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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to .
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Commission file number 1-13300
CAPITAL ONE FINANCIAL CORPORATION
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(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
Delaware 54-1719854
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2980 Fairview Park Drive, Suite 1300, Falls Church, Virginia 22042-4525
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(Address of principal executive offices) (Zip Code)
</TABLE>
(703) 205-1000
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(Registrant's telephone number, including area code)
(Not Applicable)
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(Former name, former address and former fiscal year,
if changed since last report)
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
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As of April 30, 1997, there were 66,417,510 shares of the registrant's Common
Stock, par value $.01 per share, outstanding.
1
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CAPITAL ONE FINANCIAL CORPORATION
FORM 10-Q
INDEX
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March 31, 1997
<TABLE>
<CAPTION>
PAGE
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PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements (unaudited):
Condensed Consolidated Balance Sheets. . . . . . . . . . . 3
Condensed Consolidated Statements of Income . . . . . . . . 4
Condensed Consolidated Statements of Changes
in Stockholders' Equity . . . . . . . . . . . . . . . . 5
Condensed Consolidated Statements of
Cash Flows . . . . . . . . . . . . . . . . . . . . . . . 6
Notes to Condensed Consolidated Financial
Statements . . . . . . . . . . . . . . . . . . . . . . . . 7
ITEM 2. Management's Discussion and Analysis
of Financial Condition and Results of
Operations . . . . . . . . . . . . . . . . . . . . . . . . 10
PART II. OTHER INFORMATION
ITEM 4. Submission of Matters to a Vote of Security Holders . . . . . . 28
ITEM 6. Exhibits and Reports on Form 8-K . . . . . . . . . . . . . . . 28
Signatures . . . . . . . . . . . . . . . . . . . . . . . . . . 29
</TABLE>
2
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ITEM 1.
CAPITAL ONE FINANCIAL CORPORATION
Condensed Consolidated Balance Sheets
(dollars in thousands, except per share data) (unaudited)
<TABLE>
<CAPTION>
MARCH 31 DECEMBER 31
1997 1996
==================================================================================================================
<S> <C> <C>
ASSETS:
Cash and due from banks $ 127,721 $ 48,724
Federal funds sold 365,660 450,000
Interest-bearing deposits at other banks 183,570 30,252
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Cash and cash equivalents 676,951 528,976
Securities available for sale 1,026,373 877,851
Consumer loans held for securitization 300,000
Consumer loans 3,516,951 4,343,902
Less: Allowance for loan losses (118,500) (118,500)
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Net loans 3,398,451 4,225,402
Premises and equipment, net 180,927 174,661
Interest receivable 32,883 78,590
Accounts receivable from securitizations 459,169 502,520
Other assets 80,225 79,445
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Total assets $ 6,154,979 $ 6,467,445
==================================================================================================================
LIABILITIES:
Interest-bearing deposits $ 741,719 $ 943,022
Short-term borrowings 355,188 530,983
Senior notes 3,468,801 3,694,237
Deposit notes 299,996 299,996
Interest payable 61,162 80,362
Other liabilities 352,882 178,454
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Total liabilities 5,279,748 5,727,054
GUARANTEED PREFERRED BENEFICIAL INTERESTS IN
CAPITAL ONE BANK'S FLOATING RATE JUNIOR
SUBORDINATED CAPITAL INCOME SECURITIES 97,470
STOCKHOLDERS' EQUITY:
Preferred stock, par value $.01 per share; authorized
50,000,000 shares, none issued or outstanding
Common stock, par value $.01 per share; authorized
300,000,000 shares, 66,375,222 and 66,325,261
issued and outstanding as of March 31, 1997 and
December 31, 1996, respectively 664 663
Paid-in capital, net 486,127 481,383
Retained earnings 290,970 258,345
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Total stockholders' equity 777,761 740,391
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Total liabilities and stockholders' equity $ 6,154,979 $ 6,467,445
==================================================================================================================
</TABLE>
See notes to condensed consolidated financial statements.
3
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CAPITAL ONE FINANCIAL CORPORATION
Condensed Consolidated Statements of Income
(in thousands, except per share data) (unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31
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1997 1996
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<S> <C> <C>
INTEREST INCOME:
Consumer loans, including fees $ 146,512 $ 114,111
Federal funds sold 5,664 7,977
Other 16,418 11,054
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Total interest income 168,594 133,142
INTEREST EXPENSE:
Deposits 10,437 12,543
Short-term borrowings 6,524 8,348
Senior and deposit notes 63,436 41,443
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Total interest expense 80,397 62,334
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Net interest income 88,197 70,808
Provision for loan losses 49,187 25,168
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Net interest income after provision for loan losses 39,010 45,640
NON-INTEREST INCOME:
Servicing 170,033 128,186
Service charges 53,648 26,624
Interchange 9,315 8,298
Other 10,061 8,040
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Total non-interest income 243,057 171,148
NON-INTEREST EXPENSE:
Salaries and associate benefits 70,636 44,276
Solicitation 54,051 51,524
Communications and data processing 21,790 14,940
Supplies and equipment 18,073 12,384
Occupancy 7,801 4,095
Other 41,196 29,231
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Total non-interest expense 213,547 156,450
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Income before income taxes 68,520 60,338
Income taxes 26,038 22,325
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Net income $ 42,482 $ 38,013
==================================================================================================================
Earnings per share $ .63 $ .57
==================================================================================================================
Dividends paid per share $ .08 $ .08
==================================================================================================================
Weighted average common and
common equivalent shares outstanding 67,900 66,806
==================================================================================================================
</TABLE>
See notes to condensed consolidated financial statements.
4
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CAPITAL ONE FINANCIAL CORPORATION
Condensed Consolidated Statements of Changes in Stockholders' Equity
(dollars in thousands, except per share data) (unaudited)
<TABLE>
<CAPTION>
COMMON STOCK TOTAL
------------ PAID-IN RETAINED STOCKHOLDERS'
SHARES AMOUNT CAPITAL, NET EARNINGS EQUITY
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<S> <C> <C> <C> <C> <C>
Balance, December 31, 1995 66,174,567 $ 662 $ 469,830 $ 128,699 $ 599,191
Net income 38,013 38,013
Cash dividends - $.08 per share (5,166) (5,166)
Issuance of common stock 32,993 647 647
Exercise of stock options 7,318 118 118
Amortization of deferred
compensation 94 94
Change in unrealized gains on
securities available for sale,
net of income taxes of $1,670 (3,102) (3,102)
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Balance, March 31, 1996 66,214,878 $ 662 $ 470,689 $ 158,444 $ 629,795
=======================================================================================================================
Balance, December 31, 1996 66,325,261 $ 663 $ 481,383 $ 258,345 $ 740,391
Net income 42,482 42,482
Cash dividends - $.08 per share (5,165) (5,165)
Issuance of common stock 39,584 1 1,183 1,184
Exercise of stock options 10,498 159 159
Tax benefit from stock awards 143 143
Restricted stock, net (121)
Amortization of deferred
compensation 28 28
Common stock issuable
under incentive plan 3,231 3,231
Foreign currency translation (76) (76)
Change in unrealized gains on
securities available for sale,
net of income taxes of $2,511 (4,616) (4,616)
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Balance, March 31, 1997 66,375,222 $ 664 $ 486,127 $ 290,970 $ 777,761
=======================================================================================================================
</TABLE>
See notes to condensed consolidated financial statements.
5
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CAPITAL ONE FINANCIAL CORPORATION
Condensed Consolidated Statements of Cash Flows
(in thousands) (unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31
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1997 1996
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OPERATING ACTIVITIES:
Net income $ 42,482 $ 38,013
Adjustments to reconcile net income to cash
provided by operating activities:
Provision for loan losses 49,187 25,168
Depreciation and amortization 11,105 10,329
Stock compensation plans 3,259 94
Decrease in interest receivable 45,707 25,638
Decrease (increase) in accounts receivable from securitizations 43,351 (34,137)
Increase in other assets (49) (2,039)
Decrease in interest payable (19,200) (32,327)
Increase in other liabilities 174,428 27,841
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Net cash provided by operating activities 350,270 58,580
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INVESTING ACTIVITIES:
Purchases of securities available for sale (547,420)
Proceeds from maturities of securities available for sale 394,844
Proceeds from securitization of consumer loans 353,457
Net decrease in consumer loans 119,606 303,698
Recoveries of loans previously charged off 4,701 3,088
Additions of premises and equipment, net (18,555) (11,380)
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Net cash provided by investing activities 306,633 295,406
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FINANCING ACTIVITIES:
Net (decrease) increase in interest-bearing deposits (201,303) 8,562
Net decrease in short-term borrowings (175,795) (458,803)
Issuances of senior notes 480,000 225,000
Maturities of senior notes (705,436) (217,500)
Issuances of preferred beneficial interests 97,428
Proceeds from exercise of stock options 159 118
Net proceeds from issuance of common stock 1,184 647
Dividends paid (5,165) (5,166)
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Net cash used for financing activities (508,928) (447,142)
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Increase (decrease) in cash and cash equivalents 147,975 (93,156)
Cash and cash equivalents at beginning of period 528,976 872,460
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Cash and cash equivalents at end of period $ 676,951 $ 779,304
==========================================================================================================
</TABLE>
See notes to condensed consolidated financial statements.
6
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CAPITAL ONE FINANCIAL CORPORATION
Notes to Condensed Consolidated Financial Statements
March 31, 1997
(dollars in thousands, except per share data) (unaudited)
NOTE A: BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Capital
One Financial Corporation (the "Corporation") and its subsidiaries. The
Corporation is a holding company whose subsidiaries provide a variety of
products and services to consumers. The principal subsidiaries are Capital One
Bank (the "Bank"), which offers credit card products, and Capital One, F.S.B.
(the "Savings Bank"), which provides certain consumer lending and deposit
services. The Corporation and its subsidiaries are collectively referred to as
the "Company".
The accompanying unaudited consolidated financial statements of the
Company have been prepared in accordance with generally accepted accounting
principles for interim financial information and with the instructions to Form
10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of
the information and footnotes required by generally accepted accounting
principles for complete consolidated financial statements. In the opinion of
management, all adjustments (consisting of normal recurring accruals)
considered necessary for a fair presentation have been included. The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the amounts reported in the financial statements and accompanying
notes. Actual results could differ from those estimates. Operating results
for the three months ended March 31, 1997 are not necessarily indicative of the
results for the year ending December 31, 1997. The notes to the consolidated
financial statements contained in the Annual Report on Form 10-K for the year
ended December 31, 1996 should be read in conjunction with these condensed
consolidated financial statements. All significant intercompany balances and
transactions have been eliminated. Certain prior period amounts have been
reclassified to conform to the 1997 presentation.
NOTE B: SIGNIFICANT ACCOUNTING POLICIES
CASH AND CASH EQUIVALENTS
Cash paid for interest for the three months ended March 31, 1997 and
1996 was $99,597 and $94,661, respectively. Cash paid for income taxes for the
three months ended March 31, 1997 was $9,075.
EARNINGS PER SHARE
Earnings per share are based upon the weighted average number of
common and common equivalent shares outstanding, including dilutive stock
options and restricted stock.
SECURITIZATIONS
In June 1996, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 125 ("SFAS 125"), "Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities," which establishes the accounting
for certain financial asset transfers including securitization transactions.
SFAS 125 requires an entity, after a transfer of financial assets that meets
the criteria for sale accounting, to recognize the financial and servicing
assets it controls and the liabilities it has incurred and to derecognize
financial assets for which control has been surrendered. The provisions of
SFAS 125 are effective January 1,
7
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1997. The adoption of the new standard did not have a material impact on the
Company's financial statements for the three months ended March 31, 1997. The
impact of the standard on the Company's financial statements is, and will
continue to be, based on the performance of the securitization transactions and
the securitization structures.
NOTE C: GUARANTEED PREFERRED BENEFICIAL INTERESTS
On January 28, 1997, the Bank, through a subsidiary created as a
Delaware statutory business trust, issued $100,000 of Floating Rate Junior
Subordinated Capital Income Securities that mature on February 1, 2027. The
discount and issuance costs are being amortized over the period from the date
of issuance to the initial call date, February 1, 2007. Distributions and
amortization are recorded as other non-interest expense.
NOTE D: ASSOCIATE STOCK PLANS
In January 1997, the Company granted options, under a 1994 Stock
Incentive Plan, to purchase 605,263 common shares at the then market price of
$40.75 per share. These options vest over a period of three years.
Additionally, in January 1997, 1,250,000, or fifty percent, of the
performance-based options granted in 1995 to the Company's Chief Executive
Officer and Chief Operating Officer vested as the market price of the Company's
stock remained at or above $37.50 for at least ten trading days in a 30
consecutive calendar day period. The Company recognized $3,231 of compensation
cost for the three months ended March 31, 1997 relating to its associate stock
plans.
NOTE E: COMMITMENTS AND CONTINGENCIES
During 1995, the Company and the Bank became involved in three
purported class action suits relating to certain collection practices engaged
in by Signet Bank and, subsequently, by the Bank. The complaints in these three
cases allege that Signet Bank and/or the Company violated a variety of federal
and state statutes and constitutional and common law duties by filing
collection lawsuits, obtaining judgments and pursuing garnishment proceedings
in the Virginia state courts against defaulted credit card customers who were
not residents of Virginia. These cases were filed in the Superior Court of
California in the County of Alameda, Southern Division, on behalf of a class of
California residents, in the United States District Court for the District of
Connecticut on behalf of a nationwide class and in the United States District
Court for the Middle District of Florida on behalf of a nationwide class
(except for California). The complaints in these three cases seek unspecified
statutory damages, compensatory damages, punitive damages, restitution,
attorneys' fees and costs, a permanent injunction and other equitable relief.
On July 31, 1996, the Florida case was dismissed without prejudice,
which permits further proceedings. The plaintiff has since noticed her appeal
to the United States Court of Appeals for the Eleventh Circuit and refiled
certain claims arising out of state law in Florida state court.
On September 30, 1996, the Connecticut court entered judgment in favor
of the Bank on plaintiff's federal claims and dismissed without prejudice
plaintiff's state law claims. The plaintiff has refiled, on behalf of a class
of Connecticut residents, her claims arising out of state law in a Connecticut
state court.
8
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On February 17, 1997, the California court entered judgment in favor
of the Bank on all of the plaintiff's claims. The plaintiff has appealed the
ruling to California Court of Appeal First Appellate District Division 4.
In connection with the transfer of substantially all of Signet Bank's
credit card business to the Bank in November 1994, the Company and the Bank
agreed to indemnify Signet Bank for certain liabilities incurred in litigation
arising from that business, which may include liabilities, if any, incurred in
the three purported class action cases described above. Because no specific
measure of damages is demanded in any of the complaints and each of these cases
is in early stages of litigation, an informed assessment of the ultimate
outcome of these cases cannot be made at this time. Management believes,
however, that there are meritorious defenses to these lawsuits and intends to
defend them vigorously.
The Company is commonly subject to various other pending and
threatened legal actions arising from the conduct of its normal business
activities. In the opinion of the Management of the Company, the ultimate
aggregate liability, if any, arising out of any pending or threatened action
will not have a material adverse effect on the consolidated financial condition
of the Company. At the present time, however, Management is not in a position
to determine whether the resolution of pending or threatened litigation will
have a material effect on the Company's results of operations in any future
reporting period.
NOTE F: RECENT ACCOUNTING PRONOUNCEMENTS
In February 1997, the FASB issued SFAS No. 128 ("SFAS 128"), "Earnings
per Share," which is required to be adopted on December 31, 1997. At that
time, the Company will be required to change the method currently used to
compute earnings per share and to restate all prior periods. Under the new
requirements, primary and fully diluted earnings per share are replaced with
basic and diluted earnings per share. Basic earnings per share excludes the
dilutive effect of stock options. The impact of SFAS 128 on the calculation of
earnings per share for the three months ended March 31, 1997 and 1996 was not
material.
9
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ITEM 2.
CAPITAL ONE FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INTRODUCTION
Capital One Financial Corporation (the "Corporation") is a holding
company whose subsidiaries provide a variety of products and services to
consumers. The principal subsidiaries are Capital One Bank (the "Bank"), which
offers credit card products, and Capital One, F.S.B. (the "Savings Bank"),
which provides certain consumer lending and deposit services. The Corporation
and its subsidiaries are collectively referred to as the "Company". The
Company is one of the largest providers of MasterCard and Visa credit cards in
the United States. As of March 31, 1997, the Company had 9.1 million customers
and $12.6 billion in managed consumer loans outstanding. The Company's
profitability is affected by the net interest margin and non-interest income
earned on earning assets, customer usage patterns, credit quality, the level of
solicitation expenses and operating efficiency.
EARNINGS SUMMARY
Net income for the three months ended March 31, 1997 of $42.5 million,
or $.63 per share, compares to net income of $38.0 million, or $.57 per share,
for the same period in the prior year.
The increase in net income is primarily a result of an increase in
asset volumes and rates. Net interest income increased $17.4 million, or 25%,
as average earning assets increased 38%. The provision for loan losses
increased $24 million, as average loans increased 48%, and the reported net
charge-off rate increased to 4.58% from 3.48%. Non-interest income increased
$71.9 million, or 42%, primarily as a result of the increase in average managed
loans of 22%, a shift to more fee-based accounts and a change in the timing and
amount of certain fees charged. Increases in salaries and associate benefits
expense of $26.4 million, or 60%, and other non-interest expense of $30.7
million, or 27%, primarily reflected additional staff associated with building
infrastructure and the cost of operations to manage the growth in accounts.
Each component is discussed in further detail in subsequent sections of this
analysis.
MANAGED CONSUMER LOAN PORTFOLIO
The Company analyzes its financial performance on a managed consumer
loan portfolio basis. Managed consumer loan data adjusts the balance sheet and
income statement to add back the effect of securitizing consumer loans.
Increases or decreases in the interest paid by the Company on variable rate
securitizations generally are offset by corresponding increases or decreases in
the amount of excess servicing income the Company receives. The Company also
evaluates its interest rate exposure on a managed portfolio basis.
10
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The Company's managed consumer loan portfolio is comprised of
on-balance sheet loans, loans held for securitization and securitized loans.
Securitized loans are not assets of the Company and, therefore, are not shown
on the balance sheet. Reported consumer loans consist of on-balance sheet
loans and loans held for securitization and excludes securitized loans. Table
1 summarizes the Company's managed consumer loan portfolio.
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TABLE 1 - MANAGED CONSUMER LOAN PORTFOLIO
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<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31
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(in thousands) 1997 1996
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<S> <C> <C>
PERIOD-END BALANCES:
Consumer loans held for securitization $ 300,000 $ 200,000
On-balance sheet consumer loans 3,516,951 2,391,725
Securitized consumer loans 8,789,969 7,523,801
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Total managed consumer loan portfolio $ 12,606,920 $ 10,115,526
==========================================================================================================
AVERAGE BALANCES:
Consumer loans held for securitization $ 122,445 $ 331,868
On-balance sheet consumer loans 3,936,256 2,409,677
Securitized consumer loans 8,500,177 7,523,801
- ----------------------------------------------------------------------------------------------------------
Total average managed consumer loan portfolio $ 12,558,878 $ 10,265,346
==========================================================================================================
</TABLE>
Since 1990, the Company has actively engaged in consumer loan
securitization transactions which are treated as sales under generally accepted
accounting principles. For securitized loans, amounts that would previously
have been reported as interest income, interest expense, service charges and
provision for loan losses are instead included in non-interest income as
servicing income. Because credit losses are absorbed against servicing income
over the life of these transactions, such income may vary depending upon the
credit performance of the securitized loans. However, exposure to credit losses
on the securitized loans is contractually limited to these cash flows.
In June 1996, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 125 ("SFAS 125"), "Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities," which establishes the accounting for certain financial asset
transfers including securitization transactions. SFAS 125 requires an entity,
after a transfer of financial assets that meets the criteria for sale
accounting, to recognize the financial and servicing assets it controls and the
liabilities it has incurred and to derecognize financial assets for which
control has been surrendered. The provisions of SFAS 125 are effective January
1, 1997. The adoption of the new standard did not have a material impact on
the Company's financial statements for the three months ended March 31, 1997.
The Company will continuously assess the performance of new and existing
securitization transactions as assumptions of cash flows change. The impact of
the standard on the Company's financial statements is, and will continue to be,
based on the performance of the securitization transactions and the
securitization structures.
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Table 2 indicates the impact of the consumer loan securitizations on
the income statement, average earning assets, return on average assets, net
interest margin and yield for the periods presented. The Company intends to
continue to securitize consumer loans.
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TABLE 2 - IMPACT OF CONSUMER LOAN SECURITIZATIONS
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<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31
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(dollars in thousands) 1997 1996
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<S> <C> <C>
STATEMENTS OF INCOME (AS REPORTED):
Net interest income $ 88,197 $ 70,808
Provision for loan losses 49,187 25,168
Non-interest income 243,057 171,148
Non-interest expense 213,547 156,450
- ----------------------------------------------------------------------------------------------------------
Income before income taxes $ 68,520 $ 60,338
- ----------------------------------------------------------------------------------------------------------
ADJUSTMENTS FOR SECURITIZATIONS:
Net interest income $ 222,493 $ 161,309
Provision for loan losses 136,756 66,796
Non-interest income (85,737) (94,513)
Non-interest expense
- ----------------------------------------------------------------------------------------------------------
Income before income taxes $ - $ -
- ----------------------------------------------------------------------------------------------------------
MANAGED STATEMENTS OF INCOME (AS ADJUSTED):
Net interest income $ 310,690 $ 232,117
Provision for loan losses 185,943 91,964
Non-interest income 157,320 76,635
Non-interest expense 213,547 156,450
- ----------------------------------------------------------------------------------------------------------
Income before income taxes $ 68,520 $ 60,338
==========================================================================================================
OPERATING DATA AND RATIOS:
Reported:
Average earning assets $ 5,579,411 $ 4,043,383
Return on average assets 2.66% 3.24%
Net interest margin(1) 6.32 7.01
Managed:
Average earning assets $ 14,079,588 $ 11,567,184
Return on average assets 1.14% 1.24%
Net interest margin(1) 8.83 8.03
Yield on managed portfolio 15.46 14.76
==========================================================================================================
</TABLE>
(1) Net interest margin is equal to net interest income divided by average
earning assets.
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RISK ADJUSTED REVENUE AND MARGIN
In originating its consumer loan portfolio in recent years, the
Company had pursued a low introductory interest rate strategy with accounts
repricing to higher rates after six to sixteen months from the date of
origination ("first generation products"). The amount of repricing is actively
managed in an effort to maximize return at the consumer level, reflecting the
risk and expected performance of the account. Separately, accounts also may
be repriced upwards or downwards based on individual customer performance.
Many of the Company's first generation products had a balance transfer feature
under which customers could transfer balances held in their other credit card
accounts to the Company. The Company's historic managed loan growth has been
principally the result of this balance transfer feature. Industry competitors
have continuously solicited the Company's customers with similar low-rate
introductory strategies. Management believes that these competitive pressures
have and will continue to put additional pressure on low-rate introductory
strategies.
In applying its Information-Based Strategies ("IBS") and in response
to competitive pressures during late 1994, the Company began to shift a
significant amount of its solicitation expense to second generation product
opportunities. Second generation products consist of secured card products and
other customized card products including affinity and co-branded cards, college
student cards and other cards targeted to certain markets that were underserved
by the Company's competitors. These products do not have the immediate impact
on managed loan balances of the first generation products but typically consist
of lower credit limit accounts which build balances over time. The terms of
the second generation products tend to include annual membership fees and
higher annual finance charge rates. The higher risk profile of the customers
targeted for the second generation products and the lower credit limit
associated with these products also tend to result in higher delinquency and
net charge-off rates and consequently higher past-due and overlimit fees than
the first generation products.
Although these second generation products have differing
characteristics, both the first generation and second generation products meet
the Company's objective of maximizing revenue for the level of risk undertaken.
Management believes that comparable measures for external analysis are the risk
adjusted revenue and risk adjusted margin of the portfolio. Risk adjusted
revenue is defined as net interest income and non-interest income less net
charge-offs. Risk adjusted margin measures risk adjusted revenue as a percent
of average earning assets. It considers not only the finance charge yield and
net interest margin, the primary focus of the first generation products, but
also the fee income associated with the second generation products. By
deducting net charge-offs, consideration is given to the risk inherent in these
differing products.
Managed risk adjusted revenue of $284.8 million for the three months
ended March 31, 1997 increased $66.7 million, or 31%, over managed risk
adjusted revenue of $218.1 million for the same period in the prior year. This
increase resulted from an increase in managed net interest income of $78.6
million to $310.7 million and an increase in managed non-interest income of
$80.7 million to $157.3 million, offset by an increase in managed net
charge-offs of $92.6 million to $183.3 million for the three months ended March
31, 1997 as compared to the same period in the prior year. Managed risk
adjusted margin increased to 8.09% for the three months ended March 31, 1997
from 7.54% for the same period in the prior year. This increase resulted from
an increase in managed net interest margin to 8.83% for the three months ended
March 31, 1997 from 8.03% in the same period in the prior year, an increase in
managed non-interest income as a percent of average managed earning assets to
4.47% for the three months ended March 31, 1997 from 2.65% in the same period
of the prior year, offset by an increase in managed net charge-offs as a
percentage of average managed earning assets to 5.21% for the three months
ended March 31, 1997 from 3.14% for the same period in the prior year. The
cause of increases and decreases in the various components of risk adjusted
revenue are discussed in further detail in subsequent sections of this
analysis.
13
<PAGE> 14
NET INTEREST INCOME
Net interest income is interest and past-due fees earned from the
Company's consumer loans and securities less interest expense on borrowings,
which include interest-bearing deposits, short-term borrowings and borrowings
from senior and deposit notes.
Net interest income for the three months ended March 31, 1997 was
$88.2 million, compared to $70.8 million for the same period in the prior year,
representing an increase of $17.4 million, or 25%. Net interest income
increased as a result of a 38% growth in average earning assets for the three
months ended March 31, 1997, versus the same period in the prior year. The
yield on earning assets decreased 108 basis points for the three months ended
March 31, 1997, to 12.09% from 13.17%, as compared to the same period in the
prior year. The decrease was primarily attributable to a 221 basis point
decrease in the yield on consumer loans for the three months ended March 31,
1997, to 14.44% from 16.65%, as compared to the same period in the prior year.
The yield on consumer loans decreased due to the securitization, and as a
result, removal from the balance sheet, of higher yielding second generation
products during the fourth quarter of 1996, offset by an increase in the amount
of past-due fees charged as compared to the same period in the prior year. The
average rates paid on borrowed funds decreased to 6.17% for the three months
ended March 31, 1997, from 6.40% for the same period in the prior year, due to
the use of retail deposits at the Savings Bank as an additional source of
funding.
14
<PAGE> 15
Table 3 provides average balance sheet data, an analysis of net
interest income, net interest spread (the difference between the yield on
earning assets and the cost of interest-bearing liabilities) and net interest
margin for the three months ended March 31, 1997 and 1996.
- --------------------------------------------------------------------------------
TABLE 3 - STATEMENTS OF AVERAGE BALANCES, INCOME AND EXPENSE, YIELDS AND RATES
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31
- ------------------------------------------------------------------------------------------------------------------------
1997 1996
- ------------------------------------------------------------------------------------------------------------------------
AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/
(dollars in thousands) BALANCE EXPENSE RATE BALANCE EXPENSE RATE
========================================================================================================================
<S> <C> <C> <C> <C> <C> <C>
ASSETS:
Earning assets
Consumer loans (1) $4,058,701 $146,512 14.44% $2,741,545 $114,111 16.65%
Federal funds sold 428,853 5,664 5.28 591,219 7,977 5.40
Other securities 1,091,857 16,418 6.01 710,619 11,054 6.22
- ------------------------------------------------------------------------------------------------------------------------
Total earning assets 5,579,411 $168,594 12.09% 4,043,383 $133,142 13.17%
Cash and due from banks 91,047 59,070
Allowance for loan losses (119,835) (74,002)
Premises and equipment, net 180,256 143,021
Other assets 668,501 519,147
- ------------------------------------------------------------------------------------------------------------------------
Total assets $6,399,380 $4,690,619
========================================================================================================================
LIABILITIES AND EQUITY:
Interest-bearing liabilities
Deposits $ 992,751 $ 10,437 4.21% $ 858,696 $12,543 5.84%
Short-term borrowings 410,924 6,524 6.35 526,914 8,348 6.34
Senior and deposit notes 3,808,926 63,436 6.66 2,509,759 41,443 6.61
- ------------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 5,212,601 $ 80,397 6.17% 3,895,369 $62,334 6.40%
Other liabilities 357,833 164,383
- ------------------------------------------------------------------------------------------------------------------------
Total liabilities 5,570,434 4,059,752
Preferred beneficial interests 64,966
Equity 763,980 630,867
- ------------------------------------------------------------------------------------------------------------------------
Total liabilities and equity $6,399,380 $4,690,619
========================================================================================================================
Net interest spread 5.92% 6.77%
========================================================================================================================
Interest income to
average earning assets 12.09% 13.17%
Interest expense to
average earning assets 5.77 6.16
- ------------------------------------------------------------------------------------------------------------------------
Net interest margin 6.32% 7.01%
========================================================================================================================
</TABLE>
(1) Interest income includes past-due fees on loans of approximately $25,248
and $15,485 for the three months ended March 31, 1997 and 1996, respectively.
15
<PAGE> 16
INTEREST VARIANCE ANALYSIS
Net interest income is affected by changes in the average interest
rate earned on earning assets and the average interest rate paid on
interest-bearing liabilities. In addition, net interest income is affected by
changes in the volume of earning assets and interest-bearing liabilities.
Table 4 sets forth the dollar amount of the increase (decrease) in interest
income and interest expense resulting from changes in the volume of earning
assets and interest-bearing liabilities and from changes in yields and rates.
- --------------------------------------------------------------------------------
TABLE 4 - INTEREST VARIANCE ANALYSIS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31, 1997 VS 1996
- ----------------------------------------------------------------------------------------------------------------
INCREASE CHANGE DUE TO (1)
(in thousands) (DECREASE) VOLUME RATE
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
INTEREST INCOME:
Consumer loans $ 32,401 $ 49,122 $ (16,721)
Federal funds sold (2,313) (2,148) (165)
Other securities 5,364 5,744 (380)
- ----------------------------------------------------------------------------------------------------------------
Total interest income 35,452 47,156 (11,704)
INTEREST EXPENSE:
Deposits (2,106) 1,762 (3,868)
Short-term borrowings (1,824) (1,841) 17
Senior and deposit notes 21,993 21,634 359
- ----------------------------------------------------------------------------------------------------------------
Total interest expense 18,063 20,390 (2,327)
- ----------------------------------------------------------------------------------------------------------------
Net interest income (1) $ 17,389 $ 24,815 $ (7,426)
================================================================================================================
</TABLE>
(1) The change in interest due to both volume and rates has been allocated in
proportion to the relationship of the absolute dollar amounts of the change in
each. The changes in income and expense are calculated independently for each
line in the schedule. The totals for the volume and rate columns are not the
sum of the individual lines.
SERVICING INCOME
Servicing income increased $41.8 million, or 33%, for the three months
ended March 31, 1997, from the same period in the prior year, primarily due to
increases in net interest income and non-interest income on securitized loans
offset by increased charge-offs on such loans. Average securitized loans
increased 13% for the three months ended March 31, 1997, from the same period
in the prior year. Net interest income on securitized loans increased $61.2
million, or 38%, for the three months ended March 31, 1997, from the same
period in the prior year, as a result of the loan growth and an increase in the
securitized portfolio's net interest margin to 10.47% for the three months
ended March 31, 1997, from 8.58% for the same period in the prior year. This
increase in net interest margin is the result of an increase in yield on
securitized loans of 189 basis points for the three months ended March 31, 1997
as a result of the securitization of second generation products and an increase
in the amount of past-due fees charged as a result of both a change in terms
and an increase in the delinquency rate on securitized loans from period to
period. Non-interest income on securitized loans increased $50.6 million, or
150%, for the three months ended March 31, 1997 as a result of loan and account
growth, the securitization of second generation products and a change in terms
of overlimit fees. Charge-offs on securitized loans for the three months ended
March 31, 1997 increased $70.0 million, or 105%, compared to the prior year due
to the increase in average securitized loans, an increase in the average age of
accounts (generally referred to as "seasoning") and general economic trends in
consumer credit performance.
16
<PAGE> 17
OTHER NON-INTEREST INCOME
Other non-interest income increased 70% to $73.0 million for the three
months ended March 31, 1997, compared to $43.0 million for the same period in
the prior year. The increase in other non-interest income was due to an
increase in the average number of accounts of 39% for the three months ended
March 31, 1997, an increase in charge volume, a shift to more fee intensive
second generation products and changes in the terms of overlimit fees charged.
NON-INTEREST EXPENSE
Non-interest expense for the three months ended March 31, 1997 was
$213.5 million, an increase of 36% over $156.5 million for the same period in
the prior year. Contributing to the increase in non-interest expense were
salaries and associate benefits expense, which rose $26.3 million, or 60%, to
$70.6 million for the three months ended March 31, 1997, compared to $44.3
million for the same period in the prior year. This increase reflected
additional staff associated with building infrastructure and the cost of
operations to manage the growth in accounts. Solicitation expense increased
$2.6 million, or 5%, to $54.1 million in the three months ended March 31, 1997
from $51.5 million for the same period in the prior year. This increase
reflects continued investment in marketing of product offerings to potential
and existing customers utilizing its information-based strategy and account
management techniques. All other non-interest expenses increased $28.2
million, or 47%, to $88.9 million for the three months ended March 31, 1997,
from $60.7 million for the same period in the prior year. The increase in
other non-interest expense was primarily a result of an increase in the average
number of accounts of 39% for the three months ended March 31, 1997, a product
mix shift to more service intensive, second generation accounts, an increase in
charge volume and an increase in certain costs associated with information
systems enhancements.
INCOME TAXES
The Company's effective income tax rate increased to 38% for the three
months ended March 31, 1997, as compared to 37% for the same period in the
prior year and includes both state and federal income tax components. The
increase in the effective tax rate was primarily the result of increased state
tax expense as the Company expanded its operations into multiple products and
jurisdictions.
ASSET QUALITY
The asset quality of a portfolio is generally a function of the
initial underwriting criteria used, seasoning of the accounts, account
management activities and geographic, demographic, or other forms of
concentration, as well as general economic conditions. The average age of the
accounts is also an important indicator of the delinquency and loss levels of
the portfolio. Accounts tend to exhibit a rising trend of delinquency and
credit losses as they season.
17
<PAGE> 18
DELINQUENCIES
Table 5 shows the Company's consumer loan delinquency trends for the
periods presented as reported for financial statement purposes and on a managed
basis. The entire balance of an account is contractually delinquent if the
minimum payment is not received by the billing date. However, the Company
generally continues to accrue interest until the loan is charged off.
- --------------------------------------------------------------------------------
TABLE 5 - DELINQUENCIES (1)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
MARCH 31
- ---------------------------------------------------------------------------------------------------------
1997 1996
- ---------------------------------------------------------------------------------------------------------
% OF % OF
(dollars in thousands) LOANS TOTAL LOANS LOANS TOTAL LOANS
=========================================================================================================
<S> <C> <C> <C> <C>
REPORTED:
Loans outstanding $ 3,816,951 100.00% $ 2,591,725 100.00%
Loans delinquent:
30 - 59 days 68,406 1.79 52,252 2.02
60 - 89 days 42,407 1.11 33,257 1.28
90 or more days 92,090 2.42 71,864 2.77
- ---------------------------------------------------------------------------------------------------------
Total $ 202,903 5.32% $ 157,373 6.07%
=========================================================================================================
MANAGED:
Loans outstanding $ 12,606,920 100.00% $ 10,115,526 100.00%
Loans delinquent:
30 - 59 days 264,705 2.10 152,091 1.50
60 - 89 days 159,809 1.27 95,107 .94
90 or more days 383,571 3.04 208,984 2.07
- ---------------------------------------------------------------------------------------------------------
Total $ 808,085 6.41% $ 456,182 4.51%
=========================================================================================================
</TABLE>
(1) Includes consumer loans held for securitization.
The delinquency rate for reported loans was 5.32% as of March 31,
1997, down from 6.07% as of March 31, 1996 and down from 6.08% as of December
31, 1996. The decrease in the reported delinquency rate from March 31, 1996 to
March 31, 1997 reflects the securitization of second generation products in the
fourth quarter of 1996. The Company's second generation products historically
have higher delinquency rates than the typical balance transfer loans. In the
case of secured card loans, collateral partially mitigates the increased risk
and impact of charge-offs. The costs associated with higher delinquency and
charge-off rates are considered in the pricing of individual products. The 76
basis point decrease in the reported delinquency rate to 5.32% as of March 31,
1997 from 6.08% as of December 31, 1996 reflected less seller's interest in
securitization trusts as of March 31, 1997. This seller's interest represents
an undivided interest in the trust receivables in excess of investor
certificates outstanding in the trust. These receivables are generally more
seasoned than the other newer on-balance sheet loans.
The delinquency rate for the total managed consumer loan portfolio was
6.41% as of March 31, 1997, up from 4.51% as of March 31, 1996 and up from
6.24% as of December 31, 1996. The managed portfolio's delinquency rate as of
March 31, 1997 principally reflected the continued seasoning of accounts and
consumer loan balances, the increased presence of second generation products
and general economic trends in consumer credit performance.
18
<PAGE> 19
NET CHARGE-OFFS
Net charge-offs include the principal amount of losses (excluding
accrued and unpaid finance charges, fees and fraud losses) less current period
recoveries. Table 6 presents the Company's net charge-offs for the periods
presented on a reported and managed basis.
- --------------------------------------------------------------------------------
TABLE 6 - NET CHARGE-OFFS (1)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31
- -------------------------------------------------------------------------------------------------------
(dollars in thousands) 1997 1996
=======================================================================================================
<S> <C> <C>
REPORTED:
Average loans outstanding $ 4,058,701 $ 2,741,545
Net charge-offs 46,500 23,816
Net charge-offs as a percentage of average loans outstanding 4.58% 3.48%
=======================================================================================================
MANAGED:
Average loans outstanding $12,558,878 $10,265,346
Net charge-offs 183,255 90,612
Net charge-offs as a percentage of average loans outstanding 5.84% 3.53%
- -------------------------------------------------------------------------------------------------------
</TABLE>
(1) Includes consumer loans held for securitization.
Net charge-offs of managed loans increased $92.6 million, or 102%,
while average managed consumer loans grew 22% for the three months ended March
31, 1997 from the same period in the prior year. For the three months ended
March 31, 1997, the Company's net charge-offs as a percentage of managed loans
was 5.84%, compared to 3.53% for the same period in the prior year. The
increase in net charge-offs was the result of continued seasoning of the
portfolio, the increased presence of second generation products and general
economic trends in consumer credit performance. The increase in the reported
charge-off rate reflects a 64% increase in the seller's interest in
securitization trusts to $1.8 billion, or 44%, of the reported average balance
for the three months ended March 31, 1997 from $1.1 billion, or 38%, of the
reported average balance for the same period in the prior year.
PROVISION AND ALLOWANCE FOR LOAN LOSSES
The provision for loan losses is the periodic expense of maintaining
an adequate allowance at the amount estimated to be sufficient to absorb
possible future losses, net of recoveries (including recovery of collateral),
inherent in the existing on-balance sheet loan portfolio. In evaluating the
adequacy of the allowance for loan losses, the Company takes into consideration
several factors including economic trends and conditions, overall asset
quality, loan seasoning and trends in delinquencies and expected charge-offs.
The Company's primary guideline is a calculation which uses current delinquency
levels and other measures of asset quality to estimate net charge-offs.
Consumer loans are typically charged off (net of any collateral) in the next
billing cycle after becoming 180 days past-due, although earlier charge-offs
may occur on accounts of bankrupt or deceased customers. Bankrupt customers'
accounts are generally charged off within 30 days of notification. Once a loan
is charged off, it is the Company's policy to continue to pursue the collection
of principal and interest.
19
<PAGE> 20
Management believes that the allowance for loan losses is adequate to
cover anticipated losses in the on-balance sheet consumer loan portfolio under
current conditions. There can be no assurance as to future credit losses that
may be incurred in connection with the Company's consumer loan portfolio, nor
can there be any assurance that the loan loss allowance that has been
established by the Company will be sufficient to absorb such future credit
losses. The allowance is a general allowance applicable to the on-balance
sheet consumer loan portfolio. Table 7 sets forth the activity in the allowance
for loan losses for the periods indicated. See "Asset Quality,"
"Delinquencies" and "Net Charge-Offs" for a more complete analysis of asset
quality.
- --------------------------------------------------------------------------------
TABLE 7 - SUMMARY OF ALLOWANCE FOR LOAN LOSSES
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31
- --------------------------------------------------------------------------------------------------------
(dollars in thousands) 1997 1996
- --------------------------------------------------------------------------------------------------------
<S> <C> <C>
Balance at beginning of period $ 118,500 $ 72,000
Provision for loan losses 49,187 25,168
Transfer to loans held for securitization (2,687) (2,125)
Charge-offs (51,201) (24,131)
Recoveries 4,701 3,088
- --------------------------------------------------------------------------------------------------------
Net charge-offs (1) (46,500) (21,043)
- --------------------------------------------------------------------------------------------------------
Balance at end of period $ 118,500 $ 74,000
========================================================================================================
Allowance for loan losses to loans at period-end (1) 3.37% 3.09%
- --------------------------------------------------------------------------------------------------------
</TABLE>
(1) Excludes consumer loans held for securitization.
For the three months ended March 31, 1997, the provision increased to
$49.2 million, from $25.2 million for the comparable period of the prior year.
This increase is due to an increase in the average reported loan balance of
48%, to $4.1 billion for the three months ended March 31, 1997, from $2.7
billion for the comparable period of the prior year, and increases in the net
charge-off rate resulting from continued loan seasoning, a shift in the
composition of reported consumer loans and general economic trends in consumer
credit performance.
LIQUIDITY AND FUNDING
Liquidity refers to the Company's ability to meet its cash needs. The
Company meets its cash requirements by securitizing assets and by debt funding.
As discussed in "Managed Consumer Loan Portfolio," a significant source of
liquidity for the Company has been the securitization of consumer loans.
Maturity terms of the existing securitizations vary from 1997 to 2001
(extendible to 2004) and typically have accumulation periods during which
principal payments are aggregated to make payments to investors. As payments on
the loans are accumulated for the participants in the securitization and are no
longer reinvested in new loans, the Company's funding requirements for such new
loans increase accordingly. The occurrence of certain events may cause the
securitization transactions to amortize earlier than scheduled which would
accelerate the need for funding.
As such loans amortize or are otherwise paid, the Company's funding
needs will increase accordingly. The Company believes that it can securitize
consumer loans, purchase federal funds and establish other funding sources to
fund the amortization or other payment of the securitizations in the future,
although no assurance can be given to that effect.
Additionally, the Company maintains a portfolio of high-quality
securities such as U.S. Government, U.S. Government Agency mortgage-backed
securities, commercial paper, interest-bearing
20
<PAGE> 21
deposits with other banks, federal funds and other cash equivalents in order to
provide adequate liquidity and to meet its on going cash needs. As of March
31, 1997, the Company held $1.7 billion in such securities.
Interest-bearing liabilities decreased $.6 billion, or 11%, to $4.9
billion as of March 31, 1997 from $5.5 billion as of December 31, 1996. The
decrease is the result of a decrease in interest-bearing deposits, short-term
borrowings and senior notes of $201 million, $176 million and $225 million,
respectively, from December 31, 1996 to March 31, 1997 and reflects the reduced
need for borrowings as total loans decreased over the quarter and capital
increased.
Table 8 shows the maturation of certificates of deposit in
denominations of $100,000 or greater (large denomination CDs) as of March 31,
1997.
- --------------------------------------------------------------------------------
TABLE 8 - MATURITIES OF LARGE DENOMINATION CERTIFICATES $100,000 OR MORE
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
MARCH 31, 1997
- --------------------------------------------------------------------------------------------------------
(dollars in thousands) BALANCE PERCENT
- --------------------------------------------------------------------------------------------------------
<S> <C> <C>
3 months or less $ 62,293 16.41%
Over 3 through 6 months 71,981 18.96
Over 6 through 12 months 243,863 64.24
Over 1 through 5 years 1,500 .39
- --------------------------------------------------------------------------------------------------------
Total $ 379,637 100.00%
========================================================================================================
</TABLE>
In addition to large denomination CDs, as of March 31, 1997 retail
deposits of $362.1 million had been raised through the Savings Bank as an
additional source of funding.
On November 25, 1996, the Company entered into a four-year, $1.7
billion unsecured revolving credit arrangement (the "Credit Facility"). The
Credit Facility is comprised of two tranches: a $1.375 billion Tranche A
facility available to the Bank and the Savings Bank, including an option for up
to $225 million in multi-currency availability, and a $325 million Tranche B
facility available to the Corporation, the Bank and the Savings Bank, including
an option for up to $100 million in multi-currency availability. Each tranche
under the facility is structured as a four-year commitment and is available for
general corporate purposes. The borrowings of the Savings Bank are limited to
$500 million during the first year of the Credit Facility, and $750 million
thereafter. The Bank has irrevocably undertaken to honor any demand by the
lenders to repay any borrowings which are due and payable by the Savings Bank
but which have not been paid. Any borrowings under the Credit Facility will
mature on November 24, 2000; however, the final maturity of each tranche may be
extended for three additional one-year periods. The Company had no
outstandings on its $1.7 billion revolving credit arrangement as of March 31,
1997. The unused commitment is available as funding needs may arise.
On April 30, 1997, the Bank increased the aggregate amount of bank
notes available for issuance under its bank note program. Under the program,
the Bank may issue from time to time up to $7.8 billion of senior bank notes
with maturities from 30 days to 30 years and up to $200 million of subordinated
bank notes with maturities from 5 to 30 years. As of March 31, 1997, the
Company had $3.3 billion in senior bank notes outstanding. As of March 31,
1997, no subordinated bank notes have been issued.
21
<PAGE> 22
On September 19, 1996, the Corporation filed a $200 million shelf
registration statement ($125 million of senior debt securities issued as of
March 31, 1997) with the Securities and Exchange Commission under which the
Corporation from time to time may offer and sell (i) senior or subordinated
debt securities consisting of debentures, notes and/or other unsecured
evidences, (ii) preferred stock, which may be issued in the form of depository
shares evidenced by depository receipts and (iii) common stock. The securities
will be limited to $200 million aggregate public offering price or its
equivalent (based on the applicable exchange rate at the time of sale) in one
or more foreign currencies, currency units of composite currencies as shall be
designated by the Corporation.
On April 30, 1996, the Bank established a deposit note program under
which the Bank may issue from time to time up to $2.0 billion of deposit notes
with maturities from 30 days to 30 years from the date of issue. As of March
31, 1997, the Company had $300 million in deposit notes outstanding.
On January 28, 1997, Capital One Capital I, a subsidiary of the Bank
created as a Delaware statutory business trust, issued $100 million aggregate
amount of Floating Rate Junior Subordinated Capital Income Securities that
mature on February 1, 2027. The securities represent a preferred beneficial
interest in the assets of the trust. The net proceeds of the offering of $97.4
million were lent to the Bank for general corporate purposes.
In January 1996, the Company implemented a dividend reinvestment and
stock purchase plan (the "DRIP") to provide existing stockholders with the
opportunity to purchase additional shares of the Company's common stock by
reinvesting quarterly dividends or making optional cash investments. The
Company uses proceeds from the DRIP for general corporate purposes.
CAPITAL ADEQUACY
The Bank and the Savings Bank are subject to capital adequacy
guidelines adopted by the Federal Reserve Board ("Federal Reserve") and the
Office of Thrift Supervision (the "OTS") (collectively, the "regulators"),
respectively. The capital adequacy guidelines and the regulatory framework for
prompt corrective action require the Bank and the Savings Bank to attain
specific capital levels based upon quantitative measures of their assets,
liabilities and off-balance sheet items as calculated under Regulatory
Accounting Principles. The inability to meet and maintain minimum capital
adequacy levels could result in regulators taking actions that could have a
material effect on the Company's consolidated financial statements.
Additionally, the regulators have broad discretion in applying higher capital
requirements. Regulators consider a range of factors in determining capital
adequacy, such as an institution's size, quality and stability of earnings,
interest rate risk exposure, risk diversification, management expertise, asset
quality, liquidity and internal controls.
22
<PAGE> 23
The most recent notifications from the regulators categorized the Bank
and the Savings Bank as "well capitalized". The Bank must maintain minimum
Tier 1 Capital, Total Capital and Tier 1 Leverage ratios of 4%, 8% and 4%, and
the Savings Bank must maintain minimum Tangible Capital, Total Capital and Core
Capital ratios of 1.5%, 8% and 3%, respectively, under capital adequacy
requirements, and both must maintain minimum ratios of 6%, 10% and 5%,
respectively, to be well capitalized under the regulatory framework for prompt
corrective action. As of March 31, 1997, the Bank's Tier 1 Capital, Total
Capital and Tier 1 Leverage ratios were 11.49%, 14.43% and 12.04%,
respectively. As of March 31, 1997, the Savings Bank's Tangible Capital, Total
Capital and Core Capital ratios were 11.22%, 21.47% and 11.22%, respectively.
In addition, the Savings Bank is subject for the first three years of its
operations to additional capital requirements, including the requirement to
maintain a minimum Total Capital ratio of 12% and a Core Capital ratio of 8%.
As of December 31, 1996, there are no conditions or events since the
notifications discussed above that Management believes have changed either the
Bank's or the Savings Bank's capital category. As of March 31, 1997, the
Bank's and the Savings Bank's ratio of common equity to managed assets was
4.68% and 8.76%, respectively.
On January 1, 1997, the basis for reporting accounting transactions in
the quarterly Consolidated Report of Condition ("Call Report") and the Thrift
Financial Report ("TFR") changed to conform with generally accepted accounting
principles ("GAAP"). New instructions reflecting such changes have been
adopted by the Office of the Comptroller of the Currency, the Federal Reserve,
the OTS and the Federal Deposit Insurance Corporation ("FDIC"), and are
effective for the March 31, 1997 reports. Additionally, in June 1996, SFAS 125
was issued to provide consistent standards for determining whether transfers of
financial assets should be treated as sales or secured borrowings. Prior to
the March 31, 1997 Call Report, amounts deposited into spread accounts from
excess servicing were not recognized as regulatory income nor booked as an
asset on the regulatory balance sheet. In accordance with the new
instructions, asset transfers that use excess servicing fees receivable as
credit enhancement are reported as off-balance sheet sales with recourse and
the transferor is required to hold risk-based capital against the full amount
of assets sold or a lesser amount if the transaction qualifies for low-level
recourse capital treatment. Under the low-level recourse rules, capital is
required to be held against the amount of excess servicing fees receivable
(which will be reported as an interest-only strip receivable under SFAS No.
125) net of any noncapital GAAP recourse liability associated with the asset
transfer, and, based on the new instructions, net of tax liabilities incurred
in connection with the transfer of assets. The implementation of SFAS 125 and
the conformity with GAAP for regulatory reporting purposes did not result in
any significant changes in the Bank's and Savings Bank's capital position.
During 1996, the Bank received regulatory approval to establish a
branch office in the United Kingdom. In connection with such approval, the
Company committed to the Federal Reserve Board that, for so long as the Bank
maintains such branch in the United Kingdom, the Company will maintain a
minimum Tier 1 leverage ratio of 3.0%. As of March 31, 1997, the Company's
Tier 1 leverage ratio was 13.71%.
Additionally, certain regulatory restrictions exist which limit the
ability of the Bank and the Savings Bank to transfer funds to the Corporation.
As of March 31, 1997, retained earnings of the Bank and the Savings Bank of
$82.6 million and $18.1 million, respectively, were available for payment of
dividends to the Corporation, without prior approval by the regulators. The
Savings Bank is required to give the Office of Thrift Supervision at least 30
days' advance notice of any proposed dividend.
23
<PAGE> 24
OFF-BALANCE SHEET RISK
The Company is subject to off-balance sheet risk in the normal course
of business including commitments to extend credit, excess servicing income
from securitization and interest rate swap agreements ("swaps"). In order to
reduce interest rate sensitivity and to match asset and liability repricings,
the Company has entered into swaps which involve elements of credit or interest
rate risk in excess of the amount recognized on the balance sheet. Swaps
present the Company with certain credit, market, legal and operational risks.
The Company has established credit policies for off-balance sheet items as it
does for on-balance sheet instruments.
As of March 31, 1997, the Company had $1.6 billion in notional amount
of swaps to match asset and liability repricings, the majority of which reduce
exposure relating to the mismatch of quarterly repricing consumer loan assets
and medium-term fixed rate bank notes and fixed rate securitizations. The
Company evaluates its overall sensitivity to interest rates by reviewing its
asset and liability repricings and the impact of anticipated transactions. In
determining the Company's swap position, management considers this overall
sensitivity to interest rates and makes adjustments as necessary to meet the
Company's objectives. The fair value, based on the forward yield curve, as of
March 31, 1997 of swap positions for which the Company is exposed to credit
risk from counterparties is $18.5 million. Tables 9 and 10 reflect the
maturity and activity of swap positions, respectively, as of March 31, 1997 and
for the three months ended March 31, 1997 and 1996.
- --------------------------------------------------------------------------------
TABLE 9 - MATURITY OF INTEREST RATE SWAPS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
MARCH 31, 1997
- ----------------------------------------------------------------------------------------------------
WITHIN OVER ONE AVERAGE
ONE THROUGH FIVE LIFE
(dollars in millions) YEAR YEARS TOTAL (YEARS)
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Receive fixed/pay floating:
Notional amount $ 789 $ 791 $ 1,580 1.26
Weighted average rates received 6.95% 7.60% 7.28%
Weighted average rates paid 5.53 5.60 5.57
====================================================================================================
</TABLE>
Weighted average rates received and paid are based on the contractual rates in
effect as of March 31, 1997. Floating rates under the interest rate swap
contracts are based on varying terms of LIBOR.
- --------------------------------------------------------------------------------
TABLE 10 - SUMMARY OF INTEREST RATE SWAPS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31
- ----------------------------------------------------------------------------------------------------
(dollars in millions) 1997 1996
- ----------------------------------------------------------------------------------------------------
NOTIONAL AMOUNT
<S> <C> <C>
Receive fixed/pay floating:
Beginning of period $ 2,104 $ 2,144
Maturities 524 40
- ----------------------------------------------------------------------------------------------------
End of period $ 1,580 $ 2,104
====================================================================================================
Receive floating/pay floating:
Beginning of period $ 260
- ----------------------------------------------------------------------------------------------------
End of period $ 260
====================================================================================================
</TABLE>
24
<PAGE> 25
BUSINESS OUTLOOK
This business outlook section summarizes the Company's expectations
for earnings for the year ending December 31, 1997 and its primary goals and
strategies for continued growth. The statements contained in this section are
based on management's current expectations. Certain of the statements are
forward looking statements and, therefore, actual results could differ
materially. Factors which could materially influence results are set forth in
the last paragraph of this section and in the Company's Annual Report on Form
10-K for the year ended December 31, 1996 (Part I, Item 1, Cautionary
Statements).
The Company has set a target, dependent on factors discussed below,
for its earnings per share for the year ending December 31, 1997 to increase by
approximately 20% over earnings per share for the year ended December 31, 1996.
As discussed elsewhere in this report and below, the Company's actual earnings
are a function of its revenues (interest income and non-interest income on its
earning assets), consumer usage and payment patterns, credit quality of its
earning assets (which affects fees and charge-offs), solicitation expenses and
operating expenses.
Recent performance of the Company's managed loan portfolio suggests
that consumers are limiting their spending and lowering their debt. These
events are evidenced by moderating delinquencies, lower past-due and overlimit
fees and lower loan growth experienced by the Company to date in 1997.
It is unknown to what extent the delinquency trends are seasonal and to what
extent they are indicative of a sustained improvement in the credit quality of
the Company's portfolio. While management believes that lower delinquencies
should result in reduced charge-offs if this trend continues, the current trend
also results in less fee income and finance charges in the short term. As a
result, the Company anticipates that its earnings will be somewhat lower than
analysts' consensus earnings estimates for the second quarter of 1997. The
Company has taken further steps to increase revenues in the third quarter of
1997, including increases to fees and continuing to reprice interest rates on
selected accounts that present higher credit risk. The results noted above are
preliminary and may or may not continue as a trend. However, if this trend
continues, the impact on earnings could adversely affect the Company's ability
to achieve its 1997 earnings target discussed above.
The Company's strategy for future growth has been, and it is expected
to continue to be, to apply its proprietary IBS to its credit card business as
well at to other businesses, both financial and non-financial, to identify new
product opportunities and to make informed investment decisions regarding its
existing products. See the Company's Annual Report on Form 10-K for the year
ended December 31, 1996 for a further description of the Company's IBS (Part I,
Item 1, Business).
Historically, the Company has concentrated its efforts on credit card
opportunities. These opportunities have included, and are expected to continue
to include, various first generation low-rate balance transfer products, as
well as second generation credit card products. Generally, these second
generation products tend to have lower credit lines, balances that build over
time, less attrition, higher margins (including fees), higher operational costs
and, in some cases, higher delinquencies and credit losses than the Company's
traditional low rate balance transfer products. In general, these second
generation products have had overall higher returns than the traditional
balance transfer products in recent market conditions. However, these second
generation products are also subject to competitive pressures, which management
anticipates will increase as this market matures. The Company uses its IBS in
an effort to balance the mix of credit card products to optimize profitability
within the context of acceptable risk. The Company continues to test market a
wide variety of first and second generation credit card products. The
25
<PAGE> 26
Company believes that this testing approach will enable it to react effectively
as general market conditions change. In this manner, the Company intends to
remain flexible in the allocation of marketing expenses spent on specific
products to take advantage of market opportunities as they emerge and will make
its marketing decisions based on the then current market conditions. As a
result, the Company expects to continue to offer a variety of first and second
generation credit card products; however, the mix of such products in the
Company's portfolio may vary significantly over time.
The Company anticipates that its 1997 solicitation (marketing)
expenses will approximate such expenses in 1996, as the Company continues to
invest in existing and new first and second generation products as marketing
opportunities develop. These opportunities are subject to a variety of
external and internal factors that may affect the actual amount of solicitation
expense, such as competition in the credit card industry, general economic
conditions affecting consumer credit performance and the asset quality of the
Company's portfolio. Moreover, the first generation and second generation
products have different account growth, loan growth and asset quality
characteristics. As a result, although the Company expects that its growth in
consumer accounts and managed consumer loan growth will continue in 1997,
actual growth may vary significantly depending on the actual mix of products
that the Company may offer in 1997. Actual growth also will depend on the
level of attrition on the Company's managed portfolio which in turn is affected
by competitive pressures.
The Company currently expects continued but moderating increases in
the delinquency and net charge-off rates of its portfolio as further discussed
below. The delinquency and charge-off rates of the Company's consumer loan
portfolio are directly correlated to general economic trends in consumer credit
performance. The rates of delinquencies and charge-offs in the credit card
industry are currently at record high levels and are expected by most industry
observers to increase. The actual amount of increases in the Company's
delinquencies and charge-offs will be affected not only by these general
economic trends but by continued seasoning of the Company's portfolio and the
product mix. As delinquency levels fluctuate, the resulting amount of past-due
and overlimit fees, which are significant sources of revenue for the Company,
will also fluctuate. Further, the timing of revenues from increasing or
decreasing delinquencies correspondingly precedes the related impact of higher
or lower charge-offs that ultimately result from varying levels of
delinquencies.
To the extent the Company markets first generation products and
experiences greater consumer loan growth, delinquency and net charge-off rates
will be less, as delinquencies and net charge-off characteristics of new
portfolios generally are lower than more seasoned portfolios. However, because
second generation products generally have higher delinquencies and net
charge-offs than first generation products, to the extent the Company increases
the proportion of second generation products in its portfolio, delinquency and
net charge-off rates will be greater. These factors notwithstanding, the
Company believes that the credit quality of its portfolio is enhanced as a
result of the application of IBS.
The Company also has been applying, and expects to continue applying,
its IBS to other financial products and non-financial products ("third
generation products"). The Company has established the Savings Bank and
several non-bank operating subsidiaries to identify and explore new product
opportunities. The Company is in various stages of developing and test
marketing a number of new products or services including, but not limited to,
selected non-card consumer lending products and the reselling of
telecommunication services. During 1996, the Company allocated an increased
percentage of its marketing expenses to non-card products or services. To
date, only a relatively small dollar percentage of assets and a relatively
small percentage of
26
<PAGE> 27
accounts have been generated as a result of such expenditures. As the Company
continues to apply its IBS to non-card opportunities and builds the
infrastructure necessary to support new businesses, the Company expects that it
may increase the percentage of its 1997 marketing and operating expenses
attributable to such businesses.
The Company expects to maintain a flexible approach to its marketing
investment. The Company intends to continue applying its IBS to all products,
even established products and businesses, and the results of ongoing testing
will influence the amount and allocation of future marketing investment.
Management believes that, through the continued application of IBS, the Company
can develop product and service offerings to sustain growth and that it has the
personnel, financial resources and business strategy necessary for continued
success. However, as the Company attempts to apply IBS to diversify and expand
its product offerings beyond credit cards, there can be no assurance that the
historical financial information of the Company will necessarily reflect the
results of operations and financial condition of the Company in the future.
The Company's actual results will be influenced by, among other things, the
factors discussed in this section.
The Company's strategies and objectives outlined above and the other
forward looking statements contained in this section involve a number of risks
and uncertainties. The Company cautions readers that any forward looking
information is not a guarantee of future performance and that actual results
could differ materially. In addition to the factors discussed above, among the
other factors that could cause actual results to differ materially are the
following: continued intense competition from numerous providers of products
and services which compete with the Company's businesses; with respect to
financial products, changes in the Company's aggregate accounts or consumer
loan balances and the growth rate thereof, including changes resulting from
factors such as shifting product mix, amount of actual marketing expenses made
by the Company and attrition of accounts and loan balances; an increase in
credit losses (including increases due to a worsening of general economic
conditions); difficulties or delays in the development, production, testing and
marketing of new products or services; losses associated with new products or
services; financial, legal, regulatory or other difficulties that may affect
investment in, or the overall performance of, a product or business; the amount
of, and rate of growth in, the Company's expenses (including associate and
marketing expenses) as the Company's business develops or changes or as it
expands into new market areas; the availability of capital necessary to fund
the Company's new businesses; the ability of the Company to build the
operational and organizational infrastructure necessary to engage in new
businesses; the ability of the Company to recruit experienced personnel to
assist in the management and operations of new products and services; and other
factors listed from time to time in the Company's SEC reports, including but
not limited to the Annual Report on Form 10-K for the year ended December 31,
1996 (Part I, Item 1, Cautionary Statements).
27
<PAGE> 28
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) The 1997 Annual Meeting of Stockholders was held on April 24,
1997.
(b) The following directors were elected at such meeting:
Richard D. Fairbank
Stanley I. Westreich
The following directors will also continue in their office
after such meeting:
Nigel W. Morris
W.Ronald Dietz
James A. Flick, Jr.
Patrick W. Gross
James V. Kimsey
(c) The following matters were voted upon at such meeting:
<TABLE>
<CAPTION>
ELECTION OF DIRECTORS VOTES FOR VOTES WITHHELD
- --------------------- --------- --------------
<S> <C> <C>
RICHARD D. FAIRBANK 54,993,676 135,719
STANLEY I. WESTREICH 55,000,376 129,019
</TABLE>
<TABLE>
<CAPTION>
ITEM VOTES FOR VOTES AGAINST ABSTAIN
---- --------- ------------- -------
<S> <C> <C> <C>
RATIFICATION OF THE SELECTION OF
ERNST & YOUNG LLP AS INDEPENDENT
AUDITORS OF THE COMPANY FOR 1997. 54,956,547 61,999 110,849
</TABLE>
No other matter was voted upon at such meeting.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
Exhibit 11-Computation of Per Share Earnings Page 30
(b) Reports on Form 8-K
The Company filed a Current Report on Form 8-K, dated January
28, 1997, Commission File No. 1-13300, enclosing its press
release dated January 22, 1997.
28
<PAGE> 29
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, the Registrant has duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized.
CAPITAL ONE FINANCIAL CORPORATION
---------------------------------
(Registrant)
Date: /s/James M. Zinn
---------------- -----------------------------
James M. Zinn
Senior Vice President,
Chief Financial Officer
(Chief Accounting Officer
and duly authorized officer
of the Registrant)
29
<PAGE> 1
EXHIBIT 11
CAPITAL ONE FINANCIAL CORPORATION
COMPUTATION OF PER SHARE EARNINGS
THREE MONTHS ENDED MARCH 31, 1997 AND 1996
(dollars in thousands, except per share data)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31
- ----------------------------------------------------------------------------------------------------------
1997 1996
==========================================================================================================
<S> <C> <C>
PRIMARY
Net income $ 42,482 $ 38,013
==========================================================================================================
WEIGHTED AVERAGE COMMON AND COMMON
EQUIVALENT SHARES OUTSTANDING
Average common shares outstanding 66,335,711 66,156,572
Net effect of dilutive restricted stock (1) 4,768 20,054
Net effect of dilutive stock options (1) 1,559,332 557,945
- ----------------------------------------------------------------------------------------------------------
Weighted average common and
common equivalent shares 67,899,811 66,734,571
==========================================================================================================
EARNINGS PER SHARE $ .63 $ .57
==========================================================================================================
FULLY DILUTED
Net income $ 42,482 $ 38,013
==========================================================================================================
WEIGHTED AVERAGE COMMON AND COMMON
EQUIVALENT SHARES OUTSTANDING
Average common shares outstanding 66,335,711 66,156,572
Net effect of dilutive restricted stock (2) 5,119 21,900
Net effect of dilutive stock options (2) 1,559,332 628,002
- ----------------------------------------------------------------------------------------------------------
Weighted average common and
common equivalent shares 67,900,162 66,806,474
==========================================================================================================
EARNINGS PER SHARE $ .63 $ .57
==========================================================================================================
</TABLE>
(1) Based on the treasury stock method using average market price.
(2) Based on the treasury stock method using the higher of ending or
average market price.
The calculations of common and common equivalent earnings per share
and fully diluted earnings per share are submitted in accordance with
Securities Exchange Act of 1934 Release No. 9083 although both
calculations are not required by footnote 2 to paragraph 14 of APB
Opinion No. 15 because there is dilution of less than 3%. The
Registrant has elected to show fully diluted earnings per share in its
financial statements.
30
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> MAR-31-1997
<CASH> 127,721
<SECURITIES> 1,026,373
<RECEIVABLES> 3,816,951
<ALLOWANCES> (118,500)
<INVENTORY> 0
<CURRENT-ASSETS> 0<F1>
<PP&E> 180,927
<DEPRECIATION> 0<F2>
<TOTAL-ASSETS> 6,154,979
<CURRENT-LIABILITIES> 0<F1>
<BONDS> 0
0
0
<COMMON> 664
<OTHER-SE> 777,097
<TOTAL-LIABILITY-AND-EQUITY> 6,154,979
<SALES> 0
<TOTAL-REVENUES> 411,651
<CGS> 0
<TOTAL-COSTS> 213,547
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 49,187
<INTEREST-EXPENSE> 80,397
<INCOME-PRETAX> 68,520
<INCOME-TAX> 26,038
<INCOME-CONTINUING> 42,482
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 42,482
<EPS-PRIMARY> .63
<EPS-DILUTED> .63
<FN>
<F1>Non-classified balance sheet
<F2>PP&E shown net
</FN>
</TABLE>
