01—Abstract
Summary
Summary of the 10-K filed March 18, 1998. Cited figures are marked; the original filing is the authoritative source.
Capital One Financial Corporation's 1997 10-K shows a company whose earnings grew while its credit quality deteriorated and its funding model relied heavily on securitization.
Net income rose 22% to $189.4 milliona ($2.80 diluted EPS, up from $2.32), driven by strong growth in managed consumer loans, which reached $14.2 billion at year-end (up 11%) with 11.7 million customers. Managed revenue growth came largely from second-generation products (secured, subprime-style, affinity and student cards), which carry higher fees and higher loss rates. Management also set a target of more than 20% diluted EPS growth for 1998.
The key concern for investors is asset quality. The reported net charge-off rate rose to 4.83% from 3.63%, and the managed charge-off rate reached 6.59% versus 4.24% a year earlier. The provision for loan losses jumped 57% to $262.8 millionb, and the allowance rose to 3.76% of on-balance-sheet loans from 2.73%.
Part of this deterioration reflects a Q4 1997 change in charge-off timing and a $50.2 millionc write-down of uncollectible finance charge receivables, which together flatter the reported delinquency rate. Net interest margin on a reported basis fell to 6.66% from 7.62%, while the managed margin rose to 8.86%. Management itself warned that delinquencies and losses are expected to keep rising as accounts season.
Funding and capital appear adequate. Securitized loans of $9.4 billiond make up about 66% of managed loans, and the Bank and Savings Bank both remain well capitalized.
The company also faces ongoing regulatory risk from proposed credit card interest rate and fee legislation, plus a pending California class action. Investors weighing this filing should note that growth and profitability depend on sustained credit performance and continued access to securitization markets.
02—Key points
Key Highlights
- Net income rose 22% to $189.4 million in 1997, and diluted EPS increased to $2.80 from $2.32.
- Managed consumer loans grew 11% year over year to $14.2 billion, and managed accounts reached 11.7 million.
- Reported net charge-off rate climbed to 4.83% from 3.63%, and managed net charge-offs reached 6.59% versus 4.24%.
- Provision for loan losses increased 57% to $262.8 million, and the allowance for loan losses rose to 3.76% of on-balance-sheet loans.
- Reported net interest margin declined to 6.66% from 7.62%, while managed net interest margin improved to 8.86% from 8.16%.
- Securitized consumer loans of $9.4 billion account for roughly 66% of managed loans, and the Bank and Savings Bank both remain well capitalized.
- Management targets diluted EPS growth of more than 20% in 1998, but it expects delinquency and charge-off pressure to continue as accounts season.
03—Questions
Frequently Asked Questions
Why did reported net interest margin fall while managed margin rose?
Reported figures are on-balance-sheet and reflect the removal of securitized loans and their higher-yielding second-generation products from the balance sheet, along with Q4 1997 charge-off and fee-recognition changes that reduced interest income. The managed figures add back securitized loans, showing a 8.86% margin, up from 8.16% in 1996, driven by a 97 basis point rise in consumer loan yield.
How significant was the change in charge-off policy?
In Q4 1997 the company moved to charging off accounts at 180 days past due, versus the prior practice of charging off in the next billing cycle. This increased reported charge-offs by $11.5 million and managed charge-offs by $47.4 million. Management also recognized a $50.2 million write-down of uncollectible finance charge and fee receivables. Without these changes, the managed charge-off rate would have been 6.22% rather than 6.59%, and the reported delinquency rate would have been 6.28% rather than 5.51%.
What are the main risks to future earnings?
Risks include rising delinquencies and losses as accounts season (53% of managed accounts were under 18 months old), a shift toward higher-risk second-generation products, intense competition that could pressure yields and increase attrition, reliance on securitization markets for funding, potential federal legislation limiting credit card rates and fees or changing bankruptcy laws, Year 2000 system risk, and a pending California class action.
Is the company adequately capitalized and funded?
Yes. As of year-end 1997, both Capital One Bank and Capital One, F.S.B. were classified as well capitalized under FDICIA. The Bank's Tier 1 risk-based ratio was 10.49%, and the Savings Bank's core capital ratio was 11.26%. Liquidity included $1.5 billion in securities and over $2.0 billion in unused credit facilities, and the company had no outstanding borrowings under its $1.7 billion credit facility.
04—Continue