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 June 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 July 31, 1999, there were 197,480,933 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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June 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>
June 30 December 31
1999 1998
- ----------------------------------------------------------- -------------- --------------
<S> <C> <C>
Assets:
Cash and due from banks $ 25,582 $ 15,974
Federal funds sold and resale agreements 261,800
Interest-bearing deposits at other banks 72,616 22,393
- ----------------------------------------------------------- -------------- --------------
Cash and cash equivalents 98,198 300,167
Securities available for sale 1,615,422 1,796,787
Consumer loans 7,426,974 6,157,111
Less: Allowance for loan losses (266,000) (231,000)
- ----------------------------------------------------------- -------------- --------------
Net loans 7,160,974 5,926,111
Premises and equipment, net 347,168 242,147
Interest receivable 60,858 52,917
Accounts receivable from securitizations 886,680 833,143
Other 411,324 268,131
- ----------------------------------------------------------- -------------- --------------
Total assets $ 10,580,624 $ 9,419,403
- ----------------------------------------------------------- -------------- --------------
Liabilities:
Interest-bearing deposits $ 2,414,933 $ 1,999,979
Other borrowings 1,356,374 1,644,279
Senior notes 4,539,776 3,739,393
Interest payable 101,150 91,637
Other 667,407 575,788
- ----------------------------------------------------------- -------------- --------------
Total liabilities 9,079,640 8,051,076
Capital Securities 98,048 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 June 30, 1999 and December 31, 1998, respectively 1,997 1,997
Paid-in capital, net 626,796 598,167
Retained earnings 839,387 679,838
Cumulative other comprehensive income 12,718 60,655
Less: Treasury stock, at cost; 2,294,933 and 2,690,910
shares as of June 30, 1999 and December 31, 1998,
respectively (77,962) (70,251)
- ----------------------------------------------------------- -------------- --------------
Total stockholders' equity 1,402,936 1,270,406
- ----------------------------------------------------------- -------------- --------------
Total liabilities and stockholders' equity $ 10,580,624 $ 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 Six Months Ended
June 30 June 30
- ----------------------------------------------------- ------------- ------------- ------------- -------------
1999 1998 1999 1998
- ----------------------------------------------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Interest Income:
Consumer loans, including fees $ 353,193 $ 245,129 $ 678,260 $ 474,767
Federal funds sold and resale agreements 764 2,140 2,251 7,218
Other 23,816 24,169 50,333 47,495
- ----------------------------------------------------- ------------- ------------- ------------- -------------
Total interest income 377,773 271,438 730,844 529,480
Interest Expense:
Deposits 26,438 13,635 50,380 27,773
Other borrowings 19,484 20,375 43,321 36,428
Senior and deposit notes 80,654 67,704 153,149 130,733
- ----------------------------------------------------- ------------- ------------- ------------- -------------
Total interest expense 126,576 101,714 246,850 194,934
- ----------------------------------------------------- ------------- ------------- ------------- -------------
Net interest income 251,197 169,724 483,994 334,546
Provision for loan losses 74,301 59,013 148,887 144,879
- ----------------------------------------------------- ------------- ------------- ------------- -------------
Net interest income after provision for loan losses 176,896 110,711 335,107 189,667
Non-Interest Income:
Servicing and securitizations 293,606 155,412 565,560 324,067
Service charges and other fees 244,874 153,170 467,327 285,615
Interchange 33,567 20,371 63,786 35,170
- ----------------------------------------------------- ------------- ------------- ------------- -------------
Total non-interest income 572,047 328,953 1,096,673 644,852
Non-Interest Expense:
Salaries and associate benefits 194,461 113,428 373,655 221,381
Marketing 178,242 85,811 354,330 160,811
Communications and data processing 62,478 34,840 120,550 64,203
Supplies and equipment 42,303 32,368 79,007 54,983
Occupancy 16,381 11,090 30,295 21,734
Other 113,984 54,299 199,980 97,607
- ----------------------------------------------------- ------------- ------------- ------------- -------------
Total non-interest expense 607,849 331,836 1,157,817 620,719
- ----------------------------------------------------- ------------- ------------- ------------- -------------
Income before income taxes 141,094 107,828 273,963 213,800
Income taxes 53,616 40,975 104,106 81,244
- ----------------------------------------------------- ------------- ------------- ------------- -------------
Net income $ 87,478 $ 66,853 $ 169,857 132,556
- ----------------------------------------------------- ------------- ------------- ------------- -------------
Basic earnings per share $ 0.44 $ 0.34 $ 0.86 $ 0.67
- ----------------------------------------------------- ------------- ------------- ------------- -------------
Diluted earnings per share $ 0.41 $ 0.32 $ 0.80 $ 0.64
- ----------------------------------------------------- ------------- ------------- ------------- -------------
Dividends paid per share $ 0.03 $ 0.03 $ 0.05 $ 0.05
- ----------------------------------------------------- ------------- ------------- ------------- -------------
</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 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 132,556 132,556
Other comprehensive income, net of income tax
Unrealized gains on securities, net of income
taxes of $839 1,370 1,370
Foreign currency translation adjustments (488) (488)
------------- -------------
Other comprehensive income 882 882
------------- -------------
Comprehensive income 133,438
Cash dividends - $.0533 per share (10,211) (10,211)
Purchases of treasury stock (12,354) (12,354)
Issuances of common stock 670 2,764 3,434
Exercise of stock options 4,500 (9,506) 14,308 4,802
Common stock issuable under incentive plan 56,495 56,495
Other items, net 298 298
- ------------------------------------------- ----------- ------- ------------ --------- ------------- ----------- -------------
Balance, June 30, 1998 199,676,190 $ 1,997 $ 560,187 $ 547,485 $ 3,421 $ (43,929) $1,069,161
- ------------------------------------------- ----------- ------- ------------ --------- ------------- ----------- -------------
Balance, December 31, 1998 199,670,376 $ 1,997 $ 598,167 $ 679,838 $ 60,655 $ (70,251) $1,270,406
Comprehensive income:
Net income 169,857 169,857
Other comprehensive income, net of income tax
Unrealized losses on securities, net of income
tax benefit of $31,048 (50,657) (50,657)
Foreign currency translation adjustments 2,720 2,720
------------- -------------
Other comprehensive income (47,937) (47,937)
------------- -------------
Comprehensive income 121,920
Cash dividends - $.0533 per share (10,328) (10,328)
Purchases of treasury stock (53,410) (53,410)
Issuances of common stock 45 1,311 20 2,002 3,333
Exercise of stock options (21,215) 43,697 22,482
Common stock issuable under incentive plan 46,372 46,372
Other items, net 2,161 2,161
- ------------------------------------------- ----------- ------- ------------ --------- ------------- ----------- -------------
Balance, June 30, 1999 199,670,421 $ 1,997 $ 626,796 $ 839,387 $ 12,718 $ (77,962) $1,402,936
- ------------------------------------------- ----------- ------- ------------ --------- ------------- ----------- -------------
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
<PAGE>
CAPITAL ONE FINANCIAL CORPORATION
Condensed Consolidated Statements of Cash Flows
(in thousands) (unaudited)
<TABLE>
<CAPTION>
Six Months Ended
June 30
- ----------------------------------------------------------------- ------------ -------------
1999 1998
- ----------------------------------------------------------------- ------------ -------------
<S> <C> <C>
Operating Activities:
Net income $ 169,857 $ 132,556
Adjustments to reconcile net income to cash
provided by operating activities:
Provision for loan losses 148,887 144,879
Depreciation and amortization, net 76,294 50,934
Stock compensation plans 46,372 56,513
(Increase) decrease in interest receivable (7,941) 6,017
Increase in accounts receivable from securitizations (102,057) (247,493)
Increase in other assets (120,326) (78,522)
Increase in interest payable 9,513 14,719
Increase in other liabilities 91,619 68,669
- ----------------------------------------------------------------- ------------ -------------
Net cash provided by operating activities 312,218 148,272
- ----------------------------------------------------------------- ------------ -------------
Investing Activities:
Purchases of securities available for sale (455,572) (706,466)
Proceeds from maturities of securities available for sale 141,207 423,726
Proceeds from sales of securities available for sale 462,071 102,269
Proceeds from securitization of consumer loans 1,225,043 1,628,598
Net increase in consumer loans (2,676,109) (2,061,269)
Recoveries of loans previously charged off 55,967 29,408
Additions of premises and equipment, net (157,732) (61,515)
- ----------------------------------------------------------------- ------------ -------------
Net cash used for investing activities (1,405,125) (645,249)
- ----------------------------------------------------------------- ------------ -------------
Financing Activities:
Net increase (decrease) in interest-bearing deposits 414,954 (26,252)
Net (decrease) increase in other borrowings (287,905) 163,368
Issuances of senior notes 1,120,059 1,009,522
Maturities of senior and deposit notes (320,000) (833,666)
Dividends paid (10,328) (10,211)
Purchases of treasury stock (53,410) (12,354)
Net proceeds from issuances of common stock 5,086 3,434
Proceeds from exercise of stock options 22,482 4,802
- ----------------------------------------------------------------- ------------ -------------
Net cash provided by financing activities 890,938 298,643
- ----------------------------------------------------------------- ------------ -------------
Decrease in cash and cash equivalents (201,969) (198,334)
Cash and cash equivalents at beginning of period 300,167 237,723
- ----------------------------------------------------------------- ------------ -------------
Cash and cash equivalents at end of period $ 98,198 $ 39,389
- ----------------------------------------------------------------- ------------ -------------
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
<PAGE>
CAPITAL ONE FINANCIAL CORPORATION
Notes to Condensed Consolidated Financial Statements
June 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 six
months ended June 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 six months ended June 30, 1999 and 1998
was $237,337 and $180,215, respectively. Cash paid for income taxes for the six
months ended June 30, 1999 and 1998 was $136,510 and $136,275, 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 Six Months Ended
June 30 June 30
---------------------------- ---------------------------
1999 1998 1999 1998
- ------------------------------------ ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Income Statement Data
Revenues:
Lending $ 872,627 $ 527,519 $ 1,674,602 $ 1,041,414
Telecommunications 36,751 12,846 67,048 24,008
Operating profit (loss):
Lending 309,185 214,550 590,107 420,822
Telecommunications (28,659) (6,212) (56,963) (14,870)
Other (10,678) (9,319) (17,036) (15,371)
- ------------------------------------ ----------- ----------- ----------- -----------
Total operating profit (loss) 269,848 199,019 516,108 390,581
Indirect expenses 128,754 91,191 242,145 176,781
- ------------------------------------ ----------- ----------- ----------- -----------
Income before taxes $ 141,094 $ 107,828 $ 273,963 $ 213,800
- ------------------------------------ ----------- ----------- ----------- -----------
</TABLE>
All 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 April 1999, the Corporation issued $225,000 of seven-year fixed rate
senior notes under an existing shelf registration.
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.
Note E: Comprehensive Income
Comprehensive income for the three months ended June 30, 1999 and 1998
was as follows:
Three Months Ended
June 30
- ----------------------------------- ---------------- ----------------
1999 1998
- ----------------------------------- ---------------- ----------------
Comprehensive Income:
Net income $ 87,478 $ 66,853
Other comprehensive income (9,836) 1,096
- ----------------------------------- ---------------- ----------------
Total comprehensive income $ 77,642 $ 67,949
- ----------------------------------- ---------------- ----------------
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 six months ended June 30, 1999.
Note G: Associate Stock Plans
In April 1999, the Company's Board of Directors approved a stock
options grant to senior management. This grant was composed of 6,870,270 options
to certain key managers (including 1,884,435 options to the Company's Chief
Executive Officer ("CEO") and Chief Operating Officer ("COO")) at the fair
market value on the date of grant (number of options and per share information
restated to reflect the effect of the Company's stock split). The CEO and COO
gave up their salary for the year of 2001, and their annual cash incentive,
annual option grants and Senior Executive Retirement Plan contributions through
the year of 2001 in exchange for these options. Other members of senior
management 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 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,
or in nine years or upon a change of control of the Company.
In April 1999, the Company granted 1,045,362 options to all recently
hired or promoted associates not granted options in the above mentioned grant.
Certain associates were granted options in exchange for giving up future
compensation. Other associates were granted a set number of options. These
options were granted at the fair market value on the date of grant and vest, in
full, on April 29, 2002 or earlier upon a change in 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 Six Months Ended
June 30 June 30
- ----------------------------------------------- ----------------------- -----------------------
(shares in thousands) 1999 1998 1999 1998
- ----------------------------------------------- --------- --------- --------- ---------
<S> <C> <C> <C> <C>
Numerator:
Net income $ 87,478 $ 66,853 $ 169,857 $ 132,556
Denominator:
Denominator for basic earnings per share -
Weighted-average shares 197,642 196,611 197,632 196,449
Effect of dilutive securities:
Stock options 13,857 11,970 13,495 10,692
Restricted stock 6
- ----------------------------------------------- --------- --------- --------- ---------
Dilutive potential common shares 13,857 11,970 13,495 10,698
Denominator for diluted earnings per share -
Adjusted weighted-average shares 211,499 208,581 211,127 207,147
- ----------------------------------------------- --------- --------- --------- ---------
Basic earnings per share $ 0.44 $ 0.34 $ 0.86 $ 0.67
- ----------------------------------------------- --------- --------- --------- ---------
Diluted earnings per share $ 0.41 $ 0.32 $ 0.80 $ 0.64
- ----------------------------------------------- --------- --------- --------- ---------
</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. The
Bank intends to petition for further appellate review of the ruling on the two
remaining counts.
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.
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 products (including credit cards) and deposit products. The Corporation
and its subsidiaries are collectively referred to as the "Company." As of June
30, 1999, the Company had 19.2 million customers and $17.9 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 June 30, 1999 of $87.5 million, or
$.41 per share, compares to net income of $66.9 million, or $.32 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 $81.5 million, or 48%, as the net interest margin increased to
10.88% from 9.64% and average earning assets increased by 31%. The provision for
loan losses increased $15.3 million, or 26%, and average reported loans
increased by 42%. Non-interest income increased $243.1 million, or 74%,
primarily as a result of the enhanced performance of the off-balance sheet
portfolio, an increase in average accounts of 43% and increases in the amounts
of certain fees charged. Marketing expense increased $92.4 million, or 108%, to
$178.2 million as the Company continues to invest in new product opportunities.
Salaries and associate benefits expense increased $81.0 million, or 71%. The
$102.5 million, or 77%, increase in all other non-interest expenses as well as
the increase in salaries and associate benefits expense primarily reflected
increased staff and the 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 six months ended June 30, 1999 was $169.9 million, or
$.80 per share, compared to net income of $132.6 million, or $.64 per share, for
the same period in 1998. This 28% 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. Managed consumer loan adds back the effect of off-balance
sheet consumer loans. The Company also evaluates its interest rate exposure on a
managed portfolio basis.
The Company's managed consumer loan portfolio is comprised of 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.
Table 1 summarizes the Company's managed consumer loan portfolio.
- --------------------------------------------------------------------------------
Table 1 - Managed Consumer Loan Portfolio
- --------------------------------------------------------------------------------
Three Months Ended
June 30
- ----------------------------------------------- ------------- --------------
(in thousands) 1999 1998
- ----------------------------------------------- ------------- --------------
Period-End Balances:
Reported consumer loans $ 7,426,974 $ 5,140,340
Off-balance sheet consumer loans 10,433,163 9,828,984
- ----------------------------------------------- ------------- --------------
Total managed consumer loan portfolio $ 17,860,137 $ 14,969,324
- ----------------------------------------------- ------------- --------------
Average Balances:
Reported consumer loans $ 7,406,257 $ 5,213,605
Off-balance sheet consumer loans 10,191,314 9,203,117
- ----------------------------------------------- ------------- --------------
Total average managed consumer loan portfolio $ 17,597,571 $ 14,416,722
- ----------------------------------------------- ------------- --------------
Six Months Ended
June 30
- ----------------------------------------------- ------------- --------------
(in thousands) 1999 1998
- ----------------------------------------------- ------------- --------------
Average Balances:
Reported consumer loans $ 7,120,578 $ 4,996,983
Off-balance sheet consumer loans 10,396,421 9,256,755
- ----------------------------------------------- ------------- --------------
Total average managed consumer loan portfolio $ 17,516,999 $ 14,253,738
- ----------------------------------------------- ------------- --------------
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 Six Months Ended
June 30 June 30
- --------------------------------------------------------------------------------------------------
(dollars in thousands) 1999 1998 1999 1998
- ---------------------------------- ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Reported:
Average earning assets $ 9,237,115 $ 7,039,261 $ 9,061,481 $ 6,868,832
Net interest margin(1) 10.88% 9.64% 10.68% 9.74%
Loan yield 19.08 18.81 19.05 19.00
- ---------------------------------- ------------ ------------ ------------ ------------
Managed:
Average earning assets $19,428,429 $16,242,378 $19,457,902 $16,125,587
Net interest margin(1) 10.89% 9.84% 10.74% 10.12%
Loan yield 17.43 16.85 17.27 17.15
- ---------------------------------- ------------ ------------ ------------ ------------
</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.
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 Six Months Ended
June 30 June 30
- ------------------------------------ -------------- -------------- -------------- --------------
(dollars in thousands) 1999 1998 1999 1998
- ------------------------------------ -------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Managed Income Statement:
Net interest income $ 528,811 $ 399,505 $ 1,044,464 $ 816,216
Non-interest income 388,112(1) 253,244 745,759(1) 473,927
Net charge-offs (164,004) (212,988) (335,133) (425,723)
- ------------------------------------ -------------- -------------- -------------- --------------
Risk adjusted revenue $ 752,919 $ 439,761 $ 1,455,090 $ 864,420
- ------------------------------------ -------------- -------------- -------------- --------------
Ratios(2):
Net interest margin 10.89% 9.84% 10.74% 10.12%
Non-interest income 7.99 6.24 7.66 5.88
Net charge-offs (3.38) (5.25) (3.44) (5.28)
- ------------------------------------ -------------- -------------- -------------- --------------
Risk adjusted margin 15.50% 10.83% 14.96% 10.72%
- ------------------------------------ -------------- -------------- -------------- --------------
</TABLE>
(1) Excludes the impact on credit card securitization income related to SFAS
125 of $10.4 million for the three and six months ended June 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 June 30, 1999
was $251.2 million, compared to $169.7 million for the same period in the prior
year, representing an increase of $81.5 million, or 48%. For the six months
ended June 30, 1999, net interest income was $484.0 million compared to $334.5
million for the same period in 1998, representing an increase of $149.4 million,
or 45%. Net interest margin increased 124 and 94 basis points for the three and
six months ended June 30, 1999, respectively, compared to the same periods in
the prior year. These increases were primarily a result of the increases in the
yield on earning assets of 94 and 71 basis points for the three and six months
ended June 30, 1999, respectively, to 16.36% from 15.42% and to 16.13% from
15.42% as compared to the same periods in the prior year. The increase in the
yield on earning assets was primarily attributable to a shift in the composition
of average earning assets towards consumer loans which yield higher returns than
the combined securities portfolio, as well as a slight increase in the yield on
those consumer loans. The yield on consumer loans nominally increased due to an
increase in the amount and frequency of past-due fees charged as compared to the
same period in the prior year and the Company's continued shift to higher
yielding products.
Managed net interest income increased $129.3 million, and $228.2
million, or 32% and 28%, for the three and six months ended June 30, 1999,
respectively, compared to the same periods in the prior year. The increases in
managed net interest income were the result of a 20% and 21% increase in managed
average earning assets and the managed net interest margin increasing 105 and 62
basis points to 10.89% and 10.74% for the three and six months ended June 30,
1999, respectively. The increases in managed net interest margin principally
reflect the increases in average earning asset composition and earning asset
yields discussed above.
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 six months ended June 30, 1999 and 1998.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------------
Table 4 - STATEMENTS OF AVERAGE BALANCES, INCOME AND EXPENSE, YIELDS AND RATES
- ------------------------------------------------------------------------------------------------------------------------------------
Three Months Ended June 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) $ 7,406,257 $ 353,193 19.08% $ 5,213,605 $ 245,129 18.81%
Federal funds sold and
resale agreements 63,578 764 4.81 151,275 2,140 5.66
Other 1,767,280 23,816 5.39 1,674,381 24,169 5.77
- ------------------------------------- ------------- ------------- ------------- ------------- ------------- -------------
Total earning assets 9,237,115 $ 377,773 16.36% 7,039,261 $ 271,438 15.42%
Cash and due from banks 16,961 22,659
Allowance for loan losses (253,500) (213,000)
Premises and equipment, net 320,661 177,487
Other 1,324,335 1,079,789
- ------------------------------------- ------------- ------------- ------------- ------------- ------------- -------------
Total assets $10,645,572 $ 8,106,196
- ------------------------------------- ------------- ------------- ------------- ------------- ------------- -------------
Liabilities and Equity:
Interest-bearing liabilities
Deposits $ 2,270,769 $ 26,438 4.66% $ 1,193,508 $ 13,635 4.57%
Other borrowings 1,501,960 19,484 5.19 1,318,889 20,375 6.18
Senior and deposit notes 4,620,921 80,654 6.98 3,905,684 67,704 6.93
- ------------------------------------- ------------- ------------- ------------- ------------- ------------- -------------
Total interest-bearing liabilities 8,393,650 $ 126,576 6.03% 6,418,081 $ 101,714 6.34%
Other 780,168 553,033
- ------------------------------------- ------------- ------------- ------------- ------------- ------------- -------------
Total liabilities 9,173,818 6,971,114
Preferred beneficial interests 98,017 97,760
Equity 1,373,737 1,037,322
- ------------------------------------- ------------- ------------- ------------- ------------- ------------- -------------
Total liabilities and equity $10,645,572 $ 8,106,196
- ------------------------------------- ------------- ------------- ------------- ------------- ------------- -------------
Net interest spread 10.33% 9.08%
- ------------------------------------- ------------- ------------- ------------- ------------- ------------- -------------
Interest income to
average earning assets 16.36% 15.42%
Interest expense to
average earning assets 5.48 5.78
- ------------------------------------- ------------- ------------- ------------- ------------- ------------- -------------
Net interest margin 10.88% 9.64%
- ------------------------------------- ------------- ------------- ------------- ------------- ------------- -------------
</TABLE>
(1) Interest income includes past-due fees on loans of approximately $111,913
and $72,700 for the three months ended June 30, 1999 and 1998,
respectively.
<PAGE>
<TABLE>
<CAPTION>
Six Months Ended June 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) $ 7,120,578 $ 678,260 19.05% $ 4,996,983 $ 474,767 19.00%
Federal funds sold and
resale agreements 94,862 2,251 4.75 256,393 7,218 5.63
Other 1,846,041 50,333 5.45 1,615,456 47,495 5.88
- ------------------------------------- ------------- ------------- ------------- ------------- ------------- -------------
Total earning assets 9,061,481 $ 730,844 16.13% 6,868,832 $ 529,480 15.42%
Cash and due from banks 10,512 21,500
Allowance for loan losses (246,417) (205,167)
Premises and equipment, net 297,168 171,543
Other 1,276,324 960,875
- ------------------------------------- ------------- ------------- ------------- ------------- ------------- -------------
Total assets $10,399,068 7,817,583
- ------------------------------------- ------------- ------------- ------------- ------------- ------------- -------------
Liabilities and Equity:
Interest-bearing liabilities
Deposits $ 2,186,397 $ 50,380 4.61% $ 1,229,586 $ 27,773 4.52%
Other borrowings 1,590,500 43,321 5.45 1,198,654 36,428 6.08
Senior and deposit notes 4,406,571 153,149 6.95 3,795,013 130,733 6.89
- ------------------------------------- ------------- ------------- ------------- ------------- ------------- -------------
Total interest-bearing liabilities 8,183,468 $ 246,850 6.03% 6,223,253 $ 194,934 6.26%
Other 779,782 502,631
- ------------------------------------- ------------- ------------- ------------- ------------- ------------- -------------
Total liabilities 8,963,250 6,725,884
Preferred beneficial interests 97,986 97,728
Equity 1,337,832 993,971
- ------------------------------------- ------------- ------------- ------------- ------------- ------------- -------------
Total liabilities and equity $10,399,068 $ 7,817,583
- ------------------------------------- ------------- ------------- ------------- ------------- ------------- -------------
Net interest spread 10.10% 9.16%
- ------------------------------------- ------------- ------------- ------------- ------------- ------------- -------------
Interest income to
average earning assets 16.13% 15.42%
Interest expense to
average earning assets 5.45 5.68
- ------------------------------------- ------------- ------------- ------------- ------------- ------------- -------------
Net interest margin 10.68% 9.74%
- ------------------------------------- ------------- ------------- ------------- ------------- ------------- -------------
</TABLE>
(1) Interest income includes past-due fees on loans of approximately $219,061
and $148,651 for the six months ended June 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 Six Months Ended
June 30, 1999 vs 1998 June 30, 1999 vs 1998
- ---------------------------------- --------------------------------------- ------------------------------------------
Increase Change due to(1) Increase Change due to(1)
(in thousands) (Decrease) Volume Yield/Rate (Decrease) Volume Yield/Rate
- ---------------------------------- ------------ ------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Interest Income:
Consumer loans $108,064 $104,516 $ 3,548 $203,493 $202,277 $ 1,216
Federal funds sold and
resale agreements (1,376) (1,092) (284) (4,967) (3,976) (991)
Other (353) 5,684 (6,037) 2,838 11,025 (8,187)
- ---------------------------------- ------------ ------------ ------------ ------------ ------------ ------------
Total interest income 106,335 89,052 17,283 201,364 175,854 25,510
Interest Expense:
Deposits 12,803 12,537 266 22,607 22,036 571
Other borrowings (891) 11,712 (12,603) 6,893 16,709 (9,816)
Senior and deposit notes 12,950 12,481 469 22,416 21,245 1,171
- ---------------------------------- ------------ ------------ ------------ ------------ ------------ ------------
Total interest expense 24,862 55,552 (30,690) 51,916 72,277 (20,361)
- ---------------------------------- ------------ ------------ ------------ ------------ ------------ ------------
Net interest income(1) $ 81,473 $ 57,800 $ 23,673 $149,448 $114,716 $ 34,732
- ----------------------------------------------- ------------ ------------ ------------ ------------ ------------
</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 securitization 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 increased $138.2 million, or 89%
to $293.6 million for the three months ended June 30, 1999, from $155.4 million
in the same period in the prior year. Servicing and securitizations income
increased $241.5 million, or 75% to $565.6 million for the six months ended June
30, 1999, from $324.1 million in the same period in the prior year. These
increases were primarily due to an increase of 11% and 12%, respectively, in
average off-balance sheet consumer loans and decreased charge-offs on such loans
as a result of improving consumer credit.
Certain estimates inherent in the determination of the fair value of
the I/O strip are influenced by factors outside the Company's control, and as a
result, such estimates could materially change in the near term. Any future
gains that will be recognized in accordance with SFAS 125 will be dependent on
the timing and amount of future securitizations. The Company will continuously
assess the performance of new and existing securitization transactions as
estimates of future cash flows change.
<PAGE>
Other Non-Interest Income
Interchange income increased to $33.6 million and $63.8 million, or
65%, and 81%, for the three and six months ended June 30, 1999, respectively,
compared to $20.4 million and $35.2 million for the same periods in the prior
year. These increases are primarily attributable to increased utilization from
existing customers, new account growth and an increase in interchange rates
received by the Company in the three months ended June 30, 1999. Service charges
and other fees increased to $244.9 million and $467.3 million, or 60% and 64%,
for the three and six months ended June 30, 1999, respectively, compared to
$153.2 million and $285.6 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 43% and 42% for the
three and six months ended June 30, 1999, respectively, and a shift to more
fee-intensive products.
Telecommunications revenue includes service revenues, which consist
primarily of charges for airtime usage and monthly network access from providing
mobile wireless services. Telecommunications revenue increased $23.9 million to
$36.7 million from $12.8 million for the three months ended June 30, 1999 and
1998, respectively. Telecommunications revenue increased $43.0 million to $67.0
million from $24.0 million for the six months ended June 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 six months ended June 30, 1999
was $607.8 million and $1.2 billion, respectively, an increase of 83% and 87%
over $331.8 million and $620.7 million, respectively, for the same periods in
the prior year. Contributing to the increase in non-interest expense for the
three and six months ended June 30, 1999 was salaries and associate benefits
expense which increased $81.0 million, or 71%, and $152.3 million, or 69%,
respectively. This was primarily a result of adding over 5,500 full time
equivalents to our staffing levels since June 30, 1998. Marketing expense
increased $92.4 million and $193.5 million, or 108% and 120%, to $178.2 million
and $354.3 million for the three and six months ended June 30, 1999,
respectively, as the Company continued to invest in new product opportunities.
All other non-interest expenses increased $102.5 million and $191.3 million, or
77% and 80%, to $235.1 million and $429.8 million for the three and six months
ended June 30, 1999, respectively, from $132.6 million and $238.5 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 a more
than 40% increase in the average number of accounts for the three and six months
ended June 30, 1999, 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 $46.4 and $85.1 million to $65.4
and $124.0 million for the three and six months ended June 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.
Income Taxes
The Company's income tax rate was 38% for the three months ended June
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
indicator of the delinquency and loss levels of the portfolio. Accounts tend to
exhibit a rising trend of delinquency and credit losses as they season.
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
- -------------------------------------------------------------------------------------------------------------
June 30
- ------------------------------------------- ----------------------------------- -----------------------------
1999 1998
- ------------------------------------------- ----------------------------------- -----------------------------
% of % of
(dollars in thousands) Loans Total Loans Loans Total Loans
- ------------------------------------------- ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Reported:
Loans outstanding $ 7,426,974 100.00% $ 5,140,340 100.00%
Loans delinquent:
30-59 days 167,399 2.25 104,819 2.04
60-89 days 91,717 1.24 61,756 1.20
90 or more days 138,264 1.86 91,747 1.79
- ------------------------------------------- ------------ ------------ ----------- ------------
Total $ 397,380 5.35% $ 258,322 5.03%
- ------------------------------------------- ------------ ------------ ------------ ------------
Managed:
Loans outstanding $ 17,860,137 100.00% $ 14,969,324 100.00%
Loans delinquent:
30-59 days 341,120 1.91 287,182 1.92
60-89 days 192,264 1.07 177,313 1.18
90 or more days 310,231 1.74 305,282 2.04
- ------------------------------------------- ------------ ------------ ------------ ------------
Total $ 843,615 4.72% $ 769,777 5.14%
- ------------------------------------------- ------------ ------------ ------------ ------------
</TABLE>
The 30-plus day delinquency rate for the reported consumer loan
portfolio was 5.35% as of June 30, 1999, up 32 basis points from 5.03% as of
June 30, 1998, and up 49 basis points from 4.86% as of March 31, 1999. The
30-plus day delinquency rate for the managed consumer loan portfolio was 4.72%
as of June 30, 1999, down 42 basis points from 5.14% as of June 30, 1998 and up
16 basis points from 4.56% as of March 31,1999.
<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 Six Months Ended
June 30 June 30
- ------------------------------------------- --------------- --------------- --------------- ---------------
(dollars in thousands) 1999 1998 1999 1998
- ------------------------------------------- --------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
Reported:
Average loans outstanding $ 7,406,257 $ 5,213,605 $ 7,120,578 $ 4,996,983
Net charge-offs 59,805 58,916 115,055 114,978
Net charge-offs as a percentage of
average loans outstanding 3.23% 4.52% 3.23% 4.60%
- ------------------------------------------- --------------- -------------- --------------- ---------------
Managed:
Average loans outstanding $ 17,597,571 $ 14,416,722 $ 17,516,999 $ 14,253,738
Net charge-offs 164,004 212,988 335,133 425,723
Net charge-offs as a percentage of
average loans outstanding 3.73% 5.91% 3.83% 5.97%
- ------------------------------------------- --------------- --------------- --------------- ---------------
</TABLE>
Net charge-offs of managed loans decreased $49.0 million and $90.6
million, or 23% and 21%, while average managed consumer loans grew 22% and 23%
for the three and six months ended June 30, 1999, respectively, from the same
periods in the prior year. For the three and six months ended June 30, 1999, the
Company's net charge-offs as a percentage of average managed loans outstanding
were 3.73% and 3.83%, respectively, compared to 5.91% and 5.97% for the same
periods in the prior year. The decrease in reported and managed net charge-off
rates were the result of improved general economic trends, a shift in portfolio
mix to higher quality credit and improved recovery efforts.
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 Six Months Ended
June 30 June 30
- ------------------------------------------------------ --------------- --------------- -------------- ----------------
(dollars in thousands) 1999 1998 1999 1998
- ------------------------------------------------------ --------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
Balance at beginning of period $ 251,000 $ 213,000 $ 231,000 $ 183,000
Provision for loan losses 74,301 59,013 148,887 144,879
Other 504 (97) 1,168 99
Charge-offs (90,627) (77,348) (171,022) (144,386)
Recoveries 30,822 18,432 55,967 29,408
- ----------------------------------------------------------------------------------------------------------------------
Net charge-offs (59,805) (58,916) (115,055) (114,978)
- ----------------------------------------------------------------------------------------------------------------------
Balance at end of period $ 266,000 $ 213,000 $ 266,000 $ 213,000
- ----------------------------------------------------------------------------------------------------------------------
Allowance for loan losses to loans at period-end 3.58% 4.14% 3.58% 4.14%
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
For the three and six months ended June 30, 1999, the provision for
loan losses increased to $74.3 million and $148.9 million, or 26% and 3%,
respectively, from $59.0 million and $144.9 million for the comparable periods
in the prior year, as average reported loans increased by 42% for the three and
six months ended June 30, 1999. The allowance for loan losses as a percentage of
reported consumer loans decreased to 3.58% as of June 30, 1999, from 4.14% as of
June 30, 1998 due to the change in mix of its reported loan portfolio and
overall improvements in loss rates and delinquencies.
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 $4.0 billion was outstanding as of June 30, 1999, with
original terms of one to ten years.
Internationally, the Company has funding programs designed for foreign
investors or to raise funds in foreign currencies. The Company has accessed the
international securitization market for a number of years with both US$ 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
June 30, 1999, the Company had $2.4 billion in interest-bearing deposits, with
original maturities of up to ten years.
Table 9 shows the maturation of certificates of deposit in
denominations of $100,000 or greater ("large denomination CDs") as of June 30,
1999.
- --------------------------------------------------------------------------------
Table 9 - Maturities of large denomination certificates-$100,000 or more
- --------------------------------------------------------------------------------
June 30, 1999
- ----------------------------------------- ----------- ---------
(dollars in thousands) Balance Percent
- ----------------------------------------- ----------- ---------
Three months or less $ 159,449 24.96%
Over 3 through 6 months 83,937 13.14
Over 6 through 12 months 63,055 9.87
Over 12 months through 10 years 332,369 52.03
- ----------------------------------------- ----------- ---------
Total $ 638,810 100.00%
- ----------------------------------------- ----------- ---------
The Company's other borrowings portfolio consists of $1.1 billion in
borrowings maturing within one year and $286.5 million in borrowings maturing
after one year.
Table 10 shows the Company's unsecured funding availability and outstanding as
of June 30, 1999.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
Table 10 - FUNDING AVAILABILITY
- --------------------------------------------------------------------------------------------------------------------
June 30, 1999
- --------------------------------------------------------------------------------------------------------------------
Effective/ Final
(dollars or dollar equivalents in millions) Issue Date Availability(1) Outstanding 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 $ 50 8/00
Senior bank note program(2) 4/97 8,000 3,986 -
Non-U.S. bank note program 10/97 1,000 5 -
Corporation Shelf Registration 7/98 625 549 -
Deposit note program 4/97 2,000 -
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 June 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 was amended in May 1999 and is
now 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 two 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 $625 million aggregate public offering
price or its equivalent (based on the applicable exchange rate at the time of
sale) in one or more foreign currencies, currency units 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 $75 million.
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 June 30, 1999, the Company held $1.6 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 June 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>
June 30, 1999
Capital One Bank
Tier 1 Capital 11.51% 4.00% 6.00%
Total Capital 14.25 8.00 10.00
Tier 1 Leverage 11.16 4.00 5.00
Capital One, F.S.B.(1)
Tangible Capital 9.89% 1.50% 6.00%
Total Capital 12.43 12.00 10.00
Core Capital 9.89 8.00 5.00
- --------------------------------- --------------- --------------------------- ----------------------------------------
June 30, 1998
Capital One Bank
Tier 1 Capital 13.02% 4.00% 6.00%
Total Capital 15.76 8.00 10.00
Tier 1 Leverage 10.42 4.00 5.00
Capital One, F.S.B.(1)
Tangible Capital 13.89% 1.50% 6.00%
Total Capital 17.81 12.00 10.00
Core Capital 13.89 8.00 5.00
- --------------------------------- --------------- --------------------------- ----------------------------------------
</TABLE>
(1) As of 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 June 30 1999, the Company's Tier 1 Leverage ratio
was 13.30%.
Additionally, certain regulatory restrictions exist which limit the
ability of the Bank and the Savings Bank to transfer funds to the Corporation.
As of June 30, 1999, retained earnings of the Bank of $196 million were
available for payment of dividends to the Corporation without prior approval by
the Federal Reserve.
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 June 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 1.0% below the mean outcome. The interest rate scenarios
evaluated as of June 30, 1999, included scenarios in which short-term interest
rates rose by as much as 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 to increase its earnings in 1999 by
approximately 30% over 1998 earnings and to achieve a return on equity in excess
of 20%. 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 expects that its overall marketing investment in America One will
decrease in the second half of 1999, especially in the fourth quarter and, as a
result, the negative impact of the telecommunications business on the Company's
earnings will also be reduced. 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. For example, the
Company recently began testing on-line account access, account underwriting and
marketing to a limited audience. 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 second half 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 on the level of attrition due to
competition in the credit card industry. As delinquency levels fluctuate, the
resulting amount of past due and overlimit fees, which are significant sources
of revenue for the Company, will also fluctuate. Further, the timing of revenues
from increasing or decreasing delinquencies precedes the related impact of
higher or lower charge-offs that ultimately result from varying levels of
delinquencies. 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 has experienced improving credit quality of its credit
portfolio in 1999. As of June 30, 1999, the Company had the lowest charge-off
rate among the top ten credit card issuers in the United States. However,
management believes that charge-offs are unlikely to continue to decrease by any
significant amount. Indeed, delinquencies increased slightly during the second
quarter of 1999. Management expects that delinquencies will continue to increase
moderately in the second half of 1999 and that, as a result, charge-offs will
begin to increase slightly 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:
- - awareness of the existence of information technology systems Company-wide;
- - assessment of those systems for year 2000 readiness;
- - renovation of those systems and their date coding functions;
- - validation (testing) of renovations; and
- - implementation of all renovations made.
With one exception, all of the Company's internally housed IT project
areas, including all of those supporting core business processes, have completed
these five milestones. The Company's automobile finance subsidiary, Summit
Acceptance Corporation, has temporarily de-installed one renovated, non-critical
system to enable full business functionality enhancements, but expects
re-implementation to occur in the third quarter.
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. Significant focus continues to be placed on
managing the risks of system modifications developments. The Company is also
conducting ongoing 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 assesses 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 our 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 accelerated contingency planning efforts. With particular
vendors supplying technology products, the Company has conducted extensive
testing and renovations or has acquired new systems. In particular, the Company
expects to complete the installation and testing of a year 2000 compliant
billing system for America One by August 31. The Company will continue to
actively monitor the efforts of all of its vendors and 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 has established individual
contingency plans for its business units. Each business unit has achieved the
first three of the four milestones in its contingency planning strategy: (i)
inventory and assessment of year 2000 risks, (ii) business impact analysis,
(iii) developing contingency plans to mitigate the risks, and (iv) testing and
validation of these contingency plans. Testing and validation of the individual
business unit plans is ongoing.
The Company has also developed an Enterprise-Wide Contingency Plan (the
"Plan") to support and unite the detailed business unit plans. The Plan
addresses risk 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. 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. Contingency
planning includes 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, and 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. An independent review of the Plan and validation strategy for
feasibility is also complete, and testing and validation of the Plan is ongoing.
In addition, the Company's Year 2000 Governance Committee is examining broad
business and economic issues related to mitigating the financial impact of the
Year 2000. The Company will continue to update and test its contingency plans
based on changes in its business situations throughout 1999.
The Costs to Address the Company's Year 2000 Issues. As of June 30, 1999, the
Company had spent a total of approximately $10.9 million for year 2000
remediation of its internal IT systems. The Company's estimate for projected
year 2000 costs for all of 1999 is $9.5 million. This includes the costs of
expanded integrated testing and quality reviews. Costs associated with non-IT
systems, which are not included, 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 is developing 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
scenerio 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>
Item 6. 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 April 15, 1999,
Commission File No. 1-13300, enclosing its press release dated April
15, 1999.
The Company filed a Current Report on Form 8-K, dated April 29, 1999,
Commission File No. 1-13300, enclosing Amendment Number 1 to Rights
Agreement dated April 29, 1999.
The Company filed a Current Report on Form 8-K, dated April 30, 1999,
Commission File No. 1-13300, enclosing its press release dated April
30, 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: August 10, 1999 /s/ David M. Willey
------------------------------
David M. Willey
Senior Vice President,
Finance and Accounting
(Chief Accounting Officer
and duly authorized officer
of the Registrant)
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