01—Abstract
Summary
Summary of the 10-K filed March 26, 1999. Cited figures are marked; the original filing is the authoritative source.
Capital One Financial Corporation's 1998 Form 10-K shows a year of sharp growth in earnings and scale.
Net income rose 45% to $275.2 milliona, or $3.96 per diluted share, up from $189.4 million ($2.80) in 1997. Managed consumer loans reached $17.4 billion at year-end, up 22% from $14.2 billion, and the company reported 16.7 million customers. Reported net interest income rose 81% to $694.8 million, driven by a reported net interest margin of 9.62% (versus 6.66% in 1997) and a 364 basis point jump in consumer loan yield, which management attributed largely to higher past-due fees.
Return on average equity was 25.3% and return on average assets was 3.30%, and management set a target of roughly 30% earnings growth and ROE above 20% for 1999. Quality of earnings is a key investor consideration. Much of the margin expansion came from fee income, including past-due and overlimit fees, and non-interest income grew 39% to $1.49 billionb.
Non-interest expense more than doubled in some categories: marketing expense rose 98% to $446 millionc and salaries rose 65%. The company is also investing in unprofitable or early-stage businesses, including the America One wireless reseller, the Summit Acceptance auto lender acquired in July 1998, and expansion in the UK and Canada. Management notes that the telecom business currently hurts earnings.
Credit metrics improved, with the managed net charge-off rate falling to 5.33% from 6.59% and the managed delinquency rate falling to 4.70% from 6.20%, though the company warned that a recession could reverse these trends. Balance sheet and risk items to note: about 65% of managed loans were securitized off balance sheet at year-end, so the company depends on securitization and capital markets funding. Reported total assets reached $9.4 billiond.
The company says it is well capitalized at both the Bank and the Savings Bank. The 10-K also discloses a pending California class action over collection practices, which management believes it can defend. Year 2000 remediation was about 63% complete, with completion targeted for the second quarter of 1999.
02—Key points
Key Highlights
- Net income up 45% to $275.2 million ($3.96 diluted EPS) vs. $189.4 million ($2.80) in 1997
- Managed consumer loans grew 22% to $17.4 billion; customer base reached 16.7 million accounts holders
- Reported net interest margin expanded to 9.62% from 6.66%, largely driven by past-due fee income
- Credit quality improved: managed net charge-off rate fell to 5.33% (from 6.59%) and delinquency to 4.70% (from 6.20%)
- Non-interest income rose 39% to $1.49 billion, while non-interest expense rose 67% to $1.47 billion, reflecting heavy marketing and staffing investment
- Strong returns: ROE of 25.3% and ROA of 3.30%; 1999 target of ~30% earnings growth and ROE above 20%
- Heavy reliance on securitization (65% of managed loans off balance sheet) and capital markets funding; pending California class action remains an open legal risk
03—Questions
Frequently Asked Questions
How profitable was Capital One in 1998, and what drove the improvement?
Net income was $275.2 million, or $3.96 per diluted share, up from $189.4 million ($2.80) in 1997. The increase came mainly from faster growth in managed accounts (up 39%) and a much wider net interest margin (9.62% reported vs. 6.66%). Higher past-due and overlimit fees, which are sensitive to delinquency levels, contributed significantly to the margin gain.
Is the 1998 margin expansion sustainable?
This is a key question for investors. Much of the yield increase came from past-due and fee income rather than from the core interest rate spread, and fee income tends to fluctuate with delinquency levels. Management acknowledged that competition is putting pressure on pricing and that delinquencies and charge-offs are not fully predictable. Investors should watch whether fee-driven yield holds up as credit conditions change.
What are the main risks from the company's growth strategy?
Growth required heavy spending: marketing rose 98% and salaries 65%. The company is also investing in businesses that currently lose money, including America One wireless and the Summit auto lending platform. Newer customized products, such as secured and subprime-like cards, carry higher delinquency and charge-off rates. Management warned that its marketing investment does not automatically translate into balance growth, since competition has reduced response rates.
How dependent is Capital One on securitization and external funding?
Very dependent. About 65% of managed loans ($11.2 billion) were securitized and removed from the balance sheet at year-end, and securitization is the primary funding source. The company also relies on senior notes, bank notes, fed funds, and deposits. Management says it can keep funding growth, but it cautions that securitization markets could become more expensive or unavailable, which would limit growth or increase funding costs.
Are there significant legal or regulatory issues disclosed?
The main legal matter is a California class action alleging improper collection lawsuits and garnishments against non-Virginia residents. The California Court of Appeals upheld the trial court's ruling for the Bank on six counts and reversed on two, and the Bank plans to seek further review. Management believes the company has meritorious defenses and that the outcome will not have a material adverse effect on financial condition, though it cannot yet assess the impact on results. The company also reports that both its Bank and Savings Bank are well capitalized.
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