10-Q 1 d311186d10q.htm FORM 10-Q FORM 10-Q
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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2012

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 No. 1-13300

 

 

CAPITAL ONE FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   54-1719854

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

1680 Capital One Drive,

McLean, Virginia

  22102
(Address of Principal Executive Offices)   (Zip Code)

Registrant’s telephone number, including area code:

(703) 720-1000

(Former name, former address and former fiscal year, if changed since last report)

(Not applicable)

 

 

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  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a Shell Company (as defined in Rule 12b-2 of the Exchange Act)    Yes  ¨    No  x

As of April 30, 2012, there were 580,342,796 shares of the registrant’s Common Stock, par value $.01 per share, outstanding.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

         Page  

PART I—FINANCIAL INFORMATION

     1   

Item 1.

  Financial Statements      60   
  Condensed Consolidated Balance Sheets      60   
  Condensed Consolidated Statements of Income      61   
  Condensed Consolidated Statements of Comprehensive Income      62   
  Condensed Consolidated Statements of Changes in Stockholders’ Equity      63   
  Condensed Consolidated Statements of Cash Flows      64   
  Notes to Condensed Consolidated Financial Statements      65   
 

Note   1—Summary of Significant Accounting Policies

     65   
 

Note   2—Acquisitions

     67   
 

Note   3—Discontinued Operations

     70   
 

Note   4—Investment Securities

     71   
 

Note   5—Loans

     82   
 

Note   6—Allowance for Loan and Lease Losses

     100   
 

Note   7—Variable Interest Entities and Securitizations

     102   
 

Note   8—Goodwill and Other Intangible Assets

     111   
 

Note   9—Deposits and Borrowings

     114   
 

Note 10—Derivative Instruments and Hedging Activities

     117   
 

Note 11—Stockholders’ Equity

     123   
 

Note 12—Earnings Per Common Share

     123   
 

Note 13—Fair Value of Financial Instruments

     124   
 

Note 14—Business Segments

     137   
 

Note 15—Commitments, Contingencies and Guarantees

     139   
 

Note 16—Subsequent Events

     150   

Item 2.      

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”)

     1   
 

Summary of Selected Financial Data

     1   
 

Introduction

     4   
 

Executive Summary and Business Outlook

     5   
 

Critical Accounting Policies and Estimates

     9   
 

Consolidated Results of Operations

     10   
 

Business Segment Financial Performance

     16   
 

Consolidated Balance Sheet Analysis and Credit Performance

     26   
 

Off-Balance Sheet Arrangements and Variable Interest Entities

     34   
 

Capital Management

     34   
 

Risk Management

     38   
 

Credit Risk Profile

     38   
 

Liquidity Risk Profile

     49   
 

Market Risk Profile

     52   
 

Supervision and Regulation

     55   
 

Accounting Changes and Developments

     55   
 

Forward-Looking Statements

     56   
 

Supplemental Tables

     58   

Item 3.

  Quantitative and Qualitative Disclosures about Market Risk      150   

Item 4.

  Controls and Procedures      151   

PART II—OTHER INFORMATION

     152   

Item 1.

  Legal Proceedings      152   

Item 1A.

  Risk factors      152   

Item 2.

  Unregistered Sales of Equity Securities and Use of Proceeds      152   

Item 3.

  Defaults upon Senior Securities      152   

Item 5.

  Other Information      152   

Item 6.

  Exhibits      152   

SIGNATURES

     153   

EXHIBIT INDEX

     154   

 

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INDEX OF MD&A TABLES AND SUPPLEMENTAL TABLES

 

Table

  

Description

  

Page

 

  

MD&A Tables:

  

1

  

Consolidated Financial Highlights (Unaudited)

     1   

2

  

Business Segment Results

     5   

3

  

Average Balances, Net Interest Income and Net Interest Yield

     11   

4

  

Rate/Volume Analysis of Net Interest Income

     12   

5

  

Non-Interest Income

     13   

6

  

Non-Interest Expense

     15   

7

  

Credit Card Business Results

     17   

7.1

  

Domestic Card Business Results

     19   

7.2

  

International Card Business Results

     20   

8

  

Consumer Banking Business Results

     21   

9

  

Commercial Banking Business Results

     24   

10

  

Investment Securities

     26   

11

  

Non-Agency Investment Securities Credit Ratings

     28   

12

  

Net Loans Held for Investment

     28   

13

  

Unpaid Principal Balance of Mortgage Loans Originated and Sold to Third Parties Based on Category of Purchaser

     30   

14

  

Open Pipeline All Vintages (all entities)

     31   

15

  

Changes in Representation and Warranty Reserve

     33   

16

  

Allocation of Representation and Warranty Reserve

     33   

17

  

Capital Ratios Under Basel I

     35   

18

  

Risk-Based Capital Components Under Basel I

     36   

19

  

Loan Portfolio Composition

     39   

20

  

30+ Day Delinquencies

     40   

21

  

Aging of 30+ Day Delinquent Loans

     41   

22

  

90+ Days Delinquent Loans Accruing Interest

     41   

23

  

Nonperforming Loans and Other Nonperforming Assets

     42   

24

  

Net Charge-Offs

     43   

25

  

Loan Modifications and Restructurings

     44   

26

  

Summary of Allowance for Loan and Lease Losses

     47   

27

  

Allocation of the Allowance for Loan and Lease Losses

     48   

28

  

Liquidity Reserves

     49   

29

  

Deposits

     49   

30

  

Expected Maturity Profile of Short-term Borrowings and Long-term Debt

     51   

31

  

Senior Unsecured Debt Credit Ratings

     52   

32

  

Interest Rate Sensitivity Analysis

     55   

  

Supplemental Tables:

  

A

  

Reconciliation of Non-GAAP Measures and Calculation of Regulatory Capital Measures

     58   

 

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PART I—FINANCIAL INFORMATION

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”)

This MD&A should be read in conjunction with our unaudited condensed consolidated financial statements and related notes in this Report and the more detailed information contained in our 2011 Annual Report on Form 10-K (“2011 Form 10-K”). This discussion contains forward-looking statements that are based upon management’s current expectations and are subject to significant uncertainties and changes in circumstances. Please review “Forward-Looking Statements” for more information on the forward-looking statements in this Report. Our actual results may differ materially from those included in these forward-looking statements due to a variety of factors including, but not limited to, those described in this Report in “Part II—Item 1A. Risk Factors,” in our 2011 Form 10-K in “Part I—Item 1A. Risk Factors.”

 

 

SUMMARY OF SELECTED FINANCIAL DATA

 

Below we provide selected consolidated financial data from our results of operations for the three months ended March 31, 2012 and 2011, and selected comparative consolidated balance sheet data as of March 31, 2012, and December 31, 2011. We also provide selected key metrics we use in evaluating our performance.

On February 17, 2012, we completed the previously announced acquisition (the “ING Direct acquisition”) of substantially all of the ING Direct business in the United States (“ING Direct”) from ING Groep N.V., ING Bank N.V., ING Direct N.V. and ING Direct Bancorp, which resulted in the addition of loans of $40.4 billion, other assets of $53.9 billion and deposits of $84.4 billion at acquisition. The ING Direct acquisition had a significant impact on our results and selected metrics for the three months ended and as of March 31, 2012. We use the term “acquired loans” to refer to the substantial majority of loans acquired in the ING Direct and Chevy Chase Bank business combinations, which were recorded at fair value at acquisition and subsequently accounted for based on expected cash flows to be collected. Because this accounting methodology takes into consideration estimated credit losses expected to be realized over the remaining estimated lives of the loans, including these acquired loans in our credit quality metrics may have a material impact. We therefore present certain credit quality metrics with and without these acquired loans.

Table 1: Consolidated Financial Highlights (Unaudited)

 

     Three Months Ended March 31,  
(Dollars in millions, except per share data as noted)        2012             2011             Change      

Income statement

      

Net interest income(1)

   $ 3,414      $ 3,140        9

Non-interest income(2)

     1,521        942        61   
  

 

 

   

 

 

   

 

 

 

Total revenue

     4,935        4,082        21   

Provision for credit losses(1)

     573        534        7   

Non-interest expense

     2,504        2,162        16   
  

 

 

   

 

 

   

 

 

 

Income from continuing operations before income taxes

     1,858        1,386        34   

Income tax provision

     353        354        **   
  

 

 

   

 

 

   

 

 

 

Income from continuing operations, net of tax

     1,505        1,032        46   

Loss from discontinued operations, net of tax(3)

     (102     (16     538   
  

 

 

   

 

 

   

 

 

 

Net income

     1,403        1,016        38   

Dividends and undistributed earnings allocated to participating securities

     (7            **   
  

 

 

   

 

 

   

 

 

 

Net income available to common shareholders

   $ 1,396      $ 1,016        37
  

 

 

   

 

 

   

 

 

 

 

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     Three Months Ended March 31,  
          2012             2011             Change      

Common share statistics

      

Earnings per common share:

      

Basic earnings per common share

   $ 2.74      $ 2.24        22

Diluted earnings per common share

     2.72        2.21        23   

Weighted average common shares outstanding:

      

Basic earnings

     508.7        454.1        12   

Diluted earnings

     513.1        460.3        11   

Dividends per common share

     0.05        0.05          

Average balances

      

Loans held for investment(4)

   $ 152,900      $ 125,077        24

Interest-earning assets

     220,246        173,440        27   

Total assets

     246,384        198,075        24   

Interest-bearing deposits

     151,625        108,633        40   

Total deposits

     170,259        124,158        37   

Borrowings

     35,994        40,538        (11

Stockholders’ equity

     32,982        27,009        22   

Performance metrics

      

Purchase volume(5)

   $ 34,498      $ 27,797        23

Revenue margin(1)(6)

     8.96     9.41     (45 )bps 

Net interest margin(1)(7)

     6.20        7.24        (104

Net charge-off rate(1)(8)

     2.04        3.66        (162

Net charge-off rate (excluding acquired loans)(1)(9)

     2.40        3.82        (142

Return on average assets(10)

     2.44        2.08        36   

Return on average total stockholders’ equity(11)

     18.25        15.28        297   

Non-interest expense as a  % of average loans held for investment(12)

     6.55        6.91        (36

Efficiency ratio(13)

     50.74        52.96        (222

Effective income tax rate

     19.0        25.5        (650

Full-time equivalent employees (in thousands), period end

     34.2        27.9        23

 

    March 31,
2012
    December 31,
2011
    Change  

Balance sheet (period end)

     

Loans held for investment(4)

  $ 173,822      $ 135,892        28

Interest-earning assets

    265,398        179,878        48   

Total assets

    294,481        206,019        43   

Interest-bearing deposits

    197,254        109,945        79   

Total deposits

    216,528        128,226        69   

Borrowings

    32,885        39,561        (17

Stockholders’ equity

    36,950        29,666        25   

Credit quality metrics (period end)

     

Allowance for loan and lease losses

  $ 4,060      $ 4,250        (4 )% 

Allowance as a  % of loans held of investment

    2.34     3.13     (79 )bps 

Allowance as a  % of loans held of investment (excluding acquired loans)

    3.08        3.22        (14

30+ day performing delinquency rate

    2.23        3.35        (112

30+ day performing delinquency rate (excluding acquired loans)

    2.96        3.47        (51

30+ day delinquency rate

    2.69        3.95        (126

30+ day delinquency rate (excluding acquired loans)

    3.57        4.09        (52

Capital ratios

     

Tier 1 common ratio(14)

    11.9     9.7     220 bps 

Tier 1 risk-based capital ratio(15)

    13.9        12.0        190   

Total risk-based capital ratio(16)

    16.5        14.9        160   

Tangible common equity (“TCE”) ratio(17)

    8.2        8.2          

 

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** Change is less than one percent or not meaningful.
(1)

Amounts attributable to Kohl’s Department Stores (‘Kohl’s”) under the revenue and loss-sharing arrangement reduced interest income by $222 million, reduced the provision for credit losses by $193 million and reduced net charge-offs by $40 million in the first quarter of 2012. The expected loss reimbursement from Kohl’s netted against our allowance for loan and lease losses was approximately $153 million and $139 million as of March 31, 2012 and December 31, 2011, respectively.

(2)

Includes a bargain purchase gain of $594 million attributable to the February 17, 2012 acquisition of ING Direct recognized in non-interest income in the first quarter of 2012. The bargain purchase gain represents the excess of the fair value of the net assets acquired from ING Direct as of the acquisition date over the consideration transferred. See “Note 2—Acquisitions” for additional information.

(3)

Discontinued operations reflect ongoing costs related to the mortgage origination operations of GreenPoint’s wholesale mortgage banking unit, GreenPoint Mortgage Funding, Inc. (“GreenPoint”), which we closed in 2007.

(4)

Loans held for investment includes loans acquired in the ING Direct and Chevy Chase Bank business combinations. The carrying value and outstanding unpaid principal balance of acquired loans accounted for based on expected cash flows at acquisition was $43.2 billion and $44.3 billion as of March 31, 2012, respectively, and $4.7 billion and $5.2 billion, respectively, as of December 31, 2011. The average balance of loans held for investment excluding the carrying value of acquired loans was $129.8 billion and $119.8 billion in the first quarter of 2012 and 2011, respectively.

(5)

Consists of credit card purchase transactions for the period, net of returns. Excludes cash advance transactions.

(6) 

Calculated based on annualized total revenue for the period divided by average interest-earning assets for the period.

(7) 

Calculated based on annualized net interest income for the period divided by average interest-earning assets for the period.

(8) 

Calculated based on annualized net charge-offs for the period divided by average loans held for investment for the period.

(9) 

Calculated based on annualized net charge-offs for the period divided by average loans held for investment, excluding acquired loans, for the period.

(10) 

Calculated based on annualized income from continuing operations, net of tax, for the period divided by average total assets for the period.

(11) 

Calculated based on annualized income from continuing operations, net of tax, for the period divided by average stockholders’ equity for the period.

(12) 

Calculated based on annualized non-interest expense, excluding goodwill impairment charges, for the period divided by average loans held for investment for the period.

(13) 

Calculated based on non-interest expense, excluding goodwill impairment charges, for the period divided by total revenue for the period.

(14) 

Tier 1 common ratio is a regulatory capital measure calculated based on Tier 1 common capital divided by risk-weighted assets. See “Capital Management” and “Supplemental Tables—Table A: Reconciliation of Non-GAAP Measures and Calculation of Regulatory Capital Measures” for additional information, including the calculation of this ratio.

(15) 

Tier 1 risk-based capital ratio is a regulatory measure calculated based on Tier 1 capital divided by risk-weighted assets. See “Capital Management” and “Supplemental Tables—Table A: Reconciliation of Non-GAAP Measures and Calculation of Regulatory Capital Measures” for additional information, including the calculation of this ratio.

(16) 

Total risk-based capital ratio is a regulatory measure calculated based on total risk-based capital divided by risk-weighted assets. See “Capital Management” and “Supplemental Tables—Table A: Reconciliation of Non-GAAP Measures and Calculation of Regulatory Capital Measures” for additional information, including the calculation of this ratio.

(17) 

TCE ratio is a non-GAAP measure calculated based on tangible common equity divided by tangible assets. See “Supplemental Tables—Table A: Reconciliation of Non-GAAP Measures and Calculation of Regulatory Capital Measures” for the calculation of this measure and reconciliation to the comparative GAAP measure.

 

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INTRODUCTION

 

We are a diversified financial services holding company with banking and non-banking subsidiaries that offer a broad array of financial products and services to consumers, small businesses and commercial clients through branches, the internet and other distribution channels. Our principal subsidiaries include Capital One Bank (USA), National Association (“COBNA”), Capital One, National Association (“CONA”) and ING Bank, fsb. The Company and its subsidiaries are hereafter collectively referred to as “we,” “us” or “our.” CONA and COBNA are hereafter collectively referred to as the “Banks.” We continue to deliver on our strategy of combining the power of national scale lending and local scale banking.

The closing of the ING Direct acquisition in the first quarter of 2012 resulted in the addition of loans of $40.4 billion and other assets of $53.9 billion at acquisition. The ING Direct acquisition strengthens our customer franchise and brand and adds over seven million customers and approximately $84.4 billion in deposits to our Consumer Banking business segment. With the ING Direct acquisition, we have grown to become the sixth largest depository institution and the largest direct banking institution in the United States. We had $173.8 billion in total loans outstanding and $216.5 billion in deposits as of March 31, 2012, compared with $135.9 billion in total loans outstanding and $128.2 billion in deposits as of December 31, 2011.

Our revenues are primarily driven by lending to consumers and commercial customers and by deposit-taking activities, which generate net interest income, and by activities that generate non-interest income, such as fee-based services provided to customers, merchant interchange fees with respect to certain credit card transactions, gains and losses and fees associated with the sale and servicing of loans. Our expenses primarily consist of the cost of funding our assets, our provision for credit losses, operating expenses (including associate salaries and benefits, infrastructure maintenance and enhancements and branch operations and expansion costs), marketing expenses and income taxes.

Our principal operations are currently organized, for management reporting purposes, into three primary business segments, which are defined primarily based on the products and services provided or the type of customer served: Credit Card, Consumer Banking and Commercial Banking. The operations of acquired businesses have been integrated into our existing business segments. Certain activities that are not part of a segment are included in our “Other” category.

 

   

Credit Card: Consists of our domestic consumer and small business card lending, national small business lending, national closed end installment lending and the international card lending businesses in Canada and the United Kingdom.

 

   

Consumer Banking: Consists of our branch-based lending and deposit gathering activities for consumers and small businesses, national deposit gathering, national auto lending and consumer home loan lending and servicing activities.

 

   

Commercial Banking: Consists of our lending, deposit gathering and treasury management services to commercial real estate and commercial and industrial customers. Our commercial and industrial customers typically include companies with annual revenues between $10 million to $1.0 billion.

In the first quarter of 2012, we re-aligned the reporting of our Commercial Banking business to reflect the operations on a product basis rather than by customer type. Table 2 summarizes our business segment results, which we report based on income from continuing operations, net of tax, for the three months ended March 31, 2012 and 2011. We provide additional information on the realignment of our Commercial Banking business segment below under “Business Segment Results” and in “Note 14—Business Segments” of this Report. We also provide a reconciliation of our total business segment results to our consolidated U.S. GAAP results in “Note 14—Business Segments.”

 

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Table 2: Business Segment Results

 

     Three Months Ended March 31,  
     2012     2011  
     Total Revenue(1)     Net Income(2)     Total  Revenue(1)     Net Income(2)  

(Dollars in millions)

   Amount      % of
Total
    Amount      % of
Total
    Amount     % of
Total
    Amount      % of
Total
 

Credit Card

   $ 2,590         53   $ 566         38   $ 2,615        64   $ 643         62

Consumer Banking

     1,464         30        224         15        1,169        29        215         21   

Commercial Banking

     516         10        210         14        447        11        162         16   

Other(3)

     365         7        505         33        (149     (4     12         1   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Total from continuing operations

   $ 4,935         100   $ 1,505         100   $ 4,082        100   $ 1,032         100
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

 

(1) 

Total revenue consists of net interest income and non-interest income.

(2) 

Net income for our business segments is reported based on income from continuing operations, net of tax.

(3) 

Includes the residual impact of the allocation of our centralized Corporate Treasury group activities, such as management of our corporate investment portfolio and asset/liability management, to our business segments as well as other items as described in “Note 14—Business Segments.”

 

 

EXECUTIVE SUMMARY AND BUSINESS OUTLOOK

 

Despite ongoing challenges and uncertainties, including high oil and gas prices and global economic concerns, the U.S. economy showed positive trends during the first quarter of 2012. Our results for the first quarter of 2012 reflected the impact of growth in consumer and business spending, coupled with traction from our geographic expansion and strategy to deepen our customer relationships, and credit performance improvement. The completion of our previously announced ING Direct acquisition also had a significant impact on our results during the first quarter. We believe that cyclical and seasonal improvement trends, as well as actions we took in underwriting and managing our business through the recession, including focusing on our most resilient businesses, have continued to drive our strong credit performance.

Financial Highlights

We reported net income of $1.4 billion, or $2.72 per diluted share, for the first quarter of 2012 on revenues of $4.9 billion, with each of our three business segments contributing to our earnings. Current-quarter results include an approximate half-quarter impact from the operations of ING Direct and a benefit from the recognition of a bargain purchase gain of $594 million in the ING Direct acquisition. The bargain purchase gain represents the excess of the fair value of the net assets acquired in the ING Direct acquisition as of the acquisition date over the consideration transferred. This gain was driven largely by a substantial decline in long-term interest rates between the period of our announcement of the ING Direct acquisition and its closing, which resulted in an increase in the fair value of the acquired assets. Net income excluding the impact of the bargain purchase gain was $809 million, or $1.56 per diluted share, for the first quarter of 2012. In comparison, we reported net income of $1.0 billion, or $2.21 per diluted share, for the first quarter of 2011 on revenues of $4.1 billion.

Our capital levels strengthened during the quarter, driven by strong earnings growth and capital actions related to the financing of the ING Direct acquisition and the acquisition of HSBC’s U.S. credit card business. On March 20, 2012, we closed a public offering of 24,442,706 shares of our common stock, which we sold to the underwriters at a per share price of $51.14 for net proceeds of approximately $1.24 billion. On February 16, 2012, we issued 40 million shares of our common stock at settlement of the forward sale agreements that we entered into with certain counterparties acting as forward purchasers in connection with a public offering of shares of our common stock on July 19, 2011 for net proceeds of $1.9 billion. In addition, on February 17, 2012, we issued 54,028,086 shares of our common stock to the ING Sellers with a fair value of $2.6 billion. Our recent equity issuances contributed to a significant increase in our regulatory capital ratios, with the Tier 1 common

 

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ratio increasing by 220 basis points during the quarter to 11.9% as of March 31, 2012. The Tier 1 risk-based capital ratio increased to 13.9% as of March 31, 2012, from 12.0% as of December 31, 2011. In addition, we issued $1.25 billion of our senior notes due 2015 in a public offering, that closed on March 23, 2012.

Below are additional highlights of our performance for the first quarter of 2012. These highlights generally are based on a comparison to the same prior year period. The changes in our financial condition and credit performance are generally based on our financial condition and credit performance as of March 31, 2012, compared with our financial condition and credit performance as of December 31, 2011. We provide a more detailed discussion of our financial performance in the sections following this “Executive Summary and Business Outlook.”

Total Company

 

   

Earnings: Our net income of $1.4 billion in the first quarter of 2012 increased by $380 million, or 37%, from the first quarter of 2011. The increase reflected the favorable impacts from the bargain purchase gain of $594 million attributable to ING Direct acquisition, income related to the sale of Visa stock of $162 million and higher revenue from our legacy businesses. These factors were partially offset by higher operating expenses related to our recent acquisitions, including an estimated $150 million of operating expenses attributable to ING Direct, increased marketing expenditures and an increase in the provision for mortgage loan repurchase losses largely due to the Government-Sponsored Enterprise (“GSE”) settlement described below in “Consolidated Balance Sheet Analysis—Potential Mortgage Representation & Warranty Liabilities.”

 

   

Total Loans: Period-end loans held for investment increased by $37.9 billion, or 28%, in the first quarter of 2012, to $173.8 billion as of March 31, 2012, from $135.9 billion as of December 31, 2011. The increase was primarily attributable to the addition of the ING Direct loan portfolio of $40.4 billion. Excluding the impact from the addition of the ING Direct loan portfolio, total loans decreased by $2.5 billion, or 2%, reflecting an expected seasonal decline in credit card loan balances.

 

   

Charge-off and Delinquency Statistics: Our net charge-off and delinquency rates continued to improve during the first quarter of 2012. The net charge-off rate decreased to 2.04% in the first quarter of 2012, from 2.69% in the fourth quarter of 2011 and 3.66% in the first quarter of 2011. The 30+ day delinquency rate decreased to 2.69% as of March 31, 2012, from 3.95% as of December 31, 2011, primarily due to seasonality trends. Although our first quarter delinquency improvements outpaced industry trends, it is important to note that the seasonality in our delinquency rates is more pronounced than the overall industry. Some of the improvement in our credit quality metrics was attributable to the addition of the ING Direct loan portfolio and the related accounting. We provide information on our credit quality metrics excluding the impact of acquired loans in the “Credit Risk Profile” section of this report.

 

   

Allowance for Loan and Lease Losses: As a result of the strong credit performance, we reduced our allowance by $190 million in the first quarter of 2012 to $4.1 billion. The coverage ratio of the allowance to total loans held for investment fell by 79 basis points to 2.34% as of March 31, 2012, primarily due to the addition of the ING Direct loan portfolio. Because we recorded the ING Direct loans at fair value at acquisition there is currently no allowance related to these loans. See the “Credit Risk Profile” section of this report for information on our credit quality metrics excluding the impact of acquired loans.

 

   

Representation and Warranty Reserve: We recorded a provision for mortgage loan repurchase losses of $169 million in the first quarter of 2012, of which $95 million related to the GSE settlement. In comparison, we recorded a provision of $44 million in the first quarter of 2011. Our representation and warranty reserve totaled $1.1 billion as of March 31, 2012, compared with $943 million as of December 31, 2011.

Business Segments

 

   

Credit Card: Our Credit Card business generated net income from continuing operations of $566 million in the first quarter of 2012, compared with net income from continuing operations of $643 million in the first

 

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quarter of 2011. The decrease in earnings was attributable to higher non-interest expense and a reduction in non-interest income, which were partially offset by an increase in net interest income. Non-interest expense rose as a result of increased marketing expenditures and merger-related expenses associated with the acquisition of the HSBC U.S. credit card portfolio. Non-interest income was reduced due to the recognition of expense of $75 million in the first quarter of 2012 to establish a reserve for expected customer refunds attributable to issues associated with cross-selling certain other products to credit card customers. The increase in net interest income was primarily attributable to growth in average loan balances. Domestic Card continued to grow and gain market share in new account originations, due in part to recent acquisitions.

 

   

Consumer Banking: Our Consumer Banking business generated net income from continuing operations of $224 million in the first quarter of 2012, compared with net income from continuing operations of $215 million in the first quarter of 2011. The increase in earnings was attributable to growth in revenue, which was partially offset by higher non-interest expense and an increase in the provision for credit losses. Growth in revenue stemmed from higher average loan balances resulting from increased auto loan originations over the past year and the half-quarter impact from home loans added in the ING Direct acquisition. The increase in non-interest expense reflected the approximate half-quarter impact of operating expenses associated with ING Direct, merger-related costs related to the ING Direct acquisition, higher infrastructure expenditures resulting from continued investments in our home loan business and growth in auto originations and modestly higher marketing expenditures in our retail banking operations. The increase in the provision for credit losses was largely due to increased loan balances due to growth in auto loan originations, as net charge-offs declined as a result of continued credit performance improvements. Because of the growth in auto loans, we recorded an allowance build in the first quarter of 2012, compared with an allowance release in the first quarter of 2011.

 

   

Commercial Banking: Our Commercial Banking business generated net income from continuing operations of $210 million in the first quarter of 2012, compared with net income from continuing operations of $162 million in the first quarter of 2011. The improvement in results for Commercial Banking was attributable to an increase in revenues driven by increased average loan balances as well as loan spreads and a decrease in the provision for credit losses due to improving credit trends. These factors were partially offset by higher non-interest expense resulting from operating costs associated with the increased volume of loan originations in our commercial real estate and commercial and industrial business, increased infrastructure expenditures and the expansion into new markets.

Significant Recent Developments

Acquisition-Related Developments

HSBC Acquisition—U.S. Credit Card Business

We completed the transaction in which we acquired substantially all of the assets and assumed liabilities of HSBC’s credit card and private-label credit card business in the United States (the “HSBC Transaction”) for a purchase price of $31.3 billion on May 1, 2012. In the HSBC Transaction, the Company acquired $28.2 billion of credit card receivables and $0.6 billion in other net assets. We used the net proceeds from the equity and debt offerings described above, along with cash sourced from current liquidity, to fund the cash consideration payable in connection with the acquisition of HSBC’s U.S credit card business.

Business Outlook

We discuss below our current expectations regarding our total company performance and the performance of each of our business segments over the near-term based on market conditions, the regulatory environment and our business strategies as of the time we filed this Quarterly Report on Form 10-Q. The statements contained in this section are based on our current expectations regarding our outlook for our financial results and business strategies. Our expectations take into account, and should be read in conjunction with, our expectations regarding

 

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economic trends and analysis of our business as discussed in “Part I—Item 1. Business” and “Part I—Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our 2011 Form 10-K. Certain statements are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual results could differ materially from those in our forward-looking statements. Forward-looking statements do not reflect (i) any change in current dividend or repurchase strategies, (ii) the effect of any acquisitions, divestitures or similar transactions, except for the forward-looking statements specifically discussing the acquisition of ING Direct or of HSBC’s U.S. credit card business, or (iii) any changes in laws, regulations or regulatory interpretations, in each case after the date as of which such statements are made. See “Forward-Looking Statements” in this Quarterly Report on Form 10-Q for more information on the forward-looking statements in this report and “Item 1A. Risk Factors” in our 2011 Form 10-K for factors that could materially influence our results.

Total Company Expectations

Our strategies and actions are designed to deliver profitable long-term growth through the acquisition and retention of franchise-enhancing customer relationships across our businesses. We believe that franchise-enhancing customer relationships produce strong long-term economics through low credit costs, low customer attrition and a gradual build in loan balances and revenues over time. Examples of franchise-enhancing customer relationships include rewards customers and new partnerships in our Credit Card business, retail deposit customers in our Consumer Banking business and primary banking relationships with commercial customers in our Commercial Banking business. We intend to grow these customer relationships by continuing to invest in our bank infrastructure to allow us to provide more convenient and flexible customer banking options, including a broader range of fee-based and credit products and services, by leveraging our direct bank customer franchise with national reach and by continued marketing investments to attract and retain credit card and auto finance customers and further strengthen our brand.

We believe our actions have created a well-positioned balance sheet and capital and liquidity levels which have provided us with investment flexibility to take advantage of attractive organic growth opportunities and adjust, where we believe appropriate, to changing market conditions. The addition of ING Direct and of the HSBC’s U.S. credit card business has grown our loan balances. Although we anticipate strong underlying growth in our Auto Finance, Commercial Banking and Domestic Card segments, we expect modest overall loan growth because of significant run-off portfolios that we acquired in the ING Direct Acquisition and HSBC Transaction. The timing and pace of this modest loan growth will depend on broader economic trends that impact overall consumer and commercial demand.

As noted above, we closed the HSBC Transaction in the second quarter of 2012. We expect that the closing of the HSBC Transaction will have a significant impact on our financial results in the second quarter. While we expect the acquisition to enhance our earnings trajectory and capital generation in the long-term, we anticipate that it will have a substantial negative effect on earnings and capital in the short-term. We anticipate that the largest impact on our earnings for the second quarter of 2012 from the HSBC Transaction, will result from an increase in our provision for credit losses due to an expected significant build in the allowance for loan and lease losses associated with loans acquired in the transaction. Over the next several years, we expect expenses and earnings to be affected by the amortization of intangibles as well as transaction and merger-related expenses.

Business Segment Expectations

Credit Card Business

In Domestic Card, the closing of the HSBC Transaction has added significant new customer relationships and loan portfolios and will affect quarterly trends in loan growth, revenue margin, non-interest expense, charge-off rates and earnings. We anticipate that the run-off of parts of the portfolios acquired in the HSBC Transaction will offset the underlying growth trajectory, resulting in modest loan growth for the segment. We expect to take a credit mark to cover expected losses on delinquent loans in the HSBC portfolio that no longer carry revolving privileges. We

 

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anticipate the credit mark would absorb most of the HSBC credit losses for the next several quarters, lowering the overall charge-off rate of the Domestic Card segment during that time. When we announced the HSBC Transaction, we planned to take certain actions to bring HSBC customer practices into alignment with our customer practices. We expect that these planned actions will put downward pressure on Domestic Card revenue margin as we implement them over the next several quarters. The overall trends and level of Domestic Card revenue margin will depend upon the competitive environment, the pace and nature of Domestic Card loan growth, and other market forces in addition to the expected impact from our planned customer actions.

Consumer Banking Business

In our Consumer Banking business, we added significant new customer relationships, loans and deposits with the acquisition of ING Direct, and the acquisition will have a significant impact on Consumer Banking loan and deposit growth trajectories. The addition of the ING Direct loan portfolio caused loan yields to decrease. We expect loan yields will decrease again in the second quarter after which we expect them to remain relatively stable because we anticipate loan yield increases from the expected mortgage run-off to be offset by loan yield decreases from a higher mix of prime loans in our Auto Finance business in 2012. We expect that the growth in auto loans will be more than offset by a sizeable run-off of the ING Direct home loan portfolio and the continuing run-off of certain loans in our legacy Home Loan portfolio, which will drive a declining trend in Consumer Banking loan volumes. We expect that seasonal patterns will drive quarterly credit trends throughout the rest of 2012.

Commercial Banking Business

Our Commercial Banking business continues to grow loans, deposits, and revenues as we attract new customers and deepen relationships with existing customers. Although we anticipate some quarterly fluctuations in nonperforming loan and charge-off rates, we expect our Commercial Banking business to continue strong and relatively steady performance trends throughout 2012.

 

 

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

 

The preparation of financial statements in accordance with U.S. GAAP requires management to make a number of judgments, estimates and assumptions that affect the reported amount of assets, liabilities, income and expenses in the consolidated financial statements. Understanding our accounting policies and the extent to which we use management judgment and estimates in applying these policies is integral to understanding our financial statements. We provide a summary of our significant accounting policies in “Note 1—Summary of Significant Accounting Policies” of our 2011 Form 10-K.

In the “MD&A—Critical Accounting Policies and Estimates” section of our 2011 Form 10-K, we identified the following accounting policies as critical because they require significant judgments and assumptions about highly complex and inherently uncertain matters and the use of reasonably different estimates and assumptions could have a material impact on our reported results of operations or financial condition.

 

   

Loan loss reserves

   

Representation and warranty reserve

   

Asset impairment

   

Fair value

   

Derivative and hedge accounting

   

Income taxes

We evaluate our critical accounting estimates and judgments on an ongoing basis and update them as necessary based on changing conditions. Management has reviewed and approved these critical accounting policies and has discussed our judgments and assumptions with the Audit and Risk Committee of the Board of Directors. There has been no material changes in the methods used to formulate these critical accounting estimates from those discussed in the “MD&A—Critical Accounting Policies and Estimates” section of our 2011 Form 10-K.

 

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CONSOLIDATED RESULTS OF OPERATIONS

 

The section below provides a comparative discussion of our consolidated financial performance for the three months ended March 31, 2012 and 2011. Following this section, we provide a discussion of our business segment results. You should read this section together with our “Executive Summary and Business Outlook” where we discuss trends and other factors that we expect will affect our future results of operations.

Net Interest Income

Net interest income represents the difference between the interest income and applicable fees earned on our interest-earning assets, which include loans held for investment and investment securities, and the interest expense on our interest-bearing liabilities, which include interest-bearing deposits, senior and subordinated notes, securitized debt and other borrowings. We include in interest income any past due fees on loans that we deem are collectible. Our net interest margin represents the difference between the yield on our interest-earning assets and the cost of our interest-bearing liabilities, including the impact of non-interest bearing funding. We expect net interest income and our net interest margin to fluctuate based on changes in interest rates and changes in the amount and composition of our interest-earning assets and interest-bearing liabilities.

Table 3 below presents, for each major category of our interest-earning assets and interest-bearing liabilities, the average outstanding balances, interest income earned or interest expense incurred, and average yield or cost for the first quarter of 2012 and 2011.

 

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Table 3: Average Balances, Net Interest Income and Net Interest Yield

 

     Three Months Ended March 31,  
     2012     2011  

(Dollars in millions)

   Average
Balance
    Interest
Income/
Expense(1)
     Yield/
Rate
    Average
Balance
    Interest
Income/
Expense(1)
     Yield/
Rate
 

Assets:

              

Interest-earning assets:

              

Consumer loans:(2)

              

Domestic(3)

   $ 110,567      $ 2,935         10.34   $ 86,353      $ 2,702         12.52

International

     8,301        340         16.38        8,697        354         16.28   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total consumer loans

     118,868        3,275         10.76        95,050        3,056         12.86   

Commercial loans

     34,032        380         4.47        30,027        361         4.81   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total loans held for investment

     152,900        3,655         9.56        125,077        3,417         10.93   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Investment securities

     50,543        298         2.36        41,532        316         3.04   

Other interest-earning assets:

              

Domestic

     16,306        22         0.54        6,150        16         1.04   

International

     497        4         3.22        681        3         1.76   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total other interest-earning assets(3)

     16,803        26         0.62        6,831        19         1.11   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total interest-earning assets

   $ 220,246      $ 3,979         7.23   $ 173,440      $ 3,752         8.65
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Cash and due from banks

     2,237             2,000        

Allowance for loan and lease losses

     (4,334          (5,629     

Premises and equipment, net

     2,898             2,720        

Other assets

     25,337             25,544        
  

 

 

        

 

 

      

Total assets

   $ 246,384           $ 198,075        
  

 

 

        

 

 

      

Liabilities and equity:

              

Interest-bearing liabilities:

              

Deposits:

              

Domestic

   $ 151,625      $ 311         0.82   $ 108,633      $ 322         1.19

International

                                            
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total Deposits

     151,625        311         0.82        108,633        322         1.19   

Securitized debt obligations:

              

Domestic

     12,855        67         2.08        21,582        117         2.17   

International

     3,330        13         1.56        3,933        23         2.34   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total securitized debt obligations

     16,185        80         1.98        25,515        140         2.19   

Senior and subordinated notes

     10,268        88         3.43        8,090        64         3.16   

Other borrowings:

              

Domestic

     5,823        79         5.43        3,006        78         10.38   

International

     3,718        7         0.75        3,927        8         0.81   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total other borrowings

     9,541        86         3.61        6,933        86         4.96   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total interest-bearing liabilities

   $ 187,619      $ 565         1.20   $ 149,171      $ 612         1.64
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Non-interest bearing deposits

     18,635             15,525        

Other liabilities

     7,148             6,370        
  

 

 

        

 

 

      

Total liabilities

     213,402             171,066        

Stockholders’ equity

     32,982             27,009        
  

 

 

        

 

 

      

Total liabilities and stockholders’ equity

   $ 246,384           $ 198,075        
  

 

 

        

 

 

      

Net interest income/spread(3)

     $ 3,414         6.03     $ 3,140         7.01
    

 

 

        

 

 

    

Impact of non-interest bearing funding

          0.17             0.23   
       

 

 

        

 

 

 

Net interest margin

          6.20          7.24
       

 

 

        

 

 

 

 

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(1) 

Past due fees included in interest income totaled approximately $283 million and $245 million for the first quarter of 2012 and 2011, respectively.

(2) 

Interest income on credit card, auto, home and retail banking loans is reflected in consumer loans. Interest income generated from small business credit card loans also is included in consumer loans.

(3) 

Amounts attributable to Kohl’s under the revenue and loss-sharing arrangement reduced interest income by $222 million for the first quarter of 2012.

Table 4 presents the variances between our net interest income for the first quarter of 2012 and 2011, and the extent to which the variance was attributable to: (i) changes in the volume of our interest-earning assets and interest-bearing liabilities or (ii) changes in the interest rates of these assets and liabilities.

Table 4: Rate/Volume Analysis of Net Interest Income(1)

 

     Three Months Ended March 31,
2012 vs. 2011
 
     Total
   Variance  
    Variance Due to  

(Dollars in millions)

       Volume         Rate    

Interest income:

      

Loans held for investment:

      

Consumer loans

   $ 219      $ 696      $ (477

Commercial loans

     19        46        (27
  

 

 

   

 

 

   

 

 

 

Total loans held for investment, including past-due fees

     238        742        (504

Investment securities

     (18     61        (79

Other

     7        18        (11
  

 

 

   

 

 

   

 

 

 

Total interest income

     227        821        (594
  

 

 

   

 

 

   

 

 

 

Interest expense:

      

Deposits

     (11     105        (116

Securitized debt obligations

     (60     (47     (13

Senior and subordinated notes

     24        18        6   

Other borrowings

            27        (27
  

 

 

   

 

 

   

 

 

 

Total interest expense

     (47     103        (150
  

 

 

   

 

 

   

 

 

 

Net interest income

   $ 274      $ 718      $ (444
  

 

 

   

 

 

   

 

 

 

 

(1) 

We calculate the change in interest income and interest expense separately for each item. The change in net interest income attributable to both volume and rates is allocated based on the relative dollar amount of each item.

Net interest income of $3.4 billion for the first quarter of 2012 increased by $274 million, or 9%, from the first quarter of 2011, driven by a 27% increase in average interest-earning assets, which was partially offset by a 14% decline in our net interest margin to 6.20%. The addition of the ING Direct loan portfolio of $40.4 billion, which primarily consisted of consumer loans, and investment security portfolio of $30.2 billion, accounted for approximately $136 million of the $274 million increase in net interest income.

 

   

Average Interest-Earning Assets: The increase in average interest-earning assets was attributable to the addition of the ING Direct loan portfolio as well as growth in our legacy loan portfolios from the addition of new credit card accounts and increased purchase volumes and a significant increase in auto loan originations over twelve months.

 

   

Net Interest Margin: The decrease in our net interest margin was attributable to a decline in the average yield on our interest-earning assets, which was partially mitigated by an improvement in our cost of funds. The decline in average yield reflected the shift in the mix of our interest-earning assets as result of the addition of ING Direct assets and temporarily higher cash balances from the recent equity and debt offerings, which had the effect of diluting the net interest margin. The ING Direct interest-earning assets

 

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generally have lower yields than our legacy loan and the investment security portfolios. Our cost of funds continued to benefit from the shift in the mix of our funding to lower cost consumer and commercial banking deposits from higher cost wholesale sources and the decline in deposit interest rates as a result of the continued overall low interest rate environment.

Non-Interest Income

Non-interest income primarily consists of service charges and other customer-related fees, interchange income (net of rewards expense) and other non-interest income. The servicing fees, finance charges, other fees, net of charge-offs and interest paid to third party investors related to our consolidated securitization trusts are reported as a component of non-interest income. We also record the provision for mortgage repurchase losses related to continuing operations in non-interest income. The “other” component of non-interest income includes gains and losses on derivatives not accounted for in hedge accounting relationships and gains and losses from the sale of investment securities, which we generally do not allocate to our business segments because they relate to centralized asset/liability and market risk management activities undertaken by our Corporate Treasury group.

Table 5 displays the components of non-interest income for the first quarter of 2012 and 2011.

Table 5: Non-Interest Income

 

     Three Months Ended March 31,  

(Dollars in millions)

       2012             2011      

Non-interest income:

    

Service charges and other customer-related fees

   $ 415      $ 525   

Interchange fees

     328        320   

Bargain purchase gain(1)

     594          

Net other-than-temporary impairment (“OTTI”)

     (14     (3

Other non-interest income:

    

Provision for mortgage repurchase losses(2)

     (17     (5

Other

     215 (3)      105   
  

 

 

   

 

 

 

Total other non-interest income

     198        100   
  

 

 

   

 

 

 

Total non-interest income

   $ 1,521      $ 942   
  

 

 

   

 

 

 

 

(1)

Represents the excess of the fair value of the net assets acquired in the ING Direct acquisition as of the acquisition date of February 17, 2012 over the consideration transferred.

(2)

We recorded a total provision for mortgage repurchase losses of $169 million and $44 million in the first quarter of 2012 and 2011, respectively. The remaining portion of the provision for repurchase losses is included in discontinued operations.

(3)

Includes a mark-to-market derivative loss of $78 million related to interest-rate swaps we entered into in 2011 to partially hedge the interest rate risk of the net assets associated with the ING Direct acquisition and income of $162 million related to the sale of Visa stock.

Non-interest income of $1.5 billion for the first quarter of 2012 increased by $579 million, or 61%, from non-interest income of $942 million for the first quarter of 2011. This increase was attributable to the recognition of a bargain purchase gain of $594 million at acquisition of ING direct and income of $162 million related to the sale of Visa stock shares in the first quarter of 2012. The bargain purchase gain represents the excess of the fair value of the net assets acquired in the ING Direct acquisition as of the acquisition date over the consideration transferred. This gain was driven largely by a substantial decline in long-term interest rates between the period shortly after our announcement of the ING Direct acquisition and the closing of the acquisition, which resulted in an increase in the fair value of the acquired assets. We provide additional information on the allocation of the ING Direct purchase price to the fair values of assets acquired and liabilities assumed and the bargain purchase gain in “Note 2—Acquisitions.”

 

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These income amounts were partially offset by the recognition of expense of $75 million in the first quarter of 2012 to establish a reserve for expected customer refunds attributable to issues associated with cross-selling certain other products to credit card customers and a mark-to-market loss of $78 million recorded in the first quarter of 2012 for interest-rate swaps we entered into in 2011 to partially hedge the interest rate risk of the net assets associated with the ING Direct acquisition. The cumulative mark-to-market loss on these interest-rate swaps, which we terminated in the first quarter of 2012, from inception to termination totaled $355 million. See the “Market Risk Profile” section below and “Note 10—Derivative Instruments and Hedging Activities” for additional information on the ING Direct acquisition related hedges.

We also recorded higher other-than-temporary impairment losses of $14 million in the first quarter of 2012, compared with $3 million in the first quarter of 2011. The impairment losses stemmed from deterioration in the credit quality of certain non-agency mortgage-backed securities due to the continued weakness in the housing market. We provide additional information on other-than-temporary impairment recognized on our available-for-sale securities in “Note 4—Investment Securities.”

Provision for Credit Losses

We build our allowance for loan and lease losses and unfunded lending commitment reserves through the provision for credit losses. Our provision for credit losses in each period is driven by charge-offs and the level of allowance for loan and lease losses that we determine is necessary to provide for probable credit losses inherent in our loan portfolio as of each balance sheet date.

We recorded a provision for credit losses of $573 million in the first quarter of 2012, compared with $534 million in the first quarter of 2011. The increase in the provision was driven primarily by the year-over-year increase in legacy loan balances and smaller allowance releases as a result of the stabilization of the improvement in credit trends. The net charge-off rate steadily declined, falling to 2.04% in the first quarter of 2012, from 2.69% in the fourth quarter of 2011 and 3.66% in the first quarter of 2011. The net charge-off rate excluding acquired loans was 2.40% in the first quarter of 2012, compared with 2.79% in the fourth quarter of 2011 and 3.82% in the first quarter of 2011.

We provide additional information on the provision for credit losses and changes in the allowance for loan and lease losses under the “Credit Risk Profile—Summary of Allowance for Loan and Lease Losses” section below.

Non-Interest Expense

Non-interest expense consists of ongoing operating costs, such as salaries and associated employee benefits, communications and other technology expenses, supplies and equipment and occupancy costs, and miscellaneous expenses. Marketing expenses are also included in non-interest expense. Table 6 displays the components of non-interest expense for the first quarter of 2012 and 2011.

 

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Table 6: Non-Interest Expense

 

     Three Months Ended March 31,  

(Dollars in millions)

        2012(1)              2011      

Non-interest expense:

     

Salaries and associated benefits

   $ 891       $ 741   

Marketing

     321         276   

Communications and data processing

     173         164   

Supplies and equipment

     150         135   

Occupancy

     123         119   

Other non-interest expense:

     

Professional services

     344         249   

Collections

     136         151   

Bankcard association assessments

     110         82   

Amortization of intangibles

     60         56   

Other

     196         189   
  

 

 

    

 

 

 

Total other non-interest expense

     846         727   
  

 

 

    

 

 

 

Total non-interest expense

   $ 2,504       $ 2,162   
  

 

 

    

 

 

 

 

(1) 

Includes transaction costs and merger-related expenses related to the ING Direct acquisition of $65 million, of which $37 million represented transaction costs. We provide additional information on the ING Direct acquisition in “Note 2—Acquisitions.”

Non-interest expense of $2.5 billion for the first quarter of 2012 increased by $342 million, or 16%, from the first quarter of 2011. The increase was primarily due to higher operating expenses related to our recent acquisitions, including an estimated $150 million of half-quarter operating expenses attributable to ING Direct, increased marketing expenditures, primarily related to reward products in our Credit Card business and higher infrastructure costs from our continued investments in our home loan business and growth in auto originations.

Income Taxes

We recorded an income tax provision based on income from continuing operations of $353 million (19.0% effective income tax rate) in the first quarter of 2012, compared with an income tax provision of $354 million (25.5% effective income tax rate) in the first quarter of 2011. The decrease in our effective tax rate in the first quarter of 2012 from the first quarter of 2011 was primarily due to the ING Direct bargain purchase gain of $594 million, which was non-taxable. In addition, we recorded tax benefits of $6 million and $42 million in the first quarter of 2012 and 2011, respectively, related to the resolution of certain discrete tax issues and audits. Our effective income tax rate, excluding both the impact of the non-taxable bargain purchase gain and the benefit from these discrete tax issues and audits, was 28.4% and 28.6% in the first quarter of 2012 and 2011, respectively.

We provide additional information on items affecting our income taxes and effective tax rate in our 2011 Form 10-K under “Note 18—Income Taxes.”

Loss from Discontinued Operations, Net of Tax

Loss from discontinued operations reflects ongoing costs, which primarily consist of mortgage loan repurchase representation and warranty charges, related to the mortgage origination operations of GreenPoint’s wholesale mortgage banking unit, which we closed in 2007.

We recorded a pre-tax provision for mortgage repurchase losses of $169 million in the first quarter of 2012, of which $153 million ($97 million, net of tax) was included in discontinued operations. In comparison, we recorded a pre-tax provision for mortgage repurchase losses of $44 million in the first quarter of 2011, of which $39 million ($29 million, net of tax) was included in discontinued operations. The increase in the provision for

 

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repurchase losses was primarily due to a GSE settlement to resolve present and future representation and warranty claims. We had already established an estimated reserve related to the GSE claims; however, we increased this reserve by $95 million in the first quarter of 2012 based on the final settlement amount, which we paid subsequent to the end of the first quarter of 2012.

We provide additional information on the provision for mortgage repurchase losses and the related reserve for potential representation and warranty claims in “Consolidated Balance Sheet Analysis—Potential Mortgage Representation and Warranty Liabilities.”

 

 

BUSINESS SEGMENT FINANCIAL PERFORMANCE

 

Our principal operations are currently organized into three major business segments, which are defined based on the products and services provided or the type of customer served: Credit Card, Consumer Banking and Commercial Banking. The operations of acquired businesses have been integrated into our existing business segments. Certain activities that are not part of a segment, such as management of our corporate investment portfolio and asset/liability management by our centralized Corporate Treasury group are included in the “Other” category.

The results of our individual businesses, which we report on a continuing operations basis, reflect the manner in which management evaluates performance and makes decisions about funding our operations and allocating resources. Our business segment results are intended to reflect each segment as if it were a stand-alone business. We use an internal management and reporting process to derive our business segment results. Our internal management and reporting process employs various allocation methodologies, including funds transfer pricing, to assign certain balance sheet assets, deposits and other liabilities and their related revenue and expenses directly or indirectly attributable to each business segment. See “Note 20—Business Segments” of our 2011 Form 10-K for information on the allocation methodologies used to derive our business segment results.

We may periodically change our business segments or reclassify business segment results based on modifications to our management reporting methodologies and changes in organizational alignment. In the first quarter of 2012, we re-aligned the reporting of our Commercial Banking business to reflect the operations on a product basis rather than by customer type. As a result of this re-alignment, we now report three product categories: commercial and multifamily real estate, commercial and industrial loans and small-ticket commercial real estate, which is a run-off portfolio. We previously reported four categories within our Commercial Banking business: commercial and multifamily real estate, middle market, specialty lending and small-ticket commercial real estate. Middle market and specialty lending related products are included in commercial and industrial loans. All tax-related commercial real estate investments, some of which were previously included in the “Other” segment, are now included in the commercial and multifamily real estate category of our Commercial Banking business. Prior period amounts have been recast to conform to the current period presentation.

We summarize our business segment results for the three months ended March 31, 2012 and 2011 in the tables below and provide a comparative discussion of these results. We also discuss changes in our financial condition and credit performance statistics as of March 31, 2012, compared with December 31, 2011. See “Note 14—Business Segments” of this Report for a reconciliation of our business segment results to our consolidated results. Information on the outlook for each of our business segments is presented above under “Executive Summary and Business Outlook.”

Credit Card Business

Our Credit Card business generated net income from continuing operations of $566 million in the first quarter of 2012, compared with $643 million in the first quarter of 2011. The primary sources of revenue for our Credit Card business are net interest income and non-interest income from customers and interchange fees. Expenses primarily consist of ongoing operating costs, such as salaries and associate benefits, communications and other technology expenses, supplies and equipment, occupancy costs, as well as marketing expenses.

 

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Table 7 summarizes the financial results of our Credit Card business, which is comprised of Domestic Card, including installment loans, and International Card operations, and displays selected key metrics for the periods indicated.

Table 7: Credit Card Business Results

 

     Three Months Ended March 31,  

(Dollars in millions)

       2012             2011             Change      

Selected income statement data:

      

Net interest income(1)

   $ 1,992      $ 1,941        3

Non-interest income

     598        674        (11
  

 

 

   

 

 

   

 

 

 

Total revenue

     2,590        2,615        (1

Provision for credit losses(1)

     458        450        2   

Non-interest expense

     1,268        1,178        8   

Income from continuing operations before income taxes

     864        987        (12

Income tax provision

     298        344        (13
  

 

 

   

 

 

   

 

 

 

Income from continuing operations, net of tax

   $ 566      $ 643        (12 )% 
  

 

 

   

 

 

   

 

 

 

Selected performance metrics:

      

Average loans held for investment

   $ 62,432      $ 60,586        3

Average yield on loans held for investment(2)

     14.41     14.68     (27 )bps 

Revenue margin(1) (3)

     16.59        17.26        (67

Net charge-off rate(1) (4)

     4.14        6.13        (199

Purchase volume(5)

   $ 34,498      $ 27,797        23

 

     March 31,
2012
    December 31,
2011
    Change  

Selected period-end data:

      

Loans held for investment

   $ 61,476      $ 65,075        (6 )% 

30+ day delinquency rate(6)

     3.51     3.86     (35 )bps 

Allowance for loan and lease losses(1)

   $ 2,671      $ 2,847        (6 )% 

 

(1)

Amounts attributable to Kohl’s under the revenue and loss-sharing arrangement reduced interest income by $222 million, reduced the provision for credit losses by $193 million and reduced net charge-offs by $40 million in the first quarter of 2012. The expected loss reimbursement from Kohl’s netted against our allowance for loan and lease losses was approximately $153 million and $139 million as of March 31, 2012 and December 31, 2011, respectively.

(2) 

Average yield on loans held for investment is calculated by dividing annualized interest income for the period by average loans held for investment during the period.

(3)

Revenue margin is calculated by dividing revenues for the period by average loans held for investment during the period for the specified loan category.

(4)

The net charge-off rate is calculated by dividing net charge-offs for the period by average loans held for investment during the period for the specified loan category.

(5)

Consists of purchase transactions for the period, net of returns. Excludes cash advance transactions.

(6) 

The delinquency rate is calculated by loan category by dividing 30+ day delinquent loans as of the end of the period by period-end loans held for investment for the specified loan category. The 30+ day performing delinquency rate is the same as the 30+ day delinquency rate for our Credit Card business, as credit card loans remain on accrual status until the loan is charged-off.

Key factors affecting the results of our Credit Card business for the first quarter of 2012, compared with first quarter of 2011 included the following:

 

   

Net Interest Income: Net interest income increased by $51 million, or 3%, in the first quarter of 2012. The increase in net interest income was primarily attributable to loan growth. Loan yields were stable as lower yielding Kohl’s loans were offset by higher yields across the rest of the portfolio.

 

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Non-Interest Income: Non-interest income decreased by $76 million, or 11%, in the first quarter of 2012. The decrease is primarily driven by the $75 million reserve established in the first quarter of 2012 which reflects an upcoming reimbursement we expect to provide customers affected by certain cross-sell sale practices.

 

   

Provision for Credit Losses: The provision for credit losses related to our Credit Card business increased by $8 million to $458 million in the first quarter of 2012. The increase was primarily driven by a lower allowance release of $176 million in the first quarter of 2012 compared to $465 million in the first quarter of 2011 due to the expected stabilization of credit, which was mostly offset by improved net charge-offs of $646 million in the first quarter of 2012, compared with $929 million in the first quarter of 2011 due to improved credit performance across all of our Credit Card segment.

 

   

Non-Interest Expense: Non-interest expense increased by $90 million, or 8%, in the first quarter of 2012. The increase in non-interest expense was primarily attributable to increased marketing expenditures. In addition, operating costs increased primarily due to merger-related expenses from the HSBC Transaction.

 

   

Total Loans: Period-end loans in our Credit Card business decreased by $3.6 billion, or 6%, to $61.5 billion as of March 31, 2012, from $65.1 billion as of December 31, 2011. The decline reflected normal seasonal credit card pay downs, as well as the continued run-off of our installment loan portfolio.

 

   

Charge-off and Delinquency Statistics: The net charge-off rate decreased to 4.14% in the first quarter of 2012 from 6.13% in the first quarter of 2011. The 30+ day delinquency rate decreased to 3.51% as of March 31, 2012, from 3.86% as of December 31, 2011. The improvement in the net charge-off and delinquency rates reflects the impact of improved credit quality across our credit card portfolio, tighter underwriting standards implemented over the last several years and ongoing stabilization of credit performance in the portfolio.

Domestic Card Business

Domestic Card generated net income from continuing operations of $515 million in the first quarter of 2012, compared with net income from continuing operations of $654 million in the first quarter of 2011. Since our Domestic Card business currently accounts for the substantial majority of our Credit Card business, the key factors driving the results for this division are similar to the key factors affecting our total Credit Card business. The decrease in Domestic Card net income from continuing operations in the first quarter of 2012 compared with first quarter of 2011 was driven by: (1) an increase in the provision for credit losses due to a lower allowance release of $170 million in the first quarter of 2012 compared to a $574 million allowance release in the first quarter of 2011 which was partially offset by lower net charge-offs of $531 million in the first quarter of 2012 compared to $804 million in the first quarter of 2011, (2) an increase in non-interest expense primarily due to increased marketing expenses as we continue to experience growth opportunities in certain customer segments and (3) a decrease in non-interest income primarily as a result of a $75 million reserve build in cross-sell for anticipated customer refunds associated with past cross-selling activities.

 

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Table 7.1 summarizes the financial results for Domestic Card and displays selected key metrics for the periods indicated.

Table 7.1: Domestic Card Business Results

 

     Three Months Ended March 31,  

(Dollars in millions)

   2012     2011     Change  

Selected income statement data:

      

Net interest income

   $ 1,713      $ 1,651        4

Non-interest income

     497        583        (15
  

 

 

   

 

 

   

 

 

 

Total revenue

     2,210        2,234        (1

Provision for credit losses

     361        230        57   

Non-interest expense

     1,052        990        6   
  

 

 

   

 

 

   

 

 

 

Income from continuing operations before income taxes

     797        1,014        (21

Income tax provision

     282        360        (22
  

 

 

   

 

 

   

 

 

 

Income from continuing operations, net of tax

   $ 515      $ 654        (21 )% 
  

 

 

   

 

 

   

 

 

 

Selected performance metrics:

      

Average loans held for investment

   $ 54,131      $ 51,889        4

Average yield on loans held for investment(1)

     14.11     14.42     (31 )bps 

Revenue margin(2)

     16.33        17.22        (89

Net charge-off rate(3)

     3.92        6.20        (228

Purchase volume(4)

   $ 31,417      $ 25,024        (26 )% 
     March 31,
2012
    December 31,
2011
    Change  

Selected period-end data:

      

Loans held for investment

   $ 53,173      $ 56,609        (6 )% 

30+ day delinquency rate(5)

     3.25     3.66     (41 )bps 

Allowance for loan and lease losses

   $ 2,205      $ 2,375        (7 )% 

 

(1) 

Average yield on loans held for investment is calculated by dividing annualized interest income for the period by average loans held for investment during the period.

(2)

Revenue margin is calculated by dividing revenues for the period by average loans held for investment during the period for the specified loan category.

(3)

The net charge-off rate is calculated by dividing net charge-offs for the period by average loans held for investment during the period for the specified loan category.

(4)

Consists of purchase transactions for the period, net of returns. Excludes cash advance transactions.

(5) 

The delinquency rate is calculated by loan category by dividing 30+ day delinquent loans as of the end of the period by period-end loans held for investment for the specified loan category. The 30+ day performing delinquency rate is the same as the 30+ day delinquency rate for our Credit Card business, as credit card loans remain on accrual status until the loan is charged-off.

International Card Business

Our International Card business generated net income from continuing operations of $51 million in the first quarter of 2012, compared with a net loss from continuing operations of $11 million in the first quarter of 2011. The increase in International Card net income in the first quarter of 2012 was driven primarily by: (1) a decrease in provision for loan losses as a result of an allowance release of $6 million in the first quarter of 2012 compared to an allowance build of $109 million in first quarter of 2011 due to the addition of the Hudson’s Bay Company (“HBC”) loan portfolio, and lower net charge-offs of $115 million in the first quarter of 2012 compared to $125 million in the first quarter of 2011 attributable to the improvement in credit environment in Canada and the U.K. and (2) partially offset by an increase in non-interest expense of $28 million from higher operating expenses in both the U.K. and Canada.

 

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Table 7.2 summarizes the financial results for International Card and displays selected key metrics for the periods indicated.

Table 7.2: International Card Business Results

 

     Three Months Ended March 31,  

(Dollars in millions)

   2012     2011     Change  

Selected income statement data:

      

Net interest income

   $ 279      $ 290        (4 )% 

Non-interest income

     101        91        11   
  

 

 

   

 

 

   

 

 

 

Total revenue

     380        381          

Provision for credit losses

     97        220        (56

Non-interest expense

     216        188        15   
  

 

 

   

 

 

   

 

 

 

Income from continuing operations before income taxes

     67        (27     348   

Income tax provision

     16        (16     200   
  

 

 

   

 

 

   

 

 

 

Income from continuing operations, net of tax

   $ 51      $ (11     564
  

 

 

   

 

 

   

 

 

 

Selected performance metrics:

      

Average loans held for investment

   $ 8,301      $ 8,697        (5 )% 

Average yield on loans held for investment(1)

     16.38     16.28     10  bps 

Revenue margin(2)

     18.31        17.52        79   

Net charge-off rate(3)

     5.52        5.74        (22

Purchase volume(4)

   $ 3,081      $ 2,773        11
     March 31,
2012
    December 31,
2011
    Change  

Selected period-end data:

      

Loans held for investment

   $ 8,303      $ 8,466        (2 )% 

30+ day delinquency rate(5)

     5.14     5.18     (4 )bps 

Allowance for loan and lease losses

   $ 466      $ 472        (1 )% 

 

(1) 

Average yield on loans held for investment is calculated by dividing annualized interest income for the period by average loans held for investment during the period.

(2)

Revenue margin is calculated by dividing revenues for the period by average loans held for investment during the period for the specified loan category.

(3)

The net charge-off rate is calculated by dividing net charge-offs for the period by average loans held for investment during the period for the specified loan category.

(4)

Consists of purchase transactions for the period, net of returns. Excludes cash advance transactions.

(5)

The delinquency rate is calculated by loan category by dividing delinquent loans as of the end of the period by period-end loans held for investment for the specified loan category. The 30+ day performing delinquency rate is the same as the 30+ day delinquency rate for our Credit Card business, as credit card loans remain on accrual status until the loan is charged-off.

Consumer Banking Business

Our Consumer Banking business generated net income from continuing operations of $224 million in the first quarter of 2012, compared with net income from continuing operations of $215 million in the first quarter of 2011. The primary sources of revenue for our Consumer Banking business are net interest income from loans and deposits and non-interest income from customer fees. Expenses primarily consist of ongoing operating costs, such as salaries and associated benefits, communications and other technology expenses, supplies and equipment and occupancy costs.

 

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On February 17, 2012, we acquired ING Direct, and the substantial majority of the lending and retail deposit businesses acquired are reported in the Consumer Banking segment. The acquisition resulted in the addition of loans with carrying value of $40.4 billion and deposits of $84.4 billion at acquisition.

Table 8 summarizes the financial results of our Consumer Banking business and displays selected key metrics for the periods indicated.

Table 8: Consumer Banking Business Results

 

     Three Months Ended March 31,  

(Dollars in millions)

   2012     2011     Change  

Selected income statement data:

      

Net interest income

   $ 1,288      $ 983        31

Non-interest income

     176        186        (5
  

 

 

   

 

 

   

 

 

 

Total revenue

     1,464        1,169        25   

Provision for credit losses

     174        95        83   

Non-interest expense

     943        740        27   
  

 

 

   

 

 

   

 

 

 

Income from continuing operations before income taxes

     347        334        4   

Income tax provision

     123        119        3   
  

 

 

   

 

 

   

 

 

 

Income from continuing operations, net of tax

   $ 224      $ 215        4
  

 

 

   

 

 

   

 

 

 

Selected performance metrics:

      

Average loans held for investment(1):

      

Auto

   $ 22,582      $ 18,025        25

Home loan

     29,502        11,960        147   

Retail banking

     4,179        4,251        (2
  

 

 

   

 

 

   

 

 

 

Total consumer banking

   $ 56,263      $ 34,236        64
  

 

 

   

 

 

   

 

 

 

Average yield on loans held for investment

     7.20     9.60     (240 )bps 

Average deposits

   $ 129,915      $ 83,884        55

Average deposit interest rate

     0.73     1.06     (33 )bps 

Core deposit intangible amortization

   $ 37      $ 35        6

Net charge-off rate(2)

     0.77     1.57     (80 )bps 

Net charge-off rate (excluding acquired loans)(1)(2)

     1.29        1.82        (53

Auto loan originations

   $ 4,270      $ 2,571        66

 

     March 31,
2012
    December 31,
2011
    Change  

Selected period-end data:

      

Loans held for investment(1):

      

Auto

   $ 23,568      $ 21,779        8

Home loan

     49,550        10,433        375   

Retail banking

     4,182        4,103        2   
  

 

 

   

 

 

   

 

 

 

Total consumer banking

   $ 77,300      $ 36,315        113
  

 

 

   

 

 

   

 

 

 

30+ day performing delinquency rate(3)(4)

     1.63     4.47     (284 )bps 

30+ day performing delinquency rate (excluding acquired loans)(3)(4)

     3.63        3.98        (35

30+ day delinquency rate(3)(4)

     2.25        5.99        (374

30+ day delinquency rate (excluding acquired loans) (3)(4)

     5.01        6.78        (1.77

Nonperforming loans rate(5)

     0.77        1.79        (102

Nonperforming loans rate (excluding acquired loans)(5)

     1.71        2.03        (32

Nonperforming asset rate(6)

     0.82        1.94        (112

Nonperforming asset rate (excluding acquired loans)(6)

     1.83        2.20        (37

Allowance for loan and lease losses

   $ 718      $ 652        10

Deposits

     176,007        88,540        99   

Loans serviced for others

     17,586        17,998        (2

 

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(1)

Loans held for investment includes loans acquired in the ING Direct and Chevy Chase Bank business combinations. The carrying value and outstanding unpaid principal balance of consumer banking acquired loans accounted for based on expected cash flows at acquisition was $42.7 billion and $44.3 billion as of March 31, 2012, respectively, and $4.2 billion and $5.2 billion, respectively, as of December 31, 2011. The average balance of consumer banking loans held for investment excluding the carrying value of acquired loans was $33.7 billion and $29.4 billion in the first quarter of 2012 and 2011, respectively.

(2)

The net charge-off rate is calculated by loan category by dividing net charge-offs for the period by average loans held for investment during the period for the specified loan category.

(3) 

The delinquency rate is calculated by loan category by dividing delinquent loans as of the end of the period by period-end loans held for investment for the specified loan category.

(4)

The 30+ day performing delinquency rate based on the contractual past due status for acquired loans was 3.08% as of March 31, 2012 and 2.94% as of December 31, 2011.

(5) 

Nonperforming loans generally include loans that have been placed on nonaccrual status and certain restructured loans whose contractual terms have been restructured in a manner that grants a concession to a borrower experiencing financial difficulty. The nonperforming loan rate is calculated by loan category by dividing nonperforming loans as of the end of the period by period-end loans held for investment for the specified loan category.

(6) 

Nonperforming assets consist of nonperforming loans and real estate owned (“REO”). The nonperforming asset rate is calculated by loan category by dividing nonperforming assets as of the end of the period by period-end loans held for investment, REO, and other foreclosed assets for the specified loan category.

Net income generated by our Consumer Banking business of $224 million for the first quarter of 2012 represented an increase of $9 million over the first quarter of 2011. Key factors contributing to the increase in the results of our Consumer Banking business for the first quarter of 2012, compared with the first quarter of 2011 included the following:

 

   

Net Interest Income: Net interest income increased by $305 million, or 31%, in the first quarter of 2012. The increase was primarily attributable to the 64% increase in average loans held for investment due to higher originations in auto loans over the past twelve months as well as the acquisition of ING Direct home loans in the first quarter of 2012. The favorable impact more than offset the decline in loan yields, which was attributable to the lower yielding ING Direct portfolio.

 

   

Non-Interest Income: Non-interest income decreased by $10 million, or 5%, in the first quarter 2012. The decrease was primarily attributable to the implementation of the Dodd-Frank amendment related to debit interchange fees in late 2011. The decrease was partially offset by the addition of ING Direct deposits in the first quarter of 2012.

 

   

Provision for Credit Losses: The increase in the provision for credit losses was due to an allowance build of $66 million in the first quarter of 2012 primarily as a result of higher auto loan originations compared with an allowance release of $34 million in the same prior year quarter. The increase in provision was partially offset by improved net charge-offs attributable to continued improvement in the credit and economic conditions.

 

   

Non-Interest Expense: Non-interest expense increased by $203 million, or 27%, in the first quarter of 2012. The increase was largely attributable to the on-going operating expenses of ING Direct, the associated merger-related expenses for the acquisition, higher infrastructure expenditure resulting from continued investments in the home loan business and growth in auto originations.

 

   

Total Loans: Period-end loans held for investment in the Consumer Banking business grew by $41.0 billion, or 113%, to $77.3 billion as of March 31, 2012, from $36.3 billion as of December 31, 2011, primarily due to the acquisition of ING Direct home loans of $40.4 billion and increased originations in auto loans, partially offset by the continued run-off of our legacy home loan portfolios.

 

   

Deposits: Period-end deposits in the Consumer Banking business increased by $87.5 billion, or 99%, to $176.0 billion as of March 31, 2012, from $88.5 billion as of December 31, 2011, primarily due to the addition of ING Direct deposits of $84.4 billion and a slight increase in deposits in our retail branch franchise.

 

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Table of Contents
   

Charge-off and Delinquency Statistics: The net charge-off and delinquency rates for the Consumer Banking business, improved during the first quarter of 2012 as a result of the improved economic environment, the addition of the ING Direct home loans portfolio and continued credit improvement on new auto loan originations. The net charge-off rate decreased to 0.77% for the first quarter of 2012, down from 1.57% for the prior year quarter. The 30+ day delinquency rate, which was 2.25% as of March 31, 2012, has declined from a rate of 5.99% as of December 31, 2011.

Commercial Banking Business

Our Commercial Banking business generated net income from continuing operations of $210 million in the first quarter of 2012, compared with net income from continuing operations of $162 million in first quarter of 2011. The primary sources of revenue for our Commercial Banking business are net interest income from loans and deposits and non-interest income from customer fees. Expenses primarily consist of ongoing operating costs, such as salaries and associated benefits, communications and other technology expenses, supplies and equipment and occupancy costs. Because we have some tax-related commercial investments that generate tax-exempt income or tax credits, we make certain reclassifications to our Commercial Banking business results to present revenues on a taxable-equivalent basis.

 

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Table 9 summarizes the financial results of our Commercial Banking business and displays selected key metrics for the periods indicated.

Table 9: Commercial Banking Business Results

 

     Three Months Ended March 31,  

(Dollars in millions)

       2012             2011             Change      

Selected income statement data:

      

Net interest income

   $ 431      $ 376        15

Non-interest income

     85        71        20   
  

 

 

   

 

 

   

 

 

 

Total revenue

     516        447        15   

Provision for credit losses

     (69     (16     331   

Non-interest expense

     261        212        23   
  

 

 

   

 

 

   

 

 

 

Income (loss) from continuing operations before income taxes

     324        251        29   

Income tax provision (benefit)

     114        89        28   
  

 

 

   

 

 

   

 

 

 

Income (loss) from continuing operations, net of tax

   $ 210      $ 162        30
  

 

 

   

 

 

   

 

 

 

Selected performance metrics:

      

Average loans held for investment(1):

      

Commercial and multifamily real estate

   $ 15,514      $ 13,579        14

Commercial and industrial

     17,038        14,630        16   
  

 

 

   

 

 

   

 

 

 

Total commercial lending

     32,552        28,209        15   

Small-ticket commercial real estate

     1,480        1,818        (19
  

 

 

   

 

 

   

 

 

 

Total commercial banking

   $ 34,032      $ 30,027        13
  

 

 

   

 

 

   

 

 

 

Average yield on loans held for investment

     4.47     4.81     (34 )bps 

Average deposits

   $ 27,569      $ 24,232        14

Average deposit interest rate

     0.37     0.55     (18 )bps 

Core deposit intangible amortization

   $ 9      $ 11        (18 )% 

Net charge-off rate(2)

     0.19     0.80     (61 )bps 

Net charge-off rate (excluding acquired loans)(2)

     0.19        0.81        (62

 

     March 31,
2012
    December 31,
2011
        Change      

Selected period-end data:

      

Loans held for investment(1):

      

Commercial and multifamily real estate

   $ 15,702      $ 15,736        **

Commercial and industrial

     17,761        17,088        4   
  

 

 

   

 

 

   

 

 

 

Total commercial lending

     33,463        32,824        2   

Small-ticket commercial real estate

     1,443        1,503        (4
  

 

 

   

 

 

   

 

 

 

Total commercial banking

   $ 34,906      $ 34,327        2
  

 

 

   

 

 

   

 

 

 

Nonperforming loans rate(3)(4)

     1.15     1.08     7 bps 

Nonperforming loans rate (excluding acquired loans)(3)(4)

     1.17     1.10     7 bps 

Nonperforming asset rate(5)(6)

     1.23        1.17        6   

Nonperforming asset rate (excluding acquired loans)(5)(6)

     1.25        1.18        7   

Allowance for loan and lease losses

   $ 636      $ 715        (11 )% 

Deposits

     28,046        26,683        5   

 

** 

Change is less than one percent.

(1) 

Loans held for investment includes loans acquired in the ING Direct and Chevy Chase Bank business combinations. The carrying value and outstanding unpaid principal balance of commercial banking acquired loans accounted for based on

 

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  expected cash flows at acquisition was $470 million and $542 million as of March 31, 2012, respectively, and $479 million and $546 million, respectively, as of December 31, 2011. The average balance of commercial banking loans held for investment excluding the carrying value of acquired loans was $33.5 billion and $29.5 billion in the first quarter of 2012 and 2011, respectively.
(2)

The net charge-off rate is calculated by loan category by dividing net charge-offs for the period by average loans held for investment during the period for the specified loan category.

(3)

The nonperforming loan rate is calculated by loan category by dividing nonperforming loans as of the end of the period by period-end loans held for investment for the specified loan category.

(4)

Nonperforming loans generally include loans that have been placed on nonaccrual status and certain restructured loans whose contractual terms have been restructured in a manner that grants a concession to a borrower experiencing financial difficulty.

(5) 

The nonperforming asset rate is calculated by loan category by dividing nonperforming assets as of the end of the period by period-end loans held for investment, REO, and other foreclosed assets for the specified loan category.

(6) 

Nonperforming assets consist of nonperforming loans and REO.

Key factors affecting the results of our Commercial Banking business for the first quarter of 2012, compared with the first quarter of 2011 included the following:

 

   

Net Interest Income: Our Commercial Banking business experienced an increase in net interest income of $55 million, or 15% in the first quarter of 2012. The increase was primarily driven by higher deposit and loan balances.

 

   

Non-Interest Income: Non-interest income increased by $14 million, or 20% in the first quarter of 2012 largely attributable to growth in fees from ancillary services.

 

   

Provision for Credit Losses: The provision for credit losses decreased by $53 million in the first quarter of 2012. The significant reduction in the provision for credit losses was due to lower charge-offs and higher allowance release in the first quarter of 2012 of $79 million compared to the allowance release in the first quarter of 2011 of $45 million. 

 

   

Non-Interest Expense: Non-interest expense increased by $49 million, or 23%, in the first quarter of 2012. The increase was due to increase in expenses due to higher originations in our commercial real estate and commercial and industrial businesses, expansion into new markets and infrastructure investments.

 

   

Total Loans: Period-end loans in the Commercial Banking business increased by $579 million, or 2%, in the first quarter of 2012 to $34.9 billion as of March 31, 2012, from $34.3 billion as of December 31, 2011. The increase was driven by stronger loan originations in the commercial and industrial and commercial real estate businesses, which was partially offset by the continued run-off of the small-ticket commercial real estate loan portfolio.

 

   

Deposits: Period-end deposits in the Commercial Banking business increased by $1.4 billion, or 5%, to $28.0 billion as of March 31, 2012 from $26.7 billion as of December 31, 2011, driven by our strategy to strengthen existing relationships and increase liquidity from commercial customers.

 

   

Charge-off Statistics: Credit metrics in our Commercial Banking business significantly improved in the first quarter of 2012 as a result of the improved economic environment. The net charge-off rate decreased to 0.19% in the first quarter of 2012 from 0.80% in the first quarter of 2011. The improvement in the net charge-off rate was attributable to improving credit trends and strengthening of underlying collateral values which is lowering loss severities and creating opportunities for recoveries on previously charged-off loans.

 

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CONSOLIDATED BALANCE SHEET ANALYSIS AND CREDIT PERFORMANCE

 

Total assets of $294.5 billion as of March 31, 2012 increased by $88.5 billion, or 43%, from $206.0 billion as of December 31, 2011. Total liabilities of $257.5 billion as of March 31, 2012, increased by $81.1 billion, or 46%, from $176.4 billion as of December 31, 2011. Stockholders’ equity increased by $7.3 billion during the first three months of 2012, to $37.0 billion as of March 31, 2012 from $29.7 billion as of December 31, 2011. The increase in stockholders’ equity was primarily attributable to our net income of $1.4 billion in the first quarter of 2012 and the $5.8 billion in equity issuances in the first quarter of 2012.

Following is a discussion of material changes in the major components of our assets and liabilities during the first three months of 2012.

Investment Securities

Our investment securities portfolio, which had a fair value of $60.8 billion and $38.8 billion, as of March 31, 2012 and December 31, 2011, respectively, consists of the following: U.S. Treasury and U.S. agency debt obligations; agency and non-agency mortgage-backed securities; other asset-backed securities collateralized primarily by credit card loans, auto loans, student loans, auto dealer floor plan inventory loans, equipment loans and home equity lines of credit; municipal securities; foreign government/agency bonds; covered bonds; and limited Community Reinvestment Act (“CRA”) equity securities. Our investment securities portfolio continues to be heavily concentrated in securities that generally have lower credit risk and high credit ratings, such as securities issued and guaranteed by the U.S. Treasury and government sponsored enterprises or agencies. Our investments in U.S. Treasury and agency securities, based on fair value, represented 72% of our total investment securities portfolio as of March 31, 2012, compared with 69% as of December 31, 2011.

All of our investment securities were classified as available for sale as of March 31, 2012 and reported in our consolidated balance sheet at fair value. Table 10 presents the amortized cost and fair value for the major categories of our investment securities as of March 31, 2012 and December 31, 2011.

Table 10: Investment Securities

 

     March 31, 2012      December 31, 2011  

(Dollars in millions)

   Amortized
Cost
     Fair
Value
     Amortized
Cost
     Fair
Value
 

U.S. Treasury debt obligations

   $ 2,048       $ 2,053       $ 115       $ 124   

U.S. Agency debt obligations(1)

     172         179         131         138   

Residential mortgage-backed securities (“RMBS”):

           

Agency(2)

     36,781         37,260         24,980         25,488   

Non-agency

     4,069         3,946         1,340         1,162   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total RMBS

     40,850         41,206         26,320         26,650  

Commercial mortgage-backed securities (“CMBS”):

           

Agency(2)

     4,337         4,365         697         711   

Non-agency

     1,195         1,220         459         476   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total CMBS

     5,532         5,585         1,156         1,187   
  

 

 

    

 

 

    

 

 

    

 

 

 

Asset-backed securities(3)

     10,207         10,239         10,119         10,150   

Other securities(4)

     1,508         1,548         462         510   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total securities available for sale

   $ 60,317       $ 60,810       $ 38,303       $ 38,759   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1)

Primarily consists of debt securities issued by Fannie Mae and Freddie Mac with amortized costs of $130 million as of both March 31, 2012 and December 31, 2011, and fair values of $136 million and $137 million, as of March 31, 2012 and December 31, 2011, respectively.

 

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(2)

Consists of MBS issued by Fannie Mae, Freddie Mac and Ginnie Mae with amortized costs of $15.5 billion, $10.4 billion, and $15.2 billion and $12.3 billion $8.9 billion and $4.5 billion, respectively, as of March 31, 2012 and December 31, 2011, respectively, and fair values of $15.7 billion, $10.6 billion, and $15.3 billion and $12.6 billion, $9.1 billion and $4.5 billion, respectively, as of March 31, 2012 and December 31, 2011, respectively. The book value of Fannie Mae, Freddie Mac and Ginnie Mae investments exceeded 10% of our stockholders’ equity as of March 31, 2012.

(3)

Consists of securities collateralized by credit card loans, auto dealer floor plan inventory loans and leases, auto loans, student loans, equipment loans, and other. The distribution among these asset types was approximately 75% credit card loans, 12% auto dealer floor plan inventory loans and leases, 6% auto loans, 2% student loans, 2% equipment loans, and 3% other as of March 31, 2012. In comparison, the distribution was approximately 75% credit card loans, 11% auto dealer floor plan inventory loans and leases, 6% auto loans, 4% student loans, 2% equipment loans, and 2% other as of December 31, 2011. Approximately 85% of the securities in our asset-backed security portfolio were rated AAA or its equivalent as of March 31, 2012, compared with 86% as of December 31, 2011.

(4)

Consists of foreign government/agency bonds, covered bonds, municipal securities and equity investments, primarily related to CRA activities.

Investment securities increased by $22.1 billion, or 57%, in the first quarter of 2012 to $60.8 billion as of March 31, 2012, from $38.8 billion as of December 31, 2011. The increase was primarily attributable to the acquisition of ING Direct which included investment securities of $30.2 billion at acquisition.

We sold approximately $7.3 billion of investment securities, consisting predominantly of agency MBS and FDIC notes in the first quarter of 2012. We recorded a net gain of $11 million on the sale of these securities. We provide additional information in “Market Risk Profile.”

Unrealized gains and losses on our available-for-sale securities are recorded net of tax as a component of accumulated other comprehensive income (“AOCI”). We had gross unrealized gains of $721 million and gross unrealized losses of $228 million on available-for sale securities as of March 31, 2012, compared with gross unrealized gains of $683 million and gross unrealized losses of $227 million on available-for sale securities as of December 31, 2011. The substantial majority of the gross unrealized losses as of March 31, 2012 related to non-agency residential MBS. Of the $228 million gross unrealized losses as of March 31, 2012, $125 million related to securities that had been in a loss position for more than 12 months.

We recognized net OTTI on debt securities of $14 million in the first quarter of 2012. In comparison, we recognized net OTTI on investment securities of $3 million in the first quarter of 2011, which was due in part to the deterioration in the credit performance and outlook of certain non-agency securities as a result of continued weaknesses in the housing market.

 

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We provide additional information on our available-for-sale securities in “Note 4—Investment Securities.”

Credit Ratings

Our investment securities portfolio continues to be heavily concentrated in securities that generally have lower credit risk and high credit ratings, such as securities issued and guaranteed by the U.S. Treasury and government sponsored enterprises or agencies. Approximately 91% of our total investment securities portfolio was rated AA+ or its equivalent, or better as of both March 31, 2012 and December 31, 2011, while approximately 6% and 4% were below investment grade as of March 31, 2012 and December 31, 2011, respectively. We categorize the credit ratings of our investment securities based on the lowest credit rating as issued by the rating agencies S&P, Moody’s Investors Service (“Moody’s”) and Fitch Ratings (“Fitch”).

Table 11 provides information on the credit ratings of our non-agency residential MBS, non-agency commercial MBS and asset-backed securities, which accounted for the substantial majority of the unrealized losses related to our investment securities portfolio as of March 31, 2012 and December 31, 2011.

Table 11: Non-Agency Investment Securities Credit Ratings

 

     March 31, 2012     December 31, 2011  

(Dollars in millions)

   Amortized
Cost
     AAA     Other
Investment
Grade
    Below
Investment
Grade or Not
Rated
    Amortized
Cost
     AAA     Other
Investment
Grade
    Below
Investment
Grade or Not
Rated
 

Non-agency residential MBS

   $ 4,069         1     8     91 %   $ 1,340             3     97

Non-agency commercial MBS

     1,195         95        5               459         92        8          

Asset-backed securities

     10,207         85        14        1        10,119         86        14          

Total Loans

Table 12 summarizes loans held for investment, net of the allowance for loan and lease losses, as of March 31, 2012 and December 31, 2011.

Table 12: Net Loans Held for Investment

 

     March 31, 2012      December 31, 2011  

(Dollars in millions)

   Total Loans
Held For
Investment
     Allowance      Net Loans
Held For
Investment
     Total Loans
Held For
Investment
     Allowance      Net Loans
Held For
Investment
 

Credit Card

   $ 61,476       $ 2,671       $ 58,805       $ 65,075       $ 2,847       $ 62,228   

Consumer Banking

     77,300         718         76,582         36,315         652         35,663   

Commercial Banking

     34,906         636         34,270         34,327         715         33,612   

Other

     140         35         105         175         36         139   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 173,822       $ 4,060       $ 169,762       $ 135,892       $ 4,250       $ 131,642   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans held for investment increased by $37.9 billion, or 28%, in the first quarter of 2012 to $173.8 billion as of March 31, 2012, from $135.9 billion as of December 31, 2011. The increase was primarily attributable to the acquisition of ING Direct which included loans of $40.4 billion. Partially offsetting the increase in loans was the continued expected run-off of loans in businesses we exited or repositioned early in the economic recession, other loan pay downs and charge-offs. The run-off portfolios include installment loans in our Credit Card business, home loans in our Consumer Banking business and small-ticket commercial real estate loans in our Commercial Banking business. We provide additional information on the composition of our loan portfolio and credit quality below in “Credit Risk Profile.”

 

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Deposits

Our deposits have become our largest source of funding for our operations and asset growth. Total deposits increased by $88.3 billion, or 69%, in the first quarter of 2012, to $216.5 billion as of March 31, 2012, from $128.2 billion as of December 31, 2011. The increase in deposits reflects the addition of $84.4 billion in deposits from the ING Direct acquisition and increased retail marketing efforts to attract new business and continued strategy to leverage our bank outlets to attract lower cost deposit funding. We provide additional information on the composition of our deposits, average outstanding balances, interest expense and yield below in “Liquidity Risk Profile.”

Senior and Subordinated Notes and Other Borrowings

Senior and subordinated notes and other borrowings decreased to $17.4 billion as of March 31, 2012, from $23.0 billion as of December 31, 2011. The $5.6 billion decrease in our debt, which excludes securitized debt obligations, was primarily attributable to an approximately $5.8 billion decrease in short-term FHLB advances offset by an increase of $1.0 billion in unsecured senior debt. We provide additional information on our borrowings in “Note 9—Deposits and Borrowings.”

Securitized Debt Obligations

Borrowings owed to securitization investors decreased by $1.0 billion to $15.5 billion as of March 31, 2012, from $16.5 billion as of December 31, 2011. This decrease was attributable to pay downs of the loans underlying the consolidated non-credit card securitization trusts and the scheduled maturities of the debt within our credit card securitization trusts.

Potential Mortgage Representation & Warranty Liabilities

In recent years, we acquired three subsidiaries that originated residential mortgage loans and sold them to various purchasers, including purchasers who created securitization trusts. These subsidiaries are Capital One Home Loans, which was acquired in February 2005; GreenPoint Mortgage Funding, Inc. (“GreenPoint”), which was acquired in December 2006 as part of the North Fork acquisition; and Chevy Chase Bank, which was acquired in February 2009 and subsequently merged into CONA.

In connection with their sales of mortgage loans, the subsidiaries entered into agreements containing varying representations and warranties about, among other things, the ownership of the loan, the validity of the lien securing the loan, the loan’s compliance with any applicable loan criteria established by the purchaser, including underwriting guidelines and the ongoing existence of mortgage insurance, and the loan’s compliance with applicable federal, state and local laws. The representations and warranties do not address the credit performance of the mortgage loans, but mortgage loan performance often influences whether a claim for breach of representation and warranty will be asserted and has an effect on the amount of any loss in the event of a breach of a representation or warranty.

Each of these subsidiaries may be required to repurchase mortgage loans in the event of certain breaches of these representations and warranties. In the event of a repurchase, the subsidiary is typically required to pay the then unpaid principal balance of the loan together with interest and certain expenses (including, in certain cases, legal costs incurred by the purchaser and/or others). The subsidiary then recovers the loan or, if the loan has been foreclosed, the underlying collateral. The subsidiary is exposed to any losses on the repurchased loans after giving effect to any recoveries on the collateral. In some instances, rather than repurchase the loans, a subsidiary may agree to make a cash payment to make an investor whole on losses or to settle repurchase claims. In addition, our subsidiaries may be required to indemnify certain purchasers and others against losses they incur as a result of certain breaches of representations and warranties. In some cases, the amount of such losses could exceed the repurchase amount of the related loans.

 

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These subsidiaries, in total, originated and sold to non-affiliates approximately $111 billion original principal balance of mortgage loans between 2005 and 2008, which are the years (or “vintages”) with respect to which our subsidiaries have received the vast majority of the repurchase requests and other related claims.

Table 13 presents the original principal balance of mortgage loan originations, by vintage for 2005 through 2008, for the three general categories of purchasers of mortgage loans and the outstanding principal balance as of March 31, 2012 and December  31, 2011:

Table 13: Unpaid Principal Balance of Mortgage Loans Originated and Sold to Third Parties Based on Category of Purchaser

 

         Unpaid Principal Balance          Original Unpaid Principal Balance  

(Dollars in billions)

   March 31,
2012
     December 31,
2011
     Total      2008      2007      2006      2005  

Government sponsored enterprises (“GSEs”)(1)

   $ 5       $ 5       $ 11       $ 1       $ 4       $ 3       $ 3   

Insured Securitizations

     6         6         19                 2         8         9   

Uninsured Securitizations and Other

     27         30         81         3         15         30         33   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 38       $ 41       $ 111       $ 4       $ 21       $ 41       $ 45   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) 

GSEs include Fannie Mae and Freddie Mac.

Between 2005 and 2008, our subsidiaries sold an aggregate amount of $11 billion in original principal balance mortgage loans to the GSEs.

Of the $19 billion in original principal balance of mortgage loans sold directly by our subsidiaries to private-label purchasers who placed the loans into securitizations supported by bond insurance (“Insured Securitizations”), approximately $16 billion original principal balance was placed in securitizations as to which the monoline bond insurers have made repurchase requests or loan file requests to one of our subsidiaries (“Active Insured Securitizations”), and the remaining approximately $3 billion original principal balance was placed in securitizations as to which the monoline bond insurers have not made repurchase requests or loan file requests to one of our subsidiaries (“Inactive Insured Securitizations”). Insured Securitizations often allow the monoline bond insurer to act independently of the investors. Bond insurers typically have indemnity agreements directly with both the mortgage originators and the securitizers, and they often have super-majority rights within the trust documentation that allow them to direct trustees to pursue mortgage repurchase requests without coordination with other investors.

Because we do not service most of the loans our subsidiaries sold to others, we do not have complete information about the current ownership of the $81 billion in original principal balance of mortgage loans not sold directly to GSEs or placed in Insured Securitizations. We have determined based on information obtained from third-party databases that about $50 billion original principal balance of these mortgage loans are currently held by private-label publicly issued securitizations not supported by bond insurance (“Uninsured Securitizations”). In contrast with the bond insurers in Insured Securitizations, investors in Uninsured Securitizations often face a number of legal and logistical hurdles before they can direct a securitization trustee to pursue mortgage repurchases, including the need to coordinate with a certain percentage of investors holding the securities and to indemnify the trustee for any litigation it undertakes. An additional approximately $21 billion original principal balance of mortgage loans were initially sold to private investors as whole loans. Of this amount, we believe approximately $10 billion original principal balance of mortgage loans were ultimately purchased by GSEs. For purposes of our reserves-setting process, we consider these loans to be private-label loans rather than GSE loans. Various known and unknown investors purchased the remaining $10 billion original principal balance of mortgage loans in this category.

With respect to the $111 billion in original principal balance of mortgage loans originated and sold to others between 2005 and 2008, we estimate that approximately $38 billion in unpaid principal balance remains

 

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outstanding as of March 31, 2012, approximately $15 billion in losses have been realized and approximately $10 billion in unpaid principal balance is at least 90 days delinquent. Because we do not service most of the loans we sold to others, we do not have complete information about the underlying credit performance levels for some of these mortgage loans. These amounts reflect our best estimates, including extrapolations where necessary. These extrapolations occur on the approximately $10 billion original principal balance of mortgage loans for which we do not have complete information about the current holders or the underlying credit performance. These estimates could change as we get additional data or refine our analysis.

The subsidiaries had open repurchase requests relating to approximately $2.3 billion original principal balance of mortgage loans as of March 31, 2012, compared with $2.1 billion as of December 31, 2011. As of March 31, 2012, the majority of new repurchase demands received over the last year and, as discussed below, the majority of our $1.1 billion reserve relates to the $27 billion of original principal balance of mortgage loans originally sold to the GSEs or to Active Insured Securitizations. Currently, repurchase demands predominantly relate to the 2006 and 2007 vintages. We have received relatively few repurchase demands from the 2008 and 2009 vintages. We believe this is because GreenPoint ceased originating mortgages in August 2007.

The following table presents information on pending repurchase requests by counterparty category and timing of initial repurchase request. The amounts presented are based on original loan principal balances.

Table 14: Open Pipeline All Vintages (all entities)(1)

 

(Dollars in millions) (All amounts are Original Principal Balance)

   GSEs     Insured
Securitizations
    Uninsured
Securitizations
and Other
    Total  

Open claims as of December 31, 2010

   $ 126      $ 832      $ 665      $ 1,623   

Gross new demands received

     196        359        131        686   

Loans repurchased/made whole

     (67 )     (14 )     (16 )     (97 )

Demands rescinded

     (85 )     (6 )     (30 )     (121 )

Reclassifications(2)

     6        72        (78       
  

 

 

   

 

 

   

 

 

   

 

 

 

Open claims as of December 31, 2011

   $ 176      $ 1,243      $ 672      $ 2,091   
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross new demands received

     107        50        172        329   

Loans repurchased/made whole

     (9 )     (1     (22     (32 )

Demands rescinded

     (35            (7 )     (42

Reclassifications(2)

            1        (1 )       
  

 

 

   

 

 

   

 

 

   

 

 

 

Open claims as of March 31, 2012

   $ 239      $ 1,293      $ 814      $ 2,346   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) 

The open pipeline includes all repurchase requests ever received by our subsidiaries where either the requesting party has not formally rescinded the repurchase request and where our subsidiary has not agreed to either repurchase the loan at issue or make the requesting party whole with respect to its losses. Accordingly, repurchase requests denied by our subsidiaries and not pursued by the counterparty remain in the open pipeline. Moreover, repurchase requests submitted by parties without contractual standing to pursue repurchase requests are included within the open pipeline unless the requesting party has formally rescinded its repurchase request. Finally, the amounts reflected in this chart are the original principal balance amounts of the mortgage loans at issue and do not correspond to the losses our subsidiary would incur upon the repurchase of these loans.

(2) 

Represents adjustments to correct the counterparty category as of March 31, 2012 and December 31, 2011 for amounts that were misclassified. The reclassification had no impact on the total pending repurchase requests.

We have established representation and warranty reserves for losses associated with the mortgage loans sold by each subsidiary that we consider to be both probable and reasonably estimable, including both litigation and non-litigation liabilities. These reserves are reported in our consolidated balance sheets as a component of other liabilities. The reserve setting process relies heavily on estimates, which are inherently uncertain, and requires the application of judgment. We evaluate these estimates on a quarterly basis. We build our representation and warranty reserves through the provision for repurchase losses, which we report in our consolidated statements of

 

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income as a component of non-interest income for loans originated and sold by Chevy Chase Bank and Capital One Home Loans and as a component of discontinued operations for loans originated and sold by GreenPoint. In establishing the representation and warranty reserves, we consider a variety of factors depending on the category of purchaser.

In establishing reserves for the $11 billion original principal balance of GSE loans, we rely on the historical relationship between GSE loan losses and repurchase outcomes to estimate: (1) the percentage of current and future GSE loan defaults that we anticipate will result in repurchase requests from the GSEs over the lifetime of the GSE loans; and (2) the percentage of those repurchase requests that we anticipate will result in actual repurchases. We also rely on estimated collateral valuations and loss forecast models to estimate our lifetime liability on GSE loans. This reserving approach to the GSE loans reflects the historical interaction with the GSEs around repurchase requests, and also includes anticipated repurchases resulting from mortgage insurance rescissions. The GSEs typically have stronger contractual rights than non-GSE counterparties because GSE contracts typically do not contain prompt notice requirements for repurchase requests or materiality qualifications to the representations and warranties.

Moreover, although we often disagree with the GSEs about the validity of their repurchase requests, we have established a negotiation pattern whereby the GSEs and our subsidiaries continually negotiate around individual repurchase requests, leading to the GSEs rescinding some repurchase requests and our subsidiaries agreeing in some cases to repurchase some loans or make the GSEs whole with respect to losses. Our lifetime representation and warranty reserves with respect to GSE loans are grounded in this history. Finally, as discussed in more detail below, one of our subsidiaries entered into a settlement with a GSE to resolve present and future repurchase claims in the first quarter of 2012. Our reserves allocated to the GSE segment reflect the amount of that settlement, which was paid after March 31, 2012.

For the $16 billion original principal balance in Active Insured Securitizations, our reserving approach also reflects our historical interaction with monoline bond insurers around repurchase requests. Typically, monoline bond insurers allege a very high repurchase rate with respect to the mortgage loans in the Active Insured Securitization category. In response to these repurchase requests, our subsidiaries typically request information from the monoline bond insurers demonstrating that the contractual requirements around a valid repurchase request have been satisfied. In response to these requests for supporting documentation, monoline bond insurers typically initiate litigation. Accordingly, our reserves within the Active Insured Securitization segment are not based upon the historical repurchase rate with monoline bond insurers, but rather upon the expected resolution of litigation with the monoline bond insurers. Every bond insurer within this category is pursuing a substantially similar litigation strategy either through active or probable litigation. Accordingly, our representation and warranty reserves for this category are litigation reserves. In establishing litigation reserves for this category each quarter, we consider current and future losses inherent within the securitization and apply legal judgment to the actual and anticipated factual and legal record to estimate the lifetime legal liability for each securitization. Our estimated legal liability for each securitization within this category assumes that we will be responsible for only a portion of the losses inherent in each securitization. Our litigation reserves with respect to both the U.S. Bank Litigation and the DBSP Litigation, in each case as referenced below, are contained within the Active Insured Securitization reserve category. Further, our litigation reserves with respect to indemnification risks from certain representation and warranty lawsuits brought by monoline bond insurers against third-party securitizations sponsors, where GreenPoint provided some or all of the mortgage collateral within the securitization but is not a defendant in the litigation, are also contained within this category.

For the $3 billion original principal balance of mortgage loans in the Inactive Insured Securitizations category and the $81 billion original principal balance of mortgage loans in the Uninsured Securitizations and other whole loan sales categories, we establish reserves by relying on our historical activity and repurchase rates to estimate repurchase liabilities over the next twelve (12) months. We do not believe we can estimate repurchase liability for these categories for a period longer than twelve (12) months because of the relatively irregular nature of repurchase activity within these categories. Some Uninsured Securitization investors from this category who

 

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have not made repurchase requests or filed representation and warranty lawsuits are currently suing investment banks and securitization sponsors under federal and/or state securities laws. Although we face some direct and indirect indemnity risks from these litigations, we generally have not established reserves with respect to these indemnity risks because we do not consider them to be both probable and reasonably estimable liabilities.

The aggregate reserves for all three subsidiaries were $1.1 billion as of March 31, 2012, as compared with $943 million as of December 31, 2011. We recorded a total provision for repurchase losses for our representation and warranty repurchase exposure of $169 million for the three months ended March 31, 2012, primarily driven by an increased reserve associated with a settlement between a subsidiary and a GSE to resolve present and future repurchase claims. This GSE settlement accounted for $95 million of the $169 million provision. The remainder of the provision is primarily driven by certain inactive insured securitizations becoming active insured securitizations in the first quarter.

During the first quarter of 2012, we had settlements of repurchase requests totaling $11 million that were charged against the reserve. The following table summarizes changes in our representation and warranty reserves for the three months ended March 31, 2012 and 2011, and for full year 2011:

Table 15: Changes in Representation and Warranty Reserve

 

     Three Months Ended
March  31,
    Full Year  

(Dollars in millions)

       2012             2011         2011  

Representation and warranty repurchase reserve, beginning of period(1)

   $ 943      $ 816        $816   

Provision for repurchase losses(2)

     169        44        212   

Net realized losses

     (11     (14     (85
  

 

 

   

 

 

   

 

 

 

Representation and warranty repurchase reserve, end of period(1)

   $ 1,101      $ 846        $943   
  

 

 

   

 

 

   

 

 

 

 

(1) 

Reported in our consolidated balance sheets as a component of other liabilities.

(2) 

The pre-tax portion of the provision for mortgage repurchase claims recognized in our consolidated statements of income as a component of non-interest income totaled $16 million and $5 million for the three months ended March 31, 2012 and 2011, respectively. The pre-tax portion of the provision for mortgage repurchase claims recognized in our consolidated statements of income as a component of discontinued operations totaled $153 million and $39 million, for the three months ended March 31, 2012 and 2011, respectively.

As indicated in the table below, most of the reserves relate to the $11 billion in original principal balance of mortgage loans sold directly to the GSEs and to the $16 billion in mortgage loans sold to purchasers who placed them into Active Insured Securitizations.

Table 16: Allocation of Representation and Warranty Reserve

 

     Reserve Liability      Loans Sold
2005 to 2008(1)
 
(Dollars in millions, except for loans sold)    March 31,
2012
     December 31,
2011
    

GSEs and Active Insured Securitizations

   $ 927       $ 778       $ 27   

Inactive Insured Securitizations and Others

     174         165         84   
  

 

 

    

 

 

    

 

 

 

Total

   $ 1,101       $ 943       $ 111   
  

 

 

    

 

 

    

 

 

 

 

(1) 

Reflects, in billions, the total original principal balance of mortgage loans originated by our subsidiaries and sold to third party investors between 2005 and 2008.

The adequacy of the reserves and the ultimate amount of losses incurred by our subsidiaries will depend on, among other things, actual future mortgage loan performance, the actual level of future repurchase and indemnification requests (including the extent, if any, to which Inactive Insured Securitizations and other

 

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currently inactive investors ultimately assert claims), the actual success rates of claimants, developments in litigation, actual recoveries on the collateral and macroeconomic conditions (including unemployment levels and housing prices).

As part of our business planning processes, we have considered various outcomes relating to the potential future representation and warranty liabilities of our subsidiaries that are possible but do not rise to the level of being both probable and reasonably estimable outcomes that would justify an incremental accrual under applicable accounting standards. We believe that the upper end of the reasonably possible future losses from representation and warranty claims beyond the current accrual levels, including reasonably possible future losses relating to the US Bank Litigation, DBSP Litigation and the FHLB of Boston Litigation, could be as high as $1.5 billion, which is unchanged from the estimate provided as of December 31, 2011. Notwithstanding our ongoing attempts to estimate a reasonably possible amount of loss beyond our current accrual levels based on current information, it is possible that actual future losses will exceed both the current accrual level and our current estimated upper end of the amount of reasonably possible losses. There is still significant uncertainty regarding the numerous factors that may impact the ultimate loss levels, including, but not limited to, litigation outcomes, future repurchase claims levels, ultimate repurchase success rates and mortgage loan performance levels.

 

 

OFF-BALANCE SHEET ARRANGEMENTS AND VARIABLE INTEREST ENTITIES

 

In the ordinary course of business, we are involved in various types of arrangements with limited liability companies, partnerships or trusts that often involve special purpose entities and variable interest entities (“VIEs”). Some of these arrangements are not recorded on our consolidated balance sheets or may be recorded in amounts different from the full contract or notional amount of the arrangements, depending on the nature or structure of, and accounting required to be applied to, the arrangement. These arrangements may expose us to potential losses in excess of the amounts recorded in the consolidated balance sheets. Our involvement in these arrangements can take many forms, including securitization and servicing activities, the purchase or sale of mortgage-backed or other asset-backed securities in connection with our home loan portfolio and loans to VIEs that hold debt, equity, real estate or other assets.

Our continuing involvement in unconsolidated VIEs primarily consists of certain mortgage loan trusts and community reinvestment and development entities. The carrying amount of assets and liabilities of these unconsolidated VIEs was $2.4 billion and $340 million, respectively, as of March 31, 2012, and our maximum exposure to loss was $2.5 billion. We provide a discussion of our activities related to these VIEs in “Note 7—Variable Interest Entities and Securitizations.”

 

 

CAPITAL MANAGEMENT

 

The level and composition of our equity capital are determined by multiple factors, including our consolidated regulatory capital requirements and an internal risk-based capital assessment, and may also be influenced by rating agency guidelines, subsidiary capital requirements, the business environment, conditions in the financial markets and assessments of potential future losses due to adverse changes in our business and market environments.

Capital Standards and Prompt Corrective Action

Bank holding companies and national banks are subject to capital adequacy standards adopted by the Federal Reserve and the OCC, respectively. The capital adequacy standards set forth minimum risk-based and leverage capital requirements that are based on quantitative and qualitative measures of their assets and off-balance sheet items. Under the capital adequacy standards, bank holding companies and banks currently are required to maintain a total risk-based capital ratio of at least 8%, a Tier 1 risk-based capital ratio of at least 4%, and a Tier 1 leverage capital ratio of at least 4% (3% for banks that meet certain specified criteria, including excellent asset quality, high liquidity, low interest rate exposure and the highest regulatory rating) in order to be considered adequately capitalized.

 

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National banks also are subject to prompt corrective action capital regulations. Under prompt corrective action regulations, a bank is considered to be well capitalized if it maintains a Tier 1 risk-based capital ratio of at least 6% (200 basis points higher than the above minimum capital standard), a total risk-based capital ratio of at least 10% (200 basis points higher than the above minimum capital standard), a Tier 1 leverage capital ratio of at least 5% and is not subject to any supervisory agreement, order or directive to meet and maintain a specific capital level for any capital reserve. A bank is considered to be adequately capitalized if it meets these minimum capital ratios and does not otherwise meet the well capitalized definition. Currently, prompt corrective action capital requirements do not apply to bank holding companies.

We also disclose Tier 1 common ratios, which are regulatory capital measures widely used by investors, analysts, rating agencies and bank regulatory agencies to assess the capital position of financial services companies. There is currently no mandated minimum or “well capitalized” standard for Tier 1 common; instead the risk-based capital rules state that voting common stockholders’ equity should be the dominant element within Tier 1 common capital. While these regulatory capital measures are widely used by investors, analysts and bank regulatory agencies to assess the capital position of financial services companies, they may not be comparable to similarly titled measures reported by other companies.

Table 17 provides a comparison of our capital ratios under the Federal Reserve’s capital adequacy standards; and the capital ratios of the Banks under the OCC’s capital adequacy standards as of March 31, 2012 and December 31, 2011. Table 18 provides the details of the calculation of our capital ratios.

Table 17: Capital Ratios Under Basel I(1)

 

     March 31, 2012     December 31, 2011  

(Dollars in millions)

   Capital
Ratio
    Minimum
Capital
Adequacy
    Well
Capitalized
    Capital
Ratio
    Minimum
Capital
Adequacy
    Well
Capitalized
 

Capital One Financial Corp.(2)

            

Tier 1 common(3)

     11.9     N/A        N/A        9.7     N/A        N/A   

Tier 1 risk-based capital(4)

     13.9        4.0     6.0     12.0        4.0     6.0

Total risk-based capital(5)

     16.5        8.0        10.0        14.9        8.0        10.0   

Tier 1 leverage(6)

     11.0        4.0        N/A        10.1        4.0        N/A   

Capital One Bank (USA) N.A.

            

Tier 1 risk-based capital

     12.5     4.0     6.0     11.2     4.0     6.0

Total risk-based capital

     16.5        8.0        10.0        15.0        8.0        10.0   

Tier 1 leverage

     10.9        4.0        5.0        10.2        4.0        5.0   

Capital One, N.A.

            

Tier 1 risk-based capital

     11.9     4.0     6.0     11.0     4.0     6.0

Total risk-based capital

     13.2        8.0        10.0        12.2        8.0        10.0   

Tier 1 leverage

     9.5        4.0        5.0        8.7        4.0        5.0   

ING Bank, fsb.

            

Tier 1 risk-based capital

     31.5     4.0     6.0     N/A        N/A        N/A   

Total risk-based capital

     31.5        8.0        10.0        N/A        N/A        N/A   

Tier 1 leverage

     9.4        4.0        5.0        N/A        N/A        N/A   

 

(1)

Calculated under capital standards and regulations based on the international capital framework commonly known as Basel I.

(2)

The regulatory framework for prompt corrective action does not apply to Capital One Financial Corp. because it is a bank holding company.

(3)

Tier 1 common ratio is a regulatory capital measure calculated based on Tier 1 common equity divided by risk-weighted assets.

(4)

Calculated based on Tier 1 capital divided by risk-weighted assets.

(5)

Calculated based on Total risk-based capital divided by risk-weighted assets.

(6)

Calculated based on Tier 1 capital divided by quarterly average total assets, after certain adjustments.

 

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We exceeded minimum capital requirements and met the “well capitalized” ratio levels for total risk-based capital and Tier 1 risk-based capital under Federal Reserve rules for bank holding companies as of March 31, 2012. The Banks and ING Bank, fsb also exceeded minimum regulatory requirements under the OCC’s applicable capital adequacy guidelines and were “well capitalized” under prompt corrective action requirements as of March 31, 2012 and December 31, 2011.

Table 18: Risk-Based Capital Components Under Basel I(1)

 

(Dollars in millions)

   March 31,
2012
    December 31,
2011
 

Total stockholders’ equity

   $ 36,950      $ 29,666   

Less: Net unrealized gains recorded in AOCI(2)

     (328     (289

Net losses on cash flow hedges recorded in AOCI(2)

     70        71   

Disallowed goodwill and other intangible assets(3)

     (14,057     (13,855

Disallowed deferred tax assets

     (902     (534

Other

     (2     (2
  

 

 

   

 

 

 

Tier 1 common capital

     21,731        15,057   

Plus: Tier 1 restricted core capital items(4)

     3,636        3,635   
  

 

 

   

 

 

 

Tier 1 risk-based capital

     25,367        18,692   
  

 

 

   

 

 

 

Plus: Long-term debt qualifying as Tier 2 capital

     2,438        2,438   

Qualifying allowance for loan and lease losses

     2,314        1,979   

Other Tier 2 components

     17        23   
  

 

 

   

 

 

 

Tier 2 risk-based capital

     4,769        4,440   

Total risk-based capital

   $ 30,136      $ 23,132   
  

 

 

   

 

 

 

Risk-weighted assets(5)

   $ 182,697      $ 155,657   
  

 

 

   

 

 

 

 

(1)

Calculated under capital standards and regulations based on the international capital framework commonly known as Basel I.

(2) 

Amounts presented are net of tax.

(3) 

Disallowed goodwill and other intangible assets are net of related deferred tax liability.

(4) 

Consists primarily of trust preferred securities.

(5)

Under regulatory guidelines for risk-based capital, on-balance sheet assets and credit equivalent amounts of derivatives and off-balance sheet items are assigned to one of several broad risk categories according to the obligor or, if relevant, the guarantor or the nature of any collateral. The aggregate dollar amount in each risk category is then multiplied by the risk weight associated with that category. The resulting weighted values from each of the risk categories are aggregated for determining total risk-weighted assets.

Under the Dodd-Frank Act, many trust preferred securities will cease to qualify for Tier 1 capital, subject to a three year phase-out period expected to begin in 2013.

In November 2011, the Federal Reserve finalized capital planning rules applicable to large bank holding companies like us (commonly referred to as Comprehensive Capital Analysis and Review or CCAR). Under the rules, bank holding companies with consolidated assets of $50.0 billion or more must submit capital plans to the Federal Reserve on an annual basis and must obtain approval from the Federal Reserve before making most capital distributions. The purpose of the rules is to ensure that large bank holding companies have robust, forward-looking capital planning processes that account for their unique risks and capital needs to continue operations through times of economic and financial stress. As part of its evaluation of a capital plan, the Federal Reserve will consider the comprehensiveness of the plan, the reasonableness of assumptions and analysis and methodologies used to assess capital adequacy and the ability of the bank holding company to maintain capital above each minimum regulatory capital ratio and above a Tier 1 common ratio of 5% on a pro forma basis under expected and stressful conditions throughout a planning horizon of at least nine quarters.

 

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In January 2012, we submitted our capital plan to the Board of Governors of the Federal Reserve as part of the 2012 Comprehensive Capital Analysis and Review. On March 13, 2012, the Company was informed that the Federal Reserve had no objection to the capital actions contained in the Company’s capital plan submitted under CCAR.

Dividend Policy

The declaration and payment of dividends to our stockholders, as well as the amount thereof, are subject to the discretion of our Board of Directors and will depend upon our results of operations, financial condition, capital levels, cash requirements, future prospects and other factors deemed relevant by the Board of Directors. As a bank holding company, our ability to pay dividends is largely dependent upon the receipt of dividends or other payments from our subsidiaries. We provide additional information on our dividend policy in our 2011 Form 10-K under “Part I—Item 1. Business—Supervision and Regulation—Dividends, Stock Purchases and Transfer of Funds.”

Regulatory restrictions exist that limit the ability of the Banks and ING Bank, fsb to transfer funds to our bank holding company. Funds available for dividend payments from COBNA, CONA and ING Bank, fsb based on the Earnings Limitation Test were $2.8 billion, $814 million and $196 million, respectively, as of March 31, 2012. Although funds are available for dividend payments from the Banks, we would execute a dividend from the Banks in consultation with the OCC. Applicable provisions that may be contained in our borrowing agreements or the borrowing agreements of our subsidiaries may limit our subsidiaries’ ability to pay dividends to us or our ability to pay dividends to our stockholders. There can be no assurance that we will declare and pay any dividends.

Issuance of Shares to ING Sellers

In exchange for the equity interests and assets and liabilities associated with the ING Direct acquisition, we issued 54,028,086 shares of Capital One common stock with a fair value of $2.6 billion on February 17, 2012.

Equity and Debt Offering

On March 20, 2012 we closed a public offering of 24,442,706 shares of our common stock which we sold to the underwriters at a per share price of $51.14 for net proceeds of approximately $1.24 billion. In addition, we issued $1.25 billion of our senior notes due 2015 in a public offering which closed on March 23, 2012. We used the net proceeds of these offerings along with cash sourced from current liquidity, to fund the consideration payable in connection with the acquisition of HSBC’s U.S credit card business.

Settlement of Forward Sale Agreements

On February 16, 2012, we settled forward sale agreements that we entered into with certain counterparties acting as forward purchasers in connection with a public offering of shares of our common stock on July 19, 2011. Pursuant to the forward sale agreements, we issued 40 million shares of our common stock at settlement. After underwriter’s discounts and commissions, the net proceeds to the company were at a forward sale price per share of $48.17 for a total of approximately $1.9 billion.

HSBC Acquisition—U.S. Credit Card Business

We completed the transaction in which we acquired substantially all of the assets and assumed liabilities of HSBC’s credit card and private-label credit card business in the United States (the “HSBC Transaction”) for a purchase price of $31.3 billion on May 1, 2012. In the HSBC Transaction, we acquired $28.2 billion of credit card receivables and $0.6 billion in other net assets. We used the net proceeds from the equity and debt offerings described above, along with cash sourced from current liquidity, to fund the cash consideration payable in connection with the acquisition of HSBC’s U.S credit card business.

 

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RISK MANAGEMENT

 

Overview

Risk management is an important part of our business model, as all financial institutions are exposed to a variety of business risks that can significantly affect their financial performance. Our business activities expose us to eight major categories of risks: strategic risk, reputational risk, compliance risk, legal risk, liquidity risk, credit risk, market risk and operational risk.

We discuss below our overall risk management principles, roles and responsibilities, framework and risk appetite. Following this section, we address in more detail the specific procedures, measures and analysis of the major categories of risks that we manage.

Risk Management Principles

Our risk management framework is intended to identify, assess and mitigate risks that affect or have the potential to affect our business. We target financial returns that compensate us for the amount of risk that we take and avoid excessive risk-taking. Our risk management framework consists of five key risk management principles:

 

   

Individual businesses take and manage risk within established tolerance levels in pursuit of strategic, financial and other business objectives.

 

   

Independent risk management organizations support individual businesses by providing risk management tools and policies and by aggregating risks; in some cases, risks are managed centrally.

 

   

The Board of Directors and senior management review our aggregate risk position, establish the risk appetite and work with management to ensure conformance to policy and adherence to our adopted mitigation strategy.

 

   

We employ a top risk identification system to maintain the appropriate focus on the risks and issues that may have the most impact and to identify emerging risks of consequence.

 

   

Independent assurance functions, such as our Internal Audit and Credit Review teams, assess the governance framework and test transactions, business processes and procedures to provide assurance as to whether our risk programs are operating as intended.

For additional information on our risk management principles, see “MD&A—Risk Management” in our 2011 Form 10-K.

 

 

CREDIT RISK PROFILE

 

Our loan portfolio accounts for the substantial majority of our credit risk exposure. Below we provide information about the composition of our loan portfolio, key concentrations and credit performance metrics.

We also engage in certain non-lending activities that may give rise to credit and counterparty settlement risk, including the purchase of securities for our investment securities portfolio, entering into derivative transactions to manage our market risk exposure and to accommodate customers, foreign exchange transactions and deposit overdrafts. We provide additional information on credit risk related to our investment securities portfolio under “Consolidated Balance Sheet Analysis—Investment Securities” and credit risk related to derivative transactions in “Note 10—Derivative Instruments and Hedging Activities.”

Loan Portfolio Composition

We provide a variety of lending products. Our primary products include credit cards, auto loans, home loans and commercial loans. For information on our lending policies and procedures, including our underwriting criteria, for our primary loan products, please refer to the “MD&A—Credit Risk Profile” section of our 2011 Form 10-K.

 

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Total loans that we manage consist of held-for-investment loans recorded on our balance sheet and loans held in our securitization trusts. Loans underlying our securitization trusts are reported on our consolidated balance sheets under restricted loans for securitization investors.

Table 19 presents the composition of our total loan portfolio, by business segments, as of March 31, 2012 and December 31, 2011.

Table 19: Loan Portfolio Composition

 

     March 31, 2012     December 31, 2011  

(Dollars in millions)

   Amount      % of
Total Loans
    Amount      % of
Total Loans
 

Credit Card business:

          

Credit card loans:

          

Domestic credit card loans

   $ 51,607         29.7   $ 54,682         40.3

International credit card loans

     8,303         4.8        8,466         6.2   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total credit card loans

     59,910         34.5        63,148         46.5   
  

 

 

    

 

 

   

 

 

    

 

 

 

Installment loans:

          

Domestic installment loans

     1,566         0.9        1,927         1.4   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total installment loans

     1,566         0.9        1,927         1.4   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total credit card

     61,476         35.4        65,075         47.9   
  

 

 

    

 

 

   

 

 

    

 

 

 

Consumer Banking business:

          

Auto

     23,568         13.5        21,779         16.0   

Home loan

     49,550         28.5        10,433         7.7   

Other retail

     4,182         2.4        4,103         3.0   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total consumer banking

     77,300         44.4        36,315         26.7   
  

 

 

    

 

 

   

 

 

    

 

 

 

Commercial Banking business:(1)

          

Commercial and multifamily real estate

     15,702         9.1        15,736         11.6   

Commercial and industrial

     17,761         10.2        17,088         12.6   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total commercial lending

     33,463         19.3        32,824         24.2   

Small-ticket commercial real estate

     1,443         0.8        1,503         1.1   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total commercial banking

     34,906         20.1        34,327         25.3   
  

 

 

    

 

 

   

 

 

    

 

 

 

Other:

          

Other loans

     140         0.1        175         0.1   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total loans

   $ 173,822         100.0   $ 135,892         100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

 

(1) 

Includes construction and land development loans totaling $2.1 billion and $2.2 billion as of March 31, 2012 and December 31, 2011, respectively.

Credit Risk Measurement

We closely monitor economic conditions and loan performance trends to manage and evaluate our exposure to credit risk. Trends in delinquency ratios are an indicator, among other considerations, of credit risk within our loan portfolios. The level of nonperforming assets represents another indicator of the potential for future credit losses. Accordingly, key metrics we track and use in evaluating the credit quality of our loan portfolio include delinquency and nonperforming asset rates, as well as charge-off rates and our internal risk ratings of larger balance, commercial loans. For information on our accounting policies regarding delinquencies, nonperforming status, charge-offs and TDRs for each of our loan categories, see “Note 1—Summary of Significant Accounting Policies” in our 2011 Form 10-K.

 

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The improvements we have experienced in our credit trends across all of our businesses are stabilizing and our credit performance is increasingly driven by seasonal trends. We present information in the section below on the credit performance of our loan portfolio, including the key metrics we use in tracking changes in the credit quality of our loan portfolio. See “Note 5—Loans” for additional information.

Delinquency Rates

Table 20 compares 30+ day performing loan delinquency rates, by loan category, as of March 31, 2012 and December 31, 2011. We also present total 30+ day delinquent loans.

Our 30+ day delinquency metrics include all held for investment loans that are 30 or more days past due, whereas our 30+ day performing delinquency metrics include loans that are 30 or more days past due and that are also currently classified as performing and accruing interest. The 30+ day delinquency and 30+ day performing delinquency metrics are the same for credit card loans, as we continue to classify credit card loans as performing until they are charged-off, generally when the loan is 180 days past due. However, the 30+ day delinquency and 30+ day performing delinquency metrics differ for other loan categories based on our policies for classifying loans as nonperforming.

The delinquency rates presented are calculated, by loan category, based on our total loan portfolio. We separately track and report the performance of acquired loans and exclude these loans from the numerator in calculating our net charge-off, delinquency, nonperforming loan and nonperforming asset rates.

Table 20: 30+ Day Delinquencies

 

    March 31, 2012     December 31, 2011  
    30+ Day Performing     30+ Day Total     30+ Day Performing     30+ Day Total  

(Dollars in millions)

  Amount     Rate(1)     Amount     Rate(1)     Amount     Rate(1)     Amount     Rate(1)  

Credit Card business:

               

Domestic credit card and installment loans

  $ 1,730        3.25   $ 1,730        3.25   $ 2,073        3.66   $ 2,073        3.66

International credit card

    427        5.14        427        5.14        438        5.18        438        5.18   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total credit card

    2,157        3.51        2,157        3.51        2,511        3.86        2,511        3.86   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Consumer Banking business:

               

Auto

    1,149        4.87        1,210        5.13        1,498        6.88        1,604        7.36   

Home loans(2)

    76        0.15        436        0.88        93        0.89        478        4.58   

Retail banking(2)

    34        0.80        92        2.20        34        0.83        94        2.29   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total consumer banking(2)

    1,259        1.63        1,738        2.25        1,625        4.47        2,176        5.99   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Commercial Banking business: