UNITED STATESUNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1997
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 number 1-13300
CAPITAL ONE FINANCIAL CORPORATION
------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 54-1719854
- ------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2980 Fairview Park Drive, Suite 1300, Falls Church, Virginia 22042-4525
- ------------------------------------------------------------ ----------
(Address of principal executive offices) (Zip Code)
(703) 205-1000
----------------------------------------------------
(Registrant's telephone number, including area code)
(Not Applicable)
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(Former name, former address and former fiscal year,
if changed since last report)
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
------- --------
As of July 31, 1997, there were 66,519,092 shares of the registrant's Common
Stock, par value $.01 per share, outstanding.
1
CAPITAL ONE FINANCIAL CORPORATION
FORM 10-Q
INDEX
June 30, 1997
PAGE
----
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements (unaudited):
Condensed Consolidated Balance Sheets.................. 3
Condensed Consolidated Statements of Income............ 4
Condensed Consolidated Statements of Changes
in Stockholders' Equity............................... 5
Condensed Consolidated Statements of
Cash Flows............................................ 6
Notes to Condensed Consolidated Financial
Statements............................................ 7
ITEM 2. Management's Discussion and Analysis
of Financial Condition and Results of
Operations............................................ 10
PART II. OTHER INFORMATION
ITEM 6. Exhibits and Reports on Form 8-K....................... 28
Signatures............................................. 28
2
ITEM 1.
- -------
CAPITAL ONE FINANCIAL CORPORATION
Condensed Consolidated Balance Sheets
(dollars in thousands, except per share data) (unaudited)
JUNE 30 DECEMBER 31
1997 1996
---------- -----------
ASSETS:
Cash and due from banks $ 136,112 $ 48,724
Federal funds sold and resale agreements 295,507 450,000
Interest-bearing deposits at other banks 21,441 30,252
---------- -----------
Cash and cash equivalents 453,060 528,976
Securities available for sale 1,142,328 877,851
Consumer loans 3,623,952 4,343,902
Less: Allowance for loan losses (118,500) (118,500)
---------- -----------
Net loans 3,505,452 4,225,402
Premises and equipment, net 181,078 174,661
Interest receivable 48,135 78,590
Accounts receivable from securitizations 729,238 502,520
Other assets 100,144 79,445
---------- -----------
Total assets $6,159,435 $ 6,467,445
========== ===========
LIABILITIES:
Interest-bearing deposits $ 869,801 $ 943,022
Other borrowings 293,734 530,983
Senior notes 3,468,801 3,694,237
Deposit notes 299,996 299,996
Interest payable 72,261 80,362
Other liabilities 236,343 178,454
---------- -----------
Total liabilities 5,240,936 5,727,054
GUARANTEED PREFERRED BENEFICIAL INTERESTS IN
CAPITAL ONE BANK'S FLOATING RATE JUNIOR
SUBORDINATED CAPITAL INCOME SECURITIES 97,534
STOCKHOLDERS' EQUITY:
Preferred stock, par value $.01 per share; authorized
50,000,000 shares, none issued or outstanding
Common stock, par value $.01 per share; authorized
300,000,000 shares, 66,484,610 and 66,325,261
issued and outstanding as of June 30, 1997 and
December 31, 1996, respectively 665 663
Paid-in capital, net 491,953 481,383
Retained earnings 328,347 258,345
---------- -----------
Total stockholders' equity 820,965 740,391
---------- -----------
Total liabilities and stockholders' equity $6,159,435 $ 6,467,445
========== ===========
See notes to condensed consolidated financial statements.
3
CAPITAL ONE FINANCIAL CORPORATION
Condensed Consolidated Statements of Income
(in thousands, except per share data) (unaudited)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30 JUNE 30
------------------------ ----------------------
1997 1996 1997 1996
-------- ---------- --------- --------
INTEREST INCOME:
Consumer loans, including fees $143,485 $ 123,403 $289,997 $237,514
Federal funds sold and resale agreements 2,613 4,487 8,277 12,464
Other 20,772 9,863 37,190 20,917
-------- ---------- --------- --------
Total interest income 166,870 137,753 335,464 270,895
INTEREST EXPENSE:
Deposits 8,635 11,031 19,072 23,574
Other borrowings 10,453 5,567 16,977 13,915
Senior and deposit notes 64,523 46,702 127,959 88,145
-------- ---------- --------- --------
Total interest expense 83,611 63,300 164,008 125,634
-------- ---------- --------- --------
Net interest income 83,259 74,453 171,456 145,261
Provision for loan losses 46,776 25,110 95,963 50,278
-------- ---------- --------- --------
Net interest income after provision for loan losses 36,483 49,343 75,493 94,983
NON-INTEREST INCOME:
Servicing and securitizations 148,562 109,115 318,595 237,301
Service charges 57,278 42,034 110,926 68,658
Interchange 11,405 14,119 20,720 22,417
Other 11,797 5,331 21,858 13,371
-------- ---------- --------- --------
Total non-interest income 229,042 170,599 472,099 341,747
NON-INTEREST EXPENSE:
Salaries and associate benefits 69,287 49,655 139,923 93,931
Solicitation 44,995 42,733 99,046 94,257
Communications and data processing 24,320 19,879 46,110 34,819
Supplies and equipment 18,406 14,399 36,479 26,783
Occupancy 7,388 4,924 15,189 9,019
Other 37,659 27,744 78,855 56,975
-------- ---------- --------- --------
Total non-interest expense 202,055 159,334 415,602 315,784
-------- ---------- --------- --------
Income before income taxes 63,470 60,608 131,990 120,946
Income taxes 24,118 22,425 50,156 44,750
-------- ---------- --------- --------
Net income $ 39,352 $ 38,183 $ 81,834 $ 76,196
======== ========== ========= ========
Earnings per share $ .58 $ .57 $ 1.21 $ 1.14
======== ========== ========= ========
Dividends paid per share $ .08 $ .08 $ .16 $ .16
======== ========== ========= ========
Weighted average common and
common equivalent shares outstanding 67,930 66,893 67,884 66,858
======== ========== ========= ========
See notes to condensed consolidated financial statements.
4
CAPITAL ONE FINANCIAL CORPORATION
Condensed Consolidated Statements of Changes in Stockholders' Equity
(dollars in thousands, except per share data) (unaudited)
COMMON STOCK TOTAL
------------------- PAID-IN RETAINED STOCKHOLDERS'
SHARES AMOUNT CAPITAL, NET EARNINGS EQUITY
---------- ------- ------------- -------- --------------
Balance, December 31, 1995 66,174,567 $662 $469,830 $128,699 $599,191
Net income 76,196 76,196
Cash dividends - $.16 per share (10,248) (10,248)
Issuance of common stock 67,379 1,376 1,376
Exercise of stock options 8,184 132 132
Tax benefit from stock awards 230 230
Restricted stock, net (664)
Amortization of deferred
compensation 134 134
Common stock issuable
under incentive plan 1,800 1,800
Change in unrealized gains on
securities available for sale,
net of income taxes of $2,488 (4,548) (4,548)
----------- ---- -------- -------- --------
Balance, June 30, 1996 66,249,466 $662 $473,502 $190,099 $664,263
=========== ==== ======== ======== ========
Balance, December 31, 1996 66,325,261 $663 $481,383 $258,345 $740,391
Net income 81,834 81,834
Cash dividends - $.16 per share (10,334) (10,334)
Issuance of common stock 85,299 1 2,421 2,422
Exercise of stock options 74,171 1 1,412 1,413
Tax benefit from stock awards 221 221
Restricted stock, net (121)
Amortization of deferred
compensation 54 54
Common stock issuable
under incentive plan 6,462 6,462
Foreign currency translation 153 153
Change in unrealized gains on
securities available for sale,
net of income taxes of $857 (1,651) (1,651)
----------- ---- -------- -------- --------
Balance, June 30, 1997 66,484,610 $665 $491,953 $328,347 $820,965
=========== ==== ======== ======== ========
See notes to condensed consolidated financial statements.
5
CAPITAL ONE FINANCIAL CORPORATION
Condensed Consolidated Statements of Cash Flows
(in thousands) (unaudited)
SIX MONTHS ENDED
JUNE 30
1997 1996
---------- -----------
OPERATING ACTIVITIES:
Net income $ 81,834 $ 76,196
Adjustments to reconcile net income to cash
provided by operating activities:
Provision for loan losses 95,963 50,278
Depreciation and amortization 23,929 21,575
Stock compensation plans 6,516 1,934
Decrease (increase) in interest receivable 30,455 (1,679)
Increase in accounts receivable from securitizations (226,718) (50,604)
Increase in other assets (28,136) (3,745)
Decrease in interest payable (8,101) (3,207)
Increase in other liabilities 57,889 43,428
---------- ----------
Net cash provided by operating activities 33,631 134,176
---------- ----------
INVESTING ACTIVITIES:
Purchases of securities available for sale (653,916) (237,152)
Proceeds from maturities of securities available for sale 396,580
Proceeds from securitization of consumer loans 1,031,456 600,000
Net increase in consumer loans (417,989) (1,302,803)
Recoveries of loans previously charged off 10,520 6,464
Additions of premises and equipment, net (31,221) (33,786)
---------- ----------
Net cash provided by (used for) investing activities 335,430 (967,277)
---------- ----------
FINANCING ACTIVITIES:
Net (decrease) increase in interest-bearing deposits (73,221) 519,462
Net decrease in other borrowings (237,249) (550,303)
Issuances of senior notes 480,000 864,848
Maturities of senior notes (705,436) (222,500)
Issuances of deposit notes 200,000
Issuances of preferred beneficial interests 97,428
Proceeds from exercise of stock options 1,413 132
Net proceeds from issuance of common stock 2,422 1,376
Dividends paid (10,334) (10,248)
---------- ----------
Net cash (used for) provided by financing activities (444,977) 802,767
---------- ----------
Decrease in cash and cash equivalents (75,916) (30,334)
Cash and cash equivalents at beginning of period 528,976 872,460
---------- ----------
Cash and cash equivalents at end of period $ 453,060 $ 842,126
---------- ----------
See notes to condensed consolidated financial statements.
6
CAPITAL ONE FINANCIAL CORPORATION
Notes to Condensed Consolidated Financial Statements
June 30, 1997
(dollars in thousands, except per share data) (unaudited)
NOTE A: BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Capital One
Financial Corporation (the "Corporation") and its subsidiaries. The Corporation
is a holding company whose subsidiaries provide a variety of products and
services to consumers. The principal subsidiaries are Capital One Bank (the
"Bank"), which offers credit card products, and Capital One, F.S.B. (the
"Savings Bank"), which provides certain consumer lending and deposit services.
The Corporation and its subsidiaries are collectively referred to as the
"Company."
The accompanying unaudited consolidated financial statements of the Company
have been prepared in accordance with generally accepted accounting principles
("GAAP") for interim financial information and with the instructions to Form 10-
Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by GAAP for complete consolidated financial
statements. In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation have been
included. The preparation of financial statements in conformity with GAAP
requires management to make estimates and assumptions that affect the amounts
reported in the financial statements and accompanying notes. Actual results
could differ from those estimates. Operating results for the three and six
months ended June 30, 1997 are not necessarily indicative of the results for the
year ending December 31, 1997. The notes to the consolidated financial
statements contained in the Annual Report on Form 10-K for the year ended
December 31, 1996 should be read in conjunction with these condensed
consolidated financial statements. All significant intercompany balances and
transactions have been eliminated. Certain prior period amounts have been
reclassified to conform to the 1997 presentation.
NOTE B: SIGNIFICANT ACCOUNTING POLICIES
CASH AND CASH EQUIVALENTS
Cash paid for interest for the six months ended June 30, 1997 and 1996 was
$172,109 and $128,841, respectively. Cash paid for income taxes for the six
months ended June 30, 1997 and 1996 was $64,095 and $40,939, respectively.
EARNINGS PER SHARE
Earnings per share are based upon the weighted average number of common and
common equivalent shares outstanding, including dilutive stock options and
restricted stock.
SECURITIZATIONS
In June 1996, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 125, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities"
("SFAS 125"), effective January 1, 1997, which establishes the accounting for
certain financial asset transfers including securitization transactions. SFAS
125 requires an entity, after a transfer of financial assets that meets the
criteria for sale accounting, to recognize the financial servicing assets it
controls and the liabilities it has incurred and to derecognize financial assets
for which control has been relinquished.
7
Under SFAS 125, the Company records gains or losses on the securitization
of consumer loan receivables prospectively for transfers made after January 1,
1997 based on the estimated fair value of assets obtained and liabilities
incurred in the sale. Gains represent the present value of estimated excess
cash flows the Company has retained over the estimated outstanding period of the
receivables. This excess cash flow represents essentially an "interest only"
("I/O") strip, consisting of the excess of finance charge and past-due fees over
the sum of the return paid to certificate holders, contractual servicing fees
and credit losses. Certain estimates inherent in the determination of the I/O
strip are influenced by the factors outside the Company's control, and, as a
result, such estimates could materially change in the near term.
NOTE C: STOCK REPURCHASE
On July 10, 1997, the Company's Board of Directors voted to repurchase up
to two million shares of the Company's common stock over the next two years in
order to mitigate the impact of shares issuable under its benefit plans,
including its dividend reinvestment and stock purchase plan, associate stock
purchase plan and its option programs.
NOTE D: COMMITMENTS AND CONTINGENCIES
During 1995, the Company and the Bank became involved in three purported
class action suits relating to certain collection practices engaged in by Signet
Bank and, subsequently, by the Bank. The complaints in these three cases allege
that Signet Bank and/or the Company violated a variety of federal and state
statutes and constitutional and common law duties by filing collection lawsuits,
obtaining judgments and pursuing garnishment proceedings in the Virginia state
courts against defaulted credit card customers who were not residents of
Virginia. These cases were filed in the Superior Court of California in the
County of Alameda, Southern Division, on behalf of a class of California
residents, in the United States District Court for the District of Connecticut
on behalf of a nationwide class and in the United States District Court for the
Middle District of Florida on behalf of a nationwide class (except for
California). The complaints in these three cases seek unspecified statutory
damages, compensatory damages, punitive damages, restitution, attorneys' fees
and costs, a permanent injunction and other equitable relief.
On July 31, 1996, the Florida case was dismissed without prejudice, which
permits further proceedings. The plaintiff refiled certain claims arising out of
state law in Florida state court and noticed her appeal of the federal claims to
the United States Court of Appeals for the Eleventh Circuit. On appeal, the
Eleventh Circuit affirmed the ruling of the District Court in favor of the Bank.
On September 30, 1996, the Connecticut court entered judgment in favor of
the Bank on plaintiff's federal claims and dismissed without prejudice
plaintiff's state law claims. The plaintiff has refiled, on behalf of a class
of Connecticut residents, her claims arising out of state law in a Connecticut
state court. The Bank removed this action to the United States District Court
for the district of Connecticut and moved to dismiss plaintiff's claims. The
Bank's motion is pending.
On February 17, 1997, the California court entered judgment in favor of the
Bank on all of the plaintiffs' claims. The plaintiffs have appealed the ruling
to California Court of Appeal First Appellate District Division 4. On July 10,
1997, the plaintiffs filed their opening brief in the appeal.
In connection with the transfer of substantially all of Signet Bank's
credit card business to the Bank in November 1994, the Company and the Bank
agreed to indemnify Signet Bank for certain liabilities incurred in litigation
arising from that business, which may include liabilities, if any, incurred in
the three purported class action cases described above. Because no specific
measure of damages is
8
demanded in any of the complaints and each of these cases is in early stages of
litigation, an informed assessment of the ultimate outcome of these cases cannot
be made at this time. Management believes, however, that there are meritorious
defenses to these lawsuits and intends to defend them vigorously.
The Company is commonly subject to various other pending and threatened
legal actions arising from the conduct of its normal business activities. In
the opinion of the Management of the Company, the ultimate aggregate liability,
if any, arising out of any pending or threatened action will not have a material
adverse effect on the consolidated financial condition of the Company. At the
present time, however, Management is not in a position to determine whether the
resolution of pending or threatened litigation will have a material effect on
the Company's results of operations in any future reporting period.
The Savings Bank has entered into an agreement pursuant to which it will
acquire the national retail deposit franchise of JCPenney National Bank. Retail
deposit balances acquired under this agreement are expected to be approximately
$425,000 and the acquisition is expected to close in early October, subject to
fulfillment with the terms and conditions of the agreement.
NOTE E: RECENT ACCOUNTING PRONOUNCEMENTS
In February 1997, the FASB issued SFAS No. 128 ("SFAS 128"), "Earnings per
Share," which is required to be adopted on December 31, 1997. At that time, the
Company will be required to change the method currently used to compute earnings
per share and to restate all prior periods. Under the new requirements, primary
and fully diluted earnings per share are replaced with basic and diluted
earnings per share. Basic earnings per share excludes the dilutive effect of
stock options. The impact of SFAS 128 on the calculation of earnings per share
for the three and six months ended June 30, 1997 and 1996 was not material.
9
ITEM 2.
- -------
CAPITAL ONE FINANCIAL CORPORATION
Management's Discussion and Analysis of Financial Condition and Results of
Operations
INTRODUCTION
Capital One Financial Corporation (the "Corporation") is a holding company
whose subsidiaries provide a variety of products and services to consumers. The
principal subsidiaries are Capital One Bank (the "Bank"), which offers credit
card products, and Capital One, F.S.B. (the "Savings Bank"), which provides
certain consumer lending and deposit services. The Corporation and its
subsidiaries are collectively referred to as the "Company." The Company is one
of the largest providers of MasterCard and Visa credit cards in the United
States. As of June 30, 1997, the Company had 9.8 million customers and $12.7
billion in managed consumer loans outstanding. The Company's profitability is
affected by the net interest margin and non-interest income earned on earning
assets, customer usage patterns, credit quality, the level of solicitation
expenses and operating efficiency.
EARNINGS SUMMARY
Net income for the three months ended June 30, 1997 of $39.4 million, or
$.58 per share, compares to net income of $38.2 million, or $.57 per share, for
the same period in the prior year.
The increase in net income is primarily a result of an increase in asset
volumes. Net interest income increased $8.8 million, or 12%, as average earning
assets increased 33%, offset by a decrease in the net interest margin to 5.99%
from 7.12%. The provision for loan losses increased $21.7 million, or 86%, as
average loans increased 23%, and the reported net charge-off rate increased to
4.95% from 2.95%. Non-interest income increased $58.4 million, or 34%,
primarily as a result of the increase in average managed loans of 18%, a shift
to more fee-based accounts and a change in the timing and amount of certain fees
charged. Increases in salaries and associate benefits expense of $19.6 million,
or 40%, and other non-interest expense of $23.1 million, or 21%, primarily
reflected additional staffing needs associated with the cost incurred to manage
the growth in accounts.
Net income for the six months ended June 30, 1997 of $81.8 million, or
$1.21 per share, compares to net income of $76.2 million, or $1.14 per share,
for the same period in 1996. This 7% increase primarily reflected the growth in
loans and accounts offset by a decline in the net interest margin described
above. Each component is discussed in further detail in subsequent sections of
this analysis.
MANAGED CONSUMER LOAN PORTFOLIO
The Company analyzes its financial performance on a managed consumer loan
portfolio basis. Managed consumer loan data adjusts the balance sheet and
income statement to add back the effect of securitizing consumer loans. The
Company also evaluates its interest rate exposure on a managed portfolio basis.
The Company's managed consumer loan portfolio is comprised of on-balance
sheet loans, loans held for securitization and securitized loans. Securitized
loans are not assets of the Company and, therefore, are not shown on the balance
sheet. Reported consumer loans consist of on-balance sheet loans and loans held
for securitization and excludes securitized loans.
10
Table 1 summarizes the Company's managed consumer loan portfolio.
TABLE 1 - MANAGED CONSUMER LOAN PORTFOLIO
THREE MONTHS ENDED
JUNE 30
(in thousands) 1997 1996
------------ -----------
PERIOD-END BALANCES:
Consumer loans held for securitization $ 1,000,000
On-balance sheet consumer loans $ 3,623,952 2,569,740
Securitized consumer loans 9,113,410 7,608,801
------------ -----------
Total managed consumer loan portfolio $12,737,362 $11,178,541
============ ===========
AVERAGE BALANCES:
Consumer loans held for securitization $ 286,813 $ 468,132
On-balance sheet consumer loans 3,709,747 2,780,794
Securitized consumer loans 8,718,310 7,490,724
------------ -----------
Total average managed consumer loan portfolio $12,714,870 $10,739,650
============ ===========
SIX MONTHS ENDED
JUNE 30
(in thousands) 1997 1996
------------ -----------
AVERAGE BALANCES:
Consumer loans held for securitization $ 199,345 $ 400,000
On-balance sheet consumer loans 3,828,113 2,595,236
Securitized consumer loans 8,609,846 7,507,263
------------ -----------
Total average managed consumer loan portfolio $12,637,304 $10,502,499
============ ===========
Since 1990, the Company has actively engaged in consumer loan
securitization transactions. In June 1996, the Financial Accounting Standards
Board issued Statement of Financial Accounting Standards ("SFAS") No. 125,
"Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities" ("SFAS 125"), effective January 1, 1997, which
establishes the accounting for certain financial asset transfers including
securitization transactions. SFAS 125 requires an entity, after a transfer of
financial assets that meets the criteria for sale accounting, to recognize the
financial servicing assets it controls and the liabilities it has incurred and
to derecognize financial assets for which control has been relinquished.
Under SFAS 125, the Company records gains or losses on the securitization
of consumer loan receivables prospectively for transfers made after January 1,
1997 based on the estimated fair value of assets obtained and liabilities
incurred in the sale. Gains represent the present value of estimated excess cash
flows the Company has retained over the estimated outstanding period of the
receivables. This excess cash flow represents essentially an "interest only"
("I/O") strip, consisting of the excess of finance charge and past-due fees over
the sum of the return paid to certificate holders, contractual servicing fees
and credit losses. Certain estimates inherent in the determination of the I/O
strip are influenced by the factors outside the Company's control, and, as a
result, such estimates could materially change in the near term.
The adoption of SFAS 125 did not have a material effect on securitization
income during the first six months of 1997. However, in large part as a result
of the impact on the I/O strip of expected increases in past-due fees, the
Company believes, as it continues to transition its securitized receivables
portfolio to the requirements of the new standard, the impact of SFAS 125 in the
second half of 1997 will
11
be more significant. This incremental impact on securitization income resulting
from the adoption of SFAS 125 in 1997 is not representative of future periods.
Any future gains that will be recognized in accordance with SFAS 125 will be
dependent on the timing and amount of future securitizations. The Company will
continuously assess the performance of new and existing securitization
transactions as estimates of future cash flows change. Table 2 indicates the
impact of the consumer loan securitizations on average earning assets, net
interest margin and yield for the periods presented. The Company intends to
continue to securitize consumer loans.
TABLE 2 - OPERATING DATA AND RATIOS
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30 JUNE 30
(dollars in thousands) 1997 1996 1997 1996
------------ ------------- ------------ ------------
REPORTED:
Average earning assets $ 5,559,574 $ 4,181,950 $ 5,568,871 $ 4,112,667
Net interest margin(1) 5.99% 7.12% 6.16% 7.06%
Yield 14.36 15.19 14.40 15.86
MANAGED:
Average earning assets $14,277,884 $11,672,674 $14,178,717 $11,619,930
Net interest margin(1) 8.30% 7.94% 8.56% 7.98%
Yield 15.17 14.21 15.31 14.48
============ ============= ============ ============
(1) Net interest margin is equal to net interest income divided by average earning assets.
RISK ADJUSTED REVENUE AND MARGIN
In originating its consumer loan portfolio in recent years, the Company has
pursued a low introductory interest rate strategy with accounts repricing to
higher rates after six to sixteen months from the date of origination ("first
generation products"). The amount of repricing is actively managed in an effort
to maximize return at the consumer level, reflecting the risk and expected
performance of the account. Separately, accounts also may be repriced upwards
or downwards based on individual customer performance. Many of the Company's
first generation products have a balance transfer feature under which customers
could transfer balances, held in their other obligations, to the Company. The
Company's historic managed loan growth has been principally the result of this
balance transfer feature. Industry competitors have continuously solicited the
Company's customers with similar low-rate introductory strategies. Management
believes that these competitive pressures have and will continue to put
additional pressure on low-rate introductory strategies.
In applying its Information-Based Strategies ("IBS") and in response to
competitive pressures during late 1994, the Company began to shift a significant
amount of its solicitation expense to second generation product opportunities.
Second generation products consist of secured card products and other customized
card products including affinity and co-branded cards, college student cards and
other cards targeted to certain markets that were underserved by the Company's
competitors. These products do not have the immediate impact on managed loan
balances of the first generation products but typically consist of lower credit
limit accounts which build balances over time. The terms of the second
generation products tend to include annual membership fees and higher annual
finance charge rates. The higher risk profile of the customers targeted for the
second generation products and the lower credit limit associated with these
products also tend to result in higher delinquency and consequently higher past-
due and overlimit fees than the first generation products.
12
Although these second generation products have differing characteristics,
both the first generation and second generation products meet the Company's
objective of maximizing revenue for the level of risk undertaken. Management
believes that comparable measures for external analysis are the risk adjusted
revenue and risk adjusted margin of the portfolio. Risk adjusted revenue is
defined as net interest income and non-interest income less net charge-offs.
Risk adjusted margin measures risk adjusted revenue as a percentage of average
earning assets. It considers not only the finance charge yield and net interest
margin, the primary focus of the first generation products, but also the fee
income associated with the second generation products. By deducting net charge-
offs, consideration is given to the risk inherent in these differing products.
Managed risk adjusted revenue of $262.9 million for the three months ended
June 30, 1997 increased $41.8 million, or 19%, compared to managed risk adjusted
revenue of $221.1 million for the same period in the prior year. This increase
resulted from an increase in managed net interest income of $64.8 million to
$296.3 million and an increase in managed non-interest income of $73.2 million
to $169.3 million, offset by an increase in managed net charge-offs of $96.2
million to $202.8 million for the three months ended June 30, 1997 as compared
to the same period in the prior year. Managed risk adjusted margin decreased to
7.36% for the three months ended June 30, 1997 from 7.58% for the same period in
the prior year. This decrease resulted from an increase in managed net charge-
offs as a percentage of average managed earning assets to 5.68% for the three
months ended June 30, 1997 from 3.65% in the same period in the prior year,
offset by an increase in managed net interest margin to 8.30% for the three
months ended June 30, 1997 from 7.94% in the same period in the prior year and
an increase in managed non-interest income as a percentage of average managed
earning assets to 4.74% for the three months ended June 30, 1997 from 3.29% in
the same period in the prior year.
Managed risk adjusted revenue of $547.6 million for the six months ended
June 30, 1997 increased $108.4 million, or 25%, over managed risk adjusted
revenue of $439.2 million for the same period in the prior year. This increase
resulted from an increase in managed net interest income of $143.3 million to
$607.0 million and an increase in managed non-interest income of $153.9 million
to $326.6 million, offset by an increase in managed net charge-offs of $188.9
million to $386.0 million for the six months ended June 30, 1997 as compared to
the same period in the prior year. Managed risk adjusted margin increased to
7.72% for the six months ended June 30, 1997 from 7.56% for the same period in
the prior year. This increase resulted from an increase in managed net interest
margin to 8.56% for the six months ended June 30, 1997 from 7.98% in the same
period in the prior year, an increase in managed non-interest income as a
percentage of average managed earning assets to 4.61% for the six months ended
June 30, 1997 from 2.97% in the same period in the prior year, offset by an
increase in managed net charge-offs as a percentage of average managed earning
assets to 5.45% for the six months ended June 30, 1997 from 3.39% in the same
period in the prior year. The cause of increases and decreases in the various
components of risk adjusted revenue are discussed in further detail in
subsequent sections of this analysis.
NET INTEREST INCOME
Net interest income is interest and past-due fees earned from the Company's
consumer loans and securities less interest expense on borrowings, which include
interest-bearing deposits, other borrowings and borrowings from senior and
deposit notes.
Net interest income for the three months ended June 30, 1997 was $83.3
million, compared to $74.5 million for the same period in the prior year,
representing an increase of $8.8 million, or 12%. For the six months ended June
30, 1997, net interest income was $171.5 million compared to $145.3 million for
the same period in 1996, representing an increase of $26.2 million, or 18%.
Average earnings assets increased 33% and 35% for the three and six months ended
June 30, 1997, respectively, versus the same periods in 1996. The yield on
earning assets decreased 117 and 112 basis points for the three and six months
ended June 30, 1997, respectively, to 12.01% from 13.18% and to 12.05% from
13.17%, as
13
compared to the same periods in the prior year. The decreases were primarily
attributable to an 83 and 146 basis point decrease in the yield on consumer
loans for the three and six months ended June 30, 1997, respectively, to 14.36%
from 15.19% and to 14.40% from 15.86%, as compared to the same periods in the
prior year. The yield on consumer loans decreased due to the securitization, and
as a result, removal from the balance sheet, of higher yielding second
generation products during the fourth quarter of 1996, offset by an increase in
the amount of past-due fees charged as compared to the same period in the prior
year.
Table 3 provides average balance sheet data, an analysis of net interest
income, net interest spread (the difference between the yield on earning assets
and the cost of interest-bearing liabilities) and net interest margin for the
three and six months ended June 30, 1997 and 1996.
TABLE 3 - STATEMENTS OF AVERAGE BALANCES, INCOME AND EXPENSE, YIELDS AND RATES
THREE MONTHS ENDED JUNE 30
1997 1996
-----------------------------------------------------------------------------
AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/
(dollars in thousands) BALANCE EXPENSE RATE BALANCE EXPENSE RATE
------------- ----------- -------- ----------- ----------- -------
ASSETS:
Earning assets
Consumer loans(1) $3,996,560 $143,485 14.36% $ 3,248,926 $123,403 15.19%
Federal funds sold and
resale agreements 187,650 2,613 5.57 336,951 4,487 5.33
Other securities 1,375,364 20,772 6.04 596,073 9,863 6.62
----------- ----------- -------- ------------ ----------- ------
Total earning assets 5,559,574 $166,870 12.01% 4,181,950 $137,753 13.18%
Cash and due from banks 111,670 25,073
Allowance for loan losses (118,833) (74,004)
Premises and equipment, net 182,227 152,285
Other assets 823,415 615,548
----------- ----------- -------- ------------ ----------- ------
Total assets $6,558,053 $4,900,852
=========== =========== ======== ============ =========== ======
LIABILITIES AND EQUITY:
Interest-bearing liabilities
Deposits $ 817,936 $ 8,635 4.22% $ 788,788 $ 11,031 5.59%
Other borrowings 694,814 10,453 6.02 348,627 5,567 6.39
Senior and deposit notes 3,768,797 64,523 6.85 2,875,119 46,702 6.50
----------- ----------- -------- ------------ ----------- ------
Total interest-bearing liabilities 5,281,547 $ 83,611 6.33% 4,012,534 $ 63,300 6.31%
Other liabilities 380,807 244,641
----------- ----------- -------- ------------ ----------- ------
Total liabilities 5,662,354 4,257,175
Preferred beneficial interests 97,503
Equity 798,196 643,677
----------- ----------- -------- ------------ ----------- ------
Total liabilities and equity $6,558,053 $4,900,852
=========== =========== ======== ============ =========== ======
Net interest spread 5.68% 6.87%
=========== =========== ======== ============ =========== ======
Interest income to
average earning assets 12.01% 13.18%
Interest expense to
average earning assets 6.02 6.06
----------- ----------- -------- ------------ ----------- ------
Net interest margin 5.99% 7.12%
=========== =========== ======== ============ =========== ======
(1) Interest income includes past-due fees on loans of approximately $24,965 and $19,525 for the three months ended
June 30, 1997 and 1996, respectively.
14
SIX MONTHS ENDED JUNE 30
1997 1996
---------------------------------------------------------------------------------------
AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/
(dollars in thousands) BALANCE EXPENSE RATE BALANCE EXPENSE RATE
------------- ------------ --------- ------------ ------------ ---------
ASSETS:
Earning assets
Consumer loans(1) $4,027,458 $289,997 14.40% $2,995,236 $237,514 15.86%
Federal funds sold and
resale agreements 306,527 8,277 5.40 464,085 12,464 5.37
Other securities 1,234,886 37,190 6.02 653,346 20,917 6.40
------------- ------------ --------- ------------ ------------ ---------
Total earning assets 5,568,871 $335,464 12.05% 4,112,667 $270,895 13.17%
Cash and due from banks 95,309 25,818
Allowance for loan losses (119,331) (74,003)
Premises and equipment, net 181,246 147,653
Other assets 745,833 565,322
------------- ------------ --------- ------------ ------------ ---------
Total assets $6,471,928 $4,777,457
============= ============ ========= ============ ============ =========
LIABILITIES AND EQUITY:
Interest-bearing liabilities
Deposits $ 904,861 $ 19,072 4.22% $ 823,742 $ 23,574 5.72%
Other borrowings 553,654 16,977 6.13 437,770 13,915 6.36
Senior and deposit notes 3,788,751 127,959 6.75 2,692,439 88,145 6.55
------------- ------------ --------- ------------ ------------ ---------
Total interest-bearing liabilities 5,247,266 $164,008 6.25% 3,953,951 $125,634 6.35%
Other liabilities 362,131 186,234
------------- ------------ --------- ------------ ------------ ---------
Total liabilities 5,609,397 4,140,185
Preferred beneficial interests 81,325
Equity 781,206 637,272
------------- ------------ --------- ------------ ------------ ---------
Total liabilities and equity $6,471,928 $4,777,457
============= ============ ========= ============ ============ =========
Net interest spread 5.80% 6.82%
============= ============ ========= ============ ============ =========
Interest income to
average earning assets 12.05% 13.17%
Interest expense to
average earning assets 5.89 6.11
------------- ------------ --------- ------------ ------------ ---------
Net interest margin 6.16% 7.06%
============= ============ ========= ============ ============ =========
(1) Interest income includes past-due fees on loans of approximately $50,213 and $35,010 for the six months ended June 30, 1997
and 1996, respectively.
The managed net interest margin decreased 53 basis points to 8.30% for the
three months ended June 30, 1997, compared to 8.83% for the three months ended
March 31, 1997. The decrease reflected decreased late fees and the addition of
low introductory rate balance transfer loans that replaced the increased
attrition of higher rate loans resulting from increased competitor mail volume.
15
INTEREST VARIANCE ANALYSIS
Net interest income is affected by changes in the average interest rate
earned on earning assets and the average interest rate paid on interest-bearing
liabilities. In addition, net interest income is affected by changes in the
volume of earning assets and interest-bearing liabilities. Table 4 sets forth
the dollar amount of the increases (decreases) in interest income and interest
expense resulting from changes in the volume of earning assets and interest-
bearing liabilities and from changes in yields and rates.
TABLE 4 - INTEREST VARIANCE ANALYSIS
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 1997 VS 1996 JUNE 30, 1997 VS 1996
----------------------------------------------- -------------------------------------------------
Increase Change due to(1) Increase Change due to(1)
(in thousands) (Decrease) Volume Rate (Decrease) Volume Rate
------------ ------------- ------------- -------------- -------------- -------------
INTEREST INCOME:
Consumer loans $20,082 $27,141 $ (7,059) $52,483 $75,911 $(23,428)
Federal funds sold
and resale agreements (1,874) (2,071) 197 (4,187) (4,254) 67
Other securities 10,909 11,840 (931) 16,273 17,583 (1,310)
-------- ------- -------- ------- ------- --------
Total interest income 29,117 42,205 (13,088) 64,569 89,314 (24,745)
INTEREST EXPENSE:
Deposits (2,396) 395 (2,791) (4,502) 2,155 (6,657)
Other borrowings 4,886 5,226 (340) 3,062 3,569 (507)
Senior and deposit notes 17,821 15,184 2,637 39,814 36,944 2,870
-------- ------- -------- ------- ------- --------
Total interest expense 20,311 20,089 222 38,374 40,456 (2,082)
-------- ------- -------- ------- ------- --------
Net interest income(1) $ 8,806 $21,898 $(13,092) $26,195 $46,590 $(20,395)
======== ======= ======== ======= ======= ========
(1) The change in interest due to both volume and rates has been allocated in proportion to the relationship of the absolute
dollar amounts of the change in each. The changes in income and expense are calculated independently for each line in the
schedule. The total for the volume and rate columns are not the sum of the individual lines.
SERVICING AND SECURITIZATION INCOME
Servicing and securitization income increased $39.4 million and $81.3
million, or 36% and 34%, for the three and six months ended June 30, 1997,
respectively, from the same periods in the prior year, primarily due to average
securitized loans increasing 16% and 15% for the three and six months ended June
30, 1997, respectively, from the same periods in the prior year. This resulted
in increases in net interest income and non-interest income on securitized loans
and was offset by increased charge-offs on such loans. Net interest income on
securitized loans increased $56.0 million and $117.1 million, or 36% and 37%,
for the three and six months ended June 30, 1997, respectively, from the same
periods in the prior year, as a result of the loan growth and an increase in the
securitized portfolio's net interest margin to 9.78% and 10.12% for the three
and six months ended June 30, 1997, respectively, from 8.39% and 8.48%,
respectively, for the same periods in the prior year. This increase in net
interest margin is the result of an increase in yield on securitized loans of
176 and 181 basis points for the three and six months ended June 30, 1997,
respectively, as a result of the securitization of second generation products
and an increase in the amount of past-due fees charged as a result of both a
change in terms and an increase in the delinquency rate on securitized loans
from period to period. Non-interest income on securitized loans increased $54.2
million and $104.8 million, or 157% and 154%, for the three and six months ended
June 30, 1997, respectively, from the same periods in the prior year, as a
result of loan and account growth, the securitization of second generation
products and a change in terms of overlimit fees.
16
Charge-offs on securitized loans for the three and six months ended June 30,
1997 increased $70.7 million and $140.7 million, or 86% and 94%, respectively,
compared to the same periods in the prior year due to the increase in average
securitized loans, an increase in the average age of accounts (generally
referred to as "seasoning") and general economic trends in consumer credit
performance. See "Managed Consumer Loan Portfolio" for the effect of SFAS 125 on
servicing and securitization income.
OTHER NON-INTEREST INCOME
Other non-interest income increased 31% and 47% to $80.5 million and $153.5
million for the three and six months ended June 30, 1997, respectively, compared
to $61.5 million and $104.4 million for the same periods in the prior year. The
increase in other non-interest income was due to an increase in the average
number of accounts of 30% and 34% for the three and six months ended June 30,
1997, respectively, a shift to more fee intensive products and changes in the
terms of overlimit fees charged. Interchange income decreased $2.7 million and
$1.7 million, or 19% and 8%, to $11.4 million and $20.7 million, for the three
and six months ended June 30, 1997, respectively, compared to $14.1 million and
$22.4 million for the same periods in the prior year. These decreases were
attributable to the securitization of a higher percentage of second generation
products in 1997 compared to the prior year.
NON-INTEREST EXPENSE
Non-interest expense for the three and six months ended June 30, 1997 was
$202.1 million and $415.6 million, respectively, an increase of 27% and 32%,
over $159.3 million and $315.8 million for the same periods in the prior year.
Contributing to the increase in non-interest expense were salaries and associate
benefits expense, which rose $19.6 million and $46.0 million, or 40% and 49%, to
$69.3 million and $139.9 million for the three and six months ended June 30,
1997, respectively, compared to $49.7 million and $93.9 million for the same
periods in the prior year. This increase reflected additional staff associated
with the cost of operations to manage the growth in accounts. All other non-
interest expenses increased $23.1 million and $53.8 million, or 21% and 24%, to
$132.8 million and $275.7 million for the three and six months ended June 30,
1997, respectively, from $109.7 million and $221.9 million for the same periods
in the prior year. The increase in other non-interest expense was primarily a
result of an increase in the average number of accounts of 30% and 34% for the
three and six months ended June 30, 1997, respectively. For the three months
ended June 30, 1997, non-interest expense (excluding solicitation) decreased
$2.4 million, or 2%, to $157.0 million from $159.5 million for the three months
ended March 31, 1997, even as average accounts increased 8%, due to the benefits
of previous quarters' investments in technology, process improvements and
management of costs. For the comparable periods, associate headcount remained
flat.
INCOME TAXES
The Company's effective income tax rate increased to 38% for the three and
six months ended June 30, 1997, as compared to 37% for the same periods in the
prior year and includes both state and federal income tax components. The
increase in the effective tax rate was primarily the result of increased state
tax expense as the Company expanded its operations into multiple products and
jurisdictions.
ASSET QUALITY
The asset quality of a portfolio is generally a function of the initial
underwriting criteria used, seasoning of the accounts, account management
activities and geographic, demographic, or other forms of concentration, as well
as general economic conditions. The average age of the accounts is also an
important indicator of the delinquency and loss levels of the portfolio.
Accounts tend to exhibit a rising trend of delinquency and credit losses as they
season.
17
DELINQUENCIES
Table 5 shows the Company's consumer loan delinquency trends for the
periods presented as reported for financial statement purposes and on a managed
basis. The entire balance of an account is contractually delinquent if the
minimum payment is not received by the payment due date. However, the Company
generally continues to accrue interest until the loan is charged off.
TABLE 5 - DELINQUENCIES (1)
JUNE 30
1997 1996
-----------------------------------------------------
% OF % OF
(dollars in thousands) LOANS TOTAL LOANS LOANS TOTAL LOANS
------------ ------------ -------------- ------------
REPORTED:
Loans outstanding $ 3,623,952 100.00% $ 3,569,740 100.00%
Loans delinquent:
30-59 days 72,090 1.99 76,328 2.14
60-89 days 40,335 1.11 38,136 1.07
90 or more days 88,150 2.43 77,621 2.17
----------- ------ ----------- ------
Total $ 200,575 5.53% $ 192,085 5.38%
=========== ====== =========== ======
MANAGED:
Loans outstanding $12,737,362 100.00% $11,178,541 100.00%
Loans delinquent:
30-59 days 268,967 2.11 186,753 1.67
60-89 days 159,239 1.25 100,301 .90
90 or more days 378,621 2.97 224,746 2.01
----------- ------ ----------- ------
Total $ 806,827 6.33% $ 511,800 4.58%
=========== ====== =========== ======
(1) Includes consumer loans held for securitization.
The delinquency rate for reported loans was 5.53% as of June 30, 1997, up
from 5.38% as of June 30, 1996 and up from 5.32% as of March 31, 1997. The
delinquency rate for the total managed consumer loan portfolio was 6.33% as of
June 30, 1997, up from 4.58% as of June 30, 1996 and down from 6.41% as of March
31, 1997. The managed portfolio's delinquency rate increase as of June 30, 1997,
when compared to June 30, 1996, principally reflected the continued seasoning of
accounts and consumer loan balances, the increased presence of second generation
products and general economic trends in consumer credit performance.
18
NET CHARGE-OFFS
Net charge-offs include the principal amount of losses (excluding accrued
and unpaid finance charges, fees and fraud losses) less current period
recoveries. Table 6 presents the Company's net charge-offs for the periods
presented on a reported and managed basis.
TABLE 6 - NET CHARGE-OFFS (1)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30 JUNE 30
(dollars in thousands) 1997 1996 1997 1996
------------ ------------- ------------ -------------
REPORTED:
Average loans outstanding $ 3,996,560 $ 3,248,926 $ 4,027,458 $ 2,995,236
Net charge-offs 49,434 23,956 95,934 47,772
Net charge-offs as a percentage
of average loans outstanding 4.95% 2.95% 4.76% 3.19%
============ =========== =========== ============
MANAGED:
Average loans outstanding $12,714,870 $10,739,650 $12,637,304 $10,502,499
Net charge-offs 202,778 106,567 386,033 197,179
Net charge-offs as a percentage
of average loans outstanding 6.38% 3.97% 6.11% 3.75%
============ =========== =========== ============
(1) Includes consumer loans held for securitization.
Net charge-offs of managed loans increased $96.2 million and $188.9
million, or 90% and 96%, while average managed consumer loans grew 18% and 20%
for the three and six months ended June 30, 1997, respectively, from the same
periods in the prior year. For the three and six months ended June 30, 1997, the
Company's net charge-offs as a percentage of managed loans was 6.38% and 6.11%,
respectively, compared to 3.97% and 3.75% for the same periods in the prior
year. The increase in managed net charge-offs was the result of continued
seasoning of the portfolio, the increased presence of second generation products
and general economic trends in consumer credit performance. The increase in the
reported charge-off rate for the three and six months ended June 30, 1997
reflected less growth in the first half of 1997 versus 1996 resulting in
seasoning of the reported loan portfolio. This increase was also compounded by
general economic trends in consumer credit performance.
PROVISION AND ALLOWANCE FOR LOAN LOSSES
The provision for loan losses is the periodic expense of maintaining an
adequate allowance at the amount estimated to be sufficient to absorb possible
future losses, net of recoveries (including recovery of collateral), inherent in
the existing on-balance sheet loan portfolio. In evaluating the adequacy of the
allowance for loan losses, the Company takes into consideration several factors
including economic trends and conditions, overall asset quality, loan seasoning
and trends in delinquencies and expected charge-offs. The Company's primary
guideline is a calculation which uses current delinquency levels and other
measures of asset quality to estimate net charge-offs. Consumer loans are
typically charged off (net of any collateral) in the next billing cycle after
becoming 180 days past-due, although earlier charge-offs may occur on accounts
of bankrupt or deceased customers. Bankrupt customers' accounts are generally
charged off within 30 days after receipt of the bankruptcy petition. Once a
loan is charged off, it is the Company's policy to continue to pursue the
collection of principal and interest for non-bankrupt accounts.
19
Management believes that the allowance for loan losses is adequate to cover
anticipated losses in the on-balance sheet consumer loan portfolio under current
conditions. There can be no assurance as to future credit losses that may be
incurred in connection with the Company's consumer loan portfolio, nor can there
be any assurance that the loan loss allowance that has been established by the
Company will be sufficient to absorb such future credit losses. The allowance is
a general allowance applicable to the on-balance sheet consumer loan portfolio.
Table 7 sets forth the activity in the allowance for loan losses for the periods
indicated. See "Asset Quality," "Delinquencies" and "Net Charge-Offs" for a more
complete analysis of asset quality.
TABLE 7 - SUMMARY OF ALLOWANCE FOR LOAN LOSSES
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30 JUNE 30
(dollars in thousands) 1997 1996 1997 1996
--------------------- --------------------
Balance at beginning of period $118,500 $ 74,000 $ 118,500 $ 72,000
Provision for loan losses 46,776 25,110 95,963 50,278
Transfer from (to) loans held for 33 (5,984) (2,654) (8,109)
securitization
Charge-offs (52,628) (22,502) (103,829) (46,633)
Recoveries 5,819 3,376 10,520 6,464
-------- -------- --------- --------
Net charge-offs(1) (46,809) (19,126) (93,309) (40,169)
-------- -------- --------- --------
Balance at end of period $118,500 $ 74,000 $ 118,500 $ 74,000
======== ======== ========= ========
Allowance for loan losses to loans at period-end(1) 3.27% 2.88% 3.27% 2.88%
-------- -------- --------- --------
(1) Excludes consumer loans held for securitization.
For the three and six months ended June 30, 1997, respectively, the
provision increased to $46.8 million and $96.0 million, from $25.1 million and
$50.3 million for the comparable periods in the prior year. This increase is due
to an increase in the average reported loan balance of 23% and 34%, to $4.0
billion for the three and six months ended June 30, 1997, respectively, from
$3.2 and $3.0 billion for the comparable periods of the prior year, and
increases in the net charge-off rate resulting from continued loan seasoning and
general economic trends in consumer credit performance.
LIQUIDITY AND FUNDING
Liquidity refers to the Company's ability to meet its cash needs. The
Company meets its cash requirements by securitizing assets and by debt funding.
As discussed in "Managed Consumer Loan Portfolio," a significant source of
liquidity for the Company has been the securitization of consumer loans.
Maturity terms of the existing securitizations vary from 1997 to 2002
(extendible to 2004) and typically have accumulation periods during which
principal payments are aggregated to make payments to investors. As payments on
the loans are accumulated for the participants in the securitization and are no
longer reinvested in new loans, the Company's funding requirements for such new
loans increase accordingly. The occurrence of certain events may cause the
securitization transactions to amortize earlier than scheduled which would
accelerate the need for funding.
As such loans amortize or are otherwise paid, the Company's funding needs
will increase accordingly. The Company believes that it can securitize consumer
loans, purchase federal funds and establish other funding sources to fund the
amortization or other payment of the securitizations in the future, although no
assurance can be given to that effect.
20
Additionally, the Company maintains a portfolio of high-quality securities
such as U.S. Government, U.S. Government Agency mortgage-backed securities,
commercial paper, interest-bearing deposits with other banks, federal funds and
other cash equivalents in order to provide adequate liquidity and to meet its on
going cash needs. As of June 30, 1997, the Company held $1.6 billion in such
securities.
Table 8 shows the maturation of certificates of deposit in denominations of
$100,000 or greater ("large denomination CDs") as of June 30, 1997.
TABLE 8 - MATURITIES OF LARGE DENOMINATION CERTIFICATES $100,000 OR MORE
JUNE 30, 1997
(dollars in thousands) BALANCE PERCENT
---------- -------
3 months or less $ 71,981 22.64%
Over 3 through 6 months 177,000 55.68
Over 6 through 12 months 67,427 21.21
Over 1 through 5 years 1,500 .47
-------- -------
Total $317,908 100.00%
======== =======
In addition to large denomination CDs, as of June 30, 1997 retail deposits
of $552 million had been raised as an additional source of funding.
The Company's other borrowings portfolio consists of $254 million in
borrowings maturing within one year and $40 million in borrowings maturing after
one year.
On November 25, 1996, the Company entered into a four-year, $1.7 billion
unsecured revolving credit arrangement (the "Credit Facility"). The Credit
Facility is comprised of two tranches: a $1.375 billion Tranche A facility
available to the Bank and the Savings Bank, including an option for up to $225
million in multi-currency availability, and a $325 million Tranche B facility
available to the Corporation, the Bank and the Savings Bank, including an option
for up to $100 million in multi-currency availability. Each tranche under the
facility is structured as a four-year commitment and is available for general
corporate purposes. The borrowings of the Savings Bank are limited to $500
million during the first year of the Credit Facility, and $750 million
thereafter. The Bank has irrevocably undertaken to honor any demand by the
lenders to repay any borrowings which are due and payable by the Savings Bank
but which have not been paid. Any borrowings under the Credit Facility will
mature on November 24, 2000; however, the final maturity of each tranche may be
extended for three additional one-year periods. The Company had no outstanding
balance on its $1.7 billion revolving credit arrangement as of June 30, 1997.
The unused commitment is available as funding needs may arise.
On April 30, 1997, the Bank increased the aggregate amount of bank notes
available for issuance under its bank note program. Under the program, the Bank
may issue from time to time up to $7.8 billion of senior bank notes with
maturities from 30 days to 30 years and up to $200 million of subordinated bank
notes with maturities from 5 to 30 years. As of June 30, 1997, the Company had
$3.3 billion in senior bank notes outstanding and no subordinated bank notes had
been issued.
On September 19, 1996, the Corporation filed a $200 million shelf
registration statement ($125 million of senior debt securities issued as of June
30, 1997) with the Securities and Exchange Commission under which the
Corporation from time to time may offer and sell (i) senior or subordinated
debt securities consisting of debentures, notes and/or other unsecured
evidences, (ii) preferred stock, which may be issued in the form of depository
shares evidenced by depository receipts and (iii) common
21
stock. The securities will be limited to $200 million aggregate public offering
price or its equivalent (based on the applicable exchange rate at the time of
sale) in one or more foreign currencies, currency units of composite currencies
as shall be designated by the Corporation.
On April 30, 1996, the Bank established a deposit note program under which
the Bank may issue from time to time up to $2.0 billion of deposit notes with
maturities from 30 days to 30 years from the date of issue. As of June 30,
1997, the Company had $300 million in deposit notes outstanding.
On January 28, 1997, Capital One Capital I, a subsidiary of the Bank
created as a Delaware statutory business trust, issued $100 million aggregate
amount of Floating Rate Junior Subordinated Capital Income Securities that
mature on February 1, 2027. The securities represent a preferred beneficial
interest in the assets of the trust. The net proceeds of the offering of $97
million were lent to the Bank for general corporate purposes.
In January 1996, the Company implemented a dividend reinvestment and stock
purchase plan (the "DRIP") to provide existing stockholders with the opportunity
to purchase additional shares of the Company's common stock by reinvesting
quarterly dividends or making optional cash investments. The Company uses
proceeds from the DRIP for general corporate purposes.
On July 10, 1997, the Company's Board of Directors voted to repurchase up
to two million shares of the Company's common stock over the next two years in
order to mitigate the impact of shares issuable under its benefit plans,
including its dividend reinvestment and stock purchase plan, associate stock
purchase plan and its option programs.
The Savings Bank has entered into an agreement pursuant to which it will
acquire the national retail deposit franchise of JCPenney National Bank. Retail
deposit balances acquired under this agreement are expected to be approximately
$425 million and the acquisition is expected to close in early October, subject
to fulfillment with the terms and conditions of the agreement.
CAPITAL ADEQUACY
The Bank and the Savings Bank are subject to capital adequacy guidelines
adopted by the Federal Reserve Board ("Federal Reserve") and the Office of
Thrift Supervision (the "OTS") (collectively, the "regulators"), respectively.
The capital adequacy guidelines and the regulatory framework for prompt
corrective action require the Bank and the Savings Bank to attain specific
capital levels based upon quantitative measures of their assets, liabilities and
off-balance sheet items as calculated under Regulatory Accounting Principles.
The inability to meet and maintain minimum capital adequacy levels could result
in regulators taking actions that could have a material effect on the Company's
consolidated financial statements. Additionally, the regulators have broad
discretion in applying higher capital requirements. Regulators consider a range
of factors in determining capital adequacy, such as an institution's size,
quality and stability of earnings, interest rate risk exposure, risk
diversification, management expertise, asset quality, liquidity and internal
controls.
22
The most recent notifications from the regulators categorized the Bank and
the Savings Bank as "well capitalized". The Bank must maintain minimum Tier 1
Capital, Total Capital and Tier 1 Leverage ratios of 4%, 8% and 4%, and the
Savings Bank must maintain minimum Tangible Capital, Total Capital and Core
Capital ratios of 1.5%, 8% and 3%, respectively, under capital adequacy
requirements, and both must maintain minimum ratios of 6%, 10% and 5%,
respectively, to be well capitalized under the regulatory framework for prompt
corrective action. As of June 30, 1997, the Bank's Tier 1 Capital, Total
Capital and Tier 1 Leverage ratios were 11.02%, 13.93% and 11.16%, respectively.
As of June 30, 1997, the Savings Bank's Tangible Capital, Total Capital and Core
Capital ratios were 13.33%, 20.49% and 13.33%, respectively. In addition, the
Savings Bank is subject for the first three years of its operations to
additional capital requirements, including the requirement to maintain a minimum
Total Capital ratio of 12% and a Core Capital ratio of 8%. As of June 30, 1997,
there are no conditions or events since the notifications discussed above that
Management believes have changed either the Bank's or the Savings Bank's capital
category. As of June 30, 1997, the Bank's and the Savings Bank's ratio of
common equity to managed assets was 4.51% and 9.76%, respectively.
During 1996, the Bank received regulatory approval and established a branch
office in the United Kingdom. In connection with such approval, the Company
committed to the Federal Reserve Board that, for so long as the Bank maintains
such branch in the United Kingdom, the Company will maintain a minimum Tier 1
leverage ratio of 3.0%. As of June 30, 1997, the Company's Tier 1 leverage
ratio was 14.00%.
Additionally, certain regulatory restrictions exist which limit the ability
of the Bank and the Savings Bank to transfer funds to the Corporation. As of
June 30, 1997, retained earnings of the Bank and the Savings Bank of $69.0
million and $34.6 million, respectively, were available for payment of dividends
to the Corporation, without prior approval by the regulators. The Savings Bank
is required to give the OTS at least 30 days' advance notice of any proposed
dividend.
OFF-BALANCE SHEET RISK
The Company is subject to off-balance sheet risk in the normal course of
business including commitments to extend credit, excess servicing income from
securitization transactions and interest rate swap agreements ("swaps"). In
order to reduce interest rate sensitivity and to match asset and liability
repricings, the Company has entered into swaps which involve elements of credit
or interest rate risk in excess of the amount recognized on the balance sheet.
Swaps present the Company with certain credit, market, legal and operational
risks. The Company has established credit policies for off-balance sheet items
as it does for on-balance sheet instruments.
As of June 30, 1997, the Company had $3.2 billion in notional amount of
swaps. The Company evaluates its overall sensitivity to interest rates by
reviewing its asset and liability repricings and the impact of anticipated
transactions. In determining the Company's swap position, management considers
this overall sensitivity to interest rates and makes adjustments as necessary to
meet the Company's objectives. During the three months ended June 30, 1997, the
Company entered into $1.6 billion of interest rate swaps to effectively offset
existing swaps related to underlying bank notes and fixed rate securitization
transactions. The original swaps which pay variable and receive fixed rates
were directly offset by swaps of matching notional amount and terms which pay
fixed and receive variable rates. The fair value, based on the forward yield
curve, as of June 30, 1997 of swap positions for which the Company is exposed to
credit risk from highly rated counterparties is approximately $13.9 million.
23
Tables 9 and 10 reflect the maturity and activity of swap positions,
respectively, as of June 30, 1997 and for the three and six months ended June
30, 1997 and 1996.
TABLE 9 - MATURITY OF INTEREST RATE SWAPS
JUNE 30, 1997
-------------------------------------------------
OVER ONE
WITHIN THROUGH AVERAGE
ONE FIVE LIFE
(dollars in millions) YEAR YEARS TOTAL (YEARS)
--------- ---------- ---------- -----------
Receive fixed/pay floating:
Notional amount $ 789 $ 791 $1,580 1.02
Weighted average rates received(1) 6.95% 7.60% 7.28%
Weighted average rates paid(1) 5.80 5.78 5.79
Receive floating/pay fixed:
Notional amount $ 789 $ 791 $1,580 1.02
Weighted average rates received(1) 5.80% 5.78% 5.79%
Weighted average rates paid(1) 6.05 6.59 6.32
====== ====== ====== ======
(1) Weighted average rates received and paid are based on the contractual
rates in effect as of June 30, 1997. Floating rates under the interest rate
swap contracts are based on varying terms of LIBOR.
TABLE 10 - SUMMARY OF INTEREST RATE SWAPS
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30 JUNE 30
(in millions) 1997 1996 1997 1996
-------- -------- -------- --------
NOTIONAL AMOUNT NOTIONAL AMOUNT
Receive fixed/pay floating:
Beginning of period $1,580 $2,104 $2,104 $2,144
Maturities 524 40
-------- -------- -------- --------
End of period $1,580 $2,104 $1,580 $2,104
======== ======== ======== ========
Receive floating/pay fixed:
Beginning of period
Additions $1,580 $1,580
-------- -------- -------- --------
End of period $1,580 $1,580
======== ======== ======== ========
Receive floating/pay floating:
Beginning of period $ 260 $ 260
-------- -------- -------- --------
End of period $ 260 $ 260
======== ======== ======== ========
24
BUSINESS OUTLOOK
This business outlook section summarizes the Company's expectations for
earnings for the year ending December 31, 1997 and its primary goals and
strategies for continued growth. The statements contained in this section are
based on management's current expectations. Certain of the statements are
forward looking statements and, therefore, actual results could differ
materially. Factors which could materially influence results are set forth in
the last paragraph of this section and in the Company's Annual Report on Form
10-K for the year ended December 31, 1996 (Part I, Item 1, Cautionary
Statements).
The Company has revised its previous earnings target and set a new target,
dependent on the factors discussed below, for its earnings per share for the
year ending December 31, 1997 to increase by approximately 5% to 10% over
earnings per share for the year ended December 31, 1996, which was $2.30 per
share. As discussed elsewhere in this report and below, the Company's actual
earnings are a function of its revenues (net interest income and non-interest
income on its earning assets), consumer usage and payment patterns, credit
quality of its earning assets (which affects fees and charge-offs), solicitation
expenses and operating expenses.
The Company's actual earnings are particularly sensitive to delinquencies
and charge-offs on the Company's portfolio and on the level of attrition from
increased competition in the credit card industry. The Company's expectations
for 1997 earnings are based on management's expectations for a higher number of
delinquent accounts in the second half of the year primarily due to seasonal
factors, which would result in increased past-due and overlimit fee revenue. In
the first half of 1997, the Company experienced a lower number of delinquent
accounts than management had expected based on the seasonal trends experienced
in previous years. As a result, fee revenue was lower than originally
anticipated. It is still not certain whether delinquencies will remain lower
than expected or, return to the higher historic seasonal pattern. Management
believes that continued lower delinquencies should eventually result in reduced
charge-offs; however, in the short term, the current trend continues to result
in less fee income. Moreover, management cautions that the relationship between
delinquencies and charge-offs has been changing over the past few years, and
delinquency rates are rising at a lesser rate than charge-offs in the industry
in general as well as in the Company's portfolio. In addition, competition in
the credit card industry, as measured by the volume of mail solicitations,
remains very high. Increased competition can affect the Company's earnings by
increasing the attrition of the Company's outstanding loans (thereby reducing
interest income) and by making it more difficult to attract more profitable
customers.
The Company's strategy for future growth has been, and is expected to
continue to be, to apply its proprietary IBS to its credit card business as well
as to other businesses, both financial and non-financial, to identify new
product opportunities and to make informed investment decisions regarding its
existing products. See the Company's Annual Report on Form 10-K for the year
ended December 31, 1996 for a further description of the Company's IBS (Part I,
Item 1, Business).
Historically, the Company has concentrated its efforts on credit card
opportunities. These opportunities have included, and are expected to continue
to include, various first generation low-rate balance transfer products, as well
as second generation credit card products. Generally, these second generation
products tend to have lower credit lines, balances that build over time, less
attrition, higher margins (including fees), higher operational costs and, in
some cases, higher delinquencies and credit losses than the Company's
traditional low rate balance transfer products. In general, these second
generation products have had overall higher returns than the traditional balance
transfer products in recent market conditions. However, these second generation
products are also subject to competitive
25
pressures, which management anticipates will increase as this market matures.
The Company uses its IBS in an effort to balance the mix of credit card products
to optimize profitability within the context of acceptable risk. The Company
continues to test market a wide variety of first and second generation credit
card products. The Company believes that this testing approach will enable it
to react effectively as general market conditions change. In this manner, the
Company intends to remain flexible in the allocation of marketing expenses spent
on specific products to take advantage of market opportunities as they emerge
and will make its marketing decisions based on the then current market
conditions. As a result, the Company expects to continue to offer a variety of
first and second generation credit card products; however, the mix of such
products in the Company's portfolio may vary significantly over time.
The Company anticipates that its 1997 solicitation (marketing) expenses
will approximate such expenses in 1996, as the Company continues to invest in
existing and new first and second generation products as marketing opportunities
develop. These opportunities are subject to a variety of external and internal
factors that may affect the actual amount of solicitation expense, such as
competition in the credit card industry, general economic conditions affecting
consumer credit performance and the asset quality of the Company's portfolio.
Moreover, the first generation and second generation products have different
account growth, loan growth and asset quality characteristics. The Company
currently expects that its growth in consumer accounts will continue in the
second half of 1997 and that its growth in managed consumer loans will resume in
the second half of 1997. Actual growth, however, may vary significantly
depending on the actual mix of products that the Company may offer in 1997.
Actual growth also will depend on the level of attrition on the Company's
managed portfolio which is affected by competitive pressures.
The Company currently expects delinquencies to increase modestly in the
second half of the year and the net charge-off rate of its portfolio to continue
to increase as further discussed below. The delinquency and net charge-off rate
of the Company's consumer loan portfolio are directly correlated to general
economic trends in consumer credit performance. Charge-off rates are also
impacted by increasing bankruptcies. The rates of delinquencies and charge-offs
in the credit card industry are currently at record high levels and are expected
by most industry observers to increase. The actual amount of increases in the
Company's delinquencies and charge-offs will be affected not only by these
general economic trends but by continued seasoning of the Company's portfolio
and the product mix. As delinquency levels fluctuate, the resulting amount of
past-due and overlimit fees, which are significant sources of revenue for the
Company, will also fluctuate. Further, the timing of revenues from increasing
or decreasing delinquencies precedes the related revenue impact of higher or
lower charge-offs that ultimately result from varying levels of delinquencies.
As discussed above, the Company's earnings results are sensitive to delinquency
levels (and the lower past-due and overlimit fees associated with lower
delinquencies). As a result, if delinquencies do not increase as anticipated
additional pressure will be placed on the Company's ability to meet its 1997
expectations.
To the extent the Company markets first generation products and experiences
greater consumer loan growth, delinquency and net charge-off rates will be less,
as delinquencies and net charge-off characteristics of new portfolios generally
are lower than more seasoned portfolios. However, because second generation
products generally have higher delinquencies and net charge-offs than first
generation products, to the extent the Company increases the proportion of
second generation products in its portfolio, delinquency and net charge-off
rates will be greater. These factors notwithstanding, the Company believes that
the credit quality of its portfolio is enhanced as a result of the application
of IBS.
The Company also has been applying, and expects to continue applying, its
IBS to other financial products and non-financial products ("third generation
products"), as well as to the expansion of its existing operations outside of
the United States. The Company has established the Savings Bank
26
and several non-bank operating subsidiaries to identify and explore these
opportunities. The Company is in various stages of developing and test
marketing a number of new products and services including, but not limited to,
selected non-card consumer lending products and the reselling of
telecommunication services. During 1996, the Company allocated an increased
percentage of its marketing expenses to non-card products or services. To date,
only a relatively small dollar percentage of assets and accounts have been
generated as a result of such expenditures. The Company is also in various
stages of developing and test marketing credit card and other products outside
of the United States. As the Company continues to apply its IBS to non-card
opportunities and builds the infrastructure necessary to support new businesses
and expansion of existing businesses in other countries, the Company expects
that it may increase the percentage of its 1997 marketing and operating expenses
attributable to third generation products.
The Company expects to maintain a flexible approach to its marketing
investment. The Company intends to continue applying its IBS to all products,
even established products and businesses, and the results of ongoing testing
will influence the amount and allocation of future marketing investments.
Management believes that, through the continued application of IBS, the Company
can develop product and service offerings to sustain growth and that it has the
personnel, financial resources and business strategy necessary for continued
success. However, as the Company attempts to apply IBS to diversify and expand
its product offerings beyond credit cards, there can be no assurance that the
historical financial information of the Company will necessarily reflect the
results of operations and financial condition of the Company in the future. The
Company's actual results will be influenced by, among other things, the factors
discussed in this section.
The Company's strategies and objectives outlined above and the other
forward looking statements contained in this section involve a number of risks
and uncertainties. The Company cautions readers that any forward looking
information is not a guarantee of future performance and that actual results
could differ materially. In addition to the factors discussed above, among the
other factors that could cause actual results to differ materially are the
following: continued intense competition from numerous providers of products
and services which compete with the Company's businesses; with respect to
financial products, changes in the Company's aggregate accounts or consumer loan
balances and the growth rate thereof, including changes resulting from factors
such as shifting product mix, amount of actual marketing expenses made by the
Company and attrition of accounts and loan balances; an increase in credit
losses (including increases due to a worsening of general economic conditions);
difficulties or delays in the development, production, testing and marketing of
new products or services; losses associated with new products or services;
financial, legal, regulatory or other difficulties that may affect investment
in, or the overall performance of, a product or business, including changes in
existing laws to regulate further the credit card and consumer loan industry and
the financial services industry, in general; the amount of, and rate of growth
in, the Company's expenses (including associate and marketing expenses) as the
Company's business develops or changes or as it expands into new market areas;
the availability of capital necessary to fund the Company's new businesses; the
ability of the Company to build the operational and organizational
infrastructure necessary to engage in new businesses; the ability of the Company
to recruit experienced personnel to assist in the management and operations of
new products and services; and other factors listed from time to time in the
Company's SEC reports, including but not limited to the Annual Report on Form
10-K for the year ended December 31, 1996 (Part I, Item 1, Cautionary
Statements).
27
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
- -------
(a) Exhibits:
Exhibit 11-Computation of Per Share Earnings Page 29
(B) Reports on Form 8-K
None
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: August 14, 1997 /s/ James M. Zinn
---------------------------------
James M. Zinn
Senior Vice President,
Chief Financial Officer
(Chief Accounting Officer
and duly authorized officer
of the Registrant)
28
EXHIBIT 11
CAPITAL ONE FINANCIAL CORPORATION
COMPUTATION OF PER SHARE EARNINGS
THREE AND SIX MONTHS ENDED JUNE 30, 1997 AND 1996
(dollars in thousands, except per share data)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30 JUNE 30
1997 1996 1997 1996
------------ ----------- ----------- -----------
PRIMARY
Net income $ 39,352 $ 38,183 $ 81,834 $ 76,196
=========== =========== =========== ===========
WEIGHTED AVERAGE COMMON AND COMMON
EQUIVALENT SHARES OUTSTANDING
Average common shares outstanding 66,428,302 66,210,275 66,381,820 66,185,555
Net effect of dilutive restricted stock(1) 2,883 7,238 3,790 11,149
Net effect of dilutive stock options(1) 1,300,920 674,354 1,439,371 615,726
----------- ----------- ----------- -----------
Weighted average common and
common equivalent shares 67,732,105 66,891,867 67,824,981 66,812,430
=========== =========== =========== ===========
EARNINGS PER SHARE $ .58 $ .57 $ 1.21 $ 1.14
=========== =========== =========== ===========
FULLY DILUTED
Net income $ 39,352 $ 38,183 $ 81,834 $ 76,196
=========== =========== =========== ===========
WEIGHTED AVERAGE COMMON AND COMMON
EQUIVALENT SHARES OUTSTANDING
Average common shares outstanding 66,428,302 66,210,275 66,381,820 66,185,555
Net effect of dilutive restricted stock(2) 3,310 8,273 4,561 11,300
Net effect of dilutive stock options(2) 1,497,979 674,354 1,497,979 661,600
----------- ----------- ----------- -----------
Weighted average common and
common equivalent shares 67,929,591 66,892,902 67,884,360 66,858,455
=========== =========== =========== ===========
EARNINGS PER SHARE $ .58 $ .57 $ 1.21 $ 1.14
=========== =========== =========== ===========
(1) Based on the treasury stock method using average market price.
(2) Based on the treasury stock method using the higher of ending or average market price.
The calculations of common and common equivalent earnings per share and
fully diluted earnings per share are submitted in accordance with the Securities
Exchange Act of 1934 Release No. 9083 although both calculations are not
required by footnote 2 to paragraph 14 of APB Opinion No. 15 because there
is dilution of less than 3%. The registrant has elected to show fully
diluted earnings per share in its financial statements .
29
5
1,000
3-MOS
DEC-31-1997
APR-01-1997
JUN-30-1997
136,112
1,142,328
3,623,952
(118,500)
0
0
181,078
0
6,159,435
0
0
0
0
665
820,965
6,159,435
0
395,912
0
202,055
0
46,776
83,611
63,470
24,118
39,352
0
0
0
39,352
.58
.58
NON-CLASSIFIED BALANCE SHEET
PP&E SHOWN NET
