How profitable was Capital One in 2002, and what drove the growth?

Net income rose 40% to $899.6 million, and diluted EPS rose 35% to $3.93. Growth came mainly from a 32% increase in managed loans, higher servicing and securitization income, and gains on securities sales and senior note repurchases. Operating expenses rose 13%, and marketing spending was cut in the second half of 2002 to slow loan growth.

Why did loan loss provisions rise so sharply?

The provision rose to $2.15 billion from $1.12 billion, driven by a 48% increase in average reported loans, higher net charge-offs, a revised application of subprime capital guidelines, and a $133.4 million one-time charge from changing the recoveries estimate. Management also said loans added in 2001 and early 2002 were seasoning, which typically raises delinquencies and charge-offs.

What are the main risks to the investment case?

The main risks are credit losses on a large subprime-heavy portfolio that is still seasoning, dependence on securitization funding (about 61% of reported loans), and a sub-investment-grade S&P rating on the parent's unsecured debt. Regulatory constraints under the informal memorandum of understanding, the pending securities litigation, and leadership changes in the finance function, including the CFO's resignation, add further uncertainty.

What does management expect for 2003?

Management targets 2003 EPS of about $4.55, roughly 16% growth over 2002, and managed loan growth of 20-25%, with marketing spending of about $300 million per quarter. It expects revenue growth of 14-16%, a net interest margin of roughly 9-10%, and risk-adjusted margin of about 10%. These forecasts depend on the economy not deteriorating significantly and on stable consumer credit.

COF 10-K FY2002 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed March 17, 2003. Cited figures are marked; the original filing is the authoritative source.

Capital One Financial Corporation's 2002 Form 10-K shows a company that grew rapidly but absorbed a sharp rise in credit costs.

Net income rose 40% to $899.6 million^a, and diluted EPS rose 35% to $3.93, helped by a deliberate slowdown in marketing and loan growth in the second half of 2002. Managed loans reached $59.7 billion (up 32%), with 47.4 million accounts. Reported net interest income grew 55% to $2.7 billion, and non-interest income grew 22% to $5.5 billion, largely from servicing and securitization income tied to off-balance-sheet loans.

The key risk for investors is credit quality. The provision for loan losses nearly doubled to $2.1 billion^b, and the reported allowance rose to 6.18% of loans from 4.02%. Reported delinquencies reached 6.51% and the managed net charge-off rate reached 5.24%, with the fourth-quarter managed rate at 6.21%.

Management attributes much of this to seasoning of subprime accounts added in 2001 and early 2002, a $133.4 million^c one-time recoveries-estimate change, and a revised application of subprime capital guidelines. The managed net interest margin fell to 9.23% from 9.40% as loan yields declined. The filing also flags regulatory and funding concerns.

The company is under an informal memorandum of understanding with its bank regulators, and its senior unsecured debt is rated just below investment grade by S&P (BB+). About 61% of reported loans were funded through securitization, and the filing discloses that the Chief Financial Officer resigned on March 3, 2003 after an SEC Wells notice to him personally. Management guided to 2003 EPS of about $4.55^d (roughly 16% growth) and managed loan growth of 20-25%, but a securities class action is pending, and results depend heavily on the economy and credit performance.

02—Key points

Key Highlights

Net income up 40% to $899.6 million; diluted EPS up 35% to $3.93, with 2002 marking the eighth consecutive year of at least 20% EPS growth.
Managed loans grew 32% to $59.7 billion at year-end, with 47.4 million accounts; the company is among the six largest U.S. Visa/MasterCard issuers.
Provision for loan losses rose 92% to $2.15 billion; the allowance for loan losses reached $1.72 billion, or 6.18% of reported loans, versus 4.02% a year earlier.
Credit quality deteriorated: the managed net charge-off rate rose to 5.24% (from 4.65%), and the reported 30+ day delinquency rate rose to 6.51% (from 4.84%).
Managed net interest margin declined to 9.23% from 9.40%, reflecting lower consumer loan yields from mix shift toward higher-quality borrowers and introductory-rate offers.
Regulatory and governance overhang: an informal memorandum of understanding with bank regulators, a pending securities class action, and the CFO's resignation following an SEC Wells notice.
2003 guidance calls for EPS of about $4.55 (about 16% growth), managed loan growth of 20-25%, and a stable net interest margin of roughly 9-10%.

03—Questions

Frequently Asked Questions

How profitable was Capital One in 2002, and what drove the growth?
Net income rose 40% to $899.6 million, and diluted EPS rose 35% to $3.93. Growth came mainly from a 32% increase in managed loans, higher servicing and securitization income, and gains on securities sales and senior note repurchases. Operating expenses rose 13%, and marketing spending was cut in the second half of 2002 to slow loan growth.
Why did loan loss provisions rise so sharply?
The provision rose to $2.15 billion from $1.12 billion, driven by a 48% increase in average reported loans, higher net charge-offs, a revised application of subprime capital guidelines, and a $133.4 million one-time charge from changing the recoveries estimate. Management also said loans added in 2001 and early 2002 were seasoning, which typically raises delinquencies and charge-offs.
What are the main risks to the investment case?
The main risks are credit losses on a large subprime-heavy portfolio that is still seasoning, dependence on securitization funding (about 61% of reported loans), and a sub-investment-grade S&P rating on the parent's unsecured debt. Regulatory constraints under the informal memorandum of understanding, the pending securities litigation, and leadership changes in the finance function, including the CFO's resignation, add further uncertainty.
What does management expect for 2003?
Management targets 2003 EPS of about $4.55, roughly 16% growth over 2002, and managed loan growth of 20-25%, with marketing spending of about $300 million per quarter. It expects revenue growth of 14-16%, a net interest margin of roughly 9-10%, and risk-adjusted margin of about 10%. These forecasts depend on the economy not deteriorating significantly and on stable consumer credit.

04—Continue

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