01—Abstract
Summary
Summary of the 10-K filed February 28, 2013. Cited figures are marked; the original filing is the authoritative source.
Capital One Financial Corp. (COF) closed 2012 as a substantially larger, more diversified bank following two transformative acquisitions: ING Direct (closed February 17, 2012, adding $40.4 billiona in loans, $84.4 billion in deposits, and over seven million customers) and the HSBC U.S. credit card business (closed May 1, 2012, adding roughly $27.8 billion in receivables and about 27 million accounts).
Total loans held for investment rose 52% to $205.9 billionb, deposits rose 66% to $212.5 billion, and total assets reached $312.9 billion. Reported net income was $3.5 billion ($6.16 per diluted share) on total net revenue of $21.4 billion, up 12% in net income from 2011, though results were shaped by purchase accounting, a $594 million bargain purchase gain, and a $1.2 billion initial allowance build on the HSBC receivables. Beneath the headline growth, credit quality and capital improved, though the balance sheet mix changed meaningfully.
The net charge-off rate fell to 1.89% from 2.94%, but this was flattered by acquired loans accounted for on an expected-cash-flow basis; excluding those loans the rate was 2.34%. The Tier 1 common ratio rose to 11.0% from 9.7%, driven by earnings and roughly $6.8 billionc of 2012 equity issuance, while the Tier 1 risk-based ratio declined to 11.3% from 12.0% as risk-weighted assets grew. Management guides to lower average loans in 2013 (run-off of about $18 billion, including a roughly $7 billion Best Buy card sale to Citi), a modestly higher net interest margin, and non-interest expense near $12.5 billion.
Investors should weigh several risks flagged in the filing: representation and warranty reserve exposure for legacy mortgage originations (reserve of $899 milliond against an estimated reasonably possible additional loss of about $2.7 billion), ongoing regulatory consent orders tied to vendor sales practices and SCRA compliance, Basel III and enhanced prudential standards that may require more capital, and ongoing litigation including interchange and overdraft matters. Management characterized Q4 2012 as showing diminishing acquisition-related distortions, and the ING Direct and HSBC integrations remain a major execution variable for 2013.
02—Key points
Key Highlights
- Net income of $3.5 billion ($6.16 diluted EPS) on total net revenue of $21.4 billion in 2012, up 12% in net income versus 2011 despite acquisition-related charges.
- Balance sheet expanded sharply: total assets rose 52% to $312.9 billion, loans held for investment to $205.9 billion, and customer deposits to $212.5 billion, driven by the ING Direct and 2012 U.S. card acquisitions.
- Tier 1 common ratio improved to 11.0% from 9.7%, supported by earnings and about $6.8 billion of common and preferred equity raised in 2012; Tier 1 risk-based ratio fell to 11.3% from 12.0% due to higher risk-weighted assets.
- Headline net charge-off rate improved to 1.89% from 2.94%, but excluding acquired loans it was 2.34%, so underlying credit improvement is more modest than the reported figure suggests.
- Representation and warranty reserve of $899 million, with management estimating reasonably possible additional losses of roughly $2.7 billion beyond the accrual, a key contingent liability tied to legacy mortgage subsidiaries.
- 2013 outlook: average loans expected to decline (about $18 billion of run-off and sales, including the ~$7 billion Best Buy portfolio), net interest margin modestly higher, and non-interest expense of approximately $12.5 billion.
- Capital actions in early 2013 include redemption of $3.65 billion of trust preferred securities, a subordinated note exchange, and a first credit card securitization since 2009; regulators continue to review capital plans under CCAR.
03—One dollar
04—Financials
Financial Highlights
Figures from 10-KFY2012filed February 28, 2013Financial Statements
FY2012 against FY2011
| Line item | FY2012FY2011 | Change |
|---|---|---|
| Revenue | $21.40B$16.28B | +31.4% |
| Operating Income | $3.71B$3.25B | +14.0% |
| Interest Expense | $2.38B$2.25B | +5.7% |
| Net Income | $3.49B$3.15B | +11.0% |
| EPS (Basic) | $6.17$6.85 | −9.9% |
| EPS (Diluted) | $6.11$6.80 | −10.1% |
| Shares Outstanding (Basic) | 561.10M455.50M | +23.2% |
| Shares Outstanding (Diluted) | 566.50M459.10M | +23.4% |
05—Questions
Frequently Asked Questions
How much of Capital One's 2012 growth came from acquisitions rather than organic expansion?
Most of it. Excluding the $40.4 billion of ING Direct loans and the $27.8 billion of HSBC card receivables, period-end loans would have grown only about $1.8 billion, or 1%. Deposit growth was similarly acquisition-driven, with $84.4 billion of the $84.3 billion increase coming from ING Direct. Management says the legacy businesses grew modestly, with commercial loan growth and auto loan growth offsetting run-off of installment and home loans.
Is the 2012 earnings level a good base for 2013?
Not necessarily. 2012 included a $594 million non-recurring bargain purchase gain on ING Direct, a $1.2 billion initial allowance build on the HSBC receivables, and $336 million of merger-related expenses, plus $252 million of discrete tax benefits. Management also expects loan balances to decline in 2013 as acquired portfolios run off, which would weigh on interest income. Investors should look at the underlying trends rather than the reported figure alone.
What are the main regulatory and legal risks disclosed in the filing?
Key items include consent orders with the OCC and CFPB over payment protection and credit monitoring sales practices, with a derivative suit following; heightened regulatory oversight tied to the ING Direct and HSBC integrations; Basel III and enhanced prudential standards that could require more capital; and litigation including interchange fee claims, a checking overdraft class action, credit card rate and late fee suits, and state attorney general actions on payment protection products. Management did not expect most of these to be individually material, but reserves and estimated reasonably possible losses are disclosed for several matters.
How exposed is Capital One to legacy mortgage repurchase claims?
Materially, relative to its reserve. The company established a $899 million representation and warranty reserve covering about $111 billion of mortgage loans sold between 2005 and 2008, but estimates reasonably possible additional losses of about $2.7 billion beyond that accrual, up from $1.5 billion a year earlier. Most of the reserve relates to loans sold to government-sponsored enterprises or insured securitizations, and several litigations, including the U.S. Bank, DBSP, and Ambac cases, are pending.
Is the company's capital position strong enough for the new Basel III rules?
Management believes so but acknowledges uncertainty. It assumes an 8% Basel III Tier 1 common target including buffers, and says it expects to exceed that in early 2013, with a Tier 1 common ratio of 11.0% at year-end 2012. However, the company expects the Basel II Advanced Approaches capital floor and rising risk-weighted assets from acquired businesses to require holding more regulatory capital in the long run, and the Basel III and U.S. capital rules were still proposed rather than final at filing.
06—Continue