UNITED 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, 1998
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
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(Exact name of registrant as specified in its charter)
Delaware 54-1719854
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(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
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(Address of principal executive offices) (Zip Code)
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(703) 205-1000
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(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
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As of July 31, 1998, there were 66,074,304 shares of the registrant's Common
Stock, par value $.01 per share, outstanding.
CAPITAL ONE FINANCIAL CORPORATION
FORM 10-Q
INDEX
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June 30, 1998
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 the Condensed Consolidated Financial
Statements............................................. 7
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of
Operations............................................... 11
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.............................. 29
Signatures.................................................... 29
Item 1.
CAPITAL ONE FINANCIAL CORPORATION
Condensed Consolidated Balance Sheets
(dollars in thousands, except per share data) (unaudited)
June 30 December 31
1998 1997
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Assets:
Cash and due from banks $ 8,463 $ 5,039
Federal funds sold and resale agreements 173,500
Interest-bearing deposits at other banks 30,926 59,184
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Cash and cash equivalents 39,389 237,723
Securities available for sale 1,431,091 1,242,670
Consumer loans 5,140,340 4,861,687
Less: Allowance for loan losses (213,000) (183,000)
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Net loans 4,927,340 4,678,687
Premises and equipment, net 188,727 162,726
Interest receivable 45,866 51,883
Accounts receivable from securitizations 836,274 588,781
Other 182,751 115,809
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Total $ 7,651,438 $ 7,078,279
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Liabilities:
Interest-bearing deposits $ 1,287,402 $ 1,313,654
Other borrowings 959,480 796,112
Senior notes 3,709,404 3,332,778
Deposit notes 99,996 299,996
Interest payable 83,167 68,448
Other 345,037 276,368
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Total liabilities 6,484,486 6,087,356
Guaranteed Preferred Beneficial Interests In
Capital One Bank's Floating Rate Junior
Subordinated Capital Income Securities: 97,791 97,664
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, 66,558,730 and 66,557,230
issued as of June 30, 1998 and December 31, 1997, respectively 666 666
Paid-in capital, net 561,518 513,561
Retained earnings 547,485 425,140
Cumulative other comprehensive income 3,421 2,539
Less: Treasury stock, at cost; 1,020,608 and 1,188,134
shares as of June 30, 1998 and December 31, 1997,
respectively (43,929) (48,647)
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Total stockholders' equity 1,069,161 893,259
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Total liabilities and stockholders' equity $ 7,651,438 $ 7,078,279
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See notes to the condensed consolidated financial statements.
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
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1998 1997 1998 1997
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Interest Income:
Consumer loans, including fees $ 245,129 $ 143,485 $ 474,767 $ 289,997
Federal funds sold and resale agreements 2,140 2,613 7,218 8,277
Other 24,169 20,772 47,495 37,190
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Total interest income 271,438 166,870 529,480 335,464
Interest Expense:
Deposits 13,635 8,635 27,773 19,072
Other borrowings 20,375 10,453 36,428 16,977
Senior and deposit notes 67,704 64,523 130,733 127,959
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Total interest expense 101,714 83,611 194,934 164,008
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Net interest income 169,724 83,259 334,546 171,456
Provision for loan losses 59,013 46,776 144,879 95,963
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Net interest income after provision for loan losses 110,711 36,483 189,667 75,493
Non-Interest Income:
Servicing and securitizations 155,412 148,562 324,067 318,595
Service charges 128,191 57,278 241,515 110,926
Interchange 20,371 11,405 35,170 20,720
Other 24,979 11,797 44,100 21,858
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Total non-interest income 328,953 229,042 644,852 472,099
Non-Interest Expense:
Salaries and associate benefits 113,428 69,287 221,381 139,923
Marketing 85,811 44,995 160,811 99,046
Communications and data processing 34,840 24,320 64,203 46,110
Supplies and equipment 32,368 18,406 54,983 36,479
Occupancy 11,090 7,388 21,734 15,189
Other 54,299 37,659 97,607 78,855
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Total non-interest expense 331,836 202,055 620,719 415,602
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Income before income taxes 107,828 63,470 213,800 131,990
Income taxes 40,975 24,118 81,244 50,156
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Net income $ 66,853 $ 39,352 $ 132,556 $ 81,834
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Basic earnings per share $ 1.02 $ 0.59 $ 2.02 $ 1.23
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Diluted earnings per share $ 0.96 $ 0.58 $ 1.92 $ 1.21
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Dividends paid per share $ 0.08 $ 0.08 $ 0.16 $ 0.16
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See notes to the condensed consolidated financial statements.
CAPITAL ONE FINANCIAL CORPORATION
Condensed Consolidated Statements of Changes in Stockholders' Equity
(dollars in thousands, except per share data) (unaudited)
Cumulative
Other Total
Common Stock Paid-In Retained Comprehensive Treasury Stockholders'
Shares Amount Capital, Net Earnings Income Stock Equity
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Balance, December 31, 1996 66,325,261 $ 663 $ 481,383 $ 256,396 $ 1,949 $ 740,391
Comprehensive income:
Net income 81,834 81,834
Other comprehensive income, net of income tax
Unrealized gains on securities net of income (1,651) (1,651)
taxes of $857
Foreign currency translation adjustments 153 153
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Other comprehensive income ( 1,498) (1,498)
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Comprehensive income 80,336
Cash dividends - $.16 per share (10,334) (10,334)
Issuances 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) 54 54
Common stock issuable
under incentive plan 6,462 6,462
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Balance, June 30, 1997 66,484,610 $ 665 $ 491,953 $ 327,896 $ 451 $ 820,965
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Balance, December 31, 1997 66,557,230 $ 666 $ 513,561 $ 425,140 $ 2,539 $ (48,647) $ 893,259
Comprehensive income:
Net income 132,556 132,556
Other comprehensive income, net of income tax
Unrealized gains on securities net of income
taxes of $839, net of reclassification
adjustment of $27, net of income taxes of $17 1,370 1,370
Foreign currency translation adjustments (488) (488)
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Other comprehensive income 882 882
----------
Comprehensive income 133,438
Cash dividends - $.16 per share (10,211) (10,211)
Purchases of treasury stock (12,354) (12,354)
Issuances of common stock 670 2,764 3,434
Exercise of stock options 1,500 (9,506) 14,308 4,802
Tax benefit from stock awards 280 280
Restricted stock, net 18 18
Common stock issuable
under incentive plan 56,495 56,495
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Balance, June 30, 1998 66,558,730 $ 666 $ 561,518 $ 547,485 $ 3,421 $ (43,929) $ 1,069,161
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See notes to the condensed consolidated financial statements.
CAPITAL ONE FINANCIAL CORPORATION
Condensed Consolidated Statements of Cash Flows
(in thousands) (unaudited)
Six Months Ended
June 30
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1998 1997
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Operating Activities:
Net income $ 132,556 $ 81,834
Adjustments to reconcile net income to cash provided by operating activities:
Provision for loan losses 144,879 95,963
Depreciation and amortization, net 35,552 23,929
Stock compensation plans 56,513 6,516
Decrease in interest receivable 6,017 30,455
Increase in accounts receivable from securitizations (247,493) (226,718)
Increase in other assets (72,871) (28,136)
Increase (decrease) in interest payable 14,719 (8,101)
Increase in other liabilities 68,669 57,889
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Net cash provided by operating activities 138,541 33,631
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Investing Activities:
Purchases of securities available for sale (706,466) (653,916)
Proceeds from maturities of securities available for sale 423,726 396,580
Proceeds from sales of securities available for sale 102,269
Proceeds from securitization of consumer loans 1,628,598 1,031,456
Net increase in consumer loans (2,051,538) (417,989)
Recoveries of loans previously charged off 29,408 10,520
Additions of premises and equipment, net (61,515) (31,221)
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Net cash (used for) provided by investing activities (635,518) 335,430
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Financing Activities:
Net decrease in interest-bearing deposits (26,252) (73,221)
Net increase (decrease) in other borrowings 163,368 (237,249)
Issuances of senior notes 1,009,522 480,000
Maturities of senior and deposit notes (833,666) (705,436)
Issuances of preferred beneficial interests 97,428
Proceeds from exercise of stock options 4,802 1,413
Net proceeds from issuances of common stock 3,434 2,422
Purchases of treasury stock (12,354)
Dividends paid (10,211) (10,334)
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Net cash provided by (used for) financing activities 298,643 (444,977)
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Decrease in cash and cash equivalents (198,334) (75,916)
Cash and cash equivalents at beginning of period 237,723 528,976
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Cash and cash equivalents at end of period $ 39,389 $ 453,060
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See notes to the condensed consolidated financial statements.
CAPITAL ONE FINANCIAL CORPORATION
Notes to the Condensed Consolidated Financial Statements June 30, 1998
(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 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 these estimates. Operating results for the three and six
months ended June 30, 1998 are not necessarily indicative of the results for the
year ending December 31, 1998. The notes to the consolidated financial
statements contained in the Annual Report on Form 10-K for the year ended
December 31, 1997 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 1998 presentation.
Note B: Significant Accounting Policies
Cash and Cash Equivalents
Cash paid for interest for the six months ended June 30, 1998 and 1997 was
$180,215 and $172,109, respectively. Cash paid for income taxes for the six
months ended June 30, 1998 and 1997 was $136,275 and $64,095, respectively.
Consumer Loans
In the fourth quarter of 1997, the Company recognized the estimated
uncollectible portion of finance charge and fee income receivables. In addition,
in the fourth quarter of 1997, the Company modified its methodology for charging
off credit card loans (net of any collateral) to 180 days past-due, from the
prior practice of charging off loans during the next billing cycle after
becoming 180 days past-due.
Earnings Per Share
In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings per
Share" ("SFAS 128") which became effective for periods ending after December 15,
1997, including interim periods. SFAS 128 replaced the calculation of primary
and fully diluted earnings per share with basic and diluted earnings per share.
Unlike primary earnings per share, basic earnings per share is based only on the
weighted average number of common shares outstanding, excluding any dilutive
effects of options and restricted stock. Diluted earnings per share is similar
to the previously reported fully diluted earnings per share and is based on the
weighted average number of common and common equivalent shares, including
dilutive stock options and restricted stock outstanding during the year.
Earnings per share amounts for all prior periods have been restated to conform
to SFAS 128 requirements.
Comprehensive Income
As of January 1, 1998, the Company adopted SFAS No. 130, "Reporting
Comprehensive Income" ("SFAS 130"), which establishes new rules for the
reporting and display of comprehensive income and its components. SFAS 130
requires unrealized gains or losses on available-for-sale securities and foreign
currency translation adjustments, which prior to adoption were reported
separately in stockholders' equity, to be included in other comprehensive
income. The adoption of SFAS 130 had no impact on the Company's net income or
stockholders' equity. Prior year amounts have been reclassified to conform to
SFAS 130 requirements.
Note C: Borrowings
In July 1998, the Corporation filed a Shelf Registration Statement on Form
S-3 with the Securities and Exchange Commission for the issuance of up to
$425,000 aggregate principal amount of senior and subordinated debt, preferred
stock and common stock, which was declared effective on July 14, 1998. In July
1998, the Corporation issued $200,000 of 10-year unsecured senior notes under
this shelf registration. Existing unsecured senior debt outstanding of the
Corporation under a prior shelf registration of $200,000 totals $125,000
maturing in 2003.
Note D: Comprehensive Income
Comprehensive income for the three months ended June 30, 1998 and 1997 was as
follows:
Three Months Ended
June 30
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1998 1997
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Comprehensive Income:
Net income $ 66,853 $ 39,352
Other comprehensive income 1,096 3,194
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Total comprehensive income $ 67,949 $ 42,546
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Note E: Associate Stock Plans
In April 1998, stockholders approved an increase of 3,250,000 shares
available for issuance under the 1994 Stock Incentive Plan. With this approval,
a December 18, 1997 grant ("EntrepreneurGrant II") to senior management became
effective at the then market price of $48.75 per share. Included in this grant
were 1,143,221 performance-based options granted to certain key managers
(including 685,755 options to the Company's Chief Executive Officer ("CEO") and
Chief Operating Officer ("COO") ), which vested in April 1998 when the market
price of the Company's stock remained at or above $84.00 for at least ten
trading days in a 30 consecutive calendar day period. The remaining 223,900 of
the options included in this grant vest in full, regardless of the stock price,
on December 18, 2000 or earlier upon a change of control of the Company.
In June 1998, the Company's Board of Directors approved a grant to senior
management ("EntrepreneurGrant III"). Included in this grant were 870,632
performance-based options granted to certain key managers (including 666,680
options to the Company's CEO and COO) at the then market price of $101.3125 per
share. The Company's CEO and COO gave up 100,000 and 66,670 vested options,
respectively, (valued at $8,760 in total) in exchange for their
EntrepreneurGrant III options. Other members of senior management gave up future
cash compensation for each of the next three years in exchange for the options.
All options made under this grant will vest if the Company's stock reaches $175
per share for at least ten trading days in a 30 consecutive calendar day period
by June 11, 2001 or earlier upon a change of control of the Company.
In April 1998, the Company granted 445,084 options to all associates not
granted options in the above mentioned entrepreneurial grants. Certain
associates were granted options in exchange for giving up future compensation.
Other associates were granted a set number of options. These options were
granted at the then market price of $95.125 per share and vest, in full, on
April 30, 2001 or earlier upon a change of control of the Company.
The Company recognized $56,495 and $6,462 of compensation cost relating to
its associate stock plans for the six months ended June 30, 1998 and 1997,
respectively.
In July 1998, the Company's Board of Directors voted to repurchase up to an
additional 1.5 million shares of the Company's common stock over the next two
years, pursuant to the July 1997 repurchase program, in order to mitigate the
dilutive impact of shares issuable under its benefits plans, including its
Associate Stock Purchase Plan, dividend reinvestment and stock incentive plans
and other incentive plans.
Note F: Earnings Per Share
The following table sets forth the computation of basic and diluted earnings per
share:
Three Months Ended Six Months Ended
June 30 June 30
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(shares in thousands) 1998 1997 1998 1997
- - ------------------------------------------------- ------------ ------------ ------------- ------------
Numerator:
Net income $ 66,853 $ 39,352 $ 132,556 $ 81,834
Denominator:
Denominator for basic earnings per share -
Weighted-average shares 65,537 66,428 65,483 66,382
Effect of dilutive securities:
Stock options 3,990 1,177 3,564 1,279
Restricted stock 3 2 4
- - ------------------------------------------------- ------------ ------------ ------------- ------------
Dilutive potential common shares 3,990 1,180 3,566 1,283
Denominator for diluted earnings per share -
Adjusted weighted-average shares 69,527 67,608 69,049 67,665
- - ------------------------------------------------- ------------ ------------ ------------- ------------
Basic earnings per share $ 1.02 $ 0.59 $ 2.02 $ 1.23
- - ------------------------------------------------- ------------ ------------ ------------- ------------
Diluted earnings per share $ 0.96 $ 0.58 $ 1.92 $ 1.21
- - ------------------------------------------------- ------------ ------------ ------------- ------------
Note G: Purchase of Summit Acceptance Corporation
In July 1998, the Company signed an agreement to acquire Summit Acceptance
Corporation, based in Dallas, Texas. Summit is a subprime automobile finance
lender with approximately 180 employees and serviced loans of approximately $260
million as of June 30, 1998. The acquisition price for Summit was approximately
$55 million which was paid through the issuance of the Company's stock on July
31, 1998. The acquisition will be accounted for as a purchase business
combination and goodwill of approximately $70 million will be amortized over 15
years.
Note H: Commitments and Contingencies
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 (which has since been acquired by First Union
Bank on November 30, 1997) for certain liabilities incurred in litigation
arising from that business, which may include liabilities, if any, incurred in
the purported class action case described below.
During 1995, the Company and the Bank became involved in a purported class
action suit relating to certain collection practices engaged in by Signet Bank
and, subsequently, by the Bank. The complaint in this case alleges that Signet
Bank and/or the Bank violated a variety of California state statutes and
constitutional and common law duties by filing collection lawsuits, obtaining
judgements and pursuing garnishment proceedings in the Virginia state courts
against defaulted credit card customers who were not residents of Virginia. This
case was filed in the Superior Court of California in the County of Alameda,
Southern Division, on behalf of a class of California residents. The complaint
in this case seeks unspecified statutory damages, compensatory damages, punitive
damages, restitution, attorneys' fees and costs, a permanent injunction and
other equitable relief.
In February 1997, the California court entered judgement in favor of the
Bank on all of the plaintiffs' claims. The plaintiffs have appealed the ruling
to the California Court of Appeal First Appellate District Division 4, and the
appeal is pending.
Because no specific measure of damages is demanded in the complaint of
the California case and the trial court entered judgement in favor of the Bank
before the parties completed any significant discovery, an informed assessment
of the ultimate outcome of this case cannot be made at this time. Management
believes, however, that there are meritorious defenses to this lawsuit and
intends to continue to defend it 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 management, 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.
Note I: Recent Accounting Pronouncements
In June 1998, the FASB issued SFAS No. 133 "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133"), which is required to be
adopted in years beginning after June 15, 1999. SFAS 133 permits early adoption
as of the beginning of any fiscal quarter after its issuance. SFAS 133 will
require the Company to recognize all derivatives on the balance sheet at fair
value. Derivatives that are not hedges must be adjusted to fair value through
income. If the derivative is a hedge, depending on the nature of the hedge,
changes in the fair value of derivatives will either be offset against the
change in fair value of the hedged assets, liabilities, or firm commitments
through earnings or recognized in other comprehensive income until the hedged
item is recognized in earnings. The ineffective portion of a derivative's change
in fair value will be immediately recognized in earnings. The Company has not
yet determined what the effect of SFAS 133 will be on the earnings and financial
position of the Company.
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." As of June 30, 1998,
the Company had 13.6 million customers and $15.0 billion in managed consumer
loans outstanding and was one of the largest providers of MasterCard and Visa
credit cards in the world. The Corporation's common stock trades on the New York
Stock Exchange under the symbol "COF" and is included in the S&P 500 Index. The
Company's profitability is affected by the net interest margin and non-interest
income earned on earning assets, consumer usage patterns, credit quality, the
level of marketing expense and operating efficiency.
Earnings Summary
Net income for the three months ended June 30, 1998 of $66.9 million, or
$.96 per share, compares to net income of $39.4 million, or $.58 per share, for
the same period in 1997. All earnings per share amounts are reported on a
diluted basis.
The increase in net income is primarily a result of an increase in asset
and account volumes and rates. Net interest income increased $86.5 million, or
104%, as the net interest margin increased to 9.64% from 5.99% and average
earning assets increased by 27%. The provision for loan losses increased $12.2
million, or 26%, as average reported loans increased by 30%. Non-interest income
increased $99.9 million, or 44%, primarily as a result of the increase in
average managed loans of 13%, a continued shift to more fee-based accounts and
increases in the amounts of certain fees charged. Marketing expense increased
$40.8 million, or 91%, to $85.8 million as the Company continues to invest in
new product opportunities. Salaries and associate benefits expense increased
$44.1 million, or 64%, of which $20.9 million, or 30%, was an increase in
compensation expense related to the associate stock plans. Supplies and
equipment expense increased $14.0 million, or 76%, of which $8.0 million, or
44%, was due to the termination of an existing lease arrangement. The remaining
$23.2 million, or 34%, increase in salaries and associate benefits, the
remaining $6.0 million, or 32%, increase in supplies and equipment and the $30.9
million, or 44%, increase in other non-interest expense (excluding marketing)
primarily reflected the cost of operations to manage the growth in accounts.
Each component is discussed in further detail in subsequent sections of this
analysis.
Net income for the six months ended June 30, 1998 was $132.6 million, or
$1.92 per share, compared to net income of $81.8 million, or $1.21 per share,
for the same period in 1997. This 62% increase primarily reflected the increases
in asset and account volumes accompanied by an increase in net interest margin
as discussed 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 and loans held for securitization (collectively, "reported loans"),
and securitized loans. Securitized loans are not assets of the Company and,
therefore, are not shown on the balance sheet.
Table 1 summarizes the Company's managed consumer loan portfolio.
- - -----------------------------------------------------------------------------------------
TABLE 1 - MANAGED CONSUMER LOAN PORTFOLIO
- - -----------------------------------------------------------------------------------------
Three Months Ended
June 30
- - ---------------------------------------------- -------------------- --------------------
(in thousands) 1998 1997
- - ---------------------------------------------- -------------------- --------------------
Period-End Balances:
On-balance sheet consumer loans $ 5,140,340 $ 3,623,952
Securitized consumer loans 9,828,984 9,113,410
- - ---------------------------------------------- -------------------- --------------------
Total managed consumer loan portfolio $ 14,969,324 $ 12,737,362
- - ---------------------------------------------- -------------------- --------------------
Average Balances:
Consumer loans held for securitization $ 286,813
On-balance sheet consumer loans $ 5,213,605 3,709,747
Securitized consumer loans 9,203,117 8,718,310
- - ---------------------------------------------- -------------------- --------------------
Total average managed consumer loan portfolio $ 14,416,722 $ 12,714,870
- - ---------------------------------------------- -------------------- --------------------
Six Months Ended
June 30
- - ---------------------------------------------- -------------------- --------------------
(in thousands) 1998 1997
- - ---------------------------------------------- -------------------- --------------------
Average Balances:
Consumer loans held for securitization $ 199,345
On-balance sheet consumer loans $ 4,996,983 3,828,113
Securitized consumer loans 9,256,755 8,609,846
- - ---------------------------------------------- -------------------- --------------------
Total average managed consumer loan portfolio $ 14,253,738 $ 12,637,304
- - ---------------------------------------------- -------------------- --------------------
Since 1990, the Company has actively engaged in consumer loan
securitization transactions. In accordance with SFAS No. 125 "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities"
("SFAS 125"), the Company records gains or losses on the securitization of
consumer loan receivables based on the estimated fair value of assets obtained
and liabilities incurred in the sale. Gains represent the present value of
estimated excess net cash flows the Company has retained over the estimated
outstanding period of the receivables and are included in servicing and
securitizations income. This excess cash flow essentially represents an
"interest only" ("I/O") strip, consisting of the excess finance charges and
past-due fees over the sum of the return paid to certificateholders, estimated
contractual servicing fees and credit losses. However, exposure to credit losses
on the securitized loans is contractually limited to these excess cash flows.
Certain estimates inherent in the determination of the fair value of the I/O
strip are influenced by factors outside the Company's control, and as a result,
such estimates could materially change in the near term. 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 loan 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) 1998 1997 1998 1997
- - -------------------------------- ------------------ ------------------- ----------------- -----------------
Reported:
Average earning assets $ 7,039,261 $ 5,559,574 $ 6,868,832 $ 5,568,871
Net interest margin(1) 9.64% 5.99% 9.74% 6.16%
Loan yield 18.81 14.36 19.00 14.40
- - -------------------------------- ------------------ ------------------- ----------------- -----------------
Managed:
Average earning assets $ 16,242,378 $ 14,277,884 $ 16,125,587 $ 14,178,717
Net interest margin(1) 9.84% 8.30% 10.12% 8.56%
Loan yield 16.85 15.17 17.15 15.31
- - -------------------------------- ------------------ ------------------- ----------------- -----------------
(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, the Company has pursued a low
introductory interest rate strategy with accounts repricing to higher rates
after six to 16 months from the date of origination. 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 consumer
performance. Recently, the Company has marketed low non-introductory rate cards
to a subset of the same population. These products typically have a balance
transfer feature under which consumers can transfer balances to the Company from
their other obligations. 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 interest rate
strategies. Management believes that the competition has put, and will continue
to put, additional pressure on interest rate strategies.
By applying its information-based strategies ("IBS") and in response to
dynamic competitive pressures, the Company also targets a significant amount of
its marketing expense to other credit card product opportunities. Examples of
such products include secured cards and other customized card products including
affinity and co-branded cards, student cards and other cards targeted to certain
markets that are underserved by the Company's competitors. These products do not
have the immediate impact on managed loan balances of the balance transfer
products but typically consist of lower credit limit accounts and balances that
build over time. The terms of these customized card products tend to include
annual membership fees and higher annual finance charge rates. The profile of
the consumers targeted for these products, in some cases, may also tend to
result in higher delinquency and consequently higher past-due and overlimit fees
as a percentage of loan receivables outstanding than the balance transfer
products.
The Company's products are designed with the 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 loan yield and net interest margin, but also the fee income associated
with these products. By deducting net charge-offs, consideration is given to the
risk inherent in these differing products.
Table 3 provides income statement data and ratios for the Company's managed
consumer loan portfolio. The causes of increases and decreases in the various
components of risk adjusted revenue are discussed in further detail in
subsequent sections of this analysis.
- - ------------------------------------------------------------------------------------------------------
TABLE 3 - MANAGED RISK ADJUSTED REVENUE
- - ------------------------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30 June 30
- - -------------------------------- ----------------- ----------------- ----------------- ---------------
(dollars in thousands) 1998 1997 1998 1997
- - -------------------------------- ----------------- ----------------- ----------------- ---------------
Managed Income Statement:
Net interest income $ 399,505 $ 296,331 $ 816,216 $ 607,021
Non-interest income 253,244 169,314 473,927 326,634
Net charge-offs (212,988) (202,778) (425,723) (386,033)
- - -------------------------------- ----------------- ----------------- ----------------- ---------------
Risk adjusted revenue $ 439,761 $ 262,867 $ 864,420 $ 547,622
- - -------------------------------- ----------------- ----------------- ----------------- ---------------
Ratios(1):
Net interest margin 9.84% 8.30% 10.12% 8.56%
Non-interest income 6.24 4.74 5.88 4.61
Net charge-offs (5.25) (5.68) (5.28) (5.45)
- - -------------------------------- ----------------- ----------------- ----------------- ---------------
Risk adjusted margin 10.83% 7.36% 10.72% 7.72%
- - -------------------------------- ----------------- ----------------- ----------------- ---------------
(1) As a percentage of average managed earning assets.
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
includes interest-bearing deposits, other borrowings and borrowings from senior
and deposit notes.
Reported net interest income for the three months ended June 30, 1998 was
$169.7 million, compared to $83.3 million for the same period in the prior year,
representing an increase of $86.4 million, or 104%. For the six months ended
June 30, 1998, net interest income was $334.5 million compared to $171.5 million
for the same period in 1997, representing an increase of $163.0 million, or 95%.
Average earning assets increased 27% and 23% for the three and six months ended
June 30, 1998, respectively, versus the same periods in 1997. The yield on
earning assets increased 341 and 337 basis points for the three and six months
ended June 30, 1998, respectively, to 15.42% from 12.01% and to 15.42% from
12.05% as compared to the same periods in the prior year. The increase was
primarily attributable to a 445 and 460 basis point increase in the yield on
consumer loans for the three and six months ended June 30, 1998, respectively,
to 18.81% from 14.36% and to 19.00% from 14.40%, respectively, as compared to
the same periods in the prior year. The yield on consumer loans increased due to
an increase in the amount and frequency of past-due fees charged as compared to
the same period in the prior year and the Company's continued shift to higher
yielding products, especially in the reported loan portfolio during the
comparable periods.
Table 4 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, 1998 and 1997.
- - -------------------------------------------------------------------------------------------------------------------
TABLE 4 - STATEMENTS OF AVERAGE BALANCES, INCOME AND EXPENSE, YIELDS AND RATES
- - -------------------------------------------------------------------------------------------------------------------
Three Months Ended June 30
- - ------------------------------------- -------------------------------------- --------------------------------------
1998 1997
- - ------------------------------------- -------------------------------------- --------------------------------------
Average Income/ Yield/ Average Income/ Yield/
(dollars in thousands) Balance Expense Rate Balance Expense Rate
- - ------------------------------------- -------------- ------------ ---------- --------------- ------------ ---------
Assets:
Earning assets
Consumer loans(1) $5,213,605 $245,129 18.81% $3,996,560 $143,485 14.36%
Federal funds sold and
resale agreements 151,275 2,140 5.66 187,650 2,613 5.57
Other 1,674,381 24,169 5.77 1,375,364 20,772 6.04
- - ------------------------------------- -------------- ------------ ---------- --------------- ------------ ---------
Total earning assets 7,039,261 $271,438 15.42% 5,559,574 $166,870 12.01%
Cash and due from banks 22,659 111,670
Allowance for loan losses (213,000) (118,833)
Premises and equipment, net 177,487 182,227
Other assets 1,079,789 823,415
- - ------------------------------------- -------------- ------------ ---------- --------------- ------------ ---------
Total assets $8,106,196 $6,558,053
- - ------------------------------------- -------------- ------------ ---------- --------------- ------------ ---------
Liabilities and Equity:
Interest-bearing liabilities
Deposits $1,193,508 $ 13,635 4.57% $ 817,936 $ 8,635 4.22%
Other borrowings 1,318,889 20,375 6.18 694,814 10,453 6.02
Senior and deposit notes 3,905,684 67,704 6.93 3,768,797 64,523 6.85
- - ------------------------------------- -------------- ------------ ---------- --------------- ------------ ---------
Total interest-bearing liabilities 6,418,081 $101,714 6.34% 5,281,547 $ 83,611 6.33%
Other liabilities 553,033 380,807
- - ------------------------------------- -------------- ------------ ---------- --------------- ------------ ---------
Total liabilities 6,971,114 5,662,354
Preferred beneficial interests 97,760 97,503
Equity 1,037,322 798,196
- - ------------------------------------- -------------- ------------ ---------- --------------- ------------ ---------
Total liabilities and equity $8,106,196 $6,558,053
- - ------------------------------------- -------------- ------------ ---------- --------------- ------------ ---------
Net interest spread 9.08% 5.68%
- - ------------------------------------- -------------- ------------ ---------- --------------- ------------ ---------
Interest income to
average earning assets 15.42% 12.01%
Interest expense to
average earning assets 5.78 6.02
- - ------------------------------------- -------------- ------------ ---------- --------------- ------------ ---------
Net interest margin 9.64% 5.99%
- - ------------------------------------- -------------- ------------ ---------- --------------- ------------ ---------
(1) Interest income includes past-due fees on loans of approximately $72,700 and
$24,965 for the three months ended June 30, 1998 and 1997, respectively.
Six Months Ended June 30
- - ------------------------------------- --------------------------------------- -------------------------------------
1998 1997
- - ------------------------------------- --------------------------------------- -------------------------------------
Average Income/ Yield/ Average Income/ Yield/
(dollars in thousands) Balance Expense Rate Balance Expense Rate
- - ------------------------------------- ------------- ------------- ----------- --------------- ----------- ---------
Assets:
Earning assets
Consumer loans(1) $4,996,983 $474,767 19.00% $4,027,458 $289,997 14.40%
Federal funds sold and
resale agreements 256,393 7,218 5.63 306,527 8,277 5.40
Other 1,615,456 47,495 5.88 1,234,886 37,190 6.02
- - ------------------------------------- ------------- ------------- ----------- --------------- ----------- ---------
Total earning assets 6,868,832 $529,480 15.42% 5,568,871 $335,464 12.05%
Cash and due from banks 21,500 95,309
Allowance for loan losses (205,167) (119,331)
Premises and equipment, net 171,543 181,246
Other assets 960,875 745,833
- - ------------------------------------- ------------- ------------- ----------- --------------- ----------- ---------
Total assets $7,817,583 $6,471,928
- - ------------------------------------- ------------- ------------- ----------- --------------- ----------- ---------
Liabilities and Equity:
Interest-bearing liabilities
Deposits $1,229,586 $ 27,773 4.52% $ 904,861 $ 19,072 4.22%
Other borrowings 1,198,654 36,428 6.08 553,654 16,977 6.13
Senior and deposit notes 3,795,013 130,733 6.89 3,788,751 127,959 6.75
- - ------------------------------------- ------------- ------------- ----------- --------------- ----------- ---------
Total interest-bearing liabilities 6,223,253 $ 194,934 6.26% 5,247,266 $164,008 6.25%
Other liabilities 502,631 362,131
- - ------------------------------------- ------------- ------------- ----------- --------------- ----------- ---------
Total liabilities 6,725,884 5,609,397
Preferred beneficial interests 97,728 81,325
Equity 993,971 781,206
- - ------------------------------------- ------------- ------------- ----------- --------------- ----------- ---------
Total liabilities and equity $7,817,583 $6,471,928
- - ------------------------------------- ------------- ------------- ----------- --------------- ----------- ---------
Net interest spread 9.16% 5.80%
- - ------------------------------------- ------------- ------------- ----------- --------------- ----------- ---------
Interest income to
average earning assets 15.42% 12.05%
Interest expense to
average earning assets 5.68 5.89
- - ------------------------------------- ------------- ------------- ----------- --------------- ----------- ---------
Net interest margin 9.74% 6.16%
- - ------------------------------------- ------------- ------------- ----------- --------------- ----------- ---------
(1) Interest income includes past-due fees on loans of approximately $148,651
and $50,213 for the six months ended June 30, 1998 and 1997, respectively.
Managed net interest income increased $103.2 million, or 35%, and $209.2
million, or 34%, for the three and six months ended June 30, 1998, respectively,
compared to the same periods in prior year. The increases in managed net
interest income were the result of a 14% increase in managed average earning
assets and the managed net interest margin increasing 154 basis points and 156
basis points to 9.84% and 10.12% for the three and six months ended June 30,
1998, respectively. The increase in managed net interest margin principally
reflects increases in the amount and frequency of past-due fees and growth in
higher yielding loans.
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 5 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 5 - INTEREST VARIANCE ANALYSIS
- - ---------------------------------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30, 1998 vs 1997 June 30, 1998 vs 1997
- - --------------------------- ----------------------------------------- -----------------------------------------
Increase Change due to(1) Increase Change due to(1)
(in thousands) (Decrease) Volume Yield/Rate (Decrease) Volume Yield/Rate
- - --------------------------- ------------- ------------ -------------- -------------- ------------- ------------
Interest Income:
Consumer loans $ 101,644 $ 50,402 $ 51,242 $ 184,770 $ 79,395 $ 105,375
Federal funds sold and
resale agreements (473) (745) 272 (1,059) (1,959) 900
Other 3,397 8,932 (5,535) 10,305 12,850 (2,545)
- - --------------------------- ------------- ------------ -------------- -------------- ------------- ------------
Total interest income 104,568 50,522 54,046 194,016 88,272 105,744
Interest Expense:
Deposits 5,000 4,241 759 8,701 7,253 1,448
Other borrowings 9,922 9,634 288 19,451 19,903 (452)
Senior and deposit notes 3,181 2,365 816 2,774 212 2,562
- - --------------------------- ------------- ------------ -------------- -------------- ------------- ------------
Total interest expense 18,103 18,012 91 30,926 30,571 355
- - --------------------------- ------------- ------------ -------------- -------------- ------------- ------------
Net interest income(1) $ 86,465 $ 26,266 $ 60,199 $ 163,090 $ 46,692 $ 116,398
- - ---------------------------------------------------------------------------------------------------------------
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 table. The totals for the volume and yield/rate columns are
not the sum of the individual lines.
Servicing and Securitizations Income
Servicing and securitizations income increased $6.9 million and $5.5
million, or 5% and 2%, for the three and six months ended June 30, 1998,
respectively, from the same periods in the prior year due to average securitized
loans increasing 6% and 8% over the same periods, offset by a reduction of the
percentage of higher yielding products included in the off-balance sheet
portfolio, which resulted in tightened estimated future spreads, and an increase
in estimated credit losses on securitized assets. Also impacting servicing and
securitizations income in the first half of 1998 was the current recognition of
estimated uncollectible finance charge and fee income receivables implemented in
the fourth quarter of 1997.
Other Non-Interest Income
Other reported non-interest income including service charges and
interchange, increased to $173.5 million and $320.8 million, or 116% and 109%,
for the three and six months ended June 30, 1998, respectively, compared to
$80.5 million and $153.5 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 38% and 39% for the three and six months ended June 30,
1998, respectively, compared to the same periods in the prior year and the
Company's continued shift to more fee-based accounts, especially in the reported
loan portfolio during the comparable periods.
Managed non-interest income increased to $253.2 million and $473.9
million, or 50% and 45%, for the three and six months ended June 30, 1998,
respectively, due to the increase in the average number of accounts and
increases in the amount and frequencies of fees (including annual membership,
interchange and overlimit) assessed on accounts.
Non-Interest Expense
Non-interest expense for the three and six months ended June 30, 1998 was
$331.8 million and $620.7 million, respectively, an increase of 64% and 49% over
$202.1 million and $415.6 million, respectively, for the same periods in the
prior year. Contributing to the increase in non-interest expense for the three
and six months ended June 30, 1998 was salaries and associate benefits expense
which increased $44.1 million, or 64%, and $81.5 million, or 58%, respectively.
These increases reflected an additional $20.9 million and $50.0 million in
compensation expense for the three and six months ended June 30, 1998,
respectively, associated with the Company's associate stock plans. Marketing
expense increased $40.8 million and $61.8 million, or 91% and 62%, to $85.8
million and $160.8 million for the three and six months ended June 30, 1998,
respectively, as the Company continues to invest in new product opportunities.
All other non-interest expenses increased $44.8 million and $61.9 million, or
51% and 35%, to $132.6 million and $238.5 million for the three and six months
ended June 30, 1998, respectively, from $87.8 million and $176.6 million for the
same periods in the prior year. The increase in other non-interest expense, as
well as, the increase in salaries associate benefits expense not attributed to
options, was primarily a result of a 38% and 39% increase in the average number
of accounts for the three months and six months ended June 30, 1998,
respectively, which resulted in a corresponding increase in infrastructure and
other operational costs, offset by efficiencies gained from improved processes
and investments in information technology. Additionally, in the second quarter
of 1998 the Company accrued an $8.0 million non-recurring charge relating to the
termination of an existing lease arrangement.
Income Taxes
The Company's income tax rate was 38% for the three and six months
ended June 30, 1998 and 1997 and includes both state and federal income tax
components.
Asset Quality
The asset quality of a portfolio is generally a function of the initial
underwriting criteria used, seasoning of the accounts, levels of competition,
account management activities and demographic concentration, as well as general
economic conditions. The seasoning of the accounts is also an important
indicator of the delinquency and loss levels of the portfolio. Generally,
accounts tend to exhibit a rising trend of delinquency and credit losses as they
season.
Delinquencies
Table 6 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 6 - DELINQUENCIES
- - ---------------------------------------------------------------------------------------------------
June 30
- - -------------------------------- -------------------------------- ---------------------------------
1998 1997
- - -------------------------------- -------------------------------- ---------------------------------
% of % of
(dollars in thousands) Loans Total Loans Loans Total Loans
- - -------------------------------- ----------------- -------------- ----------------- ---------------
Reported:
Loans outstanding $ 5,140,340 100.00% $ 3,623,952 100.00%
Loans delinquent:
30-59 days 104,819 2.04 72,074 1.99
60-89 days 61,756 1.20 40,330 1.11
90 or more days 91,747 1.79 88,141 2.43
- - -------------------------------- ----------------- -------------- ----------------- ---------------
Total $ 258,322 5.03% $ 200,545 5.53%
- - -------------------------------- ----------------- -------------- ----------------- ---------------
Managed:
Loans outstanding $ 14,969,324 100.00% $ 12,737,362 100.00%
Loans delinquent:
30-59 days 287,182 1.92 268,951 2.11
60-89 days 177,313 1.18 159,234 1.25
90 or more days 305,282 2.04 378,612 2.97
- - -------------------------------- ----------------- -------------- ----------------- ---------------
Total $ 769,777 5.14% $ 806,797 6.33%
- - -------------------------------- ----------------- -------------- ----------------- ---------------
In the fourth quarter of 1997, the Company modified its methodology for
charging off credit card loans (net of any collateral) to 180 days past-due from
the prior practice of charging off loans during the next billing cycle after
becoming 180 days past-due. In addition, in the fourth quarter of 1997, the
Company recognized the estimated uncollectible portion of finance charge and fee
income receivables. The delinquency rate for reported loans was 5.03% as of June
30, 1998, down from 5.53% as of June 30, 1997 and down from 5.33% as of March
31, 1998. The delinquency rate for the managed consumer loan portfolio was 5.14%
as of June 30, 1998, down from 6.33% as of June 30, 1997 and down from 5.75% as
of March 31, 1998. Both the managed and reported portfolio's delinquency rate
decrease as of June 30, 1998 reflected seasonality and improvements in consumer
credit performance as well as the impact from modifications in charge-off policy
and finance charge and fee income recognition.
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 7 shows the Company's net charge-offs for the periods
presented on a reported and managed basis.
- - ----------------------------------------------------------------------------------------------------------------------
TABLE 7 - NET CHARGE-OFFS (1)
- - ----------------------------------------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30 June 30
- - ------------------------------------------------ ----------------- ----------------- ----------------- ---------------
(dollars in thousands) 1998 1997 1998 1997
- - ------------------------------------------------ ----------------- ----------------- ----------------- ---------------
Reported:
Average loans outstanding $ 5,213,605 $ 3,996,560 $ 4,996,983 $ 4,027,458
Net charge-offs 58,916 49,434 114,978 95,934
Net charge-offs as a percentage
of average loans outstanding 4.52% 4.95% 4.60% 4.76%
- - ------------------------------------------------ ----------------- ----------------- ----------------- ---------------
Managed:
Average loans outstanding $ 14,416,722 $ 12,714,870 $ 14,253,738 $ 12,637,304
Net charge-offs 212,988 202,778 425,723 386,033
Net charge-offs as a percentage
of average loans outstanding 5.91% 6.38% 5.97% 6.11%
- - ------------------------------------------------ ----------------- ----------------- ----------------- ---------------
(1) Includes consumer loans held for securitization.
Net charge-offs of managed loans increased $10.2 million and $39.7
million, or 5% and 10%, while average managed consumer loans grew 13% for the
three and six months ended June 30, 1998, respectively, from the same periods in
the prior year. For the three and six months ended June 30, 1998, the Company's
net charge-offs as a percentage of managed loans were 5.91% and 5.97%,
respectively, compared to 6.38% and 6.11% for the same periods in the prior
year. The decreases in managed and reported net charge-offs was the result of
improved general economic trends in consumer credit performance compared to the
same periods in the prior year.
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) at 180 days past-due, although
earlier charge-offs may occur on accounts of bankrupt or deceased consumers.
Bankrupt consumers' 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, interest and
fees for non-bankrupt accounts.
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 8 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 8 - SUMMARY OF ALLOWANCE FOR LOAN LOSSES
- - ------------------------------------------------ ----------------------------------------------------------
Three Months Ended Six Months Ended
June 30 June 30
- - ------------------------------------------------ ---------------- ------------- ------------- -------------
(dollars in thousands) 1998 1997 1998 1997
- - ------------------------------------------------ ---------------- ------------- ------------- -------------
Balance at beginning of period $ 213,000 118,500 $ 183,000 $ 118,500
Provision for loan losses 59,013 46,776 144,879 95,963
Transfer to loans held for securitization (2,625)
Other (97) 33 99 (29)
Charge-offs (77,348) (52,628) (144,386) (103,829)
Recoveries 18,432 5,819 29,408 10,520
- - ------------------------------------------------ ---------------- ------------- ------------- -------------
Net charge-offs(1) (58,916) (46,809) (114,978) (93,309)
- - ------------------------------------------------ ---------------- ------------- ------------- -------------
Balance at end of period $ 213,000 $ 118,500 $ 213,000 $ 118,500
- - ------------------------------------------------ ---------------- ------------- ------------- -------------
Allowance for loan losses to loans at period-end 4.14% 3.27% 4.14% 3.27%
- - ------------------------------------------------ ---------------- ------------- ------------- -------------
(1) Excludes consumer loans held for securitization.
For the three and six months ended June 30, 1998, the provision for
loan losses increased to $59.0 million and $144.9 million, or 26% and 51%,
respectively, from $46.8 million and $96.0 million for the comparable periods in
the prior year, as average reported loans increased by 30% and 24%,
respectively. The allowance for loan losses as a percentage of on-balance sheet
consumer loans increased to 4.14% as of June 30, 1998, from 3.27% as of June 30,
1997 due to the change in mix of its reported loan portfolio. The allowance for
loan losses increase also reflects the increase in on-balance sheet loans to
$5.1 billion as of June 30, 1998, an increase of 42% from June 30, 1997.
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 1998 to 2008 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.
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.
Additionally, the Company maintains a portfolio of high-quality
securities such as U.S. Treasuries, U.S. Government Agency and 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 ongoing cash needs. As of June 30, 1998, the Company held $1.5
billion in such securities.
Table 9 shows the maturation of certificates of deposit in
denominations of $100,000 or greater ("large denomination CDs") as of June 30,
1998.
- - -------------------------------------------------------------------------------------
TABLE 9 - MATURITIES OF LARGE DENOMINATION CERTIFICATES-$100,000 OR MORE
- - -------------------------------------------------------------------------------------
June 30, 1998
- - -------------------------------------------- ----------------------- --------------
(dollars in thousands) Balance Percent
- - -------------------------------------------- ----------------------- --------------
3 months or less $ 46,781 23.56%
Over 3 through 6 months 63,497 31.99
Over 6 through 12 months 30,270 15.25
Over 1 through 5 years 57,970 29.20
- - -------------------------------------------- ----------------------- --------------
Total $ 198,518 100.00%
- - -------------------------------------------- ----------------------- --------------
The Company's other borrowings portfolio consists of $925 million in
borrowings maturing within one year and $34 million in borrowings maturing after
one year.
Table 10 shows the Company's unsecured funding availability and
outstandings as of June 30, 1998.
- - --------------------------------------------------------------------------------------------------------
TABLE 10 - FUNDING AVAILABILITY
- - --------------------------------------------------------------------------------------------------------
June 30, 1998
- - -------------------------------------------- ------------ ----------------- ---------------- -----------
Effective/ Final
(dollars or dollar equivalents in millions) Issue Date Availability(1) Outstanding Maturity
- - -------------------------------------------- ------------ ----------------- ---------------- -----------
Domestic revolving credit facility 11/96 $ 1,700 11/00
UK/Canada revolving credit facility 8/97 350 $ 121 8/00
Senior bank note program(2) 4/97 8,000 3,579 -
Non-U.S. bank note program 10/97 1,000 5 -
Deposit note program 4/97 2,000 100 -
Floating rate junior subordinated
capital income securities(3) 1/97 100 98 2/27
Corporation Shelf Registration 12/96 200 125 12/03
- - --------------------------------------------------------------------------------------------------------
(1) All funding sources are revolving except for the Corporation Shelf
Registration and the floating rate junior subordinated capital income
securities. Funding availability under the credit facilities is subject to
compliance with certain representations, warranties and covenants. Funding
availability under all other sources is subject to market conditions.
(2) Includes availability to issue up to $200 million of subordinated bank
notes.
(3) Qualifies as Tier 1 capital at the Corporation and Tier 2 capital at the
Bank.
The domestic revolving 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. The borrowings of the Savings Bank are limited to $750 million.
The final maturity of each tranche may be extended for two additional one-year
periods.
The UK/Canada revolving credit facility is used to finance the
Company's expansion in the United Kingdom and Canada. The facility is comprised
of two tranches: a Tranche A facility in the amount of (pound)156.5 million
($249.8 million equivalent based on the exchange rate at closing) and a Tranche
B facility in the amount of C$139.6 million ($100.2 million equivalent based on
the exchange rate at closing). An amount of (pound)34.6 million or C$76.9
million ($55.2 million equivalent based on the exchange rates at closing) may be
transferred between the Tranche A facility and the Tranche B facility,
respectively, upon the request of the Company. The Corporation serves as the
guarantor of all borrowings by its subsidiaries under the UK/Canada revolving
facility.
Under the Corporation's shelf registration statements, filed with the
Securities and Exchange Commission, 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 stock. In July 1998, the Corporation filed a Shelf Registration
Statement on Form S-3 with the Securities and Exchange Commission for the
issuance of up to $425 million aggregate principal amount of senior and
subordinated debt, preferred stock and common stock, which was declared
effective on July 14, 1998. In July 1998, the Corporation issued $200 million of
10-year unsecured senior notes under this shelf registration. Existing unsecured
senior debt outstanding of the Corporation under a prior shelf registration of
$200 million totals $125 million maturing in 2003.
Capital Adequacy
The Bank and the Savings Bank are subject to capital adequacy
guidelines adopted by the Federal Reserve Board (the "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 maintain
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.
The most recent notifications from the regulators categorized the Bank
and the Savings Bank as "well-capitalized." To be categorized as
"well-capitalized," the Bank and the Savings Bank must maintain minimum capital
ratios as set forth in the following table. As of June 30, 1998, there are no
conditions or events since the notifications discussed above that management
believes have changed either the Bank or the Savings Bank's capital category. As
of June 30, 1998, the Bank and the Savings Bank's ratios of capital to managed
assets were 5.44% and 9.63%, respectively.
- - -----------------------------------------------------------------------------------------------------
TABLE 11 - REGULATORY CAPITAL RATIOS
- - -----------------------------------------------------------------------------------------------------
To Be "Well-Capitalized" Under
Minimum for Capital Prompt Corrective Action
Ratios Adequacy Purposes Provisions
- - ---------------------------- ------------- ------------------------- --------------------------------
June 30, 1998
Capital One Bank
Tier 1 Capital 13.02% 4.00% 6.00%
Total Capital 15.76 8.00 10.00
Tier 1 Leverage 10.42 4.00 5.00
Capital One, F.S.B.(1)
Tangible Capital 13.89% 1.50% 6.00%
Total Capital 17.81 12.00 10.00
Core Capital 13.89 8.00 5.00
- - ---------------------------- ------------- ------------------------- --------------------------------
June 30, 1997
Capital One Bank
Tier 1 Capital 11.02% 4.00% 6.00%
Total Capital 13.93 8.00 10.00
Tier 1 Leverage 11.16 4.00 5.00
Capital One, F.S.B.(1)
Tangible Capital 13.33% 1.50% 6.00%
Total Capital 20.49 12.00 10.00
Core Capital 13.33 8.00 5.00
- - ---------------------------- ------------- ------------------------- --------------------------------
(1) Until June 30, 1999, the Savings Bank is subject to capital requirements
that exceed minimum capital adequacy requirements, including the requirement
to maintain a minimum Core Capital ratio of 8% and a Total Capital ratio of
12%.
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 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, 1998, the Company's Tier 1 leverage ratio
was 14.25%.
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, 1998, retained earnings of the Bank and the Savings Bank of
$106.5 million and $41.8 million, respectively, were available for payment of
dividends to the Corporation, without prior approval by the regulators. The
Savings Bank, however, is required to give the OTS at least 30 days' advance
notice of any proposed dividend and the OTS, in its discretion, may object to
such 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, interest rate swap agreements ("swaps") and forward
foreign exchange rate agreements ("FRAs"). In order to reduce the 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. In order to reduce the exchange rate
sensitivity on foreign currency denominated assets, the Company has entered into
FRAs which involve elements of credit or exchange rate risk in excess of the
amount recognized on the balance sheet. Swaps and FRAs 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.
The Company measures exposure to its interest rate risk through the use of
a simulation model. The model generates a distribution of possible twelve-month
managed net interest income outcomes based on (i) a set of plausible interest
rate scenarios, as determined by management based upon historical trends and
market expectations, (ii) all existing financial instruments, including swaps,
and (iii) an estimate of ongoing business activity over the coming twelve
months. The Company's asset/liability management policy requires that based
on this distribution there be at least a 95% probability that managed net
interest income achieved over the coming twelve months will be no more than 4%
below the mean managed net interest income of the distribution. As of June 30,
1998, the Company was in compliance with the policy; more than 95% of the
outcomes generated by the model produced a managed net interest income of no
more than 1.1% below the mean outcome.
Business Outlook
This business outlook section summarizes the Company's expectations for
earnings for the year ending December 31, 1998 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
throughout this section and in the Company's Annual Report on Form 10-K for the
year ended December 31, 1997 (Part I, Item 1, Cautionary Statements).
The Company has set an earnings target, dependent on the factors set
forth below, for diluted earnings per share to be $3.90 for the year ending
December 31, 1998. 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), marketing expenses and operating expenses.
Product and Market Opportunities
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. Credit card opportunities include, and are expected to
continue to include, various low introductory and intermediate-rate balance
transfer products, low non-introductory rate products, as well as other
customized credit card products; such as secured cards, affinity and co-branded
cards, student cards and other cards tailored for specific customer segments.
The Company intends to continue to offer these customized products, certain of
which are distinguished by several characteristics, including better response
rates, less adverse selection, higher yields (including fees), lower credit
lines, less attrition and a greater ability to reprice than the Company's
traditional low introductory-rate balance transfer products. Some of these
products involve higher operational costs and, in some cases, higher
delinquencies and credit losses than the Company's traditional low
introductory-rate balance transfer products. More importantly, these customized
products continue to have overall higher and less volatile returns than the
traditional low introductory-rate balance transfer products in recent market
conditions.
The Company also has been applying, and expects to continue to apply,
its IBS to other financial and non-financial products. These products and
services include selected non-card consumer lending products and
telecommunication services. On July 31, 1998, the Company completed the
acquisition of Summit Acceptance Corporation ("Summit"), a Texas corporation.
Summit is a subprime automobile finance lender located in Dallas, Texas, with
180 employees and serviced loans of approximately $260 million as of June 30,
1998. Summit provides the Company with a platform to test and apply its IBS to
the automobile loan market. The Company has also expanded its existing
operations outside of the United States, with an initial focus on the United
Kingdom and Canada. The Company's credit card and other financial and
non-financial products are subject to competitive pressures, which management
anticipates will increase as these markets mature.
The Company continues to apply its IBS in an effort to balance the mix
of balance transfer and other credit card products together with other financial
and non-financial products and services, to optimize profitability within the
context of acceptable risk. The Company's growth through expansion and product
diversification will be affected by the ability of the Company to internally
build or to acquire the operational and organizational infrastructure necessary
to engage in new businesses and to recruit experienced personnel to assist in
the management and operations of these businesses and the availability of
capital necessary to fund these new businesses. Although management believes
that, it has the personnel, financial resources and business strategy necessary
for continued success, there can be no assurance that the Company's historical
financial performance will necessarily reflect its results of operations and
financial condition in the future.
Marketing Investment
The Company anticipates that its 1998 marketing expenses will
substantially exceed such expenses in 1997, as the Company continues to invest
in existing and new balance transfer products, low non-introductory rate
products and other credit card products and services, and other financial and
non-financial products and services. The Company cautions, however, that an
increase in marketing expenses does not necessarily equate to a comparable
increase in accounts based on historical results. As the Company's portfolio
continues to increase, additional growth to offset attrition requires increasing
amounts of marketing. Intense competition in the credit card market has
resulted in a decrease in credit card response rates and reduced productivity
of marketing dollars invested. In addition, the cost to acquire new accounts
varies among product lines. The Company intends to continue a flexible approach
in its allocation of marketing expenses. The actual amount of marketing
investment is subject to a variety of external and internal factors, such
as competition in the credit card industry, general economic conditions
affecting consumer credit performance, the asset quality of the Company's
portfolio and the identification of market opportunities that exceed company
targeted rates for return on investment. With competition affecting the
profitability of existing balance transfer products, the Company has been
allocating and expects to continue to allocate a greater portion of its
marketing expense to other customized credit card products and other financial
and non-financial products.
Moreover, the amount of marketing expense allocated to various product
segments will influence the characteristics of the Company's portfolio because
the various product segments are characterized by different account growth, loan
growth and asset quality characteristics. The Company currently expects that its
growth in consumer accounts and in managed consumer loans will continue in 1998.
Actual growth, however, may vary significantly depending on the Company's actual
product mix and the level of attrition on the Company's managed portfolio, which
is affected by competitive pressures.
Impact of Delinquencies, Charge-off Rates and Attrition
The Company's earnings are particularly sensitive to delinquencies and
charge-offs on the Company's portfolio and on the level of attrition due to
competition in the credit card industry. 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 impact of
higher or lower charge-offs that ultimately result from varying levels of
delinquencies. Delinquency and net charge-off rates are not only impacted by
general economic trends in consumer credit performance but also by the continued
seasoning of the Company's portfolio and the product mix. Charge-off rates are
also impacted by bankruptcies.
The Company's expectations for 1998 earnings are based on management's
belief that consumer credit quality is stabilizing. Management expects that
during the third quarter of 1998 charge-offs will remain stable, while
delinquency rates will increase due to seasonality and the seasoning of the
customized card products. Management, however, cautions that delinquency and
charge-off levels are not always predictable and may vary from projections. 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 attrition of the Company's outstanding loans
(thereby reducing interest and fee income) and by making it more difficult to
retain and attract more profitable customers.
Cautionary Factors
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 salaries and associate benefits 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 or to
expand internationally; the ability of the Company to recruit experienced
personnel to assist in the management and operations of new products and
services; the ability of the Company and its suppliers to successfully address
Year 2000 compliance issues; 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, 1997 (Part I, Item 1, Cautionary
Statements).
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
- - -------
(a) Exhibits:
None
(b) Reports on Form 8-K:
The Company filed a Current Report on Form 8-K, dated April
16, 1998, Commission File No. 1-13300, enclosing its press
release dated April 16, 1998.
The Company filed a Current Report on Form 8-K, dated June 12, 1998,
Commission File No. 1-13300, enclosing its press release dated June 12, 1998.
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, 1998 /s/James M. Zinn
---------------------------------
James M. Zinn
Senior Vice President,
Chief Financial Officer
(Chief Accounting Officer
and duly authorized officer
of the Registrant)
5
1,000
3-mos
Dec-31-1998
Apr-01-1998
Jun-30-1998
8,463
1,431,091
5,140,340
(213,000)
0
0
188,727
0
7,651,438
0
0
0
0
666
1,068,495
7,651,438
0
600,391
0
331,836
0
59,013
101,714
107,828
40,975
66,853
0
0
0
66,853
1.02
.96
Non classified balance sheet
PP&E Shown Net
