Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

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

For the quarterly period ended March 31, 2013

OR

 

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

For the transition period from              to             

Commission File No. 1-13300

 

 

CAPITAL ONE FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   54-1719854

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

1680 Capital One Drive,

McLean, Virginia

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

Registrant’s telephone number, including area code: (703) 720-1000

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

(Not applicable)

 

 

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

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

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

 

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

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

As of April 30, 2013, there were 584,162,780 shares of the registrant’s Common Stock, par value $.01 per share, outstanding.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

          Page  

PART I—FINANCIAL INFORMATION

     1   
Item 1.    Financial Statements      61   
   Condensed Consolidated Statements of Income      62   
   Condensed Consolidated Statements of Comprehensive Income      63   
   Condensed Consolidated Balance Sheets      64   
   Condensed Consolidated Statements of Changes in Stockholders’ Equity      65   
   Condensed Consolidated Statements of Cash Flows      66   
   Notes to Condensed Consolidated Financial Statements      67   
       Note   1 — Summary of Significant Accounting Policies      67   
       Note   2 — Discontinued Operations      69   
       Note   3 — Investment Securities      70   
       Note   4 — Loans      80   
       Note   5 — Allowance for Loan and Lease Losses      101   
       Note   6 — Variable Interest Entities and Securitizations      104   
       Note   7 — Goodwill and Other Intangible Assets      109   
       Note   8 — Deposits and Borrowings      110   
       Note   9 — Derivative Instruments and Hedging Activities      113   
       Note 10 — Stockholders’ Equity      119   
       Note 11 — Earnings Per Common Share      121   
       Note 12 — Fair Value of Financial Instruments      122   
       Note 13 — Business Segments      136   
       Note 14 — Commitments, Contingencies and Guarantees      138   
Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”)      1   
       Summary of Selected Financial Data      1   
       Introduction      6   
       Executive Summary and Business Outlook      7   
       Critical Accounting Policies and Estimates      11   
       Accounting Changes and Developments      13   
       Consolidated Results of Operations      13   
       Business Segment Financial Performance      19   
       Consolidated Balance Sheet Analysis and Credit Performance      32   
       Off-Balance Sheet Arrangements and Variable Interest Entities      37   
       Capital Management      37   
       Risk Management      39   
       Credit Risk Profile      40   
       Liquidity Risk Profile      51   
       Market Risk Profile      55   
       Supervision and Regulation      58   
       Forward-Looking Statements      58   
       Supplemental Tables      60   
Item 3.    Quantitative and Qualitative Disclosures about Market Risk      151   
Item 4.    Controls and Procedures      151   

PART II—OTHER INFORMATION

     152   
Item 1.    Legal Proceedings      152   
Item 1A.    Risk factors      152   
Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds      152   

 

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          Page  
Item 3.    Defaults upon Senior Securities      152   
Item 5.    Other Information      152   
Item 6.    Exhibits      152   

SIGNATURES

     153   

EXHIBIT INDEX

     154   

 

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INDEX OF MD&A TABLES AND SUPPLEMENTAL TABLES

 

Table

  

Description

   Page  
   MD&A Tables:   
1    Consolidated Financial Highlights (Unaudited)      3   
2    Business Segment Results      7   
3    Average Balances, Net Interest Income and Net Interest Yield      14   
4    Rate/Volume Analysis of Net Interest Income      15   
5    Non-Interest Income      16   
6    Non-Interest Expense      18   
7    Credit Card Business Results      20   
7.1    Domestic Card Business Results      23   
7.2    International Card Business Results      24   
8    Consumer Banking Business Results      26   
9    Commercial Banking Business Results      29   
10    “Other” Results      31   
11    Investment Securities Available for Sale      33   
12    Non-Agency Investment Securities Credit Ratings      34   
13    Net Loans Held for Investment      34   
14    Changes in Representation and Warranty Reserve      36   
15    Capital Ratios Under Basel I      38   
16    Loan Portfolio Composition      41   
17    30+ Days Delinquencies      43   
18    Aging and Geography of 30+ Days Delinquent Loans      44   
19    90+ Days Delinquent Loans Accruing Interest      44   
20    Nonperforming Loans and Other Nonperforming Assets      45   
21    Net Charge-Offs      46   
22    Loan Modifications and Restructurings      47   
23    Allowance for Loan and Lease Losses Activity      49   
24    Allocation of the Allowance for Loan and Lease Losses      50   
25    Liquidity Reserves      51   
26    Deposit Composition and Average Deposit Rates      52   
27    Short-term Borrowings      53   
28    Contractual Maturity Profile of Outstanding Debt      54   
29    Senior Unsecured Debt Credit Ratings      55   
30    Interest Rate Sensitivity Analysis      57   
   Supplemental Tables:   
A    Reconciliation of Non-GAAP Measures and Calculation of Regulatory Capital Measures under Basel I      60   

 

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PART I—FINANCIAL INFORMATION

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”)

 

 

This discussion contains forward-looking statements that are based upon management’s current expectations and are subject to significant uncertainties and changes in circumstances. Please review “Forward-Looking Statements” for more information on the forward-looking statements in this Quarterly Report on Form 10-Q (“this Report”). Our actual results may differ materially from those included in these forward-looking statements due to a variety of factors including, but not limited to, those described in “Part II—Item 1A. Risk Factors” in this Report and in “Part I—Item 1A. Risk Factors” in our 2012 Annual Report on Form 10-K (“2012 Form 10-K”). Unless otherwise specified, references to Notes to our consolidated financial statements are to the Notes to our unaudited condensed consolidated financial statements as of March 31, 2013 included in this Report.

 

 

Management monitors a variety of key indicators to evaluate our business results and financial condition. The following MD&A is intended to provide the reader with an understanding of our results of operations, financial condition and liquidity by focusing on changes from year to year in certain key measures used by management to evaluate performance, such as profitability, growth and credit quality metrics. MD&A is provided as a supplement to, and should be read in conjunction with, our unaudited condensed consolidated financial statements and related notes in this Report and the more detailed information contained in our 2012 Form 10-K. MD&A is organized in the following sections:

 

•    Summary of Selected Financial Data

  

•    Capital Management

•    Executive Summary and Business Outlook

  

•    Risk Management

•    Critical Accounting Policies and Estimates

  

•    Credit Risk Profile

•    Accounting Changes and Developments

  

•    Liquidity Risk Profile

•    Consolidated Results of Operations

  

•    Market Risk Profile

•    Business Segment Financial Performance

  

•    Supplemental Tables

•    Consolidated Balance Sheet Analysis

  

•    Capital Management

•    Off-Balance Sheet Arrangements and Variable Interest Entities

  

 

 

SUMMARY OF SELECTED FINANCIAL DATA

 

The following table presents selected consolidated financial data from our results of operations for the three months ended March 31, 2013 and 2012, and selected comparative consolidated balance sheet data as of March 31, 2013, and December 31, 2012. We also provide selected key metrics we use in evaluating our performance. Certain prior period amounts have been reclassified to conform to the current period presentation. The comparability of our results of operations between reported periods is impacted by the following acquisitions completed in 2012:

 

   

On February 17, 2012, we completed the acquisition (the “ING Direct acquisition”) of substantially all of the ING Direct business in the United States (“ING Direct”) from ING Groep N.V., ING Bank N.V., ING Direct N.V. and ING Direct Bancorp (collectively the “ING Direct Sellers”). The ING Direct acquisition resulted in the addition of loans of $40.4 billion, other assets of $53.9 billion and deposits of $84.4 billion as of the acquisition date.

 

   

On May 1, 2012, pursuant to the agreement with HSBC Finance Corporation, HSBC USA Inc. and HSBC Technology and Services (USA) Inc. (collectively, “HSBC”), we closed the acquisition of substantially all of the assets and assumed liabilities of HSBC’s credit card and private-label credit card business in the United States (other than the HSBC Bank USA, National Association consumer credit card program and certain other retained assets and liabilities) (the “2012 U.S. card acquisition”). The 2012 U.S. card

 

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acquisition included (i) the acquisition of HSBC’s U.S. credit card portfolio, (ii) its on-going private label and co-branded partnerships, and (iii) other assets, including infrastructure and capabilities. At closing, we acquired approximately 27 million new active accounts, $27.8 billion in outstanding credit card receivables designated as held for investment and $327 million in other net assets.

We use the term “acquired loans” to refer to a limited portion of the credit card loans acquired in the 2012 U.S. card acquisition and the substantial majority of consumer and commercial loans acquired in the ING Direct and Chevy Chase Bank (“CCB”) acquisitions, which were recorded at fair value at acquisition and subsequently accounted for based on expected cash flows to be collected (under the accounting standard formerly known as “Statement of Position 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer,” commonly referred to as “SOP 03-3”). The period-end carrying value of acquired loans accounted for subsequent to acquisition based on expected cash flows to be collected was $34.9 billion and $37.1 billion as of March 31, 2013 and December 31, 2012, respectively. The difference between the fair value at acquisition and initial expected cash flows represents the accretable yield, which is recognized into interest income over the life of the loans. The difference between the contractual payments on the loans and the expected cash flows represents the nonaccretable difference or the amount not considered collectible, which approximates what we refer to as the “credit mark.” The credit mark established under the accounting for these loans takes into consideration future expected credit losses over the life of the loans. Accordingly, there are no charge-offs or an allowance associated with these loans unless the estimated cash flows expected to be collected decrease subsequent to acquisition. In addition, these loans are not classified as delinquent or nonperforming even though the customer may be contractually past due because we expect that we will fully collect the carrying value of these loans. The accounting and classification of these loans may significantly alter some of our reported credit quality metrics. We therefore supplement certain reported credit quality metrics with metrics adjusted to exclude the impact of these acquired loans. For additional information, see “Credit Risk Profile” and “Note 4—Loans—Acquired Loans.”

 

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Table 1: Consolidated Financial Highlights (Unaudited)

 

     Three Months Ended March 31,  

(Dollars in millions, except per share data as noted)

       2013             2012             Change      

Income statement

                  

Net interest income(1)

   $ 4,570      $ 3,414        34

Non-interest income(2)

     981        1,521        (36
  

 

 

   

 

 

   

 

 

 

Total net revenue(3)

     5,551        4,935        12   

Provision for credit losses

     885        573        54   

Non-interest expense(4)

     3,028        2,504        21   
  

 

 

   

 

 

   

 

 

 

Income from continuing operations before income taxes

     1,638        1,858        (12

Income tax provision

     494        353        40   
  

 

 

   

 

 

   

 

 

 

Income from continuing operations, net of tax

     1,144        1,505        (24

Loss from discontinued operations, net of tax(5)

     (78     (102     (24
  

 

 

   

 

 

   

 

 

 

Net income

     1,066        1,403        (24

Dividends and undistributed earnings allocated to participating securities

     (5     (7     (29

Preferred stock dividends

     (13            **   
  

 

 

   

 

 

   

 

 

 

Net income available to common shareholders

   $ 1,048      $ 1,396        (25 )% 
  

 

 

   

 

 

   

 

 

 

Common share statistics

                  

Earnings per common share:

      

Basic earnings per common share

   $ 1.81      $ 2.74        (34 )% 

Diluted earnings per common share

     1.79        2.72        (34

Weighted average common shares outstanding:

      

Basic earnings per common share

     580.5        508.7        14   

Diluted earnings per common share

     586.3        513.1        14   

Dividends per common share

     0.05        0.05        **   
      

Average balances

                  

Loans held for investment(6)

   $ 195,997      $ 152,900        28

Interest-earning assets

     272,345        220,246        24   

Total assets

     303,223        246,384        23   

Interest-bearing deposits

     190,612        151,625        26   

Total deposits

     211,555        170,259        24   

Borrowings

     41,574        35,994        16   

Stockholders’ equity

     40,960        32,982        24   

Selected performance metrics

                  

Purchase volume(7)

   $ 45,098      $ 34,498        31

Total net revenue margin(8)

     8.15     8.96     (81 )bps 

Net interest margin(9)

     6.71        6.20        51   

Net charge-offs

   $ 1,079      $ 780        38

Net charge-off rate(10)

     2.20     2.04     16 bps 

Net charge-off rate (excluding acquired loans)(11)

     2.69        2.40        29   

Return on average assets(12)

     1.51        2.44        (93

Return on average total stockholders’ equity(13)

     11.17        18.25        (708

Equity-to-assets ratio(14)

     13.51        13.39        12   

Non-interest expense as a % of average loans held for investment(15)

     6.18        6.55        (37

Efficiency ratio(16)

     54.55        50.74        381   

Effective income tax rate

     30.2        19.0        1,120   

 

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         March 31,    
2013
        December 31,    
2012
        Change      

Balance sheet (period end)

                  

Loans held for investment(6)

   $ 191,333      $ 205,889        (7 )% 

Interest-earning assets

     268,479        280,096        (4

Total assets

     300,163        312,918        (4

Interest-bearing deposits

     191,093        190,018        1   

Total deposits

     212,410        212,485        **   

Borrowings

     37,492        49,910        (25

Stockholders’ equity

     41,296        40,499        2   

Credit quality metrics (period end)

                  

Allowance for loan and lease losses

   $ 4,606      $ 5,156        (11 )% 

Allowance as a % of loans held of investment (“allowance coverage ratio”)

     2.41     2.50     (9 )bps 

Allowance as a % of loans held of investment (excluding acquired loans)(11)

     2.91        3.02        (11

30+ days performing delinquency rate

     2.37        2.70        (33

30+ days performing delinquency rate (excluding acquired loans)(11)

     2.90        3.29        (39

30+ days delinquency rate

     2.74        3.09        (35

30+ days delinquency rate (excluding acquired loans)(11)

     3.35        3.77        (42

Capital ratios

                  

Tier 1 common ratio(17)

     11.79     10.96     83 bps 

Tier 1 risk-based capital ratio(18)

     12.18        11.34        84   

Total risk-based capital ratio(19)

     14.43        13.56        87   

Tangible common equity (“TCE”) ratio(20)

     8.61        7.90        71   

Associates

                  

Full-time equivalent employees (in thousands)

     39.3        39.6        (1 )% 

 

** Change is less than one percent or not meaningful.
(1) 

Premium amortization related to the ING Direct and 2012 U.S. card acquisitions reduced net interest income by $111 million and $30 million in the first quarter of 2013 and 2012, respectively.

(2) 

Includes a bargain purchase gain of $594 million attributable to the ING Direct acquisition recognized in non-interest income in the first quarter of 2012. The bargain purchase gain represents the excess of the fair value of the net assets acquired from ING Direct as of the acquisition date over the consideration transferred.

(3)

Total net revenue was reduced by $265 million and $123 million in the first quarter of 2013 and 2012, respectively, for the estimated uncollectible amount of billed finance charges and fees.

(4) 

Includes purchased credit card relationship (“PCCR”) intangible amortization of $116 million and $4 million in the first quarter of 2013 and 2012, respectively, the substantial majority of which is attributable to the 2012 U.S. card acquisition. Also includes core deposit intangible amortization of $44 million and $46 million in the first quarter of 2013 and 2012, respectively.

(5) 

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

(6)

Loans held for investment includes loans acquired in the CCB, ING Direct and 2012 U.S. card acquisitions. The period-end carrying value of acquired loans accounted for subsequent to acquisition based on expected cash flows to be collected was $34.9 billion and $37.1 billion as of March 31, 2013 and December 31, 2012, respectively. The average carrying value of acquired loans was $35.7 billion and $23.1 billion in the first quarter of 2013 and 2012, respectively. The average balance of loans held for investment, excluding the carrying value of acquired loans, was $160.3 billion and $129.8 billion in the first quarter of 2013 and 2012, respectively. See “Note 4—Loans” for additional information.

(7)

Consists of credit card purchase transactions, net of returns, for the period for both loans classified as held for investment and loans classified as held for sale. Excludes cash advance transactions.

(8)

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

 

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(9)

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

(10)

Calculated based on annualized net charge-offs for the period divided by average loans held for investment for the period.

(11)

Calculation of ratio adjusted to exclude from the denominator acquired loans accounted for subsequent to acquisition based on expected cash flows to be collected. See “Business Segment Financial Performance,” “Credit Risk Profile” and “Note 4—Loans—Credit Quality” for additional information on the impact of acquired loans on our credit quality metrics.

(12)

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

(13)

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

(14)

Calculated based on average stockholders’ equity for the period divided by average total assets for the period.

(15)

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

(16)

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

(17)

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

(18)

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

(19)

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

(20)

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

 

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INTRODUCTION

 

We are a diversified financial services holding company with banking and non-banking subsidiaries. Capital One Financial Corporation and its subsidiaries (the “Company”) offer a broad array of financial products and services to consumers, small businesses and commercial clients through branches, the internet and other distribution channels. As of March 31, 2013, our principal subsidiaries included:

 

   

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

 

   

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

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

We had total loans held for investment of $191.3 billion, deposits of $212.4 billion and stockholders’ equity of $41.3 billion as of March 31, 2013, compared with total loans held for investment of $205.9 billion, deposits of $212.5 billion and stockholders’ equity of $40.5 billion as of December 31, 2012.

Our consolidated total net revenues are derived primarily from lending to consumer and commercial customers and by deposit gathering activities net of the costs associated with funding our assets, which generate net interest income, and by activities that generate non-interest income, such as fee-based services provided to customers and merchant interchange fees with respect to certain credit card transactions. Our expenses primarily consist of the provision for credit losses, operating expenses (including associate salaries and benefits, occupancy and equipment costs, professional services, infrastructure enhancements and branch operations and expansion costs), marketing expenses and income taxes.

Our principal operations are currently organized for management reporting purposes into three primary business segments, which are defined primarily based on the products and services provided or the type of customer served: Credit Card, Consumer Banking and Commercial Banking. The operations of acquired businesses have been integrated into our existing business segments. The acquired ING Direct business is primarily reflected in our Consumer Banking business, while the business acquired in the 2012 U.S. card acquisition is reflected in our Credit Card business. Certain activities that are not part of a segment are included in our “Other” category.

 

   

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

 

   

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

 

   

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

Table 2 summarizes our business segment results, which we report based on income from continuing operations, net of tax, for the three months ended March 31, 2013 and 2012. We provide information on the allocation methodologies used to derive our business segment results in “Note 20—Business Segments” in our 2012 Form 10-K. We also provide additional information on the allocation methodologies used to derive our business segment results and a reconciliation of our total business segment results to our consolidated U.S. GAAP results in “Note 13—Business Segments” of this Report.

 

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Table 2: Business Segment Results

 

    Three Months Ended March 31,  
    2013     2012  
    Total Net  Revenue(1)     Net Income  (Loss)(2)     Total Net  Revenue(1)     Net Income  (Loss)(2)  

(Dollars in millions)

  Amount     % of
Total
    Amount     % of
Total
    Amount     % of
Total
    Amount     % of
Total
 

Credit Card

  $ 3,651        66   $ 686        60   $ 2,590        53   $ 566        38

Consumer Banking

    1,659        30        383        33        1,464        30        224        15   

Commercial Banking

    538        9        203        18        516        10        210        14   

Other(3)

    (297     (5     (128     (11     365        7        505        33   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total from continuing operations

  $ 5,551        100   $ 1,144        100   $ 4,935        100   $ 1,505        100
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) 

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

(2) 

Net income for our business segments is reported based on income from continuing operations, net of tax.

(3) 

Includes the residual impact of the allocation of our centralized Corporate Treasury group activities, such as management of our corporate investment portfolio and asset/liability management, to our business segments as well as other items as described in “Note 20—Business Segments” in our 2012 Form 10-K.

 

 

EXECUTIVE SUMMARY AND BUSINESS OUTLOOK

 

Each of our businesses delivered solid results in the first quarter of 2013. Our earnings for the quarter, which were led by strong profitability in our Domestic Card business and continued positive credit quality trends, added to our existing capital strength. Notable events during the quarter included the following:

 

   

Our redemption on January 2, 2013 of $3.65 billion of our trust preferred securities, which generally carried a higher coupon than other funding sources available to us.

 

   

Our February 19, 2013 announcement of our agreement with Best Buy Stores, L.P. (“Best Buy”) to end our contractual credit card relationship early and to sell the Best Buy portfolio of private label and co-branded credit card accounts that we acquired in the 2012 U.S. card acquisition to Citibank, N.A. We reclassified the assets subject to the sale agreement, which included loans of approximately $7 billion as of the date of the transfer, to the held for sale category from the held for investment category in the first quarter. The sale of the portfolio to Citibank, which is subject to customary closing conditions, and early termination of the Best Buy partnership are expected to be finalized in the third quarter of 2013.

 

   

In January 2013 we submitted our capital plan to the Board of Governors of the Federal Reserve as part of the 2013 Comprehensive Capital Analysis and Review (“CCAR”). On March 14, 2013, we were informed by the Board of Governors of the Federal Reserve that it had completed its review under the CCAR process and that it did not object to our proposed capital distribution plans submitted pursuant to CCAR, which included an increase in the quarterly dividend on our common stock. On May 2, 2013, our Board of Directors approved an increase in our quarterly common stock dividend per share from $0.05 per share to $0.30 per share, payable May 23, 2013 to stockholders of record as of May 13, 2013.

 

   

Our transition from the ING Direct brand to the Capital One 360 brand, which is now the leading digital online depository bank in the U.S.

In the near term, we continue to navigate the challenges of the prolonged low interest rate environment, weak consumer demand and the planned run-off of certain acquired mortgage and card loans. However, the ING Direct and 2012 U.S. card acquisitions have strengthened and expanded our customer base and driven substantial growth in our total net revenues, putting us in what we believe is a strong position to generate capital, deliver sustained shareholder value and deepen our customer relationships with new products and services, even in the current challenging environment.

 

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Financial Highlights

We reported net income of $1.1 billion ($1.79 per diluted share) on total net revenue of $5.6 billion for the first quarter of 2013, with each of our three business segments contributing to our earnings. In comparison, we reported net income of $1.4 billion ($2.72 per diluted share), which included a bargain purchase gain of $594 million attributable to the ING Direct acquisition, on total net revenue of $4.9 billion for the first quarter of 2012. Net income, excluding the impact of the bargain purchase gain, was $809 million ($1.56 per diluted share) for the first quarter of 2012.

Our Tier 1 common ratio, as calculated under Basel I, increased to 11.8% as of March 31, 2013, up from 11.0% as of December 31, 2012. The increase in our Tier 1 common ratio reflected strong internal capital generation from earnings. See “Capital Management” below for additional information.

Below are additional highlights of our performance in the first quarter of 2013. These highlights generally are based on a comparison between our first quarter 2013 and 2012 results, except as otherwise noted. The changes in our financial condition and credit performance are generally based on our financial condition and credit performance as of March 31, 2013, compared with our financial condition and credit performance as of December 31, 2012. We provide a more detailed discussion of our financial performance in the sections following this “Executive Summary and Business Outlook.”

Total Company

 

   

Earnings: Our net income of $1.1 billion for the first quarter of 2013 decreased by $337 million, or 24%, from the first quarter of 2012, primarily due to the absence of the bargain purchase gain of $594 million recorded at acquisition of ING Direct in the first quarter of 2012. Excluding the impact of the bargain purchase gain, net income of $1.1 billion for the first quarter of 2013 increased by $257 million, or 32%, from the first quarter of 2012. The increase was driven by growth in net interest income of approximately $1.2 billion attributable to the substantial increase in average interest-earning assets as a result of the ING Direct and 2012 U.S. card acquisitions, which was partially offset by an increase in the provision for credit losses of $312 million and an increase in non-interest expense of $524 million. The increase in the provision was driven by higher net charge-offs resulting from the addition of loans from the 2012 U.S. card acquisition. The increase in non-interest expense was due in part to higher operating expenses associated with the recent acquisitions as well as an increase in intangible amortization expense. Amortization of intangibles totaled $177 million in the first quarter of 2013, compared with $62 million in the first quarter of 2012.

 

   

Loans Held for Investment: Period-end loans held for investment decreased by $14.6 billion, or 7%, in the first quarter of 2013, to $191.3 billion as of March 31, 2013, from $205.9 billion as of December 31, 2012. The decrease was due in part to the transfer of the Best Buy loan portfolio to the held for sale category. Excluding the transfer of the Best Buy portfolio of approximately $7 billion to held for sale, period-end loans held for investment decreased by approximately $7.6 billion, or 4%, due to typical seasonally lower credit card purchase volumes and higher pay downs in the first quarter of the year, the continued expected run-off of installment loans in our Credit Card business and home loans in our Consumer Banking business, as well as the expected run-off of certain other credit card loans acquired in the 2012 U.S. card acquisition. The pay downs and run-off of card balances were partially offset by higher period-end auto balances due to the continued high volume of auto loan originations and strong loan originations in our commercial and industrial and commercial real estate loan portfolios.

 

   

Charge-off and Delinquency Statistics: Our reported net charge-off rate was 2.20% in the first quarter of 2013, compared with 2.04% in the first quarter of 2012. We experienced higher net charge-offs in our Domestic Card business in the first quarter of 2013 due to the addition of loans from the 2012 U.S. card acquisition. Our reported 30+ day delinquency rate declined to 2.74% as of March 31, 2013, from 3.09% as of December 31, 2012. Delinquency rates in our consumer lending businesses have historically exhibited

 

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seasonal patterns, with delinquency rates generally tending to decrease in the first two quarters of the year as customers use income tax refunds to pay down outstanding loan balances. We provide information on our credit quality metrics, excluding the impact of acquired loans accounted for based on estimated cash flows expected to be collected, below under “Business Segments” and “Credit Risk Profile.”

 

   

Allowance for Loan and Lease Losses: We reduced our allowance by $550 million to $4.6 billion as of March 31, 2013, from $5.2 billion as of December 31, 2012. The reduction was attributable to the transfer of the Best Buy loan portfolio to held for sale and an allowance release of $261 million. The allowance coverage ratio declined to 2.41% as of March 31, 2013, from 2.50% as of December 31, 2012, due in part to an improved credit outlook.

 

   

Representation and Warranty Reserve: We recorded a provision for mortgage representation and warranty losses of $97 million in the first quarter of 2013, compared with a provision for mortgage representation and warranty losses of $169 million in the first quarter of 2012. Our mortgage representation and warranty reserve increased to $994 million as of March 31, 2013, from $899 million as of December 31, 2012.

Business Segments

 

   

Credit Card: Our Credit Card business generated net income from continuing operations of $686 million in the first quarter of 2013, an increase of $120 million, or 21%, from net income from continuing operations of $566 million in the first quarter of 2012. The increase in earnings reflected the impact of the 2012 U.S. card acquisition, which contributed to an increase in total net revenues of $1.1 billion. The net revenue increase was partially offset by a higher provision for credit losses and higher operating expenses, including PCCR intangible amortization expense of $113 million, resulting from the 2012 U.S. card acquisition. Period-end loans held for investment in our Credit Card business decreased by $13.4 billion, or 15%, in the first quarter of 2013, to $78.4 billion as of March 31, 2013, from $91.8 billion as of December 31, 2012. The decrease was due in part to the transfer of the Best Buy portfolio to the held for sale category. Excluding the transfer of the Best Buy portfolio, period-end loans held for investment decreased by $6.4 billion, or 7%, due in part to typical seasonally lower purchase volumes and higher pay downs in the first quarter of the year, the expected continued run-off of our installment loan portfolio, as well as the expected run-off of certain other credit card loans acquired in the 2012 U.S. card acquisition. We experience fluctuations in purchase volumes and the level of outstanding receivables in our Credit Card business due to higher seasonal consumer spending and payment patterns around the winter holiday season, summer vacations and back-to-school periods.

 

   

Consumer Banking: Our Consumer Banking business generated net income from continuing operations of $383 million in the first quarter of 2013, an increase of $159 million, or 71%, from net income from continuing operations of $224 million in the first quarter of 2012. The results for the first quarter of 2013 reflect a full-quarter impact from ING Direct, whereas the results for the first quarter of 2012 reflect a partial-quarter impact. The increase in earnings was attributable to growth in total net revenue and a decrease in non-interest expense. Growth in net revenue was primarily due to a significant increase in average loan balances due to the addition of home loans from the ING Direct acquisition and higher auto loan originations over the past twelve months. The decrease in non-interest expense was largely due to the absence of ING Direct acquisition-related costs incurred in the first quarter of 2012, which was partially offset by increased expenses related to the growth in our auto loan portfolio. Period-end loans held for investment in our Consumer Banking business declined by $1.5 billion, or 2%, to $73.6 billion as of March 31, 2013, from $75.1 billion as of December 31, 2012, due to the continued run-off of acquired home loans, which was partially offset by higher period-end auto balances due to the continued portfolio growth.

 

   

Commercial Banking: Our Commercial Banking business generated net income from continuing operations of $203 million in the first quarter of 2013, a decrease of $7 million, or 3%, from net income from continuing operations of $210 million in the first quarter of 2012. Growth in commercial real estate and commercial and industrial loans and higher deposit balances contributed to an increase in total net revenues. The favorable impact from higher net revenue was offset by a lower negative provision for credit losses of

 

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$35 million recorded in the first quarter of 2013, compared with a negative provision of $69 million recorded in the first quarter of 2012. Period-end loans held for investment in our Commercial Banking business increased by $330 million, or 1%, in the first quarter of 2013 to $39.2 billion as of March 31, 2013, from $38.8 billion as of December 31, 2012. The increase was driven by stronger loan originations in the commercial and industrial and commercial real estate businesses, which was partially offset by the continued run-off of the small-ticket commercial real estate loan portfolio.

Business Outlook

We discuss below our current expectations regarding our total company performance and the performance of each of our business segments over the near-term based on market conditions, the regulatory environment and our business strategies as of the time we filed this Quarterly Report on Form 10-Q. The statements contained in this section are based on our current expectations regarding our outlook for our financial results and business strategies. Our expectations take into account, and should be read in conjunction with, our expectations regarding economic trends and analysis of our business as discussed in “Part I—Item 1. Business” and “Part I—Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our 2012 Form 10-K. Certain statements are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual results could differ materially from those in our forward-looking statements. Forward-looking statements do not reflect: (i) any change in current dividend or repurchase strategies, (ii) the effect of any acquisitions, divestitures or similar transactions that have not been previously disclosed, or (iii) any changes in laws, regulations or regulatory interpretations, in each case after the date as of which such statements are made. See “Forward-Looking Statements” in this Quarterly Report on Form 10-Q for more information on the forward-looking statements in this report and “Item 1A. Risk Factors” in our 2012 Form 10-K for factors that could materially influence our results.

Total Company Expectations

Our strategies and actions are designed to deliver and sustain strong returns and capital generation through the acquisition and retention of franchise-enhancing customer relationships across our businesses. We believe that franchise-enhancing customer relationships create and sustain significant long-term value through low credit costs, long and loyal customer relationships and a gradual build in loan balances and revenues over time. Examples of franchise-enhancing customer relationships include rewards customers and new partnerships in our Credit Card business, retail deposit customers in our Consumer Banking business and primary banking relationships with commercial customers in our Commercial Banking business. We intend to grow these customer relationships by continuing to invest in scalable infrastructure and operating platforms that are appropriate for a bank of our size and business mix so that we can meet the rising regulatory and compliance expectations facing all banks and deliver a “brand-defining” customer experience that builds and sustains a valuable, long-term customer franchise. The ING Direct and 2012 U.S. card acquisitions strengthened and expanded our customer base and over time, we expect these acquisitions to expand and deepen our customer relationships with new products and services.

We expect average interest-earning assets to decline in 2013. We expect average loan balances for full-year 2013 to decline from average loan balances for full-year 2012, as significant run-off of certain mortgage and card loans we acquired, coupled with the sale of the Best Buy portfolio expected to be finalized in the third quarter of 2013, is partially offset by growth in our businesses. We expect run-off and sales of approximately $19 billion in ending loan balances in 2013, primarily comprised of approximately $10 billion in run-off of mortgage loans acquired from ING Direct and CCB, approximately $2 billion in run-off of certain other credit card loans purchased in the 2012 U.S. card acquisition and approximately $7 billion from the sale of the Best Buy portfolio. We expect this decline to be partially offset by growth in certain of our businesses, including Auto, Commercial Banking and parts of Domestic Card. However, we expect continued weak consumer demand across our Credit Card and Auto lending businesses, as well as intensifying competition in several businesses, particularly Auto and commercial and industrial lending.

 

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We continue to expect total net revenue in 2013 to be approximately $22.5 billion. We also expect non-interest expense in 2013 to total approximately $12.5 billion, comprised of operating expense of approximately $11 billion and marketing expense of approximately $1.5 billion. We expect these estimates to vary within a reasonable margin, and they do not contemplate the potential impact of non-recurring items.

We believe our actions have created a well-positioned balance sheet with strong capital and liquidity levels, and a strong capital generation trajectory. We exceeded an assumed Basel III Tier 1 common ratio internal target of 8% in the first quarter. Our estimated Basel III capital trajectory includes the estimated impact of implementing the Basel II Advanced Approaches to calculate regulatory capital, which we expect will apply to us in 2016 or later. The assumed 8% Basel III Tier 1 common ratio target assumes a buffer of 50 basis points for a systemically important financial institution under applicable rules and regulations and a further buffer of 50 basis points to cover potential volatility in both the numerator and denominator of the Tier 1 common ratio. Our actual operating levels for capital will vary over time depending on our outlook for near-to-medium term growth, our view of where we are in the economic cycle and our resilience under ongoing stress-testing processes. The assumed Basel III Tier 1 common level is estimated based on our current interpretation, expectations and understanding of the Basel III capital rules and other capital regulations proposed by U.S. regulators and the application of such rules to our businesses as currently conducted. Basel III calculations are necessarily subject to change based on, among other things, the scope and terms of the final rules and regulations, model calibration and other implementation guidance, changes in our businesses and certain actions of management, including those affecting the composition of our balance sheet. We believe this ratio provides useful information to investors and others by measuring our progress against expected future regulatory capital standards.

Business Segment Expectations

Credit Card Business

As noted above, in Domestic Card, the closing of the 2012 U.S. card acquisition has impacted and will continue to affect quarterly trends in loan growth, revenue margin and credit metrics. We anticipate that the run-off of parts of the portfolio acquired in the 2012 U.S. card acquisition, the sale of the Best Buy portfolio as well as anticipated run-off in our installment loan portfolio will result in a decline in full-year average loan balances in 2013 from average loan balances in 2012.

Consumer Banking Business

In our Consumer Banking business, we expect the ING Direct acquisition to continue to have a significant impact on Consumer Banking loan volumes as we anticipate that run-off in the acquired home loan portfolios will more than offset growth in auto loans.

Commercial Banking Business

Our Commercial Banking business continues to grow loans, deposits, and revenues as we attract new customers and deepen relationships with existing customers. We expect our Commercial Banking business to continue to deliver steady growth.

 

 

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

 

The preparation of financial statements in accordance with U.S. GAAP requires management to make a number of judgments, estimates and assumptions that affect the reported amount of assets, liabilities, income and expenses in the consolidated financial statements. Understanding our accounting policies and the extent to which we use management judgment and estimates in applying these policies is integral to understanding our financial statements. We provide a summary of our significant accounting policies under “Note 1—Summary of Significant Accounting Policies” in our 2012 Form 10-K.

 

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

 

   

Loan loss reserves

   

Asset impairment

   

Fair value

   

Representation and warranty reserve

   

Customer rewards reserve

   

Income taxes

We evaluate our critical accounting estimates and judgments on an ongoing basis and update them, as necessary, based on changing conditions. We discuss below changes we made in the first quarter of 2013 in estimating the allowance for loan and lease losses and reserve for unfunded lending commitments for our commercial loan portfolio. Management has discussed our critical accounting policies and estimates with the Audit and Risk Committee of the Board of Directors.

Allowance for Loan and Lease Losses and Reserve for Unfunded Lending Commitments—Commercial Loans

Our commercial loan portfolio is primarily composed of larger-balance, non-homogeneous loans. We determine the allowance for loan and lease losses (“allowance”) and reserve for unfunded lending commitments for our commercial loan portfolio by evaluating loans with similar risk characteristics and applying internal risk ratings. We use these risk ratings to assess credit quality and derive a total loss estimate based on an estimated probability of default and loss given default. Factors we consider in determining risk ratings and deriving loss estimates include historical loss experience for loans with similar risk characteristics, the financial condition of the borrower, geography, collateral performance, and industry-specific information that management believes is relevant in determining the occurrence of a loss event and measuring impairment. Management may also apply judgment to adjust the derived loss factors, taking into consideration both quantitative and qualitative factors, including general economic conditions, specific industry and geographic trends, portfolio concentrations, trends in internal credit quality indicators and current and past underwriting standards that have occurred but are not yet reflected in the historical data underlying our loss estimates.

In the first quarter of 2013, we changed our process for estimating the allowance and reserve for unfunded lending commitments for our commercial loan portfolio. First, we extended our internal historical credit loss experience period back to at least 2008 and incorporated external industry loss data over a longer horizon to derive our loss estimates. We previously generally used the most recent three-year period of internal historical loss experience to derive our loss estimates. Second, we incorporated more borrower-specific and loan-specific risk factors into our analysis and established a statistically-based internal risk rating system. Based on this statistically-based risk rating system, we now apply an estimated probability of default and loss given default for nearly each loan in our portfolio to derive the total loss estimate for our commercial loan portfolio. These changes, which were supplemented by management judgment, resulted in a net increase in the combined allowance and reserve for unfunded lending commitments of $37 million as of March 31, 2013 and a corresponding increase in the provision for credit losses of $37 million in the first quarter of 2013. The gross impact of these changes resulted in a decrease in the allowance of $2 million and an increase in the reserve for unfunded lending commitments of $39 million as of March 31, 2013. We do not expect these changes to have a material future impact on our allowance and reserve for unfunded lending commitments for our commercial loan portfolio. See “Note 5—Allowance for Loan and Lease Losses” in this Report for additional information.

We provide additional information on our critical accounting policies and estimates under “MD&A—Critical Accounting Policies and Estimates” in our 2012 Form 10-K.

 

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ACCOUNTING CHANGES AND DEVELOPMENTS

 

See “Note 1—Summary of Significant Accounting Policies” for information on accounting standards adopted in 2013, as well as recently issued accounting standards not yet required to be adopted and the expected impact of these changes in accounting standards. To the extent we believe the adoption of new accounting standards has had or will have a material impact on our results of operations, financial condition or liquidity, we discuss the impacts in the applicable sections(s) of MD&A.

 

 

CONSOLIDATED RESULTS OF OPERATIONS

 

The section below provides a comparative discussion of our consolidated financial performance for the three months ended March 31, 2013 and 2012. Following this section, we provide a discussion of our business segment results. You should read this section together with our “Executive Summary and Business Outlook,” where we discuss trends and other factors that we expect will affect our future results of operations.

Net Interest Income

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

Table 3 below presents, for each major category of our interest-earning assets and interest-bearing liabilities, the average outstanding balances, interest income earned or interest expense incurred, and average yield or cost for the three months ended March 31, 2013 and 2012.

 

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Table 3: Average Balances, Net Interest Income and Net Interest Yield(1)

 

     Three Months Ended March 31,  
     2013     2012  

(Dollars in millions)

   Average
Balance
    Interest
Income/
Expense(2)
     Yield/
Rate
    Average
Balance
    Interest
Income/
Expense(2)
     Yield/
Rate
 

Assets:

              

Interest-earning assets:

              

Credit card:(3)

              

Domestic

   $ 78,985      $ 2,816         14.26   $ 54,131      $ 1,910         14.11

International

     8,238        329         15.97        8,301        340         16.38   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Credit card

     87,223        3,145         14.42        62,432        2,250         14.41   

Consumer banking(4)

     74,456        1,102         5.92        56,482        1,015         7.19   

Commercial banking

     38,579        377         3.91        34,245        380         4.44   

Other

     183        25         54.64        173        12         27.75   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total loans, including loans held for sale

     200,441        4,649         9.28        153,332        3,657         9.54   

Investment securities

     64,798        374         2.31        50,543        298         2.36   

Cash equivalents and other interest-earning assets

     7,106        28         1.58        16,371        24         0.59   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total interest-earning assets

   $ 272,345      $ 5,051         7.42   $ 220,246      $ 3,979         7.23
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Cash and due from banks

     2,642             12,540        

Allowance for loan and lease losses

     (4,954          (4,334     

Premises and equipment, net

     3,682             2,898        

Other assets

     29,508             15,034        
  

 

 

        

 

 

      

Total assets

   $ 303,223           $ 246,384        
  

 

 

        

 

 

      

Liabilities and stockholders’ equity:

              

Interest-bearing liabilities:

              

Deposits

   $ 190,612      $ 326         0.68   $ 151,625      $ 311         0.82

Securitized debt obligations

     11,758        56         1.91        16,185        80         1.98   

Senior and subordinated notes

     11,984        82         2.74        10,268        88         3.43   

Other borrowings

     17,832        17         0.38        9,541        86         3.61   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total interest-bearing liabilities

   $ 232,186      $ 481         0.83   $ 187,619      $ 565         1.20
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Non-interest bearing deposits

     20,943             18,634        

Other liabilities

     9,134             7,149        
  

 

 

        

 

 

      

Total liabilities

     262,263             213,402        

Stockholders’ equity

     40,960             32,982        
  

 

 

        

 

 

      

Total liabilities and stockholders’ equity

   $ 303,223           $ 246,384        
  

 

 

        

 

 

      

Net interest income/spread

     $ 4,570         6.59     $ 3,414         6.03
    

 

 

        

 

 

    

Impact of non-interest bearing funding

          0.12             0.17   
       

 

 

        

 

 

 

Net interest margin

          6.71          6.20
       

 

 

        

 

 

 

 

(1) 

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

(2) 

Past due fees included in interest income totaled approximately $480 million and $283 million in the first quarter of 2013 and 2012, respectively. Premium amortization related to the ING Direct and 2012 U.S. card acquisitions reduced net interest income by $111 million and $30 million in the first quarter of 2013 and 2012, respectively.

(3) 

Credit card loans consist of domestic and international credit card loans and installment loans.

(4) 

Consumer banking loans consist of auto, home and retail banking loans.

 

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Table 4 displays the change in our net interest income between periods and the extent to which the variance is attributable to: (i) changes in the volume of our interest-earning assets and interest-bearing liabilities or (ii) changes in the interest rates of these assets and liabilities.

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

 

     Three Months Ended March 31,
2013 vs. 2012
 
     Total
Variance
    Variance Due to  

(Dollars in millions)

     Volume     Rate  

Interest income:

      

Loans:

      

Credit card

   $ 895      $ 894      $ 1   

Consumer banking

     87        286        (199

Commercial banking

     (3     45        (48

Other

     13        1        12   
  

 

 

   

 

 

   

 

 

 

Total loans, including loans held for sale

     992        1,226        (234
  

 

 

   

 

 

   

 

 

 

Investment securities

     76        82        (6

Cash equivalents and other interest-earning assets

     4        (19     23   
  

 

 

   

 

 

   

 

 

 

Total interest income

     1,072        1,289        (217
  

 

 

   

 

 

   

 

 

 

Interest expense:

      

Deposits

     15        72        (57

Securitized debt obligations

     (24     (21     (3

Senior and subordinated notes

     (6     13        (19

Other borrowings

     (69     42        (111
  

 

 

   

 

 

   

 

 

 

Total interest expense

     (84     106        (190
  

 

 

   

 

 

   

 

 

 

Net interest income

   $ 1,156      $ 1,183      $ (27
  

 

 

   

 

 

   

 

 

 

 

(1) 

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

Net interest income of $4.6 billion in the first quarter of 2013 increased by $1.2 billion, or 34%, from the first quarter of 2012, driven by a 24% increase in average interest-earning assets and an 8% (51 basis point) expansion of the net interest margin to 6.71%.

 

   

Average Interest-Earning Assets: The increase in average interest-earning assets reflects the full-quarter impact of the addition of loans and investment securities from the acquisition of ING Direct in the first quarter of 2012 and the addition of loans from the 2012 U.S. card acquisition in the second quarter of 2012. Growth in average-interest earning assets also was driven by strong commercial loan growth and continued growth in auto loans, which was partially offset by the transfer of the Best Buy loan portfolio of approximately $7 billion to the held for sale category in the first quarter of 2013, the continued run-off of installment loans in our Credit Card business and home loans in our Consumer Banking business, as well as the expected run-off of certain other credit card loans acquired in the 2012 U.S. card acquisition.

 

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Net Interest Margin: The 51 basis point improvement in our net interest margin was primarily attributable to a reduction in our cost of funds of 37 basis points to 0.83% for the first quarter of 2013. The redemption on January 2, 2013 of $3.65 billion of our trust preferred securities, which generally carried a higher coupon than other funding sources available to us, accounted for approximately 11 basis points of the reduction in our funding costs. The remaining reduction reflects the continued benefit from the shift in the mix of our funding to lower cost consumer and commercial banking deposits from higher cost wholesale sources and a decline in deposit interest rates as a result of the continued overall low interest rate environment.

Non-Interest Income

Non-interest income primarily consists of service charges and other customer-related fees, interchange income (net of rewards expense), other non-interest income and, in 2012, the bargain purchase gain attributable to the ING Direct acquisition. The “other” component of non-interest income includes the pre-tax provision for mortgage representation and warranty losses related to continuing operations. Other also includes gains and losses from the sale of investment securities, gains and losses on derivatives not accounted for in hedge accounting relationships and hedge ineffectiveness, which we generally do not allocate to our business segments because they relate to centralized asset/liability and market risk management activities undertaken by our Corporate Treasury group.

Table 5 displays the components of non-interest income for the first quarter of 2013 and 2012.

Table 5: Non-Interest Income

 

     Three Months Ended March 31,  

(Dollars in millions)

       2013             2012      

Service charges and other customer-related fees

   $ 550      $ 415   

Interchange fees, net

     445        328   

Bargain purchase gain(1)

            594   

Net other-than-temporary impairment (“OTTI”)

     (25     (14

Other non-interest income:

    

Provision for mortgage representation and warranty losses(2)

     9        (17

Net gains from the sale of investment securities

     2        11   

Net fair value losses on free-standing derivatives(3)

     (5     (86

Other

     5        290   
  

 

 

   

 

 

 

Other non-interest income

     11        198   
  

 

 

   

 

 

 

Total non-interest income

   $ 981      $ 1,521   
  

 

 

   

 

 

 

 

(1) 

Represents the amount by which the fair value of the net assets acquired in the ING Direct acquisition, as of the acquisition date of February 17, 2012, exceeded the consideration transferred.

(2) 

We recorded a total provision for mortgage representation and warranty losses of $97 million and $169 million in the first quarter of 2013 and 2012, respectively. The remaining portion of the provision for mortgage representation and warranty losses is included, net of tax, in discontinued operations.

(3) 

Excludes changes in cumulative credit risk valuation adjustments related to derivatives in a gain position. Credit risk valuation adjustments for derivative assets totaled $8 million and $9 million as of March 31, 2013 and December 31, 2012, respectively. See “Note 9—Derivative Instruments and Hedging Activities” for additional information.

Non-interest income of $981 million in the first quarter of 2013 decreased by $540 million, or 36%, from non-interest income of $1.5 billion in the first quarter of 2012.

The decrease in non-interest income reflected the combined unfavorable impact of (i) the absence of the bargain purchase gain of $594 million recognized at acquisition of ING Direct in the first quarter of 2012 and (ii) the absence of income of $162 million from the sale of Visa stock shares in the first quarter of 2012.

 

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The unfavorable impact of these items was partially offset by the favorable impact of (i) increased net interchange and other fees resulting from continued growth and market share from new account originations, due in part to the ING Direct and the 2012 U.S. card acquisitions; (ii) the absence of expense of $75 million for expected customer refunds attributable to credit card cross-selling issues and (iii) the absence of a mark-to-market derivative loss of $78 million recognized in the first quarter of 2012 related to the settlement of interest-rate swaps we entered into in 2011 to partially hedge the interest rate risk of the net assets associated with the ING Direct acquisition.

We recorded net OTTI losses of $25 million in the first quarter of 2013, compared with $14 million in the first quarter of 2012. The OTTI losses in each period were attributable to deterioration in the credit performance of loans underlying certain non-agency mortgage-backed securities. Our portfolio of non-agency mortgage backed securities significantly increased as a result of our acquisition of ING Direct in the first quarter of 2012, which contributed to the increase in OTTI losses in the first quarter of 2013. We provide additional information on other-than-temporary impairment recognized on our securities available for sale in “Note 3—Investment Securities.”

Provision for Credit Losses

We build our allowance for loan and lease losses and unfunded lending commitment reserves through the provision for credit losses. Our provision for credit losses in each period is driven by charge-offs and the level of allowance for loan and lease losses that we determine is necessary to provide for probable loan and lease losses incurred that are inherent in our loan portfolio as of each balance sheet date.

We recorded a provision for credit losses of $885 million in the first quarter of 2013, compared with $573 million in the first quarter of 2012. The increase in the provision for credit losses in the first quarter of 2013 from the first quarter of 2012 was driven by higher net charge-offs resulting from the addition of loans from the 2012 U.S. card acquisition, coupled with growth in auto loan balances and commercial loan originations.

We provide additional information on the provision for credit losses and changes in the allowance for loan and lease losses under the “Credit Risk Profile—Summary of Allowance for Loan and Lease Losses” and “Note 5—Allowance for Loan and Lease Losses.” For information on the allowance methodology for each of our loan categories, see “Note 1—Summary of Significant Accounting Policies” in our 2012 Form 10-K.

Non-Interest Expense

Non-interest expense consists of ongoing operating costs, such as salaries and associate benefits, occupancy and equipment costs, professional services, communications and data processing technology expenses, and other miscellaneous expenses. Non-interest expense also includes marketing costs, merger-related expense and amortization of intangibles. Table 6 displays the components of non-interest expense for the first quarter of 2013 and 2012.

 

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Table 6: Non-Interest Expense

 

     Three Months Ended March 31,  

(Dollars in millions)

       2013              2012      

Salaries and associate benefits

   $ 1,080       $ 864   

Occupancy and equipment

     350         270   

Marketing

     317         321   

Professional services

     307         293   

Communications and data processing

     210         172   

Amortization of intangibles(1)

     177         62   

Acquisition-related

     46         86   

Other non-interest expense:

     

Collections

     129         137   

Fraud losses

     52         40   

Bankcard, regulatory and other fee assessments

     138         110   

Other

     222         149   
  

 

 

    

 

 

 

Other non-interest expense

     541         436   
  

 

 

    

 

 

 

Total non-interest expense

   $ 3,028       $ 2,504   
  

 

 

    

 

 

 

 

(1) 

Includes PCCR intangible amortization of $116 million and $4 million in the first quarter of 2013 and 2012, respectively, the substantial majority of which is attributable to the 2012 U.S. card acquisition. Also includes core deposit intangible amortization of $44 million and $46 million in the first quarter of 2013 and 2012, respectively.

Non-interest expense of $3.0 billion in the first quarter of 2013 increased by $524 million, or 21%, from the first quarter of 2012. The increase reflected higher operating expenses, increased salaries and associate benefits and infrastructure costs attributable to acquired businesses, amortization of intangibles resulting from the ING Direct and 2012 U.S. card acquisitions and expenses related to the growth in our auto loan portfolio, which was partially offset by a reduction in acquisition-related costs.

Income Taxes

We recorded an income tax provision on income from continuing operations of $494 million (30.2% effective income tax rate) in the first quarter of 2013, compared with an income tax provision of $353 million (19.0% effective income tax rate) in the first quarter of 2012. Our effective tax rate varies between periods due, in part, to fluctuations in our pre-tax earnings, which affects the relative tax benefit of tax-exempt income, tax credits and other permanent tax items.

The increase in our effective tax rate in the first quarter of 2013 from the first quarter of 2012 was primarily attributable to the absence of the non-taxable bargain purchase gain of $594 million recorded in the first quarter of 2012 related to the ING Direct acquisition, which substantially reduced our effective tax rate in first quarter of 2012.

Our effective income tax rate excluding the impact of the non-taxable bargain purchase gain was 30.2% and 28.1% in the first quarter of 2013 and 2012, respectively. The increase in the effective tax rate in the first quarter of 2013 was primarily due to higher pre-tax earnings in the first quarter of 2013 compared with the first quarter of 2012, which diluted the relative tax benefit from tax credits and tax-exempt income.

We provide additional information on items affecting our income taxes and effective tax rate in our 2012 Form 10-K under “Note 18—Income Taxes.”

 

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Loss from Discontinued Operations, Net of Tax

Loss from discontinued operations reflects ongoing costs, which primarily consist of mortgage loan repurchase representation and warranty charges related to the mortgage origination operations of GreenPoint’s wholesale mortgage banking unit, which we closed in 2007.

We recorded a loss from discontinued operations, net of tax, of $78 million and $102 million in the first quarter of 2013 and 2012, respectively. The variance in the loss from discontinued operations between the first quarter of 2013 and the first quarter of 2012 is attributable to the provision for mortgage representation and warranty losses. We recorded a total pre-tax provision for mortgage representation and warranty losses of $97 million in the first quarter of 2013, compared with a total pre-tax provision of $169 million in the first quarter of 2012. The portion of these amounts included in loss from discontinued operations totaled $107 million ($67 million net of tax) and $153 million ($97 million, net of tax) in the first quarter of 2013 and 2012, respectively.

We provide additional information on the provision for mortgage representation and warranty losses and the related reserve for potential representation and warranty claims in “Consolidated Balance Sheet Analysis—Potential Mortgage Representation and Warranty Liabilities” and “Note 14—Commitments, Contingencies and Guarantees.”

 

 

BUSINESS SEGMENT FINANCIAL PERFORMANCE

 

The results of our individual businesses, which we report on a continuing operations basis, reflect the manner in which management evaluates performance and makes decisions about funding our operations and allocating resources. Our business segment results are intended to reflect each segment as if it were a stand-alone business. We use an internal management accounting and reporting process to derive our business segment results. Our internal management accounting and reporting process employs various allocation methodologies, including funds transfer pricing, to assign certain balance sheet assets, deposits and other liabilities and their related revenue and expenses directly or indirectly attributable to each business segment. Total interest income and net fees are directly attributable to the segment in which they are reported. The net interest income of each segment reflects the results of our funds transfer pricing process, which is primarily based on a matched maturity method that takes into consideration market rates. Our funds transfer pricing process provides a funds credit for sources of funds, such as deposits generated by our Consumer Banking and Commercial Banking businesses, and a funds charge for the use of funds by each segment. The allocation process is unique to each business segment and acquired businesses. We provide additional information on the allocation methodologies used to derive our business segment results in “Note 20—Business Segments” in our 2012 Form 10-K.

We refer to the business segment results derived from our internal management accounting and reporting process as our “managed” presentation, which differs in some cases from our reported results prepared based on U.S. GAAP. There is no comprehensive, authoritative body of guidance for management accounting equivalent to U.S. GAAP; therefore, the managed basis presentation of our business segment results may not be comparable to similar information provided by other financial service companies. In addition, our individual business segment results should not be used as a substitute for comparable results determined in accordance with U.S. GAAP. See “Note 13—Business Segments” of this Report for a reconciliation of our total business segment results to our reported consolidated results.

Below we summarize our business segment results for the first quarter of 2013 and 2012 and provide a comparative discussion of these results. We also discuss changes in our financial condition and credit performance statistics as of March 31, 2013, compared with December 31, 2012. Information on the outlook for each of our business segments is presented above under “Executive Summary and Business Outlook.”

 

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Credit Card Business

Our Credit Card business generated net income from continuing operations of $686 million in the first quarter of 2013, an increase of $120 million, or 21%, from net income from continuing operations of $566 million in the first quarter of 2012. The primary sources of revenue for our Credit Card business are interest income and non-interest income from customers and interchange fees. Expenses primarily consist of ongoing operating costs, such as salaries and associate benefits, occupancy and equipment, professional services, communications and data processing technology expenses, as well as marketing expenses.

On February 1, 2013, we transferred the Best Buy loan portfolio, which had loan balances of approximately $7 billion as of the date of the transfer, to held for sale from held for investment. While the transfer of this portfolio reduced period-end loans held for investment for Domestic Card, the accounting for held for sale loans had a favorable impact on Domestic Card total net revenue and the provision for credit losses, as charge-offs of finance charges, fees and principal are reflected in the carrying value of loans classified as held for sale.

Table 7 summarizes the financial results of our Credit Card business, which is comprised of Domestic Card, including installment loans, and International Card, and displays selected key metrics for the periods indicated.

Table 7: Credit Card Business Results

 

     Three Months Ended March 31,  

(Dollars in millions)

       2013             2012             Change      

Selected income statement data:

      

Net interest income(1)

   $ 2,830      $ 1,992        42

Non-interest income

     821        598        37   
  

 

 

   

 

 

   

 

 

 

Total net revenue(2)

     3,651        2,590        41   

Provision for credit losses

     743        458        62   

Non-interest expense(3)

     1,848        1,268        46   
  

 

 

   

 

 

   

 

 

 

Income from continuing operations before income taxes

     1,060        864        23   

Income tax provision

     374        298        26   
  

 

 

   

 

 

   

 

 

 

Income from continuing operations, net of tax

   $ 686      $ 566        21
  

 

 

   

 

 

   

 

 

 

Selected performance metrics:

      

Average loans held for investment(4)

   $ 82,952      $ 62,432        33

Average yield on loans held for investment(5)

     15.16     14.41     75 bps 

Total net revenue margin(6)

     17.61        16.59        102   

Net charge-offs

   $ 922      $ 645        43

Net charge-off rate(7)

     4.45     4.14     31 bps 

PCCR intangible amortization(3)

   $ 116      $ 4        **

Purchase volume(8)

     45,098        34,498        31   

(Dollars in millions)

   March 31,
2013
    December 31,
2012
        Change      

Selected period-end data:

      

Loans held for investment(4)

   $ 78,397      $ 91,755        (15 )%

30+ days performing delinquency rate(9)

     3.44     3.61     (17 )bps 

30+ days delinquency rate(10)

     3.53        3.69        (16

30+ days delinquency rate (excluding acquired loans)(11)

     3.54        3.70        (16

Nonperforming loan rate(12)

     0.12        0.11        1   

Allowance for loan and lease losses

   $ 3,494      $ 3,979        (12 )% 

Allowance coverage ratio(13)

     4.46     4.34     12 bps 

 

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** Change is less than one percent or not meaningful.
(1)

Includes premium amortization related to the 2012 U.S. card acquisition of $43 million in the first quarter of 2013.

(2) 

We recognize billed finance charges and fee income on open-ended loans in accordance with the contractual provisions of the credit arrangements and estimate the uncollectible amount on a quarterly basis. The estimated uncollectible amount of billed finance charges and fees is reflected as a reduction in revenue and is not included in our net charge-offs. Total net revenue was reduced by $265 million and $123 million in the first quarter of 2013 and 2012, respectively, for the estimated uncollectible amount of billed finance charges and fees.

(3) 

Includes PCCR intangible amortization expense of $116 million and $4 million in the first quarter of 2013 and 2012, respectively, of which $113 million in the first quarter of 2013 is attributable to the PCCR intangible asset of $2.2 billion recorded in connection with the closing on May 1, 2012 of the 2012 U.S. card acquisition.

(4) 

Credit card period-end loans held for investment and average loans held for investment include accrued finance charges and fees, net of the estimated uncollectible amount.

(5) 

Calculated by dividing annualized interest income for the period by average loans held for investment during the period for the specified loan category. The transfer of the Best Buy loan portfolio to held for sale resulted in an increase in the average yield for Total Credit Card of 97 basis points in the first quarter of 2013.

(6) 

Calculated by dividing annualized total net revenue for the period by average loans held for investment during the period for the specified loan category. The transfer of the Best Buy portfolio to held for sale resulted in an increase in the net revenue margin for Total Card of 112 basis points in the first quarter of 2013.

(7) 

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

(8) 

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

(9) 

Calculated by loan category by dividing 30+ day performing delinquent loans as of the end of the period by period-end loans held for investment for the specified loan category.

(10) 

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

(11) 

Calculation of ratio adjusted to exclude from the denominator acquired loans accounted for subsequent to acquisition based on expected cash flows to be collected. See “Summary of Selected Financial Data,” “Credit Risk Profile” and “Note 4—Loans—Credit Quality” for additional information on the impact of acquired loans on our credit quality metrics.

(12) 

Calculated by loan category by dividing nonperforming loans as of the end of the period by period-end loans held for investment for the specified loan category. Nonperforming credit card loans generally include international card loans that are 90 or 120 days delinquent.

(13) 

Calculated by dividing the allowance for loan and lease losses as of the end of the period by period-end loans held for investment.

Key factors affecting the results of our Credit Card business for the first quarter of 2013, compared with the first quarter of 2012, and changes in financial condition and credit performance between March 31, 2013 and December 31, 2012 include the following:

 

   

Net Interest Income: Net interest income increased by $838 million, or 42%, in the first quarter of 2013 to $2.8 billion, attributable to the substantial increase in average loans held for investment resulting from the 2012 U.S. card acquisition in the second quarter of 2012 and higher average yields on loans held for investment. The increase in average loan yields was largely due to the transfer of the Best Buy loan portfolio, which generally had lower yields relative to our overall loan portfolio, to the held for sale category in the first quarter of 2013.

 

   

Non-Interest Income: Non-interest income increased by $223 million, or 37%, in the first quarter of 2013 to $821 million. The increase was primarily driven by higher net interchange fees generated from purchase volume growth and customer-related fees resulting from the addition of customer accounts associated with the 2012 U.S. card acquisition. Purchase volume increased by $10.6 billion, or 31%, in the first quarter of 2013. Excluding purchase volume attributable to loans from the 2012 U.S. card acquisition, purchase volume increased by approximately 5% in the first quarter of 2013.

 

   

Provision for Credit Losses: The provision for credit losses related to our Credit Card business increased to $743 million in the first quarter of 2013, from $458 million in the first quarter of 2012. The increase in the provision was primarily driven by higher net charge-offs resulting from the addition of loans from the 2012 U.S. card acquisition, which more than offset the impact of an improving credit outlook . Although higher

 

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net charge-offs drove an increase in the provision for credit losses, we reduced the allowance related to our Credit Card business by $485 million in the first quarter of 2013 to $3.5 billion as of March 31, 2013. The reduction was attributable to the transfer of the Best Buy loan portfolio to held for sale, as well as an allowance release of $196 million. In comparison, our Credit Card business recorded an allowance release of $176 million in the first quarter of 2012.

 

   

Non-Interest Expense: Non-interest expense increased by $580 million, or 46%, in the first quarter of 2013 to $1.8 billion. The increase was largely due to higher operating expenses resulting from the 2012 U.S. card acquisition and the amortization of intangibles and other assets associated with the 2012 U.S. card acquisition, including PCCR intangible amortization expense of $113 million in the first quarter of 2013.

 

   

Loans Held for Investment: Period-end loans held for investment in our Credit Card business decreased by $13.4 billion, or 15%, in the first quarter of 2013, to $78.4 billion as of March 31, 2013. The decrease was due in part to the transfer of the Best Buy loan portfolio to the held for sale category. Excluding the transfer of the Best Buy loan portfolio of approximately $7 billion to held for sale, period-end loans held for investment decreased by $6.4 billion, or 7%, due in part to typical seasonally lower purchase volumes and higher pay downs in the first quarter of the year, the continued run-off of our installment loan portfolio, as well as the expected run-off of certain other credit card loans acquired in the 2012 U.S. card acquisition.

 

   

Charge-off and Delinquency Statistics: Our reported net charge-off rate increased to 4.45% in the first quarter of 2013, from 4.14% in the first quarter of 2012. The increase was primarily driven by higher net charge-offs resulting from the addition of loans from the 2012 U.S. card acquisition. The 30+ day delinquency rate decreased to 3.53% as of March 31, 2013, from 3.69% as of December 31, 2012.

Domestic Card Business

Domestic Card generated net income from continuing operations of $644 million in the first quarter of 2013, an increase of $129 million, or 25%, from net income from continuing operations of $515 million in the first quarter of 2012. Domestic Card accounted for 90% of total net revenues for our Credit Card business in the first quarter of 2013, compared with 85% in the first quarter of 2012. Income attributable to Domestic Card represented 94% of income for our Credit Card business in the first quarter of 2013, compared with 91% in the first quarter of 2012.

 

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Table 7.1 summarizes the financial results for Domestic Card and displays selected key metrics for the periods indicated.

Table 7.1: Domestic Card Business Results

 

     Three Months Ended March 31,  

(Dollars in millions)

       2013             2012             Change      

Selected income statement data:

      

Net interest income(1)

   $ 2,556      $ 1,713        49

Non-interest income

     724        497        46   
  

 

 

   

 

 

   

 

 

 

Total net revenue

     3,280        2,210        48   

Provision for credit losses

     647        361        79   

Non-interest expense(2)

     1,633        1,052        55   
  

 

 

   

 

 

   

 

 

 

Income from continuing operations before income taxes

     1,000        797        25   

Income tax provision

     356        282        26   
  

 

 

   

 

 

   

 

 

 

Income from continuing operations, net of tax

   $ 644      $ 515        25
  

 

 

   

 

 

   

 

 

 

Selected performance metrics:

      

Average loans held for investment(3)

   $ 74,714      $ 54,131        38

Average yield on loans held for investment(4)

     15.07 %     14.11 %     96 bps 

Total net revenue margin(5)

     17.56        16.33        123   

Net charge-offs

   $ 827      $ 531        56

Net charge-off rate(6)

     4.43     3.92     51 bps 

PCCR intangible amortization(2)

   $ 116      $ 4        **

Purchase volume(7)

     41,831        31,417        33   

(Dollars in millions)

   March 31,
2013
    December 31,
2012
        Change      

Selected period-end data:

      

Loans held for investment(3)

   $ 70,361      $ 83,141        (15 )%

30+ days delinquency rate(8)

     3.37     3.61     (24 )bps 

30+ days delinquency rate (excluding acquired loans)(9)

     3.38        3.62        (24

Allowance for loan and lease losses

   $ 3,057      $ 3,526        (13 )% 

 

** Change is less than one percent or not meaningful.
(1) 

Includes premium amortization related to the 2012 U.S. card acquisition of $43 million in the first quarter of 2013.

(2)

Includes amortization expense of $113 million in the first quarter of 2013 related to the PCCR intangible asset of $2.2 billion recorded in connection with the closing on May 1, 2012 of the 2012 U.S. card acquisition.

(3) 

Credit card period-end loans held for investment and average loans held for investment include accrued finance charges and fees, net of the estimated uncollectible amount.

(4) 

Calculated by dividing annualized interest income for the period by average loans held for investment during the period for the specified loan category. The transfer of the Best Buy loan portfolio to held for sale resulted in an increase in the average yield for Domestic Card of 107 basis points in the first quarter of 2013.

(5) 

Calculated by dividing annualized total net revenue for the period by average loans held for investment during the period for the specified loan category. The transfer of the Best Buy portfolio to held for sale resulted in an increase in the net revenue margin for Domestic Card of 123 basis points in the first quarter of 2013.

(6) 

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

(7)

Consists of credit card purchase transactions, net of returns, for the period for both loans classified as held for investment and loans classified as held for sale. Excludes cash advance transactions.

(8) 

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

(9) 

Calculation of ratio adjusted to exclude from the denominator acquired loans accounted for subsequent to acquisition based on expected cash flows to be collected. See “Summary of Selected Financial Data,” “Credit Risk Profile” and “Note 4—Loans—Credit Quality” for additional information on the impact of acquired loans on our credit quality metrics.

 

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Because our Domestic Card business accounts for the substantial majority of our Credit Card business, the key factors driving the results for this division are similar to the key factors affecting our total Credit Card business. The increase in Domestic Card net income from continuing operations in the first quarter of 2013, compared with the first quarter of 2012 reflected the impact of the following items: (i) an increase in net interest income and non-interest income, primarily attributable to the substantial increase in average loans held for investment, higher average loan yields and increased fees resulting from the 2012 U.S. card acquisition; (ii) an increase in the provision for credit losses, driven by higher net charge-offs resulting from the addition of loans from the 2012 U.S. card acquisition; and (iii) an increase in non-interest expense, also largely due to operating expenses related to the 2012 U.S. card acquisition as well as amortization of intangibles and other assets associated with the 2012 U.S. card acquisition.

International Card Business

International Card generated net income from continuing operations of $42 million in the first quarter of 2013, a decrease of $9 million, or 18%, from net income from continuing operations of $51 million in the first quarter of 2012. International Card accounted for 10% of total net revenues for our Credit Card business in the first quarter of 2013, compared with 15% in the first quarter of 2012. Income attributable to International Card represented 6% of income for our Credit Card business in the first quarter of 2013, compared with 9% in the first quarter of 2012. Table 7.2 summarizes the financial results for International Card and displays selected key metrics for the periods indicated.

Table 7.2: International Card Business Results

 

     Three Months Ended March 31,  

(Dollars in millions)

       2013             2012             Change      

Selected income statement data:

      

Net interest income

   $ 274      $ 279        (2 )%

Non-interest income

     97        101        (4
  

 

 

   

 

 

   

 

 

 

Total net revenue

     371        380        (2

Provision for credit losses

     96        97        (1

Non-interest expense

     215        216        **   
  

 

 

   

 

 

   

 

 

 

Income from continuing operations before income taxes

     60        67        (10

Income tax provision

     18        16        13   
  

 

 

   

 

 

   

 

 

 

Income from continuing operations, net of tax

   $ 42      $ 51        (18 )%
  

 

 

   

 

 

   

 

 

 

Selected performance metrics:

      

Average loans held for investment(1)

   $ 8,238      $ 8,301        (1 )%

Average yield on loans held for investment(2)

     15.97 %     16.38     (41 )bps 

Total net revenue margin(3)

     18.01        18.31        (30

Net charge-offs

   $ 95      $ 114        (17 )%

Net charge-off rate(4)

     4.59     5.52     (93 )bps 

Purchase volume(5)

   $ 3,267      $ 3,081        6 %

(Dollars in millions)

   March 31,
2013
    December 31,
2012
        Change      

Selected period-end data:

      

Loans held for investment(1)

   $ 8,036      $ 8,614        (7 )%

30+ days performing delinquency rate(6)

     4.04     3.58     46 bps 

30+ days delinquency rate(7)

     4.93        4.49        44   

Nonperforming loan rate(8)

     1.13        1.16        (3

Allowance for loan and lease losses

   $ 437      $ 453        (4 )% 

 

** Change is less than one percent or not meaningful.

 

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(1) 

Credit card period-end loans held for investment and average loans held for investment include accrued finance charges and fees, net of the estimated uncollectible amount.

(2) 

Calculated by dividing annualized interest income for the period by average loans held for investment during the period for the specified loan category.

(3) 

Calculated by dividing annualized total net revenue for the period by average loans held for investment during the period for the specified loan category.

(4) 

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

(5) 

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

(6)

Calculated by loan category by dividing 30+ day performing delinquent loans as of the end of the period by period-end loans held for investment for the specified loan category.

(7)

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

(8)

Calculated by loan category by dividing nonperforming loans as of the end of the period by period-end loans held for investment for the specified loan category. Nonperforming credit card loans generally include international card loans that are 90 or 120 days delinquent.

The results for International Card in the first quarter of 2013 were comparable to the first quarter of 2012, as average loan balances, yields and expenses remained relatively stable.

Consumer Banking Business

Our Consumer Banking business generated net income from continuing operations of $383 million in the first quarter of 2013, an increase of $159 million, or 71%, from net income from continuing operations of $224 million in the first quarter of 2012. The primary sources of revenue for our Consumer Banking business are net interest income from loans and deposits and non-interest income from customer fees. Expenses primarily consist of ongoing operating costs, such as salaries and associate benefits, occupancy and equipment, professional services and communications and data processing technology expenses, as well as marketing expenditures.

On February 17, 2012, we acquired ING Direct, which resulted in the addition of loans with carrying value of $40.4 billion and deposits of $84.4 billion at acquisition. The substantial majority of the lending and retail deposit businesses acquired are reported in our Consumer Banking business; however, the results of our Consumer Banking business for the first quarter of 2012 reflect only a partial-quarter impact from the operations of ING Direct.

 

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

Table 8: Consumer Banking Business Results

 

     Three Months Ended March 31,  

(Dollars in millions)

       2013             2012             Change      

Selected income statement data:

      

Net interest income

   $ 1,478      $ 1,288        15 %

Non-interest income

     181        176        3   
  

 

 

   

 

 

   

 

 

 

Total net revenue

     1,659        1,464        13   

Provision for credit losses

     175        174        1   

Non-interest expense

     890        943        (6
  

 

 

   

 

 

   

 

 

 

Income from continuing operations before income taxes

     594        347        71   

Income tax provision

     211        123        72   
  

 

 

   

 

 

   

 

 

 

Income from continuing operations, net of tax

   $ 383      $ 224        71 %
  

 

 

   

 

 

   

 

 

 

Selected performance metrics:

      

Average loans held for investment:(1)

      

Auto

   $ 27,477      $ 22,582        22 %

Home loan

     43,023        29,502        46   

Retail banking

     3,786        4,179        (9
  

 

 

   

 

 

   

 

 

 

Total consumer banking

   $ 74,286      $ 56,263        32
  

 

 

   

 

 

   

 

 

 

Average yield on loans held for investment(2)

     5.93     7.20     (127 )bps 

Average deposits

   $ 171,089      $ 129,915        32 %

Average deposit interest rate

     0.64     0.73     (9 )bps 

Core deposit intangible amortization

   $ 37      $ 37        ** %

Net charge-offs

     143        109        (31 )

Net charge-off rate(3)

     0.78     0.77     1 bps 

Net charge-off rate (excluding acquired loans)(4)

     1.47        1.29        18   

Automobile loan originations

   $ 3,789      $ 4,270        (11 )% 

(Dollars in millions)

   March 31,
2013
    December 31,
2012
        Change      

Selected period-end data:

      

Loans held for investment:(1)

      

Auto

   $ 27,940      $ 27,123        3 %

Home loan

     41,931        44,100        (5

Retail banking

     3,742        3,904        (4
  

 

 

   

 

 

   

 

 

 

Total consumer banking

   $ 73,613      $ 75,127        (2 )% 
  

 

 

   

 

 

   

 

 

 

30+ days performing delinquency rate(5)

     2.24 %     2.65 %     (41 )bps 

30+ days performing delinquency rate (excluding acquired loans)(4)

     4.20        5.14        (94 )

30+ days delinquency rate(6)

     2.81        3.34        (53 )

30+ days delinquency rate (excluding acquired loans)(4)

     5.27        6.49        (122 )

Nonperforming loans rate(7)

     0.74        0.85        (11 )

Nonperforming loans rate (excluding acquired loans)(4)

     1.39        1.66        (27 )

Nonperforming asset rate(8)

     0.80        0.91        (11 )

Nonperforming asset rate (excluding acquired loans)(4)

     1.49        1.76        (27 )

Allowance for loan and lease losses

   $ 743      $ 711        5

Allowance coverage ratio(9)

     1.01     0.95     6 bps 

Deposits

   $ 172,605      $ 172,396        ** %

Loans serviced for others

     14,869        15,333        (3

 

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** Change is less than one percent or not meaningful.
(1) 

Loans held for investment includes loans acquired in the ING Direct and Chevy Chase Bank acquisitions. The carrying value of consumer banking acquired loans accounted for subsequent to acquisition based on expected cash flows to be collected was $34.4 billion and $36.5 billion as of March 31, 2013 and December 31, 2012, respectively. The average balance of consumer banking loans held for investment, excluding the carrying value of acquired loans, was $39.2 billion and $33.7 billion in the first quarter of 2013 and 2012, respectively.

(2) 

Calculated by dividing interest income for the period by average loans held for investment during the period for the specified loan category.

(3)

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

(4) 

Calculation of ratio adjusted to exclude from the denominator acquired loans accounted for subsequent to acquisition based on expected cash flows to be collected. See “Credit Risk Profile” and “Note 4—Loans—Credit Quality” for additional information on the impact of acquired loans on our credit quality metrics.

(5) 

Calculated by loan category by dividing 30+ days performing delinquent loans as of the end of the period by period-end loans held for investment for the specified loan category.

(6)

Calculated by loan category by dividing 30+ days delinquent loans as of the end of the period by period-end loans held for investment for the specified loan category.

(7) 

Calculated by loan category by dividing nonperforming loans as of the end of the period by period-end loans held for investment.

(8) 

Calculated by loan category by dividing nonperforming assets as of the end of the period by period-end loans held for investment, REO, and other foreclosed assets for the specified loan category.

(9)

Calculated by dividing the allowance for loan and lease losses as of the end of the period by period-end loans held for investment.

Key factors affecting the results of our Consumer Banking business for the first quarter of 2013, compared with the first quarter of 2012, and changes in financial condition and credit performance between March 31, 2013 and December 31, 2012 include the following:

 

   

Net Interest Income: Net interest income increased by $190 million, or 15%, in the first quarter of 2013 to $1.5 billion. The increase was primarily attributable to a significant increase in average loans held for investment due to the addition of home loans from the ING Direct acquisition and higher auto loan originations over the past twelve months, which was partially offset by the continued expected run-off of acquired home loans. The favorable impact of the increase in average loan balances more than offset the decrease in average loans yields due to the shift in the composition of our consumer loan portfolio from the addition of the acquired ING Direct loans, which generally had lower yields.

 

   

Non-Interest Income: Non-interest income increased slightly by $5 million, or 3%, in the first quarter 2013 to $181 million.

 

   

Provision for Credit Losses: The provision for credit losses related to our Consumer Banking business of $175 million in the first quarter of 2013, was comparable to the provision of $174 million in the first quarter of 2012, reflecting modestly higher auto loan charge-offs attributable to the continued high volume of auto loan originations, which was offset by an allowance release for our home loan portfolio. As discussed above under “Summary of Selected Financial Data,” the substantial majority of the ING Direct home loan portfolio is accounted for based on estimated cash flows expected to be collected over the life of the loans. Because the credit mark established at acquisition for these loans takes into consideration future credit losses expected to be incurred, there are no charge-offs or an allowance associated with these loans unless the estimated cash flows expected to be collected decrease subsequent to acquisition.

 

   

Non-Interest Expense: Non-interest expense decreased by $53 million, or 6%, in the first quarter of 2013 to $890 million. The decrease was largely due to the absence of ING Direct acquisition-related costs incurred in the first quarter of 2012, which was partially offset by increased expenses related to the growth in our auto loan portfolio.

 

   

Loans Held for Investment: Period-end loans held for investment in our Consumer Banking business declined by $1.5 billion, or 2%, in the first quarter of 2013, to $73.6 billion as of March 31, 2013, due to the continued expected run-off of acquired home loans, which was partially offset by higher period-end auto balances due to the continued high volume of auto loan originations.

 

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Deposits: Period-end deposits in our Consumer Banking business of $172.6 billion as of March 31, 2013, remained relatively stable compared with period-end deposits of $172.4 billion as of December 31, 2012.

 

   

Charge-off and Delinquency Statistics: The reported net charge-off rate of 0.78% in the first quarter of 2013 was relatively unchanged from 0.77% in the first quarter of 2012. However, the 30+ day delinquency rate decreased to 2.81% as of March 31, 2013, from 3.34% as of December 31, 2012. As discussed above under “Summary of Selected Financial Data,” the addition of the ING Direct home loan portfolio affects our reported credit metrics, as the credit mark established at acquisition for these loans takes into consideration future credit losses expected to be incurred. Accordingly, there are no charge-offs or an allowance associated with these loans unless the estimated cash flows expected to be collected decrease subsequent to acquisition. In addition, these loans are not classified as delinquent or nonperforming even though the customer may be contractually past due because we expect that we will fully collect the carrying value of these loans. The overall improvement in delinquency rates reflects improved credit performance in our legacy consumer loan portfolios.

Commercial Banking Business

Our Commercial Banking business generated net income from continuing operations of $203 million in the first quarter of 2013, a decrease of $7 million, or 3%, from net income from continuing operations of $210 million in the first quarter of 2012. The primary sources of revenue for our Commercial Banking business are net interest income from loans and deposits and non-interest income from customer fees. Because we have some affordable housing tax-related investments that generate tax-exempt income or tax credits, we make certain reclassifications to our Commercial Banking business results to present revenues on a taxable-equivalent basis. Expenses primarily consist of ongoing operating costs, such as salaries and associate benefits, occupancy and equipment, professional services and communications and data processing technology expenses, as well as marketing expenditures.

 

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

Table 9: Commercial Banking Business Results

 

     Three Months Ended March 31,  

(Dollars in millions)

       2013             2012             Change      

Selected income statement data:

      

Net interest income

   $ 454      $ 431        5 %

Non-interest income

     84        85        (1
  

 

 

   

 

 

   

 

 

 

Total net revenue

     538        516        4   

Provision for credit losses

     (35     (69     (49

Non-interest expense

     258        261        (1
  

 

 

   

 

 

   

 

 

 

Income from continuing operations before income taxes

     315        324        (3

Income tax provision

     112        114        (2
  

 

 

   

 

 

   

 

 

 

Income from continuing operations, net of tax

   $ 203      $ 210        (3 )%
  

 

 

   

 

 

   

 

 

 

Selected performance metrics:

      

Average loans held for investment:(1)

      

Commercial and multifamily real estate

   $ 17,454      $ 15,514        13 %

Commercial and industrial

     19,949        17,038        17   
  

 

 

   

 

 

   

 

 

 

Total commercial lending

     37,403        32,552        15   

Small-ticket commercial real estate

     1,173        1,480        (21
  

 

 

   

 

 

   

 

 

 

Total commercial banking

   $ 38,576      $ 34,032        13
  

 

 

   

 

 

   

 

 

 

Average yield on loans held for investment(2)

     3.91     4.47     (56 )bps 

Average deposits

   $ 30,335      $ 27,569        10 %

Average deposit interest rate

     0.28     0.37     (9 )bps 

Core deposit intangible amortization

   $ 7      $ 9        (22 )%

Net charge-offs

     7        16        (56

Net charge-off rate(3)

     0.07     0.19     (12 )bps 

Net charge-off rate (excluding acquired loans)(3)

     0.07        0.19        (12

(Dollars in millions)

   March 31,
2013
    December 31,
2012
        Change      

Selected period-end data:

      

Loans held for investment:

      

Commercial and multifamily real estate

   $ 17,878      $ 17,732        1 %

Commercial and industrial

     20,127        19,892        1   
  

 

 

   

 

 

   

 

 

 

Total commercial lending

     38,005        37,624        1   

Small-ticket commercial real estate

     1,145        1,196        (4
  

 

 

   

 

 

   

 

 

 

Total commercial banking

   $ 39,150      $ 38,820        1
  

 

 

   

 

 

   

 

 

 

Nonperforming loans rate(5)

     0.71 %     0.73     (2 )bps 

Nonperforming loans rate (excluding acquired loans)(4)

     0.71        0.73        (2 )

Nonperforming asset rate(6)

     0.74        0.77        (3 )

Nonperforming asset rate (excluding acquired loans)(4)

     0.75        0.78        (3 )

Allowance for loan and lease losses

   $ 342      $ 433        (21 )% 

Allowance coverage ratio(7)

     0.87     1.12     (25 )bps 

Deposits

   $ 30,275      $ 29,866        1 %

 

** Change is less than one percent or not meaningful.

 

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(1)

Loans held for investment includes loans acquired in the ING Direct and Chevy Chase Bank acquisitions. The carrying value of commercial banking acquired loans accounted for subsequent to acquisition based on expected cash flows to be collected was $323 million and $359 million as of March 31, 2013 and December 31, 2012, respectively. The average balance of commercial banking loans held for investment, excluding the carrying value of acquired loans, was $38.2 billion and $33.5 billion in the first quarter of 2013 and 2012, respectively.

(2)

Calculated by dividing annualized interest income for the period by average loans held for investment during the period for the specified loan category.

(3) 

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

(4) 

Calculation of ratio adjusted to exclude from the denominator acquired loans accounted for subsequent to acquisition based on expected cash flows to be collected. See “Summary of Selected Financial Data,” “Credit Risk Profile” and “Note 4—Loans—Credit Quality” for additional information on the impact of acquired loans on our credit quality metrics.

(5) 

Calculated by loan category by dividing nonperforming loans as of the end of the period by period-end loans held for investment for the specified loan category. Nonperforming loans generally include loans that have been placed on nonaccrual status and certain restructured loans whose contractual terms have been restructured in a manner that grants a concession to a borrower experiencing financial difficulty.

(6) 

Calculated by loan category by dividing nonperforming assets as of the end of the period by period-end loans held for investment, REO, and other foreclosed assets for the specified loan category.

(7)

Calculated by dividing the allowance for loan and lease losses as of the end of the period by period-end loans held for investment.

Key factors affecting the results of our Commercial Banking business for the first quarter of 2013, compared with the first quarter of 2012, and changes in financial condition and credit performance between March 31, 2013 and December 31, 2012 include the following:

 

   

Net Interest Income: Net interest income increased by $23 million, or 5%, in the first quarter of 2013 to $454 million. The increase was primarily driven by higher deposit balances and growth in commercial real estate and commercial and industrial loans.

 

   

Non-Interest Income: Non-interest income of $84 million in the first quarter of 2013 was relatively flat compared with non-interest income of $85 million in the first quarter of 2012, as lower revenues from investment banking activities were offset by increases in other customer fees.

 

   

Provision for Credit Losses: The Commercial Banking business recorded a negative provision for credit losses of $35 million in the first quarter of 2013, compared with a negative provision of $69 million in the first quarter of 2012. The negative provision for credit losses in the first quarter of 2013 reflected the continued improvement in the underlying credit performance of our commercial loan portfolio and the impact of a change in the process for estimating the combined allowance for loan losses and reserve for unfunded lending commitments for our commercial loan portfolio. This change in process resulted in a net increase in the combined allowance and reserve for unfunded lending commitments as of March 31, 2013. See “Critical Accounting Policies and Estimates—Allowance for Loan Losses and Reserve for Unfunded Lending Commitments—Commercial Loans” above for additional information on this change. The negative provision of $69 million in the first quarter of 2012 reflected improvement in underlying credit performance trends, which resulted in a release in the combined allowance and reserve of $85 million in the first quarter of 2012.

 

   

Non-Interest Expense: Non-interest expense of $258 million in the first quarter of 2013 remained relatively comparable to non-interest expense of $261 million in the first quarter of 2012.

 

   

Loans Held for Investment: Period-end loans held for investment in our Commercial Banking business increased by $330 million, or 1%, in the first quarter of 2013, to $39.2 billion as of March 31, 2013. The increase was driven by stronger loan originations in the commercial and industrial and commercial real estate businesses, which was partially offset by the continued run-off of the small-ticket commercial real estate loan portfolio.

 

   

Deposits: Period-end deposits in the Commercial Banking business increased by $409 million, or 1%, to $30.3 billion as of March 31, 2013, from $29.9 billion as of December 31, 2012, driven by our strategy to strengthen existing relationships and increase liquidity from commercial customers.

 

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Charge-off Statistics: The net charge-off rate decreased to 0.07% in the first quarter of 2013, from 0.19% in the first quarter of 2012. The nonperforming loan rate decreased to 0.71% as of March 31, 2013, from 0.73% as of December 31, 2012. The improvement in the credit metrics in our Commercial Banking business reflected a continued improvement in credit trends and strengthening of underlying collateral values, resulting in lower loss severities.

“Other” Category

Net loss from continuing operations recorded in Other was $128 million in the first quarter of 2013, compared with net income from continuing operations of $505 million in the first quarter of 2012. Other includes the residual impact of the allocation of our centralized Corporate Treasury group activities, such as management of our corporate investment portfolio and asset/liability management, to our business segments. Accordingly, net gains and losses on our investment securities portfolio and certain trading activities are included in the Other category. The Other category also includes foreign exchange-rate fluctuations related to the revaluation of foreign currency-denominated investments; certain gains (losses) on the sale and securitization of loans; unallocated corporate expenses that do not directly support the operations of the business segments or for which the business segments are not considered financially accountable in evaluating their performance, such as acquisition and restructuring charges; provisions for representation and warranty reserves related to continuing operations; certain material items that are non-recurring in nature; and offsets related to certain line-item reclassifications.

Table 10: “Other” Results

 

     Three Months Ended March 31,  

(Dollars in millions)

       2013             2012             Change      

Selected income statement data:

      

Net interest income (expense)

   $ (192   $ (297     (35 )%

Non-interest income

     (105     662        (116
  

 

 

   

 

 

   

 

 

 

Total net revenue

     (297     365        (181

Provision for credit losses

     2        10        (80

Non-interest expense

     32        32        **   
  

 

 

   

 

 

   

 

 

 

Income from continuing operations before income taxes

     (331     323        (202

Income tax benefit

     (203     (182     12   
  

 

 

   

 

 

   

 

 

 

Income from continuing operations, net of tax

   $ (128   $ 505        (125 )%
  

 

 

   

 

 

   

 

 

 

 

** Change is less than one percent or not meaningful.

The shift in the Other category to a net loss from continuing operations of $128 million in the first quarter of 2013, from net income from continuing operations of $505 million in the first quarter of 2012 was primarily due to the recognition of the bargain purchase gain of $594 million related to the ING Direct acquisition in the first quarter of 2012, which was partially offset by a derivative loss of $78 million recognized in the first quarter of 2012 related to the interest rate swaps we entered into in 2011 to partially hedge the interest rate risk of the net assets associated with the expected ING Direct acquisition.

 

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CONSOLIDATED BALANCE SHEET ANALYSIS AND CREDIT PERFORMANCE

 

Total assets of $300.2 billion as of March 31, 2013 decreased by $12.7 billion, or 4%, from $312.9 billion as of December 31, 2012. Total liabilities of $258.9 billion as of March 31, 2013, decreased by $13.5 billion, or 5%, from $272.4 billion as of December 31, 2012. Stockholders’ equity increased by $797 million in the first quarter of 2013, to $41.3 billion as of March 31, 2013. The increase in stockholders’ equity was primarily attributable to our net income of $1.1 billion in the first quarter of 2013.

Following is a discussion of material changes in the major components of our assets and liabilities in the first quarter of 2013. Period-end balance sheet amounts may vary from average balance sheet amounts due to liquidity and balance sheet management activities that are intended to ensure the adequacy of capital while managing our ability to manage liquidity requirements for the company and our customers and our market risk exposure in accordance with our risk appetite.

Investment Securities

Substantially all of our investment securities were classified as available for sale as of March 31, 2013 and December 31, 2012. Investment securities classified as available for sale are reported in our condensed consolidated balance sheets at fair value. Our investment securities portfolio, which had a fair value of $64.0 billion as of both March 31, 2013 and December 31, 2012, consisted primarily of the following: U.S. Treasury debt, U.S. agency debt and corporate debt securities guaranteed by U.S. government agencies; agency and non-agency mortgage-backed securities (“MBS”); other asset-backed securities and other investments. Based on fair value, investments in U.S. Treasury, agency securities and other securities explicitly or implicitly guaranteed by the U.S. government represented 78% of our total investment securities available for sale as of March 31, 2013, compared with 77% as of December 31, 2012.

We had investment securities designated as held to maturity reported at amortized cost of $2 million and $9 million as of March 31, 2013 and December 31, 2012, respectively. These investment securities are included in other assets in our condensed consolidated balance sheets.

 

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Table 11 presents the amortized cost and fair value for the major categories of our portfolio of investment securities available for sale as of March 31, 2013 and December 31, 2012.

Table 11: Investment Securities Available for Sale

 

    March 31, 2013     December 31, 2012  

(Dollars in millions)

  Amortized
Cost
    Fair
Value
    Amortized
Cost
    Fair
Value
 

U.S. Treasury debt obligations

  $ 1,043      $ 1,046      $ 1,548      $ 1,552   

U.S. agency debt obligations(1)

    301        301        301        302   

Corporate debt securities guaranteed by U.S. government agencies(2)

    1,117        1,128        1,003        1,012   

Residential mortgage-backed securities (“RMBS”):

       

Agency(3)

    40,413        40,749        39,408        40,002   

Non-agency

    3,499        3,868        3,607        3,871   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total RMBS

    43,912        44,617        43,015        43,873   
 

 

 

   

 

 

   

 

 

   

 

 

 

Commercial mortgage-backed securities (“CMBS”):

       

Agency(3)

    6,322        6,393        6,045        6,144   

Non-agency

    1,686        1,730        1,425        1,485   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total CMBS

    8,008        8,123        7,470        7,629   
 

 

 

   

 

 

   

 

 

   

 

 

 

Other asset-backed securities(4)

    7,298        7,357        8,393        8,458   

Other securities(5)

    1,369        1,396        1,120        1,153   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total securities available for sale

  $ 63,048      $ 63,968      $ 62,850      $ 63,979   
 

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) 

Includes debt securities issued by Fannie Mae and Freddie Mac with an amortized cost of $300 million as of both March 31, 2013 and December 31, 2012, and a fair value of $300 million and $302 million as of March 31, 2013 and December 31, 2012, respectively.

(2) 

Consists of corporate debt securities guaranteed by U.S. government agencies, such as the Export-Import Bank of the United States.

(3) 

Includes MBS issued by Fannie Mae, Freddie Mac and Ginnie Mae, each of which individually exceeded 10% of our stockholders’ equity as of the end of each reported period. Fannie Mae MBS had an amortized cost of $24.8 billion and $22.9 billion as of March 31, 2013 and December 31, 2012, respectively, and a fair value of $25.0 billion and $23.2 billion as of March 31, 2013 and December 31, 2012, respectively. Freddie Mac MBS had an amortized cost of $12.6 billion as of both March 31, 2013 and December 31, 2012, and a fair value of $12.7 billion and $12.9 billion as of March 31, 2013 and December 31, 2012, respectively. Ginnie Mae MBS had an amortized cost of $9.0 billion and $9.9 billion as of March 31, 2013 and December 31, 2012, respectively, and a fair value of $9.1 billion and $10.0 billion as of March 31, 2013 and December 31, 2012, respectively.

(4) 

The other asset-backed securities portfolio was collateralized by approximately 68% credit card loans, 18% auto dealer floor plan inventory loans and leases, 6% auto loans, 1% student loans, 5% equipment loans and 2% of other assets as of March 31, 2013. In comparison, the distribution was approximately 64% credit card loans, 18% auto dealer floor plan inventory loans and leases, 6% auto loans, 1% student loans, 5% equipment loans, 2% commercial paper and 4% of other assets as of December 31, 2012. Approximately 88% of the securities in our other asset-backed security portfolio were rated AAA or its equivalent as of March 31, 2013, compared with 82% as of December 31, 2012.

(5) 

Includes foreign government/agency bonds, covered bonds, corporate securities, municipal securities and equity investments primarily related to activities under the Community Reinvestment Act (“CRA”).

Our portfolio of investment securities available for sale had a fair value of approximately $64.0 billion as of both March 31, 2013 and December 31, 2012. We had purchases during the quarter totaling approximately $6.0 billion, which were offset by pay downs and maturities of $4.9 billion, sales of $720 million and a decrease in fair value of $209 million.

Unrealized gains and losses on our portfolio of investment securities available for sale are recorded net of tax as a component of accumulated other comprehensive income (“AOCI”). We had gross unrealized gains of $1.2 billion and gross unrealized losses of $258 million on available-for sale securities as of March 31, 2013, compared with gross unrealized gains of $1.2 billion and gross unrealized losses of $120 million on available-for sale securities as of December 31, 2012. The increase in gross unrealized losses in the first quarter of 2013 was primarily driven by an increase in interest rates, which resulted in a decrease in fair value of certain securities. Of

 

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the $258 million in gross unrealized losses as of March 31, 2013, $29 million related to securities that had been in a loss position for 12 months or longer.

We provide information on OTTI losses recognized in earnings on our investment securities above under “Consolidated Results of Operations—Non-Interest Income.”

Credit Ratings

Our portfolio of investment securities available for sale continues to be concentrated in securities that generally have low credit risk and high credit ratings, such as securities issued and guaranteed by the U.S. Treasury and other government sponsored enterprises or agencies. Approximately 92% of our total investment securities portfolio was rated AA+ or its equivalent, or better as of March 31, 2013 and December 31, 2012, while approximately 6% were below investment grade as of both March 31, 2013 and December 31, 2012. We categorize the credit ratings of our investment securities based on the lowest credit rating as issued by the rating agencies Standard & Poor’s Ratings Services (“S&P”), Moody’s Investors Service (“Moody’s”) and Fitch Ratings (“Fitch”).

Table 12 provides information on the credit ratings of our non-agency RMBS, non-agency CMBS, other asset-backed securities and other securities in our portfolio as of March 31, 2013 and December 31, 2012.

Table 12: Non-Agency Investment Securities Credit Ratings

 

    March 31, 2013     December 31, 2012  

(Dollars in millions)

  Amortized
Cost
    AAA     Other
Investment
Grade
    Below
Investment
Grade or Not
Rated
    Amortized
Cost
    AAA     Other
Investment
Grade
    Below
Investment
Grade or Not
Rated
 

Non-agency RMBS

  $ 3,499            5     95   $ 3,607            5     95

Non-agency CMBS

    1,686        98        2               1,425        97        3          

Other asset-backed securities

    7,298        88        11        1        8,393        82        17        1   

Other securities(1)

    1,369        46        44        10        1,120        67        24        9   

 

(1) 

Includes foreign government/agency bonds, covered bonds, corporate securities, municipal securities and equity investments primarily related to activities under the CRA.

For additional information on our investment securities, see “Note 3—Investment Securities.”

Loans Held for Investment

Total loans that we manage consist of held-for-investment loans recorded on our consolidated balance sheets and loans held in our securitization trusts. Loans underlying our securitization trusts are reported on our consolidated balance sheets in restricted loans for securitization investors. Table 13 summarizes our portfolio of loans held for investment by business segment, net of the allowance for loan and lease losses, as of March 31, 2013 and December 31, 2012.

Table 13: Net Loans Held for Investment

 

     March 31, 2013      December 31, 2012  

(Dollars in millions)

   Total Loans
Held For
Investment
     Allowance      Net Loans
Held For
Investment
     Total Loans
Held For
Investment
     Allowance      Net Loans
Held For
Investment
 

Credit Card

   $ 78,397       $ 3,494       $ 74,903       $ 91,755       $ 3,979       $ 87,776   

Consumer Banking

     73,613         743         72,870         75,127         711         74,416   

Commercial Banking

     39,150         342         38,808         38,820         433         38,387   

Other

     173         27         146         187         33         154   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 191,333       $ 4,606       $ 186,727       $ 205,889       $ 5,156       $ 200,733   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Period-end loans held for investment decreased by $14.6 billion, or 7%, in the first quarter of 2013, to $191.3 billion as of March 31, 2013. The decrease was due in part to the transfer of the loans in the Best Buy portfolio to the held for sale category. Excluding the transfer of the Best Buy portfolio of approximately $7 billion to held for sale, period-end loans held for investment decreased by approximately $7.6 billion, or 4%. This decrease reflected typical seasonally lower credit card purchase volumes and higher pay downs in the first quarter of the year, the continued expected run-off of installment loans in our Credit Card business and home loans in our Consumer Banking business, as well as the expected run-off of certain other credit card loans acquired in the 2012 U.S. card acquisition. The pay downs and run-off of card balances were partially offset by higher period-end auto balances due to the continued high volume of auto loan originations and strong loan originations in our commercial and industrial and commercial real estate loan portfolios.

We provide additional information on the composition of our loan portfolio and credit quality below in “Credit Risk Profile” and in “Note 4—Loans.”

Loans Held for Sale

Loans held for sale, which are carried at lower of cost or fair value, increased to $6.4 billion as of March 31, 2013, from $201 million as of December 31, 2012. The increase was due to the transfer of the Best Buy loan portfolio to held for sale from held for investment in the first quarter of 2013. At the time of the transfer, the portfolio had loan balances of approximately $7 billion. The Best Buy portfolio had outstanding loan balances of $6.3 billion as of March 31, 2013.

Customer Deposits

Our customer deposits have become our largest source of funding for our operations and asset growth, providing a sizeable and consistent source of low-cost funds. Total customer deposits of $212.4 billion as of March 31, 2013 were relatively unchanged from $212.5 billion as of December 31, 2012. We provide information on the composition of our deposits, average outstanding balances, interest expense and yield below in “Liquidity Risk Profile.”

Securitized Debt Obligations

Borrowings due to securitization investors decreased by $352 million to $11.0 billion as of March 31, 2013, from $11.4 billion as of December 31, 2012. This decrease was attributable to the scheduled maturities of debt within our credit card securitization trusts, which was partially offset by the February 1, 2013 execution of our first credit securitization transaction since 2009 in which Capital One Multi-Asset Execution Trust issued $750 million of 3-year, AAA-rated fixed-rate notes from our credit card securitization trust.

Other Debt

Other debt, which consists of federal funds purchased and securities loaned or sold under agreements to repurchase, senior and subordinated notes and other borrowings, including junior subordinated debt and FHLB advances, but exclude securitized debt obligations, totaled $26.4 billion as of March 31, 2013, of which $12.2 billion represented short-term borrowings and $14.2 billion represented long-term debt. Other debt decreased $12.1 billion in the first quarter of 2013 from a total $38.5 billion as of December 31, 2012, of which $21.1 billion represented short-term borrowings and $17.4 billion represented long-term borrowings.

During the first quarter, we exchanged $1.2 billion of outstanding 8.80% subordinated notes due 2019. The transaction involved offering current holders market value plus an exchange premium for these outstanding notes, which consideration was paid through a combination of $1.4 billion of new 3.375% subordinated notes due 2023 and cash of $209 million. The exchange was accounted for as a modification of debt.

 

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In addition, other debt decreased as a result of our redemption of $3.65 billion of our junior subordinated debt on January 2, 2013 in connection with our redemption of our outstanding trust preferred securities. This decrease was partially offset by the issuance of $850 million in new unsecured senior bank notes. The remaining decrease was due to the maturities of short-term FHLB advances of $12.4 billion, which was partially offset by $3.8 billion of new FHLB borrowings during the quarter. We provide additional information on our borrowings in “Note 8—Deposits and Borrowings.”

Potential Mortgage Representation & Warranty Liabilities

We acquired three subsidiaries that originated residential mortgage loans and sold them to various purchasers, including purchasers who created securitization trusts. These subsidiaries are Capital One Home Loans, which was acquired in February 2005; GreenPoint Mortgage Funding, Inc. (“GreenPoint”), which was acquired in December 2006 as part of the North Fork acquisition; and CCB, which was acquired in February 2009 and subsequently merged into CONA.

We have established representation and warranty reserves for losses associated with the mortgage loans sold by each subsidiary that we consider to be both probable and reasonably estimable, including both litigation and non-litigation liabilities. These reserves are reported in our condensed consolidated balance sheets as a component of other liabilities. The aggregate reserves for all three subsidiaries totaled $994 million as of March 31, 2013, compared with $899 million as of December 31, 2012, and $1.1 billion as of March 31, 2012.

The table below summarizes changes in our representation and warranty reserves in first quarter of 2013 and 2012, and for full year 2012.

Table 14: Changes in Representation and Warranty Reserve

 

     Three Months Ended March 31,     Full
Year

2012
 

(Dollars in millions)

       2013             2012        

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

   $ 899      $ 943      $ 943   

Provision for mortgage representation and warranty losses(2)

     97        169        349   

Net realized losses

     (2     (11     (393
  

 

 

   

 

 

   

 

 

 

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

   $ 994      $ 1,101      $ 899   
  

 

 

   

 

 

   

 

 

 

 

(1) 

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

(2) 

The pre-tax portion of the provision for mortgage representation and warranty losses recognized in our condensed consolidated statements of income as a component of non-interest income was negative $10 million in the first quarter of 2013, compared with expense of $16 million in the first quarter of 2012. The pre-tax portion of the provision for mortgage representation and warranty losses recognized in our consolidated statements of income as a component of discontinued operations totaled $107 million and $153 million in the first quarter of 2013 and 2012, respectively.

As part of our business planning processes, we have considered various outcomes relating to the potential future representation and warranty liabilities of our subsidiaries that are possible but do not rise to the level of being both probable and reasonably estimable outcomes justifying an incremental accrual under applicable accounting standards. Our current best estimate of reasonably possible future losses from representation and warranty claims beyond what was in our reserve as of March 31, 2013, is approximately $2.7 billion, unchanged from our estimate of $2.7 billion as of December 31, 2012.

We provide additional information related to the representation and warranty reserve, including factors that may impact the adequacy of the reserves and the ultimate amount of losses incurred by our subsidiaries, in “Note 14—Commitments, Contingencies and Guarantees.”

 

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OFF-BALANCE SHEET ARRANGEMENTS AND VARIABLE INTEREST ENTITIES

 

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

Our continuing involvement in unconsolidated VIEs primarily consists of certain mortgage loan trusts and community reinvestment and development entities. The carrying amount of assets and liabilities of these unconsolidated VIEs was $2.8 billion and $401 million, respectively, as of March 31, 2013, and our maximum exposure to loss was $2.8 billion. We provide a discussion of our activities related to these VIEs in “Note 6—Variable Interest Entities and Securitizations.”

 

 

CAPITAL MANAGEMENT

 

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

Capital Standards and Prompt Corrective Action

Bank holding companies and national banks are subject to capital adequacy standards adopted by the Federal Reserve and the Office of the Comptroller of the Currency (“OCC”), respectively. The capital adequacy standards set forth minimum risk-based and leverage capital requirements that are based on quantitative and qualitative measures of assets and off-balance sheet items. Under the capital adequacy standards, bank holding companies and banks currently are required to maintain a total risk-based capital ratio of at least 8%, a Tier 1 risk-based capital ratio of at least 4%, and a Tier 1 leverage capital ratio of at least 4% (3% for banks that meet certain specified criteria, including excellent asset quality, high liquidity, low interest rate exposure and the highest regulatory rating) in order to be considered adequately capitalized.

National banks also are subject to prompt corrective action capital regulations. Under prompt corrective action regulations, a bank is considered to be well capitalized if it maintains a Tier 1 risk-based capital ratio of at least 6% (200 basis points higher than the above minimum capital standard), a total risk-based capital ratio of at least 10% (200 basis points higher than the above minimum capital standard), a Tier 1 leverage capital ratio of at least 5% and is not subject to any supervisory agreement, order or directive to meet and maintain a specific capital level for any capital reserve. A bank is considered to be adequately capitalized if it meets these minimum capital ratios and does not otherwise meet the well capitalized definition. Currently, prompt corrective action capital requirements do not apply to bank holding companies. We also disclose a Tier 1 common ratio for our bank holding company, which is a regulatory capital measure widely used by investors, analysts, rating agencies and bank regulatory agencies to assess the capital position of financial services companies. There is currently no mandated minimum or “well capitalized” standard for the Tier 1 common ratio; instead the risk-based capital rules state that voting common stockholders’ equity should be the dominant element within Tier 1 common capital. In addition, we disclose a non-GAAP TCE ratio in “Summary of Selected Financial Data.” While the

 

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Tier 1 common and TCE ratios are capital measures widely used by investors, analysts and bank regulatory agencies to assess the capital position of financial services companies, they may not be comparable to similarly titled measures reported by other companies. We provide information on the calculation of these ratios in “Supplemental Tables—Table A: Reconciliation of Non-GAAP Measures and Calculation of Regulatory Capital Measures Under Basel I.”

Table 15 provides a comparison of our capital ratios under the Federal Reserve’s capital adequacy standards; and the capital ratios of the Banks under the OCC’s capital adequacy standards as of March 31, 2013 and December 31, 2012.

Table 15: Capital Ratios Under Basel I(1)

 

     March 31, 2013     December 31, 2012  

(Dollars in millions)

   Capital
Ratio
    Minimum
Capital

Adequacy
    Well
Capitalized
    Capital
Ratio
    Minimum
Capital
Adequacy
    Well
Capitalized
 

Capital One Financial Corp:

            

Tier 1 common(2)

     11.79     N/A        N/A        10.96     N/A        N/A   

Tier 1 risk-based capital(3)

     12.18        4.00     6.00     11.34        4.00     6.00

Total risk-based capital(4)

     14.43        8.00        10.00        13.56        8.00        10.00   

Tier 1 leverage(5)

     9.15        4.00        N/A        8.66        4.00        N/A   

Capital One Bank (USA) N.A. (“COBNA”):

            

Tier 1 risk-based capital(3)

     11.91     4.00     6.00     11.32     4.00     6.00

Total risk-based capital(4)

     15.43        8.00        10.00        14.74        8.00        10.00   

Tier 1 leverage(5)

     10.16        4.00        5.00        10.43        4.00        5.00   

Capital One, N.A. (“CONA”):

            

Tier 1 risk-based capital(3)

     13.45     4.00     6.00     13.59     4.00     6.00

Total risk-based capital(4)

     14.60        8.00        10.00        14.85        8.00        10.00   

Tier 1 leverage(5)

     9.01        4.00        5.00        9.15        4.00        5.00   

 

(1) 

Calculated under capital standards and regulations based on the international capital framework commonly known as Basel I. Capital ratios that are not applicable are denoted by “N/A.”

(2) 

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

(3) 

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

(4) 

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

(5) 

Tier 1 leverage ratio is calculated based on Tier 1 capital divided by quarterly average total assets, after certain adjustments.

Our Tier 1 common ratio, as calculated under Basel I, increased to 11.79% as of March 31, 2013, up from 10.96% as of December 31, 2012. The increase in our Tier 1 common ratio reflected strong internal capital generation from earnings. We exceeded minimum capital requirements and would meet the “well capitalized” ratio levels specified under prompt corrective action for Tier 1 risk-based capital, total risk-based capital and Tier 1 leverage under Federal Reserve capital standards for bank holding companies as of both March 31, 2013 and December 31, 2012. The Banks also exceeded minimum regulatory requirements under the OCC’s applicable capital adequacy guidelines and were “well capitalized” under prompt corrective action requirements as of both March 31, 2013 and December 31, 2012.

Recent Developments in Capital Requirements

As of December 31, 2012, we had outstanding trust preferred securities with a combined aggregate principal amount of $3.65 billion that previously qualified as Tier 1 capital. On January 2, 2013, we redeemed all of our outstanding trust preferred securities, which generally carried a higher coupon cost, ranging from 3.36% to 10.25%, than other funding sources available to us. Pursuant to the Dodd-Frank Act, the Tier 1 capital treatment of trust preferred securities is to be phased out over a three year period starting on January 1, 2013.

 

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In January 2013 we submitted our capital plan to the Board of Governors of the Federal Reserve as part of the 2013 Comprehensive Capital Analysis and Review (“CCAR”). On March 14, 2013, we were informed by the Board of Governors of the Federal Reserve that it had completed its review under the CCAR process and that it did not object to our proposed capital distribution plans submitted pursuant to CCAR.

Dividends

On May 2, 2013, our Board of Directors approved an increase in our quarterly common stock dividend per share from $0.05 per share to $0.30 per share, payable May 23, 2013 to stockholders of record as of May 13, 2013. The Board of Directors also declared a quarterly dividend on the outstanding shares of our 6.00% fixed rate non-cumulative perpetual preferred stock, Series B (the “Series B Preferred Stock”). Each outstanding share of the Series B Preferred Stock is represented by depository shares, each representing a 1/40th interest in a share of Series B Preferred Stock. The dividend of $15.00 per share (equivalent to $0.375 per outstanding depository share) will be paid on June 3, 2013 to stockholders of record at the close of business on May 17, 2013.

On January 31, 2013, our Board of Directors declared a quarterly common stock dividend of $0.05 per share, which was payable on February 22, 2013 to stockholders of record as of February 11, 2013, and a quarterly dividend on the outstanding Series B Preferred Stock. The dividend of $15.00 per share (equivalent to $0.375 per outstanding depository share) was paid on March 1, 2013 to stockholders of record at the close of business on February 14, 2013.

The declaration and payment of dividends to our stockholders, as well as the amount thereof, are subject to the discretion of our Board of Directors and depend upon our results of operations, financial condition, capital levels, cash requirements, future prospects and other factors deemed relevant by the Board of Directors. As a bank holding company, our ability to pay dividends is largely dependent upon the receipt of dividends or other payments from our subsidiaries. Funds available for dividend payments from COBNA and CONA were $4.3 billion and $791 million, respectively, as of March 31, 2013. There can be no assurance that we will declare and pay any dividends. For additional information on dividends, see “Item 1. Business—Supervision and Regulation—Dividends, Stock Purchases and Transfer of Funds” in our 2012 Form 10-K.

 

 

RISK MANAGEMENT

 

Overview

Risk management is a critical part of our business model, as all financial institutions are exposed to a variety of risks that can significantly affect their financial performance. Our business activities expose us to eight major categories of risk: credit risk, liquidity risk, market risk, compliance risk, operational risk, legal risk, reputational risk and strategic risk. Our risk management framework is intended to identify, assess and mitigate risks that affect or have the potential to affect our business. We target financial returns that compensate us for the amount of risk that we take and avoid excessive risk-taking.

 

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We use a consistent risk management framework to manage risk. This framework applies at all levels, from the development of the Enterprise Risk Management Program itself to the tactical operations of the front-line business team. We are continuing to make changes to our risk management framework as we enhance our enterprise-wide compliance risk management programs, including further expanding the “Three Lines of Defense” model referenced under the “Risk Management Principles” set forth under “MD&A—Risk Management—Risk Management Principles” in our 2012 Form 10-K. Our risk management framework, which is built around governance, processes and people, currently consists of the following six key elements:

 

   

Objective Setting

   

Risk Assessment

   

Control Activities

   

Communication and Information

   

Program Monitoring

   

Organization and Culture

We provide additional discussion of our risk management principles, roles and responsibilities, framework and risk appetite under “MD&A—Risk Management” in our 2012 Form 10-K.

 

 

CREDIT RISK PROFILE

 

Our loan portfolio accounts for the substantial majority of our credit risk exposure. Below we provide information about the composition of our loan portfolio, key concentrations and credit performance metrics.

We also engage in certain non-lending activities that may give rise to credit and counterparty settlement risk, including the purchase of securities for our investment securities portfolio, entering into derivative transactions to manage our market risk exposure and to accommodate customers, foreign exchange transactions and deposit overdrafts. We provide additional information on credit risk related to our investment securities portfolio under “Consolidated Balance Sheet Analysis—Investment Securities” and credit risk related to derivative transactions in “Note 9—Derivative Instruments and Hedging Activities.”

Loan Portfolio Composition

We provide a variety of lending products. Our primary products include credit cards, auto loans, home loans and commercial loans. For information on our lending policies and procedures, including our underwriting criteria, for our primary loan products, please refer to the “MD&A—Credit Risk Profile” section in our 2012 Form 10-K.

Total loans that we manage consist of held-for-investment loans recorded on our balance sheet and loans held in our securitization trusts. Loans underlying our securitization trusts are reported on our consolidated balance sheets under restricted loans for securitization investors. Table 16 presents the composition of our total loan portfolio, by business segments, as of March 31, 2013 and December 31, 2012. Table 16 also displays acquired loans accounted for based on estimated cash flows expected to be collected, which consists of a limited portion of the credit card loans acquired in the 2012 U.S. card acquisition and the substantial majority of consumer and commercial loans acquired in the ING Direct and Chevy Chase Bank acquisitions. For additional information on the accounting for acquired loans, see “MD&A—Credit Risk Profile—Loan Portfolio Composition—Loans Acquired” and “Note 1—Summary of Significant Accounting Policies—Loan” in our 2012 Form 10-K. Table 16 and the credit metrics presented in this section exclude loans held for sale, which are carried at lower of cost or fair value and totaled $6.4 billion and $201 million as of March 31, 2013 and December 31, 2012, respectively.

 

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Table 16: Loan Portfolio Composition(1)

 

    March 31, 2013     December 31, 2012  

(Dollars in millions)

  Loans     Acquired
Loans(2)
    Total(4)     % of
Total
    Loans     Acquired
Loans(2)
    Total(4)     % of
Total
 

Credit Card business:

               

Credit card loans:

               

Domestic credit card loans

  $ 69,531      $ 191      $ 69,722        36.4   $ 82,058      $ 270      $ 82,328        40.0

International credit card loans

    8,036               8,036        4.2        8,614               8,614        4.2   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total credit card loans

    77,567        191        77,758        40.6        90,672        270        90,942        44.2   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Installment loans:

               

Domestic installment loans

    626        13        639        0.3        795        18        813        0.4   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total credit card

    78,193        204        78,397        41.0        91,467        288        91,755        44.6   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Consumer Banking business:

               

Auto

    27,927        13        27,940        14.6        27,106        17        27,123        13.2   

Home loan

    7,605        34,326        41,931        21.9        7,697        36,403        44,100        21.4   

Other retail

    3,704        38        3,742        2.0        3,870        34        3,904        1.9   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total consumer banking

    39,236        34,377        73,613        38.5        38,673        36,454        75,127        36.5   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Commercial Banking business:(3)

               

Commercial and multifamily real estate

    17,769        109        17,878        9.3        17,605        127        17,732        8.6   

Commercial and industrial

    19,913        214        20,127        10.5        19,660        232        19,892        9.7   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial lending

    37,682        323        38,005        19.9        37,265        359        37,624        18.3   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Small-ticket commercial real estate

    1,145               1,145        0.6        1,196               1,196        0.5   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial banking

    38,827        323        39,150        20.5        38,461        359        38,820        18.8   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other:

               

Other loans

    134        39        173        0.1        154        33        187        0.1   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans held for investment

  $ 156,390      $ 34,943      $ 191,333        100.0   $ 168,755      $ 37,134      $ 205,889        100.0
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) 

Excludes loans held for sale of $6.4 billion and $201 million as of March 31, 2013 and December 31, 2012, respectively.

(2)

Consists of acquired loans accounted for based on estimated cash flows expected to be collected. See “Note 1—Summary of Significant Accounting Policies” in our 2012 Form 10-K and “Note 4—Loans” in this Report for additional information.

(3) 

Includes construction loans and land development loans totaling $2.1 billion as of both March 31, 2013 and December 31, 2012.

(4) 

We had a net unamortized premium on purchased loans of $397 million and $461 million as of March 31, 2013 and December 31, 2012, respectively.

Credit Risk Measurement

We closely monitor economic conditions and loan performance trends to assess and manage our exposure to credit risk. Key metrics we track in evaluating the credit quality of our loan portfolio include delinquency and nonperforming asset rates, as well as charge-off rates and our internal risk ratings of larger balance, commercial loans. Trends in delinquency rates are a primary indicator of credit risk within our consumer loan portfolios, as changes in delinquency rate provide an early warning of changes in credit losses. The primary indicator of credit risk in our commercial loan portfolios is risk ratings. Because we generally classify loans that have been delinquent for an extended period of time and other loans with significant risk of loss as nonperforming, the level of nonperforming assets represents another indicator of the potential for future credit losses. In addition to delinquency rates, the geographic distribution of our loans provides insight as to the credit quality of the portfolio based on regional economic conditions.

 

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We use borrower credit scores in underwriting for most consumer loans. We do not use credit scores as a primary indicator of credit quality, because product differences, loan structure, and other factors drive large differences in credit quality for a given credit score, and because a borrower’s credit score tends to be a lagging indicator of credit quality. We continuously adjust our credit line management of credit lines and collection strategies based on customer behavior and risk profile changes.

As noted above, our Credit Card business accounted for $78.4 billion, or 41%, of our total loan portfolio as of March 31, 2013, with Domestic Card accounting for $70.4 billion, or 37%, of our total loan portfolio as of March 31, 2013. In comparison, our Credit Card business accounted for $91.8 billion, or 45%, of our total loan portfolio as of December 31, 2012, with Domestic Card accounting for $83.1 billion, or 40%, of our total loan portfolio as of December 31, 2012. Based on our most recent data, we estimate that approximately one-third of our Domestic Card portfolio had credit scores less than 660 or no score, based on loan balances, as of March 31, 2013, relatively consistent with the proportion of the Domestic Card portfolio with credit scores below 660 or no score as of December 31, 2012. For loans related to the 2012 U.S. card acquisition and certain other partnerships, data is obtained on a lagged basis.

We present information in the section below on the credit performance of our loan portfolio, including the key metrics we use in tracking changes in the credit quality of our loan portfolio. Loans acquired as part of the CCB, ING Direct and 2012 U.S. card acquisitions are included in the denominator used in calculating the credit quality metrics presented below. Because some of these loans are accounted for based on expected cash flows to be collected, which takes into consideration future credit losses expected to be incurred, there are no charge-offs or an allowance associated with these loans unless the estimated cash flows expected to be collected decrease subsequent to acquisition. In addition, these loans are not classified as delinquent or nonperforming even though the customer may be contractually past due because we expect that we will fully collect the carrying value of these loans. The accounting and classification of these loans may significantly alter some of our reported credit quality metrics. We therefore supplement certain reported credit quality metrics with metrics adjusted to exclude the impact of these acquired loans.

See “Note 4—Loans” in this Report for additional credit quality information. See “Note 1—Summary of Significant Accounting Policies” in our 2012 Form 10-K for information on our accounting policies for delinquent, nonperforming loans, charge-offs and troubled debt restructurings (“TDRs”) for each of our loan categories.

Delinquency Rates

We consider the entire balance of an account to be delinquent if the minimum required payment is not received by the first statement cycle date equal to or following the due date specified on the customer’s billing statement. Table 17 compares 30+ day performing and total 30+ day delinquency rates, by loan category, as of March 31, 2013 and December 31, 2012. Table 17 also presents these metrics adjusted to exclude from the denominator acquired loans accounted for based on estimated cash flows expected to be collected over the life of the loans.

Our 30+ day delinquency metrics include all held-for-investment loans that are 30 or more days past due, whereas our 30+ day performing delinquency metrics include loans that are 30 or more days past due and that are also currently classified as performing and accruing interest. The 30+ day delinquency and 30+ day performing delinquency metrics are generally the same for credit card loans, as we continue to classify the substantial majority of credit card loans as performing until the account is charged-off, typically when the account is 180 days past due. See “Note 1—Summary of Significant Accounting Policies—Loans” in our 2012 Form 10-K for information on our policies for classifying loans as nonperforming for each of our loan categories.

 

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Table 17: 30+ days Delinquencies

 

    March 31, 2013     December 31, 2012  
    30+ Day Performing     30+ Day Total     30+ Day Performing     30+ Day Total  

(Dollars in millions)

  Amount     Rate(1)     Adjusted
Rate(2)
    Amount     Rate(1)     Adjusted
Rate(2)
    Amount     Rate(1)     Adjusted
Rate(2)
    Amount     Rate(1)     Adjusted
Rate(2)
 

Credit Card business:

                       

Domestic credit card and installment loans

  $ 2,374        3.37     3.38   $ 2,374        3.37     3.38   $ 3,001        3.61     3.62   $ 3,001        3.61     3.62

International credit card

    325        4.04        4.04        396        4.93        4.93        308        3.58        3.58        387        4.49        4.49   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total credit card

    2,699        3.44        3.45        2,770        3.53        3.54        3,309        3.61        3.62        3,388        3.69        3.70   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Consumer Banking business:

                       

Automobile

    1,560        5.58        5.59        1,655        5.92        5.93        1,900        7.00        7.01        2,049        7.55        7.56   

Home loan

    57        0.14        0.75        352        0.84        4.63        59        0.13        0.77        380        0.86        4.94   

Retail banking

    32        0.83        0.84        59        1.58        1.59        30        0.76        0.77        81        2.07        2.09   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total consumer banking

    1,649        2.24        4.20        2,066        2.81        5.27        1,989        2.65        5.14        2,510        3.34        6.49   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Commercial Banking business:

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