<PAGE>
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 September 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________ to _________.
Commission file number 1-13300
CAPITAL ONE FINANCIAL CORPORATION
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
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)
(703) 205-1000
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(Registrant's telephone number, including area code)
(Not Applicable)
- --------------------------------------------------------------------------------
(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
--- ---
As of October 31, 1998, there were 65,593,584 shares of the registrant's Common
Stock, par value $.01 per share, outstanding.
<PAGE>
CAPITAL ONE FINANCIAL CORPORATION
FORM 10-Q
INDEX
- --------------------------------------------------------------------------------
September 30, 1998
Page
----
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 the Condensed Consolidated Financial
Statements.................................... 7
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of
Operations.................................... 11
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K..................... 30
Signatures.................................... 30
<PAGE>
Item 1.
CAPITAL ONE FINANCIAL CORPORATION
Condensed Consolidated Balance Sheets
(dollars in thousands, except per share data) (unaudited)
<TABLE>
<CAPTION>
September 30 December 31
1998 1997
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C>
Assets:
Cash and due from banks $ 14,974 $ 5,039
Federal funds sold and resale agreements 365,000 173,500
Interest-bearing deposits at other banks 32,993 59,184
- -------------------------------------------------------------------- ------------------- ------------------
Cash and cash equivalents 412,967 237,723
Securities available for sale 1,296,959 1,242,670
Consumer loans 5,666,998 4,861,687
Less: Allowance for loan losses (231,000) (183,000)
- -------------------------------------------------------------------- ------------------- ------------------
Net loans 5,435,998 4,678,687
Premises and equipment, net 228,550 162,726
Interest receivable 49,934 51,883
Accounts receivable from securitizations 921,602 588,781
Other 234,766 115,809
- -------------------------------------------------------------------- ------------------- ------------------
Total assets $ 8,580,776 $ 7,078,279
- -------------------------------------------------------------------- ------------------- ------------------
Liabilities:
Interest-bearing deposits $ 1,598,335 $ 1,313,654
Other borrowings 1,439,690 796,112
Senior notes 3,729,234 3,332,778
Deposit notes 299,996
Interest payable 80,373 68,448
Other 466,160 276,368
- -------------------------------------------------------------------- ------------------- ------------------
Total liabilities 7,313,792 6,087,356
Guaranteed Preferred Beneficial Interests In
Capital One Bank's Floating Rate Junior
Subordinated Capital Income Securities: 97,856 97,664
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, 66,558,730 and 66,557,230 issued as of
September 30, 1998 and December 31, 1997, respectively 666 666
Paid-in capital, net 599,536 513,561
Retained earnings 612,331 425,140
Cumulative other comprehensive income 31,524 2,539
Less: Treasury stock, at cost; 987,339 and 1,188,134
shares as of September 30, 1998 and December 31, 1997,
respectively (74,929) (48,647)
- -------------------------------------------------------------------- ------------------- ------------------
Total stockholders' equity 1,169,128 893,259
- -------------------------------------------------------------------- ------------------- ------------------
Total liabilities and stockholders' equity $ 8,580,776 $ 7,078,279
- -------------------------------------------------------------------- ------------------- ------------------
</TABLE>
See notes to the condensed consolidated financial statements.
<PAGE>
CAPITAL ONE FINANCIAL CORPORATION
Condensed Consolidated Statements of Income
(in thousands, except per share data) (unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30 September 30
- ----------------------------------------------------- ----------------- ---------------- ----------------- ----------------
1998 1997 1998 1997
- ----------------------------------------------------- ----------------- ---------------- ----------------- ----------------
<S> <C> <C> <C> <C>
Interest Income:
Consumer loans, including fees $ 259,339 $ 153,377 $ 734,106 $ 443,374
Federal funds sold and resale agreements 957 3,753 8,175 12,030
Other 22,813 21,840 70,308 59,030
Total interest income 283,109 178,970 812,589 514,434
Interest Expense:
Deposits 15,805 9,052 43,578 28,124
Other borrowings 24,752 9,168 61,180 26,145
Senior and deposit notes 65,498 63,596 196,231 191,555
Total interest expense 106,055 81,816 300,989 245,824
Net interest income 177,054 97,154 511,600 268,610
Provision for loan losses 67,569 72,518 212,448 168,481
Net interest income after provision for loan losses 109,485 24,636 299,152 100,129
Non-Interest Income:
Servicing and securitizations 217,094 180,348 541,161 498,943
Service charges and other fees 146,648 87,979 432,263 220,763
Interchange 23,213 12,606 58,383 33,326
- ----------------------------------------------------- ----------------- ---------------- ----------------- ----------------
Total non-interest income 386,955 280,933 1,031,807 753,032
Non-Interest Expense:
Salaries and associate benefits 116,107 73,214 337,488 213,137
Marketing 126,481 60,781 287,292 159,827
Communications and data processing 38,415 25,935 102,618 72,045
Supplies and equipment 27,416 21,721 82,399 58,200
Occupancy 11,115 8,198 32,849 23,387
Other 63,993 36,154 161,600 115,009
- ----------------------------------------------------- ----------------- ---------------- ----------------- ----------------
Total non-interest expense 383,527 226,003 1,004,246 641,605
- ----------------------------------------------------- ----------------- ---------------- ----------------- ----------------
Income before income taxes 112,913 79,566 326,713 211,556
Income taxes 42,907 30,236 124,151 80,392
- ----------------------------------------------------- ----------------- ---------------- ----------------- ----------------
Net income $ 70,006 $ 49,330 $ 202,562 $ 131,164
- ----------------------------------------------------- ----------------- ---------------- ----------------- ----------------
Basic earnings per share $ 1.07 $ 0.75 $ 3.09 $ 1.98
- ----------------------------------------------------- ----------------- ---------------- ----------------- ----------------
Diluted earnings per share $ 1.00 $ 0.73 $ 2.92 $ 1.94
- ----------------------------------------------------- ----------------- ---------------- ----------------- ----------------
Dividends paid per share $ 0.08 $ 0.08 $ 0.24 $ 0.24
- ----------------------------------------------------- ----------------- ---------------- ----------------- ----------------
</TABLE>
See notes to the condensed consolidated financial statements.
<PAGE>
CAPITAL ONE FINANCIAL CORPORATION
Condensed Consolidated Statements of Changes in Stockholders' Equity
(dollars in thousands, except per share data) (unaudited)
<TABLE>
<CAPTION>
Cumulative
Other Total
Common Stock Paid-In Retained Comprehensive Treasury Stockholders'
Shares Amount Capital, Net Earnings Income Stock Equity
- ------------------------------------ ---------- -------- ------------- ---------- ---------------- ---------- --------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1996 66,325,261 $663 $ 481,383 $256,396 $ 1,949 $ 740,391
Comprehensive income:
Net income 131,164 131,164
Other comprehensive income, net of income tax:
Unrealized gains on securities net of income
taxes of $177, net of loss reclassification
adjustment of $192, net of income tax benefit
of $118 36 36
Foreign currency translation adjustments (112) (112)
-------- ------------
Other comprehensive income (76) (76)
------------
Comprehensive income 131,088
Cash dividends - $.24 per share (15,512) (15,512)
Purchases of treasury stock 1,552 $ (37,467) (35,915)
Issuances of common stock 112,949 1 3,208 469 3,678
Exercise of stock options 129,890 2 2,611 308 2,921
Tax benefit from stock awards 298 298
Restricted stock, net (121) 80 80
Common stock issuable under incentive plan 15,035 15,035
- ------------------------------------ ---------- -------- ------------- ---------- ---------------- ---------- --------------
Balance, September 30, 1997 66,567,979 $666 $ 504,167 $372,048 $ 1,873 $ (36,690) $ 842,064
- ------------------------------------ ---------- -------- ------------- ---------- ---------------- ---------- --------------
Balance, December 31, 1997 66,557,230 $666 $ 513,561 $425,140 $ 2,539 $ (48,647) 893,259
Comprehensive income:
Net income 202,562 202,562
Other comprehensive income, net of income tax:
Unrealized gains on securities net
of income taxes of $20,686 3,751 33,751
Foreign currency translation adjustments (4,766) (4,766)
-------- ------------
Other comprehensive income 28,985 28,985
------------
Comprehensive income 231,547
Cash dividends - $.24 per share (15,371) (15,371)
Purchases of treasury stock 1,708 (71,360) (69,652)
Issuances of common stock 36,526 22,790 59,316
Exercise of stock options 1,500 (15,716) 22,288 6,572
Tax benefit from stock awards 422 422
Restricted stock, net 18 18
Common stock issuable under incentive plan 63,017 63,017
- ------------------------------------ ---------- -------- ------------- ---------- ---------------- ---------- --------------
Balance, September 30, 1998 66,558,730 $666 $ 599,536 $612,331 $ 31,524 $ (74,929) $1,169,128
- ------------------------------------ ---------- -------- ------------- ---------- ---------------- ---------- --------------
</TABLE>
See notes to the condensed consolidated financial statements.
<PAGE>
CAPITAL ONE FINANCIAL CORPORATION
Condensed Consolidated Statements of Cash Flows
(in thousands) (unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
September 30
- -------------------------------------------------------------- ----------------- -------------------
1998 1997
- -------------------------------------------------------------- ----------------- -------------------
<S> <C> <C>
Operating Activities:
Net income $ 202,562 $ 131,164
Adjustments to reconcile net income to cash
provided by operating activities:
Provision for loan losses 212,448 168,481
Depreciation and amortization, net 69,774 27,188
Stock compensation plans 63,035 15,115
Decrease in interest receivable 2,842 43,051
Increase in accounts receivable from securitizations (275,885) (37,405)
Increase in other assets (80,916) (30,443)
Increase (decrease) in interest payable 11,403 (14,564)
Increase in other liabilities 183,638 148,582
- -------------------------------------------------------------- -------------------------------------
Net cash provided by operating activities 388,901 451,169
- -------------------------------------------------------------- -------------------------------------
Investing Activities:
Purchases of securities available for sale (761,670) (914,194)
Proceeds from maturities of securities available for sale 626,749 250,667
Proceeds from sales of securities available for sale 112,279 523,867
Proceeds from securitizations of consumer loans 3,322,892 1,733,669
Net increase in consumer loans (4,281,127) (1,878,797)
Recoveries of loans previously charged off 47,567 19,250
Additions of premises and equipment, net (118,545) (45,629)
- -------------------------------------------------------------- -------------------------------------
Net cash used for investing activities (1,051,855) (311,167)
- -------------------------------------------------------------- -------------------------------------
Financing Activities:
Net increase in interest-bearing deposits 284,681 106,992
Net increase (decrease) in other borrowings 530,699 (209,520)
Issuances of senior notes 1,258,700 480,000
Maturities of senior and deposit notes (1,163,162) (866,436)
Issuances of preferred beneficial interests 97,428
Dividends paid (15,371) (15,512)
Purchases of treasury stock (69,652) (35,915)
Net proceeds from issuances of common stock 5,731 3,678
Proceeds from exercise of stock options 6,572 2,921
- -------------------------------------------------------------- ----------------- -------------------
Net cash provided by (used for) financing activities 838,198 (436,364)
- -------------------------------------------------------------- ----------------- -------------------
Increase (decrease) in cash and cash equivalents 175,244 (296,362)
Cash and cash equivalents at beginning of period 237,723 528,976
- -------------------------------------------------------------- ----------------- -------------------
Cash and cash equivalents at end of period $ 412,967 $ 232,614
- -------------------------------------------------------------- ----------------- -------------------
</TABLE>
See notes to the condensed consolidated financial statements.
<PAGE>
CAPITAL ONE FINANCIAL CORPORATION
Notes to the Condensed Consolidated Financial Statements
September 30, 1998
(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 have been
prepared in accordance with generally accepted accounting principles ("GAAP")
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 GAAP 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 GAAP
requires management to make estimates and assumptions that affect the amounts
reported in the financial statements and accompanying notes. Actual results
could differ from these estimates. Operating results for the three and nine
months ended September 30, 1998 are not necessarily indicative of the results
for the year ending December 31, 1998. The notes to the consolidated financial
statements contained in the Annual Report on Form 10-K for the year ended
December 31, 1997 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 1998 presentation.
Note B: Significant Accounting Policies
Cash and Cash Equivalents
Cash paid for interest for the nine months ended September 30, 1998 and
1997 was $289,064 and $260,388, respectively. Cash paid for income taxes for the
nine months ended September 30, 1998 and 1997 was $170,806 and $94,295,
respectively.
Consumer Loans
In the fourth quarter of 1997, the Company recognized the estimated
uncollectible portion of finance charge and fee income receivables. In addition,
in the fourth quarter of 1997, the Company modified its methodology for charging
off credit card loans (net of any collateral) to 180 days past-due, from the
prior practice of charging off loans during the next billing cycle after
becoming 180 days past-due.
Earnings Per Share
In February 1997, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings
per Share" ("SFAS 128") which became effective for periods ending after December
15, 1997, including interim periods. SFAS 128 replaced the calculation of
primary and fully diluted earnings per share with basic and diluted earnings per
share. Unlike primary earnings per share, basic earnings per share is based only
on the weighted average number of common shares outstanding, excluding any
dilutive effects of options and restricted stock. Diluted earnings per share is
similar to the previously reported fully diluted earnings per share and is based
on the weighted average number of common and common equivalent shares, including
dilutive stock options and restricted stock outstanding during the year.
Earnings per share amounts for all prior periods have been restated to conform
to SFAS 128 requirements.
<PAGE>
Comprehensive Income
As of January 1, 1998, the Company adopted SFAS No. 130, "Reporting
Comprehensive Income" ("SFAS 130"), which establishes new rules for the
reporting and display of comprehensive income and its components. SFAS 130
requires unrealized gains or losses on available-for-sale securities and foreign
currency translation adjustments, which prior to adoption were reported
separately in stockholders' equity, to be included in other comprehensive
income. The adoption of SFAS 130 had no impact on the Company's net income or
stockholders' equity. Prior year amounts have been reclassified to conform to
SFAS 130 requirements.
Note C: Borrowings
In July 1998, the Corporation filed a Shelf Registration Statement on
Form S-3 with the Securities and Exchange Commission for the issuance of up to
$425,000 aggregate principal amount of senior and subordinated debt, preferred
stock and common stock, which was declared effective on July 14, 1998. In July
1998, the Corporation issued $200,000 of 10 year unsecured senior notes under
this shelf registration. Existing unsecured senior debt outstanding of the
Corporation under a prior shelf registration of $200,000 totals $125,000
maturing in 2003.
Note D: Comprehensive Income
Comprehensive income for the three months ended September 30, 1998 and 1997 was
as follows:
<TABLE>
<CAPTION>
Three Months Ended
September 30
- --------------------------------------- ------------------------------------
1998 1997
- --------------------------------------- ------------------- ----------------
<S> <C> <C>
Comprehensive Income:
Net income $ 70,006 $ 49,330
Other comprehensive income 28,103 1,422
- --------------------------------------- ------------------- ----------------
Total comprehensive income $ 98,109 $ 50,752
- --------------------------------------- ------------------- ----------------
</TABLE>
Note E: Stock Repurchase
In July 1998, the Company's Board of Directors voted to repurchase up to an
additional 1.5 million shares of the Company's common stock over the next two
years, pursuant to the repurchase program initially adopted in July 1997, in
order to mitigate the dilutive impact of shares issuable under its benefits
plans, including its Associate Stock Purchase Plan, dividend reinvestment plan,
stock incentive plans and other benefit plans.
<PAGE>
Note F: Earnings Per Share
The following table sets forth the computation of basic and diluted earnings per
share:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30 September 30
- ------------------------------------------------ ---------------------------- ---------------------------
(shares in thousands) 1998 1997 1998 1997
- ------------------------------------------------ -------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Numerator:
Net income $ 70,006 $ 49,330 $ 202,562 $ 131,164
Denominator:
Denominator for basic earnings per share -
Weighted-average shares 65,726 66,185 65,565 66,315
Effect of dilutive securities:
Stock options 4,286 1,385 3,739 1,353
Restricted stock 3 2 4
- ------------------------------------------------ -------------- ------------- ------------- -------------
Dilutive potential common shares 4,286 1,388 3,741 1,357
Denominator for diluted earnings per share -
Adjusted weighted-average shares 70,012 67,573 69,306 67,672
- ------------------------------------------------ -------------- ------------- ------------- -------------
Basic earnings per share $ 1.07 $ 0.75 $ 3.09 $ 1.98
- ------------------------------------------------ -------------- ------------- ------------- -------------
Diluted earnings per share $ 1.00 $ 0.73 $ 2.92 $ 1.94
- ------------------------------------------------ -------------- ------------- ------------- -------------
</TABLE>
Note G: Purchase of Summit Acceptance Corporation
In July 1998, the Company acquired Summit Acceptance Corporation
("Summit"), based in Dallas, Texas. Summit is a subprime automobile finance
lender with approximately 180 employees and serviced loans of approximately
$263,000 as of the purchase date. The acquisition price for Summit was $53,585
which was paid through the issuance of the Company's stock on July 31, 1998. The
acquisition was accounted for as a purchase business combination and goodwill of
approximately $68,000 will be amortized over 15 years.
Note H: Commitments and Contingencies
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 (which has since been acquired by First Union
Bank on November 30, 1997) for certain liabilities incurred in litigation
arising from that business, which may include liabilities, if any, incurred in
the purported class action case described below.
During 1995, the Company and the Bank became involved in a purported
class action suit relating to certain collection practices engaged in by Signet
Bank and, subsequently, by the Bank. The complaint in this case alleges that
Signet Bank and/or the Bank violated a variety of California state statutes and
constitutional and common law duties by filing collection lawsuits, obtaining
judgements and pursuing garnishment proceedings in the Virginia state courts
against defaulted credit card customers who were not residents of Virginia. This
case was filed in the Superior Court of California in the County of Alameda,
Southern Division, on behalf of a class of California residents. The complaint
in this case seeks unspecified statutory damages, compensatory damages, punitive
damages, restitution, attorneys' fees and costs, a permanent injunction and
other equitable relief.
In February 1997, the California court entered judgement in
favor of the Bank on all of the plaintiffs' claims. The plaintiffs have appealed
the ruling to the California Court of Appeal First Appellate District Division
4, and the appeal is pending.
Because no specific measure of damages is demanded in the complaint of
the California case and the trial court entered judgement in favor of the Bank
before the parties completed any significant discovery, an informed assessment
of the ultimate outcome of this case cannot be made at this time. Management
believes, however, that there are meritorious defenses to this lawsuit and
intends to continue to defend it 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 management, 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 I: Recent Accounting Pronouncements
In June 1998, the FASB issued SFAS No. 133 "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133"), which is required to be
adopted in years beginning after June 15, 1999. SFAS 133 permits early adoption
as of the beginning of any fiscal quarter after its issuance. SFAS 133 will
require the Company to recognize all derivatives on the balance sheet at fair
value. Derivatives that are not hedges must be adjusted to fair value through
income. If the derivative is a hedge, depending on the nature of the hedge,
changes in the fair value of derivatives will either be offset against the
change in fair value of the hedged assets, liabilities, or firm commitments
through earnings or recognized in other comprehensive income until the hedged
item is recognized in earnings. The ineffective portion of a derivative's change
in fair value will be immediately recognized in earnings. The Company has not
yet determined what the effect of SFAS 133 will be on the earnings and financial
position of the Company.
<PAGE>
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." As of September 30,
1998, the Company had 14.9 million customers and $16.3 billion in managed
consumer loans outstanding and was one of the largest providers of MasterCard
and Visa credit cards in the world. The Corporation's common stock trades on the
New York Stock Exchange under the symbol "COF" and is included in the S&P 500
Index. The Company's profitability is affected by the net interest income and
non-interest income earned on earning assets, consumer usage patterns, credit
quality, the level of marketing expense and operating efficiency.
Earnings Summary
Net income for the three months ended September 30, 1998 of
$70.0 million, or $1.00 per share, compares to net income of $49.3 million, or
$.73 per share, for the same period in 1997. All earnings per share amounts are
reported on a diluted basis.
The increase in net income is primarily a result of an increase in
asset and account volumes and rates. Net interest income increased $79.9
million, or 82%, as the net interest margin increased to 9.77% from 7.02% and
average earning assets increased by 31%. The provision for loan losses decreased
$4.9 million, or 7% as the reported net charge-off rate decreased to 4.04% from
4.57%. Non-interest income increased $106.0 million, or 38%, primarily as a
result of the increase in average managed accounts of 40%. Marketing expense
increased $65.7 million, or 108%, to $126.5 million as the Company continues to
invest in new product opportunities. Increases in salaries and associate
benefits expense of $42.9 million, or 59%, and other non-interest expense
(excluding marketing) of $48.9 million, or 53%, primarily reflected the cost of
operations to manage the growth in accounts and the change in product mix. Each
component is discussed in further detail in subsequent sections of this
analysis.
Net income for the nine months ended September 30, 1998 was
$202.6 million, or $2.92 per share, compared to net income of $131.2 million, or
$1.94 per share, for the same period in 1997. This 54% increase primarily
reflected the increases in asset and account volumes accompanied by an increase
in net interest margin as discussed above. Each component is discussed in
further detail in subsequent sections of this analysis.
<PAGE>
Managed Consumer Loan Portfolio
The Company analyzes its financial performance on a managed consumer
loan portfolio basis. Managed consumer loan data adds back the effect of
off-balance sheet consumer loans. The Company also evaluates its interest rate
exposure on a managed portfolio basis.
The Company's managed consumer loan portfolio is comprised of
on-balance sheet loans and loans held for securitization (collectively,
"reported loans"), and off-balance sheet loans. Securitized loans are not assets
of the Company and, therefore, are not shown on the balance sheet.
Table 1 summarizes the Company's managed consumer loan portfolio.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------
TABLE 1 - MANAGED CONSUMER LOAN PORTFOLIO
- --------------------------------------------------------------------------------------------------
Three Months Ended
September 30
- ------------------------------------------------------ -------------------- ---------------------
(in thousands) 1998 1997
- ------------------------------------------------------ -------------------- ---------------------
<S> <C> <C>
Period-End Balances:
On-balance sheet consumer loans $ 5,666,998 $ 4,329,799
Off-balance sheet consumer loans 10,670,791 9,142,796
- ------------------------------------------------------ -------------------- ---------------------
Total managed consumer loan portfolio $ 16,337,789 $ 13,472,595
- ------------------------------------------------------ -------------------- ---------------------
Average Balances:
On-balance sheet consumer loans $ 5,623,012 $ 3,847,150
Off-balance sheet consumer loans 10,123,079 9,070,817
- ------------------------------------------------------ -------------------- ---------------------
Total average managed consumer loan portfolio $ 15,746,091 $ 12,917,967
- ------------------------------------------------------ -------------------- ---------------------
Nine Months Ended
September 30
- ------------------------------------------------------ -------------------- ---------------------
(in thousands) 1998 1997
- ------------------------------------------------------ -------------------- ---------------------
Average Balances:
Consumer loans held for securitization $ 132,146
On-balance sheet consumer loans $ 5,210,649 3,834,547
Off-balance sheet consumer loans 9,548,182 8,765,192
- ------------------------------------------------------ -------------------- ---------------------
Total average managed consumer loan portfolio $ 14,758,831 $ 12,731,885
- ------------------------------------------------------ -------------------- ---------------------
</TABLE>
Since 1990, the Company has actively engaged in consumer loan
securitization transactions. In accordance with SFAS No. 125 "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities"
("SFAS 125"), the Company records gains or losses on the securitization of
consumer loan receivables based on the estimated fair value of assets sold and
retained and liabilities incurred in the sale. Gains represent the present value
of estimated excess net cash flows the Company has retained over the estimated
outstanding period of the receivables and are included in servicing and
securitizations income. This excess cash flow essentially represents an
"interest only" ("I/O") strip, consisting of the excess finance charges and
past-due fees over the sum of the return paid to certificateholders, estimated
contractual servicing fees and credit losses. However, exposure to credit losses
on the securitized loans is contractually limited to these excess cash flows.
Certain estimates inherent in the determination of the fair value of the I/O
strip are influenced by factors outside the Company's control, and as a result,
such estimates could materially change in the near term. Any future gains that
will be recognized in accordance with SFAS 125 will be dependent on the timing
and amount of future securitizations. The Company will continuously assess the
performance of new and existing securitization transactions as estimates of
future cash flows change.
<PAGE>
Table 2 indicates the impact of off-balance sheet consumer loans on
average earning assets, net interest margin and loan yield for the periods
presented. The Company intends to continue to securitize consumer loans.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------
TABLE 2 - OPERATING DATA AND RATIOS
- -------------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30 September 30
- ----------------------------- ------------------ ------------------ ------------------ ---------------
(dollars in thousands) 1998 1997 1998 1997
- ----------------------------- ------------------ ------------------ ------------------ ---------------
<S> <C> <C> <C> <C>
Reported:
Average earning assets $ 7,249,179 $ 5,537,280 $ 6,998,626 $ 5,558,685
Net interest margin(1) 9.77% 7.02% 9.75% 6.44%
Loan yield 18.45 15.95 18.78 14.90
- ----------------------------- ------------------ ------------------ ------------------ ---------------
Managed:
Average earning assets $ 17,372,258 $ 14,608,097 $ 16,546,808 $ 14,323,877
Net interest margin(1) 10.15% 9.05% 10.13% 8.73%
Loan yield 17.06 16.06 17.11 15.56
- ------------------------------------------------------------------------------------------------------
</TABLE>
(1) Net interest margin is equal to net interest income divided by average
earning assets.
Risk Adjusted Revenue and Margin
In originating its consumer loan portfolio, the Company has and
continues to pursue a low introductory interest rate strategy with accounts
repricing to higher rates after six to 18 months from the date of origination.
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 consumer performance. Recently, the Company has marketed low
non-introductory rate cards to customers with the best established credit
profiles. These low introductory rate and low non-introductory rate products
typically have a balance transfer feature under which consumers can transfer
balances to the Company from their other obligations. 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 interest rate strategies. Management believes that the
competition has put, and will continue to put, additional pressure on interest
rate strategies.
By applying its information-based strategies ("IBS") and in response to
dynamic competitive pressures, the Company also targets a significant amount of
its marketing expense to other credit card product opportunities. Examples of
such products include secured cards and other customized card products including
affinity and co-branded cards, student cards and other cards targeted to certain
markets that are underserved by the Company's competitors. These products do not
have the immediate impact on managed loan balances of the balance transfer
products but typically consist of lower credit limit accounts and balances that
build over time. The terms of these customized card products tend to include
annual membership fees and higher annual finance charge rates. The profile of
the consumers targeted for these products, in some cases, may also tend to
result in higher delinquency and consequently higher past-due and overlimit fees
as a percentage of loan receivables outstanding than the balance transfer
products.
The Company's products are designed with the 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 percentage of average earning assets. It considers not
only the loan yield and net interest margin, but also the fee income associated
with these products. By deducting net charge-offs, consideration is given to the
risk inherent in these differing products.
<PAGE>
Table 3 provides income statement data and ratios for the Company's
managed consumer loan portfolio. The causes of increases and decreases in the
various components of risk adjusted revenue are discussed in further detail in
subsequent sections of this analysis.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------
TABLE 3 - MANAGED RISK ADJUSTED REVENUE
- ----------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30 September 30
- ----------------------------------------------------------------------------------------------------
(dollars in thousands) 1998 1997 1998 1997
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Managed Income Statement:
Net interest income $ 440,760 $ 330,670 $ 1,256,976 $ 937,691
Non-interest income 264,592 202,490(1) 738,519 529,124(1)
Net charge-offs (198,069) (215,041) (623,792) (601,074)
- ---------------------------- ----------------- ----------------- ----------------- -----------------
Risk adjusted revenue $ 507,283 $ 318,119 $ 1,371,703 $ 865,741
- ---------------------------- ----------------- ----------------- ----------------- -----------------
Ratios(2):
Net interest margin 10.15% 9.05% 10.13% 8.73%
Non-interest income 6.09 5.54 5.95 4.93
Net charge-offs (4.56) (5.88) (5.03) (5.60)
- ---------------------------- ----------------- ----------------- ----------------- -----------------
Risk adjusted margin 11.68% 8.71% 11.05% 8.06%
- ---------------------------- ----------------- ----------------- ----------------- -----------------
</TABLE>
(1) Excludes the $16 million incremental impact on credit card securitization
income resulting from the implementation of SFAS 125.
(2) As a percentage of average managed earning assets.
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 includes interest-bearing deposits, other borrowings and borrowings from
senior and deposit notes.
Reported net interest income for the three months ended September 30,
1998 was $177.1 million, compared to $97.2 million for the same period in the
prior year, representing an increase of $79.9 million, or 82%. For the nine
months ended September 30, 1998, net interest income was $511.6 million compared
to $268.6 million for the same period in 1997, representing an increase of
$243.0 million, or 90%. Average earning assets increased 31% and 26% for the
three and nine months ended September 30, 1998, respectively, versus the same
periods in 1997. The yield on earning assets increased 269 and 314 basis points
for the three and nine months ended September 30, 1998, respectively, to 15.62%
from 12.93% and to 15.48% from 12.34% as compared to the same periods in the
prior year. The increase was primarily attributable to a 250 and 388 basis point
increase in the yield on consumer loans for the three and nine months ended
September 30, 1998, respectively, to 18.45% from 15.95% and to 18.78% from
14.90%, respectively, as compared to the same periods in the prior year. The
yield on consumer loans increased due to an increase in the amount and frequency
of past-due fees charged as compared to the same period in the prior year and
the Company's continued shift to higher yielding products, especially in the
reported loan portfolio, during the comparable periods.
<PAGE>
Table 4 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 and nine months ended September 30, 1998 and 1997.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------
TABLE 4 - STATEMENTS OF AVERAGE BALANCES, INCOME AND EXPENSE, YIELDS AND RATES
- ---------------------------------------------------------------------------------------------------------------------
Three Months Ended September 30
- ------------------------------------- -------------------------------------------------------------------------------
1998 1997
- ------------------------------------- -------------------------------------------------------------------------------
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) $5,623,012 $259,339 18.45% $3,847,150 $153,377 15.95%
Federal funds sold and
resale agreements 69,293 957 5.52 255,594 3,753 5.87
Other 1,556,874 22,813 5.86 1,434,536 21,840 6.09
- ------------------------------------- -------------- ------------ ---------- --------------- ------------ ----------
Total earning assets 7,249,179 $283,109 15.62% 5,537,280 $178,970 12.93%
Cash and due from banks 2,182 114,882
Allowance for loan losses (216,000) (123,250)
Premises and equipment, net 202,887 184,272
Other assets 1,268,047 843,326
- ------------------------------------- -------------- ------------ ---------- --------------- ------------ ----------
Total assets $8,506,295 $6,556,510
- ------------------------------------- -------------- ------------ ---------- --------------- ------------ ----------
Liabilities and Equity:
Interest-bearing liabilities
Deposits $1,368,833 $ 15,805 4.62% $ 851,916 $ 9,052 4.25%
Other borrowings 1,495,731 24,752 6.62 594,519 9,168 6.17
Senior and deposit notes 3,819,061 65,498 6.86 3,686,416 63,596 6.90
- ------------------------------------- -------------- ------------ ---------- --------------- ------------ ----------
Total interest-bearing liabilities 6,683,625 $106,055 6.35% 5,132,851 $ 81,816 6.38%
Other liabilities 575,510 485,218
- ------------------------------------- -------------- ------------ ---------- --------------- ------------ ----------
Total liabilities 7,259,135 5,618,069
Preferred beneficial interests 97,825 97,568
Equity 1,149,335 840,873
- ------------------------------------- -------------- ------------ ---------- --------------- ------------ ----------
Total liabilities and equity $8,506,295 $6,556,510
- ------------------------------------- -------------- ------------ ---------- --------------- ------------ ----------
Net interest spread 9.27% 6.55%
- ------------------------------------- -------------- ------------ ---------- --------------- ------------ ----------
Interest income to
average earning assets 15.62% 12.93%
Interest expense to
average earning assets 5.85 5.91
- ------------------------------------- -------------- ------------ ---------- --------------- ------------ ----------
Net interest margin 9.77% 7.02%
- ------------------------------------- -------------- ------------ ---------- --------------- ------------ ----------
</TABLE>
(1)Interest income includes past-due fees on loans of approximately $73,198 and
$39,123 for the three months ended September 30, 1998 and 1997, respectively.
<PAGE>
<TABLE>
<CAPTION>
Nine Months Ended September 30
- -------------------------------------------------------------------------------------------------------------------
1998 1997
- -------------------------------------------------------------------------------------------------------------------
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) $5,210,649 $ 734,106 18.78% $3,966,693 $443,374 14.90%
Federal funds sold and
resale agreements 193,341 8,175 5.64 289,363 12,030 5.54
Other 1,594,636 70,308 5.88 1,302,629 59,030 6.04
- ------------------------------------- ------------- ------------- ----------- --------------- ----------- ----------
Total earning assets 6,998,626 $812,589 15.48% 5,558,685 $514,434 12.34%
Cash and due from banks 11,414 104,136
Allowance for loan losses (208,778) (120,637)
Premises and equipment, net 186,271 182,265
Other assets 1,064,351 778,536
- ------------------------------------- ------------- ------------- ----------- --------------- ----------- ----------
Total assets $8,051,884 $6,502,985
- ------------------------------------- ------------- ------------- ----------- --------------- ----------- ----------
Liabilities and Equity:
Interest-bearing liabilities
Deposits $1,276,512 $ 43,578 4.55% $ 887,019 $ 28,124 4.23%
Other borrowings 1,298,768 61,180 6.28 567,425 26,145 6.14
Senior and deposit notes 3,803,117 196,231 6.88 3,754,264 191,555 6.80
- ------------------------------------- ------------- ------------- ----------- --------------- ----------- ----------
Total interest-bearing liabilities 6,378,397 $ 300,989 6.29% 5,208,708 $ 245,824 6.29%
Other liabilities 529,398 406,167
Total liabilities 6,907,795 5,614,875
Preferred beneficial interests 97,761 86,798
Equity 1,046,328 801,312
- ------------------------------------- ------------- ------------- ----------- --------------- ----------- ----------
Total liabilities and equity $8,051,884 $6,502,985
- ------------------------------------- ------------- ------------- ----------- --------------- ----------- ----------
Net interest spread 9.19% 6.05%
- ------------------------------------- ------------- ------------- ----------- --------------- ----------- ----------
Interest income to
average earning assets 15.48% 12.34%
Interest expense to
average earning assets 5.73 5.90
- ------------------------------------- ------------- ------------- ----------- --------------- ----------- ----------
Net interest margin 9.75% 6.44%
- ------------------------------------- ------------- ------------- ----------- --------------- ----------- ----------
</TABLE>
(1) Interest income includes past-due fees on loans of approximately $221,849
and $89,336 for the nine months ended September 30, 1998 and 1997,
respectively.
Managed net interest income increased $110.1 million, or 33%,
and $319.3 million, or 34%, for the three and nine months ended September 30,
1998, respectively, compared to the same periods in the prior year. The
increases in managed net interest income were the result of managed average
earning assets increasing 19% and 16% and the managed net interest margin
increasing 110 basis points and 140 basis points to 10.15% and 10.13% for the
three and nine months ended September 30, 1998, respectively. The increase in
managed net interest margin principally reflects increases in the amount and
frequency of past-due fees and growth in higher yielding loans.
<PAGE>
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 5 sets forth
the dollar amount of the increases (decreases) 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>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------
TABLE 5 - INTEREST VARIANCE ANALYSIS
- -----------------------------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30, 1998 vs 1997 September 30, 1998 vs 1997
- -----------------------------------------------------------------------------------------------------------------------
Increase Change due to(1) Increase Change due to(1)
(in thousands) (Decrease) Volume Yield/Rate (Decrease) Volume Yield/Rate
- ---------------------------------- ------------- ------------ -------------- -------------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Interest Income:
Consumer loans $ 105,962 $ 79,088 $26,874 $ 290,732 $ 158,825 $ 131,907
Federal funds sold and
resale agreements (2,796) (2,585) (211) (3,855) (4,187) 332
Other 973 5,229 (4,256) 11,278 13,863 (2,585)
- ---------------------------------- ------------- ------------ -------------- -------------- ------------- -------------
Total interest income 104,139 62,216 41,923 298,155 150,371 147,784
Interest Expense:
Deposits 6,753 5,909 844 15,454 13,156 2,298
Other borrowings 15,584 14,867 717 35,035 34,438 597
Senior and deposit notes 1,902 4,201 (2,299) 4,676 2,508 2,168
- ---------------------------------- ------------- ------------ -------------- -------------- ------------- -------------
Total interest expense 24,239 26,788 (2,549) 55,165 55,217 (52)
- ---------------------------------- ------------- ------------ -------------- -------------- ------------- -------------
Net interest income(1) $ 79,900 $ 35,228 $44,672 $ 242,990 $ 81,557 $161,433
- ---------------------------------- ------------- ------------ -------------- -------------- ------------- -------------
</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 table. The totals for the volume and
yield/rate columns are not the sum of the individual lines.
Servicing and Securitizations Income
Servicing and securitizations income increased $36.7 million and $42.2
million, or 20% and 8%, for the three and nine months ended September 30, 1998,
respectively, from the same periods in the prior year due to average securitized
loans increasing 12% and 9% over the same periods, coupled with decreasing
losses in the off-balance sheet portfolio for the three months ended September
30, 1998, which resulted in increasing estimated future spreads. Also impacting
servicing and securitizations income in the first nine months of 1998 was the
current recognition of estimated uncollectible finance charge and fee income
receivables implemented in the fourth quarter of 1997.
Other Non-Interest Income
Other reported non-interest income including service charges and other
fees and interchange, increased to $169.9 million and $490.6 million, or 69% and
93%, for the three and nine months ended September 30, 1998, respectively,
compared to $100.6 million and $254.1 million for the same periods in the prior
year. The increase in other non-interest income was due to an increase in the
average number of accounts of 40% and 39% for the three and nine months ended
September 30, 1998, respectively, compared to the same periods in the prior year
and the Company's continued shift to more fee-based accounts, especially in the
reported loan portfolio during the comparable periods.
Managed non-interest income increased to $264.6 million and $738.5
million, or 31% and 40%, for the three and nine months ended September 30, 1998,
respectively, due to the increase in the average number of accounts and
increases in the amount and frequencies of fees (including annual membership,
interchange and overlimit) assessed on accounts.
Non-Interest Expense
Non-interest expense for the three months ended September 30, 1998 was
$383.5 million, an increase of $157.5 million, or 70%, over $226.0 million for
the same period in the prior year. Contributing to the increase was marketing
expense which increased $65.7 million, or 108%, to $126.5 million for the three
months ended September 30, 1998 from $60.8 million for the same period in the
prior year, as the Company continued to invest in new product opportunities,
including a $23.1 million investment in the Company's marketing of
telecommunications services, as described under "Business Outlook." Salaries and
associate benefits increased $42.9 million, or 59%, to $116.1 million for the
three months ended September 30, 1998 from $73.2 million for the same period in
the prior year. All other non-interest expense increased $48.9 million, or 53%,
to $140.9 million from $92.0 million for the same period in the prior year. The
increase in other non-interest expense, as well as, the increase in salaries and
benefits expense, was primarily the result of a 40% increase in the average
number of accounts for the three months ended September 30, 1998, and a
continued shift in product mix to more service-intensive accounts, which
resulted in an increase in infrastructure and other operational costs.
Non-interest expense for the nine months ended September 30, 1998 was $1.0
billion, an increase of $362.6 million, or 57%, over $641.6 million for the same
period in the prior year. Contributing to the increase was marketing expense
which increased $127.5 million, or 80%, to $287.3 million for the nine months
ended September 30, 1998 from $159.8 million for the same period in the prior
year, as the Company continued to invest in new product opportunities. Salaries
and associate benefits increased $124.4 million, or 58%, to $337.5 million for
the nine months ended September 30, 1998 from $213.1 million for the same period
in the prior year. This increase reflects an additional $48.0 million in
compensation expense associated with the Company's associate stock plans as
compared to the same period in the prior year. All other non-interest expense
increased $110.8 million, or 41%, to $379.5 million for the nine months ended
September 30, 1998 from $268.6 million for the same period in the prior year.
The increase in other non-interest expense, as well as, the increase in salaries
and benefits expense not attributed to options, was primarily the result of a
39% increase in the average number of accounts for the nine months ended
September 30, 1998.
Income Taxes
The Company's income tax rate was 38% for the three and nine months
ended September 30, 1998 and 1997 and includes both state and federal income tax
components.
Asset Quality
The asset quality of a portfolio is generally a function of the initial
underwriting criteria used, seasoning of the accounts, levels of competition,
account management activities and demographic concentration, as well as general
economic conditions. The seasoning of the accounts is also an important
indicator of the delinquency and loss levels of the portfolio. Generally,
accounts tend to exhibit a rising trend of delinquency and credit losses as they
season.
<PAGE>
Delinquencies
Table 6 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 payment due date. However, the Company
generally continues to accrue interest until the loan is charged off.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------
TABLE 6 - DELINQUENCIES
- ---------------------------------------------------------------------------------------
September 30
- ---------------------------------------------------------------------------------------
1998 1997
- ---------------------------------------------------------------------------------------
% of % of
(dollars in thousands) Loans Total Loans Loans Total Loans
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Reported:
Loans outstanding $ 5,666,998 100.00% $ 4,329,799 100.00%
Loans delinquent:
30-59 days 118,384 2.09 81,929 1.89
60-89 days 64,980 1.14 49,686 1.15
90 or more days 103,084 1.82 99,572 2.30
- ------------------------ ----------------- --------------- --------------- ------------
Total $ 286,448 5.05% $ 231,187 5.34%
- ------------------------ ----------------- --------------- --------------- ------------
Managed:
Loans outstanding $16,337,789 100.00% $13,472,595 100.00%
Loans delinquent:
30-59 days 313,443 1.92 286,194 2.12
60-89 days 178,883 1.09 177,434 1.32
90 or more days 308,285 1.89 393,070 2.92
- ------------------------ ----------------- --------------- --------------- ------------
Total $ 800,611 4.90% $ 856,698 6.36%
- ------------------------ ----------------- --------------- --------------- ------------
</TABLE>
In the fourth quarter of 1997, the Company modified its methodology for
charging off credit card loans (net of any collateral) to 180 days past-due from
the prior practice of charging off loans during the next billing cycle after
becoming 180 days past-due. In addition, in the fourth quarter of 1997, the
Company recognized the estimated uncollectible portion of finance charge and fee
income receivables. The delinquency rate for reported loans was 5.05% as of
September 30, 1998, down from 5.34% as of September 30, 1997 and up from 5.03%
as of June 30, 1998. The delinquency rate for the managed consumer loan
portfolio was 4.90% as of September 30, 1998, down from 6.36% as of September
30, 1997 and down from 5.14% as of June 30, 1998. During the three months ended
September 30, 1998, the Company's reported portfolio experienced an increase in
higher yielding accounts and more seasoned accounts as newer loans were
securitized. Both the managed and reported portfolio's delinquency rate decrease
as of September 30, 1998, as compared to September 30, 1997, reflected
seasonality and improvements in consumer credit performance, as well as the
impact from previous modifications in charge-off policy and finance charge and
fee income recognition.
<PAGE>
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 7 shows the Company's net charge-offs for the periods
presented on a reported and managed basis.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------
TABLE 7 - NET CHARGE-OFFS (1)
- -------------------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30 September 30
- -------------------------------------------------------------------------------------------------------------
(dollars in thousands) 1998 1997 1998 1997
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Reported:
Average loans outstanding $ 5,623,012 $ 3,847,150 $ 5,210,649 $ 3,966,693
Net charge-offs 56,726 43,967 171,704 139,901
Net charge-offs as a percentage
of average loans outstanding 4.04% 4.57% 4.39% 4.70%
- ---------------------------------------- ----------------- ----------------- ----------------- --------------
Managed:
Average loans outstanding $15,746,091 $12,917,967 $14,758,831 $12,731,885
Net charge-offs 198,069 215,041 623,792 601,074
Net charge-offs as a percentage
of average loans outstanding 5.03% 6.66% 5.64% 6.29%
- ---------------------------------------- ----------------- ----------------- ----------------- --------------
(1) Includes consumer loans held for securitization.
</TABLE>
The managed net charge-off rate decreased 163 basis points and 65 basis
points to 5.03% and 5.64% for the three and nine months ended September 30,
1998, respectively from 6.66% and 6.29% for the comparable periods in the prior
year. The reported net charge-off rate decreased 53 basis points and 31 basis
points to 4.04% and 4.39% for the three and nine months ended September 30,
1998, respectively, from 4.57% and 4.70% for the comparable periods in the prior
year. The decreases in managed and reported net charge-off rates were the result
of improved general economic trends in consumer credit performance compared to
the same periods in the prior year, with less of an impact on the reported
charge-offs due to the increased level of seasoned and higher yielding products
included in the on-balance sheet portfolio.
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) at 180 days past-due, although
earlier charge-offs may occur on accounts of bankrupt or deceased consumers.
Bankrupt consumers' accounts are generally charged off within 30 days after
receipt of the bankruptcy petition. Once a loan is charged off, it is the
Company's policy to continue to pursue the collection of principal, interest and
fees for non-bankrupt accounts.
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 8 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>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------
TABLE 8 - SUMMARY OF ALLOWANCE FOR LOAN LOSSES
- ----------------------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30 September 30
- ----------------------------------------------------------------------------------------------------------------
(dollars in thousands) 1998 1997 1998 1997
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Balance at beginning of period $ 213,000 $ 118,500 $ 183,000 $ 118,500
Provision for loan losses 67,569 72,518 212,448 168,481
Transfer to loans held for securitization (2,625)
Increase from Summit acquisition 6,720 6,720
Other 437 (51) 536 (80)
Charge-offs (74,885) (52,697) (219,271) (156,526)
Recoveries 18,159 8,730 47,567 19,250
Net charge-offs(1) (56,726) (43,967) (171,704) (137,276)
Balance at end of period $ 231,000 $147,000 $ 231,000 $ 147,000
- --------------------------------------------------- --------------- -------------- -------------- --------------
Allowance for loan losses to loans at period-end 4.08% 3.40% 4.08% 3.40%
- --------------------------------------------------- --------------- -------------- -------------- --------------
</TABLE>
(1) Excludes consumer loans held for securitization.
For the three months ended September 30, 1998, the provision for loan
losses decreased 7% to $67.6 million from $72.5 million for the same period in
the prior year as the reported net charge-off rate decreased to 4.04% from
4.57%, offset by the increase in average reported loans of 46%. For the nine
months ended September 30, 1998, the provision for loan losses increased 26% to
$212.4 million from $168.5 million for the comparable period in the prior year,
as average reported loans increased by 31%. The allowance for loan losses as a
percentage of on-balance sheet consumer loans increased to 4.08% as of September
30, 1998, from 3.40% as of September 30, 1997 due to the change in mix of its
reported loan portfolio. The increase in the allowance for loan losses also
reflects the increase in on-balance sheet loans to $5.7 billion as of September
30, 1998, an increase of 31% from September 30, 1997.
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 1998 to 2008 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.
Additionally, the Company maintains a portfolio of high-quality
securities such as U.S. Treasuries, U.S. Government Agency and mortgage-backed
securities, commercial paper, interest-bearing deposits with other banks,
federal funds and other cash equivalents in order to provide adequate liquidity
and to meet its ongoing cash needs. As of September 30, 1998, the Company held
$1.7 billion in such securities.
<PAGE>
Table 9 shows the maturation of certificates of deposit in
denominations of $100,000 or greater ("large denomination CDs") as of September
30, 1998.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
TABLE 9 - MATURITIES OF LARGE DENOMINATION CERTIFICATES-$100,000 OR MORE
- -------------------------------------------------------------------------------
September 30, 1998
- -------------------------------------------------------------------------------
(dollars in thousands) Balance Percent
- -------------------------------------------------------------------------------
<S> <C> <C>
3 months or less $ 90,350 30.01%
Over 3 through 6 months 38,832 12.90
Over 6 through 12 months 23,083 7.67
Over 1 through 5 years 148,801 49.42
- -------------------------------- -------------------------- -------------------
Total $ 301,066 100.00%
- -------------------------------- -------------------------- -------------------
</TABLE>
The Company's other borrowings portfolio consists of $1.4 billion in
borrowings maturing within one year and $26.1 million in borrowings maturing
after one year.
Table 10 shows the Company's unsecured funding availability and
outstandings as of September 30, 1998.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------
TABLE 10 - FUNDING AVAILABILITY
- --------------------------------------------------------------------------------------------------------
September 30, 1998
- --------------------------------------------------------------------------------------------------------
Effective/ Outstanding, Final
(dollars or dollar equivalents in millions) Issue Date Availability(1) Net Maturity
- --------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Domestic revolving credit facility 11/96 $ 1,700 11/00
UK/Canada revolving credit facility 8/97 350 $ 146 8/00
Senior bank note program(2) 4/97 8,000 3,400 -
Non-U.S. bank note program 10/97 1,000 5 -
Corporation Shelf Registration 7/98 625 324 -
Deposit note program 4/96 2,000 -
Floating rate junior subordinated
capital income securities(3) 1/97 100 98 2/27
- --------------------------------------------------------------------------------------------------------
</TABLE>
(1) All funding sources are revolving except for the Corporation Shelf
Registration and the floating rate junior subordinated capital income
securities. Funding availability under the credit facilities is subject to
compliance with certain representations, warranties and covenants. Funding
availability under all other sources is subject to market conditions.
(2) Includes availability to issue up to $200 million of subordinated bank
notes, none outstanding as of September 30, 1998.
(3) Qualifies as Tier 1 capital at the Corporation and Tier 2 capital at the
Bank.
The domestic revolving 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. The borrowings of the Savings Bank are limited to $750 million.
The final maturity of each tranche may be extended for two additional one-year
periods.
The UK/Canada revolving credit facility is used to finance the
Company's expansion in the United Kingdom and Canada. The facility is comprised
of two tranches: a Tranche A facility in the amount of (pound)156.5 million
($249.8 million equivalent based on the exchange rate at closing) and a Tranche
B facility in the amount of C$139.6 million ($100.2 million equivalent based on
the exchange rate at closing). An amount of (pound)34.6 million or C$76.9
million ($55.2 million equivalent based on the exchange rates at closing) may be
transferred between the Tranche A facility and the Tranche B facility,
respectively, upon the request of the Company. The Corporation serves as the
guarantor of all borrowings by its subsidiaries under the UK/Canada revolving
facility.
<PAGE>
Under the Corporation's shelf registration statements, filed with the
Securities and Exchange Commission, 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. In July 1998, the Corporation filed a Shelf Registration
Statement on Form S-3 with the Securities and Exchange Commission for the
issuance of up to $425 million aggregate principal amount of senior and
subordinated debt, preferred stock and common stock, which was declared
effective on July 14, 1998. In July 1998, the Corporation issued $200 million of
10 year unsecured senior notes under this shelf registration. Existing unsecured
senior debt outstanding of the Corporation under the a prior shelf registration
of $200 million totals $125 million maturing in 2003.
Capital Adequacy
The Bank and the Savings Bank are subject to capital adequacy
guidelines adopted by the Federal Reserve Board (the "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 maintain
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.
The most recent notifications from the regulators categorized the Bank
and the Savings Bank as "well-capitalized." To be categorized as
"well-capitalized," the Bank and the Savings Bank must maintain minimum capital
ratios as set forth in the following table. As of September 30, 1998, there are
no conditions or events since the notifications discussed above that management
believes have changed either the Bank or the Savings Bank's capital category.
As of September 30, 1998, the Bank and the Savings Bank's ratios of
capital to managed assets were 5.40% and 8.01%, respectively.
<PAGE>
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------
TABLE 11 - REGULATORY CAPITAL RATIOS
- ------------------------------------------------------------------------------------------------------
To Be "Well-Capitalized" Under
Minimum for Capital Prompt Corrective Action
Ratios Adequacy Purposes Provisions
- --------------------------- --------------- ------------------------ ---------------------------------
<S> <C> <C> <C>
September 30, 1998
Capital One Bank
Tier 1 Capital 12.12% 4.00% 6.00%
Total Capital 14.70 8.00 10.00
Tier 1 Leverage 10.89 4.00 5.00
Capital One, F.S.B.(1)
Tangible Capital 12.88% 1.50% 6.00%
Total Capital 19.28 12.00 10.00
Core Capital 12.88 8.00 5.00
- --------------------------- --------------- ------------------------ ---------------------------------
September 30, 1997
Capital One Bank
Tier 1 Capital 10.70% 4.00% 6.00%
Total Capital 13.58 8.00 10.00
Tier 1 Leverage 11.01 4.00 5.00
Capital One, F.S.B.(1)
Tangible Capital 10.70% 1.50% 6.00%
Total Capital 16.52 12.00 10.00
Core Capital 10.70 8.00 5.00
- --------------------------- --------------- ------------------------ ---------------------------------
</TABLE>
(1) Until June 30, 1999, the Savings Bank is subject to capital requirements
that exceed minimum capital adequacy requirements, including the requirement
to maintain a minimum Core Capital ratio of 8% and a Total Capital ratio of
12%.
During 1996, the Bank received regulatory approval and established a
branch office in the United Kingdom. In connection with such approval, the
Company committed to the Federal Reserve 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 September 30, 1998, the Company's Tier 1 leverage
ratio was 13.67%.
Additionally, certain regulatory restrictions exist which limit the
ability of the Bank and the Savings Bank to transfer funds to the Corporation.
As of September 30, 1998, retained earnings of the Bank and the Savings Bank of
$122.5 million and $44.0 million, respectively, were available for payment of
dividends to the Corporation, without prior approval by the regulators. The
Savings Bank, however, is required to give the OTS at least 30 days' advance
notice of any proposed dividend and the OTS, in its discretion, may object to
such dividend.
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 transactions, interest rate swap agreements ("swaps") and forward
foreign exchange rate agreements ("FRAs"). In order to reduce the 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. In order to reduce the exchange rate
sensitivity on foreign currency denominated assets, the Company has entered into
FRAs which involve elements of credit or exchange rate risk in excess of the
amount recognized on the balance sheet. Swaps and FRAs present the Company with
certain credit, market, legal and operational risks. The Company has established
credit policies for off-balance sheet instruments as it does for on-balance
sheet instruments.
The Company measures exposure to its interest rate risk through the use
of a simulation model. The model generates a distribution of possible
twelve-month managed net interest income outcomes based on (i) a set of a
plausible interest rate scenarios, as determined by management based upon
historical trends and market expectations, (ii) all existing financial
instruments, including swaps, and (iii) an estimate of ongoing business activity
over the coming twelve months. The Company's asset/liability management policy
requires that based on this distribution there be at least a 95% probability
that managed net interest income achieved over the coming twelve months will be
no more than 3% below the mean managed net interest income of the distribution.
As of September 30, 1998, the Company was in compliance with the policy; more
than 95% of the outcomes generated by the model produce a managed net interest
income of no more than 1.1% below the mean outcome.
Business Outlook
Earnings, Goals and Strategies
This business outlook section summarizes the Company's expectations for
earnings for the year ending December 31, 1998 and, to a limited extent, for the
year ending December 31, 1999 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 throughout this section and in the
Company's Annual Report on Form 10-K for the year ended December 31, 1997 (Part
I, Item 1, Cautionary Statements).
The Company has set an earnings target, dependent on the factors set
forth below, for its diluted earnings per share for the year ending December 31,
1998 to increase by 40% over 1997 and for the year ending December 31, 1999 to
increase approximately 30% over 1998. As discussed elsewhere in this report and
below, the Company's actual earnings are a function of its revenues (net
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), marketing expenses and operating expenses.
Product and Market Opportunities
The Company's strategy for future growth has been, and is expected to
continue to be, to apply its proprietary IBS to its credit card business as well
as to other businesses, including selected non-card consumer lending products
and telecommunication services. The Company will seek to identify new product
opportunities and to make informed investment decisions regarding new and
existing products. The Company's credit card and other financial and
non-financial products are subject to competitive pressures, which management
anticipates will increase as these markets mature.
Credit Cards
Credit card opportunities include, and are expected to continue to include,
various low introductory and intermediate-rate balance transfer products, low
non-introductory rate products, as well as other customized credit card
products; such as secured cards, affinity and co-branded cards, student cards
and other cards tailored for specific customer segments. The Company intends to
continue to offer these customized products, which are distinguished by a varied
range of credit lines, targeted borrowers and pricing structures. Certain of
these cards, the low non-introductory rate products, are marketed to customers
with the best established credit profiles and are characterized by higher credit
lines and an expectation of lower delinquencies and credit losses than the
Company's traditional low introductory-rate balance transfer products. Other
customized card products are distinguished by several characteristics, including
better response rates, less adverse selection, higher yields (including fees),
lower credit lines, less attrition and a greater ability to reprice than the
Company's traditional products. These other products involve higher operational
costs and, in some cases, higher delinquencies and credit losses than the
Company's traditional products. More importantly, all of these customized
products continue to have less volatile returns than the traditional products in
recent market conditions.
Automobile Finance
On July 31, 1998, the Company completed the acquisition of Summit
Acceptance Corporation ("Summit"), a Texas corporation. Summit is a subprime
automobile finance lender located in Dallas, Texas, with 180 employees and
serviced loans of approximately $263 million as of July 31, 1998. Summit
provides the Company with a platform to test and apply its IBS to the automobile
loan market.
Telecommunications
The Company is increasing its efforts to market telecommunications
services, through its subsidiary America One Communications, Inc. ("America
One"). America One's initial business, the reselling of wireless services, has
recently begun to experience growth in the number of customers and accounts.
Significant marketing investment is being allocated to America One's
telecommunications business.
International Expansion
The Company has expanded its existing operations outside of the United
States, with an initial focus on the United Kingdom and Canada. The Company has
experienced growth in the number of accounts and loan balances in its
international business. To support its expansion in the United Kingdom and
provide a platform into Europe, in July the Company opened a new operations
center in Nottingham, England.
The Company will continue to apply its IBS in an effort to balance the mix
of credit card products together with other financial and non-financial products
and services, to optimize profitability within the context of acceptable risk.
The Company's growth through expansion and product diversification will be
affected by the ability of the Company to internally build or to acquire the
operational and organizational infrastructure necessary to engage in new
businesses and to recruit experienced personnel to assist in the management and
operations of these businesses and the availability of capital necessary to fund
these new businesses. Although management believes that it has the personnel,
financial resources and business strategy necessary for continued success, there
can be no assurance that the Company's historical financial performance will
necessarily reflect its results of operations and financial condition in the
future.
Marketing Investment
The Company's 1998 marketing expenses are expected to exceed such expenses
in 1997, as the Company continues to invest in its various credit card products
and services, and other financial and non-financial products and services. The
Company cautions, however, that an increase in marketing expenses does not
necessarily equate to a comparable increase in outstanding balances or accounts
based on historical results. As the Company's portfolio continues to increase,
additional growth to offset attrition requires increasing amounts of marketing.
Intense competition in the credit card market has resulted in a decrease in
credit card response rates and reduced productivity of marketing dollars
invested in certain lines of business. In addition, the cost to acquire new
accounts varies among product lines. With competition affecting the
profitability of existing balance transfer card products, the Company has been
allocating and expects to continue to allocate a greater portion of its
marketing expense to other customized credit card products and other financial
and non-financial products. Additionally, the costs to acquire an America One
wireless account include the cost of a free phone delivered to the customer, and
consequently are substantially more than the cost to acquire a credit card
account. The Company intends to continue a flexible approach in its allocation
of marketing expenses. The actual amount of marketing investment is subject to a
variety of external and internal factors, such as competition in the consumer
credit industry, general economic conditions affecting consumer credit
performance, the asset quality of the Company's portfolio and the identification
of market opportunities along product lines that exceed company targeted rates
for return on investment.
Moreover, the amount of marketing expense allocated to various product
segments will influence the characteristics of the Company's portfolio because
the various product segments are characterized by different account growth, loan
growth and asset quality characteristics. The Company currently expects that its
growth in consumer accounts and in managed consumer loans will continue in the
last quarter of 1998 and into 1999. Actual growth, however, may vary
significantly depending on the Company's actual product mix and the level of
attrition on the Company's managed portfolio, which is primarily affected by
competitive pressures.
Impact of Delinquencies, Charge-off Rates and Attrition
The Company's earnings are particularly sensitive to delinquencies and
charge-offs on the Company's portfolio and on the level of attrition due to
competition in the credit card industry. 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 precedes the related impact of
higher or lower charge-offs that ultimately result from varying levels of
delinquencies. Delinquency and net charge-off rates are not only impacted by
general economic trends in consumer credit performance, including bankruptcies,
but also by the continued seasoning of the Company's portfolio and the product
mix.
The Company's expectations for 1998 and 1999 earnings are based on
management's belief that consumer credit quality is stabilizing. Management
expects that during the fourth quarter of 1998 charge-offs will remain stable,
while delinquency rates may increase modestly due to seasonality and the
seasoning of the customized card products. Management, however, cautions that
delinquency and charge-off levels are not always predictable and may vary from
projections. In the case of an economic downturn or recession, delinquencies and
charge-offs are likely to increase. In addition, competition in the credit card
industry, as measured by the volume of mail solicitations, remains very high.
Increased competition can affect the Company's earnings by increasing attrition
of the Company's outstanding loans (thereby reducing interest and fee income)
and by making it more difficult to retain and attract more profitable customers.
Year 2000
The Year 2000 Issue and the Company's State of Readiness
The year 2000 problem is a result of computer systems using two digits
rather than four digits to define an applicable year. The Company utilizes a
significant number of internal computer software programs and operating systems
across its entire organization. In addition, the Company depends on its external
business vendors to provide external services for its operations. To the extent
the software applications of the Company or its vendors contain codes that are
unable to appropriately interpret the year 2000 and beyond, some level of
modification, or even possibly replacement of such applications, may be
necessary.
In October 1996, the Company formed a year 2000 project office to
identify software systems and computer-related devices that required
modification for the year 2000. Shortly after its inception, the project office
executed a five step program for the Company's information technology computer
based systems. This strategy calls for awareness of the existence of information
technology systems Company wide, assessment of those systems for year 2000
readiness, renovation of those systems and their date coding functions,
validation of those renovations and implementation of all renovations made. This
strategy is based in large part on the regulatory guidelines published by the
Federal Financial Institutions Examination Counsel.
The Company identified approximately 70 distinct project areas to
categorize its information technology systems. These project areas consist of
not only typical information technology systems, like the cardholder, credit and
customer service systems, but also certain other non-information technology
systems such as the Company's air conditioning, telephone and elevator systems.
The strategy requires prioritization of all project areas and assignment of
individual implementation milestones. As of September 30, 1998, approximately
seventy-nine percent of all of the Company's project areas have been renovated.
More importantly, this includes the complete renovation of all of the Company's
mission critical information technology systems, which renovations the Company
is currently implementing and testing. The Company's start-up information
technology systems in the U.K. and those in its newly acquired subsidiary,
Summit Acceptance Corporation, are in the process of being evaluated for
compliance. The Company expects to have all systems and applications in place
and fully tested by the end of first quarter 1999, and will use the remaining
time in 1999 for any system refinements that may be needed.
The Company is also addressing the effect of the year 2000 on other
non-information technology systems not included as part of the project areas.
These non-information systems primarily consist of desk top computer
applications used by the Company's employees. The Company expects to renovate
these applications using products prepared by outside vendors and the
renovations are expected to be completed by the end of the first quarter of
1999.
In addition, the Company utilizes outside business vendors in its
day-to-day operations. Consequently, the Company is assessing the year 2000
readiness of its external business vendors to project their viability into the
year 2000. These vendors include credit bureaus, collection agencies, utilities
and other related service providers, the U.S. postal service, telephone
companies, technology vendors, banks that are creditors of the Company or which
provide cash management, trustee, paying agent, stock transfer agent or other
services. The Company has requested information from its vendors about their
actions to become year 2000 compliant, placing extensive focus on its high
priority vendors. At this point, management is unable to determine whether or to
what extent the systems of its business vendors will, in fact, be timely
remediated. The Company will continue to actively monitor the efforts of its
vendors and take actions to mitigate exposure to year 2000 issues resulting from
the failure of its vendors to be compliant.
The Costs to Address the Company's Year 2000 Issues
The costs incurred by the Company through the third quarter of fiscal 1998
to address year 2000 compliance for its information technology systems were
approximately $4.7 million, of which $2.5 million was incurred during the first
nine months of 1998. The Company estimates it expects to incur an additional
$1.3 million in costs for a total of approximately $6 million in direct costs
for remediation of its information technology systems. Total costs, including
costs associated with non-information technology systems and vendor contingency
planning, will not materially impact the Company's results.
The Company's Contingency Plan
The Company's Year 2000 Project Office is in the assessment stage of
contingency planning. To date, the Company has established contingency planning
work groups in each of its business units. These work groups are tasked with (i)
identifying year 2000 risks, (ii) assessing the business impact of these risks
and (iii) developing contingency plans to mitigate the risks. The Company
expects to complete the contingency planning assessment stage by the end of
1998. The Company will then document and test individual contingency plans
through the first quarter of 1999.
The Risks of the Company's Year 2000 Issues
Although the Company expects to have all of its system modifications
complete by the end of the first quarter of 1999, allowing a sufficient amount
of time to further test systems in 1999, unforeseen problems could arise in the
year 2000 giving rise to delays and malfunctions which may impact the Company's
business and financial results. In addition, the failure of third parties to
provide the Company with products, services or systems that meet year 2000
requirements could impact the Company's business and operations. For example,
failure of the U.S. postal service or the Company's local and long distance
carriers to be year 2000 compliant could cause disruption or delay in the
Company's ability to solicit new customers and service the accounts of its
existing customers.
The estimated year 2000 costs and the Company's expectations that its
systems, and those of its third-party partners and vendors, will be year 2000
compliant are forward-looking statements. These statements are based on
management's reasonable estimates and assumptions about future events and are
subject to risks and uncertainties. Although the Company believes that its has
taken the necessary precautionary measures to assure that the year 2000 will not
adversely affect its business, there is no guarantee that the Company's year
2000 expectations will be achieved and actual results could differ materially.
Cautionary Factors
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); the
ability of the Company to continue to securitize its credit cards and consumer
loans and to otherwise access the capital markets at attractive rates and terms
to fund its operations and future growth; 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, including changes in existing laws to regulate further
the credit card and consumer loan industry and the financial services industry,
in general; the amount of, and rate of growth in, the Company's expenses
(including salaries and associate benefits 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 or to expand
internationally; the ability of the Company to recruit experienced personnel to
assist in the management and operations of new products and services; the
ability of the Company and its suppliers to successfully address Year 2000
compliance issues; 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, 1997 (Part I, Item 1, Cautionary Statements).
<PAGE>
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
None
(b) Reports on Form 8-K:
The Company filed on August 21, 1998 a Current Report on Form
8-K, dated July 16, 1998, Commission File No. 1-13300,
enclosing its press release dated July 16, 1998.
The Company filed on July 23, 1998 a Current Report on Form
8-K, dated July 22, 1998, Commission File No. 1-13300,
enclosing its Underwriting Agreement with J.P. Morgan
Securities Inc. dated July 22, 1998.
The Company filed on August 20, 1998 a Current Report on Form
8-K, dated July 30, 1998, Commission File No. 1-13300,
enclosing its press release dated July 30, 1998.
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: November 13, 1998 /s/James M. Zinn
----------------
James M. Zinn
Senior Vice President,
Chief Financial Officer
(Chief Accounting Officer
and duly authorized officer
of the Registrant)
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<FISCAL-YEAR-END> Dec-31-1998
<PERIOD-START> Jul-01-1998
<PERIOD-END> Sep-30-1998
<CASH> 412,967
<SECURITIES> 1,296,959
<RECEIVABLES> 5,666,998
<ALLOWANCES> 231,000
<INVENTORY> 0
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<COMMON> 666
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