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, 1999
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
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(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)
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(703) 205-1000
(Registrant's telephone number, including area code)
(Not Applicable)
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(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
As of October 31, 1999, there were 197,180,208 shares of the registrant's Common
Stock, par value $.01 per share, outstanding.
<PAGE>
CAPITAL ONE FINANCIAL CORPORATION
FORM 10-Q
INDEX
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September 30, 1999
PART I. FINANCIAL INFORMATION Page
Item 1. Financial Statements (unaudited):
Condensed Consolidated Balance Sheets...........3
Condensed Consolidated Statements of Income.....4
Condensed Consolidated Statements of Changes
in Stockholders' Equity.......................5
Condensed Consolidated Statements of
Cash Flows....................................6
Notes to Condensed Consolidated Financial
Statements....................................7
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of
Operations.....................................11
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K....................31
Signatures..........................................31
<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
1999 1998
- --------------------------------------------------------------- -------------- -------------
<S> <C> <C>
Assets:
Cash and due from banks $ 59,934 $ 15,974
Federal funds sold and resale agreements 261,800
Interest-bearing deposits at other banks 53,493 22,393
- --------------------------------------------------------------- -------------- -------------
Cash and cash equivalents 113,427 300,167
Securities available for sale 1,708,609 1,796,787
Consumer loans 8,286,210 6,157,111
Less: Allowance for loan losses (306,000) (231,000)
- --------------------------------------------------------------- -------------- -------------
Net loans 7,980,210 5,926,111
Premises and equipment, net 429,504 242,147
Interest receivable 65,350 52,917
Accounts receivable from securitizations 614,962 833,143
Other 460,847 268,131
- --------------------------------------------------------------- -------------- -------------
Total assets $ 11,372,909 $ 9,419,403
- --------------------------------------------------------------- -------------- -------------
Liabilities:
Interest-bearing deposits $ 3,576,400 $ 1,999,979
Other borrowings 1,016,868 1,644,279
Senior notes 4,328,237 3,739,393
Interest payable 87,688 91,637
Other 828,422 575,788
- --------------------------------------------------------------- -------------- -------------
Total liabilities 9,837,615 8,051,076
Capital Securities 98,113 97,921
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, 199,670,421 and 199,670,376 issued as of
September 30, 1999 and December 31, 1998, respectively 1,997 1,997
Paid-in capital, net 625,771 598,167
Retained earnings 929,585 679,838
Cumulative other comprehensive income (loss) (32,232) 60,655
Less: Treasury stock, at cost; 2,557,263 and 2,690,910
shares as of September 30, 1999 and December 31, 1998,
respectively (87,940) (70,251)
- --------------------------------------------------------------- -------------- -------------
Total stockholders' equity 1,437,181 1,270,406
- --------------------------------------------------------------- -------------- -------------
Total liabilities and stockholders' equity $ 11,372,909 $ 9,419,403
- --------------------------------------------------------------- -------------- -------------
</TABLE>
See Notes to 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
- ---------------------------------------------------- ------------- ------------- -------------- --------------
1999 1998 1999 1998
- ---------------------------------------------------- ------------- ------------- -------------- --------------
<S> <C> <C> <C> <C>
Interest Income:
Consumer loans, including fees $ 386,727 $ 259,339 $ 1,064,987 $ 734,106
Federal funds sold and resale agreements 638 957 2,889 8,175
Other 24,671 22,813 75,004 70,308
- ---------------------------------------------------- ------------- ------------- -------------- --------------
Total interest income 412,036 283,109 1,142,880 812,589
Interest Expense:
Deposits 38,003 15,805 88,383 43,578
Other borrowings 19,030 24,752 62,351 61,180
Senior and deposit notes 76,980 65,498 230,129 196,231
- ---------------------------------------------------- ------------- ------------- -------------- --------------
Total interest expense 134,013 106,055 380,863 300,989
- ---------------------------------------------------- ------------- ------------- -------------- --------------
Net interest income 278,023 177,054 762,017 511,600
Provision for loan losses 114,061 67,569 262,948 212,448
- ---------------------------------------------------- ------------- ------------- -------------- --------------
Net interest income after provision for loan losses 163,962 109,485 499,069 299,152
Non-Interest Income:
Servicing and securitizations 311,217 217,094 876,777 541,161
Service charges and other fees 275,900 146,648 743,227 432,263
Interchange 33,946 23,213 97,732 58,383
- ---------------------------------------------------- ------------- ------------- -------------- --------------
Total non-interest income 621,063 386,955 1,717,736 1,031,807
Non-Interest Expense:
Salaries and associate benefits 199,048 116,107 572,703 337,488
Marketing 175,163 126,481 529,493 287,292
Communications and data processing 68,755 38,415 189,305 102,618
Supplies and equipment 48,076 27,416 127,083 82,399
Occupancy 19,117 11,115 49,412 32,849
Other 121,056 63,993 321,036 161,600
- ---------------------------------------------------- ------------- ------------- -------------- --------------
Total non-interest expense 631,215 383,527 1,789,032 1,004,246
- ---------------------------------------------------- ------------- ------------- -------------- --------------
Income before income taxes 153,810 112,913 427,773 326,713
Income taxes 58,448 42,907 162,554 124,151
- ---------------------------------------------------- ------------- ------------- -------------- --------------
Net income $ 95,362 $ 70,006 $ 265,219 $ 202,562
- ---------------------------------------------------- ------------- ------------- -------------- --------------
Basic earnings per share $ 0.48 $ 0.36 $ 1.34 $ 1.03
- ---------------------------------------------------- ------------- ------------- -------------- --------------
Diluted earnings per share $ 0.45 $ 0.33 $ 1.26 $ 0.97
- ---------------------------------------------------- ------------- ------------- -------------- --------------
Dividends paid per share $ 0.03 $ 0.03 $ 0.08 $ 0.08
- ---------------------------------------------------- ------------- ------------- -------------- --------------
</TABLE>
See Notes to 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 (Loss) Stock Equity
- ------------------------------------------- ----------- ------- ------------ --------- ------------- ---------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1997 199,671,690 $ 1,997 $ 512,230 $ 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 33,751 33,751
Foreign currency translation adjustments (4,766) (4,766)
------------- -------------
Other comprehensive income 28,985 28,985
-------------
Comprehensive income 231,547
Cash dividends - $.08 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 4,500 (15,716) 22,288 6,572
Common stock issuable under incentive plan 63,017 63,017
Other items, net 440 440
- ------------------------------------------- ----------- ------- ------------ --------- ------------- ---------- -------------
Balance, September 30, 1998 199,676,190 $ 1,997 $ 598,205 $ 612,331 $ 31,524 $ (74,929) $ 1,169,128
- ------------------------------------------- ----------- ------- ------------ --------- ------------- ---------- -------------
Balance, December 31, 1998 199,670,376 $ 1,997 $ 598,167 $ 679,838 $ 60,655 $ (70,251) $ 1,270,406
Comprehensive income:
Net income 265,219 265,219
Other comprehensive income (loss), net of income tax
Unrealized losses on securities, net of
income tax benefit of $58,019 (94,662) (94,662)
Foreign currency translation adjustments 1,775 1,775
------------- -------------
Other comprehensive loss (92,887) (92,887)
-------------
Comprehensive income 172,332
Cash dividends - $.08 per share (15,492) (15,492)
Purchases of treasury stock (80,004) (80,004)
Issuances of common stock 45 (740) 20 8,228 7,508
Exercise of stock options (22,614) 54,087 31,473
Common stock issuable under incentive plan 47,221 47,221
Other items, net 3,737 3,737
- ------------------------------------------- ----------- ------- ------------ --------- ------------- ---------- -------------
Balance, September 30, 1999 199,670,421 $ 1,997 $ 625,771 $ 929,585 $(32,232) $ (87,940) $ 1,437,181
- ------------------------------------------- ----------- ------- ------------ --------- ------------- ---------- -------------
</TABLE>
See Notes to 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
- -------------------------------------------------------------------- ------------- -------------
1999 1998
- -------------------------------------------------------------------- ------------- -------------
<S> <C> <C>
Operating Activities:
Net income $ 265,219 $ 202,562
Adjustments to reconcile net income to cash
provided by operating activities:
Provision for loan losses 262,948 212,448
Depreciation and amortization, net 122,518 77,836
Stock compensation plans 47,221 63,035
(Increase) decrease in interest receivable (12,433) 2,842
Decrease (increase) in accounts receivable from securitizations 101,577 (275,885)
Increase in other assets (150,303) (88,978)
(Decrease) increase in interest payable (3,949) 11,403
Increase in other liabilities 252,634 183,638
- -------------------------------------------------------------------- ------------- -------------
Net cash provided by operating activities 885,432 388,901
- -------------------------------------------------------------------- ------------- -------------
Investing Activities:
Purchases of securities available for sale (649,863) (761,670)
Proceeds from maturities of securities available for sale 178,884 626,749
Proceeds from sales of securities available for sale 522,357 112,279
Proceeds from securitizations of consumer loans 1,714,514 3,322,892
Net increase in consumer loans (4,136,573) (4,281,127)
Recoveries of loans previously charged off 87,676 47,567
Additions of premises and equipment, net (273,532) (118,545)
- -------------------------------------------------------------------- ------------- -------------
Net cash used for investing activities (2,556,537) (1,051,855)
- -------------------------------------------------------------------- ------------- -------------
Financing Activities:
Net increase in interest-bearing deposits 1,576,421 284,681
Net (decrease) increase in other borrowings (627,411) 530,699
Issuances of senior notes 1,453,059 1,258,700
Maturities of senior and deposit notes (864,779) (1,163,162)
Dividends paid (15,492) (15,371)
Purchases of treasury stock (80,004) (69,652)
Net proceeds from issuances of common stock 11,098 5,731
Proceeds from exercise of stock options 31,473 6,572
- -------------------------------------------------------------------- ------------- -------------
Net cash provided by financing activities 1,484,365 838,198
- -------------------------------------------------------------------- ------------- -------------
(Decrease) increase in cash and cash equivalents (186,740) 175,244
Cash and cash equivalents at beginning of period 300,167 237,723
- -------------------------------------------------------------------- ------------- -------------
Cash and cash equivalents at end of period $ 113,427 $ 412,967
- -------------------------------------------------------------------- ------------- -------------
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
<PAGE>
CAPITAL ONE FINANCIAL CORPORATION
Notes to Condensed Consolidated Financial Statements
September 30, 1999
(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 offers consumer lending (including credit cards) and
deposit products. The Corporation and its subsidiaries are collectively referred
to as the "Company."
On April 29, 1999, the Company's Board of Directors approved a
three-for-one split of the common stock of the Corporation. The stock split was
effected through a 200 percent stock distribution on June 1, 1999, to
stockholders of record on May 20, 1999. For periods prior to the effective date
of the stock split, outstanding shares and per share data contained in this
report have been restated to reflect the impact of the stock split.
The accompanying unaudited condensed 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, 1999 are not necessarily indicative of the results
for the year ending December 31, 1999. The notes to the consolidated financial
statements contained in the Annual Report on Form 10-K for the year ended
December 31, 1998 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 1999 presentation.
Note B: Significant Accounting Policies
Cash and Cash Equivalents
Cash paid for interest for the nine months ended September 30, 1999 and
1998 was $384,812 and $289,064, respectively. Cash paid for income taxes for the
nine months ended September 30, 1999 and 1998 was $205,515 and $170,806,
respectively.
Note C: Business Segment Information
The Company maintains three distinct business segments: lending,
telecommunications, and "other." The lending segment is comprised primarily of
credit card lending activities. The telecommunications segment consists
primarily of direct marketing wireless service. "Other" consists of various,
non-lending new business initiatives, none of which exceed the quantitative
thresholds for reportable segments in Statement of Financial Accounting
Standards No. 131, "Disclosures about Segments of an Enterprise and Related
Information."
The accounting policies of these reportable segments are the same as
those described in the summary of significant accounting policies. The
consolidation adjustments (included in "other" due to immateriality) reflect
certain eliminations of intersegment revenue and expense. Management measures
the performance of its business segments and makes resource allocation decisions
based upon several factors, including income before taxes, less indirect
expenses ("Operating profit (loss)" in table below). Indirect expenses not
allocated to segments are included in the "indirect expenses" reconciling item
below.
<PAGE>
The following table presents income statement information by business
segment:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30 September 30
--------------------------- ---------------------------
1999 1998 1999 1998
- ------------------------------------- ----------- ---------- ----------- -----------
<S> <C> <C> <C> <C>
Income Statement Data
Revenues:
Lending $ 931,197 $ 593,764 $ 2,605,799 $ 1,635,178
Telecommunications 42,282 15,974 109,330 39,982
Operating profit (loss):
Lending 286,854 217,044 876,961 637,866
Telecommunications (9,289) (22,116) (66,252) (36,986)
Other (8,855) (6,380) (25,891) (21,751)
- ------------------------------------- ----------- ----------- ----------- -----------
Total operating profit (loss) 268,710 188,548 784,818 579,129
Indirect expenses 114,900 75,635 357,045 252,416
- ------------------------------------- ----------- ----------- ----------- -----------
Income before taxes $ 153,810 $ 112,913 $ 427,773 $ 326,713
- ------------------------------------- ----------- ----------- ----------- -----------
</TABLE>
All segment revenue is generated from external customers. Substantially
all of the Company's reported assets are derived from the lending segment in all
periods presented.
Note D: Borrowings
In May 1999, the Company's domestic revolving credit facility was
amended and is now comprised of two tranches as follows: a Tranche A facility in
the amount of $810,000 available to the Bank and the Savings Bank, including an
option for up to $250,000 in multi-currency availability, and a Tranche B
facility in the amount of $390,000 available to the Corporation, the Bank and
the Savings Bank, including an option for up to $150,000 in multi-currency
availability. The facility terminates on May 24, 2003; however, it may be
extended for an additional one-year period.
In August 1999, the Corporation filed a Shelf Registration Statement on
Form S-3 with the Securities and Exchange Commission for the issuance of up to
$925,000 aggregate principal amount of senior and subordinated debt, preferred
stock and common stock. The registration statement was declared effective on
August 25, 1999. Existing unsecured senior debt outstanding of the Corporation
under prior shelf registrations totaling $625,000 are $125,000 maturing in 2003,
$200,000 maturing in 2008 and $225,000 maturing in 2006, resulting in a total
remaining availability of $1,000,000.
Note E: Comprehensive Income
Comprehensive income for the three months ended September 30, 1999 and
1998 was as follows:
Three Months Ended
September 30
- ------------------------------------ ------------------------------
1999 1998
- ------------------------------------ ---------- ----------
Comprehensive Income:
Net income $ 95,362 $ 70,006
Other comprehensive income (loss) (44,950) 28,103
- ------------------------------------ ---------- ----------
Total comprehensive income $ 50,412 $ 98,109
- ------------------------------------ ---------- ----------
Note F: Recent Accounting Pronouncements
In January 1999, the Company adopted Statement of Position 98-1,
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use" ("SOP 98-1"). In accordance with SOP 98-1, the Company capitalizes
certain internal use software costs which would have previously been expensed.
The effect of this new accounting standard on net income was not material for
the nine months ended September 30, 1999.
<PAGE>
Note G: Associate Stock Plans
In April 1999, the Company's Board of Directors approved stock option
grants to senior management. In July 1999, 635,652 options were granted to
recently hired or promoted senior executives not granted options in the April
1999 grant. The options were granted at the fair market value on the date of the
April grant which was higher than the fair market value on the July grant date.
Grantees gave up all potential annual stock option grants for the next two years
in exchange for this one-time grant. All options under this grant will vest (i)
if the stock's fair market value is at or above $100 per share for at least ten
trading days in any thirty calendar-day period on or before June 15, 2002, (ii)
on April 29, 2008, or (iii) upon a change of control of the Company.
Note H: Earnings Per Share
Basic earnings per share is based on the weighted average number of
common shares outstanding, excluding any dilutive effects of options and
restricted stock. Diluted earnings per share is based on the weighted average
number of common and common equivalent shares, dilutive stock options or other
dilutive securities outstanding during the year.
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) 1999 1998 1999 1998
- ---------------------------------------------- --------- --------- --------- ---------
<S> <C> <C> <C> <C>
Numerator:
Net income $ 95,362 $ 70,006 $ 265,219 $ 202,562
Denominator:
Denominator for basic earnings per share -
Weighted-average shares 197,424 197,178 197,562 196,695
Effect of dilutive securities:
Stock options 12,718 12,858 13,108 11,217
Restricted stock 6
- ---------------------------------------------- --------- --------- --------- ---------
Dilutive potential common shares 12,718 12,858 13,108 11,223
Denominator for diluted earnings per share -
Adjusted weighted-average shares 210,142 210,036 210,670 207,918
- ---------------------------------------------- --------- --------- --------- ---------
Basic earnings per share $ 0.48 $ 0.36 $ 1.34 $ 1.03
- ---------------------------------------------- --------- --------- --------- ---------
Diluted earnings per share $ 0.45 $ 0.33 $ 1.26 $ 0.97
- ---------------------------------------------- --------- --------- --------- ---------
</TABLE>
Note I: 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 early 1997, the California court entered judgement in favor of the
Bank on all of the plaintiffs' claims. The plaintiffs appealed the ruling to the
California Court of Appeal First Appellate District Division 4. In early 1999,
the Court of Appeals affirmed the trial court's ruling in favor of the Bank on
six counts, but reversed the trial court's ruling on two counts of the
Plaintiff's complaint. The California Supreme Court rejected the Bank's Petition
for Review of the remaining two counts and remitted them to the trial court for
further proceedings. In August 1999, the trial court denied without prejudice
plaintiffs' motion to certify a class on the one remaining common law claim. In
November 1999, the United States Supreme Court denied the Bank's writ of
certiorari on the remaining two counts, declining to exercise its discretionary
power to review these issues.
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.
<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 using its Information-Based Strategy ("IBS"). The principal
subsidiaries are Capital One Bank (the "Bank"), which offers credit card
products, and Capital One, F.S.B. (the "Savings Bank"), which offers consumer
lending (including credit cards) and deposit products. The Corporation and its
subsidiaries are collectively referred to as the "Company." As of September 30,
1999, the Company had 20.8 million customers and $18.5 billion in managed
consumer loans outstanding and was one of the largest providers of MasterCard
and Visa credit cards in the world. 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, 1999 of $95.4
million, or $.45 per share, compares to net income of $70.0 million, or $.33 per
share, for the same period in 1998.
The increase in net income is primarily a result of an increase in
asset and account volumes and rates as well as improved credit quality. Net
interest income increased $101.0 million, or 57%, as the net interest margin
increased to 11.48% from 9.77% and average earning assets increased by 34%. The
provision for loan losses increased $46.5 million, or 69%, and average reported
loans increased 39%. Non-interest income increased $234.1 million, or 61%,
primarily as a result of an increase in average accounts of 40%, increases in
the amounts and frequency of certain fees charged and improvements in the
performance of the off-balance sheet portfolio. Marketing expense increased
$48.7 million, or 38%, to $175.2 million as the Company continues to invest in
new product opportunities. Increases in salaries and associate benefits expense
of $82.9 million, or 71% and other non-interest expense (excluding marketing) of
$116.1 million, or 82%, primarily reflected increased staff and cost of
operations, and the building of infrastructure to manage the growth in accounts
and new product opportunities. Each component is discussed in further detail in
subsequent sections of this analysis.
Net income for the nine months ended September 30, 1999 was $265.2
million, or $1.26 per share, compared to net income of $202.6 million, or $.97
per share, for the same period in 1998. This 31% 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.
Managed Consumer Loan Portfolio
The Company analyzes its financial performance on a managed consumer
loan portfolio basis. The Company also evaluates its interest rate exposure on a
managed portfolio basis.
The Company's managed consumer loan portfolio is comprised of reported
and off-balance sheet loans. Off-balance sheet loans are those which have been
securitized and accounted for as sales in accordance with Statement of Financial
Accounting Standards ("SFAS") No. 125, "Accounting for Transfers and Servicing
of Financial Assets and Extinguishment of Liabilities" ("SFAS 125"), and are not
assets of the Company. Therefore, those loans are not shown on the balance
sheet.
<PAGE>
Table 1 summarizes the Company's managed consumer loan portfolio.
- --------------------------------------------------------------------------------
TABLE 1 - MANAGED CONSUMER LOAN PORTFOLIO
- --------------------------------------------------------------------------------
Three Months Ended
September 30
- --------------------------------------------------- ------------ ------------
(in thousands) 1999 1998
- --------------------------------------------------- ------------ ------------
Period-End Balances:
Reported consumer loans $ 8,286,210 $ 5,666,998
Off-balance sheet consumer loans 10,231,201 10,670,791
- --------------------------------------------------- ------------ ------------
Total managed consumer loan portfolio $ 18,517,411 $ 16,337,789
- --------------------------------------------------- ------------ ------------
Average Balances:
Reported consumer loans $ 7,790,933 $ 5,623,012
Off-balance sheet consumer loans 10,371,042 10,123,079
- --------------------------------------------------- ------------ ------------
Total average managed consumer loan portfolio $ 18,161,975 $ 15,746,091
- --------------------------------------------------- ------------ ------------
Nine Months Ended
September 30
- --------------------------------------------------- ------------ ------------
(in thousands) 1999 1998
- --------------------------------------------------- ------------ ------------
Average Balances:
Reported consumer loans $ 7,346,484 $ 5,210,649
Off-balance sheet consumer loans 10,387,868 9,548,182
- --------------------------------------------------- ------------ ------------
Total average managed consumer loan portfolio $ 17,734,352 $ 14,758,831
- --------------------------------------------------- ------------ ------------
Since 1990, the Company has actively engaged in consumer loan
securitization transactions. Securitization involves the transfer by the Company
of a pool of loan receivables to an entity created for securitizations,
generally a trust or other special purpose entity ("the trusts"). The credit
quality of the receivables is supported by credit enhancements, which may be in
various forms including a letter of credit, a cash collateral guaranty or
account, or a subordinated interest in the receivables in the pool. Certificates
representing undivided ownership interests in the receivables are sold to the
public through an underwritten offering or to private investors in private
placement transactions. The Company receives the proceeds of the sale. The
Company retains an interest in the trusts ("seller's interest") equal to the
amount of the receivables transferred to the trust in excess of the principal
balance of the certificates. The Company's interest in the trusts varies as the
amount of the excess receivables in the trusts fluctuates as the accountholders
make principal payments and incur new charges on the selected accounts. The
securitization generally results in the removal of the receivables, other than
the seller's interest, from the Company's balance sheet for financial and
regulatory accounting purposes.
The Company's relationship with its customers is not affected by the
securitization. The Company acts as a servicing agent and receives a fee for
doing so.
Collections received from securitized receivables are used to pay
interest to certificateholders, servicing and other fees, and are available to
absorb the investors' share of credit losses. Amounts collected in excess of
that needed to pay the above amounts are remitted to the Company, as described
in Servicing and Securitizations Income.
Certificateholders in the Company's securitization program are
generally entitled to receive principal payments either through monthly payments
during an amortization period or in one lump sum after an accumulation period.
Amortization may begin sooner in certain circumstances, including if the
annualized portfolio yield (consisting, generally, of interest and fees) for a
three-month period drops below the sum of the certificate rate payable to
investors, loan servicing fees and net credit losses during the period.
Prior to the commencement of the amortization or accumulation period,
all principal payments received on the trusts' receivables are reinvested in new
receivables to maintain the principal balance of certificates. During the
amortization period, the investors' share of principal payments is paid to the
certificateholders until they are paid in full. During the accumulation period,
the investors' share of principal payments is paid into a principal funding
account designed to accumulate amounts so that the certificates can be paid in
full on the expected final payment date.
Table 2 indicates the impact of the consumer loan securitizations 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) 1999 1998 1999 1998
- ------------------------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Reported:
Average earning assets $ 9,688,556 $ 7,249,179 $ 9,262,944 $ 6,998,626
Net interest margin(1) 11.48% 9.77% 10.97% 9.75%
Loan yield 19.86 18.45 19.33 18.78
- ------------------------------ ------------ ------------ ------------ ------------
Managed:
Average earning assets $ 20,059,598 $ 17,372,258 $ 19,650,812 $ 16,546,808
Net interest margin(1) 11.18% 10.15% 10.89% 10.13%
Loan yield 17.92 17.06 17.49 17.11
- ------------------------------ ------------ ------------ ------------ ------------
</TABLE>
(1) Net interest margin is equal to net interest income divided by average
earning assets.
Risk Adjusted Revenue and Margin
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 managed 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.
The Company markets its card products to specific consumer segments.
The terms of each card product are actively managed in an effort to maximize
return at the consumer level, reflecting the risk and expected performance of
the account. For example, card product terms typically include the ability to
reprice individual accounts upwards or downwards based on the consumer's
performance. In addition, since 1998, the Company has aggressively marketed low
non-introductory rate cards to consumers with the best established credit
profiles to take advantage of the favorable risk return characteristics of this
consumer segment. Industry competitors have continuously solicited the Company's
customers with similar interest rate strategies. Management believes the
competition has put, and will continue to put, additional pressure on the
Company's pricing strategies.
By applying its 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 a
significant, immediate impact on managed loans balances; rather they 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 account
delinquency rates and consequently higher past-due and overlimit fees as a
percentage of loan receivables outstanding than the low non-introductory rate
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) 1999 1998 1999 1998
- ----------------------------- ---------------- ---------------- ---------------- -----------------
<S> <C> <C> <C> <C>
Managed Income Statement:
Net interest income $ 560,683 $ 440,760 $ 1,605,147 $ 1,256,976
Non-interest income 422,404(1) 264,592 1,168,163(1) 738,519
Net charge-offs (176,019) (198,069) (511,152) (623,792)
- ----------------------------- ---------------- ---------------- ---------------- ----------------
Risk adjusted revenue $ 807,068 $ 507,283 $ 2,262,158 $ 1,371,703
- ----------------------------- ---------------- ---------------- ---------------- ----------------
Ratios(2):
Net interest margin 11.18% 10.15% 10.89% 10.13%
Non-interest income 8.42 6.09 7.93 5.95
Net charge-offs (3.51) (4.56) (3.47) (5.03)
- ----------------------------- ---------------- ---------------- ---------------- ----------------
Risk adjusted margin 16.09% 11.68% 15.35% 11.05%
- ----------------------------- ---------------- ---------------- ---------------- ----------------
</TABLE>
(1) Excludes the impact on securitization income related to SFAS 125 of $16.2
million and $26.6 million for the three and nine months ended September 30,
1999, respectively.
(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,
1999 was $278.0 million, compared to $177.1 million for the same period in the
prior year, representing an increase of $101.0 million, or 57%. For the nine
months ended September 30, 1999, net interest income was $762.0 million compared
to $511.6 million for the same period in 1998, representing an increase of
$250.4 million, or 49%. Net interest margin increased 171 and 122 basis points
for the three and nine months ended September 30, 1999, respectively, compared
to the same periods in the prior years. These increases were primarily a result
of the increases in the yield on earning assets of 139 and 97 basis points for
the three and nine months ended September 30, 1999, respectively, to 17.01% from
15.62% and to 16.45% from 15.48% as compared to the same periods in the prior
year. The increase was primarily attributable to a 141 and 55 basis point
increase in the yield on consumer loans for the three and nine months ended
September 30, 1999, respectively, to 19.86% from 18.45% and to 19.33% from
18.78%, 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 continued
growth in the Company's portfolio of higher yielding products, especially in the
reported loan portfolio, during the comparable periods. The increased yield was
a result of repricings of low introductory rate loans during late 1998 and early
1999.
<PAGE>
Managed net interest income increased $119.9 million, or 27%, and
$348.2 million, or 28%, for the three and nine months ended September 30, 1999,
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 15% and 19% and the managed net interest margin increasing 103 basis
points and 76 basis points to 11.18% and 10.89% for the three and nine months
ended September 30, 1999, 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.
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, 1999 and 1998.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------
TABLE 4 - STATEMENTS OF AVERAGE BALANCES, INCOME AND EXPENSE, YIELDS AND RATES
- -----------------------------------------------------------------------------------------------------------------------------
Three Months Ended September 30
- ------------------------------------- ---------------------------------------------------------------------------------------
1999 1998
- ------------------------------------- ------------------------------------------ ------------------------------------------
Average Income/ Yield/ Average Income/ Yield/
(dollars in thousands) Balance Expense Rate Balance Expense Rate
- ------------------------------------- ------------ ------------ ------------ ------------ ------------ ------------
Assets:
Earning assets
<S> <C> <C> <C> <C> <C> <C>
Consumer loans(1) $ 7,790,933 $ 386,727 19.86% $ 5,623,012 $ 259,339 18.45%
Federal funds sold and
resale agreements 54,375 638 4.69 69,293 957 5.52
Other 1,843,248 24,671 5.35 1,556,874 22,813 5.86
- ------------------------------------- ------------ ------------ ------------ ------------ ------------ ------------
Total earning assets 9,688,556 $ 412,036 17.01% 7,249,179 $ 283,109 15.62%
Cash and due from banks 44,732 2,182
Allowance for loan losses (272,667) (216,000)
Premises and equipment, net 399,289 202,887
Other 1,359,173 1,268,047
- ------------------------------------- ------------ ------------ ------------ ------------ ------------ ------------
Total assets $ 11,219,083 $ 8,506,295
- ------------------------------------- ------------ ------------ ------------ ------------ ------------ ------------
Liabilities and Equity:
Interest-bearing liabilities
Deposits $ 3,001,711 $ 38,003 5.06% $ 1,368,833 $ 15,805 4.62%
Other borrowings 1,235,352 19,030 6.16 1,495,731 24,752 6.62
Senior and deposit notes 4,494,440 76,980 6.85 3,819,061 65,498 6.86
- ------------------------------------- ------------ ------------ ------------ ------------ ------------ ------------
Total interest-bearing liabilities 8,731,503 $ 134,013 6.14% 6,683,625 $ 106,055 6.35%
Other 928,919 575,510
- ------------------------------------- ------------ ------------ ------------ ------------ ------------ ------------
Total liabilities 9,660,422 7,259,135
Preferred beneficial interests 98,082 97,825
Equity 1,460,579 1,149,335
- ------------------------------------- ------------ ------------ ------------ ------------ ------------ ------------
Total liabilities and equity $ 11,219,083 $ 8,506,295
- ------------------------------------- ------------ ------------ ------------ ------------ ------------ ------------
Net interest spread 10.87% 9.27%
- ------------------------------------- ------------ ------------ ------------ ------------ ------------ ------------
Interest income to
average earning assets 17.01% 15.62%
Interest expense to
average earning assets 5.53 5.85
- ------------------------------------- ------------ ------------ ------------ ------------ ------------ ------------
Net interest margin 11.48% 9.77%
- ------------------------------------- ------------ ------------ ------------ ------------ ------------ ------------
</TABLE>
(1) Interest income includes past-due fees on loans of approximately $122,409
and $73,198 for the three months ended September 30, 1999 and 1998,
respectively.
<PAGE>
<TABLE>
<CAPTION>
Nine Months Ended September 30
------------------------------------ -----------------------------------------------------------------------------
1999 1998
------------------------------------ -------------------------------------- --------------------------------------
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) $ 7,346,484 $ 1,064,987 19.33% $ 5,210,649 $ 734,106 18.78%
Federal funds sold and
resale agreements 81,218 2,889 4.74 193,341 8,175 5.64
Other 1,835,242 75,004 5.44 1,594,636 70,308 5.88
------------------------------------ ------------ ------------ ------------ ------------ ------------ ------------
Total earning assets 9,262,944 $ 1,142,880 16.45% 6,998,626 $ 812,589 15.48%
Cash and due from banks 18,133 11,414
Allowance for loan losses (255,167) (208,778)
Premises and equipment, net 331,584 186,271
Other 1,303,482 1,064,351
------------------------------------ ------------ ------------ ------------ ------------ ------------ ------------
Total assets $ 10,660,976 $ 8,051,884
------------------------------------ ------------ ------------ ------------ ------------ ------------ ------------
Liabilities and Equity:
Interest-bearing liabilities
Deposits $ 2,461,154 $ 88,383 4.79% $ 1,276,512 $ 43,578 4.55%
Other borrowings 1,470,817 62,351 5.65 1,298,768 61,180 6.28
Senior and deposit notes 4,436,182 230,129 6.92 3,803,117 196,231 6.88
------------------------------------ ------------ ------------ ------------ ------------ ------------ ------------
Total interest-bearing liabilities 8,368,153 $ 380,863 6.07% 6,378,397 $ 300,989 6.29%
Other 815,606 529,398
------------------------------------ ------------ ------------ ------------ ------------ ------------ ------------
Total liabilities 9,183,759 6,907,795
Preferred beneficial interests 98,018 97,761
Equity 1,379,199 1,046,328
------------------------------------ ------------ ------------ ------------ ------------ ------------ ------------
Total liabilities and equity $ 10,660,976 $ 8,051,884
------------------------------------ ------------ ------------ ------------ ------------ ------------ ------------
Net interest spread 10.38% 9.19%
------------------------------------ ------------ ------------ ------------ ------------ ------------ ------------
Interest income to
average earning assets 16.45% 15.48%
Interest expense to
average earning assets 5.48 5.73
------------------------------------ ------------ ------------ ------------ ------------ ------------ ------------
Net interest margin 10.97% 9.75%
------------------------------------ ------------ ------------ ------------ ------------ ------------ ------------
</TABLE>
(1) Interest income includes past-due fees on loans of approximately $341,470
and $221,849 for the nine months ended September 30, 1999 and 1998,
respectively.
<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, 1999 vs 1998 September 30, 1999 vs 1998
- ----------------------------- ---------------------------------------- --------------------------------------
Increase Change due to(1) Increase Change due to(1)
(in thousands) (Decrease) Volume Yield/Rate (Decrease) Volume Yield/Rate
- ----------------------------- ---------- ---------- ---------- ---------- ---------- ----------
Interest Income:
<S> <C> <C> <C> <C> <C> <C>
Consumer loans $127,388 $106,352 $ 21,036 $330,881 $ 309,047 $21,834
Federal funds sold and
resale agreements (319) (188) (131) (5,286) (4,150) (1,136)
Other 1,858 12,007 (10,149) 4,696 12,394 (7,698)
- ----------------------------- ---------- ---------- ---------- ---------- ---------- ----------
Total interest income 128,927 101,970 26,957 330,291 276,703 53,588
Interest Expense:
Deposits 22,198 20,537 1,661 44,805 42,431 2,374
Other borrowings (5,722) (4,096) (1,626) 1,171 9,968 (8,797)
Senior and deposit notes 11,482 12,079 (597) 33,898 32,835 1,063
- ----------------------------- ---------- ---------- ---------- ---------- ---------- ----------
Total interest expense 27,955 50,361 (22,403) 79,874 97,298 (17,424)
- ----------------------------- ---------- ---------- ---------- ---------- ---------- ----------
Net interest income(1) $100,969 $ 66,436 $ 34,533 $250,417 $ 180,478 $ 69,939
- ----------------------------- ---------- ---------- ---------- ---------- ---------- ----------
</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
In accordance with SFAS 125, the Company records gains or losses on the
securitizations of consumer loan receivables on the date of sale 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 cash flows the
Company has retained over the estimated outstanding period of the receivable and
are included in servicing and securitizations income. This excess cash flow
essentially represents an "interest only" ("I/O") strip, consisting of the
excess of 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 cash flows.
Servicing and securitizations income for the three months ended
September 30, 1999 increased $94.1 million, or 43%, to $311.2 million from
$217.1 million in the same period in the prior year. Servicing and
securitizations income for the nine months ended September 30, 1999 increased
$335.6 million, or 62%, to $876.8 million from $541.2 million in the same period
in the prior year. These increases were primarily due to a decrease in net
charge-offs as a result of improved general economic trends in consumer credit,
increased purchase volume, membership and overlimit fees, as well as a slight
increase in the average off-balance sheet consumer loan portfolio.
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.
Other Non-Interest Income
Interchange income increased 46% and 67%, to $33.9 million and $97.7
million, for the three and nine months ended September 30, 1999, respectively,
compared to $23.2 million and $58.4 million for the same periods in the prior
year. These increases are primarily attributable to increased purchase volume,
new account growth and an increase in interchange rates received by the Company.
Service charges and other fees increased 88% and 72% to $275.9 million and
$743.2 million, for the three and nine months ended September 30, 1999,
respectively, compared to $146.6 million and $432.3 million for the same periods
in the prior year. These increases were composed primarily of increases in
overlimit and annual membership fees, as well as increased telecommunications
and cross-selling revenue, resulting from the increase in average accounts of
40% and 42% for the three and nine months ended September 30, 1999,
respectively, and a shift in the Company's portfolio to more fee-intensive
products.
Telecommunications revenue includes service revenues, which consist
primarily of charges for airtime usage and monthly network access derived from
providing mobile wireless services. Telecommunications revenue increased $26.3
million to $42.3 million from $16.0 million for the three months ended September
30, 1999 and 1998, respectively. Telecommunications revenue increased $69.3
million to $109.3 million from $40.0 million for the nine months ended September
30, 1999 and 1998, respectively. These increases are composed primarily of
increases in airtime charges, including peak, non-peak and roaming usage, and
monthly network access charges. These increases are a direct result of the
increased number of subscriber accounts as well as increased usage by existing
subscriber accounts.
Non-Interest Expense
Non-interest expense for the three and nine months ended September 30,
1999 was $631.2 million and $1.8 billion, respectively, an increase of 65% and
78% over $383.5 million and $1.0 billion, respectively, for the same periods in
the prior year. Contributing to the increase in non-interest expense for the
three and nine months ended September 30, 1999 was salaries and associate
benefits expense which increased $82.9 million, or 71%, and $235.2 million, or
70%, respectively. This was primarily a result of adding over 5,700 full time
equivalents to our staffing levels since September 30, 1998. Marketing expense
increased $48.7 million and $242.2 million, or 38% and 84%, to $175.2 million
and $529.5 million for the three and nine months ended September 30, 1999,
respectively, compared to the same periods in the prior year as the Company
continued to invest in new product opportunities. All other non-interest
expenses increased $116.1 million and $307.4 million, or 82% and 81%, to $257.0
million and $686.8 million for the three and nine months ended September 30,
1999, respectively, from $140.9 million and $379.5 million for the same periods
in the prior year. The increase in all other non-interest expenses primarily
consists of increased telecommunications costs of revenue, professional service
costs, costs of collections, fraud losses and increased associate recruitment
efforts. These increases were primarily a result of the 40% and 42% increases in
the average number of accounts for the three and nine months ended September 30,
1999, respectively, as compared to the same periods in the prior year, as well
as the Company's continued expansion into new product and geographic markets,
which resulted in a corresponding increase in all operational costs.
Non-interest expense includes telecommunications operating expenses,
which primarily include salaries and associate benefits expense, marketing,
telecommunications costs of revenue and other operational costs. Marketing
consists of the costs to acquire a wireless account, which includes the cost of
providing a phone to the customer. Telecommunications costs of revenue consists
primarily of the cost of airtime purchased for resale to customers and the cost
of monthly network access used in providing mobile wireless services.
Telecommunications operating expenses increased $13.5 and $98.6 million to $51.6
and $175.6 million for the three and nine months ended September 30, 1999,
respectively, compared to the same periods for the prior year. These increases
are primarily a result of increased staffing levels, marketing expense and costs
of airtime and monthly network access related to growing the wireless services
subscriber accounts base. Telecommunications operating expenses in the third
quarter declined from the second quarter of 1999 as the Company began reducing
activities in certain product categories of its telecommunications business.
Income Taxes
The Company's income tax rate was 38% for the three and nine months
ended September 30, 1999 and 1998
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 factor
in the delinquency and loss levels of the portfolio. 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 on a reported and managed basis. The entire balance of an
account is contractually delinquent if the minimum payment is not received by
the payment due date. Delinquencies not only have the potential to impact
earnings if the account charges off, they also are costly in terms of the
personnel and other resources dedicated to resolving the delinquencies.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------
TABLE 6 - DELINQUENCIES
- ----------------------------------------------------------------------------------------------
September 30
- ------------------------------- --------------------------------------------------------------
1999 1998
- ------------------------------- ---------------------------- ----------------------------
Percent of Percent of
(dollars in thousands) Loans Total Loans Loans Total Loans
- ------------------------------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Reported:
Loans outstanding $ 8,286,210 100.00% $ 5,666,998 100.00%
Loans delinquent:
30-59 days 193,051 2.33 118,384 2.09
60-89 days 106,666 1.29 64,980 1.14
90 or more days 167,812 2.02 103,084 1.82
- ------------------------------- ----------- ----------- ----------- -----------
Total $ 467,529 5.64% 286,448 5.05%
- ------------------------------- ----------- ----------- ----------- -----------
Managed:
Loans outstanding $18,517,411 100.00% $16,337,789 100.00%
Loans delinquent:
30-59 days 379,764 2.05 313,443 1.92
60-89 days 211,022 1.14 178,883 1.09
90 or more days 345,630 1.87 308,285 1.89
- ------------------------------- ----------- ----------- ----------- -----------
Total $ 936,416 5.06% $ 800,611 4.90%
- ------------------------------- ----------- ----------- ----------- -----------
</TABLE>
The 30-plus day delinquency rate for the reported consumer loan
portfolio was 5.64% as of September 30, 1999, up 59 basis points from 5.05% as
of September 30, 1998 and up 29 basis points from 5.35% as of June 30, 1999. The
delinquency rate for the managed consumer loan portfolio was 5.06% as of
September 30, 1999, up 16 basis points from 4.90% as of September 30, 1998 and
up 34 basis points from 4.72% as of June 30, 1999.
<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
- -------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30 September 30
- -------------------------------------------------------------------------------------------
(dollars in thousands) 1999 1998 1999 1998
- -------------------------------------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Reported:
Average loans outstanding $ 7,790,933 $ 5,623,012 $ 7,346,484 $ 5,210,649
Net charge-offs 75,737 56,726 190,792 171,704
Net charge-offs as a percentage of
average loans outstanding 3.89% 4.04% 3.46% 4.39%
- -------------------------------------- ----------- ----------- ----------- -----------
Managed:
Average loans outstanding $18,161,975 $15,746,091 $17,734,352 $14,758,831
Net charge-offs 176,019 198,069 511,152 623,792
Net charge-offs as a percentage of
average loans outstanding 3.88% 5.03% 3.84% 5.64%
- -------------------------------------- ----------- ----------- ----------- -----------
</TABLE>
The managed net charge-off rate decreased 115 basis points and 180
basis points to 3.88% and 3.84% for the three and nine months ended September
30, 1999, respectively from 5.03% and 5.64% for the comparable periods in the
prior year. The reported net charge-off rate decreased 15 basis points and 93
basis points to 3.89% and 3.46% for the three and nine months ended September
30, 1999, respectively, from 4.04% and 4.39% for the comparable periods in the
prior year. The decreases in managed net charge-off rates were the result of
improved general economic trends in consumer credit performance as well as
improved recovery efforts compared to the same periods in the prior year. The
impact was less apparent in the reported portfolio due to changes in the
composition of the reported portfolio compared to the off-balance sheet
portfolio. Also, the managed net charge-off rate for the three months ended
September 30, 1999 increased slightly from 3.73% for the three months ended June
30, 1999. This was the result of a slight deterioration in consumer credit
performance from its historically low levels.
Provision and Allowance for Loan Losses
The allowance for loan losses is maintained at an amount estimated to
be sufficient to absorb probable future losses, net of recoveries (including
recovery of collateral), inherent in the existing reported loan portfolio. The
provision for loan losses is the periodic cost of maintaining an adequate
allowance. Management believes that the allowance for loan losses is adequate to
cover anticipated losses in the reported homogeneous 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 reported
homogeneous consumer loan portfolio. The amount of allowance necessary is
determined primarily based on a migration analysis of delinquent and current
accounts. In evaluating the sufficiency of the allowance for loan losses,
management also takes into consideration the following factors: recent trends in
delinquencies and charge-offs including bankrupt, deceased and recovered
amounts; historical trends in loan volume; forecasting uncertainties and size of
credit risks; the degree of risk inherent in the composition of the loan
portfolio; economic conditions; credit evaluations and underwriting policies.
<PAGE>
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) 1999 1998 1999 1998
- -------------------------------------------------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Balance at beginning of period $ 266,000 $ 213,000 $ 231,000 $ 183,000
Provision for loan losses 114,061 67,569 262,948 212,448
Other 1,676 7,157 2,844 7,256
Charge-offs (107,447) (74,885) (278,469) (219,271)
Recoveries 31,710 18,159 87,677 47,567
- -------------------------------------------------- ---------- ---------- ---------- ----------
Net charge-offs (75,737) (56,726) (190,792) (171,704)
- -------------------------------------------------- ---------- ---------- ---------- ----------
Balance at end of period $ 306,000 $ 231,000 $ 306,000 $ 231,000
- -------------------------------------------------- ---------- ---------- ---------- ----------
Allowance for loan losses to loans at period-end 3.69% 4.08% 3.69% 4.08%
- -------------------------------------------------- ---------- ---------- ---------- ----------
</TABLE>
For the three and nine months ended September 30, 1999, the provision
for loan losses increased 69% and 24%, respectively, to $114.1 million and
$262.9 million from $67.6 million and $212.4 million for the comparable periods
in the prior year, as average reported loans increased by 39% and 41% for the
three and nine months ended September 30, 1999, respectively. The allowance for
loan losses as a percentage of reported consumer loans decreased to 3.69% as of
September 30, 1999, from 4.08% as of September 30, 1998.
Liquidity and Funding
The Company has established access to a wide range of domestic funding
alternatives, in addition to securitization of its consumer loans. The Company
primarily issues senior unsecured debt of the Bank through its $8.0 billion bank
note program, of which $3.8 billion was outstanding as of September 30, 1999,
with original terms of one to ten years.
Internationally, the Company has funding programs designed for foreign
investors or to raise funds in foreign currencies. The Company has accessed the
international securitization market for a number of years with both US$ and
foreign denominated transactions. Both of the Company's committed revolving
credit facilities offer foreign currency funding options. The Bank has
established a $1.0 billion Euro Medium Term Note program that is targeted to
non-U.S. investors. The Company funds its foreign assets by directly or
synthetically borrowing or securitizing in the local currency to mitigate the
financial statement effect of currency translation.
The Company has significantly expanded its retail deposit gathering
efforts through both direct and broker marketing channels. The Company uses its
IBS capabilities to test and market a variety of retail deposit origination
strategies, as well as to develop customized account management programs. As of
September 30, 1999, the Company had $3.6 billion in interest-bearing deposits,
with original maturities of up to ten years.
<PAGE>
Table 9 shows the maturity distribution of certificates of deposit in
denominations of $100,000 or greater ("large denomination CDs") as of September
30, 1999.
- ------------------------------------------------------------------------------
TABLE 9 - MATURITIES OF LARGE DENOMINATION CERTIFICATES-$100,000 OR MORE
- ------------------------------------------------------------------------------
September 30, 1999
- -------------------------------- -------------------------
(dollars in thousands) Balance Percent
- -------------------------------- ---------- ----------
3 months or less $ 115,858 11.87%
Over 3 through 6 months 113,764 11.65
Over 6 through 12 months 252,036 25.82
Thereafter 494,588 50.66
- -------------------------------- ---------- ----------
Total $ 976,246 100.00%
- -------------------------------- ---------- ----------
The Company's other borrowings portfolio consists of $689.2 million in
borrowings maturing within one year and $327.7 million in borrowings maturing
after one year.
Table 10 shows the Company's unsecured funding availability and
outstandings as of September 30, 1999.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------
TABLE 10 - FUNDING AVAILABILITY
- ------------------------------------------------------------------------------------------------------
September 30, 1999
- -----------------------------------------------------------------------------------------------------
Effective/ Outstanding, Final
(dollars or dollar equivalents in millions) Issue Date Availability(1) Net Maturity(4)
- -------------------------------------------- ---------- --------------- ------------ -----------
<S> <C> <C> <C> <C>
Domestic revolving credit facility 5/99 $ 1,200 5/03
UK/Canada revolving credit facility 8/97 350 8/00
Senior bank note program(2) 4/97 8,000 $ 3,774 -
Non-U.S. bank note program 10/97 1,000 5 -
Corporation Shelf Registration 8/99 1,550 549 -
Capital 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, 1999.
(3) Qualifies as Tier 1 capital at the Corporation and Tier 2 capital at the
Bank.
(4) Maturity date refers to the date the facility terminates, where applicable.
The domestic revolving credit facility is comprised of two tranches as
follows: a Tranche A facility in the amount of $810 million available to the
Bank and the Savings Bank, including an option for up to $250 million in
multi-currency availability, and a Tranche B facility in the amount of $390
million available to the Corporation, the Bank and the Savings Bank, including
an option for up to $150 million in multi-currency availability. The facility
terminates on May 24, 2003; however, it may be extended for an additional
one-year period.
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 under the UK/Canada revolving facility. The
commitment terminates on August 29, 2000; however, it may be extended for two
additional one-year periods.
The Corporation has three shelf registration statements under which the
Corporation from time to time may offer and sell (i) senior or subordinated debt
securities, consisting of debentures, notes and/or other unsecured evidences,
(ii) preferred stock, which may be issued in the form of depository shares
evidenced by depository receipts and (iii) common stock. The amount of
securities registered is limited to a $1.6 billion aggregate public offering
price or its equivalent (based on the applicable exchange rate at the time of
sale) in one or more foreign currencies, currency units or composite currencies
as shall be designated by the Corporation. The Corporation issued $225 million
of seven-year fixed rate senior notes in April 1999, $200 million of ten-year
fixed rate senior notes in July 1998 and $125 million of seven-year fixed rate
senior notes in December 1996. The remaining amount of securities available for
issuance under the Corporation's shelf registrations is $1.0 billion.
Liquidity
Liquidity refers to the Company's ability to meet its cash needs. The
Company meets its cash requirements by securitizing assets, gathering deposits
and through issuing debt. 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 1999 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 and are no longer reinvested in new loans, the Company's funding
requirements for such new loans increase accordingly. The occurrence of certain
events may cause the securitization transactions to amortize earlier than
scheduled, which would accelerate the need for funding.
As such loans amortize or are otherwise paid, the Company believes it
can securitize consumer loans, purchase federal funds and establish other
funding sources to fund the amortization or other payment of the securitizations
in the future, although no assurance can be given to that effect. Additionally,
the Company maintains a portfolio of high-quality securities such as U.S.
Treasuries and other U.S. government obligations, 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, 1999, the Company held $1.7 billion in such
securities.
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.
The most recent notifications received 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 Table 11. As of September 30, 1999, there were no
conditions or events since the notifications discussed above that management
believes would have changed either the Bank or the Savings Bank's capital
category.
<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, 1999
Capital One Bank
Tier 1 Capital 11.58% 4.00% 6.00%
Total Capital 14.31 8.00 10.00
Tier 1 Leverage 10.75 4.00 5.00
Capital One, F.S.B.(1)
Tier 1 Capital 8.84% 4.00% 6.00%
Total Capital 10.51 8.00 10.00
Tier 1 Leverage 7.61 4.00 5.00
- --------------------------------- --------------- --------------------------- ------------------------------
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)
Tier 1 Capital 23.84% 4.00% 6.00%
Total Capital 19.28 12.00 10.00
Tier 1 Leverage 12.88 8.00 5.00
- --------------------------------- --------------- --------------------------- ------------------------------
</TABLE>
(1) Before June 30, 1999, the Savings Bank was 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
a branch in the United Kingdom, the Company will maintain a minimum Tier 1
leverage ratio of 3.0%. As of September 30, 1999, the Company's Tier 1 leverage
ratio was 13.33%.
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, 1999, retained earnings of the Bank and the Savings Bank of
$186.3 million and $51.8 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, reduce the interest rate
sensitivity of its securitization transactions and its off-balance sheet
financial instruments. The Company enters into interest rate swap agreements in
the management of its interest rate exposure. The Company also enters into
forward foreign currency exchange contracts and currency swaps to reduce its
sensitivity to changing foreign currency exchange rates. These off-balance sheet
financial instruments involve elements of credit, interest rate or foreign
currency exchange rate risk in excess of the amount recognized on the balance
sheet. These instruments also present the Company with certain credit, market,
legal and operational risks. The Company has established credit policies for
off-balance sheet instruments as it has for on-balance sheet instruments.
Interest Rate Sensitivity
Interest rate sensitivity refers to the change in earnings that may
result from changes in the level of interest rates. To the extent that managed
interest income and expense do not respond equally to changes in interest rates,
or that all rates do not change uniformly, earnings could be affected. The
Company's managed net interest income is affected by changes in short-term
interest rates, primarily LIBOR, as a result of its issuance of interest-bearing
deposits, variable rate loans and variable rate securitizations. The Company
manages and mitigates its interest rate sensitivity through several techniques
which include, but are not limited to, changing the maturity, repricing and
distribution of assets and liabilities and entering into interest rate swaps.
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
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, 1999, the Company was in compliance with the policy; more
than 99% of the outcomes generated by the model produced a managed net interest
income of no more than 1.3% below the mean outcome. The interest rate scenarios
evaluated as of September 30, 1999, included scenarios in which short-term
interest rates rose by nearly 400 basis points or fell by as much as 180 basis
points over twelve months.
The analysis does not consider the effects of the changed level of
overall economic activity associated with various interest rate scenarios.
Further, in the event of a rate change of large magnitude, management would
likely take actions to further mitigate its exposure to any adverse impact. For
example, management may reprice interest rates on outstanding credit card loans
subject to the right of the consumers in certain states to reject such repricing
by giving timely written notice to the Company and thereby relinquishing
charging privileges. However, the repricing of credit card loans may be limited
by competitive factors as well as certain legal constraints.
Interest rate sensitivity at a point in time can also be analyzed by
measuring the mismatch in balances of earning assets and interest-bearing
liabilities that are subject to repricing in future periods.
<PAGE>
Business Outlook
Earnings, Goals and Strategies
This business outlook section summarizes the Company's expectations for
earnings 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 statements are forward
looking 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, 1998
(Part I, Item 1, Risk Factors).
The Company has set targets, dependent on the factors set forth below,
to increase its earnings per share in 1999 by approximately 30% over 1998
earnings per share and increase its earnings per share in 2000 by approximately
30% over 1999 earnings per share. 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 lending business as well as
to other businesses, both financial and non-financial, including
telecommunications services. The Company will seek to identify new product
opportunities and to make informed investment decisions regarding new and
existing products. The Company's lending and other financial and non-financial
products are subject to competitive pressures, which management anticipates will
increase as these markets mature.
Lending. Lending includes credit card and other consumer lending
products, including automobile financing. Credit card opportunities include, and
are expected to continue to include, a wide variety of highly customized
products with interest rates, credit lines and other features specifically
tailored for numerous consumer segments. The Company expects continued growth
across a broad spectrum of new and existing customized products, which are
distinguished by a varied range of credit lines, pricing structures and other
characteristics. For example, the Company's low non-introductory rate products,
which are marketed to consumers with the best established credit profiles, are
characterized by higher credit lines, lower yields and an expectation of lower
delinquencies and credit losses than the traditional low introductory rate
balance transfer products. On the other hand, certain other customized card
products are characterized by lower credit lines, higher yields (including fees)
and in some cases, higher delinquencies and credit losses than the Company's
traditional products. These products also involve higher operational costs but
exhibit better response rates, less adverse selection, less attrition and a
greater ability to reprice than the Company's traditional introductory rate
products. More importantly, as a whole, all of these customized products
continue to have less volatile returns than the traditional products in recent
market conditions.
Telecommunications. The Company recently announced that it expects to
change the focus of its efforts to market telecommunications services through
its subsidiary America One Communications, Inc. ("America One"). In the first
half of 1999, America One's primary business, the reselling of analog and
digital wireless services through direct marketing channels, began experiencing
significant competitive pressures in its core wireless markets. In response to
these changing market conditions, the Company expects to decrease its marketing
investment in these market segments and, over time, to increase its investment
in other market segments that generally are not being served by the major
wireless telecommunications competitors. As a result of this shift in marketing,
the Company decreased its overall marketing investment in America One in the
third quarter of 1999 and expects a further decrease in the fourth quarter of
1999. Management remains optimistic that, over time, its strategy can be
successful in the wireless telecommunications industry.
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 the continued growth
of its United Kingdom business and any future business in Europe, the Company
opened a new operations center in Nottingham, England in July 1998 and expanded
it in early 1999.
The Company will continue to apply its IBS in an effort to balance the
mix of credit card products 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 to internally build or acquire the necessary operational and
organizational infrastructure, recruit experienced personnel, fund these new
businesses and manage expenses. Although management believes 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 expects its 1999 marketing expenses to exceed 1998's
expense level significantly, as the Company continues to invest in its various
credit card products and services, brand management 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 across product lines and is
expected to rise as the Company moves beyond the domestic card business. With
competition affecting the profitability of traditional introductory rate 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 cost
to acquire an America One wireless account has included the cost of providing a
free phone to the customer, and consequently has been 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 Company is also
developing a brand marketing strategy to supplement current strategies. The
actual amount of marketing investment is subject to a variety of external and
internal factors, such as competition in the consumer credit and wireless
service industries, general economic conditions affecting consumer credit
performance, the asset quality of the Company's portfolio and the identification
of market opportunities across product lines that exceed the Company's targeted
rates of return on investment.
The amount of marketing expense allocated to various products or
businesses will influence the characteristics of the Company's portfolio as
various products or businesses are characterized by different account growth,
loan growth and asset quality characteristics. The Company currently expects
continued strong account growth and loan growth in the fourth quarter of 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-Offs and Attrition
The Company's earnings are particularly sensitive to delinquencies and
charge-offs on the Company's portfolio and to 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. Delinquencies and net charge-offs are impacted by general
economic trends in consumer credit performance, including bankruptcies, the
continued seasoning of the Company's portfolio and the product mix.
The Company experienced improving credit quality of its credit
portfolio in the first half of 1999. As of September 30, 1999, the Company had
the lowest net charge-off rate among the top ten credit card issuers in the
United States. However, management expects delinquencies to increase moderately
through the first half of 2000 and that, as a result, charge-offs will begin to
increase in the year 2000. Management 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 more quickly. 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.
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 services for its operations. To the extent the
software applications of the Company or its vendors contain programmed code that
is 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. The project office's strategy for the Company's
information technology computer-based ("IT") systems is based, in large part, on
the regulatory guidelines published by the Federal Financial Institutions
Examination Counsel. This strategy calls for five milestones for each of the
Company's 79 internal IT project areas:
o awareness of the existence of information technology systems Company-wide;
o assessment of those systems for year 2000 readiness;
o renovation of those systems and their date coding functions;
o validation (testing) of renovations; and
o implementation of all renovations made.
All 79 of the Company's internally housed IT project areas have
completed each of the five milestones and are functioning in a Y2K ready state.
The Company has also completed several integrated tests for systems with cross
functionality and completed an internal audit validation of its testing measures
and results. The Company is conducting extensive audits to ensure that
maintenance procedures, including regression testing, are in place. The Company
will continue to monitor and test its internal IT systems, as necessary,
throughout the remainder of 1999.
The Company has also addressed the effect of the year 2000 on its
non-IT systems, which are not included as part of the IT project areas set forth
above. These non-IT systems primarily consist of desktop computer applications
and data used by the Company's employees. The Company has inventoried, assessed
and renovated these applications and data and will continue to monitor and test
these systems, as necessary, throughout the remainder of 1999.
In addition, the Company relies on outside business vendors in its
day-to-day operations. The Company continues to monitor the overall year 2000
readiness of its external business vendors and year 2000 compliance of specific
vendor systems used in the Company's operations. These vendors include credit
bureaus, collection agencies, utilities and other related service providers,
third party processors, the U.S. postal service, telephone companies, technology
vendors, and banks that are creditors of the Company or which provide cash
management, trustee, paying agent, stock transfer agent or other services. These
vendors also include third parties that the Company uses to outsource certain
operations for America One, Summit and its business in the United Kingdom.
The Company is actively communicating with third parties through
face-to-face meetings and correspondence to obtain test results and perform
integrated testing with service providers. The Company, however, must rely on
the actions of and the information provided by its vendors and cannot guarantee
that vendor systems will, in fact, be compliant. For high priority vendors that
the Company determines may not be taking appropriate and timely action or have
failed to provide sufficient information, the Company has put contingency plans
in place. The Company will continue to actively monitor the efforts of all of
its vendors and to take actions to mitigate year 2000 issues resulting from any
failure of its vendors to be year 2000 compliant.
The Company's Contingency Plans
The Company's business units have completed a contingency planning
process to: (i) inventory and assess year 2000 risks; (ii) conduct business
impact analyses; (iii) develop contingency plans to mitigate the risks; and (iv)
test and validate these contingency plans. All of these stages have been
successfully completed and the plans continue to be tested.
The Company has also developed a more comprehensive Enterprise-Wide
Contingency Plan (the "Plan") to support and unite the detailed business unit
plans. The Plan addresses risks to core business processes as well as certain
global enterprise risks. The Company's core business processes include, but are
not limited to, credit authorization, funding and securitizations, transaction
processing, customer billing, customer statement processing, remittance
processing and fraud detection. The Plan sets forth the overall communication,
operations, and information technology strategies needed to enable rapid
response and minimize impacts in the event of failure or interruption to these
processes.
The Plan sets forth pre-event planning assessment, prioritization and
communication of issues, and recovery of operations. Some of the strategies
address reliance on back-up systems, on-site internal and external technical
support, implementation of manual processes, shifting of workloads and moving to
alternate service providers to continue operations. The Plan also addresses
global enterprise risks such as interruptions of power supply,
telecommunications supply, postal service and the Company's cardholder
authorization system and sets forth plans to minimize negative impacts. The
Company completed an independent review of the Plan and validation strategy for
feasibility, and continues to test and validate the Plan.
In addition, the Company's Year 2000 Senior Governance Committee, which
is composed of senior management, continues to develop solutions to broad
business and economic issues related to mitigating the financial impact of the
year 2000. It has also formed an Event Management Center, which is staffed with
individuals from many of the Company's business units. This will be the nucleus
for decision the millennium weekend.
The Costs to Address the Company's Year 2000 Issues
As of September 30, 1999, the Company had spent approximately $12.7
million to remediate its internal systems. The Company estimates it will spend
an additional $2.3 million in the remainder of 1999. Costs for readiness
activities not directly related to internal systems remediation, such as third
party vendor assessment and business unit contingency planning, are not included
and are not expected to be material.
The Risks of the Company's Year 2000 Issues
Although the Company expects to have all of its system modifications
completed and tested extensively by the onset of the new millennium, unforeseen
problems could arise from not being year 2000 compliant. The Company's business
is heavily reliant on computer technologies and problems could arise resulting
in delays and malfunctions that may impact the Company's operations, liquidity
and financial results. In addition, the Company cannot guarantee that all of its
vendors will have completed system renovations and be compliant by the year
2000. Although the Company has developed and continues to reassess contingency
plans to mitigate the risks from third party vendors and systems, the failure of
third parties to provide the Company with products, services or systems that
meet year 2000 requirements could materially impact the Company's business and
operations. A reasonably likely worst case scenario would involve a major
failure of the U.S. Postal Service, the Company's local and long distance
carriers, one or more of the primary financial switching networks, or its
material third party processors to be year 2000 compliant. These failures 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 it has taken
the necessary precautionary measures to assure 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
and other 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 or expansion internationally;
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, 1998 (Part I, Item 1, Risk Factors).
<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 a Current Report on Form 8-K, dated July 15,
1999, Commission File No. 1-13300, enclosing its press release
dated July 15, 1999.
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 15, 1999 /s/David M. Willey
------------------------------
David M. Willey
Senior Vice President,
Corporate Financial Management
(Chief Accounting Officer
and duly authorized officer
of the Registrant)
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