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 March 31, 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)
(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
As of April 30, 1998, there were 65,582,514 shares of the registrant's Common
Stock, par value $.01 per share, outstanding.
1
CAPITAL ONE FINANCIAL CORPORATION
FORM 10-Q
INDEX
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March 31, 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.......................................... 10
PART II. OTHER INFORMATION
ITEM 4. Submission of Matters to a Vote of Security Holders...... 25
ITEM 6. Reports on Form 8-K...................................... 25
Signatures............................................... 26
2
ITEM 1.
CAPITAL ONE FINANCIAL CORPORATION
Condensed Consolidated Balance Sheets
(dollars in thousands, except per share data) (unaudited)
MARCH 31 DECEMBER 31
1998 1997
ASSETS:
Cash and due from banks $ 2,983 $ 5,039
Federal funds sold and resale agreements 105,000 173,500
Interest-bearing deposits at other banks 34,077 59,184
- -------------------------------------------------------------------- -------------- -------------
Cash and cash equivalents 142,060 237,723
Securities available for sale 1,513,398 1,242,670
Consumer loans 4,748,186 4,861,687
Less: Allowance for loan losses (213,000) (183,000)
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Net loans 4,535,186 4,678,687
Premises and equipment, net 163,757 162,726
Interest receivable 44,213 51,883
Accounts receivable from securitizations 696,599 588,781
Other assets 128,689 115,809
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Total assets $ 7,223,902 $ 7,078,279
==================================================================== ============== =============
LIABILITIES:
Interest-bearing deposits $ 1,160,850 $ 1,313,654
Other borrowings 723,614 796,112
Senior notes 3,464,176 3,332,778
Deposit notes 299,996 299,996
Interest payable 67,544 68,448
Other liabilities 422,480 276,368
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Total liabilities 6,138,660 6,087,356
GUARANTEED PREFERRED BENEFICIAL INTERESTS IN
CAPITAL ONE BANK'S FLOATING RATE JUNIOR
SUBORDINATED CAPITAL INCOME SECURITIES: 97,727 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 March 31, 1998 and December 31, 1997, respectively 666 666
Paid-in capital, net 543,179 513,561
Retained earnings 485,750 425,140
Cumulative other comprehensive income 2,325 2,539
Less: Treasury stock, at cost; 1,092,283 and 1,188,134
shares as of March 31, 1998
and December 31, 1997, respectively (44,405) (48,647)
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Total stockholders' equity 987,515 893,259
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Total liabilities and stockholders' equity $ 7,223,902 $ 7,078,279
==================================================================== ============== ===========
See notes to the condensed consolidated financial statements.
3
CAPITAL ONE FINANCIAL CORPORATION Condensed Consolidated Statements of Income
(in thousands, except per share data) (unaudited)
THREE MONTHS ENDED
MARCH 31
1998 1997
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INTEREST INCOME:
Consumer loans, including fees $ 229,638 $ 146,512
Federal funds sold and resale agreements 5,078 5,664
Other 23,326 16,418
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Total interest income 258,042 168,594
INTEREST EXPENSE:
Deposits 14,138 10,437
Other borrowings 16,053 6,524
Senior and deposit notes 63,029 63,436
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Total interest expense 93,220 80,397
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Net interest income 164,822 88,197
Provision for loan losses 85,866 49,187
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Net interest income after provision for loan losses 78,956 39,010
NON-INTEREST INCOME:
Servicing and securitizations 168,655 170,033
Service charges 113,324 53,648
Interchange 14,799 9,315
Other 19,121 10,061
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Total non-interest income 315,899 243,057
NON-INTEREST EXPENSE:
Salaries and associate benefits 107,953 70,636
Marketing 75,000 54,051
Communications and data processing 29,363 21,790
Supplies and equipment 22,615 18,073
Occupancy 10,644 7,801
Other 43,308 41,196
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Total non-interest expense 288,883 213,547
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Income before income taxes 105,972 68,520
Income taxes 40,269 26,038
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Net income $ 65,703 $ 42,482
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Basic earnings per share $ 1.00 $ 0.64
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Diluted earnings per share $ 0.96 $ 0.63
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Dividends paid per share $ 0.08 $ 0.08
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See notes to the 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)
CUMULATIVE
OTHER TOTAL
COMMON STOCK PAID-IN RETAINED COMPREHENSIVE TREASURY STOCKHOLDERS'
SHARES AMOUNT CAPITAL, NET EARNINGS INCOME STOCK EQUITY
- ---------------------------------- ----------- --------- ------------ ----------- --------------- ----------- --------------
Balance, December 31, 1996 66,325,261 $ 663 $ 481,383 $ 256,396 $ 1,949 $ 740,391
Comprehensive income:
Net income 42,482 42,482
Other comprehensive income, net
of income tax
Unrealized gains on
securities net of income
taxes of $2,511 (4,616) (4,616)
Foreign currency translation
adjustments (76) (76)
--------------- --------------
Other comprehensive income (4,692) (4,692)
--------------
Comprehensive income 37,790
Cash dividends - $.08 per share (5,165) (5,165)
Issuances of common stock 39,584 1 1,183 1,184
Exercise of stock options 10,498 159 159
Tax benefit from stock awards 143 143
Restricted stock, net (121) 28 28
Common stock issuable
under incentive plan 3,231 3,231
- ---------------------------------- ----------- --------- ------------ ----------- --------------- ----------- --------------
Balance, March 31, 1997 66,375,222 $ 664 $ 486,127 $ 293,713 $ (2,743) $777,761
- ---------------------------------- ----------- --------- ------------ ----------- --------------- ----------- --------------
Balance, December 31, 1997 66,557,230 $ 666 $ 513,561 $ 425,140 $ 2,539 $ (48,647) $ 893,259
Comprehensive income:
Net income 65,703 65,703
Other comprehensive income, net
of income tax
Unrealized gains on
securities net of income
taxes of $134, net of
reclassification
adjustment of $44, net of
income taxes of $17 (218) (218)
Foreign currency
translation adjustments 4 4
--------------- --------------
Other comprehensive income (214) (214)
--------------- --------------
Comprehensive income 65,489
Cash dividends - $.08 per share (5,093) (5,093)
Purchases of treasury stock (2,364) (2,364)
Issuances of common stock 572 960 1,532
Exercise of stock options 1,500 (3,531) 5,646 2,115
Tax benefit from stock awards 164 164
Restricted stock, net 18 18
Common stock issuable
under incentive plan 32,395 32,395
- ---------------------------------- ----------- --------- ------------ ----------- --------------- ----------- --------------
Balance, March 31, 1998 66,558,730 $ 666 $ 543,179 $ 485,750 $ 2,325 $ (44,405) $ 987,515
- ---------------------------------- ----------- --------- ------------ ----------- --------------- ----------- --------------
See notes to the condensed consolidated financial statements.
5
CAPITAL ONE FINANCIAL CORPORATION
Condensed Consolidated Statements of Cash Flows
(in thousands) (unaudited)
THREE MONTHS ENDED
MARCH 31
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1998 1997
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OPERATING ACTIVITIES:
Net income $ 65,703 $ 42,482
Adjustments to reconcile net income to cash
provided by operating activities:
Provision for loan losses 85,866 49,187
Depreciation and amortization, net 16,278 11,105
Stock compensation plans 32,413 3,259
Decrease in interest receivable 7,670 45,707
(Increase) decrease in accounts receivable from
securitizations (107,818) 43,351
Increase in other assets (16,976) (49)
Decrease in interest payable (904) (19,200)
Increase in other liabilities 146,112 174,428
- --------------------------------------------------------------- ------------------ -------------
Net cash provided by operating activities 228,344 350,270
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INVESTING ACTIVITIES:
Purchases of securities available for sale (670,782) (547,420)
Proceeds from maturities of securities available for sale 303,344 394,844
Proceeds from sales of securities available for sale 102,271
Proceeds from securitization of consumer loans 353,457
Net decrease in consumer loans 46,659 119,606
Recoveries of loans previously charged off 10,976 4,701
Additions of premises and equipment, net (18,761) (18,555)
- --------------------------------------------------------------- ------------------ -------------
Net cash (used for) provided by investing activities (226,293) 306,633
- --------------------------------------------------------------- ------------------ -------------
FINANCING ACTIVITIES:
Net decrease in interest-bearing deposits (152,804) (201,303)
Net decrease in other borrowings (72,498) (175,795)
Issuances of senior notes 505,064 480,000
Maturities of senior notes (373,666) (705,436)
Issuances of preferred beneficial interests 97,428
Proceeds from exercise of stock options 2,115 159
Net proceeds from issuances of common stock 1,532 1,184
Purchases of treasury stock (2,364)
Dividends paid (5,093) (5,165)
- --------------------------------------------------------------- ---------------- ---------------
Net cash used for financing activities (97,714) (508,928)
- --------------------------------------------------------------- ---------------- ---------------
(Decrease) increase in cash and cash equivalents (95,663) 147,975
Cash and cash equivalents at beginning of period 237,723 528,976
- --------------------------------------------------------------- ------------------ -------------
Cash and cash equivalents at end of period $ 142,060 $ 676,951
- --------------------------------------------------------------- ---------------- ---------------
See notes to the condensed consolidated financial statements.
6
CAPITAL ONE FINANCIAL CORPORATION
Notes to the Condensed Consolidated Financial Statements March 31, 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 months ended
March 31, 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 three months ended March 31, 1998 and
1997 was $94,124 and $99,597, respectively. Cash paid for income taxes for the
three months ended March 31, 1997 was $9,075.
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 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.
7
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: ASSOCIATE STOCK PLANS
In April 1998, stockholders approved an increase of 3,250,000 in shares
available for issuance under the 1994 Stock Incentive Plan. With this approval,
a December 18, 1997 grant ("Entrepreneur Grant II") to senior management became
effective. 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 and Chief Operating Officer), 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 Company
recognized $32,395 and $3,231 of compensation cost relating to its associate
stock plans for the three months ended March 31, 1998 and 1997, respectively.
NOTE D: EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted
earnings per share.
THREE MONTHS ENDED
MARCH 31
- ----------------------------------------------- -------------- ------------
(shares in thousands) 1998 1997
- ----------------------------------------------- -------------- ------------
NUMERATOR:
Net income $ 65,703 $ 42,482
- ----------------------------------------------- -------------- ------------
DENOMINATOR:
Denominator for basic earnings per share -
Weighted-average shares 65,428 66,336
EFFECT OF DILUTIVE SECURITIES:
Stock options 2,985 1,361
Restricted stock 2 7
- ----------------------------------------------- -------------- ------------
Dilutive potential common shares 2,987 1,368
Denominator for diluted earnings per share -
Adjusted weighted-average shares 68,415 67,704
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BASIC EARNINGS PER SHARE $ 1.00 $ 0.64
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DILUTED EARNINGS PER SHARE $ 0.96 $ 0.63
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NOTE E: 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.
8
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.
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." As of March 31,
1998, the Company had 12.7 million customers and $14.0 billion in managed
consumer loans outstanding and was one of the largest providers of Master Card
and Visa credit cards in the world. 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 March 31, 1998 of $65.7 million,
or $.96 per share (diluted), compares to net income of $42.5 million, or $.63
per share (diluted), for the same period in 1997.
The increase in net income is primarily a result of an increase in
asset and account volumes and rates. Net interest income increased $76.6
million, or 87%, as the net interest margin increased to 9.83% from 6.32% and
average earning assets increased by 20%. The provision for loan losses increased
$36.7 million, or 75%, as average reported loans increased by 18% and the
reported charge-off rate increased to 4.69% from 4.58%. Non-interest income
increased $72.8 million, or 30%, primarily as a result of the increase in
average managed loans of 12%, a continued shift to more fee-based accounts and
increases in the amounts of certain fees charged. Marketing expense increased
$20.9 million, or 39%, to $75.0 million as the Company continues to invest in
new product opportunities. Salaries and associate benefits expense increased
$37.3 million, or 53%, of which $29.2 million, or 41%, was an increase in
compensation expense related to the associate stock plans. The remaining $8.1
million, or 12%, increase in salaries and associate benefits and the $17.1
million, or 19%, 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.
10
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 consumer 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.
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TABLE 1 - MANAGED CONSUMER LOAN PORTFOLIO
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THREE MONTHS ENDED
MARCH 31
- ------------------------------------------------------ -------------------- ---------------------
(in thousands) 1998 1997
- ------------------------------------------------------ -------------------- ---------------------
PERIOD-END BALANCES:
Consumer loans held for securitization $ 300,000
On-balance sheet consumer loans $ 4,748,186 3,516,951
Securitized consumer loans 9,254,063 8,789,969
- ------------------------------------------------------ -------------------- ---------------------
Total managed consumer loan portfolio $ 14,002,249 $ 12,606,920
- ------------------------------------------------------ -------------------- ---------------------
AVERAGE BALANCES:
Consumer loans held for securitization $ 122,445
On-balance sheet consumer loans $ 4,786,489 3,936,256
Securitized consumer loans 9,310,986 8,500,177
- ------------------------------------------------------ -------------------- ---------------------
Total average managed consumer loan portfolio $ 14,097,475 $ 12,558,878
- ------------------------------------------------------ -------------------- ---------------------
Since 1990, the Company has actively engaged in consumer loan
securitization transactions. In accordance with Statement of Financial
Accounting Standards No. 125 "Accounting for 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 excess present value of estimated 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.
11
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
MARCH 31
(dollars in thousands) 1998 1997
- --------------------------------------------------------------------------------------------------
REPORTED:
Average earning assets $ 6,708,901 $ 5,579,411
Net interest margin(1) 9.83% 6.32%
Loan yield 19.19 14.44
MANAGED:
Average earning assets $ 16,019,887 $ 14,079,588
Net interest margin(1) 10.40% 8.83%
Loan yield 17.45 15.46
- --------------------------------------------------------------------------------------------------
(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 since the early 1990's, 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. Many of the Company's products have a balance
transfer feature under which consumers can transfer balances from 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
introductory interest rate strategies. Management believes that the competition
has put, and will continue to put, additional pressure on low introductory
interest rate 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 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, 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 balance transfer products but typically consist of lower credit
limit accounts and balances that build over time. The terms of the other credit
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.
Each of 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 managed 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.
12
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
MARCH 31
(dollars in thousands) 1998 1997
- ------------------------------------------------------------------------------------
MANAGED INCOME STATEMENT:
Net interest income $ 416,711 $ 310,690
Non-interest income 220,683 157,320
Net charge-offs (212,735) (183,255)
- ---------------------------------------------------- ---------------- --------------
Risk adjusted revenue $ 424,659 $ 284,755
- ---------------------------------------------------- ---------------- --------------
RATIOS(1):
Net interest margin 10.40% 8.83%
Non-interest income 5.51 4.47
Net charge-offs (5.31) (5.21)
- ---------------------------------------------------- ---------------- --------------
Risk adjusted margin 10.60% 8.09%
- ---------------------------------------------------- ---------------- --------------
(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 include interest-bearing deposits, other borrowings and borrowings from
senior and deposit notes.
Net interest income for the three months ended March 31, 1998 was
$164.8 million, compared to $88.2 million for the same period in the prior year,
representing an increase of $76.6 million, or 87%. Average earning assets
increased 20% for the three months ended March 31, 1998, versus the same period
in 1997. The yield on earning assets increased 330 basis points for the three
months ended March 31, 1998, to 15.39% from 12.09%, as compared to the same
period in the prior year. The increase was primarily attributable to a 475 basis
point increase in the yield on consumer loans for the three months ended March
31, 1998, to 19.19% from 14.44%, as compared to the same period 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.
13
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 months ended March 31, 1998 and 1997.
- -------------------------------------------------------------------------------------------------------------------
TABLE 4 - STATEMENTS OF AVERAGE BALANCES, INCOME AND EXPENSE, YIELDS AND RATES
- -------------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED MARCH 31
1998 1997
AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/
(dollars in thousands) BALANCE EXPENSE RATE BALANCE EXPENSE RATE
- -------------------------------------------------------------------------------------------------------------------
ASSETS:
Earning assets
Consumer loans(1) $4,786,489 $ 229,638 19.19% $4,058,701 $146,512 14.44%
Federal funds sold and
resale agreements 362,680 5,078 5.60 428,853 5,664 5.28
Other 1,559,732 23,326 5.98 1,091,857 16,418 6.01
- ------------------------------------- ------------- ------------- ----------- --------------- ----------- --------
Total earning assets 6,708,901 $258,042 15.39% 5,579,411 $168,594 12.09%
Cash and due from banks 18,622 91,047
Allowance for loan losses (197,333) (119,835)
Premises and equipment, net 165,532 180,256
Other assets 840,727 668,501
- ------------------------------------- ------------- ------------- ----------- --------------- ----------- --------
Total assets $7,536,449 $6,399,380
- ------------------------------------- ------------- ------------- ----------- --------------- ----------- --------
LIABILITIES AND EQUITY:
Interest-bearing liabilities
Deposits $1,266,064 $ 14,138 4.47% $ 992,751 $ 10,437 4.21%
Other borrowings 1,077,082 16,053 5.96 410,924 6,524 6.35
Senior and deposit notes 3,683,113 63,029 6.85 3,808,926 63,436 6.66
- ------------------------------------- ------------- ------------- ----------- --------------- ----------- --------
Total interest-bearing liabilities 6,026,259 $ 93,220 6.19% 5,212,601 $ 80,397 6.17%
Other liabilities 462,355 357,833
- ------------------------------------- ------------- ------------- ----------- --------------- ----------- --------
Total liabilities 6,488,614 5,570,434
Preferred beneficial interests 97,696 64,966
Equity 950,139 763,980
- ------------------------------------- ------------- ------------- ----------- --------------- ----------- --------
Total liabilities and equity $7,536,449 $6,399,380
- ------------------------------------- ------------- ------------- ----------- --------------- ----------- --------
Net interest spread 9.20% 5.92%
- ------------------------------------- ------------- ------------- ----------- --------------- ----------- --------
Interest income to
average earning assets 15.39% 12.09%
Interest expense to
average earning assets 5.56 5.77
- ------------------------------------- ------------- ------------- ----------- --------------- ----------- --------
Net interest margin 9.83% 6.32%
- ------------------------------------- ------------- ------------- ----------- --------------- ----------- --------
(1) Interest income includes past-due fees on loans of approximately $75,951 and
$25,248 for the three months ended March 31, 1998 and 1997, respectively.
Managed net interest income increased $106.0 million, or 34%, for the
three months ended March 31, 1998, compared to the same period in the prior year
as managed average earning assets increased 14% and the managed net interest
margin increased 157 basis points to 10.40%. The increase in managed net
interest margin principally reflects growth in higher yielding loans and
increases in the amount and frequency of past-due fees.
14
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
MARCH 31, 1998 VS. 1997
----------------------------------------------------------------------------------------------------
INCREASE CHANGE DUE TO(1)
(in thousands) (DECREASE) VOLUME YIELD/RATE
- -----------------------------------------------------------------------------------------------------
INTEREST INCOME:
Consumer loans $ 83,126 $ 29,321 $ 53,805
Federal funds sold and resale agreements (586) (912) 326
Other 6,908 6,998 (90)
- ------------------------------------------------------- --------------- --------------- -------------
Total interest income 89,448 38,097 51,351
INTEREST EXPENSE:
Deposits 3,701 3,019 682
Other borrowings 9,529 9,952 (423)
Senior and deposit notes (407) (2,127) 1,720
- ------------------------------------------------------- --------------- --------------- -------------
Total interest expense 12,823 12,586 237
- ------------------------------------------------------- --------------- --------------- -------------
Net interest income(1) $ 76,625 $ 20,502 $ 56,123
- -----------------------------------------------------------------------------------------------------
(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 decreased $1.4 million, or 1%, for
the three months ended March 31, 1998, from the same period in the prior year
due to 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 quarter 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 increased to $147.2 million, or
102%, for the three months ended March 31, 1998, compared to $73.0 million for
the same period in the prior year. The increase in other non-interest income was
due to an increase in the average number of accounts of 39% 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.
Managed other non-interest income increased $63.4 million, or 40%, for
the three months ended March 31, 1998, primarily due to the increase in the
average number of accounts.
15
NON-INTEREST EXPENSE
Non-interest expense for the three months ended March 31, 1998 was
$288.9 million, an increase of 35% over $213.5 million for the same period in
the prior year. Contributing to the increase in non-interest expense was
salaries and associate benefits expense, which rose $37.3 million, or 53%, for
the three months ended March 31, 1998, compared to the same period in the prior
year. This increase reflected a $29.2 million increase in additional
compensation expense associated with the Company's associate stock plans.
Marketing expense increased $20.9 million, or 39%, to $75.0 million as the
Company continues to invest in new product opportunities. All other non-interest
expenses increased $17.1 million, or 19%, to $105.9 million for the three months
ended March 31, 1998, from $88.9 million for the same period in the prior year.
The increase in other non-interest expense was primarily a result of a 39%
increase in the average number of accounts for the three months ended March 31,
1998, which resulted in a corresponding increase in infrastructure and other
operational costs, offset by efficiencies gained from improved processes and
investments in information technology.
Salaries and benefits expense includes $32.4 million for the
performance-based stock options granted in December 1997 and reflects the 46%
stock price increase during the quarter. The continued increase in the stock
price and subsequent vesting of these options in April will result in $22.0
million in additional expense being recorded in the second quarter of 1998
related to this grant. The Company does not, however, expect this charge to
impact its ability to meet its earnings targets for 1998 as discussed in the
"Business Outlook" section.
INCOME TAXES
The Company's income tax rate was 38% for the three months ended March
31, 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. Accounts tend to
exhibit a rising trend of delinquency and credit losses as they season.
16
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(1)
- ------------------------------------------------------------------------------------------------
MARCH 31
1998 1997
% OF % OF
(dollars in thousands) LOANS TOTAL LOANS LOANS TOTAL LOANS
- -------------------------------------- ---------------------------------------------------------
REPORTED:
Loans outstanding $ 4,748,186 100.00% $ 3,816,951 100.00%
Loans delinquent:
30-59 days 92,673 1.95 68,406 1.79
60-89 days 59,435 1.25 42,407 1.11
90 or more days 100,971 2.13 92,090 2.42
- -------------------------------------- ---------------- ------------ ---------------- -----------
Total $ 253,079 5.33% $ 202,903 5.32%
- -------------------------------------- ---------------- ------------ ---------------- -----------
MANAGED:
Loans outstanding $ 14,002,249 100.00% $ 12,606,920 100.00%
Loans delinquent:
30-59 days 283,346 2.02 264,705 2.10
60-89 days 179,974 1.29 159,809 1.27
90 or more days 342,261 2.44 383,571 3.04
- -------------------------------------- ---------------- ------------ ---------------- -----------
Total $ 805,581 5.75% $ 808,085 6.41%
- -------------------------------------- ---------------- ------------ ---------------- -----------
(1) Includes consumer loans held for securitization.
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 5.33% as of
March 31, 1998 reflects a higher percentage of higher yielding loans in the
reported portfolio as compared to the prior year, offset by the modifications in
charge-off policy and finance charge and fee income recognition. The delinquency
rate for the managed consumer loan portfolio was 5.75% as of March 31, 1998,
down from 6.41% as of March 31, 1997 and down from 6.20% as of December 31,
1997. Both the managed and reported (5.51% as of December 31, 1997) portfolio's
delinquency rate decrease as of March 31, 1998, when compared to December 31,
1997, reflected seasonality and improvements in consumer credit performance.
17
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
MARCH 31
(dollars in thousands) 1998 1997
- ------------------------------------------------------------------------------------------------------
REPORTED:
Average loans outstanding $ 4,786,489 $ 4,058,701
Net charge-offs 56,062 46,500
Net charge-offs as a percentage of average loans outstanding 4.69% 4.58%
- -------------------------------------------------------------------- ------------------ --------------
MANAGED:
Average loans outstanding $ 14,097,475 $ 12,558,878
Net charge-offs 212,735 183,255
Net charge-offs as a percentage of average loans outstanding 6.04% 5.84%
- -------------------------------------------------------------------- ------------------ --------------
(1) Includes consumer loans held for securitization.
Net charge-offs of managed loans increased $29.5 million, or 16%, while
average managed consumer loans grew 12% for the three months ended March 31,
1998, from the same period in the prior year. For the three months ended March
31, 1998, the Company's net charge-offs as a percentage of managed loans were
6.04%, compared to 5.84% for the same period in the prior year. The increase in
net charge-offs was the result of worsened general economic trends in consumer
credit performance compared to the same period in the prior year. The increase
in the reported charge-offs from period to period reflect these same trends.
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 consumer 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.
18
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
MARCH 31
(dollars in thousands) 1998 1997
- ---------------------------------------------------------------------------------------------
Balance at beginning of period $ 183,000 $ 118,500
Provision for loan losses 85,866 49,187
Transfer to loans held for securitization (2,625)
Other 196 (62)
Charge-offs (67,038) (51,201)
Recoveries 10,976 4,701
Net charge-offs(1) (56,062) (46,500)
Balance at end of period $ 213,000 $ 118,500
- ------------------------------------------------------------ ---------------- ---------------
Allowance for loan losses to loans at period-end(1) 4.49% 3.37%
- ------------------------------------------------------------ ---------------- ---------------
(1) Excludes consumer loans held for securitization.
For the three months ended March 31, 1998, the provision for loan
losses increased to $85.9 million, or 75%, from $49.2 million for the comparable
period in the prior year, as average reported loans increased by 18% and the
reported charge-off rate increased to 4.69% from 4.58%. The allowance for loan
losses as a percentage of on-balance sheet consumer loans increased to 4.49% as
of March 31, 1998, from 3.37% as of March 31, 1997. The increase reflects the
increase in on-balance sheet consumer loans to $4.7 billion as of March 31,
1998, an increase of 35% from March 31, 1997. The increase also reflects a
moderate increase in the net charge-off rate in the same periods resulting from
worsened general economic trends in consumer credit performance. For the three
months ended March 31, 1998, the Company increased the allowance for loan losses
by $30 million due to the continued growth and mix of its consumer lending
products.
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 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.
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 March 31, 1998, the Company held $1.7
billion in such securities.
19
Table 9 shows the maturation of certificates of deposit in
denominations of $100,000 or greater ("large denomination CDs") as of March 31,
1998.
- ----------------------------------------------------------------------------------------
TABLE 9 - MATURITIES OF LARGE DENOMINATION CERTIFICATES-$100,000 OR MORE
- ----------------------------------------------------------------------------------------
MARCH 31, 1998
(dollars in thousands) BALANCE PERCENT
- ----------------------------------------------------------------------------------------
3 months or less $ 62,548 31.71%
Over 3 through 6 months 36,676 18.59
Over 6 through 12 months 48,586 24.63
Over 1 through 5 years 49,447 25.07
- -------------------------------- ----------------- ------------------------- -----------
Total $ 197,257 100.00%
- -------------------------------- ----------------- ------------------------- -----------
The Company's other borrowings portfolio consists of $679 million in
borrowings maturing within one year and $45 million in borrowings maturing after
one year.
Table 10 shows the Company's unsecured funding availability and
outstandings as of March 31, 1998.
- --------------------------------------------------------------------------------------------------------
TABLE 10 - FUNDING AVAILABILITY
- --------------------------------------------------------------------------------------------------------
MARCH 31, 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 $ 51 8/00
Senior bank note program(2) 4/97 8,000 3,339 -
Non-U.S. bank note program 10/97 1,000 -
Deposit note program 4/97 2,000 300 -
Floating rate junior subordinated
capital income securities(3) 1/97 100 98 2/27
Corporation Universal Shelf Registration 12/96 200 125 12/03
- --------------------------------------------------------------------------------------------------------
(1) All funding sources are revolving except for the Corporation Universal Shelf
Registration.
(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 under the UK/Canada revolving facility.
20
Under the Corporation's $200 million shelf registration, 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. As of March 31, 1998, one issue of senior notes was
outstanding.
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 table below. As of March 31, 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 March 31, 1998, the Bank and the Savings Bank's ratios of capital to managed
assets were 5.67% and 7.71%, respectively.
- --------------------------------------------------------------------------------------------------
TABLE 11 - REGULATORY CAPITAL RATIOS
- --------------------------------------------------------------------------------------------------
TO BE "WELL-CAPITALIZED" UNDER
MINIMUM FOR CAPITAL PROMPT CORRECTIVE ACTION
RATIOS ADEQUACY PURPOSES PROVISIONS
- ------------------------------ --------------- ------------------ ------------------------------
MARCH 31, 1998
Capital One Bank
Tier 1 Capital 14.08% 4.00% 6.00%
Total Capital 16.94 8.00 10.00
Tier 1 Leverage 11.34 4.00 5.00
Capital One, F.S.B.(1)
Tangible Capital 9.34% 1.50% 6.00%
Total Capital 15.99 12.00 10.00
Core Capital 9.34 8.00 5.00
- ------------------------------ --------------- ------------------ -------------------------------
MARCH 31, 1997
Capital One Bank
Tier 1 Capital 11.49% 4.00% 6.00%
Total Capital 14.43 8.00 10.00
Tier 1 Leverage 12.04 4.00 5.00
Capital One, F.S.B.(1)
Tangible Capital 11.22% 1.50% 6.00%
Total Capital 21.47 12.00 10.00
Core Capital 11.22 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%.
21
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 March 31, 1998 and 1997, the Company's Tier 1
leverage ratio was 14.26% and 13.71%, respectively.
Additionally, certain regulatory restrictions exist which limit the
ability of the Bank and the Savings Bank to transfer funds to the Corporation.
As of March 31, 1998, retained earnings of the Bank and the Savings Bank of
$116.8 million and $14.3 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 and interest rate swap agreements ("swaps"). 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.
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.
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, as well as other customized credit card products. 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 margins (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. 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.
22
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 information 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 and other credit card products and
services, and other financial and non-financial products and services. 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 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, however, notes
that during the second quarter of 1998, it expects that charge-offs will
increase, while delinquency rates will remain stable or possibly decrease.
Therefore, the Company expects that it will experience a more moderate increase
in revenue than it experienced in recent quarters due to the timing of revenue
noted above. Management, further 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.
23
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 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 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; 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).
24
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(A) The 1998 Annual Meeting of Stockholders was held April 23, 1998.
(B) The following directors were elected at such meeting:
W. Ronald Dietz
Nigel W. Morris
The following directors will also continue in their office
after such meeting:
Richard D. Fairbank
James A. Flick, Jr.
Patrick W. Gross
James V. Kimsey
Stanley I. Westreich
(C) The following matters were voted upon at such meeting:
ELECTION OF DIRECTORS VOTES FOR VOTES WITHHELD
W. RONALD DIETZ 55,230,950 1,212,024
NIGEL W. MORRIS 55,894,225 548,749
ITEM VOTES FOR VOTES AGAINST ABSTAIN
APPROVAL OF AMENDMENT TO
THE 1994 STOCK INCENTIVE PLAN. 45,996,458 10,072,500 374,016
RATIFICATION OF THE SELECTION OF
ERNST & YOUNG LLP AS INDEPENDENT
AUDITORS OF THE COMPANY FOR 1998. 56,244,702 84,881 113,391
No other matter was voted upon at such meeting.
ITEM 6. REPORTS ON FORM 8-K
(A) The Company filed a Current Report on Form 8-K, dated January
15, 1998, Commission File No. 1-13300, enclosing its press
release dated January 15, 1998.
25
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: May 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)
26
5
1,000
3-mos
Dec-31-1998
Jan-01-1998
Mar-31-1998
2,983
1,513,398
4,748,186
(213,000)
0
0
163,757
0
7,223,902
0
0
0
0
666
986,849
7,223,902
0
573,941
0
288,883
0
85,866
93,220
105,972
40,269
65,703
0
0
0
65,703
1.00
.96
Non classified balance sheet
PP&E Shown Net
