rate is calculated by loan category by dividing delinquent loans as of the end of the period by period-end loans held for investment for the specified loan category. The 30+ day performing delinquency rate, excluding loans acquired from Chevy Chase Bank from the denominator, was 4.57% as of September 30, 2011 and 5.01% as of December 31, 2010. The 30+ day delinquency rate, excluding loans acquired from Chevy Chase Bank from the denominator, was 6.36% as of September 30, 2011 and 6.98% as of December 31, 2010.

(4)

Nonperforming loans generally include loans that have been placed on nonaccrual status and certain restructured loans whose contractual terms have been restructured in a manner that grants a concession to a borrower experiencing financial difficulty. The nonperforming loan rate is calculated by loan category by dividing nonperforming loans as of the end of the period by period-end loans held for investment for the specified loan category. The nonperforming loan rate, excluding the impact of loans acquired from Chevy Chase Bank from the denominator, was 2.15% and 2.30% as of September 30, 2011 and December 31, 2010, respectively.

(5) 

Nonperforming assets consist of nonperforming loans and real estate owned (“REO”). The nonperforming asset rate is calculated by loan category by dividing nonperforming assets as of the end of the period by period-end loans held for investment and REO for the specified loan category. The nonperforming asset rate, excluding loans acquired from Chevy Chase Bank from the denominator, was 2.33% and 2.54% as of September 30, 2011 and December 31, 2010, respectively.

Key factors affecting the results of our Consumer Banking business for the third quarter and first nine months of 2011, compared with the third quarter and first nine months of 2010 included the following:

 

   

Net Interest Income: Net interest income increased by $151 million, or 16%, in the third quarter of 2011, and $354 million, or 13%, in the first nine months of 2011. The primary drivers of the increase in net interest income were improved loan margins attributable to an increase in average loan yields, coupled with a decrease in the cost of funds. The increase in loan yields reflects the shift in product mix as we replace the legacy home loan run-off with higher yielding auto loans. The decrease in the cost of funds reflects reduced deposit interest rates due to the prevailing low interest rate environment, combined with our disciplined pricing. Although average deposit rates have declined, we experienced strong deposit growth.

 

   

Non-Interest Income: Non-interest income decreased by $8 million, or 4%, in the third quarter of 2011 and decreased by $106 million, or 16%, in the first nine months of 2011. The decrease in non-interest income in the first nine months of 2011 from the same prior year period was primarily attributable to the combined impact of the absence of a net gain of $128 million recorded in the first quarter of 2010 related to the deconsolidation of certain option-adjustable rate mortgage trusts that were consolidated on January 1, 2010 as a result of our adoption of the new consolidation accounting standards and the absence of the impairment charge on mortgage servicing rights recorded in the second quarter of 2010.

 

   

Provision for Loan and Lease Losses: The provision for loan and lease losses increased by $22 million in the third quarter of 2011 to $136 million, and by $220 million in the first nine months of 2011 to $272 million. Although we experienced continued improvement in credit performance in our Consumer Banking business, including reduced delinquency and net charge-off rates, we recorded a higher provision for loan and lease losses in the third quarter and first nine months of 2011 relative to the same prior year periods due to the absence of significant allowance releases that we experienced in 2010, growth in our auto loan portfolio and an increase in the allowance for home equity loans we acquired from Chevy Chase Bank.

 

   

Non-Interest Expense: Non-interest expense increased by $96 million, or 13%, in the third quarter and by $171 million, or 8%, in the first nine months of 2011. The increases over the same prior year periods were largely attributable to the recognition of expense for contingent payments related to recent acquisitions, higher infrastructure expenditures resulting from investments in our mortgage business and growth in auto originations.

 

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Total Loans: Period-end loans in the Consumer Banking business increased by $969 million, or 3%, in the first nine months of 2011 to $35.4 billion as of September 30, 2011, from $34.4 billion as of December 31, 2010, primarily due to growth in auto loans that was partially offset by the continued run-off of our legacy home loan portfolios.

 

   

Deposits: Period-end deposits in the Consumer Banking business increased by $5.6 billion, or 7%, in the first nine months of 2011 to $88.6 billion as of September 30, 2011, reflecting the impact of our strategy to replace maturing higher cost wholesale funding sources with lower cost funding sources and our continued retail marketing efforts to attract new business to meet this objective.

 

   

Charge-off and Delinquency Statistics: The net charge-off rate decreased to 1.32% and 1.30% in the third quarter and first nine months of 2011, respectively, from 1.79% and 1.77% in the third quarter and first nine months of 2010, respectively. The 30+ day delinquency rate was 5.57% as of September 30, 2011, compared with 5.96% as of December 31, 2010. The improvement in the net charge-off and delinquency rates reflects the impact from strong underlying credit performance trends and the higher credit quality of our more recent auto loan vintages, as well as current favorable benefits from elevated auction prices.

Commercial Banking Business

Our Commercial Banking business generated net income from continuing operations of $145 million and $435 million for the third quarter and first nine months of 2011, respectively, compared with a net income from continuing operations of $39 million and $67 million in the third quarter and first nine months of 2010, respectively. The primary sources of revenue for our Commercial Banking business are net interest income from loans and deposits and non-interest income from customer fees. Expenses primarily consist of ongoing operating costs, such as salaries and associated benefits, communications and other technology expenses, supplies and equipment and occupancy costs.

Table 9 summarizes the financial results of our Commercial Banking business and displays selected key metrics for the periods indicated.

 

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Table 9: Commercial Banking Business Results

 

6666666 6666666 6666666 6666666 6666666 6666666
    Three Months Ended September 30,     Nine Months Ended September 30,  
(Dollars in millions)       2011             2010           Change           2011             2010           Change    

Selected income statement data:

           

Net interest income

  $ 353      $ 325        9   $ 1,007      $ 956        5

Non-interest income

    62        30        107        195        132        48   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

    415        355        17        1,202        1,088        10   

Provision (Benefit) for loan and lease losses

    (10     95        (111     (43     395        (111

Non-interest expense

    200        199        1        569        589        (3
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations before income taxes

    225        61        269        676        104        550   

Income tax provision

    80        22        264        241        37        551   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations, net of tax

  $ 145      $ 39        272   $ 435      $ 67        549
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Selected performance metrics:

           

Average loans held for investment:

           

Commercial and multifamily real estate

  $ 14,021      $ 13,411        5   $ 13,657      $ 13,556        1

Middle market

    11,572        10,352        12        11,075        10,317        7   

Specialty lending

    4,154        3,715        12        4,045        3,660        11   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial lending

    29,747        27,478        8        28,777        27,533        5   

Small-ticket commercial real estate

    1,598        1,957        (18     1,713        2,030        (16
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial banking

  $ 31,345      $ 29,435        6   $ 30,490      $ 29,563        3
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Average yield on loans held for investment

    4.69     5.13     (44 )bps      4.74     5.03     (29 )bps 

Average deposits

  $ 25,227      $ 21,899        15   $ 24,553      $ 21,976        12

Average interest rate on deposits

    0.48     0.67     (19 )bps      0.50     0.71     (21 )bps 

Core deposit intangible amortization

  $ 10      $ 14        (29 )%    $ 31      $ 42        (26 )% 

Net charge-off rate(1)(2)

    0.37     1.27     (90 )bps      0.55     1.28     (73 )bps 

 

6666666 6666666 6666666 6666666 6666666 6666666

Selected period-end data:

   
 
September 30,
2011
  
  
   

 

December 31,

2010

  

  

      Change           

Loans held for investment:

           

Commercial and multifamily real estate

  $ 14,389      $ 13,396        7      

Middle market

    11,924        10,484        14         

Specialty lending

    4,221        4,020        5         
 

 

 

   

 

 

   

 

 

       

Total commercial lending

    30,534        27,900        9         

Small-ticket commercial real estate

    1,571        1,842        (15      
 

 

 

   

 

 

   

 

 

       

Total commercial banking

  $ 32,105      $ 29,742        8      
 

 

 

   

 

 

   

 

 

       

Nonperforming loan rate(1)(3)

    1.43     1.66     (23 )bps       

Nonperforming asset rate(1)(4)

    1.55        1.80        (25      

Allowance for loan and lease losses

  $ 700      $ 826        (15 )%       

Deposits

    25,282        22,630        12         

 

(1) 

Average loans held for investment used in the denominator in calculating net charge-off, delinquency and nonperforming loan and nonperforming asset rates includes the impact of loans acquired as part of the Chevy Chase Bank acquisition, which were considered purchased credit-impaired (“PCI”) loans. However, we separately track and report PCI loans and exclude these loans from our net charge-off, delinquency, nonperforming loan and nonperforming asset rates.

 

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(2) 

The net charge-off rate is calculated by loan category by dividing annualized net charge-offs for the period by average loans held for investment during the period for the specified loan category. The net charge-off rate, excluding loans acquired from Chevy Chase Bank from the denominator, was 0.38% and 1.30% for the three months ended September 30, 2011 and 2010, respectively, and 0.56% and 1.32% for the nine months ended September 30, 2011 and 2010, respectively.

(3)

The nonperforming loan rate is calculated by loan category by dividing nonperforming loans as of the end of the period by period-end loans held for investment for the specified loan category. The nonperforming loan rate, excluding the impact of loans acquired from Chevy Chase Bank from the denominator, was 1.45% and 1.69% as of September 30, 2011 and December 31, 2010, respectively.

(4) 

The nonperforming asset rate is calculated by loan category by dividing nonperforming assets as of the end of the period by period-end loans held for investment and REO for the specified loan category. The nonperforming asset rate, excluding loans acquired from Chevy Chase Bank from the denominator, was 1.57% and 1.83% as of September 30, 2011 and December 31, 2010, respectively.

Key factors affecting the results of our Commercial Banking business for the third quarter and first nine months of 2011, compared with the third quarter and first nine months of 2010 included the following:

 

   

Net Interest Income: Net interest income increased by $28 million, or 9%, in the third quarter of 2011, and by $51 million, or 5%, in the first nine months of 2011. The primary drivers of the increase in net interest income from the same prior year periods were an increase in loans and deposits and continued downward pricing on deposits while growing loan yields.

 

   

Non-Interest Income: Non-interest income increased by $32 million, or 107%, in the third quarter of 2011 and $63 million, or 48%, in the first nine months of 2011. The increase in non-interest income from the same prior year periods was largely attributable to increased customer fees related to treasury management and public financing activities and the absence of a loss of $18 million recognized in the third quarter of 2010 from the sale of a legacy portfolio of small-ticket commercial real estate loans.

 

   

Provision for Loan and Lease Losses: The Commercial Banking business recorded a negative provision for loan and lease losses of $10 million and $43 million in the third quarter and first nine months of 2011, respectively, compared with provision expense of $95 million and $395 million in the third quarter and first nine months of 2010, respectively. The negative provision in the third quarter and first nine months of 2011 was attributable to lower loss severities resulting from improvements in underlying collateral asset values. As a result, we reduced the allowance related to the Commercial Banking business by $30 million and $126 million in the third quarter and first nine months of 2011, respectively. In comparison, we increased the allowance by $9 million in the third quarter of 2010 and by $106 million in the first nine months of 2010.

 

   

Non-Interest Expense: Non-interest expense of $200 million in the third quarter of 2011 was flat relative to the third quarter of 2010 despite an increase in loan volume, reflecting operational efficiency improvements. Non-interest expense decreased by $20 million, or 3%, in the first nine months of 2011 to $569 million, primarily due to a reduction in integration costs related to the Chevy Chase Bank acquisition.

 

   

Total Loans: Period-end loans increased by $2.4 billion, or 8%, in the first nine months of 2011 to $32.1 billion as of September 30, 2011, from $29.7 billion as of December 31, 2010. The increase was driven by stronger loan originations in the middle market and commercial real estate businesses, which was partially offset by the run-off and sale of a portion of the small-ticket commercial real estate loan portfolio.

 

   

Deposits: Period-end deposits in the Commercial Banking business increased by $2.7 billion, or 12%, in the first nine months of 2011 to $25.3 billion as of September 30, 2011, driven by our strategy to strengthen existing relationships and increase liquidity from commercial customers.

 

   

Charge-off and Nonperforming Loan Statistics: The net charge-off rate decreased to 0.37% and 0.55% in the third quarter and first nine months of 2011, respectively, from 1.27% and 1.28% in the third quarter and first nine months of 2010, respectively. The nonperforming loan rate decreased to 1.43% as of September 30, 2011, from 1.66% as of December 31, 2010. The improvement in the net charge-off and nonperforming loan rates was attributable to slowly improving underlying credit trends and improvements in underlying collateral asset values.

 

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CONSOLIDATED BALANCE SHEET ANALYSIS AND CREDIT PERFORMANCE

 

Total assets of $200.1 billion as of September 30, 2011 increased by $2.6 billion, or 1%, from $197.5 billion as of December 31, 2010. Total liabilities of $170.8 billion as of September 30, 2011, decreased by $192 million, or less than 1%, from $171.0 billion as of December 31, 2010. Stockholders’ equity increased by $2.8 billion during the first nine months of 2011, to $29.4 billion as of September 30, 2011 from $26.5 billion as of December 31, 2010. The increase in stockholders’ equity was primarily attributable to our net income of $2.7 billion in the first nine months of 2011. Following is a discussion of material changes in the major components of our assets and liabilities during the first nine months of 2011.

Investment Securities

Our investment securities portfolio, which had a fair value of $38.4 billion and $41.5 billion, as of September 30, 2011 and December 31, 2010, respectively, consists of the following: U.S. Treasury and U.S. agency debt obligations; agency and non-agency mortgage-backed securities; other asset-backed securities collateralized primarily by credit card loans, auto loans, student loans, auto dealer floor plan inventory loans and leases, equipment loans and home equity lines of credit; municipal securities; and limited Community Reinvestment Act (“CRA”) equity securities. Our investments in U.S. Treasury and agency securities, based on fair value, represented approximately 69% and 70% of our total investment securities portfolio as of September 30, 2011, and December 31, 2010, respectively.

All of our investment securities were classified as available for sale as of September 30, 2011 and December 31, 2010, and reported in our consolidated balance sheet at fair value. Table 10 presents the amortized cost and fair value of our investment securities, by investment type, as of September 30, 2011 and December 31, 2010.

Table 10: Investment Securities

 

     September 30, 2011      December 31, 2010  
(Dollars in millions)    Amortized
Cost
     Fair
Value
     Amortized
Cost
     Fair
Value
 

U.S. Treasury debt obligations

   $ 115       $ 125       $ 373       $ 386   

U.S. Agency debt obligations(1)

     166         175         301         314   

Residential mortgage-backed securities (“RMBS”):

           

Agency(2)

     25,139         25,747         27,980         28,504   

Non-agency

     1,405         1,273         1,826         1,700   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total RMBS

     26,544         27,020         29,806         30,204   

Commercial mortgage-backed securities (“CMBS”):

           

Agency(2)

     418         429         44         45   

Non-agency

     400         398         0         0   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total CMBS

     818         827         44         45   

Asset-backed securities (“ABS”)(3)

     9,691         9,734         9,901         9,966   

Other securities(4)

     467         519         563         622   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total securities available for sale

   $ 37,801       $ 38,400       $ 40,988       $ 41,537   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1)

Consists of debt securities issued by Fannie Mae and Freddie Mac with an amortized cost of $165 million and $200 million, as of September 30, 2011 and December 31, 2010, respectively, and fair value of $174 million and $213 million, as of September 30, 2011 and December 31, 2010, respectively.

(2)

Consists of MBS issued by Fannie Mae, Freddie Mac and Ginnie Mae with an amortized cost of $12.9 billion, $8.4 billion and $4.3 billion, respectively, and fair value of $13.2 billion, $8.6 billion and $4.4 billion, respectively, as of September 30, 2011. The book value of Fannie Mae, Freddie Mac and Ginnie Mae investments each exceeded 10% of our stockholders’ equity as of September 30, 2011.

 

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Table of Contents
(3)

Consists of securities collateralized by credit card loans, auto dealer and floor plan inventory loans and leases, student loans, auto loans, equipment loans and other. The distribution among these asset types was approximately 73.2% credit card loans, 11.3% auto dealer floor plan inventory loans and leases, 6.8% auto loans, 4.6% student loans, 2.3% equipment loans, and 1.8% of other loans as of September 30, 2011. In comparison, the distribution was approximately 77.8% credit card loans, 5.6% auto dealer floor plan inventory loans and leases, 6.7% auto loans, 7.2% student loans, 2.5% equipment loans and 0.2% home equity lines of credit as of December 31, 2010. Approximately 89% of the securities in our asset-backed security portfolio were rated AAA or its equivalent as of September 30, 2011, compared with 90% as of December 31, 2010.

(4)

Consists of municipal securities and equity investments, primarily related to CRA activities.

We sold approximately $6.4 billion of investment securities, consisting predominantly of agency MBS, in the third quarter of 2011. We recorded a gain of $239 million on the sale of these securities. We provide additional information in “Market Risk Management.”

Unrealized gains and losses on our available-for-sale securities are recorded net of tax as a component of accumulated other comprehensive income (“AOCI”). We had gross unrealized gains of $776 million and gross unrealized losses of $177 million on available-for-sale securities as of September 30, 2011, compared with gross unrealized gains of $830 million and gross unrealized losses of $281 million as of December 31, 2010. Of the $177 million in gross unrealized losses as of September 30, 2011, $134 million related to securities that had been in a loss position for more than 12 months.

We evaluate available-for-sale securities in an unrealized loss position as of the end of each quarter for other-than-temporary impairment (“OTTI”) based on a number of criteria, including the extent and duration of the decline in value, the severity and duration of the impairment, recent events specific to the issuer and/or industry to which the issuer belongs, the payment structure of the security, external credit ratings, the failure of the issuer to make scheduled interest or principal payments, the value of underlying collateral, our intent and ability to hold the security and current market conditions. We recognized OTTI losses on investment securities of $6 million and $15 million in the third quarter and first nine months of 2011, respectively. In comparison, we recognized OTTI losses on investment securities of $5 million and $62 million in the third quarter and first nine months of 2010, respectively, which was due in part to our decision to sell certain other securities before recovery of the impairment amount as well as the deterioration in the credit performance of certain non-agency mortgage-related securities resulting from weaknesses in the housing market and high unemployment.

We provide additional information on our available-for-sale securities and OTTI assessment in “Note 4—Investment Securities.”

Credit Ratings

Our investment securities portfolio continues to be heavily concentrated in securities that generally have lower credit risk and high credit ratings, such as securities issued and guaranteed by the U.S. Treasury and government sponsored enterprises or agencies. On August 6, 2011, Standard & Poor’s (“S&P”) downgraded the long-term sovereign credit rating of the U.S. government from AAA to AA+. As a result, the credit ratings for our U.S. Treasury and U.S. Agency securities, which accounted for $26.1 billion, or 69%, of our total investment securities portfolio were lowered to AA+. This credit rating reduced the percentage of securities in our investment portfolio with a AAA or equivalent rating to 24% as of September 30, 2011, from 92% as of December 31, 2010. If the S&P downgrade had not occurred, the securities in our investment portfolio with a AAA or equivalent rating would have been approximately 93% as of September 30, 2011. We categorize our available-for-sale securities based on the lowest credit ratings issued by the rating agencies.

 

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The table below presents information on the credit ratings of our non-agency residential MBS, which account for the substantial majority of the unrealized losses related to our investment securities portfolio as of September 30, 2011 and December 31, 2010:

 

     September 30, 2011     December 31, 2010  
     % of
Investment
Securities
Portfolio(1)
   AAA     Other
Investment
Grade
   Below
Investment
Grade or Not
Rated
    % of
Investment
Securities
Portfolio(1)
   AAA    Other
Investment
Grade
   Below
Investment
Grade or Not
Rated
 

Non-agency residential MBS

   4%      0 %    4%      96 %    5%    0%    9%      91

 

(1)

Calculated based on the amortized cost of the major security type presented divided by the amortized cost of our total investment securities portfolio as of the end of each period.

Total Loans

Table 11 presents the composition of our total loan portfolio, by business segments, as of September 30, 2011 and December 31, 2010.

Table 11: Loan Portfolio Composition

 

     September 30, 2011     December 31, 2010  
(Dollars in millions)    Amount      % of
Total Loans
    Amount      % of
Total Loans
 

Credit Card business:

          

Credit card loans:

          

Domestic credit card loans

   $ 51,510         39.6   $ 49,979         39.7

International credit card loans

     8,210         6.3        7,513         6.0   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total credit card loans

     59,720         45.9        57,492         45.7   
  

 

 

    

 

 

   

 

 

    

 

 

 

Installment loans:

          

Domestic installment loans

     2,310         1.8        3,870         3.0   

International installment loans

                    9           
  

 

 

    

 

 

   

 

 

    

 

 

 

Total installment loans

     2,310         1.8        3,879         3.0   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total credit card

     62,030         47.7        61,371         48.7   
  

 

 

    

 

 

   

 

 

    

 

 

 

Consumer Banking business:

          

Automobile

     20,422         15.7        17,867         14.2   

Home loan

     10,916         8.4        12,103         9.6   

Retail banking

     4,014         3.1        4,413         3.5   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total consumer banking

     35,352         27.2        34,383         27.3   
  

 

 

    

 

 

   

 

 

    

 

 

 

Commercial Banking business:

          

Commercial and multifamily real estate(1)

     14,389         11.1        13,396         10.6   

Middle market

     11,924         9.2        10,484         8.3   

Specialty lending

     4,221         3.2        4,020         3.2   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total commercial lending

     30,534         23.5        27,900         22.1   

Small-ticket commercial real estate

     1,571         1.2        1,842         1.5   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total commercial banking

     32,105         24.7        29,742         23.6   
  

 

 

    

 

 

   

 

 

    

 

 

 

Other:

          

Other loans

     465         0.4        451         0.4   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total loans

   $ 129,952         100.0   $ 125,947         100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

 

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(1)

Includes construction and land development loans totaling $2.2 billion and $2.4 billion as of September 30, 2011 and December 31, 2010, respectively.

Total loans increased by $4.0 billion, or 3%, during the first nine months of 2011, to $130.0 billion as of September 30, 2011, from $125.9 billion as of December 31, 2010. The increase was primarily attributable to the additions of the $3.7 billion private-label credit card loan portfolio of Kohl’s in the second quarter of 2011 and the $1.4 billion credit card loan portfolio of HBC in the first quarter of 2011, as well as growth in our auto finance, commercial and revolving domestic card balances. Excluding the impact of the addition of the Kohl’s and HBC portfolios, total loans decreased by $1.1 billion, or 1%, in the first nine months of 2011, due to the continued expected run-off of loans in businesses we exited or repositioned early in the economic recession, other loan paydowns and charge-offs. The run-off portfolios include installment loans in our Credit Card business, home loans in our Consumer Banking business and small-ticket commercial real estate loans in our Commercial Banking business.

Credit Performance

We closely monitor economic conditions and loan performance trends to manage and evaluate our exposure to credit risk. Trends in delinquency ratios are an indicator, among other considerations, of credit risk within our loan portfolios. The level of nonperforming assets represents another indicator of the potential for future credit losses. Accordingly, key metrics we track and use in evaluating the credit quality of our loan portfolio include delinquency and nonperforming asset rates, as well as charge-off rates and our internal risk ratings of commercial loans. The improvements we have experienced in our credit trends across all of our businesses are stabilizing and our credit performance is increasingly driven by seasonal trends. We present information in the section below on the credit performance of our loan portfolio, including the key metrics we use in tracking changes in the credit quality of our loan portfolio. See “Note 5—Loans” for additional information.

Delinquency Rates

We consider the entire balance of an account to be delinquent if the minimum required payment is not received by the first statement cycle date equal to or following the due date specified on the customer’s billing statement. Table 12 below compares 30+ day performing loan delinquency rates, by loan category, as of September 30, 2011 and December 31, 2010. We also present total 30+ day delinquent loans.

Our 30+ day delinquency metrics include all held for investment loans that are 30 or more days past due, whereas our 30+ day performing delinquency metrics include loans that are 30 or more days past due and that are also currently classified as performing and accruing interest. The 30+ day delinquency and 30+ day performing delinquency metrics are the same for credit card loans, as we continue to classify credit card loans as performing until they are charged-off, generally when the loan is 180 days past due. However, the 30+ day delinquency and 30+ day performing delinquency metrics differ for other loan categories based on our policies for classifying loans as nonperforming. See “Note 5—Loans” for additional information on our policies for classifying loans as nonperforming and for charging-off loans.

The delinquency rates presented are calculated, by loan category, based on our total loan portfolio. Our total loan portfolio consists of loans recorded on our balance sheet, which includes purchased credit-impaired (“PCI”) loans acquired from Chevy Chase Bank, and loans held in our securitization trusts. Loans acquired from Chevy Chase Bank were recorded at fair value at acquisition. We separately track and report the performance of PCI loans and exclude these loans from the numerator in calculating our net charge-off, delinquency, nonperforming loan and nonperforming asset rates.

 

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Table 12: 30+ Day Delinquencies

 

     September 30, 2011     December 31, 2010  
      30+ Day Performing       30+ Day Total       30+ Day Performing       30+ Day Total   
(Dollars in millions)     Amount        Rate(1)       Amount        Rate(1)       Amount       Rate(1)       Amount        Rate(1)   

Credit Card business:(3)

                    

Domestic credit card and installment loans

   $ 1,962         3.65   $ 1,962         3.65   $ 2,200         4.09   $ 2,200         4.09

International credit card and installment loans

     439         5.35        439         5.35        432         5.75        432         5.75   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total credit card

     2,401         3.87        2,401         3.87        2,632         4.29        2,632         4.29   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Consumer Banking business:

                    

Automobile

     1,295         6.34        1,387         6.79        1,355         7.58        1,453         8.13   

Home loan(2)

     85         0.78        497         4.55        77         0.64        504         4.16   

Retail banking(2)

     36         0.89        85         2.12        41         0.93        93         2.11   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total consumer banking(2)

     1,416         4.01        1,969         5.57        1,473         4.28        2,050         5.96   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Commercial Banking business:

                    

Commercial and multifamily real estate(2)

     145         1.01        333         2.31        147         1.10        302         2.25   

Middle market(2)

     13         0.11        76         0.64        28         0.27        89         0.85   

Specialty lending

     22         0.51        41         0.97        33         0.81        58         1.44   

Small-ticket commercial real estate

     43         2.75        63         4.01        95         5.16        131         7.11   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total commercial banking(2)

     223         0.69        513         1.60        303         1.02        580         1.95   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Other:

                    

Other loans

     21         4.52        63         13.55        22         4.88        69         15.30   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 4,061         3.13   $ 4,946         3.81   $ 4,430         3.52   $ 5,331         4.23
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

(1)

Delinquency rates are calculated by loan category by dividing 30+ day delinquent loans as of the end of the period by period-end loans held for investment for the specified loan category.

(2)

The 30+ day performing delinquency rate, excluding the impact of loans acquired from Chevy Chase Bank from the denominator, for home loans, retail banking, total consumer banking, commercial and multifamily real estate, middle market, and total commercial banking was 1.28%, 0.90%, 4.57%, 1.02%, 0.11% and 0.71%, respectively, as of September 30, 2011, compared with 1.06%, 0.97%, 5.01%, 1.12%, 0.28% and 1.04%, respectively, as of December 31, 2010.

(3) 

The September 30, 2011 30+ day delinquency rate for Domestic Card reflects the impact of the change we made in the way we estimate recoveries in determining the uncollectible amount of finance charges and fees, which resulted in an increase of 11 basis points as of September 30, 2011. For International Card, the change did not have a significant impact on the 30+ day delinquency rate as of September 30, 2011.

Table 13 presents an aging of total 30+ day delinquent loans included in the above table.

 

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Table 13: Aging of 30+ Day Delinquent Loans

 

     September 30, 2011     December 31, 2010  
(Dollars in millions)    Amount      % of
Total Loans(1)
    Amount      % of
Total Loans(1)
 

Total loan portfolio

   $ 129,952         100.00   $ 125,947         100.00
  

 

 

    

 

 

   

 

 

    

 

 

 

Delinquency status:

          

30 – 59 days

   $ 1,904         1.47   $ 2,008         1.59

60 – 89 days

     1,055         0.81        1,103         0.88   

90 + days

     1,987         1.53        2,220         1.76   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 4,946         3.81   $ 5,331         4.23
  

 

 

    

 

 

   

 

 

    

 

 

 

Geographic region:

          

Domestic

   $ 4,507         3.47   $ 4,899         3.89

International

     439         0.34        432         0.34   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 4,946         3.81   $ 5,331         4.23
  

 

 

    

 

 

   

 

 

    

 

 

 

 

(1)

Calculated by dividing loans in each delinquency status category and geographic region as of the end of the period by the total loan portfolio.

Table 14 summarizes loans that were 90 days or more past due as to interest or principal payments and still accruing interest as of September 30, 2011 and December 31, 2010. These loans consist primarily of credit card accounts between 90 days and 179 days past due. As permitted by regulatory guidance issued by The Federal Financial Institutions Examination Council (“FFIEC”), we continue to accrue interest on credit card loans through the date of charge-off, typically in the period the account becomes 180 days past due. While credit card loans remain on accrual status until the loan is charged-off, we establish a reserve for finance charges and fees billed but not expected to be collected and exclude this amount from revenue.

Table 14: 90+ Day Delinquent Loans Accruing Interest

 

     September 30, 2011     December 31, 2010  
(Dollars in millions)    Amount      % of
Total Loans
    Amount      % of
Total Loans
 

Loan category:(1)

          

Credit card(2)

   $ 1,109         1.79   $ 1,379         2.25

Consumer

     2         0.01        5         0.01   

Commercial

     40         0.13        14         0.05   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 1,151         0.89   $ 1,398         1.11
  

 

 

    

 

 

   

 

 

    

 

 

 

Geographic region:(3)

          

Domestic

   $ 957         0.74   $ 1,195         0.95

International

     194         0.15        203         0.16   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 1,151         0.89   $ 1,398         1.11
  

 

 

    

 

 

   

 

 

    

 

 

 

 

(1)

Delinquency rates are calculated by loan category by dividing 90+ day delinquent loans accruing interest as of the end of the period by period-end loans held for investment for the specified loan category.

(2)

Includes credit card loans that continue to accrue finance charges and fees until charged-off at 180 days. The amounts reported for credit card loans are net of billed finance charges and fees that we do not expect to collect. The estimated uncollectible portion of billed finance charges and fees excluded from revenue totaled $24 million and $190 million in the third quarter of 2011 and 2010, respectively, and $241 million and $805 million in the first nine months of 2011 and 2010, respectively. The reserve for uncollectible billed finance charges and fees decreased to $67 million as of September 30, 2011, from $211 million as of December 31, 2010.

(3)

Calculated by dividing loans in each geographic region as of the end of the period by the total loan portfolio.

 

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Nonperforming Assets

Nonperforming assets consist of nonperforming loans and foreclosed property and repossessed assets. Nonperforming loans generally include loans that have been placed on nonaccrual status and certain restructured loans whose contractual terms have been restructured in a manner that grants a concession to a borrower experiencing financial difficulty. We continue to classify credit card loans as performing until they are charged-off. As a result, delinquent credit cards loans are excluded from the numerator in calculating our nonperforming loan and nonperforming asset rates. We provide an aging of delinquent loans by loan category and describe our policies for classifying loans as nonperforming and for charging-off loans in “Note 5—Loans.”

Table 15 presents comparative information on nonperforming loans, by loan category, as of September 30, 2011 and December 31, 2010, and the ratio of nonperforming loans to total loans. We do not report loans classified as held for sale as nonperforming, as they are recorded at lower of cost or fair value. We also do not report PCI loans as nonperforming, as these loans were written down to fair value at acquisition and accrete interest income over the remaining life of the loan. We separately track and report the performance of PCI loans. See “Purchased Credit-Impaired Loans” below for additional information on PCI loans.

Table 15: Nonperforming Loans and Other Nonperforming Assets(1)(2)

 

     September 30, 2011(3)     December 31, 2010  
(Dollars in millions)    Amount      % of Total
HFI Loans
    Amount      % of Total
HFI Loans
 

Nonperforming loans held for investment:

          

Consumer Banking business:

          

Automobile

   $ 92         0.45   $ 99         0.55

Home loans

     495         4.54        486         4.01   

Retail banking

     79         1.97        91         2.07   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total consumer banking

     666         1.88        676         1.97   
  

 

 

    

 

 

   

 

 

    

 

 

 

Commercial Banking business:

          

Commercial and multifamily real estate

     287         1.99        276         2.06   

Middle market

     116         0.97        133         1.27   

Specialty lending

     35         0.83        48         1.20   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total commercial lending

     438         1.44        457         1.64   

Small-ticket commercial real estate

     21         1.32        38         2.04   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total commercial banking

     459         1.43        495         1.66   
  

 

 

    

 

 

   

 

 

    

 

 

 

Other:

          

Other loans

     47         10.19        54         12.12   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total nonperforming loans held for investment(4)

   $ 1,172         0.90   $ 1,225         0.97
  

 

 

    

 

 

   

 

 

    

 

 

 

Other nonperforming assets:

          

Foreclosed property(5)

   $ 193         0.15   $ 306         0.24

Repossessed assets

     17         0.01        20         0.02   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total other nonperforming assets

     210         0.16        326         0.26   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total nonperforming assets

   $ 1,382         1.06   $ 1,551         1.23
  

 

 

    

 

 

   

 

 

    

 

 

 

 

(1)

The ratio of nonperforming loans as a percentage of total loans held for investment is calculated based on the nonperforming loans in each loan category divided by the total outstanding unpaid principal balance of loans held for investment in each loan category. The denominator used in calculating the nonperforming asset ratios consists of total loans held for investment and other nonperforming assets.

(2)

The nonperforming loan ratios, excluding the impact of loans acquired from Chevy Chase Bank from the denominator, for home loans, retail banking, total consumer banking, commercial and multifamily real estate, middle market, total

 

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  commercial banking, and total nonperforming loans held for investment were 7.47%, 1.99%, 2.15%, 2.02%, 1.00%, 1.45% and 0.94%, respectively, as of September 30, 2011, compared with 6.67%, 2.16%, 2.30%, 2.11%, 1.30%, 1.69% and 1.02%, respectively, as of December 31, 2010. The nonperforming asset ratio, excluding loans acquired from Chevy Chase Bank, was 1.10% and 1.29% as of September 30, 2011 and December 31, 2010, respectively.
(3)

For the nine months ended September 30, 2011, we recognized interest income for loans classified as nonperforming of $23 million. For the nine months ended September 30, 2011, interest income foregone related to nonperforming loans was $37 million. Foregone interest income represents the amount of interest income that would have been recorded during the period for nonperforming loans as of the end of the period had the loans performed according to their contractual terms.

(4)

Nonperforming loans as a percentage of loans held for investment, excluding credit card loans from the denominator, was 1.73% and 1.90% as of September 30, 2011 and December 31, 2010, respectively.

(5)

Includes $98 million and $201 million of foreclosed properties related to loans acquired from Chevy Chase Bank, as of September 30, 2011 and December 31, 2010, respectively.

Net Charge-Offs

Net charge-offs consist of the unpaid principal balance of loans held for investment that we determine are uncollectible, net of recovered amounts. We exclude accrued and unpaid finance charges and fees and fraud losses from charge-offs. Charge-offs are recorded as a reduction to the allowance for loan and lease losses and subsequent recoveries of previously charged-off amounts are credited to the allowance for loan and lease losses. Costs incurred to recover charged-off loans are recorded as collection expense and included in our consolidated statements of income as a component of other non-interest expense. We discuss our charge-off time frame for loans, which varies based on the loan type, in “Note 5—Loans.”

Table 16 presents our net charge-off amounts and rates, by business segment, for the three and nine months ended September 30, 2011 and 2010. We provide additional information on the amount of charge-offs by loan category below in Table 18.

Table 16: Net Charge-Offs

 

     Three Months Ended September 30,     Nine Months Ended September 30,  
     2011     2010     2011     2010  
(Dollars in millions)    Amount      Rate(1)     Amount      Rate(1)     Amount      Rate(1)     Amount      Rate(1)  

Credit card(2)

   $ 661         4.23   $ 1,251         8.16   $ 2,383         5.13   $ 4,408         9.30

Consumer banking(3)(4)

     115         1.32        157         1.79        336         1.30        483         1.77   

Commercial banking(3) (4)

     29         0.37        93         1.27        126         0.55        284         1.28   

Other

     7         6.39        21         17.63        43         12.28        83         21.20   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total company(4)

   $ 812         2.52   $ 1,522         4.82   $ 2,888         3.02   $ 5,258         5.41
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Average loans held for investment(5)

   $ 129,043         $ 126,307         $ 127,360         $ 129,565      

 

(1)

Calculated for each loan category by dividing annualized net charge-offs for the period by average loans held for investment during the period.

(2)

The reduction in the provision for loan and lease losses attributable to Kohl’s was $236 million for the first nine months of 2011. Loss sharing amounts attributable to Kohl’s reduced net charge-offs by $39 million and $80 million in the third quarter and first nine months of 2011, respectively. The expected reimbursement from Kohl’s netted in our allowance for loan and lease losses was approximately $156 million as of September 30, 2011.

(3)

Excludes losses on the purchased credit-impaired loans acquired from Chevy Chase Bank. We separately track and report these loans. We provide additional information on the loans acquired from Chevy Chase Bank in “Note 5—Loans.”

(4)

The average loans held for investment used in calculating net charge-off rates includes the impact of loans acquired as part of the Chevy Chase Bank acquisition. Our total net charge-off rate, excluding the impact of acquired Chevy Chase Bank loans, was 2.62% and 5.06% for the three months ended September 30, 2011 and 2010, respectively and 3.15% and 5.70% for the nine months ended September 30, 2011 and 2010, respectively.

(5)

The average balances of the acquired Chevy Chase Bank loan portfolio, which are included in the total average loans held for investment used in calculating the net charge-off rates, were $5.0 billion and $6.0 billion for the three months

 

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  ended September 30, 2011 and 2010, respectively, and $5.1 billion and $6.5 billion for the nine months ended September 30, 2011 and 2010, respectively.

The overall decrease in net charge-offs in the third quarter and first nine months of 2011 from the third quarter and first nine months of 2010 reflects the improvement in credit performance.

Loan Modifications and Restructurings

As part of our customer retention efforts, we may modify loans for certain borrowers who have demonstrated performance under the previous terms. As part of our loss mitigation efforts, we may make loan modifications to a borrower experiencing financial difficulty that are intended to minimize our economic loss and avoid the need for foreclosure or repossession of collateral. We may provide short-term (three to twelve months) or long-term (greater than twelve months) modifications to improve the long-term collectability of the loan. Our most common types of modifications include a reduction in the borrower’s initial periodic principal and interest payment through an extension of the loan term, a reduction in the interest rate or a combination of both. These modifications may result in our receiving the full amount due, or certain installments due, under the loan over a period of time that is longer than the period of time originally provided for under the terms of the loan. In some cases, we may curtail the amount of principal owed by the borrower. Loan modifications in which an economic concession has been granted to a borrower experiencing financial difficulty are accounted for and reported as troubled debt restructurings (“TDRs”). Loan modifications that involve a trial period are not classified as TDRs until the borrower successfully completes the trial period under the revised payment terms and the loan modification becomes permanent. We did not have a significant number of loans in a trial modification period as of September 30, 2011.

In the third quarter of 2011, we adopted new accounting guidance that provides clarification on determining whether a debtor is experiencing financial difficulties and whether a concession has been granted to the debtor for purposes of determining if a loan modification constitutes a TDR. The new guidance applies retrospectively to our loan restructurings on or after January 1, 2011. The adoption of this amended accounting guidance in the third quarter of 2011 resulted in a net increase in loan modifications considered to be TDRs of $56 million for consumer loans and $77 million for commercial loans. The allowance for credit losses associated with these loans was $22 million as of September 30, 2011.

Table 17 presents the loan balances as of September 30, 2011 and December 31, 2010 of loan modifications made as part of our loss mitigation efforts, all of which are considered to be TDRs. Table 17 excludes loan modifications that do not meet the definition of a TDR and acquired loans from Chevy Chase Bank, which we track and report separately. We provide additional detail on acquired loans from Chevy Chase Bank below under “Purchased Credit-Impaired Loans.”

Table 17: Loan Modifications and Restructurings(1)

 

(Dollars in millions)    September 30,
2011
     December 31,
2010(2)
 

Modified and restructured loans:

     

Credit card(3)

   $ 915       $ 913   

Auto(4)

     44         —     

Home loan

     101         57   

Retail banking

     65         13   

Commercial

     379         162   
  

 

 

    

 

 

 

Total

   $ 1,504       $ 1,145   
  

 

 

    

 

 

 

Status of modified and restructured loans:

     

Performing

   $ 1,380       $ 1,049   

Nonperforming

     124         96   
  

 

 

    

 

 

 

Total

   $ 1,504       $ 1,145   
  

 

 

    

 

 

 

 

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(1)

Reflects modifications and restructuring of loans in our total loan portfolio. The total loan portfolio includes loans recorded on our balance sheet and loans held in securitization trusts.

(2)

Certain prior period amounts have been reclassified to conform to the current period presentation.

(3)

Amount reported reflects the total outstanding customer balance, which consists of unpaid principal balance, accrued interest and fees.

(4)

Prior to the first quarter of 2011, modified Auto loans were charged-off at the net collateral value and the remaining asset balance was reclassified to Other Assets on our consolidated balance sheet.

The outstanding balance of TDR loan modifications increased to $1.5 billion as of September 30, 2011 from $1.1 billion as of December 31, 2010. Of these modifications, $124 million, or 8%, were classified as nonperforming as of September 30, 2011, compared with $96 million, or 8%, as of December 31, 2010.

Credit card loan modifications have accounted for the substantial majority of our TDR loan modifications, representing $915 million, or 61%, of the outstanding balance of total TDR loans as of September 30, 2011, and $913 million, or 80%, of the outstanding balance of total TDR loans as of December 31, 2010. The vast majority of our credit card TDR loan modifications involve a reduction in the interest rate on the account and placing the customer on a fixed payment plan not exceeding 60 months. In some cases, the interest rate on a credit card account is automatically increased due to non-payment, late payment or similar events. We determine the effective interest rate for purposes of measuring impairment on modified loans that involve an increase and are considered to be a TDR based on the interest rate in effect immediately prior to the loan entering the modification program. In all cases, we cancel the customer’s available line of credit on the credit card. If the cardholder does not comply with the modified payment terms, then the credit card loan agreement will revert back to its original payment terms, with the amount of any loan outstanding reflected in the appropriate delinquency category. The loan amount may then be charged-off in accordance with our standard charge-off policy.

Home loan modifications represented $101 million, or 7%, of the outstanding balance of total modified loans as of September 30, 2011, compared with $57 million, or 5%, of the outstanding balance of total modified loans as of December 31, 2010. The majority of our modified mortgage loans involve a combination of an interest rate reduction, term extension or principal reduction.

Commercial loan modifications represented $379 million, or 25%, of the outstanding balance of total modified loans as of September 30, 2011, compared with $162 million, or 14%, of the outstanding balance of total modified loans as of December 31, 2010. The vast majority of modified commercial loans include a reduction in interest rate or a term extension.

We provide additional information on modified loans accounted for as TDRs, including the performance of those loans subsequent to modification, in “Note 5—Loans.”

Impaired Loans

A loan is considered impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due from the borrower in accordance with the original contractual terms of the loan. Loans defined as individually impaired, based on applicable accounting guidance, include larger balance commercial nonperforming loans and TDR loans. We do not report nonperforming consumer loans that have not been modified in a TDR as individually impaired, as we collectively evaluate these smaller-balance homogenous loans for impairment in accordance with applicable accounting guidance. Loans held for sale are also not reported as impaired, as these loans are recorded at lower of cost or fair value. Impaired loans also exclude loans acquired from Chevy Chase Bank because these loans were recorded at fair value upon acquisition.

Impaired loans, including TDRs, totaled $1.8 billion as of September 30, 2011, compared with $1.5 billion as of December 31, 2010. TDRs accounted for $1.5 billion and $1.1 billion of impaired loans as of September 30, 2011 and December 31, 2010, respectively. We provide additional information on our impaired loans, including the allowance established for these loans, in “Note 5—Loans” and “Note 6—Allowance for Loan and Lease Losses.”

 

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Purchased Credit-Impaired Loans

Purchased credit-impaired loans decreased to $4.9 billion as of September 30, 2011, from $5.6 billion as of December 31, 2010. Our portfolio of purchased credit-impaired loans consists of loans acquired in the Chevy Chase Bank transaction, which were recorded at fair value at the date of acquisition. The fair value of these loans included an estimate of credit losses expected to be realized over the remaining lives of the loans. Therefore, no allowance for loan and lease losses was recorded for these loans as of the acquisition date. However, we regularly update the amount of expected principal and interest to be collected from these loans and evaluate the results on an aggregated pool basis for loans with common risk characteristics. Probable decreases in expected loan principal cash flows would trigger the recognition of impairment through our provision for loan and lease losses. Probable and significant increases in expected cash flows would first reverse any previously recorded allowance for loan and losses, with any remaining increase in expected cash flows recognized prospectively in interest income over the remaining estimated life of the underlying loans. In the first quarter of 2011, we recorded impairment of $8 million related to certain loan pools. In the second quarter of 2011, we reduced the allowance related to these loans by $28 million as a result of an increase in expected loan principal cash flows. In the third quarter of 2011, we recorded impairment of $9 million related to certain loan pools. Cumulative impairment recognized on PCI loans totaled $22 million as of September 30, 2011. The credit performance of the remaining pools has generally been in line with our expectations, and, in some cases, more favorable than expected, which has resulted in the reclassification of amounts from the nonaccretable difference to the accretable yield. We provide additional information on the PCI loans acquired from Chevy Chase Bank in “Note 5—Loans.”

Allowance for Loan and Lease Losses

Our allowance for loan and lease losses represents management’s best estimate of incurred loan and lease credit losses inherent in our held-for-investment portfolio as of each balance sheet date. We do not maintain an allowance for held-for-sale loans or purchased credit-impaired loans that are performing in accordance with or better than our expectations as of the date of acquisition, as the fair values of these loans already reflect a credit component. The allowance for loan and lease losses is increased through the provision for loan and lease losses and reduced by net charge-offs. The provision for loan and lease losses, which is charged to earnings, reflects credit losses we believe have been incurred and will eventually be reflected over time in our charge-offs. Charge-offs of uncollectible amounts are deducted from the allowance and subsequent recoveries are added.

Table 18, which displays changes in our allowance for loan and lease losses for the three and nine months ended September 30, 2011 and 2010, details, by loan type, the provision for credit losses recognized in our consolidated statements of income each period and the charge-offs recorded against our allowance for loan and lease losses.

 

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Table 18: Allowance for Loan and Lease Losses Activity

 

     Three Months  Ended
September 30,
    Nine Months Ended
September 30,
 
(Dollars in millions)        2011             2010             2011             2010      

Balance at beginning of period, as reported

   $ 4,488      $ 6,799      $ 5,628      $ 4,127   

Impact from January 1, 2010 adoption of new consolidation accounting

     —          —          —          4,317   
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance at beginning of period, as adjusted

   $ 4,488      $ 6,799      $ 5,628      $ 8,444   

Provision for loan and lease losses(1)(2)

     633        867        1,553        3,069   

Charge-offs:

        

Credit Card business:(2)

        

Domestic credit card and installment loans

     (783     (1,381     (2,780     (4,793

International credit card and installment loans

     (184     (182     (582     (591
  

 

 

   

 

 

   

 

 

   

 

 

 

Total credit card

     (967     (1,563     (3,362     (5,384
  

 

 

   

 

 

   

 

 

   

 

 

 

Consumer Banking business:

        

Auto

     (129     (166     (372     (508

Home loan

     (20     (14     (74     (68

Retail banking

     (23     (32     (78     (97
  

 

 

   

 

 

   

 

 

   

 

 

 

Total consumer banking

     (172     (212     (524     (673
  

 

 

   

 

 

   

 

 

   

 

 

 

Commercial Banking business:

        

Commercial and multifamily real estate

     (6     (60     (45     (162

Middle market

     (14     (17     (28     (62

Specialty lending

     (6     (8     (17     (26
  

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial lending

     (26     (85     (90     (250

Small-ticket commercial real estate

     (9     (17     (62     (63
  

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial banking

     (35     (102     (152     (313
  

 

 

   

 

 

   

 

 

   

 

 

 

Other loans

     (9     (23     (47     (89
  

 

 

   

 

 

   

 

 

   

 

 

 

Total charge-offs

     (1,183     (1,900     (4,085     (6,459
  

 

 

   

 

 

   

 

 

   

 

 

 

Recoveries:

        

Credit Card business:

        

Domestic credit card and installment loans

     256        269        811        853   

International credit card and installment loans

     50        43        168        123   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total credit card

     306        312        979        976   
  

 

 

   

 

 

   

 

 

   

 

 

 

Consumer Banking business:

        

Automobile

     46        48        148        168   

Home loans

     5        1        21        3   

Retail banking

     6        6        19        19   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total consumer banking

     57        55        188        190   
  

 

 

   

 

 

   

 

 

   

 

 

 

Commercial Banking business:

        

Commercial and multifamily real estate

     3        —          10        13   

Middle market

     2        6        8        10   

Specialty lending

     1        3        4        4   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial lending

     6        9        22        27   

Small-ticket commercial real estate

     —          —          4        2   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial banking

     6        9        26        29   

Other loans

     2        2        4        6   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total recoveries

     371        378        1,197        1,201   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net charge-offs

     (812     (1,522     (2,888     (5,258

Impact from loan sales and other changes

     (29 )(3)      31 (4)      (13 )(3)      (80 )(4) 
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance at end of period(2)

   $ 4,280      $ 6,175      $ 4,280      $ 6,175   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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(1) 

Excludes negative provision for unfunded lending commitments of $11 million and $8 million for the three months ended September 30, 2011 and 2010, respectively, and a provision of $54 million and $7 million for the nine months ended September 30, 2010, respectively.

(2)

The reduction in the provision for loan and lease losses attributable to Kohl’s was $236 million for the first nine months of 2011. Loss sharing amounts attributable to Kohl’s reduced charge-offs by $39 million and $80 million in the third quarter and first nine months of 2011, respectively. The expected reimbursement from Kohl’s netted in our allowance for loan and lease losses was approximately $156 million as of September 30, 2011.

(3)

Includes foreign translation adjustment of $29 million and $13 million for the third quarter and first nine months of 2011, respectively.

(4)

Includes a reduction in our allowance for loan and lease losses of $73 million in the first quarter of 2010 attributable to the sale of certain interest-only option-ARM bonds and the deconsolidation of the related securitization trusts related to Chevy Chase Bank in the first quarter of 2010.

Table 19 presents an allocation of our allowance for loan and lease losses by loan category as of September 30, 2011 and December 31, 2010:

Table 19: Allocation of the Allowance for Loan and Lease Losses

 

     September 30, 2011     December 31, 2010  
(Dollars in millions)    Amount      % of  Total
Loans(1)
    Amount      % of  Total
Loans(1)
 

Credit Card:

          

Domestic credit card and installment loans(2)

   $ 2,409         4.48   $ 3,581         6.65

International credit card and installment loans

     506         6.16        460         6.12   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total credit card(2)

     2,915         4.70        4,041         6.58   
  

 

 

    

 

 

   

 

 

    

 

 

 

Consumer Banking:

          

Auto

     358         1.75        353         1.98   

Home loan

     93         0.85        112         0.93   

Retail banking

     169         4.21        210         4.76   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total consumer banking

     620         1.75        675         1.96   
  

 

 

    

 

 

   

 

 

    

 

 

 

Commercial Banking:

          

Commercial and multifamily real estate

     411         2.86        495         3.70   

Middle market

     113         0.95        162         1.55   

Specialty lending

     74         1.75        91         2.26   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total commercial lending

     598         1.96        748         2.68   

Small-ticket commercial real estate

     102         6.49        78         4.23   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total commercial banking

     700         2.18        826         2.78   
  

 

 

    

 

 

   

 

 

    

 

 

 

Other loans

     45         9.68        86         19.07   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total(2)

   $ 4,280         3.29   $ 5,628         4.47
  

 

 

    

 

 

   

 

 

    

 

 

 

Total allowance coverage ratios:

          

Period-end loans

   $ 129,952         3.29   $ 125,947         4.47

Nonperforming loans(3)

     1,172         365.17        1,225         459.43   

Allowance coverage ratios by loan category:

          

Credit card (30 + day delinquent loans)

   $ 2,401         121.41   $ 2,632         153.53

Consumer banking (30 + day delinquent loans)

     1,969         31.49        2,050         32.93   

Commercial banking (nonperforming loans)

     459         152.51        495         166.87   

 

(1)

Calculated based on the allowance for loan and lease losses attributable to each loan category divided by the outstanding balance of loans within the specified loan category.

 

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(2) 

The reduction in the provision for loan and lease losses attributable to Kohl’s was $236 million in the first nine months of 2011. Loss sharing amounts attributable to Kohl’s reduced net charge-offs by $39 million and $80 million in the third quarter and first nine months of 2011, respectively. The expected reimbursement from Kohl’s netted in our allowance for loan and lease losses was approximately $156 million as of September 30, 2011.

(3)

As permitted by regulatory guidance issued by the FFIEC, our policy is generally not to classify credit card loans as nonperforming. We accrue interest on credit card loans through the date of charge-off, typically in the period that the loan becomes 180 days past due. The allowance for loan and lease losses as a percentage of nonperforming loans, excluding the allowance related to our credit card loans, was 116.47% as of September 30, 2011 and 129.55% as of December 31, 2010.

Our allowance for loan and lease losses decreased by $1.3 billion during the first nine months of 2011 to $4.3 billion. The decrease in our allowance reflects the improvements in credit performance across our portfolios, which have generally outpaced the modest and fragile economic recovery. These improvements are due in part to actions taken over the past several years to tighten our underwriting standards and exit certain portfolios. Our allowance as a percentage of our total loan portfolio also decreased to 3.29% as of September 30, 2011, from 4.47% as of December 31, 2010.

Deposits

Our deposits have become our largest source of funding for our operations and asset growth. Total deposits increased by $6.1 billion, or 5%, in the first nine months of 2011, to $128.3 billion as of September 30, 2011. The increase in deposits reflects our increased retail marketing efforts to attract new business and continued strategy to leverage our bank outlets to attract lower cost deposit funding. We provide additional information on the composition of our deposits, average outstanding balances, interest expense and yield, below in “Liquidity and Funding.”

Senior and Subordinated Notes and Other Borrowings

Senior and subordinated notes and other borrowings increased to $17.2 billion as of September 30, 2011, from $14.9 billion as of December 31, 2010. The $2.3 billion increase in senior and subordinated notes and other borrowing was primarily attributable to the proceeds of approximately $3.0 billion from our public debt offering in July 2011. These proceeds were partially offset by the maturity in the third quarter of 2011 of a senior note totaling $854 million.

The public debt offering included four different series of our senior notes (the “2011 Notes”): $250 million aggregate principal amount of our Floating Rate Senior Notes due 2014; $750 million aggregate principal amount of our 2.125% Senior Notes due 2014; $750 million aggregate principal amount of our 3.150% Senior Notes due 2016 and $1.25 billion aggregate principal amount of our 4.750% Senior Notes due 2021. If we do not consummate the ING Direct acquisition on or prior to June 30, 2012, or if the purchase and sale agreement governing the ING Direct acquisition is terminated at any time prior to such date, we must redeem all the 2011 Notes at a redemption price equal to 101% of the aggregate principal amount of the 2011 Notes, plus accrued and unpaid interest from July 19, 2011, or the most recent date to which interest has been paid or provided for, as the case may be, to but excluding the mandatory redemption date of the 2011 Notes.

Securitized Debt Obligations

Borrowings owed to securitization investors decreased by $9.7 billion to $17.1 billion as of September 30, 2011, from $26.8 billion as of December 31, 2010. This decrease was attributable to pay downs of the loans underlying the consolidated securitization trusts.

Potential Mortgage Representation & Warranty Liabilities

In recent years, we acquired three subsidiaries that originated residential mortgage loans and sold them to various purchasers, including purchasers who created securitization trusts. These subsidiaries are Capital One Home

 

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Loans, which was acquired in February 2005; GreenPoint Mortgage Funding, Inc. (“GreenPoint”), which was acquired in December 2006 as part of the North Fork acquisition; and Chevy Chase Bank, which was acquired in February 2009 and subsequently merged into CONA.

In connection with their sales of mortgage loans, the subsidiaries entered into agreements containing varying representations and warranties about, among other things, the ownership of the loan, the validity of the lien securing the loan, the loan’s compliance with any applicable loan criteria established by the purchaser, including underwriting guidelines and the ongoing existence of mortgage insurance, and the loan’s compliance with applicable federal, state and local laws. The representations and warranties do not address the credit performance of the mortgage loans, but mortgage loan performance often influences whether a claim for breach of representation and warranty will be asserted and has an effect on the amount of any loss in the event of a breach of a representation or warranty.

Each of these subsidiaries may be required to repurchase mortgage loans in the event of certain breaches of these representations and warranties. In the event of a repurchase, the subsidiary is typically required to pay the then unpaid principal balance of the loan together with interest and certain expenses (including, in certain cases, legal costs incurred by the purchaser and/or others). The subsidiary then recovers the loan or, if the loan has been foreclosed, the underlying collateral. The subsidiary is exposed to any losses on the repurchased loans after giving effect to any recoveries on the collateral. In some instances, rather than repurchase the loans, a subsidiary may agree to make a cash payment to make an investor whole on losses or to settle repurchase claims. In addition, our subsidiaries may be required to indemnify certain purchasers and others against losses they incur as a result of certain breaches of representations and warranties. In some cases, the amount of such losses could exceed the repurchase amount of the related loans.

These subsidiaries, in total, originated and sold to non-affiliates approximately $111 billion original principal balance of mortgage loans between 2005 and 2008, which are the years (or “vintages”) with respect to which our subsidiaries have received the vast majority of the repurchase requests and other related claims.

The following table presents the original principal balance of mortgage loan originations, by vintage, for the three general categories of purchasers of mortgage loans and the outstanding principal balance as of September 30, 2011 and December 31, 2010:

Table 20: Unpaid Principal Balance of Mortgage Loans Originated and Sold to Third Parties Based on Category of Purchaser

 

     Unpaid Principal Balance                                     
     September 30,
2011
     December 31,
2010
     Original Unpaid Principal Balance  
(Dollars in billions)          Total      2008      2007      2006      2005  

Government sponsored enterprises (“GSEs”)(1)

   $ 5       $ 5       $ 11       $ 1       $ 4       $ 3       $ 3   

Insured Securitizations

     7         7         18         —           1         8         9   

Uninsured Securitizations and Other

     30         33         82         3         16         30         33   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 42       $ 45       $ 111       $ 4       $ 21       $ 41       $ 45   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) 

GSEs include Fannie Mae and Freddie Mac.

Between 2005 and 2008, our subsidiaries sold an aggregate amount of $11 billion in original principal balance mortgage loans to the GSEs.

Of the $18 billion in original principal balance of mortgage loans sold directly by our subsidiaries to private-label purchasers who placed the loans into securitizations supported by bond insurance (“Insured Securitizations”), approximately $13 billion original principal balance was placed in securitizations as to which the monoline bond

 

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insurers have made repurchase requests or loan file requests to one of our subsidiaries (“Active Insured Securitizations”), and the remaining approximately $5 billion original principal balance was placed in securitizations as to which the monoline bond insurers have not made repurchase requests or loan file requests to one of our subsidiaries (“Inactive Insured Securitizations”). Insured Securitizations often allow the monoline bond insurer to act independently of the investors. Bond insurers typically have indemnity agreements directly with both the mortgage originators and the securitizers, and they often have super-majority rights within the trust documentation that allow them to direct trustees to pursue mortgage repurchase requests without coordination with other investors.

Because we do not service most of the loans our subsidiaries sold to others, we do not have complete information about the current ownership of the $82 billion in original principal balance of mortgage loans not sold directly to GSEs or placed in Insured Securitizations. We have determined based on information obtained from third-party databases that about $49 billion original principal balance of these mortgage loans are currently held by private-label publicly issued securitizations not supported by bond insurance (“Uninsured Securitizations”). In contrast with the bond insurers in Insured Securitizations, investors in Uninsured Securitizations often face a number of legal and logistical hurdles before they can direct a securitization trustee to pursue mortgage repurchases, including the need to coordinate with a certain percentage of investors holding the securities and to indemnify the trustee for any litigation it undertakes. An additional approximately $23 billion original principal balance of mortgage loans were initially sold to private investors as whole loans. Of this amount, we believe approximately $10 billion original principal balance of mortgage loans were ultimately purchased by GSEs. For purposes of our reserves-setting process, we consider these loans to be private-label loans rather than GSE loans. We do not have information about the current holders or disposition of the remaining $10 billion original principal balance of mortgage loans in this category.

With respect to the $111 billion in original principal balance of mortgage loans originated and sold to others between 2005 and 2008, we estimate that approximately $42 billion in unpaid principal balance remains outstanding as of September 30, 2011, approximately $14 billion in losses have been realized and approximately $11 billion in unpaid principal balance is at least 90 days delinquent. Because we do not service most of the loans we sold to others, we do not have complete information about the underlying credit performance levels for some of these mortgage loans. These amounts reflect our best estimates, including extrapolations where necessary. These extrapolations occur on the approximately $10 billion original principal balance of mortgage loans for which we do not have information about the current holders or any underlying credit performance. These estimates could change as we get additional data or refine our analysis.

The subsidiaries had open repurchase requests relating to approximately $1.9 billion original principal balance of mortgage loans as of September 30, 2011, compared with $1.7 billion as of June 30, 2011 and $1.6 billion as of December 31, 2010. As of September 30, 2011, the majority of new repurchase demands received over the last year and, as discussed below, the majority of our $892 million reserve relates to the $24 billion of original principal balance of mortgage loans originally sold to the GSEs or to Active Insured Securitizations. Currently, repurchase demands predominantly relate to the 2006 and 2007 vintages. We have received relatively few repurchase demands from the 2008 and 2009 vintages, mostly because GreenPoint ceased originating mortgages in August 2007.

Table 21 presents information on pending repurchase requests by counterparty category and timing of initial repurchase request. The amounts presented are based on original loan principal balances.

 

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Table 21: Open Pipeline All Vintages (all entities)(1)

 

(Dollars in millions)    GSEs     Insured
Securitizations
    Uninsured
Securitizations
and Other
    Total  

Open claims as of December 31, 2009

   $ 61      $ 366      $ 588      $ 1,015   

Gross new demands received

     204        645        104        953   

Loans repurchased/made whole(2)

     (52     (179     (5     (236

Demands rescinded(2)

     (87     —          (22     (109
  

 

 

   

 

 

   

 

 

   

 

 

 

Open claims as of December 31, 2010

   $ 126      $ 832      $ 665      $ 1,623   

Gross new demands received

     142        171        102        415   

Loans repurchased/made whole

     (56     (15     (14     (85

Demands rescinded

     (65     —          (16     (81

Reclassifications(3)

     4        70        (74     —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Open claims as of September 30, 2011

   $ 151      $ 1,058      $ 663      $ 1,872   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) 

The open pipeline includes all repurchase requests ever received by our subsidiaries where the requesting party has not formally rescinded the repurchase request and where our subsidiary has not agreed to either repurchase the loan at issue or make the requesting party whole with respect to its losses. Accordingly, repurchase requests denied by our subsidiaries and not pursued by the counterparty remain in the open pipeline. Moreover, repurchase requests submitted by parties without contractual standing to pursue repurchase requests are included within the open pipeline unless the requesting party has formally rescinded its repurchase request. Finally, the amounts reflected in this chart are original principal balance amounts and do not correspond to the losses our subsidiary would incur upon the repurchase of these loans.

(2) 

Activity in 2010 relates to repurchase demands from all years prior.

(3) 

Represents adjustments to correct the counterparty category as of September 30, 2011 for amounts that were misclassified. The reclassification had no impact on the total pending repurchase requests; however, it resulted in an increase in open claims attributable to insured securitizations and a decrease in open claims attributable to GSEs and Uninsured Securitizations & Other.

We have established representation and warranty reserves for losses associated with the mortgage loans sold by each subsidiary that we consider to be both probable and reasonably estimable, including both litigation and non-litigation liabilities. These reserves are reported in our consolidated balance sheets as a component of other liabilities. The reserve setting process relies heavily on estimates, which are inherently uncertain, and requires the application of judgment. We evaluate these estimates on a quarterly basis. We build our representation and warranty reserves through the provision for repurchase losses, which we report in our consolidated statements of income as a component of non-interest income for loans originated and sold by Chevy Chase Bank and Capital One Home Loans and as a component of discontinued operations for loans originated and sold by GreenPoint. In establishing the representation and warranty reserves, we consider a variety of factors depending on the category of purchaser.

In establishing reserves for the $11 billion original principal balance of GSE loans, we rely on the historical relationship between GSE loan losses and repurchase outcomes to estimate: (1) the percentage of current and future GSE loan defaults that we anticipate will result in repurchase requests from the GSEs over the lifetime of the GSE loans; and (2) the percentage of those repurchase requests that we anticipate will result in actual repurchases. We also rely on estimated collateral valuations and loss forecast models to estimate our lifetime liability on GSE loans. This reserving approach to the GSE loans reflects the historical interaction with the GSEs around repurchase requests, and also includes anticipated repurchases resulting from mortgage insurance rescissions. The GSEs typically have stronger contractual rights than non-GSE counterparties because GSE contracts typically do not contain prompt notice requirements for repurchase requests or materiality qualifications to the representations and warranties. Moreover, although we often disagree with the GSEs about the validity of their repurchase requests, we have established a negotiation pattern whereby the GSEs and our subsidiaries continually negotiate around individual repurchase requests, leading to the GSEs rescinding some

 

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repurchase requests and our subsidiaries agreeing in some cases to repurchase some loans or make the GSEs whole with respect to losses. Our lifetime representation and warranty reserves with respect to GSE loans are grounded in this history.

For the $13 billion original principal balance in Active Insured Securitizations, our reserving approach also reflects our historical interaction with monoline bond insurers around repurchase requests. Typically, monoline bond insurers allege a very high repurchase rate with respect to the mortgage loans in the Active Insured Securitization category. In response to these repurchase requests, our subsidiaries typically request information from the monoline bond insurers demonstrating that the contractual requirements around a valid repurchase request have been satisfied, such as, for example, the typical requirements that the counterparty promptly notify us upon discovery of any breach and that any breach materially and adversely affect the value of the mortgage loan at issue. In response to these requests for supporting documentation, monoline bond insurers typically initiate litigation. Accordingly, our reserves within the Active Insured Securitization are not based upon the historical repurchase rate with monoline bond insurers, but rather upon the expected resolution of litigation with the monoline bond insurers. Every bond insurer within this category is pursuing a substantially similar litigation strategy either through active or probable litigation. Accordingly, our representation and warranty reserves for this category are litigation reserves. In establishing litigation reserves for this category, we consider current and future losses inherent within the securitization and apply legal judgment to the anticipated factual and legal record to estimate the lifetime legal liability for each securitization. Our estimated legal liability for each securitization within this category assumes that we will be responsible for only a portion of the losses inherent in each securitization. Our litigation reserves with respect to both the U.S. Bank Litigation and the DBSP Litigation, in each case as referenced below, are contained within the Active Insured Securitization reserve category. Further, our litigation reserves with respect to indemnification risks from certain representation and warranty lawsuits brought by monoline bond insurers against third-party securitizations sponsors, where GreenPoint provided some or all of the mortgage collateral within the securitization but is not a defendant in the litigation, are also contained within this category. Our estimated legal liability for securitizations within this category often assumes we will pay only a portion of the liabilities ultimately incurred by the party defendants to the litigation.

For the $5 billion original principal balance of mortgage loans in the Inactive Insured Securitizations category and the $82 billion original principal balance of mortgage loans in the Uninsured Securitizations and other whole loan sales categories, we establish reserves by relying on our historical repurchase rates and current negotiation patterns to estimate repurchase liabilities over the next twelve (12) months. We do not believe we can estimate repurchase liability for these categories for a period longer than twelve (12) months because of the relatively irregular nature of repurchase activity within these categories. Some Uninsured Securitization investors from this category who have not made repurchase requests or filed representation and warranty lawsuits have filed actions under federal and/or state securities laws against investment banks and securitization sponsors. Although we face some direct and indirect indemnity risks from these litigations, we have not established reserves with respect to these indemnity risks because we do not consider them to be both probable and reasonably estimable liabilities.

The aggregate reserve for all three subsidiaries was $892 million as of September 30, 2011, compared with $869 million as of June 30, 2011, and $816 million as of December 31, 2010. Almost all of the increase in the reserve from June 30, 2011 is allocated to the Uninsured Securitizations and Other category, resulting from an increase in repurchase activity with respect to certain uninsured investors. We recorded a total provision for repurchase losses for our representation and warranty repurchase exposure of $72 million and $153 million for the three and nine months ended September 30, 2011, respectively, and we had settlements of repurchase requests of $49 million and $77 million for the three and nine months ended September 30, 2011, respectively, that were charged against the reserve.

 

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Table 22 summarizes changes in our representation and warranty reserve for the three and nine months ended September 30, 2011 and 2010, and for full year 2010:

Table 22: Changes in Representation and Warranty Reserve

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
    Full Year  
(Dollars in millions)    2011     2010     2011     2010     2010  

Representation and warranty repurchase reserve, beginning of period(1)

   $ 869      $ 853      $ 816      $ 238      $ 238   

Provision for repurchase losses(2)

     72        16        153        644        636   

Net realized losses

     (49     (33     (77     (46     (58
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Representation and warranty repurchase reserve, end of period(1)

   $ 892      $ 836      $ 892      $ 836      $ 816   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) 

Reported in our consolidated balance sheets as a component of other liabilities.

(2) 

In the third quarter of 2011, we recognized a reduction to the reserve for mortgage repurchase claims of $3 million in our consolidated statements of income as a component of non-interest income. In the first nine months of 2011, we recognized a provision for mortgage repurchase claims of $5 million. In the third quarter and first nine months of 2010, we recognized a provision for mortgage repurchase claims of $16 million and $211 million, respectively. The pre-tax portion of the provision for mortgage repurchase claims recognized in our consolidated statements of income as a component of discontinued operations totaled $75 million and $147 million, for the three and nine months ended September 30, 2011, respectively, and $0 million and $433 million for the three and nine months ended September 30, 2010, respectively.

As indicated in the table below, most of the representation and warranty reserve relates to the $11 billion in original principal balance of mortgage loans sold directly to the GSEs and to the $13 billion in mortgage loans sold to purchasers who placed them into Active Insured Securitizations.

Table 23: Allocation of Representation and Warranty Reserve

 

     Reserve Liability      Loans Sold
2005 to 2008(1)
 
(Dollars in millions, except for loans sold)    September 30,
2011
     December 31,
2010
    

GSEs and Active Insured Securitizations

   $ 771       $ 796       $ 24   

Inactive Insured Securitizations, Uninsured Securitizations and Other

     121         20         87   
  

 

 

    

 

 

    

 

 

 

Total

   $ 892       $ 816       $ 111   
  

 

 

    

 

 

    

 

 

 

 

(1) 

Reflects, in billions, the total original principal balance of mortgage loans originated by our subsidiaries and sold to third party investors between 2005 and 2008.

The adequacy of the reserves and the ultimate amount of losses incurred by our subsidiaries will depend on, among other things, actual future mortgage loan performance, the actual level of future repurchase and indemnification requests (including the extent, if any, to which Inactive Insured Securitizations and other currently inactive investors ultimately assert claims), the actual success rates of claimants, developments in litigation, actual recoveries on the collateral and macroeconomic conditions (including unemployment levels and housing prices).

As part of our business planning processes, we have considered various outcomes relating to the potential future representation and warranty liabilities of our subsidiaries that are possible but do not rise to the level of being both probable and reasonably estimable outcomes that would justify an incremental accrual under applicable accounting standards. We believe that the upper end of the reasonably possible future losses from representation

 

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and warranty claims beyond the current accrual levels, including reasonably possible future losses relating to the US Bank Litigation, DBSP Litigation and the FHLB of Boston Litigation, could be as high as $1.5 billion, an increase of $400 million from the estimate we provided as of June 30, 2011. This increase is attributable to increased activity from uninsured investors, increased governmental and regulatory scrutiny of mortgage practices and continued difficulty in the housing market and overall economy. Notwithstanding our ongoing attempts to estimate a reasonably possible amount of loss beyond our current accrual levels based on current information, it is possible that actual future losses will exceed both the current accrual level and our current estimated upper-end of the amount of reasonably possible losses. There is still significant uncertainty regarding the numerous factors that may impact the ultimate loss levels, including, but not limited to, litigation outcomes, future repurchase claims levels, ultimate repurchase success rates and mortgage loan performance levels.

 

 

OFF-BALANCE SHEET ARRANGEMENTS AND VARIABLE INTEREST ENTITIES

 

In the ordinary course of business, we are involved in various types of arrangements with limited liability companies, partnerships or trusts that often involve special purpose entities and variable interest entities (“VIEs”). Some of these arrangements are not recorded on our consolidated balance sheets or may be recorded in amounts different from the full contract or notional amount of the arrangements, depending on the nature or structure of, and accounting required to be applied to, the arrangement. These arrangements may expose us to potential losses in excess of the amounts recorded in the consolidated balance sheets. Our involvement in these arrangements can take many forms, including securitization and servicing activities, the purchase or sale of mortgage-backed or other asset-backed securities in connection with our home loan portfolio and loans to VIEs that hold debt, equity, real estate or other assets. Under previous accounting guidance, we were not required to consolidate the majority of our securitization trusts because they were qualified special purpose entities. Accordingly, we considered these trusts to be off-balance sheet arrangements.

Our continuing involvement in unconsolidated VIEs primarily consists of certain mortgage loan trusts and community reinvestment and development entities. The carrying amount of assets and liabilities of these unconsolidated VIEs was $2.2 billion and $294 million, respectively, as of September 30, 2011, and our maximum exposure to loss was $2.3 billion. We provide a discussion of our activities related to these VIEs in “Note 7—Variable Interest Entities and Securitizations.”

 

 

RISK MANAGEMENT

 

Our business activities expose us to eight major categories of risks: liquidity risk, credit risk, reputational risk, market risk, strategic risk, operational risk, compliance risk and legal risk. Our risk management framework is intended to identify, assess and mitigate risks that affect or have the potential to affect our business in order to target financial returns commensurate with our risk appetite and to avoid excessive risk-taking. We follow four key risk management principles:

 

   

Individual businesses take and manage risk in pursuit of strategic, financial and other business objectives.

 

   

Independent risk management organizations support individual businesses by providing risk management tools and policies and by aggregating risks; in some cases, risks are managed centrally.

 

   

The Board of Directors and senior management review our aggregate risk position, establish the risk appetite and work with management to ensure conformance to policy and adherence to our adopted mitigation strategy.

We employ a top risk identification system to maintain the appropriate focus on the risks and issues that may have the most impact and to identify emerging risks of consequence.

 

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LIQUIDITY AND CAPITAL MANAGEMENT

 

Liquidity Management

We have established liquidity guidelines that are intended to ensure that we have sufficient asset-based liquidity to withstand the potential impact of deposit attrition or diminished liquidity in the funding markets. Our guidelines include maintaining an adequate liquidity reserve to cover our potential funding requirements and diversified funding sources to avoid over-dependence on volatile, less reliable funding markets. Our liquidity reserves consist of cash and cash equivalents and unencumbered available-for-sale securities. Table 24 below presents the composition of our liquidity reserves as of September 30, 2011 and December 31, 2010.

Table 24: Liquidity Reserves

 

(Dollars in millions)    September 30,
2011
    December 31,
2010
 

Cash and cash equivalents

   $ 6,358      $ 5,249   

Securities available-for-sale(1)

     38,400        41,537   

Less: Pledged available-for-sale securities

     (8,850     (9,963
  

 

 

   

 

 

 

Unencumbered available-for-sale securities

     29,550        31,574   

Undrawn committed securitization borrowing facilities

     —          207   
  

 

 

   

 

 

 

Total liquidity reserves

   $ 35,908      $ 37,030   
  

 

 

   

 

 

 

 

(1)

The weighted average life of our available-for-sale securities was approximately 2.9 years and 3.8 years as of September 30, 2011, and December 31, 2010, respectively.

Funding

Our funding objective is to establish an appropriate maturity profile using a cost-effective mix of both short-term and long-term funds. We use a variety of funding sources, including deposits, loan securitizations, debt and equity securities, securitization borrowing facilities and Federal Home Loan Bank (“FHLB”) advances.

Deposits

Our deposits provide a stable and relatively low cost of funds and have become our largest source of funding. We have expanded our opportunities for deposit growth through direct and indirect marketing channels, our existing branch network and branch expansion. These channels offer a broad range of deposit products that include demand deposits, money market deposits, negotiable order of withdrawal (“NOW”) accounts, savings accounts and certificates of deposit. Table 25 presents the composition of our deposits by type as of September 30, 2011 and December 31, 2010.

Table 25: Deposits

 

(Dollars in millions)    September 30,
2011
     December 31,
2010
 

Non-interest bearing

   $ 17,541       $ 15,048   

NOW accounts

     12,777         13,536   

Money market deposit accounts

     47,745         44,485   

Savings accounts

     31,225         26,077   

Other consumer time deposits

     12,972         15,753   
  

 

 

    

 

 

 

Total core deposits

     122,260         114,899   

Public fund certificates of deposit $100,000 or more

     84         177   

Certificates of deposit $100,000 or more

     5,149         6,300   

Foreign time deposits

     825         834   
  

 

 

    

 

 

 

Total deposits

   $ 128,318       $ 122,210   
  

 

 

    

 

 

 

 

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Total deposits increased by $6.1 billion, or 5.0%, in the first nine months of 2011, to $128.3 billion as of September 30, 2011. Of our total deposits, $825 million and $834 million were held in foreign banking offices as of September 30, 2011 and December 31, 2010, respectively. Large domestic denomination certificates of deposits of $100,000 or more represented $5.2 billion and $6.5 billion of our total deposits as of September 30, 2011 and December 31, 2010, respectively. Our funding and liquidity strategy takes into consideration the scheduled maturities of large denomination time deposits. Of the $5.2 billion in large domestic denomination certificates of deposit as of September 30, 2011, $1.0 billion is scheduled to mature within the next three months, $1.1 billion is scheduled to mature between three and 12 months and $3.1 billion is scheduled to mature over 12 months. Based on past activity, we expect to retain a portion of these deposits as they mature.

We have brokered deposits, which we obtained through the use of third-party intermediaries. Brokered deposits are included in money market deposit accounts and other consumer time deposits in Table 25 above. The Federal Deposit Insurance Corporation Improvement Act of 1991 limits the use of brokered deposits to “well capitalized” insured depository institutions and, with a waiver from the Federal Deposit Insurance Corporation, to “adequately capitalized” institutions. COBNA and CONA were “well capitalized,” as defined under the federal banking regulatory guidelines, as of September 30, 2011, and therefore permitted to maintain brokered deposits. Our brokered deposits totaled $14.4 billion, or 11%, of total deposits as of September 30, 2011. Brokered deposits totaled $16.5 billion, or 14%, of total deposits as of December 31, 2010. Based on our historical access to the brokered deposit market, we expect to replace maturing brokered deposits with new brokered deposits or direct deposits and branch deposits.

Other Funding Sources

We also access the capital markets to meet our funding needs through the use of federal funds purchased and securities loaned or sold under agreements to purchase, the issuance of senior and subordinated notes and other borrowings and, to a lesser extent, loan securitization transactions. In addition, we utilize advances from the FHLB for our funding needs. FHLB advances are secured by our investment securities and certain of our loan portfolios.

Our debt, including federal funds purchased and securities loaned or sold under agreements to repurchase, senior and subordinated notes and other borrowings, such as FHLB advances, but excluding securitized debt obligations, totaled $17.2 billion as of September 30, 2011, up from $14.9 billion as of December 31, 2010. We had no open committed loan securitization conduit lines as of September 30, 2011. The $2.3 billion increase in our debt, excluding securitized debt obligations, was primarily attributable to the proceeds of approximately $3.0 billion from the issuance of senior notes in the third quarter of 2011, which was partially offset by the maturity of one senior note totaling $854 million in the third quarter of 2011.

Our public debt offering in the third quarter of 2011 included four different series of our senior notes: $250 million aggregate principal amount of our Floating Rate Senior Notes due 2014; $750 million aggregate principal amount of our 2.125% Senior Notes due 2014; $750 million aggregate principal amount of our 3.150% Senior Notes due 2016 and $1.25 billion aggregate principal amount of our 4.750% Senior Notes due 2021. If we do not consummate the ING Direct acquisition on or prior to June 30, 2012, or if the purchase and sale agreement governing the ING Direct acquisition is terminated at any time prior to such date, we must redeem all of these notes at a redemption price equal to 101% of the aggregate principal amount of the 2011 Notes, plus accrued and unpaid interest from July 19, 2011, or the most recent date to which interest has been paid or provided for, as the case may be, to but excluding the mandatory redemption date of the 2011 Notes.

We participate in the federal funds market daily to take advantage of attractive offers and to keep a visible presence in the market, which is intended to ensure that we are able to access the federal funds market in a time of need. We expect monthly fluctuations in our borrowings, as borrowing amounts are highly dependent on our counterparties’ cash positions. Our FHLB membership is secured by our investment in FHLB stock, which totaled $218 million as of September 30, 2011.

 

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Table 26 presents our short-term borrowings and long-term debt and the maturity profile based on expected maturities as of September 30, 2011. We provide additional information on our short-term borrowings and long-term debt in “Note 9—Deposits and Borrowings.”

Table 26: Expected Maturity Profile of Short-term Borrowings and Long-term Debt

 

(Dollars in millions)    Up to 1
Year
    > 1 Year
to 2 Years
    > 2 Years
to 3 Years
    > 3 Years
to 4 Years
    > 4 Years
To 5 Years
    > 5 Years     Total  

Short-term borrowings:

              

Federal funds purchased and securities loaned or sold under agreements to repurchase

   $ 1,441      $ —        $ —        $ —        $ —        $ —        $ 1,441   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total short-term borrowings

     1,441        —          —          —          —          —          1,441   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Long-term debt:(1)

              

Securitized debt obligations

     4,671        3,650        2,907        502        1,330        4,060        17,120   

Senior and subordinated notes:

              

Unsecured senior debt

     285        —          2,632        413        749        3,033        7,112   

Unsecured subordinated debt

     360        523        107        —          1,199        1,750        3,939   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total senior and subordinated notes

     645        523        2,739        413        1,948        4,783        11,051   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other long-term borrowings:

              

Junior subordinated debt

     —          —          —          —          —          3,642        3,642   

FHLB advances

     15        19       948       15       9       55       1,061   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other long-term borrowings

     15        19       948       15       9       3,697       4,703   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total long-term debt(2)

     5,331        4,192        6,594        930        3,287        12,540        32,874   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total short-term borrowings and long-term debt

   $ 6,772      $ 4,192      $ 6,594      $ 930      $ 3,287      $ 12,540      $ 34,315   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Percentage of total

     20     12     19     3     10     36     100
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1)

Includes fair value adjustments of $830 million as of September 30, 2011.

(2)

Includes unamortized net discount of $28 million as of September 30, 2011.

Borrowing Capacity

As of September 30, 2011, we had an effective shelf registration statement filed with the U.S. Securities & Exchange Commission (“SEC”) under which, from time to time, we may offer and sell an indeterminate aggregate amount of senior or subordinated debt securities, preferred stock, depository shares representing preferred stock, common stock, purchase contracts, warrants, units, trust preferred securities, junior subordinated debt securities, guarantees of trust preferred securities and certain back-up obligations. There is no limit under this shelf registration statement to the amount or number of such securities that we may offer and sell. Under SEC rules, the shelf registration statement, which we filed in May 2009, expires three years after filing. As previously discussed, during the third quarter of 2011, we issued four different series of our senior notes for total proceeds of approximately $3.0 billion. The offering of senior notes included $250 million aggregate principal amount of our Floating Rate Senior Notes due 2014, $750 million aggregate principal amount of our 2.125% Senior Notes due 2014, $750 million aggregate principal amount of our 3.150% Senior Notes due 2016 and $1.25 billion aggregate principal amount of our 4.750% Senior Notes due 2021.

 

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In addition to issuance capacity under the shelf registration statement, we have access to other borrowing programs. Table 27 summarizes our borrowing capacity as of September 30, 2011.

Table 27: Borrowing Capacity

 

(Dollars in millions)    Capacity(1)      Outstanding      Availability(1)      Termination  Date(2)  

FHLB advances and letters of credit(3)

   $ 8,277       $ 1,297       $ 6,980         —     

 

(1)

All funding sources are non-revolving. Funding availability under all other sources is subject to market conditions. Capacity is the maximum amount that can be borrowed. Availability is the amount that can still be borrowed against the facility.

(2)

Refers to the date the facility terminates, where applicable.

(3)

The ability to draw down funding is based on membership status, and the amount is dependent upon the Banks’ ability to post collateral.

Credit Ratings

Rating agencies base their ratings on numerous factors, including liquidity, capital adequacy, asset quality and quality of earnings. Significant changes in these factors could result in different ratings. Such ratings help to support our cost effective unsecured funding as part of our overall financing programs. Table 28 provides a summary of the credit ratings for the senior unsecured debt of Capital One Financial Corporation, COBNA and CONA as of September 30, 2011.

Table 28: Senior Unsecured Debt Credit Ratings

 

     As of September 30, 2011  
     Capital One
Financial Corporation
    Capital One Bank
(USA), N.A.
    Capital One, N.A.  

Moody’s Investor Services (“Moody’s”)

     Baa1        A3        A3   

Standard & Poor’s (“S&P”)

     BBB        BBB+        BBB+   

Fitch Ratings (“Fitch”)

     A-        A-        A-   

Dominion Bond Rating Services (“DBRS”)

     BBB **      A     A

 

* low
** high

As of October 31, 2011, DBRS had us on a stable outlook while Fitch, Moody’s and S&P had us on negative outlook.

Capital Management

The level and composition of our equity capital are determined by multiple factors, including our consolidated regulatory capital requirements and an internal risk-based capital assessment, and may also be influenced by rating agency guidelines, subsidiary capital requirements, the business environment, conditions in the financial markets and assessments of potential future losses due to adverse changes in our business and market environments.

Capital Standards and Prompt Corrective Action

Bank holding companies and national banks are subject to capital adequacy standards adopted by the Federal Reserve and the Office of the Comptroller of the Currency (“OCC”), respectively. The capital adequacy standards set forth minimum risk-based and leverage capital requirements that are based on quantitative and

 

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qualitative measures of their assets and off-balance sheet items. Under the capital adequacy standards, bank holding companies and banks currently are required to maintain a Tier 1 risk-based capital ratio of at least 4%, a total risk-based capital ratio of at least 8%, and a Tier 1 leverage capital ratio of at least 4% (3% for banks that meet certain specified criteria, including excellent asset quality, high liquidity, low interest rate exposure and the highest regulatory rating). Table 29 provides the details of the calculation of our capital ratios as of September 30, 2011 and December 31, 2010.

National banks also are subject to prompt corrective action capital regulations. Under prompt corrective action regulations, a bank is considered to be well capitalized if it maintains a Tier 1 risk-based capital ratio of at least 6% (200 basis points higher than the above minimum capital standard), a total risk-based capital ratio of at least 10% (200 basis points higher than the above minimum capital standard), a Tier 1 leverage capital ratio of at least 5% and is not subject to any supervisory agreement, order or directive to meet and maintain a specific capital level for any capital reserve. A bank is considered to be adequately capitalized if it meets the above minimum capital ratios and does not otherwise meet the well capitalized definition. Currently, prompt corrective action capital requirements do not apply to bank holding companies.

In addition to disclosing our regulatory capital ratios, we also disclose Tier 1 common equity and TCE ratios, which are non-GAAP measures widely used by investors, analysts, rating agencies and bank regulatory agencies to assess the capital position of financial services companies. There is currently no mandated minimum or “well capitalized” standard for Tier 1 common equity; instead the risk-based capital rules state that voting common stockholders’ equity should be the dominant element within Tier 1 common equity. While these non-GAAP capital measures are widely used by investors, analysts and bank regulatory agencies to assess the capital position of financial services companies, they may not be comparable to similarly titled measures reported by other companies. We provide information on the calculation of these ratios and non-GAAP reconciliation in “Supplemental Tables” below.

Capital Ratios

Table 29 provides a comparison of our capital ratios under the Federal Reserve’s capital adequacy standards and the capital ratios of the Banks under the OCC’s capital adequacy standards as of September 30, 2011 and December 31, 2010. Table 30 provides the details of the calculation of our capital ratios.

Table 29: Capital Ratios Under Basel I(1)

 

     September 30, 2011     December 31, 2010  
(Dollars in millions)    Capital
Ratio
    Minimum
Capital
Adequacy
    Well
Capitalized
    Capital
Ratio
    Minimum
Capital
Adequacy
    Well
Capitalized
 

Capital One Financial Corp.(2)

            

Tier 1 common equity(3)

     10.0     N/A        N/A        8.8     N/A        N/A   

Tier 1 risk-based capital(4)

     12.4        4.0     6.0     11.6        4.0     6.0

Total risk-based capital(5)

     15.4        8.0        10.0        16.8        8.0        10.0   

Tier 1 leverage(6)

     9.9        4.0        N/A        8.1        4.0        N/A   

Capital One Bank (USA) N.A.

            

Tier 1 risk-based capital

     13.0     4.0     6.0     13.5     4.0     6.0

Total risk-based capital

     17.0        8.0        10.0        23.6        8.0        10.0   

Tier 1 leverage

     11.3        4.0        5.0        8.3        4.0        5.0   

Capital One, N.A.

            

Tier 1 risk-based capital

     12.3     4.0     6.0     11.1     4.0     6.0

Total risk-based capital

     13.5        8.0        10.0        12.4        8.0        10.0   

Tier 1 leverage

     9.2        4.0        5.0        8.1        4.0        5.0   

 

(1)

Calculated under capital standards and regulations based on the international capital framework commonly known as Basel I.

 

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(2)

The regulatory framework for prompt corrective action does not apply to Capital One Financial Corp. because it is a bank holding company.

(3)

Tier 1 common equity ratio is a non-GAAP measure calculated based on Tier 1 common equity divided by risk-weighted assets.

(4)

Calculated based on Tier 1 capital divided by risk-weighted assets.

(5)

Calculated based on Total risk-based capital divided by risk-weighted assets.

(6)

Calculated based on Tier 1 capital divided by quarterly average total assets, after certain adjustments.

We exceeded minimum capital requirements and met the “well capitalized” ratio levels for total risk-based capital and Tier 1 risk-based capital under Federal Reserve rules for bank holding companies as of September 30, 2011. The Banks also exceeded minimum regulatory requirements under the OCC’s applicable capital adequacy guidelines and were “well capitalized” under prompt corrective action requirements as of September 30, 2011. Based on our current understanding of the Basel III framework, which has not been implemented by the U.S. banking agencies and is subject to change, we estimate that our Tier 1 common equity ratio was 10.1% as of September 30, 2011. See “Supplemental Tables—Table B: Reconciliation of Basel III Capital Measures” for a calculation of this measure.

Table 30: Risk-Based Capital Components Under Basel I(1)

 

(Dollars in millions)    September 30,
2011
    December 31,
2010
 

Total stockholders’ equity

   $ 29,378      $ 26,541   

Less: Net unrealized gains recorded in AOCI(2)

     (401     (368

Net losses on cash flow hedges recorded in AOCI(2)

     55        86   

Disallowed goodwill and other intangible assets(3)

     (13,899     (13,953

Disallowed deferred tax assets

     (227     (1,150

Other

     (2     (2
  

 

 

   

 

 

 

Tier 1 common equity

     14,904        11,154   

Plus: Tier 1 restricted core capital items(4)

     3,636        3,636   
  

 

 

   

 

 

 

Tier 1 risk-based capital

     18,540        14,790   
  

 

 

   

 

 

 

Plus: Long-term debt qualifying as Tier 2 capital

     2,438        2,827   

Qualifying allowance for loan and lease losses

     1,896        3,748   

Other Tier 2 components

     24        29   
  

 

 

   

 

 

 

Tier 2 risk-based capital

     4,358        6,604   
  

 

 

   

 

 

 

Total risk-based capital

   $ 22,898      $ 21,394   
  

 

 

   

 

 

 

Risk-weighted assets(5)

   $ 149,028      $ 127,043   
  

 

 

   

 

 

 

 

(1) 

Calculated under capital standards and regulations based on the international capital framework commonly known as Basel I.

(2)

Amounts presented are net of tax.

(3)

Disallowed goodwill and other intangible assets are net of related deferred tax liability.

(4)

Consists primarily of trust preferred securities.

(5)

Under regulatory guidelines for risk-based capital, on-balance sheet assets and credit equivalent amounts of derivatives and off-balance sheet items are assigned to one of several broad risk categories according to the obligor or, if relevant, the guarantor or the nature of any collateral. The aggregate dollar amount in each risk category is then multiplied by the risk weight associated with that category. The resulting weighted values from each of the risk categories are aggregated for determining total risk-weighted assets.

The January 1, 2010 adoption of the new consolidation accounting standards resulted in our consolidating a substantial portion of our securitization trusts and establishing an allowance for loan and lease losses for the assets underlying these trusts, which reduced retained earnings and our Tier 1 capital ratios. In January 2010, banking regulators issued regulatory capital rules related to the impact of the new consolidation accounting standards. Under these rules, we were required to hold additional capital for the assets we consolidated. The

 

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capital rules also provided for an optional phase-in of the impact from the adoption of the new consolidation accounting standards, including a two-quarter implementation delay followed by a two-quarter partial implementation of the effect on regulatory capital ratios.

We elected the phase-in option, which required us to phase-in 50% of consolidated assets beginning with the third quarter of 2010 for purposes of determining risk-weighted assets. The phase-in provisions expired after December 31, 2010, and we completed the final phase-in during the first quarter of 2011, which resulted in the addition of approximately $15.5 billion of assets to the denominator used in calculating our regulatory ratios. The addition of these assets contributed to a decrease in our risk-based regulatory capital ratios as of September 30, 2011 from December 31, 2010.

Under the Dodd-Frank Act, many trust preferred securities will cease to qualify for Tier 1 capital, subject to a three year phase-out period expected to begin in 2013.

Dividend Policy

The declaration and payment of dividends to our stockholders, as well as the amount thereof, are subject to the discretion of our Board of Directors, in consultation with the Federal Reserve, and will depend upon our results of operations, financial condition, capital levels, cash requirements, future prospects, assessments of potential future losses due to adverse changes in our business and market environments and other factors deemed relevant by the Board of Directors. As a bank holding company, our ability to pay dividends is largely dependent upon the receipt of dividends or other payments from our subsidiaries. We provide additional information on factors affecting our dividend policy in our 2010 Form 10-K under “Part I—Item 1. Business—Supervision and Regulation—Dividends, Stock Purchases and Transfer of Funds.”

Restrictions exist that limit the ability of the Banks to transfer funds to our bank holding company. Funds available for dividend payments from COBNA and CONA based on the Earnings Limitation Test were $3.1 billion and $1.2 billion, respectively, as of September 30, 2011. Applicable provisions that may be contained in our borrowing agreements or the borrowing agreements of our subsidiaries may limit our subsidiaries’ ability to pay dividends to us or our ability to pay dividends to our stockholders. There can be no assurance that we will declare and pay any dividends.

Equity Offering

On July 19, 2011, we closed a public underwritten offering of 40 million shares of our common stock at a price per share of $50.00, subject to forward sale agreements. After underwriter’s discounts and commissions, the net proceeds to us will be at an initial forward sale price per share of $48.50. The forward sale price is subject to adjustment under the forward sale agreements. We have not received any proceeds from this public offering of our shares of common stock yet. Under the terms of the forward sale agreements, we must settle the forward sale agreements on or before February 15, 2012. We expect to settle the forward sale agreements entirely by physical delivery of shares of common stock in exchange for cash proceeds from the forward purchasers of approximately $1.9 billion based on the initial forward price. However, we may, subject to certain conditions, elect cash or net share settlement of all or a portion of our obligation to deliver shares of common stock. We expect to use the net proceeds from this equity offering, along with proceeds from our recent debt offering and cash sourced from our current liquidity, to fund the $6.2 billion in cash consideration payable in connection with the ING Direct acquisition.

Pending HSBC U.S. Credit Card Business Acquisition

In August 2011, we announced that we entered into a purchase agreement with HSBC to acquire substantially all of the assets and assume liabilities of HSBC’s credit card and private-label credit card business in the United States. We currently expect the HSBC acquisition to close in the second quarter of 2012, subject to customary closing conditions, including certain governmental clearances and approvals. We also announced that we expect

 

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our Tier 1 common equity ratio will be in the mid-9% range at the end of the second quarter of 2012, inclusive of our planned capital raise of $1.25 billion in connection with the HSBC acquisition. We have the option, subject to certain conditions, to issue $750 million of the $1.25 billion to HSBC in the form of our common stock (valued at $39.23 per share). The decision to raise any capital and, if so, the amount of capital to be raised will be dependent on a number of factors, including the timing of the closings for our pending ING Direct and HSBC acquisitions, changes in interest rates, regulatory expectations, our results of operations and financial condition and our assessment of the appropriate level of regulatory capital to hold at that time.

 

 

MARKET RISK MANAGEMENT

 

Overview

Market risk represents the risk that our earnings and/or economic value of equity may be adversely affected by changes in market conditions, including changes in interest rates and foreign currency exchange rates, changes in credit spreads and price fluctuations and changes in value due to changes in market perception or the actual credit quality of issuers. Market risk is inherent in the financial instruments associated with our operations and activities, including loans, deposits, securities, short-term borrowings, long-term debt and derivatives. Below we discuss our primary sources of market risk, our market risk management strategies and measures used to evaluate our market risk exposure.

Primary Market Risk Exposures

Our primary sources of market risk include interest rate risk and foreign exchange risk.

Interest Rate Risk

Interest rate risk, which represents exposure to instruments whose yield or price varies with the level or volatility of interest rates, is our most significant source of market risk exposure. Banks are inevitably exposed to interest rate risk due to differences in the timing between the maturities or repricing of assets and liabilities. For example, if more assets are repricing than deposits and other borrowings when interest rates are declining, our earnings will decrease. Similarly, if more deposits and other borrowings are repricing than assets when interest rates are rising, our earnings will decrease.

Interest rate risk also results from changes in customer behavior and competitors’ responses to changes in interest rates or other market conditions. For example, decreases in mortgage rates generally result in faster than expected prepayments, which may adversely affect earnings. Increases in interest rates, coupled with strong demand from competitors for deposits, may influence industry pricing. Such competition may affect customer decisions to maintain balances in the deposit accounts, which may require replacing lower cost deposits with higher cost alternative sources of funding.

Foreign Exchange Risk

Foreign exchange risk represents exposure to changes in the values of current holdings and future cash flows denominated in other currencies. The types of instruments exposed to this risk include investments in foreign subsidiaries, foreign currency-denominated loans and securities, future cash flows in foreign currencies arising from foreign exchange transactions, foreign currency-denominated debt and various foreign exchange derivative instruments whose values fluctuate with changes in the level or volatility of currency exchange rates or foreign interest rates.

 

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Market Risk Management

We employ several techniques to manage our interest rate and foreign currency risk, which include, but are not limited to, changing the maturity and re-pricing characteristics of our various assets and liabilities. Derivatives are one of the primary tools we use in managing interest rate and foreign exchange risk.

We execute our derivative contracts in both over-the-counter and exchange-traded derivative markets. Although the majority of our derivatives are interest rate swaps, we also use a variety of other derivative instruments, including caps, floors, options, futures and forward contracts, to manage our interest rate and foreign currency risk. The outstanding notional amount of our derivative contracts increased to $71.9 billion as of September 30, 2011, from $50.7 billion as of December 31, 2010. This increase was primarily attributable to actions we took during the third quarter of 2011 to manage the anticipated impact of the pending ING Direct acquisition on our market risk exposure and regulatory capital requirements, as discussed above in “Executive Summary and Business Outlook.”

Since the date we entered into the agreement to acquire ING Direct, interest rates have declined substantially, and our current estimate of the fair value of the ING Direct net assets and liabilities has increased correspondingly. In order to capture some of the anticipated benefits to regulatory capital on the closing date attributable to this decline in interest rates, in August 2011, we entered into various pay-fixed/receive-floating interest-rate swap transactions with a total notional principal amount of approximately $23.8 billion. These swap transactions are designed to mitigate the effect of a rise in interest rates on the fair values of a significant portion of the ING Direct assets and liabilities during the period from when we entered into the swap transactions to the anticipated closing date of the ING Direct acquisition in late 2011 or early 2012. Although the interest-rate swaps represent economic hedges, they are not designated for hedge accounting. Accordingly, changes in the fair value are recorded in earnings. We recognized a mark-to-market loss on these interest-rate swaps of $266 million in the third quarter of 2011, which was attributable to the decline in interest rates as of the end of the quarter. Changes in the fair value of these interest-rate swaps will continue to be recorded in earnings until the swaps are terminated. See “Note 10—Derivative Instruments and Hedging Activities” for additional information.

Market Risk Measurement

We have prescribed risk management policies and limits established by our Asset/Liability Management Committee. Our objective is to manage our asset/liability risk position and exposure to market risk in accordance with these policies and prescribed limits based on prevailing market conditions and long-term expectations. Because no single measure can reflect all aspects of market risk, we use various industry standard market risk measurement techniques and analyses to measure, assess and manage the impact of changes in interest rates and foreign exchange rates on our earnings and the economic value of equity.

We consider the impact on both earnings and economic value of equity in measuring and managing our interest rate risk. Our earnings sensitivity measure estimates the impact on net interest income and the valuation of our mortgage servicing rights, including derivative hedging activity, resulting from movements in interest rates. Our economic value of equity sensitivity measure estimates the impact on the net present value of our assets and liabilities, including derivative hedging activity, resulting from movements in interest rates. Our earnings sensitivity and economic value of equity measurements are based on our existing assets and liabilities, including derivatives, and do not incorporate business growth assumptions or projected plans for funding mix changes. We do, however, assess and factor into our interest rate risk management decisions the potential impact of growth assumptions, changing business activities and alternative interest rate scenarios, such as a steepening or flattening of the yield curve.

Under our current asset/liability management policy, our objective is to: (i) limit the potential decrease in our projected net interest income resulting from a gradual plus or minus 200 basis point change in forward rates to less than 5% over the next 12 months and (ii) limit the adverse change in the economic value of our equity due to

 

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an instantaneous parallel interest rate shock to spot rates of plus or minus 200 basis points to less than 12%. The federal funds rate remained at a target range of zero to 0.25% during the first nine months of 2011. Given the level of short-term rates as of September 30, 2011 and December 31, 2010, a scenario where interest rates would decline by 200 basis points is not plausible. Therefore, in 2008, we temporarily revised our customary declining interest rate scenario of 200 basis points to a 50 basis point decrease. Our current asset/liability management policy also includes the use of derivatives to hedge material foreign currency denominated transactions to limit our earnings exposure to foreign exchange risk.

Table 31 shows the estimated percentage impact on our adjusted projected net interest income and economic value of equity, calculated under our base case interest rate scenario, as of September 30, 2011 and December 31, 2010, resulting from selected hypothetical interest rate scenarios. Our adjusted projected net interest income consists of net interest income adjusted to include changes in the fair value of mortgage service rights, including related derivative hedging activity, and changes in the fair value of free-standing interest rate swaps. In measuring the sensitivity of interest rate movements on our adjusted projected net interest income, we assume a hypothetical gradual increase in interest rates of 200 basis points and a hypothetical gradual decrease of 50 basis points to forward rates over the next three quarters. In measuring the sensitivity of interest rate movements on our economic value of equity, we assume a hypothetical instantaneous parallel shift in the level of interest rates of plus 200 basis points and minus 50 basis points to spot rates in measuring the sensitivity of the valuation of our economic value of equity.

Table 31: Interest Rate Sensitivity Analysis

 

     September 30, 2011        
     Excluding ING
Direct Swaps(1)
    Including ING
Direct Swaps
    December 31,
2010
 

Impact on adjusted projected base-line net interest income:

      

+ 200 basis points

     1.2     15.0     (0.7 )% 

- 50 basis points

     (0.4     (4.3     (0.2

Impact on economic value of equity:

      

+ 200 basis points

     (1.7 )%      2.7     (3.8 )% 

- 50 basis points

     (0.2     (1.4     0.1   

 

(1) 

Calculated excluding the impact of the interest-rate swap transactions of approximately $23.8 billion entered into in the third quarter of 2011 to mitigate some of the interest rate risk related to the pending ING Direct acquisition.

Because of the large but temporary impact of the ING Direct-related swap transactions on our standard interest rate risk reporting measures, we expanded our standard interest rate sensitivity analysis to present our interest rate risk measures with and without the impact of the $23.8 billion of interest rate swaps described above. This presentation highlights changes in our core interest rate risk profile and the incremental impact of the ING Direct-related swaps on our core profile over the time period that the swaps will remain outstanding. Excluding the $23.8 billion swap transactions, our interest rate sensitivity measures reflect that we became more asset sensitive between December 31, 2010 and September 30, 2011. Our asset sensitivity position is larger when factoring in the effect of the $23.8 billion of swaps, given their pay-fixed structure and non-designation for hedge accounting. As noted, we currently expect the impact of the $23.8 billion of interest-swaps to be temporary in nature, as it is our intention to terminate them around the timing of the ING Direct acquisition. Our adjusted projected net interest income and economic value of equity sensitivity measures, excluding the impact of the ING-Direct related swap transactions, were within our prescribed asset/liability policy limits as of September 30, 2011 and December 31, 2010.

The interest rate risk models that we use in deriving these measures incorporate contractual information, internally-developed assumptions and proprietary modeling methodologies, which project borrower and deposit behavior patterns in certain interest rate environments. Other market inputs, such as interest rates, market prices and interest rate volatility, are also critical components of our interest rate risk measures. We regularly evaluate,

 

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update and enhance these assumptions, models and analytical tools as we believe appropriate to reflect our best assessment of the market environment and the expected behavior patterns of our existing assets and liabilities.

Limitations of Market Risk Measures

There are inherent limitations in any methodology used to estimate the exposure to changes in market interest rates. The above sensitivity analyses contemplate only certain movements in interest rates and are performed at a particular point in time based on the existing balance sheet, and do not incorporate other factors that may have a significant effect, most notably future business activities and strategic actions that management may take to manage interest rate risk. Actual earnings and economic value of equity could differ from the above sensitivity analyses.

We provide additional information on our market risk exposure and interest rate risk management process in our 2010 Form 10-K under “Part II—Item 7. MD&A—Market Risk Management.”

 

 

SUPERVISION AND REGULATORY DEVELOPMENTS

 

Dodd-Frank Act

We continue to assess the potential impact of proposed and final rules promulgated by the agencies charged with implementing the Dodd-Frank Act, including rules relating to resolution plans, the FDIC’s orderly liquidation authority, proprietary trading and fund investment restrictions (the “Volcker Rule”), derivatives, and other capital markets matters. These rules may result in modifications to our business models and organizational structure, and may subject us to escalating costs associated with any such changes.

Basel II

In December 2007, U.S. Federal banking regulators finalized the Basel II Final Rules. The rule is mandatory for those institutions with consolidated total assets of $250 billion or more or consolidated total on-balance-sheet foreign exposure of $10 billion or more. Capital One is not yet subject to this rule but will likely become so in the future, due to growth in our reported total assets or foreign assets.

Prior to full implementation of the Basel II framework, organizations must complete a qualification period of four consecutive quarters during which they must meet the requirements of the rule to the satisfaction of their primary U.S. banking regulator. The Collins Amendment within the Dodd-Frank Act and the U.S. banking regulators’ implementing final rules establish a risk-based capital floor so that organizations subject to Basel II rules may not hold less capital than would be required using Basel I capital calculations. Our current analysis suggests that our risk-weighted assets will increase under the Basel II framework, and therefore we would need to hold more regulatory capital in order to maintain a given capital ratio.

 

 

ACCOUNTING CHANGES AND DEVELOPMENTS

 

See “Note 1—Summary of Significant Accounting Policies” for information concerning recently issued accounting pronouncements, including those that we have not yet adopted and that will likely affect our consolidated financial statements.

 

 

FORWARD-LOOKING STATEMENTS

 

From time to time, we have made and will make forward-looking statements, including those that discuss, among other things, strategies, goals, outlook or other non-historical matters; projections, revenues, income, returns, accruals for claims in litigation and for other claims against us; earnings per share or other financial measures for

 

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us; future financial and operating results; our plans, objectives, expectations and intentions; the projected impact and benefits of the pending transactions involving HSBC, ING Direct and us (the “Transactions”); and the assumptions that underlie these matters.

To the extent that any such information is forward-looking, it is intended to fit within the safe harbor for forward-looking information provided by the Private Securities Litigation Reform Act of 1995. Numerous factors could cause our actual results to differ materially from those described in such forward-looking statements, including, among other things:

 

   

general economic and business conditions in the U.S., the U.K., Canada, or our local markets, including conditions affecting employment levels, interest rates, consumer income and confidence, spending and savings that may affect consumer bankruptcies, defaults, charge-offs and deposit activity;

 

   

an increase or decrease in credit losses (including increases due to a worsening of general economic conditions in the credit environment);

 

   

the possibility that regulatory and other approvals and conditions to either of the Transactions are not received or satisfied on a timely basis or at all;

 

   

the possibility that modifications to the terms of either of the Transactions may be required in order to obtain or satisfy such approvals or conditions;

 

   

the possibility that we will not receive third-party consents necessary to fully realize the anticipated benefits of the Transactions;

 

   

the possibility that we may not fully realize the projected cost savings and other projected benefits of the Transactions;

 

   

changes in the anticipated timing for closing either of the Transactions;

 

   

difficulties and delays in integrating the assets and businesses acquired in the Transactions;

 

   

business disruption during the pendency of or following the Transactions;

 

   

diversion of management time on issues related to the Transactions;

 

   

reputational risks and the reaction of customers and counterparties to the Transactions;

 

   

disruptions relating to the Transactions negatively impacting our ability to maintain relationships with customers, employees and suppliers;

 

   

changes in asset quality and credit risk as a result of the Transactions;

 

   

financial, legal, regulatory, tax or accounting changes or actions, including the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act and the regulations promulgated thereunder;

 

   

developments, changes or actions relating to any litigation matter involving us;

 

   

the inability to sustain revenue and earnings growth;

 

   

increases or decreases in interest rates;

 

   

our ability to access the capital markets at attractive rates and terms to capitalize and fund our operations and future growth;

 

   

the success of our marketing efforts in attracting and retaining customers;

 

   

increases or decreases in our aggregate loan balances or the number of customers and the growth rate and composition thereof, including increases or decreases resulting from factors such as shifting product mix, amount of actual marketing expenses we incur and attrition of loan balances;

 

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the level of future repurchase or indemnification requests we may receive, the actual future performance of mortgage loans relating to such requests, the success rates of claimants against us, any developments in litigation and the actual recoveries we may make on any collateral relating to claims against us;

 

   

the amount and rate of deposit growth;

 

   

changes in the reputation of or expectations regarding the financial services industry or us with respect to practices, products or financial condition;

 

   

any significant disruption in our operations or technology platform;

 

   

our ability to maintain a compliance infrastructure suitable for our size and complexity;

 

   

our ability to control costs;

 

   

the amount of, and rate of growth in, our expenses as our business develops or changes or as it expands into new market areas;

 

   

our ability to execute on our strategic and operational plans;

 

   

any significant disruption of, or loss of public confidence in, the United States Mail service affecting our response rates and consumer payments;

 

   

our ability to recruit and retain experienced personnel to assist in the management and operations of new products and services;

 

   

changes in the labor and employment markets;

 

   

fraud or misconduct by our customers, employees or business partners;

 

   

competition from providers of products and services that compete with our businesses; and

 

   

other risk factors listed from time to time in reports that we file with the SEC.

Any forward-looking statements made by us or on our behalf speak only as of the date they are made or as of the date indicated, and we do not undertake any obligation to update forward-looking statements as a result of new information, future events or otherwise. You should carefully consider the factors discussed above in evaluating these forward-looking statements. For additional information on factors that could materially influence forward-looking statements included in this Report, see the risk factors set forth under “Part I—Item 1A. Risk Factors” in our 2010 Form 10-K and the risk factors set forth in Exhibit 99.5 to our Current Report on Form 8-K filed on July 13, 2011.

 

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SUPPLEMENTAL TABLES

 

Table A: Reconciliation of Non-GAAP Measures and Calculation of Regulatory Capital Measures

 

(Dollars in millions)    September 30,
2011
    December 31,
2010
 

Stockholders’ Equity to Non-GAAP Tangible Common Equity

    

Total stockholders’ equity

   $ 29,378      $ 26,541   

Less: Intangible assets(1)

     (13,953     (13,983
  

 

 

   

 

 

 

Tangible common equity

   $ 15,425      $ 12,558   
  

 

 

   

 

 

 

Total Assets to Tangible Assets

    

Total assets

   $ 200,148      $ 197,503   

Less: Assets from discontinued operations

     (304     (362
  

 

 

   

 

 

 

Total assets from continuing operations

     199,844        197,141   

Less: Intangible assets(1)

     (13,953     (13,983
  

 

 

   

 

 

 

Tangible assets

   $ 185,891      $ 183,158   
  

 

 

   

 

 

 

Non-GAAP TCE Ratio

    

Tangible common equity

   $ 15,425      $ 12,558   

Tangible assets

     185,891        183,158   
  

 

 

   

 

 

 

TCE ratio(2)

     8.3     6.9
  

 

 

   

 

 

 

Regulatory Capital and Non-GAAP Tier 1 Common Equity Ratios

    

Total stockholders’ equity

   $ 29,378      $ 26,541   

Less: Net unrealized gains recorded in AOCI(3)

     (401     (368

           Net losses on cash flow hedges recorded in AOCI(3)

     55        86   

           Disallowed goodwill and other intangible assets(4)

     (13,899     (13,953

           Disallowed deferred tax assets

     (227     (1,150

           Other

     (2     (2
  

 

 

   

 

 

 

Tier 1 common equity

     14,904        11,154   

Plus: Tier 1 restricted core capital items(5)

     3,636        3,636   
  

 

 

   

 

 

 

Tier 1 capital

     18,540        14,790   
  

 

 

   

 

 

 

Plus: Long-term debt qualifying as Tier 2 capital

     2,438        2,827   

           Qualifying allowance for loan and lease losses

     1,896        3,748   

           Other Tier 2 components

     24        29   
  

 

 

   

 

 

 

Tier 2 capital

     4,358        6,604   
  

 

 

   

 

 

 

Total risk-based capital(6)

   $ 22,898      $ 21,394   
  

 

 

   

 

 

 

Risk-weighted assets(7)

   $ 149,028      $ 127,043   
  

 

 

   

 

 

 

Tier 1 common equity ratio(8)

     10.0     8.8

Tier 1 risk-based capital ratio(9)

     12.4        11.6   

Total risk-based capital ratio(10)

     15.4        16.8   

 

(1)

Includes impact from related deferred taxes.

(2)

Calculated based on tangible common equity divided by tangible assets.

(3)

Amounts presented are net of tax.

(4)

Disallowed goodwill and other intangible assets are net of related deferred tax liability.

(5)

Consists primarily of trust preferred securities.

 

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(6)

Total risk-based capital equals the sum of Tier 1 capital and Tier 2 capital.

(7)

Calculated based on prescribed regulatory guidelines.

(8)

Tier 1 common equity ratio is a non-GAAP measure calculated based on Tier 1 common equity divided by risk-weighted assets.

(9)

Tier 1 risk-based capital ratio is a regulatory capital measure calculated based on Tier 1 capital divided by risk-weighted assets.

(10)

Total risk-based capital ratio is a regulatory capital measure calculated based on total risk-based capital divided by risk-weighted assets.

 

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Table B: Reconciliation of Basel III Capital Measures(1)

 

(Dollars in millions)    September 30,
2011
 

Regulatory Capital and Non-GAAP Tier 1 Common Equity Ratios

  

Total stockholders’ equity

   $ 29,378   

Less: Net unrealized gains recorded in AOCI(2)

     (401 ) 

           Net losses on cash flow hedges recorded in AOCI(2)

     55   

           Disallowed goodwill and other intangible assets(3)

     (13,899 ) 

           Disallowed deferred tax assets

     (227 )  

           Other

     (2 ) 
  

 

 

 

Tier 1 common equity

     14,904   

Plus: Tier 1 restricted core capital items(4)

     3,636   
  

 

 

 

Tier 1 capital

     18,540   
  

 

 

 

Less: Tier 1 restricted core capital items(4)

     (3,636 ) 

           Defined benefit pension fund asset

     (42 ) 

           90% of purchased credit card relationship intangibles

     (51 ) 

           Other Tier 1 components

     (32 ) 

Plus: Unrealized gain on available-for-sale securities

     401   

           90% of mortgage servicing rights

     85   

           Disallowed deferred tax assets

     227   
  

 

 

 

Tier 1 common equity under Basel III

   $ 15,492   
  

 

 

 

Risk-weighted assets under Basel I(5)

   $ 149,028   

Less: Defined benefit pension fund asset

     (42 ) 

           Deferred tax assets included in the risk weighted assets under Basel I

     (2,010 ) 

           90% of MSR

     (85 ) 

           90% of purchased credit card relationship intangibles

     (51 ) 

Plus: Deferred tax assets and MSR included in Tier 1 common equity at 250%

     5,827   

           Other adjustments at 1250%

     230   
  

 

 

 

Adjusted risk-weighted assets under Basel III

   $ 152,897   
  

 

 

 

Tier 1 common equity ratio under Basel III(6)

     10.1 % 

 

(1) 

Calculations are based on our current understanding of the Basel III framework, which has not been implemented by the U.S. banking agencies and is subject to change.

(2) 

Amounts presented are net of tax.

(3) 

Disallowed goodwill and other intangible assets are net of related deferred tax liability.

(4) 

Consists primarily of trust preferred securities.

(5) 

Calculated based on prescribed regulatory guidelines.

(6)

Tier 1 common equity ratio is a non-GAAP measure calculated based on Tier 1 common equity divided by risk-weighted assets.

 

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Item 1. Financial Statements

CAPITAL ONE FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
(Dollars in millions, except per share-related data)        2011             2010             2011             2010      

Interest income:

        

Loans held for investment, including past-due fees

   $ 3,550      $ 3,447      $ 10,334      $ 10,582   

Investment securities

     264        347        893        1,037   

Other

     21        21        59        60   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total interest income

     3,835        3,815        11,286        11,679   
  

 

 

   

 

 

   

 

 

   

 

 

 

Interest expense:

        

Deposits

     294        358        923        1,125   

Securitized debt obligations

     89        191        342        644   

Senior and subordinated notes

     84        72        211        211   

Other borrowings

     85        85        251        265   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total interest expense

     552        706        1,727        2,245   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

     3,283        3,109        9,559        9,434   

Provision for loan and lease losses

     622        867        1,499        3,069   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income after provision for loan and lease losses

     2,661        2,242        8,060        6,365   
  

 

 

   

 

 

   

 

 

   

 

 

 

Non-interest income:

        

Servicing and securitizations

     12        13        35        (3

Service charges and other customer-related fees

     542        496        1,527        1,577   

Interchange fees

     321        346        972        991   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other-than-temporary losses

     (33     (39     (83     (116

Less: Non-credit component of other-than-temporary impairment losses recorded in AOCI

     27        34        68        54   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net other-than-temporary losses recognized in earnings

     (6     (5     (15     (62

Other

     2        57        151        272   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total non-interest income

     871        907       2,670        2,775   
  

 

 

   

 

 

   

 

 

   

 

 

 

Non-interest expense:

        

Salaries and associate benefits

     750        641        2,206        1,937   

Marketing

     312        250        917        650   

Communications and data processing

     178        178        504        512   

Supplies and equipment

     143        129        402        381   

Occupancy

     122        135        359        371   

Other

     792        663        2,326        1,992   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total non-interest expense

     2,297        1,996        6,714        5,843   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations before income taxes

     1,235        1,153        4,016        3,297   

Income tax provision

     370        335        1,174        948   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations, net of tax

     865        818        2,842        2,349   

Loss from discontinued operations, net of tax

     (52     (15     (102     (303
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 813      $ 803     $ 2,740      $ 2,046   
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic earnings per common share:

        

Income from continuing operations

   $ 1.89      $ 1.81      $ 6.24      $ 5.19   

Loss from discontinued operations

     (0.11     (0.03     (0.22     (0.66
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income per basic common share

   $ 1.78      $ 1.78     $ 6.02      $ 4.53   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted earnings per common share:

        

Income from continuing operations

   $ 1.88      $ 1.79      $ 6.17      $ 5.15   

Loss from discontinued operations

     (0.11     (0.03     (0.22     (0.66
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income per diluted common share

   $ 1.77      $ 1.76      $ 5.95      $ 4.49   
  

 

 

   

 

 

   

 

 

   

 

 

 

Dividends paid per common share

   $ 0.05      $ 0.05      $ 0.15      $ 0.15   
  

 

 

   

 

 

   

 

 

   

 

 

 

See Notes to Consolidated Financial Statements.

 

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CAPITAL ONE FINANCIAL CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)

 

(Dollars in millions, except per share data)    September 30,
2011
    December 31,
2010
 

Assets:

    

Cash and due from banks

   $ 1,794      $ 2,067   

Interest-bearing deposits with banks

     3,238        2,776   

Federal funds sold and securities purchased under agreements to resell

     1,326        406   
  

 

 

   

 

 

 

Cash and cash equivalents

     6,358        5,249   

Restricted cash for securitization investors

     984        1,602   

Securities available for sale, at fair value

     38,400        41,537   

Loans held for investment:

    

Unsecuritized loans held for investment, at amortized cost

     83,010        71,921   

Restricted loans for securitization investors

     46,942        54,026   
  

 

 

   

 

 

 

Total loans held for investment

     129,952        125,947   

Less: Allowance for loan and lease losses

     (4,280     (5,628
  

 

 

   

 

 

 

Net loans held for investment

     125,672        120,319   

Loans held for sale, at lower-of-cost-or-fair value

     312        228   

Accounts receivable from securitizations

     101        118   

Premises and equipment, net

     2,785        2,749   

Interest receivable

     958        1,070   

Goodwill

     13,593        13,591   

Other

     10,985        11,040   
  

 

 

   

 

 

 

Total assets

   $ 200,148      $ 197,503   
  

 

 

   

 

 

 

Liabilities:

    

Interest payable

   $ 401      $ 488   

Customer deposits:

    

Non-interest bearing deposits

     17,541        15,048   

Interest bearing deposits

     110,777        107,162   
  

 

 

   

 

 

 

Total customer deposits

     128,318        122,210   

Securitized debt obligations

     17,120        26,915   

Other debt:

    

Federal funds purchased and securities loaned or sold under agreements to repurchase

     1,441        1,517   

Senior and subordinated notes

     11,051        8,650   

Other borrowings

     4,703        4,714   
  

 

 

   

 

 

 

Total other debt

     17,195        14,881   

Other liabilities

     7,736        6,468   
  

 

 

   

 

 

 

Total liabilities

   $ 170,770      $ 170,962   
  

 

 

   

 

 

 

Stockholders’ equity:

    

Preferred stock, par value $.01 per share; authorized 50,000,000 shares; zero shares issued or outstanding as of September 30, 2011 and December 31, 2010

     0        0   

Common stock, par value $.01 per share; authorized 1,000,000,000 shares; 508,195,751 and 504,801,064 issued as of September 30, 2011 and December 31, 2010, respectively

     5        5   

Paid-in capital, net

     19,234        19,084   

Retained earnings

     13,091        10,406   

Accumulated other comprehensive income

     291        248   

Less: Treasury stock, at cost; 48,622,469 and 47,787,697 shares as of September 30, 2011 and December 31, 2010, respectively

     (3,243     (3,202
  

 

 

   

 

 

 

Total stockholders’ equity

     29,378        26,541   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 200,148      $ 197,503   
  

 

 

   

 

 

 

See Notes to Consolidated Financial Statements.

 

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CAPITAL ONE FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (UNAUDITED)

 

(Dollars in millions, except per share data)   Common Stock     Additional
Paid-In
    Retained    

Accumulated
Other
Comprehensive
Income

    Treasury     Total
Stockholders’
 
  Shares     Amount     Capital     Earnings     (Loss)     Stock     Equity  

Balance as of December 31, 2010

    504,801,064      $ 5      $ 19,084      $ 10,406      $ 248      $ (3,202   $ 26,541   

Net income

          2,740            2,740   

Other comprehensive income (loss), net of tax:

             

Unrealized gain on securities, net of taxes of $30 million

            47          47   

Other-than-temporary impairment on available-for-sale securities not recognized in earnings, net of taxes of $8 million

            (14       (14

Defined benefit plans, net of taxes of $1 million

            (1       (1

Foreign currency translation adjustments

            (20       (20

Unrealized gains on cash flow hedges, net of taxes of $18 million

            31          31   
         

 

 

     

 

 

 

Other comprehensive income

            43          43   
         

 

 

     

 

 

 

Total comprehensive income

                2,783   

Cash dividends—common stock $0.15 per share

          (69         (69

Purchases of treasury stock

              (41     (41

Issuances of common stock and restricted stock, net of forfeitures

    2,220,598          28              28   

Exercise of stock options and tax benefits of exercises and restricted stock vesting

    1,174,089          59              59   

Restricted stock awards and stock options

        63              63   

Other

          14            14   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance as of September 30, 2011

    508,195,751      $ 5      $ 19,234      $ 13,091      $ 291      $ (3,243   $ 29,378   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance as of December 31, 2009

    502,394,396      $ 5      $ 18,955      $ 10,727      $ 83      $ (3,180   $ 26,590   

Cumulative effect from adoption of new consolidation accounting standards

          (2,957     (16       (2,973

Cumulative effect from July 1, 2010 adoption of new embedded credit derivative accounting standard, net of taxes

          (16         (16

Comprehensive income:

             

Net income

          2,046            2,046   

Other comprehensive income (loss), net of tax:

             

Change in net unrealized gains on available-for-sale securities, net of taxes of $178 million

            355          355   

Other-than-temporary impairment on available-for-sale securities not recognized in earnings, net of taxes of $24 million

            40          40   

Defined benefit pension plans

            (1       (1

Foreign currency translation adjustments

            (9       (9

Unrealized gains on cash flow hedges, net of taxes of $9 million

            17          17   
         

 

 

     

 

 

 

Other comprehensive income

            402          402   
         

 

 

     

 

 

 

Total comprehensive income

                2,448   

Cash dividends—common stock $0.15 per share

          (70         (70

Purchases of treasury stock

              (22     (22

Issuances of common stock and restricted stock, net of forfeitures

    1,727,412          22              22   

Exercise of stock options and tax benefits of exercises and restricted stock vesting

    536,474          6              6   

Restricted stock awards and stock options

        76              76   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance as of September 30, 2010

    504,658,282      $ 5      $ 19,059      $ 9,730      $ 469      $ (3,202   $ 26,061   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See Notes to Consolidated Financial Statements.

 

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CAPITAL ONE FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

 

     Nine Months Ended September 30,  
(Dollars in millions)          2011                 2010        

Operating activities:

    

Income from continuing operations, net of tax

   $ 2,842      $ 2,349   

Loss from discontinued operations, net of tax

     (102     (303
  

 

 

   

 

 

 

Net income

     2,740        2,046   
  

 

 

   

 

 

 

Adjustments to reconcile net income to cash provided by operating activities:

    

Provision for loan and lease losses

     1,499        3,069   

Depreciation and amortization, net

     424        422   

Net gains on sales of securities available for sale

     (251     (134

Net gains on deconsolidation

     0        (177

Loans held for sale:

    

Transfers in

     (781     (400

Losses on sales

     16        (25

Proceeds from sales

     681        516   

Other

     13        0   

Stock plan compensation expense

     135        117   

Changes in assets and liabilities, net of effects from purchase of companies acquired and the effect of new accounting standards:

    

(Increase) decrease in interest receivable

     112        (92

(Increase) decrease in accounts receivable from securitizations(1)

     17        17   

(Increase) decrease in other assets(1)

     222        1,473   

Increase (decrease) in interest payable

     (87     (45

Increase (decrease) in other liabilities(1)

     1,096        1,215   

Net cash provided by operating activities attributable to discontinued operations

     80        18   
  

 

 

   

 

 

 

Net cash provided by operating activities

     5,916        8,020   
  

 

 

   

 

 

 

Investing activities:

    

Increase in restricted cash for securitization investors(1)

     618        1,312   

Sales (purchases) of securities available for sale

     (12,689     (20,561

Proceeds from paydowns and maturities of securities available for sale

     7,065        8,710   

Proceeds from sales of securities available for sale

     8,980        11,483   

Proceeds from sale of interest-only bonds

     0        57   

Net (increase) decrease in loans held for investment(1)

     (6,607     3,974   

Principal recoveries of loans previously charged off

     1,197        1,201   

Additions of premises and equipment

     (269     (225

Net payment for companies acquired

     (1,444     0   

Net cash provided by (used in) investing activities attributable to discontinued operations

     0        (1
  

 

 

   

 

 

 

Net cash provided by (used in) investing activities

     (3,149     5,950   
  

 

 

   

 

 

 

Financing activities:

    

Net increase in deposits

     6,104        3,403   

Net decrease in securitized debt obligations

     (9,795     (18,795

Net decrease in other borrowings(1)

     (82     (1,723

Maturities of senior notes

     (854     (516

Issuance of senior notes

     2,992        0   

Purchases of treasury stock

     (41     (22

Dividends paid on common stock

     (69     (69

Net proceeds from issuances of common stock

     28        22   

Proceeds from share-based payment activities

     59        6   

Net cash used in financing activities attributable to discontinued operations

     0        (19
  

 

 

   

 

 

 

Net cash used in financing activities

     (1,658     (17,713
  

 

 

   

 

 

 

Increase (decrease) in cash and cash equivalents

     1,109        (3,743

Cash and cash equivalents at beginning of the period

     5,249        8,685   
  

 

 

   

 

 

 

Cash and cash equivalents at end of the period

   $ 6,358      $ 4,942   
  

 

 

   

 

 

 

Supplemental cash flow information:

    

Non-cash items:

    

Impact of the net fair value of assets acquired and liabilities assumed for acquisitions

   $ 3      $ 0   

Cumulative effect from adoption of new consolidation accounting standards

     0        2,973   

  

 

(1)

Excludes the initial impact from the January 1, 2010 adoption of the new consolidation standards.

See Notes to Consolidated Financial Statements.

 

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CAPITAL ONE FINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

 

NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

The Company

Capital One Financial Corporation, which was established in 1995, is a diversified financial services holding company headquartered in McLean, Virginia. Capital One Financial Corporation and its subsidiaries (the “Company”) offer a broad array of financial products and services to consumers, small businesses and commercial clients through branches, the internet and other distribution channels. Our principal subsidiaries include Capital One Bank (USA), National Association (“COBNA”) and Capital One, National Association (“CONA”). The Company and its subsidiaries are hereafter collectively referred to as “we,” “us” or “our.” CONA and COBNA are hereafter collectively referred to as the “Banks.” As one of the 10 largest banks in the United States based on deposits, we serve banking customers through branch locations primarily in New York, New Jersey, Texas, Louisiana, Maryland, Virginia and the District of Columbia. In addition to bank lending and depository services, we offer credit and debit card products, mortgage banking and treasury management services. We offer our products outside of the United States principally through operations in the United Kingdom and Canada.

Our principal operations are organized into three primary business segments, which are defined based on the products and services provided, or the type of customer served: Credit Card, Consumer Banking and Commercial Banking.

Basis of Presentation and Use of Estimates

The accompanying unaudited consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States (“U.S. GAAP”) for interim financial information and should be read in conjunction with the audited consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2010 (“2010 Form 10-K”). Certain financial information that is normally included in annual financial statements prepared in conformity with U.S. GAAP, but is not required for interim reporting purposes, has been condensed or omitted. In the opinion of management, all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of our interim unaudited financial statements have been reflected.

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and related disclosures. These estimates are based on information available as of the date of the consolidated financial statements. While management makes its best judgment, actual amounts or results could differ from these estimates. Interim period results may not be indicative of results for the full year.

Principles of Consolidation

The consolidated financial statements include the accounts of Capital One Financial Corporation and all other entities in which we have a controlling financial interest. All significant intercompany accounts and transactions have been eliminated. Certain prior period amounts have been reclassified to conform to the current period presentation.

Significant Accounting Policies

We provide a summary of our significant accounting policies in our 2010 Form 10-K under “Notes to Consolidated Financial Statements—Note 1—Summary of Significant Accounting Policies.” Below we describe accounting standards that we adopted in 2011 and recently issued accounting standards that we have not yet adopted.

 

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CAPITAL ONE FINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

Accounting Standards Adopted in 2011

Receivables: A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring

In April 2011, the Financial Accounting Standards Board (“FASB”) issued an amendment to the accounting guidance for financing receivables, which includes loans, to clarify when a restructuring, such as a loan modification, is considered a troubled debt restructuring (“TDR”). This amendment provides clarification on determining whether a debtor is experiencing financial difficulties and whether a concession has been granted to the debtor for purposes of determining if a loan modification constitutes a TDR. The amended guidance is effective for interim and annual periods beginning on or after June 15, 2011 and applies retrospectively to restructurings occurring on or after the beginning of the fiscal year of adoption, with early adoption permitted. The adoption of this amended accounting guidance in the third quarter of 2011 resulted in a net increase in loan modifications considered to be TDRs of $56 million for consumer loans and $77 million for commercial loans. The allowance for credit losses associated with these loans was $22 million as of September 30, 2011.

Fair Value Measurements and Disclosures—Improving Disclosures about Fair Value Measurements

In January 2010, the FASB issued guidance to improve disclosures about fair value measurements. The guidance, which amended previous disclosure requirements for fair value measurements, requires new disclosures for significant transfers of financial assets and liabilities into and out of Level 1 and Level 2 of the fair value hierarchy, and requires that information on purchases, sales, issuances and settlements in the rollforward of Level 3 activity be presented on a gross basis rather than on a net basis The amended guidance also provides several clarifications with respect to disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring instruments classified as either Level 2 or Level 3. We adopted the requirement for gross presentation in the Level 3 rollforward on January 1, 2011. The remaining provisions of the guidance were effective for us on January 1, 2010. Our adoption of the updated guidance did not affect our financial condition, results of operations or liquidity since it amends only the disclosure requirements for fair value measurements.

Recently Issued but Not Yet Adopted Accounting Standards

Testing Goodwill for Impairment

In September 2011, the FASB issued guidance that is intended to simplify goodwill impairment testing by providing entities with the option to first assess qualitatively whether it is necessary to perform the two-step quantitative analysis currently required. If an entity chooses to perform a qualitative assessment and determines that it is more likely than not that the fair value of a reporting period is less than its carrying amount, the quantitative two-step goodwill impairment test is required. Otherwise, goodwill is deemed to be not impaired and no further evaluation analysis would be necessary. The amended goodwill impairment guidance does not affect the manner in which a company estimates fair value. The amended guidance is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011, with early adoption permitted. We are considering early adoption for our annual goodwill impairment testing scheduled to be performed in the fourth quarter of 2011. We had $13.6 billion in goodwill as of September 30, 2011, the value of which will not be affected by the adoption of this standard.

Presentation of Comprehensive Income

In June 2011, the FASB issued new accounting guidance that revises the manner in which comprehensive income is required to be presented in financial statements. The new guidance will require companies to present the components of net income and other comprehensive income either as one continuous statement or as two

 

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CAPITAL ONE FINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

consecutive statements. The guidance eliminates the option to present components of other comprehensive income in the statement of changes in stockholders’ equity. It does not change the items which must be reported in other comprehensive income, how such items are measured or when they must be reclassified from other comprehensive income to net income. The guidance requires retrospective application and is effective for interim and annual periods beginning on or after December 15, 2011. We intend to adopt the guidance in the first quarter of 2012. Our adoption of the guidance will have no effect on our financial condition, results of operations or liquidity since it impacts presentation only.

Fair Value Measurement: Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards (“IFRS”)

In May 2011, the FASB issued amended guidance on fair value that is intended to provide a converged fair value framework for U.S. GAAP and IFRS. The amended guidance results in a consistent definition of fair value and common requirements for measurement of and disclosure about fair value between U.S. GAAP and IFRS. While the amended guidance continues to define fair value as an exit price, it changes some fair value measurement principles and expands the existing disclosure requirements for fair value measurements. The amended guidance is effective for public entities for interim and annual periods beginning on or after December 15, 2011, with early adoption prohibited. The new guidance requires prospective application and disclosure in the period of adoption of the change, if any, in valuation techniques and related inputs resulting from application of the amendments and quantification of the total effect, if practicable. We intend to adopt the amended guidance in the first quarter of 2012, and are currently assessing the impact that the adoption will have on our consolidated financial statements.

Transfers and Servicing: Reconsideration of Effective Control for Repurchase Agreements

In April 2011, the FASB issued an amendment to the guidance for transfers and servicing with regard to repurchase agreements and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before their maturity. This amendment removes the criterion related to collateral maintenance from the transferor’s assessment of effective control. It focuses the assessment of effective control on the transferor’s rights and obligations with respect to the transferred financial assets and not whether the transferor has the practical ability to perform in accordance with those rights or obligations. As a result of this amendment, we do not expect that repurchase agreements will qualify for derecognition from the transferor’s financial statements and will be treated as secured borrowings. The amendment is effective prospectively for transactions or modification of existing transactions that occur on or after the first interim or annual period beginning on or after December 15, 2011. We intend to adopt the amended guidance on January 1, 2012. We do not expect that the adoption will have a material impact on our consolidated financial statements.

 

 

NOTE 2—ACQUISITIONS

 

We regularly explore opportunities to enter into strategic partnership agreements or acquire financial services companies and businesses to expand our distribution channels and grow our customer base. We may structure these transactions with both an initial payment and later contingent payments tied to future financial performance. In some partnership agreements, we may enter into collaborative risk-sharing arrangements that provide for revenue and loss sharing.

Accounting for Acquisitions

We account for acquisitions in accordance with the accounting guidance for business combinations. Under the guidance for business combinations, the accounting differs depending on whether the acquired set of activities

 

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and assets meets the definition of a business. A business is considered to be an integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing economic benefits directly to investors or other owners, members, or participants. If the acquired set of activities and assets meets the definition of a business, the transaction is accounted for as a business combination. Otherwise, it is accounted for as an asset acquisition.

In a business combination, identifiable assets acquired, liabilities assumed and any noncontrolling interest in the acquiree are recorded at fair value as of the acquisition date, with limited exceptions. Transaction costs and costs to restructure the acquired company are generally expensed as incurred. Goodwill is recognized as the excess of the acquisition price over the estimated fair value of the net assets acquired. The operating results of the acquired business are reflected in our consolidated financial statements subsequent to the date of the merger or acquisition. In an asset acquisition, the assets acquired are recorded at the purchase price plus any transaction costs incurred. Goodwill is not recognized in an asset acquisition.

Accounting for Partnership Agreements

Our partnership agreements primarily relate to alliances with third parties to provide lending and other services to co-branded and private label credit card customers. We evaluate the specific terms of each agreement to determine whether it meets the definition of a collaborative arrangement and how revenue generated from third parties, costs incurred and transactions between participants in the partnership agreement should be accounted for and reported in our consolidated financial statements. A collaborative arrangement is a contractual arrangement that involves a joint operating activity involving two or more parties that are both active participants in the activity and exposed to significant risks and rewards dependent on the economic success of the activity.

If the agreement involves payments between participants under a revenue or loss sharing arrangement, we must determine whether to report revenue or loss amounts on a gross basis or on a net basis after taking into consideration payments due to or due from participants. We evaluate the contractual provisions of each transaction and applicable accounting guidance in determining the manner in which to report the impact of revenue and loss sharing amounts in our consolidated balance sheet and the related impact on our allowance for loan and lease losses. Our consolidated net income is the same regardless of whether we record revenue or expense amounts on a gross or net basis.

2011 Acquisitions

Hudson’s Bay Company Credit Card Portfolio

On January 7, 2011, in a cash transaction, we acquired the credit card portfolio of Hudson’s Bay Company (“HBC”), a Canadian operation, from GE Capital Retail Finance. The acquisition and partnership with HBC significantly expands our credit card customer base in Canada, tripling the number of customer accounts, and provide an additional distribution channel. The acquisition included outstanding credit card loan receivables with a fair value of approximately $1.4 billion, and a transfer of approximately 400 employees directly involved in managing the HBC portfolio.

We accounted for the acquisition as a business combination. Accordingly, we recorded the assets acquired, including identifiable intangible assets, and liabilities assumed at their respective fair values as of the acquisition date and consolidated with our results. In connection with the acquisition, we recorded goodwill of $3 million representing the amount by which the purchase price exceeded the fair value of the net assets acquired. We also recognized a purchased credit card relationship intangible asset of $11 million at acquisition and a contract-based intangible asset of $70 million. Because the acquisition was considered to be a taxable transaction, the goodwill

 

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is deductible for tax purposes. The goodwill was assigned to the International Card reporting unit of our Credit Card segment, and the acquired loan portfolio is reflected in the operations of our International Card business.

Kohl’s Credit Card Portfolio

In August 2010, we entered into a private-label credit card partnership agreement with Kohl’s Department Stores (“Kohl’s”). In connection with the partnership agreement, effective April 1, 2011, we acquired Kohl’s existing private-label credit card loan portfolio from JPMorgan Chase & Co. The existing portfolio, which consists of more than 20 million Kohl’s customer accounts, had an outstanding principal and interest balance of approximately $3.7 billion at acquisition. The partnership agreement has an initial seven-year term and an automatic one-year renewal thereafter. We accounted for the purchase as an asset acquisition.

Under the terms of the partnership agreement and in conjunction with the acquisition, we began issuing Kohl’s branded private-label credit cards to new and existing Kohl’s customers on April 1, 2011. Risk management decisions are jointly managed by Kohl’s and us, but we retain final authority over risk management decisions. Kohl’s has primary responsibility for handling customer service functions and advertising and marketing related to credit card customers.

We share a fixed percentage of revenues, consisting of finance charges and late fees, with Kohl’s, and Kohl’s is required to reimburse us for a fixed percentage of credit losses incurred. Revenues and losses related to the Kohl’s credit card program are reported on a net basis in our consolidated financial statements. The revenue sharing amounts earned by Kohl’s are reflected as an offset against our revenues in our consolidated statements of income. The loss sharing amounts from Kohl’s are reflected as a reduction in our provision for loan and lease losses in our consolidated statements of income. We also report the related allowance for loan and lease losses attributable to the Kohl’s portfolio in our consolidated balance sheets net of the loss sharing amount due from Kohl’s.

Interest income was reduced by $206 million and $421 million in the third quarter and first nine months of 2011, respectively, for amounts earned by Kohl’s. Loss sharing amounts attributable to Kohl’s reduced charge-offs by $39 million and $80 million in the third quarter and first nine months of 2011, respectively. In addition, the expected reimbursement from Kohl’s netted in our allowance for loan and lease losses was approximately $156 million as of September 30, 2011. The reduction in the provision for loan and lease losses attributable to Kohl’s was $236 million for the first nine months of 2011.

 

 

NOTE 3—DISCONTINUED OPERATIONS

 

Shutdown of Mortgage Origination Operations of Wholesale Mortgage Banking Unit

In the third quarter of 2007, we closed the mortgage origination operations of our wholesale mortgage banking unit, acquired by us in December 2006 as part of the North Fork acquisition. The results of the mortgage origination operations and wholesale banking unit have been accounted for as a discontinued operation and therefore not included in our results from continuing operations for the three and nine months ended September 30, 2011 and 2010. We have no significant continuing involvement in these operations.

 

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The following table summarizes the results from discontinued operations related to the closure of our wholesale mortgage banking unit:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
(Dollars in millions)        2011             2010             2011             2010      

Net interest expense

   $ 0      $ 0      $ 0      $ (1

Non-interest expense

     (81     (23     (159     (468
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss from discontinued operations before taxes

     (81     (23     (159     (469

Income tax benefit

     29        8        57        166   
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss from discontinued operations, net of taxes

   $ (52   $ (15   $ (102   $ (303
  

 

 

   

 

 

   

 

 

   

 

 

 

The loss from discontinued operations includes an expense of $75 million ($53 million net of tax) and $147 million ($104 million net of tax) in the third quarter and first nine months of 2011, respectively, primarily attributable to provisions for mortgage loan repurchase losses related to representations and warranties provided on loans previously sold to third parties by the wholesale banking unit. We recorded a provision for mortgage loan repurchase losses of $433 million ($308 million net of tax) in discontinued operations in the first nine months of 2010; however, we did not recognize a provision in discontinued operations in the third quarter of 2010.

The discontinued mortgage origination operations of our wholesale home loan banking unit had remaining assets of $305 million and $362 million as of September 30, 2011 and December 31, 2010, respectively, which consisted primarily of income tax receivables. Liabilities totaled $665 million and $585 million as of September 30, 2011 and December 31, 2010, respectively, consisting primarily of reserves for representations and warranties on loans previously sold to third parties.

 

 

NOTE 4—INVESTMENT SECURITIES

 

Our investment securities portfolio, which had a fair value of $38.4 billion and $41.5 billion, as of September 30, 2011 and December 31, 2010, respectively, consists of U.S. Treasury and U.S. agency debt obligations; agency and non-agency residential and commercial mortgage-backed securities; other asset-backed securities collateralized primarily by credit card loans, auto loans, student loans, auto dealer floor plan inventory loans and leases, equipment loans, and other; municipal securities and limited Community Reinvestment Act (“CRA”) equity securities. Our investment securities portfolio continues to be heavily concentrated in securities that generally have lower credit risk and high credit ratings, such as securities issued and guaranteed by the U.S. Treasury and government sponsored enterprises or agencies. Our investments in U.S. Treasury and agency securities, based on fair value, represented approximately 69% of our total investment securities portfolio as of September 30, 2011, compared with 70% as of December 31, 2010.

 

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Securities Amortized Cost and Fair Value

All of our investment securities were classified as available-for-sale as of September 30, 2011, and are reported in our consolidated balance sheet at fair value. The following tables present the amortized cost, fair values and corresponding gross unrealized gains (losses), by major security type, for our investment securities as of September 30, 2011 and December 31, 2010. The gross unrealized gains (losses) related to our available-for-sale securities are recorded, net of tax, as a component of accumulated other comprehensive income (“AOCI”):

 

    September 30, 2011  
(Dollars in millions)   Amortized
Cost
    Total
Gross
Unrealized
Gains
    Gross
Unrealized
Losses-
OTTI(1)
    Gross
Unrealized
Losses-
Other(2)
    Total
Gross
Unrealized
Losses
    Fair
Value
 

Securities available-for-sale:

           

U.S. Treasury debt obligations

  $ 115      $ 10      $ 0      $ 0      $ 0      $ 125   

U.S. Agency debt obligations(3)

    166        9        0        0        0        175   

Residential mortgage-backed securities (“RMBS”):

           

Agency(4)

    25,139        633        0        (25     (25     25,747   

Non-agency

    1,405        2        (126     (8     (134     1,273   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total RMBS

    26,544        635        (126     (33     (159     27,020   

Commercial mortgage-backed securities (“CMBS”):

           

Agency(4)

    418        11        0        0        0        429   

Non-agency

    400        1        0        (3     (3     398   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total CMBS

    818        12        0        (3     (3     827   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Asset-backed securities (“ABS”)(5)

    9,691        55        0        (12     (12     9,734   

Other(6)

    467        55        0        (3     (3     519   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total securities available-for-sale

  $ 37,801      $ 776      $ (126   $ (51   $ (177   $ 38,400   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

    December 31, 2010  
(Dollars in millions)   Amortized
Cost
    Total
Gross
Unrealized
Gains
    Gross
Unrealized
Losses-
OTTI(1)
    Gross
Unrealized
Losses-
Other(2)
    Total
Gross
Unrealized
Losses
    Fair
Value
 

Securities available-for-sale:

           

U.S. Treasury debt obligations

  $ 373      $ 13      $ 0      $ 0      $ 0      $ 386   

U.S. Agency debt obligations(3)

    301        13        0        0        0        314   

Residential mortgage-backed securities (“RMBS”):

           

Agency(4)

    27,980        667        0        (143     (143     28,504   

Non-agency

    1,826        1        (105     (22     (127     1,700   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total RMBS

    29,806        668        (105     (165     (270     30,204   

Commercial mortgage-backed securities (“CMBS”):

           

Agency(4)

    44        1        0        0        0        45   

Non-agency

    0        0        0        0        0        0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total CMBS

    44        1        0        0        0        45   

Asset-backed securities (“ABS”)(5)

    9,901        69        0        (4     (4     9,966   

Other(6)

    563        66        0        (7     (7     622   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total securities available-for-sale

  $ 40,988      $ 830      $ (105   $ (176   $ (281   $ 41,537   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1)

Represents the amount of cumulative non-credit other-than-temporary impairment (“OTTI”) losses recorded in AOCI. These losses are included in total gross unrealized losses.

(2)

Represents the amount of cumulative gross unrealized losses on securities for which we have not recognized OTTI.

 

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(3)

Consists of debt securities issued by Fannie Mae and Freddie Mac, which had amortized cost of $165 million and $200 million as of September 30, 2011 and December 31, 2010, respectively, and fair value of $174 million and $213 million as of September 30, 2011 and December 31, 2010, respectively.

(4)

Consists of mortgage-backed securities issued by Fannie Mae, Freddie Mac and Ginnie Mae, which had amortized cost of $12.9 billion, $8.4 billion and $4.3 billion, respectively, and fair value of $13.2 billion, $8.6 billion and $4.4 billion, respectively, as of September 30, 2011. The book value of Fannie Mae, Freddie Mac and Ginnie Mae investments exceeded 10% of our stockholders’ equity as of September 30, 2011.

(5)

Consists of securities collateralized by credit card loans, auto dealer and floor plan inventory loans and leases, student loans, auto loans, equipment loans and other. The distribution among these asset types was approximately 73% credit card loans, 11% auto dealer floor plan inventory loans and leases, 7% auto loans, 5% student loans, 2% equipment loans, and 2% of other loans as of September 30, 2011. In comparison, the distribution was approximately 78% credit card loans, 6% auto dealer floor plan inventory loans and leases, 7% auto loans, 7% student loans, 3% equipment loans and less than 1% of home equity lines of credit as of December 31, 2010. Approximately 89% of the securities in our asset-backed security portfolio were rated AAA or its equivalent as of September 30, 2011, compared with 90% as of December 31, 2010.

(6)

Consists of municipal securities and equity investments related primarily to CRA activities.

Securities Available for Sale in a Gross Unrealized Loss Position

The table below provides, by major security type, information about our available-for-sale securities in a gross unrealized loss position and the length of time that individual securities have been in a continuous unrealized loss position as of September 30, 2011 and December 31, 2010:

 

     September 30, 2011  
      Less than 12 Months     12 Months or Longer     Total  
(Dollars in millions)    Fair Value      Gross
Unrealized
Losses
    Fair Value      Gross
Unrealized
Losses
    Fair Value      Gross
Unrealized
Losses
 

Securities available-for-sale:

               

RMBS:

               

Agency(1)

     4,519         (23     385         (2     4,904         (25

Non-agency

     156         (7     1,067         (127     1,223         (134
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total RMBS

     4,675         (30     1,452         (129     6,127         (159

CMBS:

               

Agency(1)

     50         0        0         0        50         0   

Non-agency

     292         (3     0         0        292         (3
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total CMBS

     342         (3     0         0        342         (3
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total ABS

     1,794         (9     86         (3     1,880         (12

Other

     86         (1     62         (2     148         (3
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total securities available-for-sale in a gross unrealized loss position

   $ 6,897       $ (43   $ 1,600       $ (134   $ 8,497       $ (177
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

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     December 31, 2010  
     Less than 12 Months     12 Months or Longer     Total  
(Dollars in millions)    Fair Value      Gross
Unrealized
Losses
    Fair Value      Gross
Unrealized
Losses
    Fair Value      Gross
Unrealized
Losses
 

Securities available-for-sale:

               

RMBS:

               

Agency(1)

     6,571         (141     456         (2     7,027         (143

Non-agency

     45         0        1,566         (127     1,611         (127
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total RMBS

     6,616         (141     2,022         (129     8,638         (270

CMBS:

               

Agency(1)

     0         0        0         0        0         0   

Non-agency

     0         0        0         0        0         0   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total CMBS

     0         0        0         0        0         0   

Total ABS

     1,411         (2     33         (2     1,444         (4

Other

     300         (1     80         (6     380         (7
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total securities available-for-sale in a gross unrealized loss position

   $ 8,327       $ (144   $ 2,135       $ (137   $ 10,462       $ (281
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

(1)

Consists of mortgage-backed securities issued by Fannie Mae, Freddie Mac and Ginnie Mae.

The gross unrealized losses on our available-for-sale securities of $177 million as of September 30, 2011 relate to approximately 320 individual securities. Our investments in non-agency residential MBS, non-agency commercial MBS and non-agency asset-backed securities accounted for $149 million, or 84%, of total gross unrealized losses as of September 30, 2011. Of the $177 million gross unrealized losses as of September 30, 2011, $134 million related to securities that had been in a loss position for more than 12 months. As discussed in more detail below, we conduct periodic reviews of all securities with unrealized losses to assess whether the impairment is other-than-temporary. Based on our assessments, we have recorded OTTI for a portion of our non-agency residential MBS, which is discussed in more detail later in this footnote.

Maturities and Yields of Securities Available-for-Sale

The following table summarizes the remaining scheduled contractual maturities, assuming no prepayments, of our investment securities as of September 30, 2011:

 

     September 30, 2011  
(Dollars in millions)    Amortized
Cost
     Fair Value  

Due in 1 year or less

   $ 2,651       $ 2,661   

Due after 1 year through 5 years

     6,856         6,909   

Due after 5 years through 10 years

     1,613         1,646   

Due after 10 years(1)

     26,681         27,184   
  

 

 

    

 

 

 

Total

   $ 37,801       $ 38,400   
  

 

 

    

 

 

 

 

(1)

Investments with no stated maturities, which consist of equity securities, are included with contractual maturities due after 10 years.

Because borrowers may have the right to call or prepay certain obligations, the expected maturities of our securities are likely to differ from the scheduled contractual maturities presented above. The table below

 

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summarizes, by major security type, the expected maturities and the weighted average yields of our investment securities as of September 30, 2011. Actual calls or prepayment rates may differ from our estimates, which may cause the actual maturities of our investment securities to differ from the expected maturities presented below.

 

    September 30, 2011  
    Due in 1 Year
or Less
    Due > 1 Year
through
5 Years
    Due > 5 Years
through
10 Years
    Due > 10 Years     Total  
(Dollars in millions)   Amount     Average
Yield(1)
    Amount     Average
Yield(1)
    Amount     Average
Yield(1)
    Amount     Average
Yield(1)
    Amount     Average
Yield(1)
 

Fair value of securities available- for-sale:

                   

U.S. Treasury debt obligations

  $ 0        0   $ 125        4.27   $ 0        0   $ 0        0   $ 125        4.27

U.S. Agency debt obligations(2)

    66        4.40        109        4.59        0        0        0        0        175        4.52   

RMBS:

                   

Agency(3)

    956        4.96        23,368        4.21        1,423        4.23        0        0        25,747        4.24   

Non-agency

    187        5.07        1,056        5.83        26        5.70        4        6.58        1,273        5.72   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total RMBS

    1,143        4.98        24,424        4.29        1,449        4.26        4        6.58        27,020        4.32   

CMBS:

                   

Agency(3)

    0        0        197        2.63        157        3.13        75        2.25        429        2.74   

Non-agency

    0        0        134        3.19        264        3.90        0        0        398        3.66   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total CMBS

    0        0        331        2.87        421        3.62        75        2.25        827        3.19   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total ABS

    2,727        2.17        6,454        1.92        553        3.34        0        0        9,734        2.07   

Other(4)

    301        2.04        51        4.02        2        4.86        165        1.16        519        2.06   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total securities available for sale

  $ 4,237        2.95   $ 31,494        3.78   $ 2,425        3.94   $ 244        1.70   $ 38,400        3.69
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Amortized cost of securities available-for-sale

  $ 4,217        $ 30,985        $ 2,407        $ 192        $ 37,801     
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

 

(1)

Yields are calculated based on the amortized cost of the securities.

(2)

Consists of debt securities issued by Fannie Mae and Freddie Mac.

(3)

Consists of mortgage-backed securities issued by Fannie Mae, Freddie Mac and Ginnie Mae.

(4)

Yields of tax-exempt securities are calculated on a fully taxable-equivalent (FTE) basis.

Other-Than-Temporary Impairment

We evaluate all securities in an unrealized loss position at least quarterly, and more often as market conditions require, to assess whether the impairment is other-than-temporary. Our OTTI assessment is a subjective process requiring the use of judgments and assumptions. Accordingly, we consider a number of qualitative and quantitative criteria in our assessment, including the extent and duration of the impairment; recent events specific to the issuer and/or industry to which the issuer belongs; the payment structure of the security; external credit ratings and the failure of the issuer to make scheduled interest or principal payments; the value of underlying collateral; our intent and ability to hold the security; and current market conditions.

We assess, measure and recognize OTTI in accordance with the accounting guidance for recognition and presentation of OTTI. Under this guidance, if we determine that impairment on our debt securities is other-than-temporary and we have made the decision to sell the security or it is more likely than not that we will be required to sell the security prior to recovery of its amortized cost basis, we recognize the entire portion of the impairment in earnings. If we have not made a decision to sell the security and we do not expect that we will be required to sell the security prior to recovery of the amortized cost basis, we recognize only the credit component of OTTI in earnings. The remaining unrealized loss due to factors other than credit, or the non-credit component, is recorded

 

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in AOCI. We determine the credit component based on the difference between the security’s amortized cost basis and the present value of its expected future cash flows, discounted based on the purchase yield. The non-credit component represents the difference between the security’s fair value and the present value of expected future cash flows.

The following table summarizes other-than-temporary impairment losses on debt securities recognized in earnings for the three and nine months ended September 30, 2011 and 2010:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
(Dollars in millions)    2011     2010     2011     2010  

Total OTTI losses

   $ 33      $ 39      $ 83      $ 116   

Less: Non-credit component of OTTI losses recorded in OCI

     (27     (34     (68     (54
  

 

 

   

 

 

   

 

 

   

 

 

 

Net OTTI losses recognized in earnings

   $ 6      $ 5      $ 15      $ 62   
  

 

 

   

 

 

   

 

 

   

 

 

 

As indicated in the table above, we recorded credit related losses in earnings totaling $6 million and $5 million for the three months ended September 30, 2011 and 2010, respectively, and $15 million and $62 million for the nine months ended September 30, 2011 and 2010, respectively. The cumulative non-credit related portion of OTTI on these securities recorded in AOCI totaled $126 million and $105 million as of September 30, 2011 and December 31, 2010, respectively. We estimate the portion of loss attributable to credit using a discounted cash flow model, and we estimate the expected cash flows from the underlying collateral using industry-standard third party modeling tools. These tools take into consideration security specific delinquencies, product specific delinquency roll rates and expected severities. Key assumptions used in estimating the expected cash flows include default rates, loss severity and prepayment rates. Assumptions used can vary widely based on the collateral underlying the securities and are influenced by factors such as collateral type, loan interest rate, geographical location of the borrower, and other borrower characteristics.

We believe the gross unrealized losses related to all other securities of $51 million as of September 30, 2011 are attributable to changes in market interest rates and asset spreads. Therefore, we currently do not expect to incur credit losses related to these securities. In addition, we have no intent to sell these securities with unrealized losses and it is not more likely than not that we will be required to sell these securities prior to recovery of the amortized cost. Accordingly, we have concluded that the impairment on these securities as of September 30, 2011 is not other-than-temporary.

 

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The table below presents activity for the three and nine months ended September 30, 2011 and 2010, related to the credit component of OTTI recognized in earnings on investment debt securities for which a portion of the OTTI loss, the non-credit component, was recorded in AOCI:

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
(Dollars in millions)    2011     2010      2011     2010  

Beginning balance

   $ 56      $ 41       $ 49      $ 32   

Additions for the credit component of OTTI on debt securities for which OTTI losses were not previously recognized

     0        3         3        10 (2) 

Additions for the credit component of OTTI on debt securities for which OTTI losses were previously recognized

     6        2         12        16   

Reductions related to debt securities for which the credit component previously recorded in AOCI was recognized in earnings because of our intent to sell the securities and for securities sold during the period(1)

     (1     0         (3     (12
  

 

 

   

 

 

    

 

 

   

 

 

 

Ending balance

   $ 61      $ 46       $ 61      $ 46   
  

 

 

   

 

 

    

 

 

   

 

 

 

 

(1)

For the three and nine months ended September 30, 2011, there were no OTTI losses recognized in earnings on securities for which no portion of the OTTI losses remained in AOCI. For the nine months ended September 30, 2010, we recognized $36 million, on securities for which no portion of the OTTI losses remained in AOCI.

(2) 

Includes $4 million of OTTI losses recognized in earnings in the first quarter of 2010 on negative amortization bonds classified as held to maturity.

AOCI, Net of Taxes, Related to Securities Available for Sale

The table below presents the changes in AOCI, net of taxes, related to our available-for-sale securities. The net unrealized gains (losses) represent the fair value adjustments recorded on available-for-sale securities, net of tax, during the period. The net reclassification adjustment for net realized losses (gains) represents the amount of those fair value adjustments, net of tax, that were recognized in earnings due to the sale of an available-for-sale security or the recognition of an other-than-temporary impairment loss.

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
(Dollars in millions)        2011             2010             2011             2010      

Beginning balance AOCI related to securities available for sale, net of tax(1)

   $ 478      $ 674      $ 369      $ 186   

Net unrealized gains (losses), net of tax(2)

     41        (77     150        437   

Net realized losses (gains) reclassified from AOCI into earnings, net of tax(3)

     (121     (11     (121     (37
  

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance AOCI related to securities available for sale, net of tax

   $ 398      $ 586      $ 398      $ 586   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1)

Net of tax benefit (expense) of $(263) million and $(371) million for the three months ended September 30, 2011 and 2010, respectively, and $(203) million and $(102) million for the nine months ended September 30, 2011 and 2010, respectively.

(2)

Net of tax benefit (expense) of $(23) million and $42 million for the three months ended September 30, 2011 and 2010, respectively, and $(83) million and $(241) million for the nine months ended September 30, 2011 and 2010, respectively.

(3)

Net of tax (benefit) expense of $67 million and $6 million for the three months ended September 30, 2011 and 2010, respectively, and $67 million and $20 million for the nine months ended September 30, 2011 and 2010, respectively.

 

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Realized Gains and Losses on Securities Available for Sale

The following table presents the gross realized gains and losses on the sale and redemption of available-for-sale securities recognized in earnings for the three and nine months ended September 30, 2011 and 2010. The gross realized investment losses presented below exclude credit losses recognized in earnings attributable to OTTI. We also present the proceeds from the sale of available-for-sale investment securities for the periods presented. We sold approximately $6.4 billion of investment securities, consisting predominantly of agency MBS, during the third quarter of 2011. We recorded a gain of $239 million on the sale of these securities.

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
(Dollars in millions)        2011              2010         2011     2010  

Gross realized investment gains

   $ 239       $ 27      $ 253      $ 135   

Gross realized investment losses

     0         (1     (3     (1
  

 

 

    

 

 

   

 

 

   

 

 

 

Net realized gains

   $ 239       $ 26      $ 250      $ 134   
  

 

 

    

 

 

   

 

 

   

 

 

 

Total proceeds from sales

   $ 6,409       $ 2,417      $ 8,979      $ 11,478   
  

 

 

    

 

 

   

 

 

   

 

 

 

Securities Pledged

As part of our liquidity management strategy, we pledge securities to secure borrowings from the Federal Home Loan Bank (“FHLB”) and the Federal Reserve Bank. We also pledge securities to secure trust and public deposits and for other purposes as required or permitted by law. We pledged securities with a fair value of $8.9 billion and $10.0 billion as of September 30, 2011 and December 31, 2010, respectively. We pledged $352 million and $229 million of cash collateral as of September 30, 2011 and December 31, 2010, respectively. The cash collateral related to securities borrowed was $9 million as of September 30, 2011, with the remainder related to derivative counterparties. All of the cash collateral pledged as of December 31, 2010 related to derivative counterparties.

 

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NOTE 5—LOANS

 

Loan Portfolio Composition

Our total loan portfolio consists of loans we own and loans underlying our securitization trusts. The table below presents the composition of our held-for-investment loan portfolio, including restricted loans for securitization investors, as of September 30, 2011 and December 31, 2010. Our loan portfolio consists of credit card, consumer banking and commercial banking loans. Credit card loans consist of domestic and international loans as well as installment loans. Consumer banking loans consist of automobile, home, and retail banking loans. Commercial banking loans consist of commercial and multifamily real estate, middle market, specialty lending and small-ticket commercial real estate loans.

 

(Dollars in millions)    September 30,
2011
     December 31,
2010
 

Credit Card business:

     

Domestic credit card loans

   $ 51,510       $ 49,979   

International credit card loans

     8,210         7,513   
  

 

 

    

 

 

 

Total credit card loans

     59,720         57,492   
  

 

 

    

 

 

 

Domestic installment loans

     2,310         3,870   

International installment loans

     0         9   
  

 

 

    

 

 

 

Total installment loans

     2,310         3,879   
  

 

 

    

 

 

 

Total credit card

     62,030         61,371   
  

 

 

    

 

 

 

Consumer Banking business:

     

Automobile

     20,422         17,867   

Home loans

     10,916         12,103   

Other retail

     4,014         4,413   
  

 

 

    

 

 

 

Total consumer banking

     35,352         34,383   
  

 

 

    

 

 

 

Commercial Banking business:

     

Commercial and multifamily real estate(1)

     14,389         13,396   

Middle market

     11,924         10,484   

Specialty lending

     4,221         4,020   
  

 

 

    

 

 

 

Total commercial lending

     30,534         27,900   

Small-ticket commercial real estate

     1,571         1,842   
  

 

 

    

 

 

 

Total commercial banking

     32,105         29,742   

Other:

     

Other loans

     465         451   
  

 

 

    

 

 

 

Total loans

   $ 129,952       $ 125,947   
  

 

 

    

 

 

 

 

(1)

Includes construction loans and land development loans totaling $2.2 billion as of September 30, 2011 and $2.4 billion as of December 31, 2010.

Credit Quality

We closely monitor economic conditions and loan performance trends to manage and evaluate our exposure to credit risk. Trends in delinquency ratios are an indicator, among other considerations, of credit risk within our loan

 

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portfolios. The level of nonperforming assets represents another indicator of the potential for future credit losses. Accordingly, key metrics we track and use in evaluating the credit quality of our loan portfolio include delinquency and nonperforming asset rates, as well as charge-off rates and our internal risk ratings of commercial loans.

Delinquent and Nonperforming Loans

The entire balance of a loan is considered contractually delinquent if the minimum required payment is not received by the first statement cycle date equal to or following the due date specified on the customer’s billing statement. Delinquency is reported on loans that are 30 or more days past due. Interest and fees continue to accrue on past due loans until the date the loan is placed on nonaccrual status, if applicable. We generally place loans on nonaccrual status when we believe the collectability of interest and principal is not reasonably assured.

Nonperforming loans generally include loans that have been placed on nonaccrual status and certain restructured loans whose contractual terms have been restructured in a manner that grants a concession to a borrower experiencing financial difficulty. We do not report loans held for sale as nonperforming. Our policies for classifying loans as nonperforming, by loan category, are as follows:

 

   

Credit card loans: As permitted by regulatory guidance issued by the Federal Financial Institutions Examination Council (“FFIEC”), our policy is generally to exempt credit card loans from being classified as nonperforming as these loans are generally charged-off in the period the account becomes 180 days past due. Consistent with industry conventions, we generally continue to accrue interest and fees on delinquent credit card loans until the loans are charged-off. When we do not expect full payment of billed finance charges and fees, we reduce the balance of the credit card loan by the estimated uncollectible portion of any billed finance charges and fees and exclude this amount from revenue. Installment loans are included in our credit card segment and classified as nonperforming when the loan is 120 days past due.

 

   

Consumer banking loans: We classify other non-credit card consumer loans as nonperforming at the earlier of the date when we determine that the collectability of interest or principal on the loan is not reasonably assured or in the period in which the loan becomes 90 days past due for automobile, home loans and unsecured small business revolving lines of credit and 120 days past due for all other non-credit card consumer loans.

 

   

Commercial banking loans: We classify commercial loans as nonperforming when we determine that the collectability of interest or principal on the loan is not reasonably assured.

 

   

Modified loans and troubled debt restructurings: Modified loans, including TDRs, that are current at the time of the restructuring remain on accrual status if there is demonstrated performance prior to the restructuring and continued performance under the modified terms is expected. Otherwise, the modified loan is classified as nonperforming and placed on nonaccrual status until the borrower demonstrates a sustained period of performance over several payment cycles, generally six months of consecutive payments, under the modified terms of the loan.

 

   

Purchased credit-impaired (“PCI”) loans: PCI loans primarily include loans acquired from Chevy Chase Bank, which we recorded at fair value at acquisition. Because the initial fair value of these loans included an estimate of credit losses expected to be realized over the remaining lives of the loans, our subsequent accounting for PCI loans differs from the accounting for non-PCI loans. We, therefore, separately track and report PCI loans and exclude these loans from our delinquency and nonperforming loan statistics.

Interest and fees accrued but not collected at the date a loan is placed on nonaccrual status are reversed against earnings. In addition, the amortization of net deferred loan fees is suspended. Interest and fee income is subsequently recognized only upon the receipt of cash payments. However, if there is doubt regarding the

 

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ultimate collectability of loan principal, all cash received is applied against the principal balance of the loan. Nonaccrual loans are generally returned to accrual status when all principal and interest is current and repayment of the remaining contractual principal and interest is reasonably assured or when the loan is both well-secured and in the process of collection and collectability is no longer doubtful.

The following table summarizes the payment status of loans in our total loan portfolio, including an aging of delinquent loans, loans 90 days or more past due continuing to accrue interest and loans classified as nonperforming. We present information below on the credit performance of our loan portfolio, by major loan category, including key metrics that we use in tracking changes in the credit quality of each of our loan portfolios. The delinquency aging includes all past due loans, both performing and nonperforming, as of September 30, 2011 and December 31, 2010.

Loans 90 days or more past due totaled approximately $2.0 billion and $2.2 billion as of September 30, 2011 and December 31, 2010, respectively. Loans classified as nonperforming totaled $1.2 billion as of both September 30, 2011 and December 31, 2010.

 

    September 30, 2011  
(Dollars in millions)   Current     30-59
Days
    60-89
Days
    > 90
Days
    Total
Delinquent
Loans
    PCI
Loans
    Total
Loans
    > 90 Days
and
Accruing(1)
    Nonperforming
Loans(1)
 

Credit card:

                 

Domestic credit card and installment loans

  $ 51,858      $ 612      $ 435      $ 915      $ 1,962      $ 0      $ 53,820      $ 915      $ 0   

International credit card and installment loans

    7,771        141        104        194        439        0        8,210        194        0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total credit card

    59,629        753        539        1,109        2,401        0        62,030        1,109        0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Consumer Banking:

                 

Auto

    18,979        919        376        92        1,387        56        20,422        0        92   

Home loans

    6,137        75        41        381        497        4,282        10,916        0        495   

Retail banking

    3,884        29        13        43        85        45        4,014        2        79   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total consumer banking

    29,000        1,023        430        516        1,969        4,383        35,352        2        666   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Commercial Banking:

                 

Commercial and multifamily real estate

    13,895        46        68        219        333        161        14,389        32        287   

Middle market

    11,518        8        1        67        76        330        11,924        5        116   

Specialty lending

    4,180        17        6        18        41        0        4,221        3        35   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial lending

    29,593        71        75        304        450        491        30,534        40        438   

Small-ticket commercial real estate

    1,508        39        6        18        63        0        1,571        0        21   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial banking

    31,101        110        81        322        513        491        32,105        40        459   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other:

                 

Other loans

    402        18        5        40        63        0        465        0        47   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 120,132      $ 1,904      $ 1,055      $ 1,987      $ 4,946      $ 4,874      $ 129,952      $ 1,151      $ 1,172   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

% of Total loans

    92.4     1.5     0.8     1.5     3.8     3.8     100.0     0.9     0.9
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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    December 31, 2010  
(Dollars in millions)   Current     30-59
Days
    60-89
Days
    > 90
Days
    Total
Delinquent
Loans
    PCI
Loans
    Total
Loans
    > 90 Days
and
Accruing(1)
    Nonperforming
Loans(1)
 

Credit card:

                 

Domestic credit card and installment loans

  $ 51,649      $ 558      $ 466      $ 1,176      $ 2,200      $ 0      $ 53,849      $ 1,176      $ 0   

International credit card and installment loans

    7,090        132        97        203        432        0        7,522        203        0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total credit card

    58,739        690        563        1,379        2,632        0        61,371        1,379        0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Consumer Banking:

                 

Auto

    16,414        952        402        99        1,453        0        17,867        0        99   

Home loans

    6,707        65        44        395        504        4,892        12,103        0        486   

Retail banking

    4,218        31        22        40        93        102        4,413        5        91   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total consumer banking

    27,339        1,048        468        534        2,050        4,994        34,383        5        676   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Commercial Banking:

                 

Commercial and multifamily real estate

    12,816        118        31        153        302        278        13,396        14        276   

Middle market

    10,113        34        5        50        89        282        10,484        0        133   

Specialty lending

    3,962        25        7        26        58        0        4,020        0        48   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial lending

    26,891        177        43        229        449        560        27,900        14        457   

Small-ticket commercial real estate

    1,711        74        24        33        131        0        1,842        0        38   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial banking

    28,602        251        67        262        580        560        29,742        14        495   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other:

                 

Other loans

    382        19        5        45        69        0        451        0        54   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 115,062      $ 2,008      $ 1,103      $ 2,220      $ 5,331      $ 5,554      $ 125,947      $ 1,398      $ 1,225   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

% of Total loans

    91.4     1.6     0.9     1.7     4.2     4.4     100.0     1.1     1.0
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1)

Purchased credit-impaired loans are excluded from loans reported as 90 days or more past due and still accruing interest and nonperforming loans.

Charge-Offs

Net charge-offs consist of the unpaid principal balance of loans held for investment that we determine are uncollectible, net of recovered amounts. We exclude accrued and unpaid finance charges and fees and fraud losses from charge-offs. Charge-offs are recorded as a reduction to the allowance for loan and lease losses and subsequent recoveries of previously charged-off amounts are credited to the allowance for loan and lease losses. Costs incurred to recover charged-off loans are recorded as collection expense and included in our consolidated statements of income as a component of other non-interest expense. Our charge-off time frame for loans, which varies based on the loan type, is presented below.

 

   

Credit card loans: We generally charge-off credit card loans when the account is 180 days past due from the statement cycle date. Credit card loans in bankruptcy are charged-off within 30 days of receipt of a complete bankruptcy notification from the bankruptcy court, except for U.K. credit card loans, which are charged-off within 60 days. Credit card loans of deceased account holders are charged-off within 60 days of receipt of notification.

 

   

Consumer banking loans: We generally charge-off consumer loans at the earlier of the date when the account is a specified number of days past due or upon repossession of the underlying collateral. Our charge-off time frame is 180 days for mortgage loans and unsecured small business lines of credit and 120

 

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days for auto and other non-credit card consumer loans. We calculate the charge-off amount for mortgage loans based on the difference between our recorded investment in the loan and the fair value of the underlying property and estimated selling costs as of the date of the charge-off. We update our home value estimates on a regular basis and recognize additional charge-offs for declines in home values below our initial fair value and selling cost estimate at the date mortgage loans are charged-off. Consumer loans in bankruptcy, except for auto and mortgage loans, generally are charged-off within 40 days of receipt of notification from the bankruptcy court. Auto and home loans in bankruptcy are charged-off in the period that the loan is both 60 days or more past due and 60 days or more past the bankruptcy notification date or in the period the loan becomes 120 days past due for auto loans and 180 days past due for mortgage loans regardless of the bankruptcy notification date. Consumer loans of deceased account holders are charged-off within 60 days of receipt of notification.

 

   

Commercial banking loans: We charge-off commercial loans in the period we determine that the unpaid principal loan amounts are uncollectible.

 

   

Purchased credit-impaired loans: We do not record charge-offs on PCI loans that are performing in accordance with or better than our expectations as of the date of acquisition, as the fair values of these loans already reflect a credit component. We record charge-offs on purchased credit-impaired loans only if actual losses exceed estimated losses incorporated into the fair value recorded at acquisition.

 

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Credit Card

Our credit card loan portfolio is generally highly diversified across millions of accounts and multiple geographies without significant individual exposures. We, therefore, generally manage credit risk on a portfolio basis. The risk in our credit card portfolio is correlated with broad economic trends, such as unemployment rates, gross domestic product (“GDP”) growth, and home values, as well as customer liquidity, which can have a material effect on credit performance. The primary factors we assess in monitoring the credit quality and risk of our credit card portfolio are delinquency and charge-off trends, including an analysis of the migration of loans between delinquency categories over time. The table below displays the geographic profile of our credit card loan portfolio and delinquency statistics as of September 30, 2011 and December 31, 2010. We also present comparative net charge-offs for the three and nine months ended September 30, 2011 and 2010.

Credit Card: Risk Profile by Geographic Region and Delinquency Status

 

     September 30, 2011     December 31, 2010  
(Dollars in millions)    Amount      % of
Total(1)
    Amount      % of
Total(1)
 

Domestic card and installment loans:

          

California

   $ 6,128         9.9   $ 6,242         10.2

Texas

     3,572         5.7        3,633         5.9   

New York

     3,658         5.9        3,599         5.8   

Florida

     3,201         5.2        3,298         5.4   

Illinois

     2,524         4.1        2,403         3.9   

Pennsylvania

     2,422         3.9        2,389         3.9   

Ohio

     2,168         3.5        2,109         3.4   

New Jersey

     2,045         3.3        1,971         3.2   

Michigan

     1,754         2.8        1,716         2.8   

Other

     26,348         42.5        26,489         43.2   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total domestic card and installment loans

     53,820         86.8     53,849         87.7
  

 

 

    

 

 

   

 

 

    

 

 

 

International card and installment loans:

          

United Kingdom

     3,879         6.2        4,102         6.7   

Canada

     4,331         7.0        3,420         5.6   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total international card and installment loans

     8,210         13.2        7,522         12.3
  

 

 

    

 

 

   

 

 

    

 

 

 

Total credit card

   $ 62,030         100.0   $ 61,371         100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

Selected credit metrics:

          

30+ day delinquencies(2)

   $ 2,401         3.87   $ 2,632         4.29

90+ day delinquencies(2)

     1,109         1.79        1,379         2.25   

 

     Three Months Ended September 30,     Nine Months Ended September 30,  
     2011     2010     2011     2010  
(Dollars in millions)    Amount      Rate     Amount      Rate     Amount      Rate     Amount      Rate  

Net charge-offs:

                    

Domestic

   $ 527         3.92   $ 1,112         8.23   $ 1,969         4.94   $ 3,940         9.43

International

     134         6.15        139         7.60        414         6.31        468         8.28   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total(3)

   $ 661         4.23   $ 1,251         8.16   $ 2,383         5.13   $ 4,408         9.30
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

(1)

Percentages by geographic region within the domestic and international credit card portfolios are calculated based on the total held for investment credit card and installment loans as of the end of the reported period.

 

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(2)

Delinquency rates calculated by dividing delinquent credit card and installment loans by the total balance of credit card and installment loans held for investment as of the end of the reported period. The balance of credit card loans includes accrued finance charges and fees, net of the estimated uncollectible finance charge and fee reserve.

(3)

Calculated by dividing annualized net charge-offs by average credit card loans held for investment during the three and nine months ended September 30, 2011 and 2010.

The 30+ day delinquency rate for our credit card loan portfolio decreased to 3.87% as of September 30, 2011, from 4.29% as of December 31, 2010, reflecting strong underlying credit improvement trends. The September 30, 2011 30+ day delinquency rate for Domestic Card reflects the impact of a revision we made in the third quarter of 2011 in the way we estimate recoveries in determining the uncollectible amount of finance charges and fees, which resulted in an increase of 11 basis points as of September 30, 2011. For International Card, the change did not have a significant impact on the 30+ day delinquency rate as of September 30, 2011.

 

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Consumer Banking

Our consumer banking loan portfolio consists of auto, home loan and retail banking loans. Similar to our credit card loan portfolio, the risk in our consumer banking loan portfolio is correlated with broad economic trends, such as unemployment rates, GDP growth, and home values, as well as customer liquidity, which can have a material effect on credit performance. Delinquency, nonperforming loans and charge-off trends are key factors we assess in monitoring the credit quality and risk of our consumer banking loan portfolio. The table below displays the geographic profile of our consumer banking loan portfolio, including PCI loans acquired from Chevy Chase Bank. We also present the delinquency and nonperforming loan rates of our consumer banking loan portfolio, excluding PCI loans as of September 30, 2011 and December 31, 2010, and net charge-offs for the three and nine months ended September 30, 2011 and 2010.

Consumer Banking: Risk Profile by Geographic Region, Delinquency Status and Performing Status

 

     September 30, 2011  
      Non-PCI Loans     PCI Loans     Total  
(Dollars in millions)    Loans      % of
Total(1)
    Loans      % of
Total(1)
    Loans      % of
Total(1)
 

Auto:

               

Texas

   $ 3,727         10.6   $ 0         0.0   $ 3,727         10.6

California

     1,620         4.6        0         0.0        1,620         4.6   

Louisiana

     1,380         3.9        0         0.0        1,380         3.9   

Florida

     1,118         3.2        0         0.0        1,118         3.2   

Georgia

     1,066         3.0        0         0.0        1,066         3.0   

New York

     929         2.6        0         0.0        929         2.6   

Illinois

     925         2.6        0         0.0        925         2.6   

Other

     9,601         27.1        56         0.2        9,657         27.3   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total auto

   $ 20,366         57.6   $ 56         0.2   $ 20,422         57.8
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Home loans:

               

New York

   $ 1,799         5.1   $ 279         0.8   $ 2,078         5.9

California

     822         2.3        1,283         3.6        2,105         5.9   

Louisiana

     1,711         4.8        2         0.0        1,713         4.8   

Maryland

     275         0.8        570         1.6        845         2.4   

Virginia

     191         0.5        551         1.6        742         2.1   

New Jersey

     354         1.0        261         0.7        615         1.7   

Other

     1,482         4.3        1,336         3.7        2,818         8.0   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total home loans

   $ 6,634         18.8   $ 4,282         12.0   $ 10,916         30.8
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Retail banking:

               

Louisiana

   $ 1,583         4.5   $ 0         0.0   $ 1,583         4.5

Texas

     965         2.7        0         0.0        965         2.7   

New York

     897         2.5        0         0.0        897         2.5   

New Jersey

     298         0.8        0         0.0        298         0.8   

Maryland

     57         0.2        23         0.1        80         0.3   

Virginia

     39         0.1        14         0.1        53         0.2   

Other

     130         0.4        8         0.0        138         0.4   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total retail banking

   $ 3,969         11.2   $ 45         0.2   $ 4,014         11.4
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total consumer banking

   $ 30,969         87.6   $ 4,383         12.4   $ 35,352         100.0
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

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     September 30, 2011  
     Auto     Home Loan     Retail Banking     Total Consumer
Banking
 
(Dollars in millions)    Amount      Rate     Amount      Rate     Amount      Rate     Amount      Rate  

Credit performance:(2)

                    

30+ day delinquencies

   $ 1,387         6.79   $ 497         4.55   $ 85         2.12   $ 1,969         5.57

90+ day delinquencies

     92         0.45        381         3.49        43         1.07        516         1.46   

Nonperforming loans

     92         0.45        495         4.54        79         1.97        666         1.88   

 

     December 31, 2010  
     Non-PCI Loans     PCI Loans     Total  
(Dollars in millions)    Loans      % of
Total(1)
    Loans      % of
Total(1)
    Loans      % of
Total(1)
 

Auto:

               

Texas

   $ 3,161         9.2   $ 0         0.0   $ 3,161         9.2

California

     1,412         4.1        0         0.0        1,412         4.1   

Louisiana

     1,334         3.9        0         0.0        1,334         3.9   

Florida

     954         2.8        0         0.0        954         2.8   

Georgia

     908         2.6        0         0.0        908         2.6   

New York

     894         2.6        0         0.0        894         2.6   

Illinois

     843         2.5        0         0.0        843         2.5   

Other

     8,361         24.3        0         0.0        8,361         24.3   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total auto

   $ 17,867         52.0   $ 0         0.0   $ 17,867         52.0
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Home loan:

               

New York

   $ 2,069         6.0   $ 311         0.9   $ 2,380         6.9

California

     959         2.8        1,380         4.0        2,339         6.8   

Louisiana

     1,776         5.2        2         0.0        1,778         5.2   

Maryland

     281         0.8        605         1.8        886         2.6   

Virginia

     200         0.6        591         1.7        791         2.3   

New Jersey

     423         1.2        278         0.8        701         2.0   

Other

     1,503         4.4        1,725         5.0        3,228         9.4   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total home loans

   $ 7,211         21.0   $ 4,892         14.2   $ 12,103         35.2
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Retail banking:

               

Louisiana

   $ 1,754         5.1   $ 0         0.0   $ 1,754         5.1

Texas

     1,125         3.3        0         0.0        1,125         3.3   

New York

     909         2.6        0         0.0        909         2.6   

New Jersey

     357         1.0        0         0.0        357         1.0   

Maryland

     58         0.2        31         0.1        89         0.3   

Virginia

     35         0.1        17         0.1        52         0.2   

Other

     73         0.2        54         0.1        127         0.3   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total retail banking

   $ 4,311         12.5   $ 102         0.3   $ 4,413         12.8
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total consumer banking

   $ 29,389         85.5   $ 4,994         14.5   $ 34,383         100.0
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

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     December 31, 2010  
     Auto     Home Loan     Retail Banking     Total Consumer
Banking
 
(Dollars in millions)    Amount      Rate     Amount      Rate     Amount      Rate     Amount      Rate  

Credit performance:(2)

                    

30+ day delinquencies

   $ 1,453         8.13   $ 504         4.16   $ 93         2.11   $ 2,050         5.96

90+ day delinquencies

     99         0.55        395         3.27        40         0.91        534         1.54   

Nonperforming loans

     99         0.55        486         4.01        91         2.07        676         1.97   

 

     Three Months Ended September 30, 2011  
     Auto     Home Loan     Retail Banking     Total Consumer
Banking
 
(Dollars in millions)    Amount      Rate     Amount      Rate     Amount      Rate     Amount      Rate  

Net charge-offs(3)

   $     83         1.69   $   15         0.53   $ 17         1.67   $   115         1.32
     Three Months Ended September 30, 2010  
     Auto     Home Loans     Retail Banking     Total Consumer
Banking
 
(Dollars in millions)    Amount      Rate     Amount      Rate     Amount      Rate     Amount      Rate  

Net charge-offs(3)

   $ 118         2.71   $ 13         0.41   $ 26         2.20   $ 157         1.79 % 

 

     Nine Months Ended September 30, 2011  
     Auto     Home Loans     Retail Banking     Total Consumer
Banking
 
(Dollars in millions)    Amount      Rate     Amount      Rate     Amount      Rate     Amount      Rate  

Net charge-offs(3)

   $ 224         1.58   $ 53         0.61   $ 59         1.91   $ 336         1.30

 

     Nine Months Ended September 30, 2010  
     Auto     Home Loans     Retail Banking     Total Consumer
Banking
 
(Dollars in millions)    Amount      Rate     Amount      Rate     Amount      Rate     Amount      Rate  

Net charge-offs(3)

   $ 340         2.59   $ 65         0.62   $ 78         2.14   $ 483         1.77 % 

 

(1)

Percentages by geographic region are calculated based on the total held-for-investment consumer banking loans as of the end of the reported period.

(2)

Credit performance statistics exclude PCI loans, which were recorded at fair value at acquisition. Although PCI loans may be contractually delinquent, we separately track these loans and do not include them in our delinquency and nonperforming loan statistics as the fair value recorded at acquisition included an estimate of credit losses expected to be realized over the remaining lives of the loans.

(3)

Calculated by dividing annualized net charge-offs by average loans held for investment for the three and nine months ended September 30, 2011 and 2010.

Home Loan

Our home loan portfolio consists of both first-lien and second-lien residential mortgage loans. In evaluating the credit quality and risk of our home loans portfolio, we continually monitor a variety of mortgage loan characteristics that may affect the default experience on our overall home loans portfolio, such as vintage, geographic concentrations, lien priority and product type. Certain loan concentrations have experienced higher delinquency rates as a result of the significant decline in home prices since the home price peak in 2006 and rise

 

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in unemployment. These loan concentrations include loans originated during 2008, 2007 and 2006 in an environment of decreasing home sales, broadly declining home prices and more relaxed underwriting standards and loans on properties in Arizona, California, Florida and Nevada, which have experienced the most severe decline in home prices. The following table presents the distribution of our home loans portfolio as of September 30, 2011 and December 31, 2010 based on selected key risk characteristics.

Home Loans: Risk Profile by Vintage, Geography, Lien Priority and Interest Rate Type

 

     September 30, 2011  
     Non-PCI Loans     PCI Loans     Total Home Loans  
(Dollars in millions)    Amount      % of
Total(1)
    Amount      % of
Total(1)
    Amount      % of
Total(1)
 

Origination year:

               

< = 2005

   $ 4,294         39.3   $ 1,592         14.6   $ 5,886         53.9

2006

     753         6.9        981         9.0        1,734         15.9   

2007

     565         5.2        1,324         12.1        1,889         17.3   

2008

     273         2.5        310         2.8        583         5.3   

2009

     237         2.2        21         0.2        258         2.4   

2010

     295         2.7        45         0.4        340         3.1   

2011

     217         2.0        9         0.1        226         2.1   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 6,634         60.8   $ 4,282         39.2   $ 10,916         100.0
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Geographic concentration:(2)

               

New York

   $ 1,799         16.5   $ 279         2.6   $ 2,078         19.1

California

     822         7.5        1,283         11.8        2,105         19.3   

Louisiana

     1,711         15.7        2         0.0        1,713         15.7   

Maryland

     275         2.5        570         5.2        845         7.7   

Virginia

     191         1.8        551         5.0        742         6.8   

New Jersey

     354         3.2        261         2.4        615         5.6   

Texas

     478         4.4        30         0.3        508         4.7   

Florida

     123         1.1        261         2.4        384         3.5   

District of Columbia

     63         0.6        145         1.3        208         1.9   

Washington

     63         0.6        101         0.9        164         1.5   

Connecticut

     85         0.8        78         0.7        163         1.5   

Other

     670         6.1        721         6.6        1,391         12.7   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 6,634         60.8   $ 4,282         39.2   $ 10,916         100.0
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Lien type:

               

1st lien

   $ 5,495         50.3   $ 3,789         34.7   $ 9,284         85.0

2nd lien

     1,139         10.5        493         4.5        1,632         15.0   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 6,634         60.8   $ 4,282         39.2   $ 10,916         100.0
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Interest rate type:

               

Fixed rate

   $ 2,856         26.2   $ 91         0.8   $ 2,947         27.0

Adjustable rate

     3,778         34.6        4,191         38.4        7,969         73.0   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 6,634         60.8   $ 4,282         39.2   $ 10,916         100.0
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

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CAPITAL ONE FINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

     December 31, 2010  
     Non-PCI Loans     PCI Loans     Total Home Loans  
(Dollars in millions)    Amount      % of
Total(1)
    Amount      % of
Total(1)
    Amount      % of
Total(1)
 

Origination year:

               

< = 2005

   $ 4,801         39.7   $ 1,852         15.3   $ 6,653         55.0

2006

     848         7.0        1,133         9.3        1,981         16.3   

2007

     609         5.0        1,527         12.6        2,136         17.6   

2008

     305         2.5        371         3.1        676         5.6   

2009

     288         2.4        9         0.1        297         2.5   

2010

     360         3.0        0         0.0        360         3.0   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 7,211         59.6   $ 4,892         40.4   $ 12,103         100.0
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Geographic concentration:(2)

               

New York

   $ 2,069         17.1   $ 311         2.6   $ 2,380         19.7

California

     959         7.9        1,380         11.4        2,339         19.3   

Louisiana

     1,776         14.7        2         0.0        1,778         14.7   

Maryland

     281         2.3        605         5.0        886         7.3   

Virginia

     200         1.7        591         4.9        791         6.6   

New Jersey

     423         3.5        278         2.3        701         5.8   

Texas

     491         4.1        32         0.3        523         4.4   

Florida

     139         1.1        290         2.4        429         3.5   

District of Columbia

     77         0.6        149         1.2        226         1.8   

Connecticut

     110         0.9        85         0.7        195         1.6   

Other

     686         5.7        1,169         9.6        1,855         15.3   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 7,211         59.6   $ 4,892         40.4   $ 12,103         100.0
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Lien type:

               

1st lien

   $ 6,015         49.7   $ 4,303         35.5   $ 10,318         85.2

2nd lien

     1,196         9.9        589         4.9        1,785         14.8   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 7,211         59.6   $ 4,892         40.4   $ 12,103         100.0
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Interest rate type:

               

Fixed rate

   $ 3,548         29.3   $ 182         1.5   $ 3,730         30.8

Adjustable rate

     3,663         30.3        4,710         38.9        8,373         69.2   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 7,211         59.6   $ 4,892         40.4   $ 12,103         100.0
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

(1)

Percentages within each risk category calculated based on total held for investment home loans.

(2)

Represents the top ten states in which we have the highest concentration of home loans.

Commercial Banking

We evaluate the credit risk of commercial loans individually and use a risk-rating system to determine the credit quality of our commercial loans. We assign internal risk grades to loans based on relevant information about the ability of borrowers to service their debt. In determining the risk rating of a particular loan, among the factors considered are the borrower’s current financial condition, historical credit performance, projected future credit performance, prospects for support from financially responsible guarantors, the estimated realizable value of any collateral and current economic trends. The ratings scale based on our internal risk-rating system is as follows:

 

   

Noncriticized: Loans that have not been designated as criticized, frequently referred to as “pass” loans.

 

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Table of Contents

CAPITAL ONE FINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

   

Criticized performing: Loans in which the financial condition of the obligor is stressed, affecting earnings, cash flows or collateral values. The borrower currently has adequate capacity to meet near-term obligations; however, the stress, left unabated, may result in deterioration of the repayment prospects at some future date.

 

   

Criticized nonperforming: Loans that are not adequately protected by the current sound worth and paying capacity of the obligor or the collateral pledged, if any. Loans classified as criticized nonperforming have a well-defined weakness, or weaknesses, which jeopardize the repayment of the debt. These loans are characterized by the distinct possibility that we will sustain a credit loss if the deficiencies are not corrected.

We use our internal risk-rating system for regulatory reporting, determining the frequency of review of the credit exposures and evaluation and determination of the allowance for commercial loans. Loans of $1 million or more designated as criticized performing and criticized nonperforming are reviewed quarterly by management for further deterioration or improvement to determine if they are appropriately classified/graded and whether impairment exists. All other loans greater than $1 million are specifically reviewed at least annually to determine the appropriate loan grading. In addition, during the renewal process of any loan, as well if a loan becomes past due, we evaluate the risk rating.

The following table presents the geographic distribution and internal risk ratings of our commercial loan portfolio as of September 30, 2011 and December 31, 2010.

Commercial Banking: Risk Profile by Geographic Region and Internal Risk Rating(1)

 

    September 30, 2011  
(Dollars in millions)   Commercial
&
Multifamily
Real Estate
    % of
Total(2)
    Middle
Market
    % of
Total(2)
    Specialty
Lending
    % of
Total(2)
    Small-ticket
Commercial
Real Estate
    % of
Total(2)
    Total
Commercial
    % of
Total(2)
 

Geographic concentration:(3)

                   

Non-PCI loans:

                   

Northeast

  $ 11,450        79.6   $ 3,565        29.9   $ 1,590        37.7   $ 974        62.0   $ 17,579        54.8

Mid-Atlantic

    913        6.4        544        4.5        191        4.5        62        3.9        1,710        5.3   

South

    1,531        10.6        6,876        57.7        756        17.9        95        6.1        9,258        28.8   

Other

    334        2.3        609        5.1        1,684        39.9        440        28.0        3,067        9.6   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total non-PCI loans

    14,228        98.9        11,594        97.2        4,221        100.0        1,571        100.0        31,614        98.5   

PCI loans

    161        1.1        330        2.8        0        0.0        0        0.0        491        1.5   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 14,389        100.0   $ 11,924        100.   $ 4,221        100.   $ 1,571        100.   $ 32,105        100.0
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Internal risk rating:(4)

                   

Non-PCI loans:

                   

Noncriticized

  $ 12,842        89.3   $ 10,893        91.3   $ 4,132        97.9   $ 1,507        96.0   $ 29,374        91.6

Criticized performing

    1,100        7.6        584        4.9        54        1.3        43        2.7        1,781        5.5   

Criticized nonperforming

    286        2.0        117        1.0        35        0.8        21        1.3        459        1.4   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total non-PCI loans

    14,228        98.9        11,594        97.2        4,221        100.0        1,571        100.0        31,614        98.5   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

PCI loans:

                   

Noncriticized

  $ 126        0.9   $ 317        2.7   $ 0        0.0   $ 0        0.0   $ 443        1.4

Criticized performing

    35        0.2        13        0.1        0        0.0        0        0.0        48        0.1   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total PCI loans

    161        1.1        330        2.8        0        0.0        0        0.0        491        1.5   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 14,389        100.0   $ 11,924        100.0   $ 4,221        100.0   $ 1,571        100.0   $ 32,105        100.0
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents

CAPITAL ONE FINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

    December 31, 2010  
(Dollars in millions)   Commercial
&
Multifamily
Real Estate
    % of
Total(2)
    Middle
Market
    % of
Total(2)
    Specialty
Lending
    % of
Total(2)
    Small-ticket
Commercial
Real Estate
    % of
Total(2)
    Total
Commercial
    % of
Total(2)
 

Geographic concentration:(3)

                   

Non-PCI loans:

                   

Northeast

  $ 10,849        81.0   $ 3,240        30.9   $ 1,548        38.5   $ 1,137        61.7   $ 16,774        56.4

Mid-Atlantic

    720        5.4        960        9.2        185        4.6        71        3.9        1,936        6.5   

South

    1,315        9.8        5,191        49.5        733        18.2        119        6.5        7,358        24.7   

Other

    234        1.8        811        7.7        1,554        38.7        515        27.9        3,114        10.5   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total non-PCI loans

    13,118        98.0        10,202        97.3        4,020        100.0        1,842        100.0        29,182        98.1   

PCI loans

    278        2.0        282        2.7        0        0.0        0        0.0        560        1.9   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 13,396        100.0   $ 10,484        100.0   $ 4,020        100.0   $ 1,842        100.0   $ 29,742        100.0
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Internal risk rating:(4)

                   

Non-PCI loans:

                   

Noncriticized

  $ 11,611        86.7   $ 9,445        90.1   $ 3,897        96.9   $ 1,710        92.8   $ 26,663        89.6

Criticized performing

    1,231        9.2        624        6.0        75        1.9        95        5.2        2,025        6.8   

Criticized nonperforming

    276        2.1        133        1.2        48        1.2        37        2.0        494        1.7   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total non-PCI loans

    13,118        98.0        10,202        97.3        4,020        100.0        1,842        100.0        29,182        98.1   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

PCI loans:

                   

Noncriticized

  $ 186        1.3   $ 235        2.3   $ 0        0.0   $ 0        0.0   $ 421        1.4

Criticized performing

    92        0.7        47        0.4        0        0.0        0        0.0        139        0.5   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total PCI loans

    278        2.0        282        2.7        0        0.0        0        0.0        560        1.9   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 13,396        100.0   $ 10,484        100.0   $ 4,020        100.0   $ 1,842        100.0   $ 29,742        100.0
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1)

Amounts based on total loans as of September 30, 2011 and December 31, 2010.

(2)

Percentages calculated based on total held for investment commercial loans in each respective loan category as of the end of the reported period.

(3)

Northeast consists of CT, ME, MA, NH, NJ, NY, PA and VT. Mid-Atlantic consists of DE, DC, MD, VA and WV. South consists of AL, AR, FL, GA, KY, LA, MS, MO, NC, SC, TN and TX.

(4)

Criticized exposures correspond to the “Special Mention”, “Substandard” and “Doubtful” asset categories defined by banking regulatory authorities.

Impaired Loans and Troubled Debt Restructurings

A loan is considered impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due from the borrower in accordance with the original contractual terms of the loan. Loans with insignificant delays or insignificant shortfalls in the amount of payments expected to be collected are not considered to be impaired. Income recognition on impaired loans is consistent with that of nonaccrual loans discussed above under “Delinquent and Nonperforming Loans.”

Loans defined as individually impaired, based on applicable accounting guidance, include larger balance nonperforming loans and TDR loans. Our policies for reporting loans as individually impaired, by loan category, are as follows:

 

   

Credit card loans: Credit card loans, including installment loans, that have been modified in a troubled debt restructuring are accounted for and reported as individually impaired.

 

   

Consumer banking loans: Consumer banking loans that have been modified in a troubled debt restructuring are accounted for and reported as individually impaired.

 

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Table of Contents

CAPITAL ONE FINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

   

Commercial banking loans: Commercial banking loans classified as nonperforming or that have been modified in a troubled debt restructuring are reported as impaired.

 

   

Purchased credit-impaired loans: We track and report PCI loans separately from other impaired loans.

We do not report nonperforming consumer loans that have not been modified in a TDR as individually impaired, as we collectively evaluate these smaller-balance homogenous loans for impairment in accordance with applicable accounting guidance. Held for sale loans are also not reported as impaired, as these loans are recorded at lower of cost or fair value.

All individually impaired loans are evaluated for an asset-specific allowance. Once a loan is modified in a TDR, the loan is generally considered impaired until maturity regardless of whether the borrower performs under the modified terms. Although the loan may be returned to accrual status if the criteria above under “Delinquent and Nonperforming Loans” are met, the loan would continue to be evaluated for an asset-specific allowance for loan losses and we would continue to report the loan as impaired.

We generally measure impairment and the related asset-specific allowance for individually impaired loans based on the difference between the recorded investment of the loan and present value of the loans’ expected future cash flows, discounted at the effective original interest rate of the loan at the time of modification or the loan’s observable market price. If the loan is collateral dependent, we measure impairment based upon the fair value of the underlying collateral, which we determine based on the current fair value of the collateral less estimated selling costs, instead of discounted cash flows. Loans are identified as collateral dependent if we believe that collateral is the sole source of repayment.

If the fair value of the loan is less than the recorded investment, we recognize impairment by establishing an allowance for the loan or by adjusting an allowance for the impaired loan.

 

100


Table of Contents

CAPITAL ONE FINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

The following table presents information about our impaired loans, excluding purchased credit-impaired loans, which are reported separately and discussed below:

 

    September 30, 2011  
(Dollars in millions)   With an
Allowance
    Without
an
Allowance
    Total
Recorded
Investment
    Related
Allowance
    Net
Recorded
Investment
    Unpaid
Principal
Balance
    Average
Recorded
Investment
    Interest
Income
Recognized
 

Credit card and Installment loans:

               

Domestic card and installment loans

  $ 728      $ 0      $ 728      $ 263      $ 465      $ 710      $ 743      $ 57   

International card and installment loans

    187        0        187        102        85        176        147        5   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total credit card and installment loans(1)

    915        0        915        365        550        886        890        62   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Consumer banking:

               

Auto

    44        0        44        6        38        44        17        2   

Home loans

    101        0        101        10        91        101        73        3   

Retail banking

    56        19        75        10        65        81        46        1   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total consumer banking

    201        19        220        26        194        226        136        6   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Commercial banking:

               

Commercial and multifamily real estate

    262        206        468        60        408        540        405        6   

Middle market

    73        98        171        9        162        200        131        1   

Specialty lending

    10        9        19        3        16        25        20        0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial lending

    345        313        658        72        586        765        556        7   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Small-ticket commercial real estate

    13        12        25        1        24        35        94        0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial banking

    358        325        683        73        610        800        650        7   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other:

               

Other loans

    0        1        1        0        1        1        1        0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 1,474      $ 345      $ 1,819      $ 464      $ 1,355      $ 1,913      $ 1,677      $ 75   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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CAPITAL ONE FINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

    December 31, 2010  
(Dollars in millions)   With an
Allowance
    Without an
Allowance
    Total
Recorded
Investment
    Related
Allowance
    Net
Recorded
Investment
    Unpaid
Principal
Balance
    Average
Recorded
Investment
    Interest
Income
Recognized
 

Credit card and installment loans:

               

Domestic card and installment loans

  $ 753      $ 0      $ 753      $ 253      $ 500      $ 739      $ 644      $ 76   

International card and installment loans

    160        0        160        133        27        154        128        0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total credit card and installment loans(1)

    913        0        913        386        527        893        772        76   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Consumer banking:

               

Auto

    0        0        0        0        0        0        0        0   

Home loans

    57        0        57        1        56        57        28        1   

Retail banking

    23        17        40        1        39        51        46        1   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total consumer banking

    80        17        97        2        95        108        74        2   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Commercial banking:

               

Commercial and multifamily real estate

    40        283        323        6        317        436        385        4   

Middle market

    25        95        120        7        113        156        109        1   

Specialty lending

    1        20        21        0        21        22        35        0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial lending

    66        398        464        13        451        614        529        5   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Small-ticket commercial real estate

    16        20        36        2        34        73        41        1   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial banking

    82        418        500        15        485        687        570        6   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other:

               

Other loans

    0        0        0        0        0        0        0        0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 1,075      $ 435      $ 1,510      $ 403      $ 1,107      $ 1,688      $ 1,416      $ 84   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1)

Credit Card and Installment loans include finance charges and fees.

TDR loans accounted for $1.5 billion and $1.1 billion of impaired loans as of September 30, 2011 and December 31, 2010, respectively. Consumer TDR loans classified as performing totaled $1.1 billion and $983 million, respectively, as of September 30, 2011 and December 31, 2010. Commercial TDR loans classified as performing totaled $379 million, and $162 million, respectively, as of September 30, 2011 and December 31.

 

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CAPITAL ONE FINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

As part of our loan modifications to borrowers experiencing financial difficulty, we may provide multiple concessions to minimize our economic loss and improve long-term loan performance and collectability. The following tables present the types, amounts and financial effects of loans modified and accounted for as troubled debt restructurings during the period:

 

     Total
Loans
Modified(1)
    Three Months Ended September 30, 2011  
      Reduced Interest Rate     Term Extension     Balance Reduction  
(Dollars in millions)     % of
TDR

activity(2)(8)
    Average
Rate
Reduction(3)
    % of TDR
Activity(4)(8)
    Average
Term
Extension
(Months)(5)
    % of
TDR
Activity(6)(8)
    Gross
Balance
Reduction(7)
 

Credit card:

             

Domestic

  $ 79        100     10.39     0     0        0   $ 0   

International

    67        100        22.01        0        0        0        0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total credit card

    146        100        15.72        0        0        0        0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Consumer banking:

             

Auto

    21        66        1.39        100        10        0        0   

Home loans

    19        45        2.01        63        115        13        0   

Retail banking

    21        9        1.51        80        15        0        0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total consumer banking

    61        39        1.63        82        44        4        0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Commercial banking:

             

Commercial and multifamily real estate

    37        46        1.03        100        13        29        3   

Middle market

    54        13        0.43        72        15        2        0   

Specialty lending

    2        48        1.19        98        38        38        1   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial lending

    93        27        0.69        83        15        14        4   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Small-ticket commercial real estate

    0        0        0.00        100        3        0        0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial banking

    93        27        0.69        84        15        13        4   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

    300        65     9.89     43     27        5   $ 4   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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CAPITAL ONE FINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

    Total
Loans

Modified (1)
    Nine Months Ended September 30, 2011  
      Reduced Interest Rate     Term Extension     Balance Reduction  
(Dollars in millions)     %  of
TDR
Activity(2)
    Average
Rate
Reduction(3)
    %  of
TDR
Activity(4)
    Average
Term
Extension
(Months)(5)
    %  of
TDR
Activity(6)
    Gross
Balance

Reduction(7)
 

Credit card:

             

Domestic

  $ 249        100     10.51     0     0        0   $ 0   

International

    194        100        22.84        0        0        0        0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total credit card

    443        100        15.93        0        0        0        0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Consumer banking:

             

Auto

    53        61        1.39        100        9        0        0   

Home loans

    49        48        2.10        76        88        8        0   

Retail banking

    58        8        0.83        81        19        0        0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total consumer banking

    160        38        1.42        86        37        2        0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Commercial banking:

             

Commercial and multifamily real estate

    161        37        2.79        96        13        7        3   

Middle market

    95        19        0.83        72        15        1        0   

Specialty lending

    10        29        0.60        83        36        8        1   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial lending

    266        31        2.01        87        15        5        4   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Small-ticket commercial real estate

    4        0        0.00        100        3        0        0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial banking

    270        30        2.01        87        15        5        4   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 873        67     9.95     43     23        2   $ 4   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1)

Represents total loans modified and accounted for as a TDR during the period. Paydowns, charge-offs and any other changes in the loan carrying value subsequent to the loan entering TDR status are not reflected.

(2)

Percentage of loans modified and accounted for as a TDR during the period that were granted a reduced interest rate.

(3)

Weighted average interest rate reduction for those loans that received an interest rate concession.

(4)

Percentage of loans modified and accounted for as a TDR during the period that were granted a maturity date extension.

(5)

Weighted average change in maturity date for those loans that received a maturity date extension.

(6)

Percentage of loans modified and accounted for as a TDR during the period that were granted forgiveness or forbearance of a portion of their balance.

(7)

Total amount of forgiven or forborne balances.

(8)

Due to multiple concessions granted to some troubled borrowers, percentages may total more than 100% for certain loan types.

 

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CAPITAL ONE FINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

TDR Subsequent Payment Defaults of Completed TDR Modifications

The following table represents the type, number and amount of loans accounted for as TDRs that experienced a payment default during the period and had completed a modification event in the twelve months prior to the payment default. A payment default occurs if the loan is either 90 days or more delinquent or the loan has been charged-off as of the end of the period presented.

 

     September 30, 2011  
   Three Months Ended      Nine Months Ended  
(Dollars in millions)    Number of
Contracts
     Amount      Number of
Contracts
     Amount  

Credit Card:

           

Domestic

     8,721       $ 22         25,235       $ 71   

International(1)

     11,733         44         34,330         137   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Credit Card

     20,454         66         59,565         208   
  

 

 

    

 

 

    

 

 

    

 

 

 

Consumer banking:

           

Auto

     110         1         130         2   

Home Loans

     27         2         60         7   

Retail banking

     63         2         188         4   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total consumer banking

     200         5         378         13   
  

 

 

    

 

 

    

 

 

    

 

 

 

Commercial banking:

           

Commercial and multifamily real estate

     9         12         13         35   

Middle market

     0         0         3         3   

Specialty Lending

     5         2         6         2   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial lending

     14         14         22         40   
  

 

 

    

 

 

    

 

 

    

 

 

 

Small-ticket commercial real estate

     1         1         1         0   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial banking

     15         15         23         40   
  

 

 

    

 

 

    

 

 

    

 

 

 

Other:

           

Other Loans

     0         0         0         0   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     20,669       $ 86         59,966       $ 261   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1)

The regulatory regime in the United Kingdom (“U.K.”) requires U.K. credit card businesses to accept payment plan proposals even when the proposed payments are less than the contractual minimum amount. As a result, loans entering long-term TDR payment programs in the U.K. typically continue to age and ultimately charge-off even when fully in compliance with the TDR program terms.

Purchased Credit-Impaired Loans

In connection with the acquisition of Chevy Chase Bank on February 27, 2009, we acquired loans with a contractual outstanding unpaid principal and interest balance at acquisition of $15.4 billion. We recorded these loans on our consolidated balance sheet at estimated fair value at the date of acquisition of $9.0 billion. We concluded that the substantial majority of the loans we acquired from Chevy Chase Bank were PCI loans. PCI loans are acquired loans with evidence of credit quality deterioration since origination for which it is probable at the date of purchase that we will be unable to collect all contractually required payments. The Chevy Chase Bank loans that we concluded were credit impaired had a contractual outstanding unpaid principal and interest balance at acquisition of $12.0 billion

 

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CAPITAL ONE FINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

and an estimated fair value of $6.3 billion. These loans consisted of Chevy Chase Bank’s entire portfolio of option-adjustable rate mortgage loans, hybrid adjustable-rate mortgage loans and construction-to-permanent mortgage loans. We also concluded that Chevy Chase Bank’s portfolio of commercial loans, auto loans, fixed-mortgage loans, home equity loans and other consumer loans included segments of PCI loans.

Initial Fair Value and Accretable Yield of Acquired Loans

At acquisition, we estimated the cash flows we expected to collect on these loans. Under the accounting guidance for PCI loans, the difference between the contractually required payments and the cash flows expected to be collected at acquisition is referred to as the nonaccretable difference. This difference is neither accreted into income nor recorded on our consolidated balance sheet. The excess of cash flows expected to be collected over the estimated fair value is referred to as the accretable yield and is recognized in interest income over the remaining life of the loan, or pool of loans, using the effective yield method. The table below displays the contractually required principal and interest, cash flows expected to be collected and fair value at acquisition related to the Chevy Chase Bank loans we acquired. The table also displays the nonaccretable difference and the accretable yield at acquisition.

 

     At Acquisition on February 27, 2009  
(Dollars in millions)    Total
Acquired
Loans
    Purchased
Credit-Impaired
Loans
    Non-
Impaired
Loans
 

Contractually outstanding principal and interest at acquisition

   $ 15,387      $ 12,039      $ 3,348   

Less: Nonaccretable difference (expected principal losses of $2,207 and foregone interest of $1,820)(1)

     (4,027     (3,851     (176
  

 

 

   

 

 

   

 

 

 

Cash flows expected to be collected at acquisition(2)

     11,360        8,188        3,172   

Less: Accretable yield

     (2,360     (1,861     (499
  

 

 

   

 

 

   

 

 

 

Fair value of loans acquired(3)

   $ 9,000      $ 6,327      $ 2,673   
  

 

 

   

 

 

   

 

 

 

 

(1)

Expected principal losses and foregone interest on purchased credit-impaired loans at acquisition totaled $2.1 billion and $1.8 billion, respectively. Expected principal losses and foregone interest on non-impaired loans at acquisition totaled $154 million and $23 million, respectively.

(2)

Represents undiscounted expected principal and interest cash flows at acquisition.

(3)

A portion of the loans acquired in connection with the Chevy Chase Bank acquisition was classified as held for sale. These loans, which had an estimated fair value at acquisition of $235 million, are not included in the above tables.

Outstanding Balance and Carrying Value of Acquired Loans

The table below presents the outstanding contractual principal balance and the carrying value of the Chevy Chase Bank acquired loans as of September 30, 2011 and December 31, 2010:

 

    September 30, 2011     December 31, 2010  
(Dollars in millions)   Total
Acquired
Loans
    Purchased
Credit-Impaired
Loans
    Non-
Impaired
Loans
    Total
Acquired
Loans
    Purchased
Credit-Impaired
Loans
    Non-
Impaired
Loans
 

Contractual balance

  $ 6,024      $ 4,789      $ 1,235      $ 7,054      $ 5,546      $ 1,508   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Carrying value(1)

    4,852        3,733        1,119        5,554        4,165        1,389   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1)

Includes $22 million and $33 million of cumulative impairment recognized as of September 30, 2011 and December 31, 2010, respectively.

 

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CAPITAL ONE FINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

Changes in Accretable Yield of Acquired Loans

Subsequent to acquisition, we are required to periodically evaluate our estimate of cash flows expected to be collected. These evaluations, performed quarterly, require the continued use of key assumptions and estimates, similar to the initial estimate of fair value. Subsequent changes in the estimated cash flows expected to be collected may result in changes in the accretable yield and nonaccretable difference or reclassifications from nonaccretable yield to accretable. Increases in the cash flows expected to be collected will generally result in an increase in interest income over the remaining life of the loan or pool of loans. Decreases in expected cash flows due to further credit deterioration will generally result in an impairment charge recognized in our provision for loan and lease losses, resulting in an increase to the allowance for loan losses We recorded impairment related to certain pool of loans of $9 million in the third quarter of 2011 compared to a reduction in the allowance related to these pools of $1 million in the third quarter of 2010. We reduced the allowance related to this pool of loans by $11 million and $4 million for the nine months ended September 30, 2011 and 2010, respectively. The cumulative impairment recognized on PCI loans totaled $22 million as of September 30, 2011 and $33 million as of December 31, 2010.

The following table presents changes in the accretable yield related to the acquired Chevy Chase Bank loans:

 

(Dollars in millions)    Total
Acquired
Loans
    Purchased
Credit-Impaired
Loans
    Non-
Impaired
Loans
 

Accretable yield as of December 31, 2009

   $ 2,067      $ 1,742      $ 325   

Accretion recognized in earnings

     (405     (299     (106

Reclassifications from nonaccretable difference for loans with improvement in expected cash flows

     350        311        39   
  

 

 

   

 

 

   

 

 

 

Accretable yield as of December 31, 2010

   $ 2,012      $ 1,754      $ 258   
  

 

 

   

 

 

   

 

 

 

Accretion recognized in earnings

     (335     (285     (50

Reclassifications from nonaccretable difference for loans with improving cash flows(1)

     233        227        6   

Reductions in accretable yield for non-credit related changes in expected cash flows(2)

     (68     (57     (11
  

 

 

   

 

 

   

 

 

 

Accretable yield as of September 30, 2011

   $ 1,842      $ 1,639      $ 203   
  

 

 

   

 

 

   

 

 

 

 

(1) 

Represents increases in accretable yields for those pools with increases primarily the result of improved credit performance.

(2) 

Represents changes in accretable yields for those pools with reductions driven primarily by changes in prepayment levels.

Unfunded Lending Commitments

We manage the potential risk in credit commitments by limiting the total amount of arrangements, both by individual customer and in total, by monitoring the size and maturity structure of these portfolios and by applying the same credit standards for all of our credit activities. Unused credit card lines available to our customers totaled $206.3 billion and $161.5 billion as of September 30, 2011 and December 31, 2010, respectively. While these amounts represented the total available unused credit card lines, we have not experienced, and do not anticipate, that all of our customers will access their entire available line at any given point in time.

In addition to available unused credit card lines, we enter into commitments to extend credit that are legally binding conditional agreements having fixed expirations or termination dates and specified interest rates and

 

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CAPITAL ONE FINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

purposes on our commercial loans. Outstanding unfunded commitments to extend credit other than credit card lines totaled approximately $14.9 billion and $13.2 billion as of September 30, 2011 and December 31, 2010, respectively. These commitments may expire without being drawn upon. Therefore, the total commitment amount does not necessarily represent future funding requirements.

We maintain a reserve for unfunded loan commitments and letters of credit to absorb estimated probable losses related to these unfunded credit facilities, which is included in Other liabilities on our consolidated balance sheets. Our reserve for unfunded loan commitments and letters of credit was $53 million and $107 million as of September 30, 2011 and December 31, 2010, respectively. See “Note 6—Allowance for Loan and Lease Losses” below for additional information.

 

 

NOTE 6—ALLOWANCE FOR LOAN AND LEASE LOSSES

 

We maintain an allowance for loan and lease losses (“the allowance”) that represents management’s best estimate of incurred loan and lease credit losses inherent in our held for investment portfolio as of each balance sheet date. We do not maintain an allowance for held for sale loans or purchased credit-impaired loans that are performing in accordance with or better than our expectations as of the date of acquisition, as the fair values of these loans already reflect a credit component. The allowance for loan and lease losses is increased through the provision for loan and lease losses and reduced by net charge-offs. The provision for loan and lease losses, which is charged to earnings, reflects credit losses we believe have been incurred and will eventually be reflected over time in our charge-offs. Charge-offs of uncollectible amounts are deducted from the allowance and subsequent recoveries are added.

In determining the allowance for loan and lease losses, we disaggregate loans in our portfolio with similar credit risk characteristics into portfolio segments. Management performs quarterly analysis of these portfolios to determine if impairment has occurred and to assess the adequacy of the allowance based on historical and current trends and other factors affecting credit losses. We apply documented systematic methodologies to separately calculate the allowance for our consumer loan and commercial loan portfolio and for loans within each of these portfolios that we identify as individually impaired. Our allowance for loan and lease losses consists of three components that are allocated to cover the estimated probable losses in each loan portfolio based on the results of our detailed review and loan impairment assessment process: (1) a formula-based component for loans collectively evaluated for impairment; (2) an asset-specific component for individually impaired loans; and (3) a component related to purchased credit-impaired loans that have experienced significant decreases in expected cash flows subsequent to acquisition. See “Note 1—Summary of Significant Accounting Policies” of our 2010 Form 10-K for a description of the methodologies and policies for determining our allowance for loan and lease losses for each of our loan portfolio segments.

 

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Allowance for Loan and Lease Losses Activity

The allowance for loan and lease losses is increased through the provision for loan and lease losses and reduced by net charge-offs. The provision for loan and lease losses, which is charged to earnings, reflects credit losses we believe have been incurred and will eventually be reflected over time in our charge-offs. Charge-offs of uncollectible amounts are deducted from the allowance and subsequent recoveries are included. The table below summarizes changes in the allowance for loan and lease losses, by portfolio segment, and our unfunded lending commitment reserve during the three and nine months ended September 30, 2011:

 

    Three Months Ended September 30, 2011  
          Consumer                       Unfunded
Lending
Commitments
Reserve
    Combined
Allowance
&
Unfunded
Reserve
 
(Dollars in millions)   Credit
Card
    Auto     Home
Loan
    Retail
Banking
    Total
Consumer
    Commercial     Other(1)     Total
Allowance
     

Balance as of June 30, 2011

  $ 3,093      $ 322      $ 90      $ 186      $ 598      $ 730      $ 67      $ 4,488      $ 64      $ 4,552   

Provision for loan and lease losses(2)

    512        119        18        0        137        (1     (15     633        (11     622   

Charge-offs(2)

    (967     (129     (20     (23     (172     (35     (9     (1,183     0        (1,183

Recoveries

    306        46        5        6        57        6        2        371        0        371   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net charge-offs

    (661     (83     (15     (17     (115     (29     (7     (812     0        (812

Other changes(3)

    (29     0        0        0        0        0        0        (29     0        (29
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance as of September 30,  2011(2)

  $ 2,915      $ 358      $ 93      $ 169      $ 620      $ 700      $ 45      $ 4,280      $ 53      $ 4,333   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

    Nine Months Ended September 30, 2011  
          Consumer                       Unfunded
Lending
Commitments
Reserve
    Combined
Allowance
&
Unfunded
Reserve
 
(Dollars in millions)   Credit
Card
    Auto     Home
Loan
    Retail
Banking
    Total
Consumer
    Commercial     Other(1)     Total
Allowance
     

Balance as of December 31, 2010

  $ 4,041      $ 353      $ 112      $ 210      $ 675      $ 826      $ 86      $ 5,628      $ 107      $ 5,735   

Provision for loan and lease  losses(2)

    1,270        229        34        18        281        0        2        1,553        (54     1,499   

Charge-offs(2)

    (3,362     (372     (74     (78     (524     (152     (47     (4,085     0        (4,085

Recoveries

    979        148        21        19        188        26        4        1,197        0        1,197   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net charge-offs

    (2,383     (224     (53     (59     (336     (126     (43     (2,888     0        (2,888

Other changes(3)

    (13     0        0        0        0        0        0        (13     0        (13
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance as of September 30,  2011(2)

  $ 2,915      $ 358      $ 93      $ 169      $ 620      $ 700      $ 45      $ 4,280      $ 53      $ 4,333   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1)

Other consists of our discontinued GreenPoint mortgage operations loan portfolio and our community redevelopment loan portfolio.

(2)

The reduction in the provision for loan and lease losses attributable to Kohl’s was $236 million for the first nine months of 2011. Loss sharing amounts attributable to Kohl’s reduced charge-offs by $39 million and $80 million in the third quarter and first nine months of 2011. The expected reimbursement from Kohl’s netted in our allowance for loan and lease losses was approximately $156 million as of September 30, 2011.

(3)

Includes foreign exchange translation adjustments of $29 million and $13 million for the three and nine months ended September 30, 2011, respectively.

 

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Components of Allowance for Loan and Lease Losses by Impairment Methodology

The table below presents the components of our allowance for loan and lease losses, by loan category and impairment methodology, and the recorded investment of the related loans as of September 30, 2011 and December 31, 2010:

 

    September 30, 2011  
          Consumer                          
(Dollars in millions)   Credit
Card
    Auto     Home
Loan
    Retail
Banking
    Total
Consumer
    Commercial     Other     Total  

Allowance for loan and lease losses by impairment methodology:

               

Collectively evaluated for impairment

  $ 2,550      $ 352      $ 64      $ 158      $ 574      $ 625      $ 45      $ 3,794   

Individually evaluated for impairment

    365        6        10        10        26        73        0        464   

Purchased credit-impaired loans

    0        0        19        1        20        2        0        22   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total allowance for loan and lease losses

  $ 2,915      $ 358      $ 93      $ 169      $ 620      $ 700      $ 45      $ 4,280   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Held for investment loans by impairment methodology:

               

Collectively evaluated for impairment

  $ 61,115      $ 20,322      $ 6,533      $ 3,894      $ 30,749      $ 30,932      $ 464      $ 123,260   

Individually evaluated for impairment

    915        44        101        75        220        682        1        1,818   

Purchased credit-impaired loans

    0        56        4,282        45        4,383        491        0        4,874   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total held for investment loans

  $ 62,030      $ 20,422      $ 10,916      $ 4,014      $ 35,352      $ 32,105      $ 465      $ 129,952   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Allowance as a percentage of period end held for investment loans

    4.70     1.75     0.85     4.21     1.75     2.18     9.68     3.29

 

    December 31, 2010  
          Consumer                          
(Dollars in millions)   Credit
Card
    Auto     Home
Loan
    Retail
Banking
    Total
Consumer
    Commercial     Other     Total  

Allowance for loan and lease losses by impairment methodology:

               

Collectively evaluated for impairment

  $ 3,655      $ 353      $ 81      $ 209      $ 643      $ 808      $ 86      $ 5,192   

Individually evaluated for impairment

    386        0        1        1        2        15        0        403   

Purchased credit-impaired loans

    0        0        30        0        30        3        0        33   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total allowance for loan and lease losses

  $ 4,041      $ 353      $ 112      $ 210      $ 675      $ 826      $ 86      $ 5,628   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Held for investment loans by impairment methodology:

               

Collectively evaluated for impairment

  $ 60,458      $ 17,867      $ 7,154      $ 4,271      $ 29,292      $ 28,682      $ 451      $ 118,883   

Individually evaluated for impairment

    913        0        57        40        97        500        0        1,510   

Purchased credit impaired loans

    0        0        4,892        102        4,994        560        0        5,554   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total held for investment loans

  $ 61,371      $ 17,867      $ 12,103      $ 4,413      $ 34,383      $ 29,742      $ 451      $ 125,947   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Allowance as a percentage of period end held for investment loans

    6.58     1.98     0.93     4.76     1.96     2.78     19.07     4.47

 

 

NOTE 7—VARIABLE INTEREST ENTITIES AND SECURITIZATIONS

 

In the normal course of business, we enter into various types of transactions with entities that are considered to be variable interest entities (“VIEs”). Historically, our primary involvement with VIEs related to our securitization transactions in which we transferred assets from our balance sheet to securitization trusts. These

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

securitization trusts typically meet the definition of a VIE. We generally securitized credit card loans, auto loans, home loans and installment loans, which provided a source of funding for us and as a means of transferring a certain portion of the economic risk of the loans or debt securities to third parties.

Under revised consolidation accounting guidance that became effective on January 1, 2010, the entity that has a controlling financial interest in a VIE is referred to as the primary beneficiary and is required to consolidate the VIE. As a result of this guidance, the vast majority of the VIEs in which we are involved have been consolidated in our financial statements.

 

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Summary of Consolidated and Unconsolidated VIEs

The table below presents a summary of VIEs, aggregated based on VIEs with similar characteristics, in which we had continuing involvement or held a variable interest as of September 30, 2011 and December 31, 2010. We separately present information for consolidated and unconsolidated VIEs.

For consolidated VIEs, we present the carrying amount of assets and liabilities reflected on our consolidated balance sheets. The assets of consolidated VIEs primarily consist of cash and loans, which we report on our consolidated balance sheets under restricted cash for securitization investors and restricted loans for securitization investors, respectively. The assets of a particular VIE are the primary source of funds to settle its obligations. The creditors of the VIEs typically do not have recourse to the general credit of our company. The liabilities primarily consist of debt securities issued by the VIEs, which we report under securitized debt obligations. For unconsolidated VIEs, we present the carrying amount of assets and liabilities reflected on our consolidated balance sheets and our maximum exposure to loss. Our maximum exposure to loss is estimated based on the unlikely event that all of the assets in the VIEs became worthless and we were required to meet our maximum remaining funding obligations.

 

     September 30, 2011  
      Consolidated      Unconsolidated  
(Dollars in millions)    Carrying
Amount
of Assets
     Carrying
Amount of
Liabilities
     Carrying
Amount
of  Assets
    Carrying
Amount of
Liabilities
    Maximum
Exposure  to
Loss(3)
 

Securitization-related VIEs:

            

Credit card loan securitizations(4)

   $ 47,808       $ 17,942       $ 0      $ 0      $ 0   

Auto loan securitizations(4)

     119         99         0        0        0   

Mortgage loan securitizations

     0         0         154 (1)      32 (2)      267   

Other asset securitizations(4)

     37         37         0        0        0   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total securitization related VIEs

     47,964         18,078         154        32        267   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Other VIEs:

            

Affordable housing entities

     0         0         1,902        259        1,902   

Entities that provide capital to low-income and rural communities

     251         0         6        3        6   

Other

     1         0         146        0        146   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total Other VIEs

     252         0         2,054        262        2,054   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total VIEs

   $ 48,216       $ 18,078       $ 2,208      $ 294      $ 2,321   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

 

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     December 31, 2010  
     Consolidated      Unconsolidated  
(Dollars in millions)    Carrying
Amount
of Assets
     Carrying
Amount of
Liabilities
     Carrying
Amount
of Assets
    Carrying
Amount
of
Liabilities
    Maximum
Exposure  to
Loss(3)
 

Securitization-related VIEs:

            

Credit card loan securitizations(4)

   $ 53,694       $ 25,622       $ 0      $ 0      $ 0   

Auto loan securitizations(4)

     1,784         1,518         0        0        0   

Mortgage loan securitizations

     0         0         174 (1)      37 (2)      297   

Other asset securitizations(4)

     198         64         0        0        0   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total securitization related VIEs

     55,676         27,204         174        37        297   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Other VIEs:

            

Affordable housing entities

     0         0         1,681        304        1,681   

Entities that provide capital to low-income and rural communities

     230         0         6        3        6   

Other

     0         0         174        0        174   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total Other VIEs

     230         0         1,861        307        1,861   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total VIEs

   $ 55,906       $ 27,204       $ 2,035      $ 344      $ 2,158   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

 

(1)

The carrying amount of assets of unconsolidated securitization-related VIEs consists of retained interests and letters of credit related to manufactured housing securitizations. Mortgage servicing rights related to unconsolidated VIEs are reported on our consolidated balance sheets under goodwill and other intangible assets. See “Note 8—Goodwill and Other Intangible Assets” for additional information on our mortgage servicing rights. Other retained interests are reported on our consolidated balance sheets under accounts receivable from securitizations.

(2)

The carrying amount of liabilities of unconsolidated securitization-related VIEs consists of obligations to fund negative amortization bonds associated with the securitization of option-adjustable rate mortgage loans (“option-ARMs”) and obligations on certain swap agreements associated with the securitization of manufactured housing loans.

(3)

The maximum exposure to loss represents the amount of loss we would incur in the unlikely event that all our assets in the VIE become worthless and we were required to meet our maximum remaining funding obligations.

(4)

Represents the gross assets and liabilities owned by the VIE which included seller’s interest and retained and repurchased noted held by other related parties.

Securitization-Related VIEs

We historically have securitized credit card loans, auto loans, home loans and installment loans. In a securitization transaction, assets from our balance sheet are transferred to a trust, which typically meets the definition of a VIE. The trust then issues various forms of interests in those assets to investors. We typically receive cash proceeds and/or other interests in the securitization trust for the assets we transfer. If the transfer of the assets to an unconsolidated securitization trust qualifies as a sale, we remove the assets from our consolidated balance sheet and recognize a gain or loss on the transfer. Alternatively, if the transfer does not qualify as a sale but instead is considered a secured borrowing or the transfer of assets is to a consolidated VIE, the assets remain on our consolidated financial statements and we record an offsetting liability for the proceeds received. We did not execute any new securitizations during the third quarter of 2011; however, we have continuing involvement in the securitization trusts.

Our continuing involvement in the majority of our securitization transactions consists primarily of holding certain retained interests and acting as the primary servicer. We also may be required to repurchase receivables from the trust if the outstanding balance of the receivables falls to a level where the cost exceeds the benefits of

 

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servicing such receivables. We also may have exposure associated with contractual obligations to repurchase previously transferred loans due to breaches of representations and warranties. See “Note 15—Commitments, Contingencies and Guarantees” for information related to reserves we have established for our potential mortgage representation and warranty exposure.

The table below presents the securitization-related VIEs in which we had continuing involvement as of September 30, 2011 and December 31, 2010:

 

     September 30, 2011  
     Non-Mortgage      Mortgage  
(Dollars in millions)    Credit
Card
     Auto
Loan
     Other
Loan
     Option
ARM
    GreenPoint
HELOCs
    GreenPoint
Manufactured
Housing
 

Securities held by third-party investors

   $ 17,001       $ 94       $ 25       $ 3,233      $ 221      $ 1,281   

Receivables in the trust

     46,844         98         37         3,342        221        1,287   

Cash balance of spread or reserve accounts

     17         12         0         8        0        175   

Retained interests

     Yes         Yes         Yes         Yes        Yes        Yes   

Servicing retained

     Yes         Yes         Yes         Yes (1)      Yes (1)      No (3) 

Amortization event(4)

     No         No         No         No        Yes (2)      No   

 

     December 31, 2010  
     Non-Mortgage      Mortgage  
(Dollars in millions)    Credit
Card
     Auto
Loan
     Other
Loan
     Option
ARM
    GreenPoint
HELOCs
    GreenPoint
Manufactured
Housing
 

Securities held by third-party investors

   $ 25,415       $ 1,453       $ 48       $ 3,690      $ 284      $ 1,386   

Receivables in the trust

     52,355         1,528         191         3,813        284        1,393   

Cash balance of spread or reserve accounts

     77         147         0         8        0        183   

Retained interests

     Yes         Yes         Yes         Yes        Yes        Yes   

Servicing retained

     Yes         Yes         Yes         Yes (1)      Yes (1)      No (3) 

Amortization event(4)

     No         No         No         No        Yes (2)      No   

 

(1)

We continue to service some of the outstanding balance of securitized mortgage receivables.

(2)

See information below regarding on-going involvement in the GreenPoint Home Equity Line of Credit (“HELOC”) securitizations.

(3)

The manufactured housing securitizations are serviced by a third party. For two of the deals, that third party works in the capacity of subservicer with Capital One being the Master Servicer.

(4)

Amortization events vary according to each specific trust agreement but generally are triggered by declines in performance or credit metrics such as charge-off rates or delinquency rates below certain predetermined thresholds. Generally, the occurrence of an amortization event changes the sequencing and amount of trust related cash flows to the benefit of senior noteholders.

Non-Mortgage Securitizations

As of September 30, 2011 and December 31, 2010, we were deemed to be the primary beneficiary of all of our non-mortgage securitization trusts. Accordingly, all of these trusts have been consolidated in our financial statements. For additional information on our principal involvement with non-mortgage securitization trusts and the impact of the consolidation of these trusts on our financial statements, see “Note 1—Summary of Significant Accounting Policies” and “Note 7—Variable Interest Entities and Securitizations” of our 2010 Form 10-K.

 

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Mortgage Securitizations

Option-ARM Loans

We had previously securitized option-ARM loans by transferring the mortgage loans to securitization trusts that issued mortgage-backed securities to investors. The outstanding balance of debt securities held by third-party investors related to our mortgage securitization trusts was $3.2 billion as of September 30, 2011 and $3.7 billion as of December 31, 2010.

We continue to service some of the outstanding balance of securitized mortgage receivables. We also retain rights to future cash flows arising from the receivables, the most significant being certificated interest-only bonds issued by the trusts, certain of which we sold during the first quarter of 2010. We generally estimate the fair value of these retained interests based on the estimated present value of expected future cash flows from securitized and sold receivables, using our best estimates of the key assumptions, which include credit losses, prepayment speeds and discount rates commensurate with the risks involved. We do not consolidate these trusts because we do not have the right to receive benefits that could potentially be significant nor the obligation to absorb losses that could potentially be significant to the trusts.

In connection with the securitization of certain option-ARM loans, a third party is obligated to advance a portion of any “negative amortization” resulting from monthly payments that are less than the interest accrued for that payment period. We have an agreement in place with the third party that mirrors this advance requirement. The amount advanced is tracked through mortgage-backed securities retained as part of the securitization transaction. As the borrowers make principal payments, these securities receive their net pro rata portion of those payments in cash, and advances of negative amortization are refunded accordingly. As advances occur, we record an asset in the form of negative amortization bonds, which are classified as trading securities. We have also entered into certain derivative contracts related to the securitization activities. These are classified as free standing derivatives, with fair value adjustments recorded in non-interest income. See “Note 10—Derivative Instruments and Hedging Activities” for further details on these derivatives.

GreenPoint Mortgage HELOCs

Our discontinued wholesale mortgage banking unit, GreenPoint, previously sold home equity lines of credit in whole loan sales and subsequently acquired a residual interest in certain trusts which securitized some of those loans. As the residual interest holder, GreenPoint is required to fund advances on the home equity lines of credit when certain performance triggers are met due to deterioration in asset performance. We had funded $27 million in advances as of September 30, 2011, all of which was expensed as funded. Our unfunded commitment related to these residual interests was $11 million as of September 30, 2011. We have not consolidated these trusts because the residual certificates did not provide the obligation to absorb losses or the right to receive benefits that could potentially be significant to the trusts.

GreenPoint Mortgage Manufactured Housing

We retain the primary obligation for certain provisions of corporate guarantees, recourse sales and clean-up calls related to the discontinued manufactured housing operations of GreenPoint Credit LLC (“GPC”) which was sold to a third party in 2004. Although we are the primary obligor, recourse obligations related to former GPC whole loan sales, commitments to exercise mandatory clean-up calls on certain GPC securitization transactions and servicing were transferred to a third party in the sale transaction. We do not consolidate the trusts used for the securitization of manufactured housing loans because we do not have the power to direct the activities that most significantly impact the economic performance of the trusts since we no longer service the loans.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

We were required to fund letters of credit in 2004 to cover losses, and are obligated to fund future amounts under swap agreements for certain transactions. We have the right to receive any funds remaining in the letters of credit after the securities are released. The amount available under the letters of credit was $175 million and $183 million as of September 30, 2011 and December 31, 2010, respectively. The fair value of the expected residual balances on the funded letters of credit was $36 million and $35 million as of September 30, 2011 and December 31, 2010, respectively, and is included in other assets on the consolidated balance sheet. Our maximum exposure under the swap agreements was $24 million and $27 million as of September 30, 2011 and December 31, 2010, respectively. The value of our obligations under these swaps, which is included in other liabilities on our consolidated balance sheets, was $15 million as of September 30, 2011 and $18 million as of December 31, 2010.

The unpaid principal balance of manufactured housing securitization transactions where we are the residual interest holder was $1.3 billion and $1.4 billion as of September 30, 2011 and December 31, 2010, respectively. In the event the third party does not fulfill on its obligations to exercise the clean-up calls on certain transactions, the obligation reverts to us and we would assume approximately $420 million of loans receivable upon our execution of the clean-up call with the requirement to absorb any losses on the loans receivable. There have been no instances of non-performance to date by the third party.

We monitor the underlying assets for trends in delinquencies and related losses and reviews the purchaser’s financial strength as well as servicing performance. These factors are considered in assessing the adequacy of the liabilities established for these obligations and the valuations of the assets.

Retained Interests in Unconsolidated Securitizations

Accounts Receivable from Securitizations

Retained interests in unconsolidated securitizations are included in accounts receivable from securitizations on our consolidated balance sheets. These retained interests consist of interest-only strips, retained tranches, cash collateral accounts, cash reserve accounts and unpaid interest and fees on the third-party investors’ portion of the transferred principal receivables.

The following table provides details of accounts receivable from securitizations as of September 30, 2011 and December 31, 2010:

 

(Dollars in millions)    September 30,
2011
     December 31,
2010
 

Interest-only strip classified as trading

   $ 64       $ 75   

Retained interests classified as trading:

     

Retained notes

     29         34   

Cash collateral

     8         8   

Investor accrued interest receivable

     0         0   
  

 

 

    

 

 

 

Total retained interests classified as trading

     37         42   

Other retained interests

     0         3   
  

 

 

    

 

 

 

Total accounts receivable from securitizations

   $ 101       $ 120   
  

 

 

    

 

 

 

We may retain tranches in certain of the securitization transactions which are considered to be higher investment grade securities and subject to lower risk of loss. Those retained tranches are classified as available-for-sale securities, and changes in the estimated fair value are recorded in other comprehensive income.

 

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CAPITAL ONE FINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

The components of the net gains (losses) recognized as a result of changes in the fair value of retained interests are presented below:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
(Dollars in millions)    2011     2010(1)     2011     2010(1)  

Interest only strip valuation changes

   $ (4   $ 6      $ (11     (19

Fair value adjustments related to spread accounts

     13        0        38        6   

Fair value adjustments related to retained subordinated notes

     0        (11     1        (16
  

 

 

   

 

 

   

 

 

   

 

 

 

Total income statement impact

   $ 9        (5   $ 28        (29
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1)

2010 includes both mortgage related amounts representing valuation changes of mortgage interest only strips, spread accounts, and retained interests held at December 31, 2010 and non-mortgage related amounts representing the one installment loan securitization that remained off-balance sheet through September 15, 2010.

The changes in the fair value of retained interests are primarily driven by rate assumption changes and volume fluctuations. All of these retained residual interests are subject to loss in the event assumptions used to determine the estimated fair value do not prevail, or if borrowers default on the related securitized receivables and our retained subordinated tranches are used to repay investors. See the table below for key assumptions and sensitivities for retained interest valuations.

Key Assumptions and Sensitivities for Retained Interest Valuations

The key assumptions used in determining the fair value of the interest-only strip and other retained residual interests include the weighted average ranges for principal payment rates, lives of receivables and discount rates, all of which are included in the following table. The principal repayment rate assumptions were determined using actual and forecast trust principal payment rates based on the collateral. The lives of receivables were determined as the number of months necessary to repay the investors given the principal payment rate assumptions. The discount rates were determined using primarily trust specific statistics and forward rate curves, and were reflective of what market participants would use in a similar valuation. Additionally, accrued interest receivable, cash reserve and spread accounts were discounted over the estimated life of the assets.

If these assumptions are not met, or if they change, the interest-only strip, retained interests and related servicing and securitizations income would be affected. The following adverse changes to the key assumptions and estimates are hypothetical and should be used with caution. As the figures indicate, any change in fair value based on a 10% or 20% variation in assumptions cannot be extrapolated because the relationship of a change in assumption to the change in fair value may not be linear. Also, the effect of a variation in a particular assumption on the fair value of the interest-only strip is calculated independently from any change in another assumption. However, changes in one factor may result in changes in other factors, which might magnify or counteract the sensitivities.

 

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CAPITAL ONE FINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

For the periods ending September 30, 2011 and December 31, 2010, the assumptions and sensitivities shown below included all off-balance sheet securitizations:

 

(Dollars in millions)    September 30,
2011
    December 31,
2010
 

Interest-only strip and retained interests

   $ 118 (1)    $ 136 (1) 

Weighted average life for receivables (months)

     66        60   

Principal repayment rate (weighted average rate)

     13.8 - 17.1     16.3 – 18.1

Impact on fair value of 10% adverse change

   $ 9      $ 2   

Impact on fair value of 20% adverse change

     (5     (6

Discount rate (weighted average rate)

     25.0 - 42.2     25.2 – 42.2

Impact on fair value of 10% adverse change

   $ (7   $ (7

Impact on fair value of 20% adverse change

     (13     (14

 

(1)

Does not include liquidity swap related to the negative amortization bonds of $17 million as of September 30, 2011 and $19 million at December 31, 2010.

Static pool credit losses were calculated by summing the actual and projected future credit losses and dividing them by the original balance of each pool of assets. Due to the short-term revolving nature of the loan receivables, the weighted average percentage of static pool credit losses was not considered materially different from the assumed charge-off rates used to determine the fair value of the retained interests.

We act as a servicing agent and receive contractual servicing fees of between 0.375% and 1% of the investor principal outstanding, based upon the type of assets serviced. For off-balance sheet securitizations, we generally did not record material servicing assets or liabilities for these rights since the contractual servicing fee approximates market rates.

Cash Flows Related to the Unconsolidated Securitizations

The following provides the details of the cash flows related to securitization transactions that qualified as off-balance sheet for the three and nine months ended September 30, 2011 and 2010:

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
(Dollars in millions)    2011      2010        2011          2010    

Servicing fees received

   $ 7         8         22       $ 25   

Cash flows received on retained interests(1)

     11         43         36         137   

 

(1)

Includes all cash receipts of excess spread and other payments (excluding servicing fees) from the program.

Supplemental Loan Information

The table below displays the unpaid principal balance of off-balance sheet single-family residential loans we serviced as of September 30, 2011 and December 31, 2010. We also display the unpaid principal balance of loans past due 90 days or more as of September 30, 2011 and December 31, 2010. Net credit losses associated with these loans totaled $31 million and $120 million for the nine months ended September 30, 2011 and 2010, respectively, and $136 million for the year ended December 31, 2010.

 

(Dollars in millions)    September 30,
2011
     December 31,
2010
 

Total principal amount of loans

   $ 1,263       $ 1,396   

Principal amount of loans past due 90 days or more

   $ 234       $ 257   

 

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CAPITAL ONE FINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

Other VIEs

Affordable Housing Entities

As part of our community reinvestment initiatives, we invest in private investment funds that make equity investments in multi-family affordable housing properties. We receive affordable housing tax credits for these investments. The activities of these entities are financed with a combination of invested equity capital and debt. For those investment funds considered to be VIEs, we are not required to consolidate if we do not have the power to direct the activities that most significantly impact the economic performance of those entities. We record our interests in these unconsolidated VIEs in loans held for investment, other assets and other liabilities. Our interests consisted of assets of approximately $1.9 billion and $1.7 billion as of September 30, 2011 and December 31, 2010, respectively. Our maximum exposure to these entities is limited to our variable interests in the entities and is $1.9 billion as of September 30, 2011. The creditors of the VIEs have no recourse to our general credit and we do not provide additional financial or other support during the period that we were not previously contractually required to provide. The total assets of the unconsolidated VIE investment funds were approximately $7.8 billion and $7.5 billion as of September 30, 2011 and December 31, 2010, respectively.

Entities that Provide Capital to Low-Income and Rural Communities

We hold variable interests in entities (“Investor Entities”) that invest in community development entities (“CDEs”) that provide debt financing to businesses and non-profit entities in low-income and rural communities. Investments of the consolidated Investor Entities are also our variable interests. The activities of the Investor Entities are financed with a combination of invested equity capital and debt. The activities of the CDEs are financed solely with invested equity capital. We receive federal and state tax credits for these investments. We consolidate the VIEs in which we have the power to direct the activities that most significantly impact the VIE’s economic performance and the obligation to absorb losses or the right to receive benefits that could be potentially significant to the VIE. The assets of the VIEs that we consolidated totaled approximately $251 million and $230 million as of September 30, 2011 and December 31, 2010, respectively. The assets of the consolidated VIEs are reflected on our consolidated balance sheets in cash, loans held for investment, interest receivable and other assets. The liabilities are reflected in other liabilities.

The total assets of the VIEs that we held an interest in but were not required to consolidate totaled approximately $6 million as of both September 30, 2011 and December 31, 2010. Our interests in these unconsolidated VIEs are reflected on our consolidated balance sheets in loans held for investment and other assets. Our maximum exposure to these entities is limited to our variable interest of $6 million as of September 30, 2011. The creditors of the VIEs have no recourse to our general credit. We have not provided additional financial or other support during the period that we were not previously contractually required to provide.

Other

We have a variable interest in Capital One Financial Advisors, LLC which we consolidate as we have the power to direct the activities that most significantly impact the VIE’s economic performance and the obligation to absorb losses or the right to receive benefits that could be potentially significant to the VIE. The assets of the VIEs that we consolidated totaled approximately $1 million and $0 million as of September 30, 2011 and December 31, 2010, respectively. The assets are consolidated in our balance sheet in cash and other assets.

We also have a variable interest in a trust that has a royalty interest in certain oil and gas properties. The activities of the trust are financed solely with debt. The total assets of the trust were $324 million and $395 million as of September 30, 2011 and December 31, 2010, respectively. We were not required to consolidate the trust because we

 

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CAPITAL ONE FINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

do not have the power to direct the activities of the trust that most significantly impact the trust’s economic performance. Our retained interest in the trust, which totaled approximately $146 million and $174 million as of September 30, 2011 and December 31, 2010, respectively, is reflected on our consolidated balance sheets under loans held for investment. Our maximum exposure is limited to our variable interest of $146 million as of September 30, 2011. The creditors of the trust have no recourse to our general credit. We have not provided additional financial or other support during the period that we were not previously contractually required to provide.

 

 

NOTE 8—GOODWILL AND OTHER INTANGIBLE ASSETS

 

The following table presents the components of goodwill and other intangible assets, including mortgage servicing rights, as of September 30, 2011 and December 31, 2010:

 

(Dollars in millions)    September 30,
2011
     December 31,
2010
 

Goodwill

   $ 13,593       $ 13,591   

Other intangible assets:

     

Core deposit intangibles

     520         650   

Contract intangible(1)

     53         0   

Purchased credit card relationship intangibles(2)

     56         42   

Lease intangibles

     22         26   

Trust intangibles

     5         6   

Other intangibles

     4         9   
  

 

 

    

 

 

 

Total other intangible assets

     660         733   
  

 

 

    

 

 

 

Total goodwill and other intangible assets

   $ 14,253       $ 14,324   
  

 

 

    

 

 

 

Mortgage servicing rights

   $ 94       $ 141   

 

(1)

Relates to the acquisition of the HBC portfolio in the first quarter of 2011.

(2)

Relates to the acquisitions of the Kohl’s private-label credit card portfolio in the second quarter of 2011, the existing HBC credit card portfolio in the first quarter of 2011 and the Sony Card portfolio in the third quarter of 2010.

Goodwill

In accordance with accounting guidance, goodwill is not amortized but is tested for impairment at the reporting unit level, which is at the operating segment level or one level below an operating segment. Impairment is the condition that exists when the carrying amount of goodwill exceeds its implied fair value. Goodwill is required to be tested for impairment annually and between annual tests if events or circumstances change, such as adverse changes in the business climate, that would more likely than not reduce the fair value of the reporting unit below its carrying value. Goodwill is assigned to one or more reporting units at the date of acquisition. Our reporting units are Domestic Card, International Card, Auto Finance, other Consumer Banking and Commercial Banking. As of September 30, 2011 and December 31, 2010, goodwill of $13.6 billion was included in the accompanying consolidated balance sheets. There were no events requiring an interim impairment test and there has been no goodwill impairment recorded for the three and nine months ended September 30, 2011.

During the first quarter of 2011, we acquired the credit card portfolio of HBC. In connection with the acquisition, we recorded goodwill of $3 million representing the amount by which the purchase price exceeded the fair value of the net assets acquired. Because the acquisition was considered to be a taxable transaction, the goodwill is deductible for tax purposes. The goodwill was assigned to the International Card reporting unit of our Credit Card segment and the acquired loan portfolio is reflected in the operations of our International Card business. See “Note 2—Acquisitions” for information regarding the credit card portfolio acquisition.

 

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CAPITAL ONE FINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

The following table presents a summary of changes in goodwill, by segment, for the nine months ended September 30, 2011:

 

(Dollars in millions)    Credit Card     Consumer      Commercial      Total  

Balance as of December 31, 2010

   $ 4,690      $ 4,583       $ 4,318       $ 13,591   

Acquisitions

     3        0         0         3   

Other adjustments

     (1     0         0         (1
  

 

 

   

 

 

    

 

 

    

 

 

 

Balance as of September 30, 2011

   $ 4,692      $ 4,583       $ 4,318       $ 13,593   
  

 

 

   

 

 

    

 

 

    

 

 

 

Other Intangible Assets

In connection with prior acquisitions, we recorded intangible assets which consisted of core deposit intangibles, trust intangibles, lease intangibles, and other intangibles, which are subject to amortization. The core deposit and trust intangibles reflect the estimated value of deposit and trust relationships. The lease intangibles reflect the difference between the contractual obligation under current lease contracts and the fair market value of the lease contracts at the acquisition date. The other intangible items relate to customer lists and brokerage relationships.

In connection with the acquisition of the credit card loan portfolios of Sony, HBC and Kohl’s, we recognized purchased credit card relationship intangibles, representing the difference between the purchase price and the fair value of the credit card loans acquired. In connection with the January 7, 2011 acquisition of the HBC credit card portfolio, we also recognized a contract-based intangible asset of $70 million. The contract intangible represents the value attributable to future draws on future accounts.

The following table summarizes our intangible assets subject to amortization as of September 30, 2011 and December 31, 2010:

 

     September 30, 2011  
(Dollars in millions)    Gross
Carrying
Amount
     Accumulated
Amortization
    Currency
Valuation
Adjustments
    Net
Carrying
Amount
     Remaining
Amortization
Period
 

Core deposit intangibles

   $ 1,562       $ (1,042   $ 0      $ 520         6.2 years   

Purchased credit card relationship intangibles(1)

     77         (20     (1     56         5.5 years   

Contract intangible(2)

     70         (14     (3     53         6.3 years   

Lease intangibles

     54         (32     0        22         21.0 years   

Trust intangibles

     11         (6     0        5         12.2 years   

Other intangibles

     25         (21     0        4         2.6 years   
  

 

 

    

 

 

   

 

 

   

 

 

    

Total

   $ 1,799       $ (1,135   $ (4   $ 660      
  

 

 

    

 

 

   

 

 

   

 

 

    

 

     December 31, 2010  
(Dollars in millions)    Gross
Carrying
Amount
     Accumulated
Amortization
    Currency
Valuation
Adjustments
     Net
Carrying
Amount
     Remaining
Amortization
Period
 

Core deposit intangibles

   $ 1,562       $ (912   $ 0       $ 650         7.0 years   

Purchased credit card relationship intangibles(1)

     47         (5     0         42         6.1 years   

Lease intangibles

     54         (28     0         26         21.7 years   

Trust intangibles

     11         (5     0         6         12.9 years   

Other intangibles

     35         (26     0         9         3.3 years   
  

 

 

    

 

 

   

 

 

    

 

 

    

Total

   $ 1,709       $ (976   $ 0       $ 733      
  

 

 

    

 

 

   

 

 

    

 

 

    

 

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(1)

Relates to the acquisitions of the existing Kohl’s private-label credit card portfolio in the second quarter of 2011, the existing HBC credit card portfolio in the first quarter of 2011 and the existing Sony Card portfolio in the third quarter of 2010.

(2)

Relates to the acquisition of the existing HBC credit card portfolio in the first quarter of 2011.

Intangible assets, which are reported in other assets on our consolidated balance sheets, are amortized over their respective estimated useful lives on an accelerated basis using the sum of the year’s digits methodology. Intangible amortization expense, which is included in non-interest expense on our consolidated statements of income, totaled $55 million and $54 million for the three months ended September 30, 2011 and 2010, respectively, and $170 million and $166 million for the nine months ended September 30, 2011 and 2010, respectively. The weighted average amortization period for purchase accounting intangibles is 6.6 years as of September 30, 2011.

The following table summarizes the estimated future amortization expense for intangible assets as of September 30, 2011:

 

(Dollars in millions)    Estimated
Future
Amortization
Amounts
 

2011 (remaining three months)

   $ 52   

2012

     183   

2013

     148   

2014

     113   

2015

     80   

2016

     49   

Thereafter

     35   
  

 

 

 

Total

   $ 660   
  

 

 

 

Mortgage Servicing Rights

MSRs are recognized at fair value when mortgage loans are sold or securitized in the secondary market and the right to service these loans is retained for a fee. MSRs are recorded at fair value and changes in fair value are recorded as a component of mortgage servicing and other income. We may enter into derivatives to economically hedge changes in fair value of MSRs. We have no other loss exposure on MSRs in excess of the recorded fair value.

We continue to operate the mortgage servicing business and to report the changes in the fair value of MSRs in continuing operations. To evaluate and measure fair value, the underlying loans are stratified based on certain risk characteristics, including loan type, note rate and investor servicing requirements.

 

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CAPITAL ONE FINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

The following table sets forth the changes in the fair value of MSRs during the three and nine months ended September 30, 2011 and 2010:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
(Dollars in millions)        2011             2010             2011             2010      

Balance at beginning of period

   $ 130      $ 137      $ 141      $ 240   

Originations

     1        2        7        8   

Sales

     0        0        0        (42

Change in fair value, net

     (37     (15     (54     (82
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance at end of period

   $ 94      $ 124      $ 94      $ 124   
  

 

 

   

 

 

   

 

 

   

 

 

 

Ratio of mortgage servicing rights to related loans serviced for others

     0.51     0.61     0.65     0.72

Weighted average service fee

     0.28        0.28        0.28        0.28   

MSR fair value adjustments for the three and nine months ended September 30, 2011 included decreases of $3 million and $10 million, respectively, due to run-off, and decreases of $34 million and $44 million, respectively, due to changes in the valuation inputs and assumptions.

MSR fair value adjustments for the three and nine months ended September 30, 2010 included decreases of $2 million and $19 million, respectively, due to run-off and cash collections, and decrease of $13 million and $63 million, respectively, due to changes in the valuation inputs and assumptions.

The significant assumptions used in estimating the fair value of the MSRs as of September 30, 2011 and 2010 were as follows:

 

     September 30,  
     2011     2010  

Weighted average prepayment rate (includes default rate)

     18.53     17.59

Weighted average life (in years)

     4.86        5.09   

Discount rate

     11.72     11.71

The increase in the weighted average prepayment rate and the corresponding decrease in weighted average life, were both driven by an increase in voluntary attrition due to market conditions.

At September 30, 2011, the sensitivities to immediate 10% and 20% increases in the weighted average prepayment rates would decrease the fair value of mortgage servicing rights by $5 million and $10 million, respectively.

At September 30, 2011, the sensitivities to immediate 10% and 20% adverse changes in servicing costs would decrease the fair value of mortgage servicing rights by $9 million and $19 million, respectively.

As of September 30, 2011, our mortgage loan servicing portfolio consisted of mortgage loans with an aggregate unpaid principal balance of $27.9 billion, of which $18.6 billion was serviced for other investors. As of December 31, 2010, our mortgage loan servicing portfolio consisted of mortgage loans with an aggregate unpaid principal balance of $30.8 billion, of which $20.2 billion was serviced for other investors.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

 

NOTE 9—DEPOSITS AND BORROWINGS

 

Customer Deposits

Our customer deposits, which have become our largest source of funding for our operations and asset growth, consist of non-interest bearing and interest-bearing deposits, including demand deposits, money market deposits, negotiable order of withdrawal (“NOW”) accounts, savings accounts and certificates of deposit.

As of September 30, 2011, we had $110.8 billion in interest-bearing deposits, of which $5.2 billion represented large denomination certificates of $100,000 or more. As of December 31, 2010, we had $107.2 billion in interest-bearing deposits, of which $6.5 billion represented large denomination certificates of $100,000 or more.

Borrowings

We also access the capital markets to meet our funding needs through loan securitization transactions and the issuance of senior and subordinated debt. As of September 30, 2011, we had an effective shelf registration statement filed with the U.S. Securities & Exchange Commission (“SEC”) under which, from time to time, we may offer and sell an indeterminate aggregate amount of senior or subordinated debt securities, preferred stock, depository shares representing preferred stock, common stock, purchase contracts, warrants, units, trust preferred securities, junior subordinated debentures, guarantees of trust preferred securities and certain back-up obligations. There is no limit under this shelf registration statement to the amount or number of such securities that we may offer and sell. Under SEC rules, the shelf registration statement, which we filed in May 2009, expires three years after filing.

In addition to issuance capacity under the shelf registration statement, we have access to other borrowing programs, including advances from the Federal Home Loan Bank (“FHLB”). Our FHLB membership is secured by our investment in FHLB stock, which totaled $218 million as of September 30, 2011 and $269 million as of December 31, 2010.

Securitized Debt Obligations

We had $17.1 billion and $26.8 billion of securitized debt obligations as of September 30, 2011 and December 31, 2010, respectively, all of which are held by third party investors.

Senior and Subordinated Debt

As of September 30, 2011, we had $11.1 billion of senior and subordinated notes outstanding, including $840 million in fair value hedging losses. As of December 31, 2010, we had $8.7 billion of senior and subordinated notes outstanding, including $578 million in fair value hedging losses. One senior note for $854 million matured during the three months ended September 30, 2011. During the third quarter of 2011, we issued four different series of our senior notes for total proceeds of approximately $3.0 billion. The offering of senior notes included $250 million aggregate principal amount of our Floating Rate Senior Notes due 2014, $750 million aggregate principal amount of our 2.125% Senior Notes due 2014, $750 million aggregate principal amount of our 3.150% Senior Notes due 2016 and $1.25 billion aggregate principal amount of our 4.750% Senior Notes due 2021.

If we do not consummate the ING Direct acquisition on or prior to June 30, 2012, or if the purchase and sale agreement governing the ING Direct acquisition is terminated at any time prior to such date, we must redeem all the senior notes we issued in 2011 described above at a redemption price equal to 101% of the aggregate principal amount of these notes, plus accrued and unpaid interest from July 19, 2011, or the most recent date to which interest has been paid or provided for, as the case may be, to but excluding the mandatory redemption date of these notes.

 

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CAPITAL ONE FINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

Under a Senior and Subordinated Global Bank Note Program, COBNA has the ability to issue debt securities to both U.S. and non-U.S. lenders and to raise funds in U.S. and foreign currencies. The Senior and Subordinated Global Bank Note Program had $817 million and $820 million outstanding at September 30, 2011 and December 31, 2010, respectively.

See “Note 10—Derivative Instruments and Hedging Activities” for information about our fair value hedging activities.

Junior Subordinated Debentures

We had $3.6 billion of outstanding junior subordinated debentures as of both September 30, 2011 and December 31, 2010. There were no junior subordinated borrowings that were called or matured during the nine months ended September 30, 2011.

FHLB Advances

We had outstanding FHLB advances, which are secured by our investment securities, residential home loan portfolio, multifamily loans, commercial real estate loans and home equity lines of credit, totaling $1.1 billion as of both September 30, 2011 and December 31, 2010.

 

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CAPITAL ONE FINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

Composition of Customer Deposits, Short-term Borrowings and Long-term Debt

The table below summarizes the components of our deposits, short-term borrowings and long-term debt as of September 30, 2011 and December 31, 2010. Our total short-term borrowings consist of federal funds purchased and securities loaned under agreements to repurchase and other short-term borrowings with an original contractual maturity of one year or less. Our long-term debt consists of borrowings with an original contractual maturity of greater than one year. The amounts presented for outstanding borrowings include unamortized debt premiums and discounts, net of fair value hedge accounting adjustments.

 

(Dollars in millions)    September 30,
2011
     December 31,
2010
 

Deposits:

     

Non-interest bearing deposits

   $ 17,541       $ 15,048   

Interest-bearing deposits

     110,777         107,162   
  

 

 

    

 

 

 

Total deposits

   $ 128,318       $ 122,210   
  

 

 

    

 

 

 

Short-term borrowings:

     

Federal funds purchased and securities loaned or sold under agreements to repurchase

   $ 1,441       $ 1,517   

Other short-term borrowings

     0         7   
  

 

 

    

 

 

 

Total short-term borrowings

     1,441         1,524   
  

 

 

    

 

 

 

Long-term debt:

     

Securitized debt obligations

     17,120         26,836 (1) 

Senior and subordinated notes:

     

Unsecured senior debt

     7,112         4,883   

Unsecured subordinated debt

     3,939         3,767   
  

 

 

    

 

 

 

Total senior and subordinated notes

     11,051         8,650   
  

 

 

    

 

 

 

Other long-term borrowings:

     

Junior subordinated debt

     3,642         3,642   

FHLB advances

     1,061         1,144   
  

 

 

    

 

 

 

Other long-term borrowings

     4,703         4,786   
  

 

 

    

 

 

 

Total long-term debt

     32,874         40,272   
  

 

 

    

 

 

 

Total short-term borrowings and long-term debt

   $ 34,315       $ 41,796   
  

 

 

    

 

 

 

 

(1)

Includes fair value hedges related to securitized debt of $79 million as of December 31, 2010, which was included on the consolidated balance sheet in Other borrowings.

 

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CAPITAL ONE FINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

Components of Interest Expense

The following table displays interest expense attributable to short-term borrowings and long-term debt for the three and nine months ended September 30, 2011 and 2010:

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
(Dollars in millions)        2011              2010              2011              2010      

Short-term borrowings:

           

Federal funds purchased and securities loaned or sold under agreements to repurchase

   $ 1       $ 1       $ 4       $ 3   

FHLB advances

     1         0         1         0   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total short-term borrowings

     2         1         5         3   
  

 

 

    

 

 

    

 

 

    

 

 

 

Long-term debt:

           

Securitized debt obligations

     89         191         342         644   

Senior and subordinated notes:

           

Unsecured senior debt

     54         41         123         119   

Unsecured subordinated debt

     30         31         88         92   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total senior and subordinated notes

     84         72         211         211   
  

 

 

    

 

 

    

 

 

    

 

 

 

Other long-term borrowings:

           

Junior subordinated debt

     79         78         231         242   

FHLB advances

     2         4         9         17   

Other

     2         2         6         3   
  

 

 

    

 

 

    

 

 

    

 

 

 

Other long-term borrowings

     83         84         246         262   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total long-term debt

     256         347         799         1,117   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total short-term borrowings and long-term debt

   $ 258       $ 348       $ 804       $ 1,120   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

 

NOTE 10—DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

 

Use of Derivatives

We manage our asset/liability position and market risk exposure in accordance with prescribed risk management policies and limits established by our Asset Liability Management Committee and approved by our Board of Directors. Our primary market risk stems from the impact on our earnings and economic value of equity from changes in interest rates, and to a lesser extent, changes in foreign exchange rates. We manage our interest rate sensitivity through several approaches, which include, but are not limited to, changing the maturity and re-pricing characteristics of various balance sheet categories and by entering into interest rate derivatives. Derivatives are also utilized to manage our exposure to changes in foreign exchange rates. Derivative instruments may be privately negotiated contracts, which are often referred to as over-the-counter (“OTC”) derivatives, or they may be listed and traded on an exchange. We execute our derivative contracts in both the OTC and exchange-traded derivative markets. In addition to interest rate swaps, we use a variety of other derivative instruments, including caps, floors, options, futures and forward contracts, to manage our interest rate and foreign currency risk. On a regular basis, we enter into customer-accommodation derivative transactions. We engage in these transactions as a service to our commercial banking customers to facilitate their risk management objectives. We typically offset the market risk exposure to our customer-accommodation derivatives through derivative transactions with other counterparties.

 

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CAPITAL ONE FINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

Accounting for Derivatives

We account for derivatives pursuant to the accounting standards for derivatives and hedging. The outstanding notional amount of our derivative contracts totaled $71.9 billion as of September 30, 2011, compared with $50.7 billion as of December 31, 2010. The notional amount provides an indication of the volume of our derivatives activity and is used as the basis on which interest and other payments are determined; however, it is generally not the amount exchanged. Derivatives are recorded at fair value in our consolidated balance sheets. The fair value of a derivative represents our estimate of the amount at which a derivative could be exchanged in an orderly transaction between market participants. We report derivatives in a gain position, or derivative assets, in our consolidated balance sheets as a component of other assets. We report derivatives in a loss position, or derivative liabilities, in our consolidated balance sheets as a component of other liabilities. We report derivative asset and liability amounts on a gross basis based on individual contracts, which does not take into consideration the effects of master counterparty netting agreements or collateral netting. The fair value of derivative assets and derivative liabilities reported in our consolidated balance sheets was $2.1 billion and $926 million, respectively, as of September 30, 2011, compared with $1.3 billion and $636 million, respectively, as of December 31, 2010.

Our derivatives are designated as either qualifying accounting hedges or free-standing derivatives. Free-standing derivatives consist of customer-accommodation derivatives and economic hedges that we enter into for risk management purposes that are not linked to specific assets or liabilities or to forecasted transactions and, therefore, do not qualify for hedge accounting. Qualifying accounting hedges are designated as fair value hedges, cash flow hedges or net investment hedges.

 

   

Fair Value Hedges: We designate derivatives as fair value hedges to manage our exposure to changes in the fair value of certain financial assets and liabilities, which fluctuate in value as a result of movements in interest rates. Changes in the fair value of derivatives designated as fair value hedges are recorded in earnings together with offsetting changes in the fair value of the hedged item and any resulting ineffectiveness. Our fair value hedges consist of interest rate swaps that are intended to modify our exposure to interest rate risk on various fixed rate senior notes, subordinated notes, securitization debt, brokered certificates of deposits and U.S. agency investments. These hedges have maturities through 2019 and have the effect of converting some of our fixed rate debt, deposits and investments to variable rate.

 

   

Cash Flow Hedges: We designate derivatives as cash flow hedges to manage our exposure to variability in cash flows related to forecasted transactions. Changes in the fair value of derivatives designated as cash flow hedges are recorded as a component of AOCI, to the extent that the hedge relationships are effective, and amounts are reclassified from AOCI to earnings as the forecasted transactions occur. To the extent that any ineffectiveness exists in the hedge relationships, the amounts are recorded in current period earnings. Our cash flow hedges consist of interest rate swaps that are intended to hedge the variability in interest payments on some of our variable rate debt issuances and assets through 2017. These hedges have the effect of converting some of our variable rate debt and assets to a fixed rate. We also have entered into forward foreign currency derivative contracts to hedge our exposure to variability in cash flows related to foreign currency denominated debt.

 

   

Net Investment Hedges: We use net investment hedges, primarily forward foreign exchange contracts, to manage the exposure related to our net investments in consolidated foreign operations that have functional currencies other than the U.S. dollar. Changes in the fair value of net investment hedges are recorded in the translation adjustment component of AOCI.

 

   

Free-Standing Derivatives: We use free-standing derivatives, or economic hedges, to hedge the risk of changes in the fair value of residential MSRs, mortgage loan origination and purchase commitments and other interests held. We also categorize our customer-accommodation derivatives and the related offsetting contracts as free-standing derivatives. Changes in the fair value of free-standing derivatives are recorded in earnings as a component of other non-interest income.

 

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CAPITAL ONE FINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

Balance Sheet Presentation

The following table summarizes the fair value and related outstanding notional amounts of derivative instruments reported in our consolidated balance sheets as of September 30, 2011 and December 31, 2010. The fair value amounts are segregated by derivatives that are designated as accounting hedges and those that are not, and are further segregated by type of contract within those two categories.

 

    September 30, 2011     December 31, 2010  
    Notional or
Contractual
Amount
    Derivatives at Fair
Value
    Notional or
Contractual
Amount
    Derivatives at Fair
Value
 
(Dollars in millions)     Assets(1)     Liabilities(1)       Assets(1)     Liabilities(1)  

Derivatives designated as accounting hedges:

           

Interest rate contracts:

           

Fair value interest rate contracts

  $ 15,052      $ 1,052      $ 1      $ 17,001      $ 747      $ 77   

Cash flow interest rate contracts

    6,325        79        137        8,585        14        151   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest rate contracts

    21,377        1,131        138        25,586        761        228   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Foreign exchange contracts:

           

Cash flow foreign exchange contracts

    4,341        279        0        2,266        5        26   

Net investment foreign exchange contracts

    0        0        0        52        0        1   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total foreign exchange contracts

    4,341        279        0        2,318        5        27   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total derivatives designated as accounting hedges

    25,718        1,410        138        27,904        766        255   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Derivatives not designated as accounting hedges:(1)

           

Interest rate contracts covering:

           

MSRs

    383        18        13        625        3        18   

Customer accommodation(2)

    15,232        458        404        12,255        282        244   

Other interest rate exposures

    28,153        35        300        7,579        46        35   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest rate contracts

    43,768        511        717        20,459        331        297   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Foreign exchange contracts

    1,488        219        66        1,384        214        67   

Other contracts

    957        3        5        980        8        17   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total derivatives not designated as accounting hedges

    46,213        733        788        22,823        553        381   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total derivatives

  $ 71,931      $ 2,143      $ 926      $ 50,727      $ 1,319      $ 636   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1)

Derivative asset and liability amounts are presented on a gross basis based on individual contracts and do not reflect the impact of legally enforceable master counterparty netting agreements, collateral received/posted or net credit risk valuation adjustments. We recorded a net cumulative credit risk valuation adjustment related to our derivative positions of $39 million and $20 million as of September 30, 2011 and December 31, 2010, respectively. See “Derivative Counterparty Credit Risk” below for additional information.

(2)

Customer accommodation derivatives include those entered into with our commercial banking customers and those entered into with other counterparties to offset the market risk.

We took several actions during the third quarter of 2011 to manage the anticipated impact of the pending ING Direct acquisition on our market risk exposure and regulatory capital requirements. Since the date we entered into the agreement to acquire ING Direct, interest rates have declined substantially, and our current estimate of the fair value of the ING Direct net assets and liabilities has increased correspondingly. In order to capture some of the anticipated benefits to regulatory capital on the closing date attributable to this decline in interest rates, in

 

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CAPITAL ONE FINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

August 2011, we entered into various pay-fixed/receive-floating interest-rate swap transactions with a total notional principal amount of approximately $23.8 billion. These swap transactions are designed to mitigate the effect of a rise in interest rates on the fair values of a significant portion of the ING Direct assets and liabilities during the period from when we entered into the swap transactions to the anticipated closing date of the ING Direct acquisition in late 2011 or early 2012. Although the interest-rate swaps represent economic hedges, they are not designated for hedge accounting. Accordingly, changes in the fair value are recorded in earnings. We recognized a mark-to-market loss on these interest-rate swaps of $266 million in the third quarter of 2011, which was attributable to a decline in interest rates as of the end of the quarter. Changes in the fair value of these interest-rate swaps will continue to be recorded in earnings until the swaps are terminated.

During the third quarter of 2011, we discontinued hedge accounting on our only net investment hedge. Therefore, we did not have any net investment hedge outstanding as of September 30, 2011.

Income Statement Presentation and AOCI

The following tables summarize the impact of derivatives and related hedged items on our consolidated statements of income and AOCI.

Fair Value Hedges and Free-Standing Derivatives

The net gains (losses) recognized in earnings related to derivatives in fair value hedging relationships and free-standing derivatives are presented below for the three and nine months ended September 30, 2011 and 2010.

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
(Dollars in millions)        2011             2010             2011             2010      

Derivatives designated as accounting hedges:

        

Fair value interest rate contracts:

        

Gain recognized in earnings on derivatives(1)

   $ 339      $ 231      $ 380      $ 757   

Loss recognized in earnings on hedged items(1)

     (334     (230     (372     (718
  

 

 

   

 

 

   

 

 

   

 

 

 

Net fair value hedge ineffectiveness gain

     5        1        8        39   
  

 

 

   

 

 

   

 

 

   

 

 

 

Derivatives not designated as accounting hedges:

        

Interest rate contracts covering:

        

MSRs(1)

     6        (4     2        (17

Customer accommodation(1)

     5        6        15        14   

Other interest rate exposures(1)(2)

     (273     (1     (267     5   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

     (262     1        (250     2   
  

 

 

   

 

 

   

 

 

   

 

 

 

Foreign exchange contracts(1)

     6        (7     4        1   

Other contracts(1)

     14        12        23        44   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total gain (loss) on derivatives not designated as accounting hedges

     (242     6        (223     47   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net derivatives gain (loss) recognized in earnings

   $ (237   $ 7      $ (215   $ 86   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1)

Amounts are recorded in our consolidated statements of income in other non-interest income.

(2)

Includes $266 million in mark-to-market losses recorded in the third quarter of 2011 on interest-rate swap transactions related to the pending ING Direct acquisition discussed above.

 

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CAPITAL ONE FINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

The derivative losses for the third quarter and first nine months of 2011 were primarily attributable to the $266 million mark-to-market loss recorded in the third quarter of 2011 on the interest-rate swap transactions related to the pending ING Direct acquisition. Because these interest-rate swaps are not designated for hedge accounting, we will continue to record changes in the fair value of these interest-rate swaps in earnings until the swaps are terminated.

Cash Flow and Net Investment Hedges

The table below shows the net gains (losses) related to derivatives designated as cash flow hedges and net investment hedges for the three and nine months ended September 30, 2011 and 2010:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
(Dollars in millions)        2011             2010             2011             2010      

Gain (loss) recorded in AOCI:(1)

        

Cash flow hedges:

        

Interest rate contracts

   $ 14      $ (13   $ 35      $ (28

Foreign exchange contracts

     (5     (1     (15     1   
  

 

 

   

 

 

   

 

 

   

 

 

 

Subtotal

     9        (14     20        (27
  

 

 

   

 

 

   

 

 

   

 

 

 

Net investment hedges:

        

Foreign exchange contracts

     (1     (3     (2     (1
  

 

 

   

 

 

   

 

 

   

 

 

 

Net derivative gain (loss) recognized in AOCI

   $ 8      $ (17   $ 18      $ (28
  

 

 

   

 

 

   

 

 

   

 

 

 

Gain (loss) recorded in earnings:

        

Cash flow hedges:

        

Gain (loss) reclassified from AOCI into earnings:

        

Interest rate contracts(2)

   $ (1   $ (8   $ 1      $ (46

Foreign exchange contracts(3)

     (5     (1     (14     1   
  

 

 

   

 

 

   

 

 

   

 

 

 

Subtotal

     (6     (9     (13     (45

Gain (loss) recognized in earnings due to ineffectiveness:

        

Interest rate contracts(3)

     0        0        0        1   

Foreign exchange contracts(3)

     0        0        0        0   
  

 

 

   

 

 

   

 

 

   

 

 

 

Subtotal

     0        0        0        1   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net derivative loss recognized in earnings

   $ (6   $ (9   $ (13   $ (44
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1)

Amounts represent the effective portion.

(2)

Amounts reclassified are recorded in our consolidated statements of income in interest income, interest expense or other non-interest income.

(3)

Amounts reclassified are recorded in our consolidated statements of income in other non-interest income.

We expect to reclassify net after-tax gains of $2 million recorded in AOCI as of September 30, 2011, related to derivatives designated as cash flow hedges to earnings over the next 12 months, which we expect to offset against the cash flows associated with the hedged forecasted transactions. The maximum length of time over which forecasted transactions were hedged was six years as of September 30, 2011. The amount we expect to reclassify into earnings may change as a result of changes in market conditions and ongoing actions taken as part of our overall risk management strategy.

 

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CAPITAL ONE FINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

Credit Default Swaps

We have credit exposure on credit default swap agreements that we entered into to manage our risk of loss on certain manufactured housing securitizations issued by GreenPoint Credit LLC in 2000. Our maximum credit exposure related to these swap agreements totaled $24 million and $27 million as of September 30, 2011 and December 31, 2010, respectively. These agreements are recorded in our consolidated balance sheets as a component of other liabilities. The value of our obligations under these swaps was $15 million as of September 30, 2011 and $18 million as of December 31, 2010. See “Note 7—Variable Interest Entities and Securitizations” for additional information about our manufactured housing securitization transactions.

Credit Risk-Related Contingency Features

Certain of our derivative contracts include provisions requiring that our debt maintain a credit rating of investment grade or above by each of the major credit rating agencies. In the event of a downgrade of our debt credit rating below investment grade, some of our derivative counterparties would have the right to terminate the derivative contract and close-out the existing positions. Other derivative contracts include provisions that would, in the event of a downgrade of our debt credit rating below investment grade, allow our derivative counterparties to demand immediate and ongoing full overnight collateralization on derivative instruments in a net liability position. Certain of our derivative contracts may allow, in the event of a downgrade of our debt credit rating of any kind, our derivative counterparties to demand additional collateralization on such derivative instruments in a net liability position. The fair value of derivative instruments with credit-risk-related contingent features in a net liability position was $81 million and $66 million as of September 30, 2011 and December 31, 2010, respectively. We were required to post collateral, consisting of a combination of cash and securities, totaling $343 million and $229 million as of September 30, 2011 and December 31, 2010, respectively. If our debt credit rating had fallen below investment grade, we would have been required to post additional collateral of $43 million and $39 million as of September 30, 2011 and December 31, 2010, respectively.

Derivative Counterparty Credit Risk

Derivative instruments contain an element of credit risk that arises from the potential failure of a counterparty to perform according to the contractual terms of the contract. Our exposure to derivative counterparty credit risk at any point in time is represented by the fair value of derivatives in a gain position, or derivative assets, assuming no recoveries of underlying collateral. To mitigate the risk of counterparty default, we maintain collateral agreements with certain derivative counterparties. These agreements typically require both parties to maintain collateral in the event the fair values of derivative financial instruments exceed established thresholds. We received cash collateral from derivatives counterparties totaling $1.1 billion and $668 million as of September 30, 2011 and December 31, 2010, respectively. We posted cash collateral in accounts maintained by derivatives counterparties totaling $343 million and $229 million as of September 30, 2011 and December 31, 2010, respectively.

We record counterparty credit risk valuation adjustments on our derivative assets to properly reflect the credit quality of the counterparty. We consider collateral and legally enforceable master netting agreements that mitigate our credit exposure to each counterparty in determining the counterparty credit risk valuation adjustment, which may be adjusted in future periods due to changes in the fair value of the derivative contract, collateral and creditworthiness of the counterparty. The cumulative counterparty credit risk valuation adjustment recorded on our consolidated balance sheets as a reduction in the derivative asset balance was $41 million and $22 million as of September 30, 2011 and December 31, 2010, respectively. We also adjust the fair value of our derivative liabilities to reflect the impact of our credit quality. We calculate this adjustment by comparing the

 

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CAPITAL ONE FINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

spreads on our credit default swaps to the discount benchmark curve. The cumulative credit risk valuation adjustment related to our credit quality recorded on our consolidated balance sheets as a reduction in the derivative liability balance was $2 million as of both September 30, 2011 and December 31, 2010.

On July 19, 2011, we closed a public offering of shares of our common stock, subject to forward sale agreements that we entered into with certain counterparties acting as forward purchasers. The forward purchasers agreed to borrow and sell to the public, through the underwriters, 40 million shares of our common stock at a price per share of $50.00. After underwriter’s discounts and commissions, the net proceeds to the company will be at an initial forward sale price per share of $48.50. The forward sale price is subject to adjustment under the forward sale agreements. Under the terms of the forward sale agreements, we must settle the forward sale agreements on or before February 15, 2012. We expect to settle the forward sale agreements entirely by physical delivery of shares of common stock in exchange for cash proceeds from the forward purchasers of approximately $1.9 billion based on the initial forward price. We have the right to elect net share or cash settlement under the forward sale agreements, rather than physical settlement. Depending on the price of our common stock at the time, we may have credit exposure to the forward purchasers in the event that we are entitled to receive payment from these counterparties should we choose to settle the forward sale agreements other than by physical settlement. Conversely, we may have the obligation to make payment to the forward purchasers if we chose net share or cash settlement. In addition, the forward purchasers have the obligation to deliver cash proceeds to us in exchange for our issuance of common stock at the time of physical settlement. Until the time of settlement, the impact of these potential obligations are not reflected in our financial statements. Neither our counterparties’ nor our obligations under the forward sale agreements are collateralized. Except under limited circumstances, under the terms of the forward sale agreements we have the right to physical settlement at any time.

We provide additional information on our management of derivative counterparty credit risk in our 2010 Form 10-K “Note 11—Derivative Instruments and Hedging Activities.”

 

 

NOTE 11— STOCKHOLDERS’ EQUITY

 

Accumulated Other Comprehensive Income (AOCI)

The following table presents the components of AOCI, net of deferred taxes of $182 million and $143 million, as of September 30, 2011 and December 31, 2010, respectively.

 

(Dollars in millions)    September 30,
2011
    December 31,
2010
 

AOCI Components:

    

Net unrealized gains on securities(1)

   $ 380      $ 333   

Net unrecognized elements of defined benefit plans

     (30     (29

Foreign currency translation adjustments

     (56     (36

Unrealized losses on cash flow hedging instruments and Other

     (21     (52

Other-than-temporary impairment not recognized in earnings on securities

     35        49   

Initial application of measurement date provisions for postretirement benefits other than pensions

     (1     (1

Initial application from adoption of consolidation standards

     (16     (16
  

 

 

   

 

 

 

Total accumulated other comprehensive income

   $ 291      $ 248   
  

 

 

   

 

 

 

 

(1)

Includes net unrealized gains (losses) on securities available for sale and retained subordinated notes. Unrealized losses not related to credit on other-than-temporarily impaired securities of $126 million (net of income tax of $81 million) and $105 million (net of income tax of $68 million) was reported in other comprehensive income as of September 30, 2011 and December 31, 2010, respectively.

 

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CAPITAL ONE FINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

 

NOTE 12— EARNINGS PER COMMON SHARE

 

The following table sets forth the computation of basic and diluted earnings per common share:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
(Dollars and shares in millions, except per share-related data)        2011             2010             2011             2010      

Earnings:

        

Income from continuing operations, net of tax

   $ 865      $ 818      $ 2,842      $ 2,349   

Loss from discontinued operations, net of tax

     (52     (15     (102     (303
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 813      $ 803      $ 2,740      $ 2,046   
  

 

 

   

 

 

   

 

 

   

 

 

 

Shares:

        

Weighted-average common shares outstanding

     456        453        455        452   

Effect of dilutive securities:(1)

        

Stock options

     1        1        2        1   

Contingently issuable shares

     1        0        2        0   

Restricted stock and units

     2        3        2        3   
  

 

 

   

 

 

   

 

 

   

 

 

 

Dilutive potential common shares

     4        4        6        4   
  

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted weighted-average common shares outstanding

     460        457        461        456   
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic earnings per share:

        

Income from continuing operations

   $ 1.89      $ 1.81      $ 6.24      $ 5.19   

Loss from discontinued operations

     (0.11     (0.03     (0.22     (0.66
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income per basic common share

   $ 1.78      $ 1.78      $ 6.02      $ 4.53   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted earnings per share:

        

Income from continuing operations

   $ 1.88      $ 1.79      $ 6.17      $ 5.15   

Loss from discontinued operations

     (0.11     (0.03     (0.22     (0.66
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income per diluted common share

   $ 1.77      $ 1.76      $ 5.95      $ 4.49   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1)

Excluded from the computation of diluted earnings per share was 49 million and 30 million of awards, options or warrants, for the three months ended September 30, 2011 and 2010, respectively, and 22 million and 26 million of awards, options or warrants, for the nine months ended September 30, 2011 and 2010, respectively, because their inclusion would be anti-dilutive.

On July 19, 2011, we closed a public offering of shares of our common stock, subject to forward sale agreements that we entered into with certain counterparties acting as forward purchasers. The forward purchasers agreed to borrow and sell to the public, through the underwriters, 40 million shares of our common stock at a price per share of $50.00. After underwriter’s discounts and commissions, the net proceeds to the company will be at an initial forward sale price per share of $48.50. The forward sale price is subject to adjustment under the forward sale agreement.

Prior to any issuance of shares of our common stock upon settlement of the forward sale agreements, the forward sale agreements will be reflected in our diluted earnings per share calculations using the treasury stock method. Under this method, the number of shares of our common stock used in calculating diluted earnings per share is increased by the excess, if any, of the number of shares that would be issued upon physical settlement of the forward sale agreements in whole over the number of shares that could be purchased by us in the market (based on the average market price during the reporting period) using the proceeds receivable upon settlement (based on the adjusted forward sale price at the end of the reporting period).

 

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CAPITAL ONE FINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

 

NOTE 13— FAIR VALUE OF FINANCIAL INSTRUMENTS

 

Fair Value

Fair value is defined as the price that would be received for an asset or paid to transfer a liability in an orderly transaction between market participants on the measurement date (also referred to as an exit price). The fair value accounting guidance provides a three-level fair value hierarchy for classifying financial instruments. This hierarchy is based on whether the inputs to the valuation techniques used to measure fair value are observable or unobservable. Fair value measurement of a financial asset or liability is assigned to a level based on the lowest level of any input that is significant to the fair value measurement in its entirety. The three levels of the fair value hierarchy are described below:

 

Level 1:

   Quoted prices (unadjusted) in active markets for identical assets or liabilities.

Level 2:

   Observable market-based inputs, other than quoted prices in active markets for identical assets or liabilities.

Level 3:

   Unobservable inputs.

The accounting guidance for fair value requires that we maximize the use of observable inputs and minimize the use of unobservable inputs in determining fair value. The accounting guidance for derivatives also provides for the irrevocable option to elect, on a contract-by-contract basis, to measure certain financial assets and liabilities at fair value at inception of the contract and record any subsequent changes in fair value into earnings. We had not made any material fair value option elections as of September 30, 2011 and December 31, 2010.

Level 1, 2 and 3 Valuation Techniques

Financial instruments are considered Level 1 when the valuation can be based on quoted prices in active markets for identical assets or liabilities. Level 2 financial instruments are valued using quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or models using inputs that are observable or can be corroborated by observable market data of substantially the full term of the assets or liabilities. Financial instruments are considered Level 3 when their values are determined using pricing models, discounted cash flow methodologies or similar techniques, and at least one significant model assumption or input is unobservable and when determination of the fair value requires significant management judgment or estimation.

 

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CAPITAL ONE FINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

The following table displays our assets and liabilities measured on our consolidated balance sheets at fair value on a recurring basis as of September 30, 2011 and December 31, 2010:

Assets and Liabilities Measured at Fair Value on a Recurring Basis

 

     September 30, 2011  
     Fair Value Measurements Using      Assets/
Liabilities
at Fair Value
 
(Dollars in millions)      Level 1          Level 2          Level 3       

Assets

           

Securities available for sale:

           

U.S. Treasury and other U.S. Agency

   $ 125       $ 175       $ 0       $ 300   

Residential mortgage-backed securities

     0         26,829         191         27,020   

Asset-backed securities

     0         9,695         39         9,734   

Commercial mortgage-backed securities

     0         485         342         827   

Other

     277         230         12         519   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total securities available for sale

     402         37,414         584         38,400   

Other assets:

           

Mortgage servicing rights

     0         0         94         94   

Derivative receivables(1)(2)

     3         2,075         65         2,143   

Retained interests in securitization

     0         0         101         101   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Assets

   $ 405       $ 39,489       $ 844       $ 40,738   
  

 

 

    

 

 

    

 

 

    

 

 

 

Liabilities

           

Other liabilities:

           

Derivative payables(1)(2)

   $ 5       $ 681       $ 240       $ 926   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Liabilities

   $ 5       $ 681       $ 240       $ 926   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     December 31, 2010  
     Fair Value Measurements Using      Assets/
Liabilities
at Fair Value
 
(Dollars in millions)      Level 1          Level 2          Level 3       

Assets

           

Securities available for sale:

           

U.S. Treasury and other U.S. Agency

   $ 386       $ 314       $ 0       $ 700   

Residential mortgage-backed securities

     0         29,626         578         30,204   

Asset-backed securities

     0         9,953         13         9,966   

Commercial mortgage-backed securities

     0         45         0         45   

Other

     293         322         7         622   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total securities available for sale

     679         40,260         598         41,537   

Other assets:

           

Mortgage servicing rights

     0         0         141         141   

Derivative receivables(1)(2)

     8         1,265         46         1,319   

Retained interests in securitizations

     0         0         117         117   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Assets

   $ 687       $ 41,525       $ 902       $ 43,114   
  

 

 

    

 

 

    

 

 

    

 

 

 

Liabilities

           

Other liabilities:

           

Derivative payables(1)(2)

   $ 18       $ 575       $ 43       $ 636   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Liabilities

   $ 18       $ 575       $ 43       $ 636   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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CAPITAL ONE FINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

 

(1)

We do not offset the fair value of derivative contracts in a loss position against the fair value of contracts in a gain position. We also do not offset fair value amounts recognized for derivative instruments and fair value amounts recognized for the right to reclaim cash collateral or the obligation to return cash collateral arising from derivative instruments executed with the same counterparty under a master netting arrangement.

(2)

Does not reflect $39 million and $20 million recognized as a net valuation allowance on derivative assets and liabilities for non-performance risk as of September 30, 2011 and December 31, 2010, respectively. Non-performance risk is reflected in other assets/liabilities on the balance sheet and offset through the income statement in other income.

The determination of the classification of financial instruments in Level 2 or Level 3 of the fair value hierarchy is performed at the end of each reporting period. We consider all available information, including observable market data, indications of market liquidity and orderliness, and our understanding of the valuation techniques and significant inputs. Based upon the specific facts and circumstances of each instrument or instrument category, judgments are made regarding the significance of the Level 3 inputs to the instruments’ fair value measurement in its entirety. If Level 3 inputs are considered significant, the instrument is classified as Level 3. The process for determining fair value using unobservable inputs is generally more subjective and involves a high degree of management judgment and assumptions.

During the third quarter of 2011, we did not have material movements between Levels 1 and 2. In connection with the adoption of the new consolidation accounting standards on January 1, 2010, retained interests in securitizations, which were considered a Level 3 security, were reclassified to loans held for investment when the underlying trusts were consolidated.

Level 3 Instruments Only

Financial instruments are considered Level 3 when their values are determined using pricing models, which include comparison of prices from multiple sources, discounted cash flow methodologies or similar techniques and at least one significant model assumption or input is unobservable or there is significant variability among pricing sources. Level 3 financial instruments also include those for which the determination of fair value requires significant management judgment or estimation. The table below presents reconciliation for all assets and liabilities measured and recognized at fair value on a recurring basis using significant unobservable inputs (Level 3).

 

(Dollars in millions)    Three Months Ended September 30, 2011  
   Securities
Available for
Sale
    Mortgage
Servicing
Rights
    Derivative
Receivables(2)
    Retained
Interests in
Securitizations(3)
    Derivative
Payables(2)
 

Balance, June 30, 2011

   $ 378      $ 130      $ 44      $ 106      $ (42

Total realized and unrealized gains (losses):

          

Included in net income

     0        (34 )(1)      27        (5     (24

Included in other comprehensive income

     (10     0        0        0        0   

Purchases

     282        0        0        0        0   

Sales

     (15     0        0        0        0   

Issuances

     0        1        3        0        (180

Settlements

     (34     (3     (8     0        5   

Transfers in to Level 3(4)

     100        0        0        0        0   

Transfers out of Level 3(4)

     (117     0        (1     0        1   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, September 30, 2011

   $ 584      $ 94      $ 65      $ 101      $ (240
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total unrealized gains (losses) included in net income related to assets and liabilities still held as of September 30, 2011(5)

   $ 0      $ (34   $ 27      $ (5   $ (24

 

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CAPITAL ONE FINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

     Three Months Ended September 30, 2011  
(Dollars in millions)    U.S. Treasury
&
Agency
     Residential
mortgage
backed
securities
    Asset-
backed
Securities
    Commercial
mortgage-
backed
Securities
    Other      Total  

Securities Available for Sale

              

Balance, June 30, 2011

   $ 0       $ 357      $ 9      $ 0      $ 12       $ 378   

Total realized and unrealized gains (losses):

              

Included in other comprehensive income

     0         (5     (4     (1     0         (10

Purchases

     0         (34     34        282        0         282   

Sales

     0         0        0        (15     0         (15

Issuances

     0         0        0        0        0         0   

Settlements

     0         (34     0        0        0         (34

Transfers in to Level 3(4)

     0         24        0        76        0         100   

Transfers out of Level 3(4)

     0         (117     0        0        0         (117
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Balance, September 30, 2011

   $ 0       $ 191      $ 39      $ 342      $ 12       $ 584   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Total unrealized gains (losses) included in net income related to assets and liabilities still held as of September 30, 2011(5)

   $ 0       $ 0      $ 0      $ 0      $ 0       $ 0   

 

    Three Months Ended September 30, 2010  
(Dollars in millions)   Securities
Available for
Sale
    Mortgage
Servicing
Rights
    Derivative
Receivables(2)
    Retained
Interests in
Securitizations(3)
    Derivative
Payables(2)
 

Balance, June 30, 2010

  $ 1,212      $ 137      $ 51      $ 196      $ (47

Total realized and unrealized gains (losses):

         

Included in net income

    (3     (13 )(1)      5        0        (7

Included in other comprehensive income

    (23     0        0        0        0   

Purchases, sales, issuances and settlements, net

    (21     0        2        (72     0   

Transfers in to Level 3(4)

    349        0        0        0        0   

Transfers out of Level 3(4)

    (385     0        (1     0        1   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, September 30, 2010

  $ 1,129      $ 124      $ 57      $ 124      $ (53
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total unrealized gains (losses) included in net income related to assets and liabilities still held as of September 30, 2010(5)

  $ (3   $ (13   $ 5      $ 0      $ (7

 

    Three Months Ended September 30, 2010  
(Dollars in millions)   U.S. Treasury
&
Agency
    Residential
mortgage
backed
securities
    Asset-
backed
Securities
    Commercial
mortgage-
backed
Securities
    Other     Total  

Securities Available for Sale

           

Balance, June 30, 2010

  $ 0      $ 1,061      $ 132      $ 0      $ 19      $ 1,212   

Total realized and unrealized gains (losses):

           

Included in net income

    0        (3     0        0        0        (3

Included in other comprehensive income

    0        (23     (1     0        1        (23

Purchases, sales, issuances and settlements, net

    0        (21     0        0        0        (21

Transfers in to Level 3(4)

    0        349        0        0        0        349   

Transfers out of Level 3(4)

    0        (335     (50     0        0        (385
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, September 30, 2010

  $ 0      $ 1,028      $ 81      $ 0      $ 20      $ 1,129   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total unrealized gains (losses) included in net income related to assets and liabilities still held as of September 30, 2010(5)

  $ 0      $ (3   $ 0      $ 0      $ 0      $ (3

 

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Table of Contents

CAPITAL ONE FINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

     Nine Months Ended September 30, 2011  
(Dollars in millions)    Securities
Available for
Sale
    Mortgage
Servicing
Rights
    Derivative
Receivables(2)
    Retained
Interests in
Securitizations(3)
    Derivative
Payables(2)
 

Balance, January 1, 2011

   $ 598      $ 141      $ 46      $ 117      $ (43

Total realized and unrealized gains (losses):

          

Included in net income

     0        (44 )(1)      39        (16     (28

Included in other comprehensive income

     (14     0        0        0        0   

Purchases

     316        0        0        0        0   

Sales

     (30     0        0        0        0   

Issuances

     0        7        5        0        (182

Settlements

     (94     (10     (23     0        12   

Transfers in to Level 3(4)

     131        0        0        0        0   

Transfers out of Level 3(4)

     (323     0        (2     0        1   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, September 30, 2011

   $ 584      $ 94      $ 65      $ 101      $ (240
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total unrealized gains (losses) included in net income related to assets and liabilities still held as of September 30, 2011(5)

   $ 0      $ (44   $ 39      $ (16   $ (28

 

     Nine Months Ended September 30, 2011  
(Dollars in millions)    U.S. Treasury
&
Agency
     Residential
mortgage
backed
securities
    Asset-
backed
Securities
    Commercial
mortgage-
backed
Securities
    Other      Total  

Securities Available for Sale

              

Balance, January 1, 2011

   $ 0       $ 578      $ 13      $ 0      $ 7       $ 598   

Total realized and unrealized gains (losses):

              

Included in other comprehensive income

     0         (9     (4     (1     0         (14

Purchases

     0         0        34        282        0         316   

Sales

     0         (15     0        (15     0         (30

Issuances

     0         0        0        0        0         0   

Settlements

     0         (93     (1     0        0         (94

Transfers in to Level 3(4)

     0         50        0        76        5         131   

Transfers out of Level 3(4)

     0         (320     (3     0        0         (323
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Balance, September 30, 2011

   $ 0       $ 191      $ 39      $ 342      $ 12       $ 584   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Total unrealized gains (losses) included in net income related to assets and liabilities still held as of September 30, 2011(5)

   $ 0       $ 0      $ 0      $ 0      $ 0       $ 0   

 

     Nine Months Ended September 30, 2010  
(Dollars in millions)    Securities
Available for
Sale
    Mortgage
Servicing
Rights
    Derivative
Receivables(2)
    Retained
Interests in
Securitizations(3)
    Derivative
Payables(2)
 

Balance, January 1, 2010

   $ 1,506      $ 240      $ 440      $ 3,945      $ (33

Total realized and unrealized gains (losses):

          

Included in net income

     (3     (62 )(1)      15        9        (20

Included in other comprehensive income

     (72     0        0        0        0   

Purchases, sales, issuances and settlements, net

     40        (54     4        (79     (1

Impact of adoption of consolidation standards

     0        0        (401     (3,751     0   

Transfers in to Level 3(4)

     1,101        0        0        0        0   

Transfers out of Level 3(4)

     (1,443     0        (1     0        1   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, September 30, 2010

   $ 1,129      $ 124      $ 57      $ 124      $ (53
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total unrealized gains (losses) included in net income related to assets and liabilities still held as of September 30, 2010(5)

   $ (3   $ (62   $ 14      $ 8      $ (20

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

    Nine Months Ended September 30, 2010  
(Dollars in millions)   U.S. Treasury
&
Agency
    Residential
mortgage backed
securities
    Asset-
backed
Securities
    Commercial
mortgage-
backed
Securities
    Other     Total  

Securities Available for Sale

           

Balance January 1, 2010

  $ 0      $ 1,468      $ 13      $ 0      $ 25      $ 1,506   

Total realized and unrealized gains (losses):

           

Included in net income

    0        (3     0        0        0        (3

Included in other comprehensive income

    0        (71     (2     0        1        (72

Purchases, sales, issuances and settlements, net

    0        (30     70        0        0        40   

Transfers in to Level 3(4)

    0        1,051        50        0        0        1,101   

Transfers out of Level 3(4)

    0        (1,387     (50     0        (6     (1,443
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, September 30, 2010

  $ 0      $ 1,028      $ 81      $ 0      $ 20      $ 1,129   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total unrealized gains (losses) included in net income related to assets and liabilities still held as of September 30, 2010(5)

  $ 0      $ (3   $ 0      $ 0      $ 0      $ (3

 

(1)

Gains (losses) related to Level 3 mortgage servicing rights are reported in other non-interest income.

(2)

An end of quarter convention is used to measure derivative activity, resulting in end of quarter values being reflected as purchases, issuances and for derivatives having a zero fair value at inception. Gains (losses) related to Level 3 derivative receivables and derivative payables are reported in Other non-interest income, which is a component of non-interest income.

(3)

An end of quarter convention is used to reflect activity in retained interests in securitizations, resulting in all transactions and assumption changes being reflected as if they occurred on the last day of the quarter. Gains (losses) related to Level 3 retained interests in securitizations are reported in servicing and securitizations income, which is a component of non-interest income.

(4)

The transfer out of Level 3 for the third quarter and first nine months of 2011 and 2010 was primarily driven by greater consistency amongst multiple pricing sources. The transfer into Level 3 was primarily driven by less consistency amongst vendor pricing on individual securities for non-agency MBS.

(5)

The amount presented for unrealized gains (losses) for assets still held as of the reporting date primarily represents impairments for available-for-sale securities and accretion on certain fixed maturity securities, and are reported in total other-than-temporary losses as a component of non-interest income. The amounts presented for unrealized gains (losses) for assets still held as of the end of the reported period for mortgage servicing rights, derivative receivable and derivative payables are reflected in Other as a component of non-interest income. The amounts presented for unrealized gains (losses) for assets still held as of the end of the reported period for retained interests in securitizations are reported in Servicing and securitizations as a component of non-interest income.

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

We are required to measure and recognize certain other financial assets at fair value on a nonrecurring basis in the consolidated balance sheet. These financial assets are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when we evaluate impairment). Fair value adjustments for loans held for sale, foreclosed assets, and other assets are recorded in other non-interest expense, and fair value adjustments for loans held for investment are recorded in provision for loan and lease losses in the consolidated statement of income.

 

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For assets measured at fair value on a nonrecurring basis and still held on the consolidated balance sheet, the following table provides the fair value measures by level of valuation assumptions used as of September 30, 2011 and 2010 and the gains or losses recognized for these assets as a result of fair value measurements for the three and nine months ended September 30, 2011 and 2010:

 

    September 30, 2011     Three Months
Ended
September 30, 2011
    Nine Months
Ended

September  30, 2011
 
    Fair Value Measurements Using     Assets at
Fair Value
    Total
Gains/(Losses)(2)
    Total
Gains/(Losses)(2)
 
(Dollars in millions)   Level 1     Level 2     Level 3        

Assets

           

Loans held for sale

  $ 0      $ 312      $ 0        312      $ 3      $ 3   

Loans held for investment

    0        55        62        117        (18     (68

Foreclosed assets(1)

    0        138        0        138        (4     (23

Other

    0        18        0        18        0        (13
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 0      $ 523      $ 62      $ 585      $ (19   $ (101
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

    September 30, 2010     Three Months
Ended
September 30, 2010
    Nine Months
Ended
September 30, 2010
 
    Fair Value Measurements Using     Assets at
Fair Value
    Total
Gains/(Losses)(2)
    Total
Gains/(Losses)(2)
 
(Dollars in millions)   Level 1     Level 2     Level 3        

Assets

           

Loans held for sale

  $ 0      $ 190      $ 0      $ 190      $ (1   $ (5

Loans held for investment

    0        91        138        229        17        (90

Foreclosed assets(1)

    0        268        0        268        (9     (29

Other

    0        8        0        8        2        0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 0      $ 557      $ 138      $ 695      $ 9      $ (124
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1)

Represents the fair value and related losses of foreclosed properties that were written down subsequent to their initial classification as foreclosed properties.

(2)

Represents the gains/losses recognized for the periods presented.

 

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CAPITAL ONE FINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

Fair Value of Financial Instruments

The table below presents the fair value of financial instruments, whether or not recognized on the consolidated balance sheet, at fair value as of September 30, 2011 and December 31, 2010:

 

     September 30, 2011      December 31, 2010  
(Dollars in millions)    Carrying
Amount
     Estimated
Fair Value
     Carrying
Amount
     Estimated
Fair Value
 

Financial assets:

           

Cash and cash equivalents

   $ 6,358       $ 6,358       $ 5,249       $ 5,249   

Restricted cash for securitization investors

     984         984         1,602         1,602   

Securities available for sale

     38,400         38,400         41,537         41,537   

Loans held for sale

     312         312         228         228   

Net loans held for investment

     125,672         128,149         120,319         124,117   

Interest receivable

     958         958         1,070         1,070   

Accounts receivable from securitization

     101         101         118         118   

Derivatives

     2,143         2,143         1,319         1,319   

Mortgage servicing rights

     94         94         141         141   

Financial liabilities:

           

Non-interest bearing deposits

   $ 17,541       $ 17,541       $ 15,048       $ 15,048   

Interest-bearing deposits

     110,777         111,478         107,162         107,587   

Senior and subordinated notes

     11,051         10,960         8,650         9,236   

Securitized debt obligations

     17,120         17,257         26,915         26,943   

Federal funds purchased and securities loaned or sold under agreements to repurchase

     1,441         1,441         1,517         1,517   

Other borrowings

     4,703         4,696         4,714         4,901   

Interest payable

     401         401         488         488   

Derivatives

     926         926         636         636   

The following describes the valuation techniques used in estimating the fair value of our financial instruments as of September 30, 2011 and December 31, 2010. We applied the fair value provisions, to the financial instruments not recognized on the consolidated balance sheet at fair value, which include loans held for investment, interest receivable, non-interest bearing and interest bearing deposits, other borrowings, senior and subordinated notes, and interest payable. The provisions requiring us to maximize the use of observable inputs and to measure fair value using a notion of exit price were factored into our selection of inputs of our established valuation techniques.

Financial Assets

Cash and Cash Equivalents

The carrying amounts of cash and due from banks, federal funds sold and securities purchased under agreements to resell and interest-bearing deposits with other banks approximate fair value.

Restricted Cash for Securitization Investors

The carrying amounts of restricted cash for securitization investors approximate their fair value due to their relatively short-term nature.

Securities Available For Sale

Quoted prices in active markets are used to measure the fair value of U.S. Treasury securities. For other investment categories, we utilize multiple third party pricing services to obtain fair value measures for the large

 

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CAPITAL ONE FINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

majority of our securities. A pricing service may be considered as the primary pricing provider for certain types of securities, and the designation of the primary pricing provider may vary depending on the type of securities. The determination of the primary pricing provider is based on our experience and validation benchmark of the pricing service’s performance in terms of providing fair value measurement for the various types of securities.

Certain securities available for sale are classified as Level 2 and 3, the majority of which are residential mortgage-backed securities. Classification indicates that significant valuation assumptions are not consistently observable in the market. When significant assumptions are not consistently observable, fair values are derived using the best available data. Such data may include quotes provided by a dealer, the use of external pricing services, independent pricing models, or other model-based valuation techniques such as calculation of the present values of future cash flows incorporating assumptions such as benchmark yields, spreads, prepayment speeds, credit ratings, and losses. The techniques used by the pricing services utilize observable market data to the extent available. Pricing models may be used, which can vary by asset class and may incorporate available trade, bid and other market information. Across asset classes, information such as trader/dealer input, credit spreads, forward curves, and prepayment speeds are used to help determine appropriate valuations. Because many fixed income securities do not trade on a daily basis, the evaluated pricing applications may apply available information through processes such as benchmarking curves, like securities, sector groupings, and matrix pricing to prepare valuations. In addition, model processes are used by the pricing services to develop prepayment and interest rate scenarios.

We validate the pricing obtained from the primary pricing providers through comparison of pricing to additional sources, including other pricing services, dealer pricing indications in transaction results, and other internal sources. Pricing variances among different pricing sources are analyzed and validated.

The decrease in the amount of Level 3 securities reflected run-off of non-agency mortgage securities and tighter pricing of these securities between third party vendors.

Loans Held For Sale

Loans held for sale are carried at the lower of aggregate cost, net of deferred fees, deferred origination costs and effects of hedge accounting, or fair value. The fair value of loans held for sale is determined using current secondary market prices for portfolios with similar characteristics. The carrying amounts as of September 30, 2011 and December 31, 2010 approximate fair value.

Loans Held For Investment, Net

The fair values of credit card loans, installment loans, auto loans, home loans and commercial loans were estimated using a discounted cash flow method, a form of the income approach. Discount rates were determined considering rates at which similar portfolios of loans would be made under current conditions and considering liquidity spreads applicable to each loan portfolio based on the secondary market. The fair value of credit card loans excluded any value related to customer account relationships.

Interest Receivable

The carrying amount of interest receivable approximates the fair value of this asset due to its relatively short-term nature.

 

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CAPITAL ONE FINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

Accounts Receivable from Securitizations

Accounts receivable from securitizations include the interest-only strip, retained notes accrued interest receivable, cash reserve accounts and cash spread accounts for those securitization structures achieving off-balance sheet treatment. We use a valuation model that calculates the present value of estimated future cash flows. The model incorporates our estimate of assumptions market participants use in determining fair value, including estimates of payment rates, defaults, and discount rates including adjustments for liquidity, and contractual interest and fees. Other retained interests related to securitizations are carried at cost, which approximates fair value. The valuation technique for these securities is discussed in more detail in “Note 7—Variable Interest Entities and Securitizations.”

Derivative Assets

Most of our derivatives are not exchange traded, but instead traded in over the counter markets where quoted market prices are not readily available. The fair value derived for those derivatives using models that use primarily market observable inputs, such as interest rate yield curves, credit curves, option volatility and currency rates are classified as Level 2. Any derivative fair value measurements using significant assumptions that are unobservable are classified as Level 3, which include interest rate swaps whose remaining terms do not correlate with market observable interest rate yield curves. The impact of counterparty non-performance risk is considered when measuring the fair value of derivative assets. These derivatives are included in other assets on the balance sheet.

We validate the pricing obtained from the internal models through comparison of pricing to additional sources, including external valuation agents and other internal sources. Pricing variances among different pricing sources are analyzed and validated.

Mortgage Servicing Rights

MSRs do not trade in an active market with readily observable prices. Accordingly, we determine the fair value of MSRs using a valuation model that calculates the present value of estimated future net servicing income. The model incorporates assumptions that market participants use in estimating future net servicing income, including estimates of prepayment spreads, discount rate, cost to service, contractual servicing fee income, ancillary income and late fees. We record MSRs at fair value on a recurring basis. Fair value measurements of MSRs use significant unobservable inputs and, accordingly, are classified as Level 3. The valuation technique for these securities is discussed in more detail in “Note 8—Goodwill and Other Intangible Assets.”

Financial Liabilities

Interest Bearing Deposits

The fair value of other interest-bearing deposits was determined based on discounted expected cash flows using discount rates consistent with current market rates for similar products with similar remaining terms.

Non-Interest Bearing Deposits

The carrying amount of non-interest bearing deposits approximates fair value.

Senior and Subordinated Notes

We engage multiple third party pricing services in order to estimate the fair value of senior and subordinated notes. The pricing service utilizes a pricing model that incorporates available trade, bid and other market information. It also incorporates spread assumptions, volatility assumptions and relevant credit information into the pricing models.

 

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CAPITAL ONE FINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

Securitized Debt Obligations

We utilized multiple third party pricing services to obtain fair value measures for the large majority of our securitized debt obligations. The techniques used by the pricing services utilize observable market data to the extent available; and pricing models may be used which incorporate available trade, bid and other market information as described in the above section. We used internal pricing models, discounted cash flow models or similar techniques to estimate the fair value of certain securitization trusts where third party pricing was not available.

Other Borrowings

The carrying amount of federal funds purchased and repurchase agreements, and other short-term borrowings approximates fair value. The fair value of junior subordinated borrowings was estimated using the same methodology as described for senior and subordinated notes. The fair value of other borrowings was determined based on trade information for bonds with similar duration and credit quality, adjusted to incorporate any relevant credit information of the issuer.

Interest Payable

The carrying amount of interest payable approximates the fair value of this liability due to its relatively short-term nature.

Derivative Liabilities

Most of our derivatives are not exchange traded, but instead traded in over the counter markets where quoted market prices are not readily available. The fair value of those derivatives, derived using models that use primarily market observable inputs, such as interest rate yield curves, credit curves, option volatility and currency rates, are classified as Level 2. Any derivative fair value measurements using significant assumptions that are unobservable are classified as Level 3, which include interest rate swaps whose remaining terms do not correlate with market observable interest rate yield curves. The impact of counterparty non-performance risk is considered when measuring the fair value of derivative assets. These derivatives are included in other liabilities on the consolidated balance sheets.

We validate the pricing obtained from the internal models through comparison of pricing to additional sources, including external valuation agents and other internal sources. Pricing variances among different pricing sources are analyzed and validated.

Commitments to Extend Credit and Letters of Credit

These financial instruments are generally not sold or traded. The fair value of the guarantees outstanding which we include on our consolidated balance sheets in other liabilities was $4 million and $3 million as of September 30, 2011 and December 31, 2010, respectively. The estimated fair values of extensions of credit and letters of credit are not readily available. However, the fair value of commitments to extend credit and letters of credit is based on fees currently charged to enter into similar agreements with comparable credit risks and the current creditworthiness of the counterparties. Commitments to extend credit issued by us are generally short-term in nature and, if drawn upon, are issued under current market terms and conditions for credits with comparable risks. At September 30, 2011 and December 31, 2010, there was no material unrealized appreciation or depreciation on these financial instruments.

 

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CAPITAL ONE FINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

 

NOTE 14—BUSINESS SEGMENTS

 

Segment Description

Our principal operations are currently organized into three primary reportable business segments, which are defined based on the products and services provided, or the type of customer served: Credit Card, Consumer Banking and Commercial Banking. The operations of acquired businesses have been integrated into our existing business segments. Certain activities that are not part of a defined business segment are included in the “Other” category.

 

   

Credit Card: Consists of our domestic consumer and small business card lending, national small business lending, national closed end installment lending and the international card lending businesses in Canada and the United Kingdom.

 

   

Consumer Banking: Consists of our branch-based lending and deposit gathering activities for consumers and small businesses, national deposit gathering, national automobile lending and consumer home loan lending and servicing activities.

 

   

Commercial Banking: Consists of our lending, deposit gathering and treasury management services to commercial real estate and middle market customers. Our middle market customers typically include commercial and industrial companies with annual revenues between $10 million to $1.0 billion.

 

   

Other Category: Includes the residual impact of the allocation of our centralized Corporate Treasury group activities, such as management of our corporate investment portfolio and asset/liability management, to our business segments. Accordingly, net gains and losses on our investment securities portfolio and certain trading activities are included in the Other category. The Other category also includes foreign exchange-rate fluctuations related to the revaluation of foreign currency-denominated investments; certain gains (losses) on the sale and securitization of loans; unallocated corporate expenses that do not directly support the operations of the business segments or for which the business segments are not considered financially accountable in evaluating their performance, such as acquisition and restructuring charges; provisions for representation and warranty reserves related to continuing operations; certain material items that are non-recurring in nature; and offsets related to certain line-item reclassifications.

Basis of Presentation

We report the financial results of our business segments on a continuing operations basis. See “Note 3—Discontinued Operations” for a discussion of discontinued operations. The results of our individual businesses, which are prepared on an internal management accounting and reporting basis, reflect the manner in which management evaluates performance and makes decisions about funding our operations and allocating resources. See “Note 20—Business Segments” of our 2010 Form 10-K for more information on our business segment reporting methodology.

We may periodically change our business segments or reclassify business segment results based on modifications to our management reporting methodologies and changes in organizational alignment.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

Business Segment Results

We summarize our business segment results for the three and nine months ended September 30, 2011 and 2010 in the tables below and provide a reconsolidation of our total business segment results, or managed results, to our consolidated U.S. GAAP results.

 

    Three Months Ended September 30, 2011  
(Dollars in millions)   Credit
Card
    Consumer
Banking
    Commercial
Banking
    Other     Total
Managed
    Reconciliation(1)     Total
Reported
 

Net interest income (expense)

  $ 2,042      $ 1,097      $ 353      $ (209   $ 3,283      $ 0      $ 3,283   

Non-interest income

    678        188        62        (57     871        0        871   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

    2,720        1,285        415        (266     4,154        0        4,154   

Provision for loan and lease losses

    511        136        (10     (15     622        0        622   

Non-interest expense:

             

Core deposit intangible amortization

    0        32        10        0        42        0        42   

Other non-interest expense

    1,188        821        190        56        2,255        0        2,255   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total non-interest expense

    1,188        853        200        56        2,297        0        2,297   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from continuing operations before income taxes

    1,021        296        225        (307     1,235        0        1,235   

Income tax provision (benefit)

    358        106        80        (174     370        0        370   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from continuing operations, net of tax

  $ 663      $ 190      $ 145      $ (133   $ 865      $ 0      $ 865   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

    Three Months Ended September 30, 2010  
(Dollars in millions)   Credit
Card
    Consumer
Banking
    Commercial
Banking
    Other     Total
Managed
    Reconciliation(1)     Total
Reported
 

Net interest income (expense)

  $ 1,934      $ 946      $ 325      $ (93   $ 3,112      $ (3   $ 3,109   

Non-interest income

    671        196        30        7        904        3        907   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

    2,605        1, 142        355        (86     4,016        0        4,016   

Provision for loan and lease losses

    660        114        95        (2     867        0        867   

Non-interest expense:

             

Core deposit intangible amortization

    0        36        14        0        50        0        50   

Other non-interest expense

    978        721        185        62        1,946        0        1,946   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total non-interest expense

    978        757        199        62        1,996        0        1,996   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from continuing operations before income taxes

    967        271        61        (146     1,153        0        1,153   

Income tax provision (benefit)

    336        96        22        (119     335        0        335   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from continuing operations, net of tax

  $ 631      $ 175      $ 39      $ (27   $ 818      $ 0      $ 818   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

    Nine Months Ended September 30, 2011  
(Dollars in millions)   Credit
Card
    Consumer
Banking
    Commercial
Banking
    Other     Total
Managed
    Reconciliation(1)     Total
Reported
 

Net interest income (expense)

  $ 5,873      $ 3,131      $ 1,007      $ (452   $ 9,559      $ 0      $ 9,559   

Non-interest income

    1,971        568        195        (64     2,670        0        2,670   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

    7,844        3,699        1,202        (516     12,229        0        12,229   

Provision for loan and lease losses

    1,270        272        (43     0        1,499        0        1,499   

Non-interest expense:

             

Core deposit intangible amortization

    0        100        31        0        131        0        131   

Other non-interest expense

    3,604        2,251        538        190        6,583        0        6,583   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total non-interest expense

    3,604        2,351        569        190        6,714        0        6,714   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from continuing operations before income taxes

    2,970        1,076        676        (706     4,016        0        4,016   

Income tax provision (benefit)

    1,046        384        241        (497     1,174        0        1,174   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from continuing operations, net of tax

  $ 1,924      $ 692      $ 435      $ (209   $ 2,842      $ 0      $ 2,842   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

    Nine Months Ended September 30, 2010  
(Dollars in millions)   Credit
Card
    Consumer
Banking
    Commercial
Banking
    Other     Total
Managed
    Reconciliation(1)     Total
Reported
 

Net interest income (expense)

  $ 6,024      $ 2,777      $ 956      $ (316   $ 9,441      $ (7   $ 9,434   

Non-interest income

    2,048        674        132        (81     2,773        2        2,775   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

    8,072        3,451        1,088        (397     12,214        (5     12,209   

Provision for loan and lease losses

    2,600        52        395        27        3,074        (5     3,069   

Non-interest expense:

             

Core deposit intangible amortization

    0        110        42        0        152        0        152   

Other non-interest expense

    2,894        2,070        547        180        5,691        0        5,691   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total non-interest expense

    2,894        2,180        589        180        5,843        0        5,843   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from continuing operations before income taxes

    2,578        1,219        104        (604     3,297        0        3,297   

Income tax provision (benefit)

    890        434        37        (413     948        0        948   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from continuing operations, net of tax

  $ 1,688      $ 785      $ 67      $ (191   $ 2,349      $ 0      $ 2,349   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) 

Reflects the impact of adjustments to reconcile our total business segment results, which are presented on a managed basis, to our reported GAAP results. These adjustments primarily consist of: (i) the reclassification of finance charges, past due fees, other interest income and interest expense amounts included in non-interest income for management reporting purposes to net interest income for GAAP reporting purposes and (ii) the reclassification of net charge-offs included in non-interest income for management reporting purposes to the provision for loan and lease losses for GAAP reporting purposes.

 

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CAPITAL ONE FINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

Business Segment Loans and Deposits

The total loan and deposit amounts attributable to each of our reportable business segments as of September 30, 2011 and December 31, 2010 are presented in the following tables.

 

     September 30, 2011  
(Dollars in millions)    Credit
Card
     Consumer
Banking
     Commercial
Banking
     Other      Total
Reported
 

Loans held for investment

   $ 62,030       $ 35,352       $ 32,105       $ 465       $ 129,952   

Total deposits

     0         88,589         25,282         14,447         128,318   
     December 31, 2010  
(Dollars in millions)    Credit
Card
     Consumer
Banking
     Commercial
Banking
     Other      Total
Reported
 

Loans held for investment

   $ 61,371       $ 34,383       $ 29,742       $ 451       $ 125,947   

Total deposits

     0         82,959         22,630         16,621         122,210   

 

 

NOTE 15—COMMITMENTS, CONTINGENCIES AND GUARANTEES

 

Letters of Credit

We issue letters of credit (financial standby, performance standby and commercial) to meet the financing needs of our customers. Standby letters of credit are conditional commitments issued by us to guarantee the performance of a customer to a third party in a borrowing arrangement. Commercial letters of credit are short-term commitments issued primarily to facilitate trade finance activities for customers and are generally collateralized by the goods being shipped to the client. Collateral requirements are similar to those for funded transactions and are established based on management’s credit assessment of the customer. Management conducts regular reviews of all outstanding letters of credit and customer acceptances, and the results of these reviews are considered in assessing the adequacy of our allowance for loan and lease losses.

We had contractual amounts of standby letters of credit and commercial letters of credit of $984 million as of September 30, 2011 and $922 million as of December 31, 2010. These financial guarantees had expiration dates ranging from 2011 to 2016 as of September 30, 2011. The fair value of the guarantees outstanding which we include on our consolidated balance sheets in other liabilities was $4 million as of September 30, 2011.

Contingent Payments Related to Acquisitions and Partnership Agreements

Certain of our acquisition and partnership agreements include contingent payment provisions in which we agree to provide future payments, up to a maximum amount, based on certain performance criteria. Our contingent payment arrangements are generally based on the difference between the expected credit performance of specified loan portfolios as of the date of the applicable agreement and the actual future performance. To the extent that actual losses associated with these portfolios are less than the expected level, we agree to share a portion of the benefit with the counterparty. The maximum contingent payment amount related to our acquisitions totaled $330 million as of September 30, 2011. The actual payment amount related to $30 million of this balance will be determined as of September 30, 2012. The actual payment amount related to the remaining $300 million of this balance will be determined as of December 31, 2013. We recognized an expense related to contingent payment arrangements of $60 million and $90 million in the third quarter and first nine months of 2011, respectively, and recorded a corresponding liability. Our liability for contingent payments related to these arrangements totaled $90 million as of September 30, 2011. We did not record a liability related to these arrangements as of December 31, 2010 based on our expectation of credit losses on the portfolios.

 

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Potential Mortgage Representation & Warranty Liabilities

In recent years, we acquired three subsidiaries that originated residential mortgage loans and sold them to various purchasers, including purchasers who created securitization trusts. These subsidiaries are Capital One Home Loans, which was acquired in February 2005; GreenPoint Mortgage Funding, Inc. (“GreenPoint”), which was acquired in December 2006 as part of the North Fork acquisition; and Chevy Chase Bank, which was acquired in February 2009 and subsequently merged into CONA.

In connection with their sales of mortgage loans, the subsidiaries entered into agreements containing varying representations and warranties about, among other things, the ownership of the loan, the validity of the lien securing the loan, the loan’s compliance with any applicable loan criteria established by the purchaser, including underwriting guidelines and the ongoing existence of mortgage insurance, and the loan’s compliance with applicable federal, state and local laws. The representations and warranties do not address the credit performance of the mortgage loans, but mortgage loan performance often influences whether a claim for breach of representation and warranty will be asserted and has an effect on the amount of any loss in the event of a breach of a representation or warranty.

Each of these subsidiaries may be required to repurchase mortgage loans in the event of certain breaches of these representations and warranties. In the event of a repurchase, the subsidiary is typically required to pay the then unpaid principal balance of the loan together with interest and certain expenses (including, in certain cases, legal costs incurred by the purchaser and/or others). The subsidiary then recovers the loan or, if the loan has been foreclosed, the underlying collateral. The subsidiary is exposed to any losses on the repurchased loans after giving effect to any recoveries on the collateral. In some instances, rather than repurchase the loans, a subsidiary may agree to make a cash payment to make an investor whole on losses or to settle repurchase claims. In addition, our subsidiaries may be required to indemnify certain purchasers and others against losses they incur as a result of certain breaches of representations and warranties. In some cases, the amount of such losses could exceed the repurchase amount of the related loans.

These subsidiaries, in total, originated and sold to non-affiliates approximately $111 billion original principal balance of mortgage loans between 2005 and 2008, which are the years (or “vintages”) with respect to which our subsidiaries have received the vast majority of the repurchase requests and other related claims.

The following table presents the original principal balance of mortgage loan originations, by vintage, for the three general categories of purchasers of mortgage loans and the outstanding principal balance as of September 30, 2011 and December 31, 2010:

Unpaid Principal Balance of Mortgage Loans Originated and Sold to Third Parties Based on Category of Purchaser

 

     Unpaid Principal Balance                                     
     September 30,
2011
     December 31,
2010
     Original Unpaid Principal Balance  
(Dollars in billions)          Total      2008      2007      2006      2005  

Government sponsored enterprises (“GSEs”)(1)

   $ 5       $ 5       $ 11       $ 1       $ 4       $ 3       $ 3   

Insured Securitizations

     7         7         18         0         1         8         9   

Uninsured Securitizations and Other

     30         33         82         3         16         30         33   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 42       $ 45       $ 111       $ 4       $ 21       $ 41       $ 45   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) 

GSEs include Fannie Mae and Freddie Mac.

 

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Between 2005 and 2008, our subsidiaries sold an aggregate amount of $11 billion in original principal balance mortgage loans to the GSEs.

Of the $18 billion in original principal balance of mortgage loans sold directly by our subsidiaries to private-label purchasers who placed the loans into securitizations supported by bond insurance (“Insured Securitizations”), approximately $13 billion original principal balance was placed in securitizations as to which the monoline bond insurers have made repurchase requests or loan file requests to one of our subsidiaries (“Active Insured Securitizations”), and the remaining approximately $5 billion original principal balance was placed in securitizations as to which the monoline bond insurers have not made repurchase requests or loan file requests to one of our subsidiaries (“Inactive Insured Securitizations”). Insured Securitizations often allow the monoline bond insurer to act independently of the investors. Bond insurers typically have indemnity agreements directly with both the mortgage originators and the securitizers, and they often have super-majority rights within the trust documentation that allow them to direct trustees to pursue mortgage repurchase requests without coordination with other investors.

Because we do not service most of the loans our subsidiaries sold to others, we do not have complete information about the current ownership of the $82 billion in original principal balance of mortgage loans not sold directly to GSEs or placed in Insured Securitizations. We have determined based on information obtained from third-party databases that about $49 billion original principal balance of these mortgage loans are currently held by private-label publicly issued securitizations not supported by bond insurance (“Uninsured Securitizations”). In contrast with the bond insurers in Insured Securitizations, investors in Uninsured Securitizations often face a number of legal and logistical hurdles before they can direct a securitization trustee to pursue mortgage repurchases, including the need to coordinate with a certain percentage of investors holding the securities and to indemnify the trustee for any litigation it undertakes. An additional approximately $23 billion original principal balance of mortgage loans were initially sold to private investors as whole loans. Of this amount, we believe approximately $10 billion original principal balance of mortgage loans were ultimately purchased by GSEs. For purposes of our reserves-setting process, we consider these loans to be private-label loans rather than GSE loans. We do not have information about the current holders or disposition of the remaining $10 billion original principal balance of mortgage loans in this category.

With respect to the $111 billion in original principal balance of mortgage loans originated and sold to others between 2005 and 2008, we estimate that approximately $42 billion in unpaid principal balance remains outstanding as of September 30, 2011, approximately $14 billion in losses have been realized and approximately $11 billion in unpaid principal balance is at least 90 days delinquent. Because we do not service most of the loans we sold to others, we do not have complete information about the underlying credit performance levels for some of these mortgage loans. These amounts reflect our best estimates, including extrapolations where necessary. These extrapolations occur on the approximately $10 billion original principal balance of mortgage loans for which we do not have information about the current holders or any underlying credit performance. These estimates could change as we get additional data or refine our analysis.

The subsidiaries had open repurchase requests relating to approximately $1.9 billion original principal balance of mortgage loans as of September 30, 2011, compared with $1.7 billion as of June 30, 2011 and $1.6 billion as of December 31, 2010. As of September 30, 2011, the majority of new repurchase demands received over the last year and, as discussed below, the majority of our $892 million reserve relates to the $24 billion of original principal balance of mortgage loans originally sold to the GSEs or to Active Insured Securitizations. Currently, repurchase demands predominantly relate to the 2006 and 2007 vintages. We have received relatively few repurchase demands from the 2008 and 2009 vintages, mostly because GreenPoint ceased originating mortgages in August 2007.

 

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The following table presents information on pending repurchase requests by counterparty category and timing of initial repurchase request. The amounts presented are based on original loan principal balances.

Open Pipeline All Vintages (all entities)(1)

 

(Dollars in millions)    GSEs     Insured
Securitizations
    Uninsured
Securitizations
and Other
    Total  

Open claims as of December 31, 2009

   $ 61      $ 366      $ 588      $ 1,015   

Gross new demands received

     204        645        104        953   

Loans repurchased/made whole(2)

     (52     (179     (5     (236

Demands rescinded(2)

     (87     0        (22     (109
  

 

 

   

 

 

   

 

 

   

 

 

 

Open claims as of December 31, 2010

   $ 126      $ 832      $ 665      $ 1,623   

Gross new demands received

     142        171        102        415   

Loans repurchased/made whole

     (56     (15     (14     (85

Demands rescinded

     (65     0        (16     (81

Reclassifications(3)

     4        70        (74     0   
  

 

 

   

 

 

   

 

 

   

 

 

 

Open claims as of September 30, 2011

   $ 151      $ 1,058      $ 663      $ 1,872   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) 

The open pipeline includes all repurchase requests ever received by our subsidiaries where the requesting party has not formally rescinded the repurchase request and where our subsidiary has not agreed to either repurchase the loan at issue or make the requesting party whole with respect to its losses. Accordingly, repurchase requests denied by our subsidiaries and not pursued by the counterparty remain in the open pipeline. Moreover, repurchase requests submitted by parties without contractual standing to pursue repurchase requests are included within the open pipeline unless the requesting party has formally rescinded its repurchase request. Finally, the amounts reflected in this chart are original principal balance amounts and do not correspond to the losses our subsidiary would incur upon the repurchase of these loans.

(2) 

Activity in 2010 relates to repurchase demands from all years prior.

(3) 

Represents adjustments to correct the counterparty category as of September 30, 2011 for amounts that were misclassified. The reclassification had no impact on the total pending repurchase requests; however, it resulted in an increase in open claims attributable to insured securitizations and a decrease in open claims attributable to GSEs and Uninsured Securitizations & Other.

We have established representation and warranty reserves for losses associated with the mortgage loans sold by each subsidiary that we consider to be both probable and reasonably estimable, including both litigation and non-litigation liabilities. These reserves are reported in our consolidated balance sheets as a component of other liabilities. The reserve setting process relies heavily on estimates, which are inherently uncertain, and requires the application of judgment. We evaluate these estimates on a quarterly basis. We build our representation and warranty reserves through the provision for repurchase losses, which we report in our consolidated statements of income as a component of non-interest income for loans originated and sold by Chevy Chase Bank and Capital One Home Loans and as a component of discontinued operations for loans originated and sold by GreenPoint. In establishing the representation and warranty reserves, we consider a variety of factors depending on the category of purchaser.

In establishing reserves for the $11 billion original principal balance of GSE loans, we rely on the historical relationship between GSE loan losses and repurchase outcomes to estimate: (1) the percentage of current and future GSE loan defaults that we anticipate will result in repurchase requests from the GSEs over the lifetime of the GSE loans; and (2) the percentage of those repurchase requests that we anticipate will result in actual repurchases. We also rely on estimated collateral valuations and loss forecast models to estimate our lifetime

 

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liability on GSE loans. This reserving approach to the GSE loans reflects the historical interaction with the GSEs around repurchase requests, and also includes anticipated repurchases resulting from mortgage insurance rescissions. The GSEs typically have stronger contractual rights than non-GSE counterparties because GSE contracts typically do not contain prompt notice requirements for repurchase requests or materiality qualifications to the representations and warranties. Moreover, although we often disagree with the GSEs about the validity of their repurchase requests, we have established a negotiation pattern whereby the GSEs and our subsidiaries continually negotiate around individual repurchase requests, leading to the GSEs rescinding some repurchase requests and our subsidiaries agreeing in some cases to repurchase some loans or make the GSEs whole with respect to losses. Our lifetime representation and warranty reserves with respect to GSE loans are grounded in this history.

For the $13 billion original principal balance in Active Insured Securitizations, our reserving approach also reflects our historical interaction with monoline bond insurers around repurchase requests. Typically, monoline bond insurers allege a very high repurchase rate with respect to the mortgage loans in the Active Insured Securitization category. In response to these repurchase requests, our subsidiaries typically request information from the monoline bond insurers demonstrating that the contractual requirements around a valid repurchase request have been satisfied, such as, for example, the typical requirements that the counterparty promptly notify us upon discovery of any breach and that any breach materially and adversely affect the value of the mortgage loan at issue. In response to these requests for supporting documentation, monoline bond insurers typically initiate litigation. Accordingly, our reserves within the Active Insured Securitization are not based upon the historical repurchase rate with monoline bond insurers, but rather upon the expected resolution of litigation with the monoline bond insurers. Every bond insurer within this category is pursuing a substantially similar litigation strategy either through active or probable litigation. Accordingly, our representation and warranty reserves for this category are litigation reserves. In establishing litigation reserves for this category, we consider current and future losses inherent within the securitization and apply legal judgment to the anticipated factual and legal record to estimate the lifetime legal liability for each securitization. Our estimated legal liability for each securitization within this category assumes that we will be responsible for only a portion of the losses inherent in each securitization. Our litigation reserves with respect to both the U.S. Bank Litigation and the DBSP Litigation, in each case as referenced below, are contained within the Active Insured Securitization reserve category. Further, our litigation reserves with respect to indemnification risks from certain representation and warranty lawsuits brought by monoline bond insurers against third-party securitizations sponsors, where GreenPoint provided some or all of the mortgage collateral within the securitization but is not a defendant in the litigation, are also contained within this category. Our estimated legal liability for securitizations within this category often assumes we will pay only a portion of the liabilities ultimately incurred by the party defendants to the litigation.

For the $5 billion original principal balance of mortgage loans in the Inactive Insured Securitizations category and the $82 billion original principal balance of mortgage loans in the Uninsured Securitizations and other whole loan sales categories, we establish reserves by relying on our historical repurchase rates and current negotiation patterns to estimate repurchase liabilities over the next twelve (12) months. We do not believe we can estimate repurchase liability for these categories for a period longer than twelve (12) months because of the relatively irregular nature of repurchase activity within these categories. Some Uninsured Securitization investors from this category who have not made repurchase requests or filed representation and warranty lawsuits have filed actions under federal and/or state securities laws against investment banks and securitization sponsors. Although we face some direct and indirect indemnity risks from these litigations, we have not established reserves with respect to these indemnity risks because we do not consider them to be both probable and reasonably estimable liabilities.

The aggregate reserve for all three subsidiaries was $892 million as of September 30, 2011, compared with $869 million as of June 30, 2011, and $816 million as of December 31, 2010. Almost all of the increase in the reserve from June 30, 2011 is allocated to the Uninsured Securitizations and Other category, resulting from an increase

 

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in repurchase activity with respect to certain uninsured investors. We recorded a total provision for repurchase losses for our representation and warranty repurchase exposure of $72 million and $153 million for the three and nine months ended September 30, 2011, respectively, and we had settlements of repurchase requests of $49 million and $77 million for the three and nine months ended September 30, 2011, respectively, that were charged against the reserve.

The following table summarizes changes in our representation and warranty reserve for the three and nine months ended September 30, 2011 and 2010, and for full year 2010:

Changes in Representation and Warranty Reserve

 

     Three Months  Ended
September 30,
    Nine Months  Ended
September 30,
    Full Year  
(Dollars in millions)      2011         2010         2011         2010       2010  

Representation and warranty repurchase reserve, beginning of period(1)

   $ 869      $ 853      $ 816      $ 238      $ 238   

Provision for repurchase losses(2)

     72        16        153        644        636   

Net realized losses

     (49     (33     (77     (46     (58
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Representation and warranty repurchase reserve, end of period(1)

   $ 892      $ 836      $ 892      $ 836      $ 816   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) 

Reported in our consolidated balance sheets as a component of other liabilities.

(2) 

In the third quarter of 2011, we recognized a reduction to the reserve for mortgage repurchase claims of $3 million in our consolidated statements of income as a component of non-interest income. In the first nine months of 2011, we recognized a provision for mortgage repurchase claims of $5 million. In the third quarter and first nine months of 2010, we recognized a provision for mortgage repurchase claims of $16 million and $211 million, respectively. The pre-tax portion of the provision for mortgage repurchase claims recognized in our consolidated statements of income as a component of discontinued operations totaled $75 million and $147 million, for the three and nine months ended September 30, 2011, respectively, and $0 million and $433 million for the three and nine months ended September 30, 2010, respectively.

As indicated in the table below, most of the representation and warranty reserve relates to the $11 billion in original principal balance of mortgage loans sold directly to the GSEs and to the $13 billion in mortgage loans sold to purchasers who placed them into Active Insured Securitizations.

Allocation of Representation and Warranty Reserve

 

    Reserve Liability        
(Dollars in millions, except for loans sold)   September  30,
2011
    December  31,
2010
    Loans Sold
2005 to  2008(1)
 

GSEs and Active Insured Securitizations

  $ 771      $ 796      $ 24   

Inactive Insured Securitizations, Uninsured Securitizations and Other

    121        20        87   
 

 

 

   

 

 

   

 

 

 

Total

  $ 892      $ 816      $ 111   
 

 

 

   

 

 

   

 

 

 

 

(1) 

Reflects, in billions, the total original principal balance of mortgage loans originated by our subsidiaries and sold to third party investors between 2005 and 2008.

The adequacy of the reserves and the ultimate amount of losses incurred by our subsidiaries will depend on, among other things, actual future mortgage loan performance, the actual level of future repurchase and

 

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indemnification requests (including the extent, if any, to which Inactive Insured Securitizations and other currently inactive investors ultimately assert claims), the actual success rates of claimants, developments in litigation, actual recoveries on the collateral and macroeconomic conditions (including unemployment levels and housing prices).

As part of our business planning processes, we have considered various outcomes relating to the potential future representation and warranty liabilities of our subsidiaries that are possible but do not rise to the level of being both probable and reasonably estimable outcomes that would justify an incremental accrual under applicable accounting standards. We believe that the upper end of the reasonably possible future losses from representation and warranty claims beyond the current accrual levels, including reasonably possible future losses relating to the US Bank Litigation, DBSP Litigation and the FHLB of Boston Litigation, could be as high as $1.5 billion, an increase of $400 million from the estimate we provided as of the June 30, 2011. This increase is attributable to increased activity from uninsured investors, increased governmental and regulatory scrutiny of mortgage practices and continued difficulty in the housing market and overall economy. Notwithstanding our ongoing attempts to estimate a reasonably possible amount of loss beyond our current accrual levels based on current information, it is possible that actual future losses will exceed both the current accrual level and our current estimated upper-end of the amount of reasonably possible losses. There is still significant uncertainty regarding the numerous factors that may impact the ultimate loss levels, including, but not limited to, litigation outcomes, future repurchase claims levels, ultimate repurchase success rates and mortgage loan performance levels.

Litigation

In accordance with the current accounting standards for loss contingencies, we establish reserves for litigation related matters when it is probable that a loss associated with a claim or proceeding has been incurred and the amount of the loss can be reasonably estimated. Litigation claims and proceedings of all types are subject to many uncertain factors that generally cannot be predicted with assurance. Below we provide a description of material legal proceedings and claims.

For some of the matters disclosed below, we are able to determine estimates of potential future outcomes that are not probable and reasonably estimable outcomes justifying either the establishment of a reserve or an incremental reserve build, but which are reasonably possible outcomes. For other disclosed matters, such an estimate is not possible at this time. For those matters where an estimate is possible, excluding the reasonably possible future losses relating to the U.S. Bank Litigation, the DBSP Litigation, and the FHLB of Boston Litigation because reasonably possible losses with respect to those litigations are included within the range of reasonably possible representation and warranty liabilities discussed above, management currently estimates the aggregate high end of the range of possible loss is $75 million to $225 million. Notwithstanding our attempt to estimate a reasonably possible range of loss beyond our current accrual levels for some litigation matters based on current information, it is possible that actual future losses will exceed both the current accrual level and the range of reasonably possible losses disclosed here. Given the inherent uncertainties involved in these matters, and the very large or indeterminate damages sought in some of these matters, there is significant uncertainty as to the ultimate liability we may incur from these litigation matters and an adverse outcome in one or more of these matters could be material to our results of operations or cash flows for any particular reporting period.

Interchange Litigation

In 2005, a number of entities, each purporting to represent a class of retail merchants, filed antitrust lawsuits (the “Interchange Lawsuits”) against MasterCard and Visa and several member banks, including our subsidiaries and us, alleging among other things, that the defendants conspired to fix the level of interchange fees. The complaints

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

seek injunctive relief and civil monetary damages, which could be trebled. Separately, a number of large merchants have asserted similar claims against Visa and MasterCard only. In October 2005, the class and merchant Interchange Lawsuits were consolidated before the U.S. District Court for the Eastern District of New York for certain purposes, including discovery. Fact and expert discovery have closed. The parties have briefed and presented oral argument on motions to dismiss and class certification and are awaiting decisions from the court. The parties have also filed motions for summary judgment and will present oral argument before the court in the fourth quarter of 2011.

The defendant banks are members of Visa U.S.A., Inc. (“Visa”). As members, our subsidiary banks have indemnification obligations to Visa with respect to final judgments and settlements of certain litigation against Visa. In the first quarter of 2008, Visa completed an IPO of its stock. With IPO proceeds, Visa established an escrow account for the benefit of member banks to fund certain litigation settlements and claims, including the Interchange Lawsuits. As a result, in the first quarter of 2008, we reduced our Visa-related indemnification liabilities of $91 million recorded in other liabilities with a corresponding reduction of other non-interest expense. We made an election in accordance with the accounting guidance for fair value option for financial assets and liabilities on the indemnification guarantee to Visa, and the fair value of the guarantee at December 31, 2010 and September 30, 2011 was zero. In January 2011, we entered into a MasterCard Settlement and Judgment Sharing Agreement, along with other defendant banks, which apportions between MasterCard and its member banks any costs and liabilities of any judgment or settlement arising from the Interchange Lawsuits.

In March 2011, a furniture store owner, on behalf of himself and other merchants who accept Visa and MasterCard branded credit cards, filed a class action in the Supreme Court of British Columbia (Vancouver Registry) against the Visa and MasterCard membership associations related to credit card interchange fees. In May 2011, another merchant, on behalf of himself and other merchants who accept Visa and MasterCard branded credit cards, filed a class action in the Ontario Superior Court of Justice (Toronto Region) asserting the same alleged violations of law related to credit card interchange fees and network rules. Both class actions name Visa and MasterCard and a number of member banks, including Capital One Financial Corporation, which only issues MasterCard branded credit cards in Canada. The class action complaints allege that the associations and member banks are liable for civil conspiracy, unjust enrichment, constructive trust and unlawful interference with economic interests and violated Canadian anti-competition laws by (a) conspiring to fix supra-competitive interchange fees and merchant discounts, and (b) requiring participation in the respective networks and adherence to Visa and MasterCard Rules to acceptance of payment guarantee services.

Late Fees Litigation

In 2007, a number of individual plaintiffs, each purporting to represent a class of cardholders, filed antitrust lawsuits in the U.S. District Court for the Northern District of California against several issuing banks, including us. These lawsuits allege, among other things, that the defendants conspired to fix the level of late fees and over-limit fees charged to cardholders, and that these fees are excessive. In May 2007, the cases were consolidated for all purposes, and a consolidated amended complaint was filed alleging violations of federal statutes and state law. The amended complaint requests civil monetary damages, which could be trebled, and injunctive relief. In November 2007, the court dismissed the amended complaint. Plaintiffs appealed that order to the Ninth Circuit Court of Appeals. The plaintiffs’ appeal challenges the dismissal of their claims under the National Bank Act, the Depository Institutions Deregulation Act of 1980 and the California Unfair Competition Law (the “UCL”), but not their antitrust conspiracy claims. In June 2009, the Ninth Circuit Court of Appeals stayed the matter pending the bankruptcy proceedings of one of the defendant financial institutions. In August 2011, the Ninth Circuit Court of Appeals entered an additional order continuing the stay of the matter pending the bankruptcy proceedings.

 

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Credit Card Interest Rate Litigation

In July 2010, the U.S. Court of Appeals for the Ninth Circuit reversed a dismissal entered in favor of COBNA in Rubio v. Capital One Bank, which was filed in the U.S. District Court for the Central District of California in 2007. The plaintiff in Rubio alleges in a putative class action that COBNA breached its contractual obligations and violated the Truth In Lending Act (the “TILA”) and the UCL when it raised interest rates on certain credit card accounts. The plaintiff seeks damages, restitution, attorney’s fees and an injunction against future rate increases. The District Court granted COBNA’s motion to dismiss all claims as a matter of law prior to any discovery. On appeal, the Ninth Circuit reversed the District Court’s dismissal with respect to the TILA and UCL claims, remanding the case back to the District Court for further proceedings. The Ninth Circuit upheld the dismissal of the plaintiff’s breach of contract claim, finding that COBNA was contractually allowed to increase interest rates. In September 2010, the Ninth Circuit denied COBNA’s Petition for Panel Rehearing and Rehearing En Banc. In January 2011, COBNA filed a writ of certiorari with the United States Supreme Court, seeking leave to appeal the Ninth Circuit’s ruling. On April 4, 2011, the United States Supreme Court denied Capital One’s writ of certiorari, and as a result, the Ninth Circuit remanded the case back to the District Court to begin discovery.

The Capital One Bank Credit Card Interest Rate Multi-district Litigation matter involves similar issues as Rubio. This multi-district litigation matter was created as a result of a June 2010 transfer order issued by the United States Judicial Panel on Multi-district Litigation (“MDL”), which consolidated for pretrial proceedings in the U.S. District Court for the Northern District of Georgia two pending putative class actions against COBNA — Nancy Mancuso, et al. v. Capital One Bank (USA), N.A., et al., (E.D. Virginia); and Kevin S. Barker, et al. v. Capital One Bank (USA), N.A., (N.D. Georgia), A third action, Jennifer L. Kolkowski v. Capital One Bank (USA), N.A., (C.D. California) was subsequently transferred into the MDL. On August 2, 2010, the plaintiffs in the MDL filed a Consolidated Amended Complaint. The Consolidated Amended Complaint alleges in a putative class action that COBNA breached its contractual obligations, and violated the TILA, the California Consumers Legal Remedies Act, the UCL, the California False Advertising Act, the New Jersey Consumer Fraud Act, and the Kansas Consumer Protection Act when it raised interest rates on certain credit card accounts. The MDL plaintiffs seek statutory damages, restitution, attorney’s fees and an injunction against future rate increases. Fact discovery is now closed. On August 8, 2011, Capital One filed a motion for summary judgment.

West Virginia Attorney General Litigation

In January 2010, the West Virginia Attorney General filed suit against COBNA and various affiliates in Mason County, West Virginia, challenging numerous credit card practices under the West Virginia Consumer Credit and Protection Act. The West Virginia Attorney General seeks injunctive relief, consumer refunds, statutory damages, disgorgement, and attorneys’ fees. COBNA removed the case to the U.S. District Court for the Southern District of West Virginia and filed a motion to dismiss the complaint. In July 2010, the U.S. District Court for the Southern District of West Virginia remanded the case back to Mason County Circuit Court and denied the motion to dismiss as moot. In August 2010, we filed a motion to dismiss and a motion to stay discovery pending resolution of the motion to dismiss. In April 2011, the Court denied our motion to dismiss and scheduled a bench trial to begin on December 6, 2011. On July 20, 2011, COBNA removed the case again to the U.S. District Court for the Southern District of West Virginia. The plaintiff filed a motion to remand the matter to state court. On August 12, 2011, the district court issued an order remanding the matter back to Mason County Circuit Court.

Mortgage Repurchase Litigation

On February 5, 2009, GreenPoint was named as a defendant in a lawsuit commenced in the Supreme Court of the State of New York, New York County, by U.S. Bank National Association, Syncora Guarantee Inc. (formerly

 

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known as XL Capital Assurance Inc.) and CIFG Assurance North America, Inc. (the “U.S. Bank Litigation”). Plaintiffs allege, among other things, that GreenPoint breached certain representations and warranties in two contracts pursuant to which GreenPoint sold approximately 30,000 mortgage loans having an aggregate original principal balance of approximately $1.8 billion to a purchaser that ultimately transferred most of these mortgage loans to a securitization trust. Some of the securities issued by the trust were insured by two of the plaintiffs. Plaintiffs have alleged breaches of representations and warranties with respect to certain specific mortgage loans. Plaintiffs seek unspecified damages and an order compelling GreenPoint to repurchase the entire portfolio of 30,000 mortgage loans based on alleged breaches of representations and warranties relating to a limited sampling of loans in the portfolio, or, alternatively, the repurchase of specific mortgage loans to which the alleged breaches of representations and warranties relate. On March 3, 2010, the Court granted GreenPoint’s motion to dismiss with respect to plaintiffs Syncora and CIFG and denied the motion with respect to U.S. Bank. In March 2010, GreenPoint answered the complaint with respect to U.S. Bank, denying the allegations, and filed a counterclaim against U.S. Bank alleging breach of covenant of good faith and fair dealing. In April 2010, plaintiffs U.S. Bank, Syncora, and CIFG filed an amended complaint seeking, among other things, the repurchase remedies described above and indemnification for losses suffered by Syncora and CIFG. GreenPoint filed a motion to dismiss the amended complaint. On January 6, 2011, the Court instructed plaintiffs to seek leave of court to file an amended complaint supported by an evidentiary showing of merit. Plaintiffs filed their motion for leave in June 2011, which is currently expected to be argued in the fourth quarter of 2011. As noted above, GreenPoint has established reserves with respect to its probable and reasonably estimable legal liability from the U.S. Bank Lawsuit, which reserves are included within the overall representation and warranty reserve. Also as noted above, GreenPoint has exposure to loss in excess of the amount established within the overall representation and warranty reserve because GreenPoint has not established reserves with respect to the portfolio-wide repurchase claim on the basis that the claim is not considered probable and reasonably estimable. In the event GreenPoint is obligated to repurchase all 30,000 mortgage loans under the portfolio-wide repurchase claim, GreenPoint would incur the current and future economic losses inherent in the portfolio. With respect to the mortgage loan portfolio at issue in the U.S. Bank Litigation, we believe approximately $824 million of losses have been realized and approximately $330 million in mortgage loans are still outstanding, of which approximately $43 million are more than 90 days delinquent, including foreclosures and REO.

In September 2010, DB Structured Products, Inc. (“DBSP”) named GreenPoint in a third-party complaint, filed in the New York County Supreme Court, alleging breach of contract and seeking indemnification (the “DBSP Litigation”). In the underlying suit, Assured Guaranty Municipal Corp. (“AGM”) sued DBSP for alleged breaches of representations and warranties made by DBSP with respect to certain residential mortgage loans that collateralize a securitization insured by AGM and sponsored by DBSP (the “Underlying Lawsuit”). DBSP purchased the HELOC loans from GreenPoint in 2006. The entire securitization is comprised of about 6,200 mortgage loans with an aggregate original principal balance of approximately $353 million. DBSP asserts that any liability it faces lies with GreenPoint, alleging that DBSP’s representations and warranties to AGM are substantially similar to the representations and warranties made by GreenPoint to DBSP. GreenPoint filed a motion to dismiss the complaint in October 2010, which the court denied on July 25, 2011. The parties are currently engaged in discovery. As noted above, GreenPoint has established reserves with respect to its estimated probable and reasonable estimable legal liability from the DBSP Litigation, which reserves are included within the overall representation and warranty reserve. Also as noted above, GreenPoint has not established a reserve with respect to any portfolio-wide repurchase claim, but in the event GreenPoint is obligated to indemnify DBSP for the repurchase of all 6,200 mortgage loans, GreenPoint would incur the current and future economic losses inherent in the securitization. With respect to these loans, we believe approximately $144 million of losses have been realized and approximately $52 million in mortgage loans are still outstanding, of which approximately $4 million are more than 90 days delinquent, including foreclosures and REO.

 

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SEC Investigation

Since July 2009, we have been providing documents and information in response to an inquiry by the Staff of the SEC. In the first quarter of 2010, the SEC issued a formal order of investigation with respect to this inquiry. Although the order, as is generally customary, authorizes a broader inquiry by the Staff, we believe that the investigation is focused largely on our method of determining the loan loss reserves for our auto finance business for certain quarterly periods in 2007. We are cooperating fully with the Staff’s investigation.

Checking Account Overdraft Litigation

In May 2010, Capital One Financial Corporation and COBNA were named as defendants in a putative class action named Steen v. Capital One Financial Corporation, et al., filed in the U.S. District Court for the Eastern District of Louisiana. Plaintiff challenges our practices relating to fees for overdraft and non-sufficient funds fees on consumer checking accounts. Plaintiff alleges that our methodology for posting transactions to customer accounts is designed to maximize the generation of overdraft fees, supporting claims for breach of contract, breach of the covenant of good faith and fair dealing, unconscionability, conversion, unjust enrichment and violations of state unfair trade practices laws. Plaintiff seeks a range of remedies, including restitution, disgorgement, injunctive relief, punitive damages and attorneys’ fees. In May 2010, the case was transferred to the Southern District of Florida for coordinated pre-trial proceedings as part of a multi-district litigation (MDL) involving numerous defendant banks, In re Checking Account Overdraft Litigation. In January 2011, plaintiffs filed a second amended complaint against CONA in the MDL court. In February 2011, CONA filed a motion to dismiss the second amended complaint. On March 21, 2011, the MDL court granted the motion to dismiss claims of breach of the covenant of good faith and fair dealing under Texas law, but denied the motion to dismiss in all other respects. On April 18, 2011, CONA moved for reconsideration of those portions of the court’s ruling denying its motion to dismiss, and on June 7, 2011, CONA moved for certification of an interlocutory appeal. The MDL court denied the motion to reconsider on June 23, 2011, and denied the motion for interlocutory appeal on July 13, 2011. The parties are now engaged in discovery.

Patent Litigation

On February 23, 2011, Capital One Financial Corporation, Capital One, N.A., and Capital One Bank (USA), N.A. (collectively, “Capital One”), were named as defendants, along with several other banks, in a patent infringement lawsuit filed by DataTreasury Corporation (“DataTreasury”) in the United States District Court for the Eastern District of Texas. DataTreasury alleges that Capital One and the other banks willfully infringed certain patents relating to remote image capture with centralized processing and storage. Capital One was served with the complaint on April 5, 2011, and filed an answer on May 26, 2011. On August 30, 2011, Capital One joined other defendants in filing a Motion to Transfer Venue from the U.S. District Court for the Eastern District of Texas, Tyler Division to the Southern District of Texas, Houston Division. That motion is currently pending.

FHLB Securities Litigation

On April 20, 2011, the Federal Home Loan Bank of Boston (the “FHLB of Boston”) filed suit against dozens of mortgage industry participants in Massachusetts Superior Court, alleging, among other things, violations of Massachusetts state securities laws in the sale and marketing of certain residential mortgage-backed securities (the “FHLB of Boston Litigation”). Capital One Financial Corporation and Capital One, National Association are named in the complaint as alleged successors in interest to Chevy Chase Bank, which allegedly marketed some of the mortgage-backed securities at issue in the litigation. The FHLB of Boston seeks rescission, unspecified damages, attorneys’ fees, and other unspecified relief. The case was removed to the United States District Court for the District of Massachusetts in May 2011, and plaintiff subsequently filed a motion to remand the matter to state court.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

Tax Matters

On September 21, 2009, the U.S. Tax Court issued a decision in the case Capital One Financial Corporation and Subsidiaries v. Commissioner covering tax years 1995-1999, with both parties prevailing on certain issues. On July 6, 2010, we filed a motion to appeal certain issues upon which the IRS prevailed. The IRS chose not to appeal the issues upon which we prevailed resulting in a final resolution of those issues favorable to us. On October 21, 2011, the Fourth Circuit Court of Appeals affirmed the Tax Court’s unfavorable decision on the issues we appealed. As we do not intend to pursue further appeals on these issues, the Fourth Circuit’s decision represents a final resolution of the remaining issues in the case. We have accounted for these matters in accordance with the accounting guidance for income taxes, and the resolution of these matters will not have a material effect on our financial position.

Other Pending and Threatened Litigation

In addition, we are commonly subject to various pending and threatened legal actions relating to the conduct of our normal business activities. In the opinion of management, the ultimate aggregate liability, if any, arising out of all such other pending or threatened legal actions will not be material to our consolidated financial position or our results of operations.

Pending Acquisitions

ING Direct

In June 2011, we announced that we entered into a definitive agreement under which we will acquire ING Direct, in exchange for $6.2 billion in cash and approximately 55.9 million shares of our common stock, subject to certain adjustments. We continue to expect the ING Direct acquisition to close in late 2011 or early 2012, subject to customary closing conditions, including certain governmental clearances and approvals.

In the third quarter of 2011, we closed a public underwritten offering of our senior notes, from which we received total proceeds of approximately $3.0 billion, and a public underwritten offering of 40 million shares of our common stock at a price per share of $50.00, subject to forward sale agreements. After underwriter’s discounts and commissions, the net proceeds to us from the equity offering will be at an initial forward sale price per share of $48.50. The forward sale price is subject to adjustment under the forward sale agreements. We have not received any proceeds from this public offering of our shares of common stock as of September 30, 2011. Under the terms of the forward sale agreements, we must settle the forward sale agreements on or before February 15, 2012. We expect to settle the forward sale agreements entirely by physical delivery of shares of common stock in exchange for cash proceeds from the forward purchasers of approximately $1.9 billion, based on the initial forward price. However, we may, subject to certain conditions, elect cash or net share settlement of all or a portion of our obligation to deliver shares of common stock. We expect to use the net proceeds from the debt and equity offerings, along with cash sourced from our current liquidity, to fund the $6.2 billion in cash consideration payable in connection with the ING Direct acquisition.

HSBC U.S. Credit Card Business

In August 2011, we announced that we entered into a purchase agreement to acquire substantially all of the assets and assume liabilities of HSBC’s credit card and private-label credit card business in the United States for a premium estimated at $2.6 billion as of June 30, 2011. We currently expect the HSBC acquisition to close in the second quarter of 2012, subject to customary closing conditions, including certain governmental clearances and approvals. Pursuant to the purchase agreement, we have the option, subject to certain conditions, to pay up to $750 million of the consideration to HSBC in the form of our common stock (valued at $39.23 per share).

 

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Item 3. Quantitative and Qualitative Disclosures about Market Risk

For a discussion of the quantitative and qualitative disclosures about market risk, see “Part I—Item 2. MD&A—Market Risk Management.”

Item 4. Controls and Procedures

Overview

We are required under applicable laws and regulations to maintain controls and procedures, which include disclosure controls and procedures as well as internal control over financial reporting, as further described below.

(a) Disclosure Controls and Procedures

Disclosure Controls and Procedures

Disclosure controls and procedures refer to controls and other procedures designed to provide reasonable assurance that information required to be disclosed in our financial reports is recorded, processed, summarized and reported within the time periods specified by SEC rules and forms and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding our required disclosure. In designing and evaluating our disclosure controls and procedures, we recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and we must apply judgment in evaluating and implementing possible controls and procedures.

Evaluation of Disclosure Controls and Procedures

As required by Rule 13a-15 of the Securities Exchange Act of 1934 (the “Exchange Act”), our management, including the Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures (as that term is defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) as of September 30, 2011, the end of the period covered by this Report. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of September 30, 2011, at a reasonable level of assurance, in recording, processing, summarizing and reporting information required to be disclosed within the time periods specified by the SEC rules and forms.

(b) Changes in Internal Control Over Financial Reporting

We regularly review our disclosure controls and procedures and make changes intended to ensure the quality of our financial reporting. There were no changes in internal control over financial reporting that occurred in the third quarter of 2011 that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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PART II—OTHER INFORMATION

Item 1. Legal Proceedings

The information required by Item 1 is included in “Notes to the Consolidated Financial Statements—Note 15— Commitments, Contingencies and Guarantees.”

Item 1A. Risk Factors

We are not aware of any material changes from the risk factors set forth under “Part I—Item 1A. Risk Factors” in our 2010 Form 10-K and the risk factors set forth in Exhibit 99.5 to our Current Report on Form 8-K filed on July 13, 2011.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

The following table shows shares of our common stock we repurchased during the third quarter of 2011:

 

(Dollars in millions, except per share information)    Total
Number

of
Shares
Purchased(1)
     Average
Price Paid
per Share
     Total Number of
Shares Purchased as
Part of Publicly
Announced

Plans
     Maximum
Amount That May
Yet be Purchased
Under the Plan
or Program
 

July 1-31, 2011

     16,861       $ 49.39         —         $ —     

August 1-31, 2011

     —           —           —           —     

September 1-30, 2011

     23,260         42.33         —           —     
  

 

 

       

 

 

    

Total

     40,121         45.30         —           —     
  

 

 

       

 

 

    

 

(1)

Shares purchased represent shares purchased and share swaps made in connection with stock option exercises and the withholding of shares to cover taxes on restricted stock lapses.

Item 3. Defaults upon Senior Securities

None.

Item 5. Other Information

None.

Item 6. Exhibits

An index to exhibits has been filed as part of this report beginning on page 164 and is incorporated herein by reference.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

       

CAPITAL ONE FINANCIAL CORPORATION

(Registrant)

Date: November 7, 2011

    By:  

/S/ GARY L. PERLIN

     

Gary L. Perlin

Chief Financial Officer

 

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INDEX TO EXHIBITS

The following exhibits are incorporated by reference or filed herewith. References to (i) the “2003 Form 10-K” are to the Company’s Annual Report on Form 10-K for the year ended December 31, 2003, filed on March 5, 2004; (ii) the “2004 Form 10-K” are to the Company’s Annual Report on Form 10-K for the year ended December 31, 2004, filed on March 9, 2005; (iii) the “2008 Form 10-K” are to the Company’s Annual Report on Form 10-K for the year Ended December 31, 2008, filed on February 26, 2009; and (iv) the “2009 Form 10-K” are to the Company’s Annual Report on Form 10-K for the year Ended December 31, 2009, filed on February 26, 2010.

 

Exhibit No.

  

Description

    2.1          Stock Purchase Agreement, dated as of December 3, 2008, by and among Capital One Financial Corporation, B.F. Saul Real Estate Investment Trust, Derwood Investment Corporation, and B.F. Saul Company Employees’ Profit Sharing and Retirement Trust (incorporated by reference to Exhibit 2.4 of the 2008 Form 10-K).
    2.2          Purchase and Sale Agreement, dated as of June 16, 2011, by and among Capital One Financial Corporation, ING Groep N.V., ING Bank N.V., ING Direct N.V. and ING Direct Bancorp (incorporated by reference to Exhibit 2.1 of the Company’s Report on Form-8-K, filed on June 22, 2011).
    2.3          Purchase and Assumption Agreement, dated as of August 10, 2011, by and among HSBC Finance Corporation, HSBC USA Inc., HSBC Technology and Services (USA) Inc. and Capital One Financial Corporation (incorporated by reference to Exhibit 2.1 of the Company’s Report on Form-8-K, filed on August 12, 2011).
    3.1          Restated Certificate of Incorporation of Capital One Financial Corporation, (as amended and restated May 16, 2011 (incorporated by reference to Exhibit 3.4 of the Company’s Report on Form 8-K, filed on May 17, 2011).
    3.2          Amended and Restated Bylaws of Capital One Financial Corporation (incorporated by reference to Exhibit 3.3 of the Company’s Report on Form 8-K, filed on May 17, 2011).
    4.1.1      Specimen certificate representing the Common Stock (incorporated by reference to Exhibit 4.1 of the 2003 Form 10-K).
    4.1.2      Warrant Agreement, dated December 3, 2009, between Capital One Financial Corporation and Computershare Trust Company, N.A. (incorporated herein by reference to the Exhibit 4.1 of the Company’s Form 8-A filed on December 4, 2009).
    4.2.1      Senior Indenture dated as of November 1, 1996 between Capital One Financial Corporation and The Bank of New York Mellon Trust Company, N.A., formerly known as The Bank of New York Trust Company, N.A. (as successor to Harris Trust and Savings Bank), as trustee (incorporated by reference to Exhibit 4.1 of the Company’s Report on Form 8-K, filed on November 13, 1996).
    4.2.2      Copy of 6.25% Senior Notes, due 2013, of Capital One Financial Corporation (incorporated by reference to Exhibit 4.5.5 of the 2003 Form 10-K).
    4.2.3      Copy of 5.25% Senior Notes, due 2017, of Capital One Financial Corporation (incorporated by reference to Exhibit 4.5.6 of the 2004 Form 10-K).
    4.2.4      Copy of 4.80% Senior Notes, due 2012, of Capital One Financial Corporation (incorporated by reference to Exhibit 4.5.7 of the 2004 Form 10-K).
    4.2.5      Copy of 5.50% Senior Notes, due 2015, of Capital One Financial Corporation (incorporated by reference to Exhibit 4.1 of the Company’s Quarterly Report on Form 10-Q for the period ending September 30, 2005).

 

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Exhibit No.

  

Description

    4.2.6      Specimen of 5.70% Senior Note, due 2011, of Capital One Financial Corporation (incorporated by reference to Exhibit 4.2 of the Company’s Report on Form 8-K, filed on September 18, 2006).
    4.2.7      Specimen of 6.750% Senior Note, due 2017, of Capital One Financial Corporation (incorporated by reference to Exhibit 4.1 of the Company’s Report on Form 8-K, filed on September 5, 2007).
    4.2.8      Specimen of 7.375% Senior Note, due 2014, of Capital One Financial Corporation (incorporated by reference to Exhibit 4.1 of the Company’s Report on Form 8-K, filed on May 22, 2009).
    4.2.8      Specimen of Floating Rate Senior Note due 2014, of Capital One Financial Corporation (incorporated by reference to Exhibit 4.3 of the Company’s Report on Form 8-K, filed on July 19, 2011).
    4.2.9      Specimen of 2.125% Senior Note due 2014, of Capital One Financial Corporation (incorporated by reference to Exhibit 4.4 of the Company’s Report on Form 8-K, filed on July 19, 2011).
    4.2.10    Specimen of 3.150% Senior Note due 2016, of Capital One Financial Corporation (incorporated by reference to Exhibit 4.5 of the Company’s Report on Form 8-K, filed on July 19, 2011).
    4.2.11    Specimen of 4.750% Senior Note due 2021, of Capital One Financial Corporation (incorporated by reference to Exhibit 4.6 of the Company’s Report on Form 8-K, filed on July 19, 2011).
    4.3        Indenture (providing for the issuance of Junior Subordinated Debt Securities), dated as of June 6, 2006, between Capital One Financial Corporation and The Bank of New York Mellon Trust Company, N.A., as indenture trustee (incorporated by reference to Exhibit 4.1 of the Company’s Current Report on Form 8-K, filed on June 12, 2006).
    4.4.1      First Supplemental Indenture, dated as of June 6, 2006, between Capital One Financial Corporation and The Bank of New York Mellon Trust Company, N.A., as indenture trustee (incorporated by reference to Exhibit 4.2 of the Company’s Current Report on Form 8-K, filed on June 12, 2006).
    4.4.2        Amended and Restated Declaration of Trust of Capital One Capital II, dated as of June 6, 2006, between Capital One Financial Corporation, as Sponsor, The Bank of New York Mellon, as institutional trustee, BNY Mellon Trust of Delaware, as Delaware Trustee and the Administrative Trustees named therein (incorporated by reference to Exhibit 4.3 of the Company’s Current Report on Form 8-K, filed on June 12, 2006).
    4.4.3        Guarantee Agreement, dated as of June 6, 2006, between Capital One Financial Corporation and The Bank of New York Mellon Trust Company, N.A., as guarantee trustee (incorporated by reference to Exhibit 4.4 of the Company’s Current Report on Form 8-K, filed on June 12, 2006).
    4.4.4        Specimen certificate representing the Enhanced TRUPS (incorporated by reference to Exhibit 4.5 of the Company’s Current Report on Form 8-K, filed on June 12, 2006).
    4.4.5        Specimen certificate representing the Junior Subordinated Debt Security (incorporated by reference to Exhibit 4.6 of the Company’s Current Report on Form 8-K, filed on June 12, 2006).
    4.5.1        Second Supplemental Indenture, dated as of August 1, 2006, between Capital One Financial Corporation and The Bank of New York Mellon Trust Company, N.A., as indenture trustee (incorporated by reference to Exhibit 4.2 of the Company’s Current Report on Form 8-K, filed on August 4, 2006).
    4.5.2        Specimen certificate representing the Junior Subordinated Debt Security (incorporated by reference to Exhibit 4.6 of the Company’s Current Report on Form 8-K, filed on August 4, 2006).
    4.5.3        Amended and Restated Declaration of Trust of Capital One Capital III, dated as of August 1, 2006, between Capital One Financial Corporation, as Sponsor, The Bank of New York Mellon, as institutional trustee, BNY Mellon Trust of Delaware, as Delaware trustee and the Administrative Trustees named therein (incorporated by reference to Exhibit 4.3 of the Company’s Current Report on Form 8-K, filed on August 4, 2006).

 

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Exhibit No.

  

Description

    4.5.4        Guarantee Agreement, dated as of August 1, 2006, between Capital One Financial Corporation and The Bank of New York Mellon Trust Company, N.A., as guarantee trustee (incorporated by reference to Exhibit 4.4 of the Company’s Current Report on Form 8-K, filed on August 4, 2006).
    4.5.5        Specimen certificate representing the Capital Security (incorporated by reference to Exhibit 4.5 of the Company’s Current Report on Form 8-K, filed on August 4, 2006).
    4.6.1        Third Supplemental Indenture, dated as of February 5, 2007, between Capital One Financial Corporation and The Bank of New York Mellon Trust Company, N.A., as indenture trustee (incorporated by reference to Exhibit 4.2 of the Company’s Current Report on Form 8-K, filed on February 8, 2007).
    4.6.2        Amended and Restated Declaration of Trust of Capital One Capital IV, dated as of February 5, 2007, between Capital One Financial Corporation, as Sponsor, The Bank of New York Mellon, as institutional trustee, BNY Mellon Trust of Delaware, as Delaware trustee and the Administrative Trustees named therein (incorporated by reference to Exhibit 4.3 of the Company’s Current Report on Form 8-K, filed on February 8, 2007).
    4.6.3        Guarantee Agreement, dated as of February 5, 2007, between Capital One Financial Corporation and The Bank of New York Mellon Trust Company, N.A., as guarantee trustee (incorporated by reference to Exhibit 4.4 of the Company’s Current Report on Form 8-K, filed on February 8, 2007).
    4.6.4        Specimen certificate representing the Capital Security (incorporated by reference to Exhibit 4.5 of the Company’s Current Report on Form 8-K, filed on February 8, 2007).
    4.6.5        Specimen certificate representing the Capital Efficient Note (incorporated by reference to Exhibit 4.6 of the Company’s Current Report on Form 8-K, filed on February 8, 2007).
    4.7.1        Fourth Supplemental Indenture, dated as of August 5, 2009, between Capital One Financial Corporation and The Bank of New York Mellon Trust Company, N.A., as indenture trustee (incorporated by reference to Exhibit 4.2 of the Company’s Current Report on Form 8-K, filed on August 6, 2009).
    4.7.2        Amended and Restated Declaration of Trust of Capital One Capital V, dated as of August 5, 2009, between Capital One Financial Corporation, as Sponsor, The Bank of New York Mellon Trust Company, N.A., as institutional trustee, BNY Mellon Trust of Delaware, as Delaware trustee and the Administrative Trustees named therein (incorporated by reference to Exhibit 4.3 of the Company’s Current Report on Form 8-K, filed on August 6, 2009).
    4.7.3        Guarantee Agreement, dated as of August 5, 2009, between Capital One Financial Corporation and The Bank of New York Mellon Trust Company, N.A., as guarantee trustee (incorporated by reference to Exhibit 4.4 of the Company’s Current Report on Form 8-K, filed on August 6, 2009).
    4.7.4        Specimen certificate representing the Trust Preferred Security (incorporated by reference to Exhibit 4.5 of the Company’s Current Report on Form 8-K, filed on August 6, 2009).
    4.7.5        Specimen certificate representing the Junior Subordinated Debt Security (incorporated by reference to Exhibit 4.6 of the Company’s Current Report on Form 8-K, filed on August 6, 2009).
    4.8.1        Fifth Supplemental Indenture, dated as of November 13, 2009, between Capital One Financial Corporation and The Bank of New York Mellon Trust Company, N.A., as indenture trustee (incorporated by reference to Exhibit 4.2 of the Company’s Current Report on Form 8-K, filed on November 13, 2009).
    4.8.2        Amended and Restated Declaration of Trust of Capital One Capital VI, dated as of November 13, 2009, between Capital One Financial Corporation, as Sponsor, The Bank of New York Mellon Trust Company, N.A., as institutional trustee, BNY Mellon Trust of Delaware, as Delaware Trustee and the Administrative Trustees named therein (incorporated by reference to Exhibit 4.3 of the Company’s Current Report on Form 8-K, filed on November 13, 2009).

 

166


Table of Contents

Exhibit No.

 

Description

    4.8.3       Guarantee Agreement, dated as of November 13, 2009, between Capital One Financial Corporation and The Bank of New York Mellon Trust Company, N.A., as guarantee trustee (incorporated by reference to Exhibit 4.4 of the Company’s Current Report on Form 8-K, filed on November 13, 2009).
    4.8.4       Specimen certificate representing the Trust Preferred Security (incorporated by reference to Exhibit 4.5 of the Company’s Current Report on Form 8-K, filed on November 13, 2009).
    4.8.5       Specimen certificate representing the Junior Subordinated Debt Security (incorporated by reference to Exhibit 4.6 of the Company’s Current Report on Form 8-K, filed on November 13, 2009).
    4.9.1       Indenture, dated as of August 29, 2006, between Capital One Financial Corporation and The Bank of New York Mellon Trust Company, N.A., as indenture trustee (incorporated by reference to Exhibit 4.1 of the Company’s Current Report on Form 8-K, filed on August 31, 2006).
    4.9.2       Specimen certificate representing the Subordinated Note Certificate (incorporated by reference to Exhibit 4.2 of the Company’s Current Report on Form 8-K, filed on August 31, 2006).
  10.1           Forward Sale Agreement between Capital One Financial Corporation and Barclays Capital Inc., dated July 14, 2011 (incorporated by reference to Exhibit 10.1 of the Company’s Report on Form 8-K, filed on July 19, 2011).
  10.2         Forward Sale Agreement between Capital One Financial Corporation and Morgan Stanley & Co. LLP, dated July 14, 2011 (incorporated by reference to Exhibit 10.2 of the Company’s Report on Form 8-K, filed on July 19, 2011).
  12.1*         Computation of Ratio of Earnings to Combined Fixed Charges
  12.2*     Computation of Ratio of Earnings to Combined Fixed Charges and Preferred Stock Dividends
  31.1*     Certification of Richard D. Fairbank
  31.2*     Certification of Gary L. Perlin
  32.1*     Certification** of Richard D. Fairbank
  32.2*     Certification** of Gary L. Perlin
101.INS*   XBRL Instance Document
101.SCH*   XBRL Taxonomy Extension Schema Document
101.CAL*   XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF*   XBRL Taxonomy Extension Definition Linkbase Document
101.LAB*   XBRL Taxonomy Extension Label Linkbase Document
101.PRE*   XBRL Taxonomy Presentation Linkbase Document

 

* Indicates a document being filed with this Form 10-Q.
** Information in this Form 10-Q furnished herewith shall not be deemed to be “filed” for the purposes of Section 18 of the 1934 Act or otherwise subject to the liabilities of that section.

 

167

Computation of Ratio of Earnings to Combined Fixed Charges

Exhibit 12.1

COMPUTATION OF RATIO OF EARNINGS TO COMBINED FIXED CHARGES

 

     Nine  Months
Ended
September 30, 2011
    Year Ended December 31,  
(Dollars in millions)     2010     2009(1)     2008     2007     2006  

Ratio (including interest expense on deposits):

           

Earnings:

           

Income from continuing operations before income taxes

  $ 4,016      $ 4,330      $ 1,336      $ 582      $ 3,870      $ 3,672   

Fixed charges

    1,731        2,903        2,975        3,985        4,583        3,087   

Equity in undistributed loss of unconsolidated subsidiaries

    49        49        60        55        43        15   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Earnings available for fixed charges, as adjusted

  $ 5,796      $ 7,282      $ 4,371      $ 4,622      $ 8,496      $ 6,774   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Fixed charges:

           

Interest expense on deposits and debt

  $ 1,727      $ 2,896      $ 2,967      $ 3,963      $ 4,548      $ 3,073   

Interest factor in rent expense

    4        7        8        22        35        14   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total fixed charges

  $ 1,731      $ 2,903      $ 3,163      $ 4,001      $ 4,583      $ 3,087   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ratio of earnings to fixed charges, including interest on deposits

    3.35        2.51        1.38        1.16        1.85        2.19   

Ratio (excluding interest expense on deposits):

           

Earnings:

           

Income from continuing operations before income taxes

  $ 4,016      $ 4,330      $ 1,336      $ 582      $ 3,870      $ 3,672   

Fixed charges

    808        1,438        882        1,473        1,677        1,272   

Equity in undistributed loss of unconsolidated subsidiaries

    49        49        60        55        43        15   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Earnings available for fixed charges, as adjusted

  $ 4,873      $ 5,817      $ 2,278      $ 2,110      $ 5,590      $ 4,959   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Fixed charges:

           

Interest expense on debt(2)

  $ 804      $ 1,431      $ 874      $ 1,451      $ 1,642      $ 1,258   

Interest factor in rent expense

    4        7        8        22        35        14   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total fixed charges

  $ 808      $ 1,438      $ 1,070      $ 1,489      $ 1,677      $ 1,272   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ratio of earnings to fixed charges, excluding interest on deposits

    6.03        4.05        2.13        1.42        3.33        3.90   

 

(1)

On February 27, 2009, we acquired Chevy Chase Bank, FSB. The transaction was accounted for as a purchase, and the related results of operations are included in our consolidated results from the date of the transaction.

(2)

Represents total interest expense reported in our consolidated statements of income, excluding interest on deposits of $923 million for the nine months ended September 30, 2011, and $1.5 billion, $2.1 billion, $2.5 billion, $2.9 billion and $1.8 billion for the years ended December 31, 2010, 2009, 2008, 2007 and 2006, respectively.

Computation of Ratio of Earnings to Combined Fixed Charges and Pref Stock Div

Exhibit 12.2

COMPUTATION OF RATIO OF EARNINGS TO COMBINED FIXED CHARGES AND

PREFERRED STOCK DIVIDENDS

 

    Nine Months
Ended
September 30, 2011
    Year Ended December 31,  
(Dollars in millions)     2010     2009(1)     2008     2007     2006  

Ratio (including interest expense on deposits):

           

Earnings:

           

Income from continuing operations before income taxes

  $ 4,016      $ 4,330      $ 1,336      $ 582      $ 3,870      $ 3,672   

Fixed charges

    1,731        2,903        2,975        3,985        4,583        3,087   

Equity in undistributed loss of unconsolidated subsidiaries

    49        49        60        55        43        15   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Earnings available for fixed charges, as adjusted

  $ 5,796      $ 7,282      $ 4,371      $ 4,622      $ 8,496      $ 6,774   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Fixed charges:

           

Interest expense on deposits and debt

  $ 1,727      $ 2,896      $ 2,967      $ 3,963      $ 4,548      $ 3,073   

Interest factor in rent expense

    4        7        8        22        35        14   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total fixed charges

    1,731        2,903        2,975        3,985        4,583        3,087   

Preferred stock dividends, pre-tax

    —          —          188        16        —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total fixed charges and preferred stock dividends

  $ 1,731      $ 2,903      $ 3,163      $ 4,001      $ 4,583      $ 3,087   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ratio of earnings to fixed charges, including interest on deposits

    3.35        2.51        1.38        1.16        1.85        2.19   

Ratio (excluding interest expense on deposits):

           

Earnings:

           

Income from continuing operations before income taxes

  $ 4,016      $ 4,330      $ 1,336      $ 582      $ 3,870      $ 3,672   

Fixed charges

    808        1,438        882        1,473        1,677        1,272   

Equity in undistributed loss of unconsolidated subsidiaries

    49        49        60        55        43        15   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Earnings available for fixed charges, as adjusted

  $ 4,873      $ 5,817      $ 2,278      $ 2,110      $ 5,590      $ 4,959   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Fixed charges:

           

Interest expense on debt(2)

  $ 804      $ 1,431      $ 874      $ 1,451      $ 1,642      $ 1,258   

Interest factor in rent expense

    4        7        8        22        35        14   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total fixed charges

  $ 808      $ 1,438      $ 882      $ 1,473      $ 1,677      $ 1,272   

Preferred stock dividends, pre-tax

    —          —          188        16        —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total fixed charges and preferred stock dividends

  $ 808      $ 1,438      $ 1,070      $ 1,489      $ 1,677      $ 1,272   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ratio of earnings to fixed charges, excluding interest on deposits

    6.03        4.05        2.13        1.42        3.33        3.90   

 

(1)

On February 27, 2009, we acquired Chevy Chase Bank, FSB. The transaction was accounted for as a purchase, and the related results of operations are included in our consolidated results from the date of the transaction.

(2)

Represents total interest expense reported in our consolidated statements of income, excluding interest on deposits of $923 million for the nine months ended September 30, 2011, and $1.5 billion, $2.1 billion, $2.5 billion, $2.9 billion and $1.8 billion for the years ended December 31, 2010, 2009, 2008, 2007 and 2006, respectively.

Certification of Richard D. Fairbank

Exhibit 31.1

CERTIFICATION FOR QUARTERLY REPORT ON FORM 10-Q OF CAPITAL ONE FINANCIAL

CORPORATION AND CONSOLIDATED SUBSIDIARIES

I, Richard D. Fairbank, certify that:

 

1. I have reviewed this quarterly report on Form 10-Q of Capital One Financial Corporation;

 

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

 

  (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

  (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

  (c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

  (d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

 

  (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

  (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

 

Date: November 7, 2011

    By:  

  /s/ RICHARD D. FAIRBANK

     

Richard D. Fairbank

Chairman of the Board, Chief Executive Officer and President

Certification of Gary L. Perlin

Exhibit 31.2

CERTIFICATION FOR QUARTERLY REPORT ON FORM 10-Q OF CAPITAL ONE FINANCIAL

CORPORATION AND CONSOLIDATED SUBSIDIARIES

I, Gary L. Perlin, certify that:

 

1. I have reviewed this quarterly report on Form 10-Q of Capital One Financial Corporation;

 

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

 

  (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

  (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

  (c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

  (d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

 

  (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

  (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

 

Date: November 7, 2011     By:  

  /s/ GARY L. PERLIN

     

Gary L. Perlin

Chief Financial Officer

Certification of Richard D. Fairbank

Exhibit 32.1

Certification

Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

(Subsections (a) and (b) of Section 1350, Chapter 63 of Title 18, United States Code)

Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Subsections (a) and (b) of Section 1350, Chapter 63 of Title 18, United States Code), I, Richard D. Fairbank, Chairman of the Board, Chief Executive Officer and President of Capital One Financial Corporation, a Delaware corporation (“Capital One”), do hereby certify that:

 

1. The Quarterly Report on Form 10-Q for the period ended September 30, 2011 (the “Form 10-Q”) of Capital One fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

 

2. The information contained in the Form 10-Q fairly presents, in all material respects, the financial condition and results of operations of Capital One.

 

Date: November 7, 2011     By:  

  /s/ RICHARD D. FAIRBANK

     

Richard D. Fairbank

Chairman of the Board, Chief Executive Officer and President

A signed original of this written statement required by Section 906 has been provided to Capital One and will be retained by Capital One and furnished to the Securities and Exchange Commission or its staff upon request.

Certification of Gary L. Perlin

Exhibit 32.2

Certification

Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

(Subsections (a) and (b) of Section 1350, Chapter 63 of Title 18, United States Code)

Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Subsections (a) and (b) of Section 1350, Chapter 63 of Title 18, United States Code), I, Gary L. Perlin, Chief Financial Officer of Capital One Financial Corporation, a Delaware corporation (“Capital One”), do hereby certify that:

 

1. The Quarterly Report on Form 10-Q for the period ended September 30, 2011 (the “Form 10-Q”) of Capital One fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

 

2. The information contained in the Form 10-Q fairly presents, in all material respects, the financial condition and results of operations of Capital One.

 

Date: November 7, 2011     By:  

  /s/ GARY L. PERLIN

     

Gary L. Perlin

Chief Financial Officer

A signed original of this written statement required by Section 906 has been provided to Capital One and will be retained by Capital One and furnished to the Securities and Exchange Commission or its staff upon request.