10-Q 1 d10q.htm FORM 10-Q Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

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

For the quarterly period ended June 30, 2009.

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED).

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)

(703) 720-1000

Registrant’s telephone number, including area code:

(Not applicable)

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

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

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  ¨

As of July 31, 2009 there were 454,964,553 shares of the registrant’s Common Stock, par value $.01 per share, outstanding.

 

 

 


Table of Contents

CAPITAL ONE FINANCIAL CORPORATION

FORM 10-Q

INDEX

June 30, 2009

 

          Page

PART 1. FINANCIAL INFORMATION

   3

Item 1

   Financial Statements (unaudited):    3
   Consolidated Balance Sheets    3
   Consolidated Statements of Income    4
   Consolidated Statements of Changes in Stockholders’ Equity    5
   Consolidated Statements of Cash Flows    6
   Notes to Consolidated Financial Statements    7

Item 2

   Management’s Discussion and Analysis of Financial Condition and Results of Operations    49

Item 3

   Quantitative and Qualitative Disclosure of Market Risk    85

Item 4

   Controls and Procedures    85

PART 2. OTHER INFORMATION

   85

Item 1

   Legal Proceedings    85

Item 1A

   Risk Factors    85

Item 2

   Unregistered Sales of Equity Securities and Use of Proceeds    86

Item 6

   Exhibits    87
   Signatures    90

 

2


Table of Contents

Part 1. Financial Information

 

Item 1. Financial Statements

CAPITAL ONE FINANCIAL CORPORATION

Consolidated Balance Sheets

(Dollars in thousands, except share and per share data) (unaudited)

 

     June 30,
2009
    December 31,
2008
 

Assets:

    

Cash and due from banks

   $ 3,001,944      $ 2,047,839   

Federal funds sold and resale agreements

     603,564        636,752   

Interest-bearing deposits at other banks

     1,166,419        4,806,752   
                

Cash and cash equivalents

     4,771,927        7,491,343   

Securities available for sale

     37,667,165        31,003,271   

Securities held to maturity

     87,545        —     

Mortgage loans held for sale

     319,975        68,462   

Loans held for investment

     101,073,629        101,017,771   

Less: Allowance for loan and lease losses

     (4,481,827     (4,523,960
                

Net loans held for investment

     96,591,802        96,493,811   

Accounts receivable from securitizations

     5,219,968        6,342,754   

Premises and equipment, net

     2,824,785        2,313,106   

Interest receivable

     951,201        827,909   

Goodwill

     13,381,056        11,964,487   

Other

     10,095,883        9,408,309   
                

Total assets

   $ 171,911,307      $ 165,913,452   
                

Liabilities:

    

Non-interest-bearing deposits

   $ 12,603,548      $ 11,293,852   

Interest-bearing deposits

     104,120,642        97,326,937   
                

Total deposits

     116,724,190        108,620,789   

Senior and subordinated notes

     10,092,619        8,308,843   

Other borrowings

     13,260,589        14,869,648   

Interest payable

     659,784        676,398   

Other

     5,844,549        6,825,341   
                

Total liabilities

     146,581,731        139,301,019   
                

Stockholders’ Equity:

    

Preferred stock, par value $.01 per share; authorized 50,000,000 shares, zero and 3,555,199 issued or outstanding as of June 30, 2009 and December 31, 2008, respectively

     —          3,096,466   

Common stock, par value $.01 per share; authorized 1,000,000,000 shares, 501,853,170 and 438,434,235 issued as of June 30, 2009 and December 31, 2008, respectively

     5,019        4,384   

Paid-in capital, net

     18,891,334        17,278,102   

Retained earnings

     10,001,299        10,621,164   

Cumulative other comprehensive loss

     (398,779     (1,221,796

Less: Treasury stock, at cost; 46,911,870 and 46,637,241 shares as of June 30, 2009 and December 31, 2008, respectively

     (3,169,297     (3,165,887
                

Total stockholders’ equity

     25,329,576        26,612,433   
                

Total liabilities and stockholders’ equity

   $ 171,911,307      $ 165,913,452   
                

See Notes to Consolidated Financial Statements.

 

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Table of Contents

CAPITAL ONE FINANCIAL CORPORATION

Consolidated Statements of Income

(Dollars in thousands, except per share data) (unaudited)

 

     Three Months Ended
June 30
    Six Months Ended
June 30
 
     2009     2008     2009     2008  

Interest Income:

        

Loans held for investment, including past-due fees

   $ 2,233,808      $ 2,297,709      $ 4,424,139      $ 4,806,102   

Investment securities

     412,845        281,084        807,625        538,825   

Other

     67,982        113,064        131,099        226,455   
                                

Total interest income

     2,714,635        2,691,857        5,362,863        5,571,382   

Interest Expense:

        

Deposits

     555,579        592,576        1,187,427        1,202,965   

Senior and subordinated notes

     57,113        114,797        115,157        255,767   

Other borrowings

     155,357        256,728        326,942        572,977   
                                

Total interest expense

     768,049        964,101        1,629,526        2,031,709   
                                

Net interest income

     1,946,586        1,727,756        3,733,337        3,539,673   

Provision for loan and lease losses

     934,038        829,130        2,213,175        1,908,202   
                                

Net interest income after provision for loan and lease losses

     1,012,548        898,626        1,520,162        1,631,471   

Non-Interest Income:

        

Servicing and securitizations

     362,416        834,740        816,053        1,917,802   

Service charges and other customer-related fees

     491,763        524,209        997,888        1,098,270   

Mortgage servicing and other

     13,163        16,552        36,543        51,807   

Interchange

     126,702        132,730        266,793        284,632   

Net impairment losses recognized in earnings(1)

     (10,031     —          (10,394     —     

Other

     247,674        114,085        215,138        326,283   
                                

Total non-interest income

     1,231,687        1,622,316        2,322,021        3,678,794   

Non-Interest Expense:

        

Salaries and associate benefits

     633,819        578,572        1,188,250        1,189,852   

Marketing

     133,970        288,100        296,682        585,893   

Communications and data processing

     194,578        195,102        393,682        382,345   

Supplies and equipment

     128,483        131,937        247,383        262,868   

Occupancy

     114,885        80,137        215,136        168,217   

Restructuring expense

     43,374        13,560        61,001        66,319   

Other

     672,647        532,193        1,264,714        986,384   
                                

Total non-interest expense

     1,921,756        1,819,601        3,666,848        3,641,878   
                                

Income (loss) from continuing operations before income taxes

     322,479        701,341        175,335        1,668,387   

Income tax (benefit) provision

     92,278        238,843        32,055        573,334   
                                

Income (loss) from continuing operations, net of tax

     230,201        462,498        143,280        1,095,053   

Loss from discontinued operations, net of tax

     (5,998     (9,593     (30,956     (93,644
                                

Net income (loss)

   $ 224,203      $ 452,905      $ 112,324      $ 1,001,409   
                                

Net income (loss) available to common shareholders

   $ (275,515   $ 452,905      $ (451,584   $ 1,001,409   
                                

Basic earnings per common share:

        

Income (loss) from continuing operations

   $ (0.64   $ 1.24      $ (1.03   $ 2.95   

Loss from discontinued operations

     (0.01     (0.03     (0.08     (0.25
                                

Net income (loss)

   $ (0.65   $ 1.21      $ (1.11   $ 2.70   
                                

Diluted earnings per common share:

        

Income (loss) from continuing operations

   $ (0.64   $ 1.24      $ (1.03   $ 2.94   

Loss from discontinued operations

     (0.01     (0.03     (0.08     (0.25
                                

Net income (loss)

   $ (0.65   $ 1.21      $ (1.11   $ 2.69   
                                

Dividends paid per common share

   $ 0.05      $ 0.375      $ 0.425      $ 0.75   
                                

 

(1) Total other-than-temporary impairment losses for the three and six months ended June 30, 2009 are $159.2 million and $159.6 million, respectively. The portion of loss recognized in other comprehensive income (before taxes) is $149.2 million for both the three and six months ended June 30, 2009.

See Notes to Consolidated Financial Statements.

 

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CAPITAL ONE FINANCIAL CORPORATION

Consolidated Statements of Changes in Stockholders’ Equity

(Dollars in thousands, except per share data) (unaudited)

 

    Common Stock   Preferred Stock     Paid-In Capital,
Net
    Retained
Earnings
    Cumulative Other
Comprehensive
Income (Loss)
    Treasury
Stock
    Total
Stockholders’
Equity
 

(In Thousands, Except Per Share Data)

  Shares   Amount            

Balance, December 31, 2007

  419,224,900   $ 4,192   $ —        $ 15,860,490      $ 11,267,568      $ 315,248      $ (3,153,386   $ 24,294,112   

Adjustment to initially apply the measurement date provision of FAS 158, net of income tax benefit of $317

  —       —       —            572        (1,161       (589

Comprehensive income:

               

Net income

  —       —       —          —          1,001,409        —          —          1,001,409   

Other comprehensive income (loss), net of income tax:

               

Unrealized losses on securities, net of income tax benefit of $82,865

  —       —       —          —          —          (153,892     —          (153,892

Defined benefit pension plans, net of income tax benefit of $1,388

  —       —       —          —          —          (2,730     —          (2,730

Foreign currency translation adjustments

  —       —       —          —          —          (29,358     —          (29,358

Unrealized loss on cash flow hedging instruments, net of income tax benefit of $810

  —       —       —          —          —          (1,504     —          (1,504
                                                         

Other comprehensive income

  —       —       —          —          —          (187,484     —          (187,484
                                                         

Comprehensive income

  —       —       —          —          —          —          —          813,925   

Cash dividends—Common stock $0.75 per share

  —       —       —          —          (280,671     —          —          (280,671

Purchase of treasury stock

  —       —       —          —          —          —          (11,662     (11,662

Issuances of common stock and restricted stock, net of forfeitures

  1,493,355     15     —          18,561        —          —          —          18,576   

Exercise of stock options and tax benefits of exercises and restricted stock vesting

  1,580,365     16     —          47,259        —          —          —          47,275   

Compensation expense for restricted stock awards and stock options

  —       —       —          37,349        —          —          —          37,349   

Allocation of ESOP shares

  —       —       —          3,150        —          —          —          3,150   
                                                         

Balance, June 30, 2008

  422,298,620     4,223     —          15,966,809        11,988,878        126,603        (3,165,048     24,921,465   
                                                         

Balance, December 31, 2008

  438,434,235   $ 4,384   $ 3,096,466      $ 17,278,102      $ 10,621,164      $ (1,221,796   $ (3,165,887   $ 26,612,433   

Comprehensive income:

               

Net income

  —       —       —          —          112,324        —          —          112,324   

Other comprehensive income (loss), net of income tax:

               

Unrealized gains on securities, net of income taxes of $294,504

  —       —       —          —          —          583,442        —          583,442   

Defined benefit pension plans, net of net income tax benefit of $326

  —       —       —          —          —          (586     —          (586

Foreign currency translation adjustments

  —       —       —          —          —          184,359        —          184,359   

Unrealized gains in cash flow hedging instruments, net of income taxes of $37,223

  —       —       —          —          —          55,802        —          55,802   
                                                         

Other comprehensive income (loss)

  —       —       —          —          —          823,017        —          823,017   
                                                         

Comprehensive income (loss)

  —       —       —          —          —          —          —          935,341   

Cash dividends-Common stock $0.425 per share

  —       —       —          —          (168,281     —          —          (168,281

Cash dividends-Preferred stock 5% per annum

  —       —       (22,714     —          (82,461     —          —          (105,175

Purchase of treasury stock

  —       —       —          —          —          —          (3,410     (3,410

Issuances of common stock and restricted stock, net of forfeitures

  60,856,434     609     —          1,521,930        —          —          —          1,522,539   

Exercise of stock options and tax benefits of exercises and restricted stock vesting

  1,900     —       —          (1,558     —          —          —          (1,558

Accretion of preferred stock discount

  —       —       33,554        —          (33,554     —          —          —     

Redemption of preferred stock

  —       —       (3,107,306     —          (447,893     —          —          (3,555,199

Compensation expense for restricted stock awards and stock options

  —       —       —          60,797        —          —          —          60,797   

Issuance of common stock for acquisition

  2,560,601     26     —          30,830        —          —          —          30,856   

Allocation of ESOP shares

  —       —       —          1,233        —          —          —          1,233   
                                                         

Balance, June 30, 2009

  501,853,170   $ 5,019   $ —        $ 18,891,334      $ 10,001,299      $ (398,779   $ (3,169,297   $ 25,329,576   
                                                         

See Notes to Consolidated Financial Statements.

 

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Table of Contents

CAPITAL ONE FINANCIAL CORPORATION

Consolidated Statements of Cash Flows

(Dollars in thousands) (unaudited)

 

     Six Months Ended
June 30,
 
     2009     2008  

Operating Activities:

    

Income from continuing operations, net of tax

   $ 143,280      $ 1,095,053   

Loss from discontinued operations, net of tax

     (30,956     (93,644
                

Net Income

     112,324        1,001,409   

Adjustments to reconcile net income to cash provided by operating activities:

    

Provision for loan and lease losses

     2,213,175        1,908,202   

Depreciation and amortization, net

     381,586        361,133   

Gains on sales of securities available for sale

     (57,209     (12,790

Gain on sales of auto loans

     —          (2,125

Gain on repurchase of senior notes

     —          (53,289

Mortgage loans held for sale:

    

Transfers and originations

     (814,804     (1,247,090

Loss (Gain) on sales

     399        (21,158

Proceeds from sales

     794,382        1,479,198   

Stock plan compensation expense

     58,108        44,854   

Changes in assets and liabilities:

    

(Increase) Decrease in interest receivable

     (123,292     60,722   

Decrease (Increase) in accounts receivable from securitizations

     1,122,786        (584,027

Decrease (Increase) in other assets

     1,404,549        (328,525

Decreases in interest payable

     (16,614     (10,120

Decreases in other liabilities

     (1,924,554     (72,984

Net cash used in operating activities attributable to discontinued operations

     (10,463     (19,640
                

Net cash provided by operating activities

     3,140,373        2,503,770   
                

Investing Activities:

    

Purchases of securities available for sale

     (11,925,539     (11,277,343

Proceeds from maturities of securities available for sale

     4,414,252        3,559,824   

Proceeds from sales of securities available for sale

     3,057,351        2,266,004   

Proceeds from securitizations of loans

     7,049,716        4,993,667   

Net decrease in loans held for investment

     (698,862     (2,212,015

Principal recoveries of loans previously charged off

     401,640        333,172   

Additions of premises and equipment, net

     (175,870     (203,047

Net payment for companies acquired

     (448,151     —     

Net cash provided by investing activities attributable to discontinued operations

     301        11,683  
                

Net cash provided by (used in) investing activities

     1,674,838        (2,528,055
                

Financing Activities:

    

Net (decrease) increase in deposits

     (5,453,238     9,645,884   

Net decreases in other borrowings

     (2,611,953     (7,518,432

Maturities of senior notes

     (417,539     (1,118,694

Repurchases of senior notes

     —          (1,064,597

Redemptions of acquired company debt and noncontrolling interest

     (464,915     —     

Issuance of senior notes

     1,000,000        —     

Issuance of subordinated notes

     1,500,000        —     

Redemption of preferred stock

     (3,555,199     —     

Purchases of treasury stock

     (3,410     (11,662

Dividends paid-common stock

     (168,281     (280,671

Dividends paid-preferred stock

     (105,175     —     

Net proceeds from issuances of common stock

     1,523,772        21,726   

Proceeds from share based payment activities

     (1,558     47,275   

Net cash (used in) provided by financing activities attributable to discontinued operations

     (3,448     6,662   
                

Net cash used in financing activities

     (8,760,944     (272,509
                

Net decreases in cash and cash equivalents

     (3,945,733     (296,794

Cash and cash equivalents at beginning of year

     7,491,343        4,821,409   

Cash and cash equivalents of acquired companies

     1,226,317        —     
                

Cash and cash equivalents at end of period

   $ 4,771,927      $ 4,524,615   
                

See Notes to Consolidated Financial Statements.

 

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CAPITAL ONE FINANCIAL CORPORATION

Notes to Consolidated Financial Statements

(in thousands, except per share data) (unaudited)

Note 1

Significant Accounting Policies

Business

Capital One Financial Corporation (the “Corporation”) is a diversified financial services company whose banking and non-banking subsidiaries market a variety of financial products and services. The Corporation’s principal subsidiaries are:

 

   

Capital One Bank (USA), National Association (“COBNA”) which currently offers credit and debit card products, other lending products and deposit products.

 

   

Capital One, National Association (“CONA”) which offers a broad spectrum of banking products and financial services to consumers, small businesses and commercial clients.

 

   

Chevy Chase Bank, F.S.B. (“Chevy Chase Bank”) which offers a broad spectrum of banking products and financial services to consumers, small businesses and commercial clients.

On February 27, 2009, the Corporation acquired Chevy Chase Bank for $475.9 million comprised of cash of $445.0 million and 2.56 million shares of common stock valued at $30.9 million. Chevy Chase Bank has the largest retail branch presence in the Washington D.C. region. See Note 2 for more information regarding the acquisition.

On July 30, 2009 the Company merged Chevy Chase Bank, F.S.B. with and into CONA.

During 2008, the Corporation completed several reorganizations and consolidations to streamline operations and regulatory relationships. On January 1, Capital One Auto Finance Inc. (“COAF”) moved from a direct subsidiary of the Corporation to become a direct operating subsidiary of CONA. In connection with the COAF move, one of COAF’s direct operating subsidiaries, Onyx Acceptance Corporation (“Onyx”), became a direct subsidiary of the Corporation. On March 1, the Corporation converted Capital One Bank from a Virginia-state chartered bank to a national association called Capital One Bank (USA), National Association (“COBNA”). On March 8, Superior Savings of New England, N.A. (“Superior”) merged with and into CONA. Both COBNA and CONA are primarily regulated by the Office of the Comptroller of the Currency (the “OCC”). In May 2008, we consolidated the business and operations of two registered broker-dealers, Capital One Securities, LLC (dba Capital One Investments, LLC) and Capital One Investment Services Corporation (formerly NFB Investment Services Corporation), into Capital One Investments Services Corporation. In addition, in May 2008, we consolidated the business and operations of three insurance agencies, Capital One Agency Corp., GreenPoint Agency, Inc. and Hibernia Insurance Agency, LLC into Green Point Agency, Inc., which is now known as Capital One Agency LLC.

The Corporation and its subsidiaries are hereafter collectively referred to as the “Company”.

CONA, COBNA and Chevy Chase Bank are hereafter collectively referred to as the “Banks”.

Basis of Presentation

The accompanying Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) that require management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from these estimates.

The Consolidated Financial Statements include the accounts of the Company in which it has a controlling financial interest. Investments in unconsolidated entities where we have the ability to exercise significant influence over the operations of the investee are accounted for using the equity method of accounting. This includes interests in variable interest entities (“VIEs”) where we are not the primary beneficiary. Investments not meeting the criteria for equity method accounting are accounted for using the cost method of accounting. Investments in unconsolidated entities are included in other assets, and our share of income or loss is recorded in other non-interest income. All significant intercompany balances and transactions have been eliminated. Certain prior year amounts have been reclassified to conform to the 2009 presentation. All amounts in the following notes, excluding per share data, are presented in thousands unless noted otherwise.

Special Purpose Entities and Variable Interest Entities

Special purpose entities (“SPEs”) are broadly defined as legal entities structured for a particular purpose. There are two different accounting frameworks applicable to SPEs: the qualifying SPE (“QSPE”) framework under Statement of Financial Accounting Standard (“SFAS”) No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (“SFAS

 

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140”) and the VIE framework under Financial Accounting Standards Board Interpretation No. 46 (Revised 2003), Consolidation of Variable Interest Entities (“VIE”), (“FIN 46(R)”).

QSPEs QSPEs are passive entities that are commonly used in mortgage, credit card, auto and installment loan securitization transactions. SFAS 140 establishes the criteria an entity must satisfy to be a QSPE which includes restrictions on the types of assets a QSPE may hold, limits on repurchase of assets, the use of derivatives and financial guarantees, and the level of discretion a servicer may exercise to collect receivables. SPEs that meet the criteria for QSPE status are not required to be consolidated. The Company uses the QSPE model to conduct off-balance sheet securitization activities. See Note 14 for more information on the Company’s off-balance sheet securitization activities.

In June 2009, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 166, An Amendment of FASB Statement No. 140 (“SFAS 166”), and Statement of Financial Accounting Standards No. 167, Amendments to FASB Interpretation No. 46(R) (“SFAS 167”). SFAS 166 removes the concept of a qualifying special-purpose entity (“QSPE”) from SFAS 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities and removes the exception from applying FASB Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities (“FIN 46R”), to variable interest entities that are qualifying special-purpose entities. SFAS 167 retains the scope of FIN 46R with the addition of entities previously considered qualifying special-purpose entities. SFAS 166 and SFAS 167 are effective for the Company’s annual reporting period beginning January 1, 2010. The adoption of SFAS 166 and SFAS 167 could have a significant impact on the Company’s consolidated financial statements because the Company expects it will be required to consolidate at least some of its special purpose entities to which pools of loan receivables have been transferred in transactions previously qualifying as sales. Holding more of these assets on the Company’s balance sheet may require it to take various actions, including raising additional capital, in order to meet regulatory capital requirements. Such capital may not be available on terms favorable to the Company, if at all, and could have a negative impact on the Company’s financial results. As of June 30, 2009, the Company had approximately $44.5 billion of credit card receivables held by QSPEs.

VIEs Special purpose entities that are not QSPEs are considered for consolidation in accordance with FIN46(R), which defines a VIE as an entity that (1) lacks sufficient equity to finance its activities without additional subordinated financial support; (2) has equity owners that lack the ability to make significant decisions about the entity; or (3) has equity owners that do not have the obligation to absorb expected losses or the right to receive expected returns. In general, a VIE may be formed as a corporation, partnership, limited liability corporation, or any other legal structure used to conduct activities or hold assets. A VIE often holds financial assets, including loans or receivables, real estate or other property.

The Company consolidates a VIE if the Company is considered to be its primary beneficiary. The primary beneficiary is subject to absorbing the majority of the expected losses from the VIE’s activities, is entitled to receive a majority of the entity’s residual returns, or both.

The Company, in the ordinary course of business, has involvement with or retains interests in VIEs in connection with some of its securitization activities, servicing activities and the purchase or sale of mortgage-backed and other asset-backed securities in connection with its investment portfolio. The Company also makes loans to VIEs that hold debt, equity, real estate or other assets. In certain instances, the Company provides guarantees to VIEs or holders of variable interests in VIEs. See Note 11—Mortgage Servicing Rights; Note 14—Securitizations; Note 15—Commitments, Contingencies and Guarantees; and Note 16—Other Variable Interest Entities for more detail on the Company’s involvement and exposure related to non-consolidated VIEs.

Derivative Instruments and Hedging Activities

The Company recognizes all of its derivative instruments as either assets or liabilities in the balance sheet at fair value. These instruments are recorded in other assets or other liabilities on the Consolidated Balance Sheets and in the operating section of the Statements of Cash Flows as increases (decreases) of other assets and other liabilities. The Company’s policy is not to offset fair value amounts recognized for derivative instruments and fair value amounts recognized for the right to reclaim cash collateral or the obligation to return cash collateral arising from derivative instruments recognized at fair value executed with the same counterparty under netting arrangements. As of June 30, 2009 the Company had recorded $310.0 million for the right to reclaim cash collateral and $355.1 million for the obligation to return cash collateral under master netting arrangements.

 

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Loans Acquired

Loans acquired in connection with acquisitions are accounted for under SFAS 141(R), Business Combinations (“SFAS 141(R)”) or Statement of Position 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer (“SOP 03-3”) if the loan has experienced a deterioration of credit quality at the time of acquisition. Under both statements, acquired loans are recorded at fair value and the carry-over of the related allowance for loan and lease losses is prohibited. Fair value of the loans involves estimating the principal and interest cash flows expected to be collected on the loans and discounting those cash flows at a market rate of interest. During the evaluation of whether a loan was considered impaired under SOP 03-3 or performing under SFAS 141(R), the Company considered a number of factors, including the delinquency status of the loan, payment options and other loan features (i.e. reduced documentation or stated income loans, interest only, or negative amortization features), the geographic location of the borrower or collateral, the loan-to-value ratio and the risk rating assigned to the loans. Based on the criteria, the Company considered the entire option arm portfolio to be impaired and accounted for under SOP 03-3. Portions of the commercial loan portfolio, HELOC portfolio and the fixed mortgage portfolio were also considered impaired.

The excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable yield and is recognized into interest income over the remaining life of the loan. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition, considering the impact of prepayments, is referred to as the nonaccretable difference. The nonaccretable difference includes estimated future credit losses expected to be incurred over the life of the loan. Subsequent decreases to the expected cash flows will require the Company to evaluate the need for an additional allowance for loan and lease losses. Subsequent improvement in cash flows will result in the reversal of the nonaccretable difference which will then get reclassified as accretable yield and have a positive impact on interest income. In addition, net charge-offs on such loans are applied to the nonaccretable difference recorded at acquisition for the estimated future credit losses.

Loans acquired that were previously classified as nonaccrual are considered performing, regardless of whether the customer is contractually delinquent. The Company expects to fully collect the new carrying value of the loans. As such, the Company no longer considers the loans to be nonaccrual or nonperforming because we will continue to accrue interest on these loans because of the establishment of an accretable yield in accordance with SFAS 141(R) and SOP 03-03.

Securities Available for Sale

The Company considers debt securities in its investment portfolio as available for sale. These securities are stated at fair value, with the unrealized gains and losses, net of tax, reported as a component of cumulative other comprehensive income. The fair value of securities is based on quoted market prices, or if quoted market prices are not available, then the fair value is estimated using the quoted market prices for similar securities, pricing models or discounted cash flow analyses, using observable market data where available. The amortized cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization or accretion is included in interest income. Realized gains and losses on sales of securities are determined using the specific identification method. The Company evaluates its unrealized loss positions for impairment in accordance with SFAS 115, as amended by FSP No. 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairment. As such, when there is other-than-temporary impairment, the Company recognizes credit related impairments in earnings while other impairments are recorded in other comprehensive income. See Note 6 for additional details.

Income Taxes

The Company accounts for income taxes in accordance with SFAS 109, recognizing the current and deferred tax consequences of all transactions that have been recognized in the financial statements using the provisions of the enacted tax laws.

The Company recorded income tax expense of $92.3 million and $32.1 million for the three and six months period ended June 30, 2009. The related effective income tax rates were 28.6% and 18.3% for the three month and six month periods ended June 30, 2009, respectively, compared to 34.1% and 34.4% for the same periods in the prior year. The decrease in tax rates were primarily due to increases in affordable housing tax credits and new market tax credits as well as the impact of other permanent differences, including tax-exempt interest relative to the lower net income before tax in 2009.

Recent Accounting Pronouncements

On June 29, 2009, the FASB issued SFAS No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles—a replacement of FASB Statement No. 162. The Codification will be effective for interim and annual periods ending after September 15, 2009. All existing accounting standard documents are superseded and all other accounting literature not included in the Codification will be considered nonauthoritative. The initial adoption of the FASB’s Accounting Standards Codification will not have an impact on the consolidated earnings or financial position of the Company because it only amends the referencing to existing accounting standards.

On June 12, 2009, the FASB issued SFAS No. 167, Determining Amendments to FASB Interpretation No. 46(R), which provides additional guidance on how a company determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. SFAS 167 will be effective for interim and annual reporting periods beginning after November 15, 2009, and early adoption is prohibited. On June 12, 2009, the FASB issued SFAS No. 166, Accounting for Transfers of Financial Assets, which will require more information about transfers of financial assets, including securitization transactions, and where companies have continuing exposure to the risks related to transferred financial assets. It eliminates the concept of a “qualifying special-purpose entity,” changes the requirements for derecognizing financial assets, and requires additional disclosures. SFAS 166 will be effective for interim and annual reporting periods beginning after November 15, 2009, and early adoption is prohibited.

 

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On May 28, 2009, the FASB issued SFAS No. 165, Subsequent Events (“SFAS 165”). This Statement establishes general standards of accounting for and disclosing events that occur after the balance sheet date, but prior to the issuance of financial statements. The Statement requires companies to disclose subsequent events as defined within SFAS 165 and disclose the date through which subsequent events have been evaluated. The Statement is effective for interim and annual periods ending after June 15, 2009. The adoption of SFAS 165 occurred during the second quarter of 2009 and did not have a material effect on consolidated earnings or financial position of the Company. See Note 17 for additional details.

On April 9, 2009, the FASB issued FASB Staff Position (“FSP”) No. FAS 157-4, Determining Whether a Market Is Not Active and a Transaction is Not Distressed (“FSP 157-4”), which provides additional guidance on determining whether a market for a financial asset is not active and a transaction is not distressed for fair value measurements under SFAS No. 157, Fair Value Measurements (“SFAS 157”). The adoption of FSP 157-4 occurred during the second quarter of 2009, and did not have a material effect on the consolidated earnings and financial position of the Company.

On April 9, 2009, the FASB issued FASB Staff Position No. FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairment (“FSP 115-2 and FAS 124-2”), which eliminates the Company’s requirement to assert its intent and ability to hold an investment until its forecasted recovery to avoid recognizing an impairment loss. The FSP requires the Company to recognize an other-than-temporary impairment when the Company intends to sell the security or it is more likely than not that it will be required to sell the security before recovery. Credit related impairments are recorded in income while other impairments are recorded in other comprehensive income. FSP 115-2 and FAS 124-2 are effective for interim and annual reporting periods ending after June 15, 2009. The adoption of FSP 115-2 and FAS 124-2 occurred during the second quarter of 2009. See Note 6 for additional detail.

On April 9, 2009, the FASB issued FASB Staff Position No. FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments (“FSP 107-1 and APB 28-1”), which will require the Company to include fair value disclosures of financial instruments for each interim and annual period that financial statements are prepared. FSP 107-1 and APB 28-1 is effective for interim and annual reporting periods ending after June 15, 2009. The adoption of FSP 107-1 and APB 28-1 occurred during the second quarter of 2009, and did not have a material effect on the consolidated earnings and financial position of the Company because it only amends the disclosure requirements. See Note 7 for additional details.

In January 2009, the FASB issued FASB Staff Position No. EITF 99-20-1, “Recognition of Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests That Continue to Be Held by a Transferor in Securitized Financial Assets“ (“FSP EITF 99-20”). The FSP was issued to achieve more consistent determination of whether an other-than-temporary impairment has occurred. The FSP also retains and emphasizes the objective of an other-than-temporary impairment assessment and the related disclosure requirements in SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,“ (“SFAS 115”) and other related guidance. FSP EITF 99-20 emphasizes that any other-than-temporary impairment resulting from the application of SFAS 115 or EITF 99-20 shall be recognized in earnings equal to the entire difference between the investment’s cost and its fair value at the balance sheet date of the reporting period for which the assessment is made. FSP EITF 99-20 is effective for interim and annual reporting periods ending after December 15, 2008, and shall be applied prospectively. Retrospective application to a prior interim or annual reporting period is not permitted. The adoption of FSP EITF 99-20 did not have impact on consolidated earnings or financial position of the Company.

In June 2008, the FASB issued FSP EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities.“ The FSP addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and therefore need to be included in the earnings allocation in calculating earnings per share under the two-class method described in SFAS No. 128, “Earnings per Share“ (“SFAS 128”). The FSP requires companies to treat unvested share-based payment awards that have non-forfeitable rights to dividend or dividend equivalents as a separate class of securities in calculating earnings per share. The FSP is effective for fiscal years beginning after December 15, 2008; earlier application is not permitted. The adoption of FSP EITF 03-6-1 did not have a material effect on our results of operations or earnings per share.

In September 2008, the FASB issued FSP No. FAS 133-1 and FIN 45-4, “Disclosures about Credit Derivatives and Certain Guarantees: An Amendment of FASB Statement No. 133 and FASB Interpretation No. 45; and Clarification of the Effective Date of FASB Statement No. 161. FSP FAS 133-1 and FIN 45-4 requires enhanced disclosures about credit derivatives and guarantees and amends FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others“ (“FIN 45”) to exclude credit derivative instruments accounted for at fair value under SFAS 133. The FSP is effective for financial statements issued for reporting periods ending after November 15, 2008. The adoption of FSP FAS 133-1 did not have a material impact on the consolidated earnings or financial position of the Company. FIN 45-4 only requires additional disclosures concerning guarantees, which did not have an impact on the consolidated earnings or financial position of the Company because it only amends the disclosure requirements. See Note 15 for additional detail.

Effective January 1, 2008, the Company adopted SFAS 157 for all financial assets and liabilities measured at fair value; and for nonfinancial assets and liabilities measured at fair value on a recurring basis. SFAS 157 defines fair value, establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements. The initial adoption of SFAS 157 did not have

 

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a material impact on the consolidated earnings and financial position of the Company. There are no material assets or liabilities recognized or disclosed at fair value for which the Company has not applied the provisions of SFAS 157. See Note 7 for additional detail.

Effective January 1, 2008, the Company adopted SFAS No. 159, The Fair Value Option for Financial Assets and Liabilities (“SFAS 159”). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value with changes in fair value included in current earnings. The election is made on specified election dates, can be made on an instrument by instrument basis, and is irrevocable. The initial adoption of SFAS 159 did not have a material impact on the consolidated earnings and financial position of the Company. See Note 7 for additional detail.

In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities-an amendment of FASB Statement No. 133, (“SFAS 161”). This Statement changes the disclosure requirements for derivative and hedging activities. Entities are required to provide enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under SFAS 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. This Statement is effective for fiscal years, and interim periods within those fiscal years, beginning after November 15, 2008. The adoption of SFAS 161 did not have an impact on the consolidated earnings or financial position of the Company because it only amends the disclosure requirements for derivatives and hedged items. See Note 13 for derivatives disclosures under SFAS 161.

In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51, (“SFAS 160”). This Statement applies to all entities that prepare consolidated financial statements, except not-for-profit organizations, but will affect only those entities that have an outstanding noncontrolling interest in one or more subsidiaries or that deconsolidate a subsidiary. This Statement amends ARB 51 to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. This Statement is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. The adoption of SFAS 160 did not have a material impact on the consolidated earnings or financial position of the Company.

In December 2007, the FASB issued SFAS No. 141(R), which applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. This Statement replaces SFAS 141, Business Combinations. It retains the fundamental requirements in SFAS 141; however, the scope is broader than that of SFAS 141 by applying to all transactions and other events in which one entity obtains control over one or more other businesses. SFAS 141(R) requires an acquirer to recognize the assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date, at their fair values as of that date, with limited exceptions, thereby replacing SFAS 141’s cost-allocation process. This Statement also changes the requirements for recognizing acquisition related costs, restructuring costs, and assets acquired and liabilities assumed arising from contingencies. It also changes the accounting for step acquisitions. The Company applied the provisions of SFAS 141(R) to the Chevy Chase Bank acquisition.

Note 2

Acquisitions

Chevy Chase Bank

On February 27, 2009, the Company acquired all of the outstanding common stock of Chevy Chase Bank in exchange for Capital One common stock and cash with a total value of $475.9 million. Under the terms of the stock purchase agreement, Chevy Chase Bank common shareholders received $445.0 million in cash and 2.56 million shares of Capital One common stock. In addition, to the extent that losses on certain of Chevy Chase Bank’s mortgage loans are less than the level reflected in the net credit mark estimated at the time the deal was signed, the Company will share a portion of the benefit with the former Chevy Chase Bank common shareholders (the “earn-out”). As of June 30, 2009, the Company has not recognized a liability associated with the earn-out as given our expectations for credit losses on the portfolio the Company does not expect to make any payments under the earn-out. The maximum payment under the earn-out is $300.0 million and would occur after December 31, 2013. Subsequent to the closing of the acquisition all of the outstanding shares of preferred stock of Chevy Chase Bank and the subordinated debt of its wholly-owned REIT subsidiary, were redeemed. This acquisition improves the Company’s core deposit funding base, increases readily available and committed liquidity, adds additional scale in bank operations, and brings a strong customer base. Chevy Chase Bank’s results of operations are included in the Company’s results after the acquisition date of February 27, 2009.

The Chevy Chase Bank acquisition is being accounted for under the acquisition method of accounting in accordance with SFAS 141(R). Accordingly, the purchase price was allocated to the acquired assets and liabilities based on their estimated fair values at the Chevy Chase Bank acquisition date, as summarized in the following table. Preliminary goodwill of $1.4 billion is calculated as the purchase premium after adjusting for the fair value of net assets acquired and represents the value expected from the synergies created through the scale, operational and product enhancement benefits that will result from combining the operations of the two companies. During the second quarter of 2009, the Company continued the analysis of the fair values and purchase price allocation of

 

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Chevy Chase Bank’s assets and liabilities. The Company recorded an increase to goodwill of $291.1 million as a result. The change was predominantly related to a reduction in the fair value of net loans, offset by a corresponding change in deferred tax assets. The Company has not finalized the analysis and still considers goodwill to be preliminary, except as it relates to deposits and borrowings. The fair value of the noncontrolling interest was calculated based on the redemption price of the interests, as well as any accrued but unpaid dividends. The shares of preferred stock of Chevy Chase Bank have been redeemed as noted above, and therefore, there is no longer a noncontrolling interest.

 

     Original Allocation     Adjustments     Revised
Allocation
 

Costs to acquire Chevy Chase Bank:

      

Cash consideration paid

   $ 445,000        $ 445,000   

Capital One common stock issued (2,560,601 shares)

     30,855          30,855   

Fair value of contingent consideration

     —            —     

Transfer taxes paid on behalf of Chevy Chase Bank

     3,151          3,151   
                        

Total consideration paid for Chevy Chase Bank

   $ 479,006        $ 479,006   

Fair value of noncontrolling interest

     283,900          283,900   
                        

Fair value of Chevy Chase Bank

   $ 762,906        $ 762,906   

Chevy Chase Bank’s net assets at fair value:

      

Chevy Chase Bank’s stockholders’ equity at February 27, 2009

     641,537          641,537   

Elimination of Chevy Chase Bank’s intangible assets (including goodwill)

     (18,383       (18,383

Adjustments to reflect assets and liabilities acquired at fair value:

      

Net loans

     (1,427,161   $ (468,580     (1,895,741

Investment securities

     (53,306     2,043        (51,263

Intangible assets

     276,195        10,555        286,750   

Other assets

     398,029        165,805        563,834   

Deposits

     (109,861     —          (109,861

Borrowings

     (12,871     —          (12,871

Other liabilities

     (45,291     (953     (46,244
                        

Less: Adjusted identifiable net liabilities acquired

     (351,112     (291,130     (642,242

Total preliminary goodwill(1)

   $ 1,114,018      $ 291,130      $ 1,405,148   
                        

 

(1) No goodwill is expected to be deductible for federal income tax purposes. The goodwill has been allocated to the Other segment for the first and second quarters of 2009 and will be reallocated during the third quarter of 2009, along with the operations of Chevy Chase Bank to the appropriate segments.

The following condensed balance sheet of Chevy Chase Bank discloses the amount assigned to each major asset and liability caption at the acquisition date of February 27, 2009. The allocation of the final purchase price is still subject to refinement as the integration process continues and additional information becomes available.

 

     Original Allocation     Adjustments     Revised
Allocation
 

Assets:

      

Cash and cash equivalents

   $ 1,217,837      $ —        $ 1,217,837   

Interest-bearing deposits

     8,480        —          8,480   

Investment securities

     1,423,568        2,043        1,425,611   

Net loans

     9,841,678        (468,580     9,373,098   

Other Intangible assets

     44,830        —          44,830   

Core deposit intangibles

     231,365        10,555        241,920   

Other assets

     2,206,552        165,805        2,372,357   
                        

Total assets

   $ 14,974,310      $ (290,177   $ 14,684,133   

Liabilities:

      

Deposits

   $ 13,556,639      $ —        $ 13,556,639   

Securities sold under repurchase agreements

     806,575        —          806,575   

Other borrowings

     376,600        —          376,600   

Other liabilities

     585,608        953        586,561   
                        

Total liabilities

     15,325,422        953        15,326,375   
                        

Net liabilities acquired

   $ (351,112   $ (291,130   $ (642,242
                        

 

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The following table discloses the impact of Chevy Chase Bank since the acquisition on February 27, 2009, through the end of the second quarter 2009. The table also presents what the pro-forma Company results would have been had the acquisition taken place on January 1, 2009 and January 1, 2008. These results include the impact of amortizing certain purchase accounting adjustments. The pro forma financial information does not indicate the impact of possible business model changes nor does it consider any potential impacts of current market conditions or revenues, reduction of expenses, asset dispositions, or other factors.

 

     Actual since acquisition as of    Pro-Forma results as of June 30,
     June 30, 2009    2009    2008

Revenue

   $ 215,217    $ 6,103,463    $ 7,640,379

Income from continuing operations, net of tax

   $ 5,552    $ 48,750    $ 1,054,568

 

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Note 3

Loans Acquired in a Transfer

The Company’s acquired loans from the Chevy Chase Bank acquisition, subject to SFAS 141(R), are recorded at fair value and no separate valuation allowance is recorded at the date of acquisition. The Company is required to review each loan at acquisition to determine if it should be accounted for under SOP 03-3 and if so, determines whether each such loan is to be accounted for individually or whether such loans will be aggregated into pools of loans based on common risk characteristics. During the second quarter of 2009, the Company performed its analysis of the loans to be accounted for as impaired under SOP 03-3. The loans acquired with the Chevy Chase Bank acquisition not accounted for under SOP 03-3 have been accounted for under SFAS 141(R) and are considered performing. The accounting treatment is essentially the same under both standards. The disclosure requirements under SOP 03-3 are more extensive, though the Company has elected to provide such disclosures for all of the acquired Chevy Chase Bank loans. During the evaluation of whether a loan was considered impaired under SOP 03-3 or performing under SFAS 141(R), the Company considered a number of factors, including the delinquency status of the loan, payment options and other loan features (i.e. reduced documentation, interest only, or negative amortization features), the geographic location of the borrower or collateral and the risk rating assigned to the loans. Based on the criteria, the Company considered the entire option arm, hybrid arm and construction to permanent portfolios to be impaired and accounted for under SOP 03-3. Portions of the commercial loan, auto, HELOC and other consumer loan portfolios and the fixed mortgage portfolio were also considered impaired.

The Company makes an estimate of the total cash flows it expects to collect from the loans (or pools of loans), which includes undiscounted expected principal and interest. The excess of that amount over the fair value of the loans is referred to as accretable yield. Accretable yield is recognized as interest income on a constant yield basis over the life of the loans. The Company also determines the loans’ contractual principal and contractual interest payments. The excess of that amount over the total cash flows it expects to collect from the loans is referred to as nonaccretable difference, which is not accreted into income. Judgmental prepayment assumptions are applied to both contractually required payments and cash flows expected to be collected at acquisition. The Company continues to estimate cash flows expected to be collected over the life of the loans. Subsequent increases in total cash flows it expects to collect are recognized as an adjustment to the accretable yield with the amount of periodic accretion adjusted over the remaining life of the loans. Subsequent decreases in cash flows expected to be collected over the life of the loans are recognized as impairment in the current period through a valuation allowance. Adjustments to the acquisition date fair value of the acquired loans made during the refinement of the allocation of purchase price could impact accretable yield and/or nonaccretable difference.

In conjunction with the Chevy Chase Bank acquisition, the acquired loan portfolio was accounted for under SOP 03-3 or SFAS 141(R) at fair value and they are as follows:

 

     At Acquisition

(In Thousands)

   SOP 03-3
Loans
   Non SOP
03-3 Loans
   Total Loans

Contractually required principal and interest at acquisition

   $ 11,141,180    $ 3,353,188    $ 14,494,368

Nonaccretable difference (expected losses of $2,205,854 and foregone interest of $766,378)(1)

     2,797,528      174,704      2,972,232
                    

Cash flows expected to be collected at acquisition

   $ 8,343,652    $ 3,178,484    $ 11,522,136

Accretable yield (interest component of expected cash flows)

     1,904,173      479,931      2,384,104
                    

Basis in acquired loans at acquisition(2)

   $ 6,439,479    $ 2,698,553    $ 9,138,032
                    

 

(1) Expected losses and foregone interest on the SOP 03-3 loans are $2,052,152 and $745,376, respectively. Expected losses and foregone interest on the non SOP 03-3 loans are $153,702 and $21,002, respectively.
(2) A portion of the acquired loans from Chevy Chase Bank acquisition were held for sale and are not included in these tabular disclosures. These held for sale loans were assigned a fair value of $235.1 million through purchase price allocation.

 

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Table of Contents

The carrying amount of these loans is included in the balance sheet amounts of loans receivable at June 30, 2009 and is as follows:

 

     SOP 03-3
Loans
    Non SOP
03-3 Loans
    Total Loans  

Outstanding Balance

   $ 7,878,029      $ 2,974,532      $ 10,852,561   

Carrying Amount

   $ 6,024,288      $ 2,786,496      $ 8,810,784   
     Accretable Yield  
     SOP 03-3
Loans
    Non SOP
03-3 Loans
    Total Loans  

Balance at January 1, 2009

   $ —        $ —        $ —     

Additions

     1,904,173        479,931        2,384,104   

Accretion

     (89,917     (42,937     (132,854
                        

Balance at June 30, 2009

   $ 1,814,256      $ 436,994      $ 2,251,250   
                        
     Credit Mark  
     SOP 03-3
Loans
    Non SOP
03-3 Loans
    Total Loans  

Balance at January 1, 2009

   $ —        $ —        $ —     

Additions

     (2,052,151     (153,702     (2,205,853

Principal and non-principal losses

     182,163        17,403        199,566   
                        

Balance at June 30, 2009

   $ (1,869,988   $ (136,299   $ (2,006,287
                        

Note 4

Discontinued Operations

Shutdown of Mortgage Origination Operations of Wholesale Mortgage Banking Unit

In the third quarter of 2007, the Company shut down the mortgage origination operations of its wholesale mortgage banking unit, GreenPoint Mortgage (“GreenPoint”). GreenPoint was acquired by the Company in December 2006 as part of the North Fork acquisition. The results of the mortgage origination operations of GreenPoint have been accounted for as a discontinued operation and have been removed from the Company’s results from continuing operations for the three and six months ended June 30, 2009 and 2008.

The results of GreenPoint’s mortgage servicing business continue to be reported as part of the Company’s continuing operations. The mortgage servicing function was moved into the Local Banking segment in conjunction with the shutdown of the mortgage origination operation and the results of the Local Banking segment include the mortgage servicing results for the three and six months ended June 30, 2009 and 2008. The commercial and consumer mortgage loans held for investment portfolios were reported in the Local Banking segment and the Other segment, respectively, for the three and six months ended June 30, 2009 and 2008. The Company will have no significant continuing involvement in the operations of the originate and sell business of GreenPoint.

The loss from discontinued operations includes an expense of zero and $26.0 million for the three and six months ended June 30, 2009, respectively, and income of $9.1 million and an expense of $95.1 million for the three and six months ended June 30, 2008, respectively, which are recorded in non-interest expense for representations and warranties provided by the Company on loans previously sold to third parties by GreenPoint’s mortgage origination operation.

The following is summarized financial information for discontinued operations related to the closure of the Company’s wholesale mortgage banking unit:

 

     Three Months Ended
June 30
    Six Months Ended
June 30
 
     2009     2008     2009     2008  

Net interest income

   $ 53      $ 1,797      $ 776      $ 3,720   

Non-interest income

     71        1,393        126        3,230   

Non-interest expense

     9,452        18,198        48,985        153,452   

Income tax benefit

     (3,330     (5,415     (17,127     (52,858
                                

Loss from discontinued operations, net of taxes

   $ (5,998   $ (9,593   $ (30,956   $ (93,644
                                

The Company’s wholesale mortgage banking unit had assets of approximately $45.9 million as of June 30, 2009 consisting of $15.8 million of mortgage loans held for sale and other related assets. The related liabilities consisted of obligations to fund these assets, and obligations for representations and warranties provided by the Company on loans previously sold to third parties.

 

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Table of Contents

Note 5

Segments

The segments reflect the manner in which financial information is currently evaluated. The Company strategically manages and reports the results of its business through two operating segment levels: Local Banking and National Lending. The Local Banking segment includes the Company’s branch, treasury services and national deposit gathering activities; its commercial, branch based small business lending and certain branch originated consumer lending; and its mortgage servicing activities.

The results of the GreenPoint mortgage origination operations are being reported as discontinued operations for 2009 and 2008, and are not included in the segment results of the Company. The results of GreenPoint’s mortgage servicing business and small ticket commercial real estate loans held for investment portfolio are reported as part of the Company’s continuing operations and included in the Local Banking segment. The results of GreenPoint’s consumer mortgage loans held for investment portfolio, that are in a state of run-off, are reported as part of the Company’s continuing operations and included in the Other segment.

The Local Banking and National Lending segments are considered reportable segments based on quantitative thresholds applied to the managed loan portfolio for reportable segments provided by SFAS 131, and are disclosed separately. The National Lending segment consists of the following sub-segments: U.S. Card, which consists of the Company’s domestic credit card business, including small business credit cards, and the installment loan businesses, Auto Finance and International lending. The Other segment includes the Company’s liquidity portfolio, emerging businesses not included in the reportable segments, and various non-lending activities. The Other segment also includes, the results of GreenPoint’s consumer mortgage loans held for investment portfolio, the GreenPoint home equity line of credit portfolio, the net impact of transfer pricing, certain unallocated expenses, gains/losses related to the securitization of assets, and restructuring charges related to the Company’s cost initiative announced in the second quarter of 2007.

The results of Chevy Chase Bank operations since acquisition are included in the Other segment and will be reclassified into appropriate reporting segments in the third quarter of 2009.

The Company maintains its books and records on a legal entity basis for the preparation of financial statements in conformity with GAAP. The following tables present information prepared from the Company’s internal management information system, which is maintained on a line of business level through allocations from the consolidated financial results.

The following tables present certain information regarding the Company’s continuing operations by segment:

 

     Three months ended June 30, 2009

Total Company

   National
Lending
   Local
Banking
    Other     Total
Managed
   Securitization
Adjustments(1)
    Total
Reported

Net interest income

   $ 2,170,316    $ 637,383      $ 151,494      $ 2,959,193    $ (1,012,607   $ 1,946,586

Non-interest income

     908,301      189,475        91,239        1,189,015      42,672        1,231,687

Provision for loan and lease losses

     1,646,258      195,765        61,950        1,903,973      (969,935     934,038

Restructuring expenses

     —        —          43,374        43,374      —          43,374

Other non-interest expenses

     1,016,331      631,417        230,634        1,878,382      —          1,878,382

Income tax provision (benefit)

     145,198      (113     (52,807     92,278      —          92,278
                                            

Net income (loss)

   $ 270,830    $ (211   $ (40,418   $ 230,201    $ —        $ 230,201
                                            

Loans held for investment

   $ 93,300,970    $ 43,662,945      $ 9,286,809      $ 146,250,724    $ (45,177,095   $ 101,073,629

Total deposits

   $ 1,281,217    $ 78,502,170      $ 36,940,803      $ 116,724,190    $ —        $ 116,724,190

 

     Three months ended June 30, 2008

Total Company

   National
Lending
   Local
Banking
   Other     Total
Managed
   Securitization
Adjustments(2)
    Total
Reported

Net interest income

   $ 2,167,529    $ 589,705    $ 30,761      $ 2,787,995    $ (1,060,239   $ 1,727,756

Non-interest income

     1,164,810      192,758      (55,594     1,301,974      320,342        1,622,316

Provision for loan and lease losses

     1,470,642      92,043      6,342        1,569,027      (739,897     829,130

Restructuring expenses

     —        —        13,560        13,560      —          13,560

Other non-interest expenses

     1,236,567      587,211      (17,737     1,806,041      —          1,806,041

Income tax provision (benefit)

     217,496      36,123      (14,776     238,843      —          238,843
                                           

Net income (loss)

   $ 407,634    $ 67,086    $ (12,222   $ 462,498    $ —        $ 462,498
                                           

Loans held for investment

   $ 102,201,802    $ 44,270,734    $ 774,724      $ 147,247,260    $ (50,182,022   $ 97,065,238

Total deposits

   $ 1,644,241    $ 74,245,677    $ 16,517,142      $ 92,407,060    $ —        $ 92,407,060

 

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Table of Contents
     Three months ended June 30, 2009

National Lending

   U.S. Card    Auto
Finance
   International    Total
National
Lending

Net interest income

   $ 1,586,686    $ 373,013    $ 210,617    $ 2,170,316

Non-interest income

     794,440      10,861      103,000      908,301

Provision for loan and lease losses

     1,336,736      125,966      183,556      1,646,258

Non-interest expenses

     785,273      108,315      122,743      1,016,331

Income tax provision (benefit)

     90,691      52,358      2,149      145,198
                           

Net income (loss)

   $ 168,426    $ 97,235    $ 5,169    $ 270,830
                           

Loans held for investment

   $ 64,760,128    $ 19,902,401    $ 8,638,441    $ 93,300,970

 

     Three months ended June 30, 2008

National Lending

   U.S. Card    Auto
Finance
   International    Total
National
Lending

Net interest income

   $ 1,523,629    $ 389,588    $ 254,312    $ 2,167,529

Non-interest income

     1,010,177      15,672      138,961      1,164,810

Provision for loan and lease losses

     1,099,453      230,614      140,575      1,470,642

Non-interest expenses

     910,619      123,021      202,927      1,236,567

Income tax provision (benefit)

     183,307      18,069      16,120      217,496
                           

Net income (loss)

   $ 340,427    $ 33,556    $ 33,651    $ 407,634
                           

Loans held for investment

   $ 68,059,998    $ 23,401,160    $ 10,740,644    $ 102,201,802

 

(1) Income statement adjustments for the three months ended June 30, 2009 reclassify the net of finance charges of $1,153.9 million, past due fees of $164.6 million, other interest income of $(38.5) million and interest expense of $267.4 million; and net charge-offs of $969.9 million to non-interest income from net interest income and provision for loan and lease losses, respectively.
(2) Income statement adjustments for the three months ended June 30, 2008 reclassify the net of finance charges of $1,385.3 million, past due fees of $229.2 million, other interest income of $(35.8) million and interest expense of $518.5 million; and net charge-offs of $739.9 million to non-interest income from net interest income and provision for loan and lease losses, respectively.

 

     Six months ended June 30, 2009

Total Company

   National
Lending
   Local
Banking
    Other     Total
Managed
   Securitization
Adjustments(1)
    Total
Reported

Net interest income

   $ 4,232,007    $ 1,236,412      $ 234,527      $ 5,702,946    $ (1,969,609   $ 3,733,337

Non-interest income

     1,913,747      373,985        (112,565     2,175,167      146,854        2,322,021

Provision for loan and lease losses

     3,495,213      415,134        125,583        4,035,930      (1,822,755     2,213,175

Restructuring expenses

     —        —          61,001        61,001      —          61,001

Other non-interest expenses

     2,117,101      1,251,271        237,475        3,605,847      —          3,605,847

Income tax provision (benefit)

     186,730      (19,603     (135,072     32,055      —          32,055
                                            

Net income (loss)

   $ 346,710    $ (36,405   $ (167,025   $ 143,280    $ —        $ 143,280
                                            

Loans held for investment

   $ 93,300,970    $ 43,662,945      $ 9,286,809      $ 146,250,724    $ (45,177,095   $ 101,073,629

Total deposits

   $ 1,281,217    $ 78,502,170      $ 36,940,803      $ 116,724,190    $ —        $ 116,724,190

 

     Six months ended June 30, 2008

Total Company

   National
Lending
   Local
Banking
   Other     Total
Managed
   Securitization
Adjustments(2)
    Total
Reported

Net interest income

   $ 4,576,112    $ 1,156,659    $ 32,074      $ 5,764,845    $ (2,225,172   $ 3,539,673

Non-interest income

     2,390,924      408,227      109,508        2,908,659      770,135        3,678,794

Provision for loan and lease losses

     3,147,862      152,437      62,940        3,363,239      (1,455,037     1,908,202

Restructuring expenses

     —        —        66,319        66,319      —          66,319

Other non-interest expenses

     2,515,738      1,192,562      (132,741     3,575,559      —          3,575,559

Income tax provision (benefit)

     453,699      79,960      42,675        573,334      —          573,334
                                           

Net income (loss)

   $ 849,737    $ 142,927    $ 102,389      $ 1,095,053    $ —        $ 1,095,053
                                           

Loans held for investment

   $ 102,201,802    $ 44,270,734    $ 774,724      $ 147,247,260    $ (50,182,022   $ 97,065,238

Total deposits

   $ 1,644,241    $ 74,245,677    $ 16,517,142      $ 92,407,060    $ —        $ 92,407,060

 

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Table of Contents
     Six months ended June 30, 2009

National Lending

   U.S. Card    Auto
Finance
   International    Total
National
Lending

Net interest income

   $ 3,091,381    $ 743,016    $ 397,610    $ 4,232,007

Non-interest income

     1,678,331      30,826      204,590      1,913,747

Provision for loan and lease losses

     2,858,733      292,135      344,345      3,495,213

Non-interest expenses

     1,648,188      222,199      246,714      2,117,101

Income tax provision (benefit)

     91,977      90,828      3,925      186,730
                           

Net income (loss)

   $ 170,814    $ 168,680    $ 7,216    $ 346,710
                           

Loans held for investment

   $ 64,760,128    $ 19,902,401    $ 8,638,441    $ 93,300,970

 

     Six months ended June 30, 2008

National Lending

   U.S. Card    Auto
Finance
    International    Total
National
Lending

Net interest income

   $ 3,267,343    $ 791,150      $ 517,619    $ 4,576,112

Non-interest income

     2,081,008      31,782        278,134      2,390,924

Provision for loan and lease losses

     2,219,478      638,865        289,519      3,147,862

Non-interest expenses

     1,849,479      259,190        407,069      2,515,738

Income tax provision (benefit)

     447,788      (26,293     32,204      453,699
                            

Net income (loss)

   $ 831,606    $ (48,830   $ 66,961    $ 849,737
                            

Loans held for investment

   $ 68,059,998    $ 23,401,160      $ 10,740,644    $ 102,201,802

 

(1) Income statement adjustments for the six months ended June 30, 2009 reclassify the net of finance charges of $2,226.7 million, past due fees of $366.2 million, other interest income of $(72.2) million and interest expense of $551.1 million; and net charge-offs of $1,822.7 million to non-interest income from net interest income and provision for loan and lease losses, respectively.
(2) Income statement adjustments for the six months ended June 30, 2008 reclassify the net of finance charges of $2,909.3 million, past due fees of $492.7 million, other interest income of $(74.6) million and interest expense of $1,102.3 million; and net charge-offs of $1,455.0 million to non-interest income from net interest income and provision for loan and lease losses, respectively.

 

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Table of Contents

Note 6

Securities Available for Sale

Expected maturities aggregated by investment category, gross unrealized gains and gross unrealized losses on securities available-for sale as of June 30, 2009 were as follows:

     Expected Maturity Schedule
     1 Year or
Less
   1–5
Years
   5–10
Years
   Over 10
Years
   Market
Value
Totals
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
    Amortized
Cost Totals

June 30, 2009

                      

U.S. Treasury and other U.S. government agency obligations

                      

U.S. Treasury

   $ 45,088    $ 393,661    $ —      $ —      $ 438,749    $ 12,278    $ (210 )    $ 426,681

FNMA

     114,495      161,880      —        —        276,375      11,860      —          264,515

FHLMC

     —        107,813      —        —        107,813      8,126      —          99,687

Other GSE and FDIC Debt Guaranteed Program (“DGP”)

     —        106,860      —        —        106,860      5,937      —          100,923
                                                        

Total U.S. Treasury and other U.S. government agency obligations

     159,583      770,214      —        —        929,797      38,201      (210 )      891,806
                                                        

Collateralized mortgage obligations (“CMO”)

                      

FNMA

     457,407      2,932,977      1,260,817      —        4,651,201      100,094      (17,915 )      4,569,022

FHLMC

     81,868      2,899,204      2,031,030      80,456      5,092,558      134,052      (16,039 )      4,974,545

Other GSE

     11,939      263,160      —        —        275,099      8,309      (106 )      266,896

Non GSE

     80,721      1,131,067      319,305      7,209      1,538,302      8      (577,065 )      2,115,359
                                                        

Total CMO

     631,935      7,226,408      3,611,152      87,665      11,557,160      242,463      (611,125 )      11,925,822
                                                        

Mortgage backed securities (“MBS”)

                      

FNMA

     106,787      3,167,358      5,997,826      782,049      10,054,020      239,480      (23,277 )      9,837,817

FHLMC

     105,367      2,542,047      2,759,587      1,090,340      6,497,341      134,071      (24,799 )      6,388,069

Other GSE

     152      39,978      354,117      —        394,247      12,897      (193 )      381,543

Non GSE

     —        113,770      682,328      —        796,098      —        (338,177 )      1,134,275
                                                        

Total MBS

     212,306      5,863,153      9,793,858      1,872,389      17,741,706      386,448      (386,446 )      17,741,704
                                                        

Asset backed securities

     2,381,100      4,402,902      211,228      —        6,995,230      123,257      (81,287 )      6,953,260

Other

     151,669      134,656      19,932      137,015      443,272      7,474      (8,045 )      443,843
                                                        

Total

   $  3,536,594    $ 18,397,333    $ 13,636,170    $  2,097,069    $  37,667,165    $  797,843    $ (1,087,113 )    $  37,956,435
                                                        

The expected maturities of the Company’s mortgage-backed and asset-backed securities and the contractual maturities of the Company’s other debt securities were used to assign the securities into the above maturity groupings. The Company believes that the use of expected maturities aligns with how the securities will actually perform and provides information regarding liquidity needs and potential impacts on portfolio yields. The maturity distribution based solely on contractual maturities is: 1 Year or Less - $339.8 million, 1-5 Years - $5,975.9 million, 5-10 Years - $2,622.2 million, and Over 10 Years - $28,729.3 million. Actual maturities may differ from the contractual or expected maturities since borrowers may have the right to prepay obligations with or without prepayment penalties.

The following table shows the weighted average yield by investment category as of June 30, 2009:

 

     Weighted Average Yield Schedule  
     1 Year
or Less
    1–5
Years
    5–10
Years
    Over 10
Years
 

June 30, 2009

        

U.S. Treasury and other U.S. government agency obligations

        

U.S. Treasury

   1.49   2.46   —     —  

FNMA

   4.23      4.47      —        —     

FHLMC

   —        4.59      —        —     

Other GSE and FDIC Debt Guaranteed Program (“DGP”)

   —        4.68      —        —     
                        

 

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Table of Contents

 

     Weighted Average Yield Schedule
     1 Year
or Less
   1–5
Years
   5–10
Years
   Over 10
Years

Total U.S. Treasury and other U.S. government agency obligations

   3.45    3.49    —      —  
                   

Collateralized mortgage obligations (“CMO”)

           

FNMA

   5.36    5.23    5.00    —  

FHLMC

   5.17    5.17    5.04    4.89

Other GSE

   4.74    4.76    —      —  

Non GSE

   5.85    5.64    5.18    6.58
                   

Total CMO

   5.40    5.27    5.05    5.03
                   

Mortgage backed securities (“MBS”)

           

FNMA

   5.50    5.11    5.09    4.12

FHLMC

   5.69    4.27    5.11    3.41

Other GSE

   7.31    6.02    5.61    —  

Non GSE

   —      5.61    6.02    —  
                   

Total MBS

   5.57    4.77    5.11    4.52
                   

Asset backed securities

   3.97    4.40    5.17    —  

Other

   3.75    4.15    4.61    4.53
                   

Total

   3.97    4.84    5.16    4.75
                   

The available for sale portfolio continues to be heavily concentrated in high credit quality assets like government-sponsored enterprise (“GSE”) mortgage-backed securities and AAA rated asset-backed securities. In addition to debt securities held in the investment portfolio, the Company reports certain equity securities related to Community Reinvestment Act (“CRA”) investments as available for sale securities.

At June 30, 2009, the portfolio was 90% rated AAA, 5% rated other investment grade (AA to BBB), and 5% non investment grade or not rated.

The following table shows the fair value of investments and amount of unrealized losses segregated by those investments that have been in a continuous unrealized loss position for less than twelve months and those that have been in a continuous unrealized loss position for twelve months or longer as of June 30, 2009.

 

     Less than 12 Months    Greater than 12 Months    Total
     Fair Value    Unrealized
Losses
   Fair Value    Unrealized
Losses
   Fair Value    Unrealized
Losses

June 30, 2009

                 

U.S. Treasury and other U.S. government agency obligations

                 

U.S. Treasury

   $ 220,543    $ 210    $ —      $ —      $ 220,543    $ 210

FNMA

     —        —        —        —        —        —  

FHLMC

     —        —        —        —        —        —  
                                         

Total U.S. Treasury and other U.S. government agency obligations

     220,543      210      —        —        220,543    $ 210
                                         

Collateralized mortgage obligations

                 

FNMA

   $ 597,794    $ 5,052    $ 362,917    $ 12,863    $ 960,711    $ 17,915

FHLMC

     366,653      4,816      460,805      11,223      827,458      16,039

Other GSE

     —        —        7,353      106      7,353      106

Non GSE

     16,491      640      1,455,066      576,425      1,471,557      577,065
                                         

Total CMO

     980,938      10,508      2,286,141      600,617      3,267,079      611,125
                                         

Mortgage backed securities

                 

FNMA

     2,149,074      23,042      23,611      235      2,172,685      23,277

FHLMC

     1,288,440      15,813      360,655      8,986      1,649,095      24,799

Other GSE

     813      8      11,090      185      11,903      193

Non GSE

     33,395      15,464      547,847      322,713      581,242      338,177
                                         

Total MBS

     3,471,722      54,327      943,203      332,119      4,414,925      386,446

Asset backed securities

     415,571      5,300      1,309,154      75,987      1,724,725      81,287

Other

     9,297      44      152,587      8,001      161,884      8,045
                                         

Total

   $ 5,098,071    $ 70,389    $ 4,691,085    $ 1,016,724    $ 9,789,156    $ 1,087,113
                                         

 

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The Company monitors securities in its available for sale investment portfolio for other-than-temporary impairment based on a number of criteria, including the size of the unrealized loss position, the duration for which that security has been in a loss position, credit rating, the nature of the investments, and current market conditions. For debt securities, the Company also considers any intent to sell the security and the likelihood it will be required to sell the security before its anticipated recovery. The Company continually monitors the ratings of its security holdings and conducts regular reviews of the Company’s credit sensitive assets to monitor collateral performance by tracking collateral trends and looking for any potential collateral degradation.

Based on the evaluation, the Company recognized other-than-temporary impairment of $10.0 million through earnings, representing credit losses, for the quarter ended June 30, 2009. In addition, other-than-temporary impairment recognized in other comprehensive income was $149.2 million (net of tax was $95.5 million) for the quarter ended June 30, 2009. Cumulative other-than-temporary impairment related to credit losses recognized in earnings for available-for-sale securities is as follows:

 

    Beginning balance of
OTTI credit losses
recognized for
securities held at the
beginning of the
period for which a
portion of OTTI was
recognized in OCI
  Additions for the
amount related to
credit loss for which
OTTI was not
previously recognized
  Additional increases
to the amount related
to credit loss for
which an OTTI was
previously recognized
  Reductions for
securities sold
during the
period
  Ending balance of
the amount related
to credit losses
held at the end of
the period for
which a portion of
OTTI was
recognized in OCI

OTTI credit losses recognized for AFS debt securities

         

CMO

  $ —     $ 3,622   $ —     $ —     $ 3,622

MBS

    —       5,592     —       —       5,592

Other-Home equity

    —       817     —       —       817
                             

Total

  $ —     $ 10,031   $ —     $ —     $ 10,031
                             

U.S. Treasury and Other U.S. Government Agency Obligations The unrealized losses on the Company’s investments in U.S. Treasury obligations and direct obligations of U.S. government agencies were caused by interest rate increases. The contractual terms of these investments do not permit the issuer to settle the securities at a price less than the amortized cost of the investment. Furthermore, since the Company does not have the intent to sell nor will it more likely than not be required to sell before anticipated recovery, it does not consider any of its investments in this category in unrealized loss positions to be other-than-temporarily impaired at June 30, 2009

Collateralized Mortgage Obligations The Company’s portfolio includes investments in GSE collateralized mortgage obligations and prime non-agency collateralized mortgage obligations. The unrealized losses on the Company’s investment in collateralized mortgage obligations were primarily caused by higher credit spreads and interest rates. As of June 30, 2009, the majority of the unrealized losses in this category are due to prime non-agency collateralized mortgage obligations, of which 21% are rated AAA, 21% are rated other investment grade and 58% are non investment grade or not rated.

The Company recognized $3.6 million in credit related other-than-temporary impairment through earnings in the second quarter of 2009 related to two prime non-agency collateralized mortgage obligations. In addition, other-than-temporary impairment recognized in other comprehensive income was $38.8 million (net of tax was $24.8 million) at June 30, 2009 for these securities. The securities experienced significant decreases in fair value due to deteriorating credit fundamentals and elevated liquidity premiums. The credit related impairment was calculated based on internal forecasts using security specific delinquencies, product specific delinquency roll rates and expected severities, using industry standard third party modeling tools. The significant key assumptions used to measure the credit related component of securities deemed to be other-than-temporary impaired are as follows: a weighted average credit default rate of 5.12% and an expected severity of 40%. Based on its view of each security’s current credit performance along with the sufficiency of subordination to protect cash flows, the Company expects to recover the entire amortized cost basis of its remaining collateralized mortgage obligations. However, future declines could result in other-than-temporary impairment being recognized. Furthermore, since the Company does not have the intent to sell nor will it more likely than not be required to sell before anticipated recovery, it does not consider any of its remaining collateralized mortgage obligations in unrealized loss positions to be other-than-temporarily impaired at June 30, 2009.

Mortgage-Backed Securities The Company’s portfolio includes investments in GSE mortgage-backed securities and prime non-agency mortgage-backed securities. As of June 30, 2009, the unrealized losses on the Company’s investment in GSE mortgage-backed securities were primarily caused by higher credit spreads and interest rates. However, since the contractual cash flows of these investments are guaranteed by a GSE of the U.S. government, it is expected that the securities will not be settled at a price less than the Company’s amortized cost. However, future declines could result in other-than-temporary impairment being recognized. Furthermore, since the Company does not have the intent to sell nor will it more likely than not be required to sell before anticipated recovery, it does not consider any of its GSE mortgage-backed securities in unrealized loss positions to be other-than-temporarily impaired at June 30, 2009.

As of June 30, 2009, the majority of unrealized losses is due to prime non-agency mortgage-backed securities of which 18% are rated AAA, 15% are rated other investment grade and 67% are non investment grade or not rated.

 

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Table of Contents

The Company recognized $5.6 million in credit related other-than-temporary impairment through earnings in the second quarter of 2009 related to eight prime non-agency mortgage-backed securities. In addition, other-than-temporary impairment recognized in other comprehensive income was $109.7 million (net of tax was $70.3 million) at June 30, 2009 for these securities. The securities experienced significant decreases in fair value due to deteriorating credit fundamentals and elevated liquidity premiums. The credit related impairment was calculated based on internal forecasts using security specific delinquencies, product specific delinquency roll rates and expected severities, using industry standard third party modeling tools. The significant key assumptions used to measure the credit related component of securities deemed to be other-than-temporary impaired are as follows: a weighted average credit default rate of 3.24% and an expected severity of 40%. Based on its view of each security’s current credit performance along with the sufficiency of subordination to protect cash flows, the Company expects to recover the entire amortized cost basis of its remaining non GSE mortgage backed securities. Furthermore, since the Company does not have the intent to sell nor will it more likely than not be required to sell before anticipated recovery, it does not consider any of its remaining non-agency mortgage backed securities in unrealized loss positions to be other-than-temporarily impaired at June 30, 2009.

Asset-Backed Securities This category is comprised of investments backed by credit card, auto and student loans; commercial mortgage backed loans; and minor investments backed by home equity lines of credit. As of June 30, 2009, the portfolio is 87.6% rated AAA and is comprised of 61% credit card, 16% auto, 7.7% student loans, 15% commercial mortgage backed loans, and 0.3% home equity lines of credit. The unrealized losses on the Company’s investments in asset-backed securities were primarily caused by higher credit spreads and interest rates. The Company recognized $0.8 million in credit related other-than-temporary impairment through earnings in the second quarter of 2009 related to one home equity line of credit asset-backed security. In addition, other-than-temporary impairment recognized in other comprehensive income was $0.6 million (net of tax was $0.4 million) at June 30, 2009 for these securities. The security experienced significant decreases in fair value due to deteriorating credit fundamentals and elevated liquidity premiums The credit related impairment was calculated based on internal forecasts using security specific delinquencies, product specific delinquency roll rates and expected severities, using industry standard third party modeling tools. The significant key assumptions used to measure the credit related component of securities deemed to be other-than-temporary impaired are as follows: a weighted average credit default rate of 3.81% and an expected severity of 100%. Based on its view of each security’s current credit performance along with the sufficiency of subordination to protect cash flows, the Company expects to recover the entire amortized cost basis of its remaining asset backed securities. Furthermore, since the Company does not have the intent to sell nor will it more likely than not be required to sell before anticipated recovery, it does not consider any of its remaining asset-backed securities in unrealized loss positions to be other-than-temporarily impaired at June 30, 2009.

Other This category consists primarily of municipal securities and limited investments in equity securities, primarily related to CRA activities. The unrealized losses on the Company’s investments in other items were primarily caused by higher risk premiums and interest rates. The Company expects to recover the entire amortized cost basis of the securities in this category. Furthermore, since the Company does not have the intent to sell nor will it more likely than not be required to sell before anticipated recovery, it does not consider any of the securities in unrealized loss positions to be other-than-temporarily impaired at June 30, 2009.

Gross realized gains on sales and calls of securities were $50.5 million and $52.8 million for the three and six months ended June 30, 2009, respectively. Gross realized losses on sales and calls of securities were $0.1 million and $0.9 million for the three and six months ended June 30, 2009, respectively. Tax expense on net realized gains was $18.0 million and $18.8 million for the three and six months ended June 30, 2009, respectively.

During 2009, the Company reclassified $13.9 million of net losses on sales of securities, after tax, from cumulative other comprehensive income into earnings.

Securities available for sale included pledged securities of $12.0 billion at June 30, 2009.

Note 7

Fair Values of Assets and Liabilities

SFAS 157 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. SFAS 157 requires that valuation techniques maximize the use of observable inputs and minimize the use of unobservable inputs. SFAS 157 also establishes a fair value hierarchy which prioritizes the valuation inputs into three broad levels. Based on the underlying inputs, each fair value measurement in its entirety is reported in one of the three levels. These levels are:

 

   

Level 1—Valuation is based upon quoted prices for identical instruments traded in active markets. Level 1 assets and liabilities include debt and equity securities traded in an active exchange market, as well as U.S. Treasury securities.

 

   

Level 2—Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

 

   

Level 3—Valuation is determined using model-based techniques with significant assumptions not observable in the market. These unobservable assumptions reflect the Company’s own estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include the use of third party pricing services, option pricing models, discounted cash flow models and similar techniques.

SFAS 159 allows an entity the irrevocable option to elect fair value for the initial and subsequent measurement for certain financial assets and liabilities on a contract-by-contract basis. The Company has not made any material SFAS 159 elections as of the end of the second quarter of 2009.

 

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Table of Contents

Assets and Liabilities Measured at Fair Value on a Recurring Basis

 

     June 30, 2009
     Fair Value Measurements Using (3)    Assets/Liabilities
at Fair Value
     Level 1    Level 2    Level 3   

Assets

           

Securities available for sale

           

U.S. Treasury and other U.S. Gov’t agency

     438,750      491,049      —        929,799

Collateralized mortgage obligations

     —        10,258,971      1,309,089      11,568,060

Mortgage-backed securities

     —        17,101,487      629,322      17,730,809

Asset-backed securities

     —        6,993,513      1,716      6,995,229

Other

     61,499      352,473      29,296      443,268
                           

Total securities available for sale

   $ 500,249    $ 35,197,493    $ 1,969,423    $ 37,667,165

Other assets

           

Mortgage servicing rights

     —        —        280,742      280,742

Derivative receivables(1)

     4,793      656,919      541,052      1,202,764

Retained interests in securitizations

     —        —        3,939,213      3,939,213
                           

Total Assets

   $ 505,042    $ 35,854,412    $ 6,730,430    $ 43,089,884
                           

Liabilities

           

Other liabilities

           

Derivative payables(1)

   $ 19,684    $ 992,862    $ 37,095    $ 1,049,641
                           

Total Liabilities

   $ 19,684    $ 992,862    $ 37,095    $ 1,049,641
                           
     December 31, 2008
     Fair Value Measurements Using    Assets/Liabilities
at Fair Value
     Level 1    Level 2    Level 3   

Assets

           

Securities available for sale(2)

   $ 291,907    $ 28,331,103    $ 2,380,261    $ 31,003,271

Other assets

           

Mortgage servicing rights

     —        —        150,544      150,544

Derivative receivables(1)

     8,020      1,768,902      59,895      1,836,817

Retained interests in securitizations

     —        —        1,470,385      1,470,385
                           

Total Assets

   $ 299,927    $ 30,100,005    $ 4,061,085    $ 34,461,017
                           

Liabilities

           

Other liabilities

           

Derivative payables(1)

   $ 937    $ 1,260,062    $ 60,672    $ 1,321,671
                           

Total Liabilities

   $ 937    $ 1,260,062    $ 60,672    $ 1,321,671
                           

 

(1) The Company does not offset the fair value of derivative contracts in a loss position against the fair value of contracts in a gain position. The Company also does not offset fair value amounts recognized for derivative instruments and fair value amounts recognized for the right to reclaim cash collateral or the obligation to return cash collateral arising from derivative instruments executed with the same counterparty under a master netting arrangement.
(2) Securities available for sale were not broken-out by security type as of December 31, 2008, as FSP FAS 157-4 is applied prospectively.
(3) The above table does not reflect $3.6 million of counterparty credit risk. Counterparty credit risk is reflected in other assets/liabilities on the balance sheet and offset through the income statement in other income.

Financial instruments are considered Level 3 when their values are determined using pricing models, which include comparison of prices from multiple sources, discounted cash flow methodologies or similar techniques and at least one significant model assumption or input is unobservable or there is significant variability among pricing sources. Level 3 financial instruments also include those for which the determination of fair value requires significant management judgment or estimation. The table below presents a reconciliation for all assets and liabilities measured and recognized at fair value on a recurring basis using significant unobservable inputs (Level 3) during 2009. All Level 3 instruments presented in the table were carried at fair value prior to the adoption of SFAS 159.

 

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Table of Contents

Level 3 Instruments Only

 

     Three Months Ended June 30, 2009  
     Securities
Available for
Sale
    Mortgage
Servicing
Rights(1)
    Derivative
Receivables(2)
    Retained
Interests in
Securitizations(3)
    Derivative
Payables(2)
 

Balance, March 31, 2009

   $ 2,310,860      $ 258,663      $ 654,146      $ 2,185,706      $ 54,379   

Total realized and unrealized gains (losses):

          

Included in earnings

     (105     24,800        (147,688     (117,340     (17,169

Included in other comprehensive income

     (141,792     —          —          28,309        —     

Purchases, issuances and settlements, net

     (92,084     (2,721     (554,544     1,842,538        933   

Transfers in/out of Level 3(4)

     (107,456     —          589,138        —          (1,048
                                        

Balance, June 30, 2009

   $ 1,969,423      $ 280,742      $ 541,052      $ 3,939,213      $ 37,095   
                                        

Change in unrealized gains (losses) included in earnings related to financial instruments held at June 30, 2009

   $ (105   $ 24,800      $ (147,688   $ (3,982   $ (17,169

 

     Three Months Ended June 30, 2009  

Securities Available for Sale

   U.S. Treasury
& other U.S.
Gov’t agency
   Collateralized
mortgage
obligations
    Mortgage-
backed
securities
    Asset-
backed

securities
    Other     Total  

Balance, March 31, 2009

   $ —      $ 1,649,287      $ 627,236      $ 2,220      $ 32,117      $ 2,310,860   

Total realized and unrealized gains (losses):

             

Included in earnings

     —        9        —          (114     —          (105

Included in other comprehensive income

     —        (135,937     (5,855     —          —          (141,792

Purchases, issuances and settlements, net

     —        (136,811     48,347        (799     (2,821     (92,084

Transfers in/out of Level 3(4)

     —        (67,459     (40,406     409        —          (107,456
                                               

Balance, June 30, 2009

   $ —        1,309,089        629,322        1,716        29,296      $ 1,969,423   
                                               

Change in unrealized gains (losses) included in earnings related to financial instruments held at June 30, 2009

   $ —      $ 9      $ —        $ (114   $ —        $ (105

 

     Six Months Ended June 30, 2009  
     Securities
Available for
Sale
    Mortgage
Servicing
Rights(1)
   Derivative
Receivables(2)
    Retained
Interests in
Securitizations(3)
    Derivative
Payables(2)
 

Balance, January 1, 2009

   $ 2,380,261      $ 150,544    $ 59,895      $ 1,470,385      $ 60,672   

Total realized and unrealized gains (losses):

           

Included in earnings

     8        27,456      (153,559     (218,467     (23,067

Included in other comprehensive income

     (253,265     —        —          51,207        —     

Purchases, issuances and settlements, net

     (30,258     102,742      45,578        2,636,088        538   

Transfers in/out of Level 3(4)

     (127,323     —        589,138        —          (1,048
                                       

Balance, June 30, 2009

   $ 1,969,423      $ 280,742    $ 541,052      $ 3,939,213      $ 37,095   
                                       

Change in unrealized gains (losses) included in earnings related to financial instruments held at June 30, 2009

   $ 8      $ 27,456    $ (153,559   $ (30,433   $ (23,067

 

     Six Months Ended June 30, 2009  

Securities Available for Sale

   U.S. Treasury
& other U.S.
Gov’t agency
   Collateralized
mortgage
obligations
    Mortgage-
backed
securities
    Asset-
backed

securities
    Other    Total  

Balance, January 1, 2009

   $ —      $ 1,579,909      $ 773,200      $ —        $ 27,152    $ 2,380,261   

Total realized and unrealized gains (losses):

              

Included in earnings

     —        122        —          (114     —        8   

Included in other comprehensive income

     —        (222,280     (30,985     —          —        (253,265

Purchases, issuances and settlements, net

     —        (79,950     48,347        (799     2,144      (30,258

Transfers in/out of Level 3(4)

     —        31,288        (161,240     2,629        —        (127,323
                                              

Balance, June 30, 2009

   $ —      $ 1,309,089      $ 629,322      $ 1,716      $ 29,296    $ 1,969,423   
                                              

Change in unrealized gains (losses) included in earnings related to financial instruments held at June 30, 2009

   $ —      $ 122      $ —        $ (114   $ —      $ 8  

 

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Table of Contents

 

(1) Gains (losses) related to Level 3 mortgage servicing rights are reported in mortgage servicing and other income, which is a component of non-interest income.
(2) An end of quarter convention is used to measure derivative activity, resulting in end of quarter values being reflected as purchases, issuances and settlements for derivatives having a zero fair value at inception. Gains (losses) related to Level 3 derivative receivables and derivative payables are reported in other non-interest income, which is a component of non-interest income.
(3) An end of quarter convention is used to reflect activity in retained interests in securitizations, resulting in all transactions and assumption changes being reflected as if they occurred on the last day of the quarter. Gains (losses) related to Level 3 retained interests in securitizations are reported in servicing and securitizations income, which is a component of non-interest income.
(4) Level 3 securities available for sale assets decreased $107.5 million and $127.3 million for the three and six months ended June 30, 2009, respectively. These assets consist primarily of senior-classes of collateralized mortgage obligations backed by prime jumbo collateral.

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

The Company is also required to measure and recognize certain other financial assets at fair value on a nonrecurring basis in the consolidated balance sheet. For assets measured at fair value on a nonrecurring basis in 2009 and still held on the consolidated balance sheet at June 30, 2009, the following table provides the fair value measures by level of valuation assumptions used and the amount of fair value adjustments recorded in earnings for those assets in 2009. Fair value adjustments for mortgage loans held for sale, foreclosed assets, and other assets are recorded in other non-interest expense, and fair value adjustments for loans held for investment are recorded in provision for loan and lease losses in the consolidated statement of income.

 

     June 30, 2009
     Fair Value Measurements Using    Assets at
Fair Value
   Total
Losses
     Level 1    Level 2    Level 3      

Assets

              

Mortgage loans held for sale

   $ —      $ 49,025    $ —      $ 49,025    $ 3,069

Loans held for investment

     —        18,777      207,832      226,609      65,216

Foreclosed assets(1)

     —        132,205      —        132,205      24,392

Other

     —        31,460      —        31,460      3,716
                                  

Total

   $ —      $ 231,467    $ 207,832    $ 439,299    $ 96,393
                                  

 

     December 31, 2008
     Fair Value Measurements Using    Assets at
Fair Value
   Total Losses
in 2008
     Level 1    Level 2    Level 3      

Assets

              

Mortgage loans held for sale

   $ —      $ 68,462    $ —      $ 68, 462    $ 14,386

Loans held for investment

     —        64,737      142,768      207,505      62,747
                                  

Total

   $ —      $ 133,199    $ 142,768    $ 275,967    $ 77,133
                                  

 

(1) Represents the fair value and related losses of foreclosed properties that were written down subsequent to their initial classification as foreclosed properties.

Fair Value of Financial Instruments

The following reflects the fair value of financial instruments whether or not recognized on the consolidated balance sheet at fair value.

 

     June 30, 2009    December 31, 2008
     Carrying
Amount
   Estimated
Fair Value
   Carrying
Amount
   Estimated
Fair Value

Financial Assets

           

Cash and cash equivalents

   $ 4,771,927    $ 4,771,927    $ 7,491,343    $ 7,491,343

Securities available for sale

     37,667,165      37,667,165      31,003,271      31,003,271

 

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Table of Contents
     June 30, 2009    December 31, 2008
     Carrying
Amount
   Estimated Fair
Value
   Carrying
Amount
   Estimated
Fair Value

Mortgage loans held for sale

     319,975      319,975      68,462      68,462

Net loans held for investment

     96,591,802      91,715,834      96,493,811      86,370,194

Interest receivable

     951,201      951,201      827,909      827,909

Accounts receivable from securitization

     5,219,968      5,219,968      6,342,754      6,342,754

Derivatives

     1,202,764      1,202,764      1,836,817      1,836,817

Mortgage servicing rights

     280,742      280,742      150,544      150,544
                           

Financial Liabilities

           

Non-interest bearing deposits

   $ 12,603,548    $ 12,603,548    $ 11,293,852    $ 11,293,852

Interest-bearing deposits

     104,120,642      105,387,059      97,326,937      98,031,913

Senior and subordinated notes

     10,092,619      9,583,028      8,308,843      6,922,300

Other borrowings

     13,260,589      12,559,331      14,869,648      12,948,145

Interest payable

     659,784      659,784      676,398      676,398

Derivatives

     1,049,641      1,049,641      1,321,671      1,321,671
                           

The following describes the valuation techniques used in estimating the fair value of the Company’s financial instruments as of June 30, 2009 and December 31, 2008. The Company applied the provisions of SFAS 157 to the fair value measurements of financial instruments not recognized on the consolidated balance sheet at fair value, which include loans held for investment, interest receivable, non-interest bearing and interest bearing deposits, other borrowings, senior and subordinated notes, and interest payable. The provisions requiring the Company to maximize the use of observable inputs and to measure fair value using a notion of exit price were factored into the Company’s selection of inputs into its established valuation techniques.

Financial Assets

Cash and cash equivalents

The carrying amounts of cash and due from banks, federal funds sold and resale agreements and interest-bearing deposits at other banks approximate fair value.

Securities available for sale

Quoted prices in active markets are used to measure the fair value of U.S. Treasury securities. For other investment categories, the Company engages third party pricing services to provide fair value measurements. The techniques used by the pricing services utilize observable market data to the extent available. The Company corroborates the pricing obtained from the pricing services through comparison of pricing to additional sources, including other pricing services, securities dealers, and internal sources.

Certain securities available for sale are classified as Level 3, the majority of which are non-agency collateralized mortgage obligations backed by prime collateral. Classification of Level 3 indicates that significant valuation assumptions are not consistently observable in the market. When significant assumptions are not consistently observable, fair values are derived using the best available data. Such data may include quotes provided by a dealer, the use of external pricing services, independent pricing models, or other model-based valuation techniques such as calculation of the present values of future cash flows incorporating assumptions such as benchmark yields, spreads, prepayment speeds, credit ratings, and losses.

Mortgage loans held for sale

Mortgage loans held for sale are carried at the lower of aggregate cost, net of deferred fees, deferred origination costs and effects of hedge accounting, or fair value. The fair value of mortgage loans held for sale is determined using current secondary market prices for portfolios with similar characteristics. The carrying amounts as of June 30, 2009 and December 31, 2008 approximate fair value.

Loans held for investment

The fair values of credit card loans, installment loans, auto loans, mortgage loans and commercial loans were estimated using a discounted cash flow method, a form of the income approach. Discount rates were determined considering rates at which similar portfolios of loans would be made under current conditions and considering liquidity spreads applicable to each loan portfolio based

 

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on the secondary market. The fair value of credit card loans excluded any value related to customer account relationships. The decrease in fair value below carrying amount at December 31, 2008 is primarily due to the significant level of illiquidity in the secondary market experienced during 2008. The most significant discounts to carrying amount were seen in the Company’s commercial and mortgage portfolios.

Commercial loans are considered impaired in accordance with the provisions of SFAS 114 when it is probable that all amounts due in accordance with the contractual terms will not be collected. From time to time, the Company records nonrecurring fair value adjustments to reflect the fair value of the loan’s collateral. See table within “Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis” above.

Interest Receivable

The carrying amount approximates the fair value of this asset due to its relatively short-term nature.

Retained interests in securitizations

Retained interests in securitizations include the interest-only strip, retained notes accrued interest receivable, cash reserve accounts and cash spread accounts. The Company uses a valuation model that calculates the present value of estimated future cash flows. The model incorporates the Company’s own estimates of assumptions market participants use in determining fair value, including estimates of payment rates, defaults, discount rates including adjustments for liquidity, and contractual interest and fees. Other retained interests related to securitizations are carried at cost, which approximates fair value.

Derivative Assets

Most of the Company’s derivatives are not exchange traded but instead traded in over the counter markets where quoted market prices are not readily available. The fair value of those derivatives is derived using models that use primarily market observable inputs, such as interest rate yield curves, credit curves, option volatility and currency rates. Any derivative fair value measurements using significant assumptions that are unobservable are classified as Level 3, which include interest rate swaps whose remaining terms extend beyond market observable interest rate yield curves. The impact of counterparty non-performance risk is considered when measuring the fair value of derivative assets. These derivatives are included in other assets on the balance sheet.

Mortgage servicing rights

Mortgage servicing rights (MSRs) do not trade in an active market with readily observable prices. Accordingly, the Company determines the fair value of MSRs using a valuation model that calculates the present value of estimated future net servicing income. The model incorporates assumptions that market participants use in estimating future net servicing income, including estimates of prepayment spreads, discount rate, cost to service, contractual servicing fee income, ancillary income and late fees. Since the adoption of SFAS No. 156, Accounting for Servicing of Financial Assets-an amendment of FASB Statement No. 140, (“SFAS 156”) in 2007, the Company records MSRs at fair value on a recurring basis. Fair value measurements of MSRs use significant unobservable inputs and, accordingly, are classified as Level 3. The valuation technique for these securities is discussed in more detail in Note 11—Mortgage Servicing Rights.

Financial Liabilities

Non-interest bearing deposits

The carrying amount approximates fair value.

Interest bearing deposits

The fair values of savings, NOW accounts and money market accounts were the amounts payable on demand at June 30, 2009 and therefore carrying value approximates fair value. The fair value of other interest-bearing deposits, include retail, brokered, and institutional CDs, was calculated by discounting the future cash flows using discount rates based on the expected current market rates for similar products with similar remaining terms.

Other borrowings

The carrying amount of federal funds purchased and resale agreements, FHLB advances, and other short-term borrowings approximates fair value. The fair value of secured borrowings was measured using the trade price for bonds that have traded recently. For others, trade information for bonds with similar duration and credit quality was used, with adjustments based on relevant credit information of the issuer. The fair value of junior subordinated debentures was estimated using the same methodology as described for senior and subordinated notes below. The decreases in fair value of the secured borrowings and the junior subordinated debentures below carrying amounts at June 30, 2009 are primarily due to significant interest rate spreads in the auto securitization market experienced in 2008 and the significant discounts in secondary trading activity seen in junior subordinated debentures in 2008.

 

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Table of Contents

Senior and subordinated notes

The Company engages third party pricing services in order to estimate the fair value of senior and subordinated notes. The pricing service utilizes a pricing model that incorporates available trade, bid and other market information. It also incorporates spread assumptions, volatility assumptions and relevant credit information into the pricing models. The decrease in fair value below carrying amount at June 30, 2009 is primarily due to an increase in credit spreads across the industry only partially offset by lower interest rates.

Interest payable

The carrying amount approximates the fair value of this liability due to its relatively short-term nature.

Derivative Liabilities

Most of the Company’s derivatives are not exchange traded but instead traded in over the counter markets where quoted market prices are not readily available. The fair value of those derivatives is derived using models that use primarily market observable inputs, such as interest rate yield curves, credit curves, option volatility and currency rates. Any derivative fair value measurements using significant assumptions that are unobservable are classified as Level 3, which include interest rate swaps whose remaining terms extend beyond market observable interest rate yield curves. The impact of Capital One’s non performance risk is considered when measuring the fair value of derivative liabilities. These derivatives are included in other liabilities on the balance sheet.

Commitments to extend credit and letters of credit

These financial instruments are generally not sold or traded. The fair value of the financial guarantees outstanding at June 30, 2009 that have been issued since January 1, 2003, was $2.8 million and was included in other liabilities. The estimated fair values of extensions of credit and letters of credit are not readily available. However, the fair value of commitments to extend credit and letters of credit is based on fees currently charged to enter into similar agreements with comparable credit risks and the current creditworthiness of the counterparties. Commitments to extend credit issued by the Company are generally short-term in nature and, if drawn upon, are issued under current market terms and conditions for credits with comparable risks. At June 30, 2009 there was no material unrealized appreciation or depreciation on these financial instruments.

Note 8

Goodwill and Other Intangible Assets

During the first quarter of 2009, the Company acquired Chevy Chase Bank, the largest retail branch presence in the Washington, D.C. region, which created $1.4 billion of goodwill. The goodwill associated with the acquisition of Chevy Chase Bank was held in the Other segment in the second quarter of 2009. See Note 2 for information regarding the Chevy Chase Bank acquisition.

Goodwill impairment is tested at the reporting unit level, which is an operating segment or one level below on an annual basis in accordance with SFAS No. 142, Goodwill and Other Intangible Assets. The Company’s reporting units are Local Banking, U.S. Card, Auto Finance, and International. The goodwill impairment analysis is a two-step test. The first step, used to identify potential impairment, involves comparing each reporting unit’s fair value to its carrying value including goodwill. If the fair value of a reporting unit exceeds its carrying value, applicable goodwill is considered not to be impaired. If the carrying value exceeds fair value, there is an indication of impairment and the second step is performed to measure the amount of impairment. Since our annual impairment testing , our stock price, along with the stock prices of others in the financial services industry, declined significantly, resulting in a decline in our market capitalization. The Company has continued to monitor its market capitalization, regulatory actions and assessments, as well as overall economic conditions and other events or circumstances. For the six months ended June 30, 2009, no impairment of goodwill was recognized.

The following table provides a summary of goodwill.

 

Total Company

   National
Lending
   Local
Banking
    Other    Total  

Balance at December 31, 2008

   $ 5,303,299    $ 6,661,188      $ —      $ 11,964,487   

Additions

     —        —          1,405,148      1,405,148   

Other adjustments

     —        (4     —        (4

Foreign currency translation

     11,425      —          —        11,425   
                              

Balance at June 30, 2009

   $ 5,314,724    $ 6,661,184      $ 1,405,148    $ 13,381,056   
                              

 

National Lending Detail

   U.S. Card    Auto
Finance
   International    National
Lending
Total

Balance at December 31, 2008

   $ 3,761,318    $ 619,512    $ 922,469    $ 5,303,299

Foreign currency translation

     —        —        11,425      11,425
                           

Balance at June 30, 2009

   $ 3,761,318    $ 619,512    $ 933,894    $ 5,314,724
                           

 

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In connection with the acquisition of Chevy Chase Bank, the Company recorded intangible assets of $286.8 million that consisted of core deposit intangibles, trust intangibles, lease intangibles, and other intangibles, which are subject to amortization. The core deposit and trust intangibles reflect the estimated value of deposit and trust relationships. The lease intangibles reflect the difference between the contractual obligation under current lease contracts and the fair market value of the lease contracts at the acquisition date. The other intangible items relate to customer lists and brokerage relationships. The following table summarizes the Company’s intangible assets subject to amortization.

 

     June 30, 2009
     Gross
Carrying
Amount
   Accumulated
Amortization
    Net Carrying
Amount
   Remaining
Weighted Avg.
Amortization
Period

Core deposit intangibles

   $ 1,561,920    $ (603,778   $ 958,142    8.5 years

Lease intangibles

     53,993      (19,840     34,153    23.2 years

Trust intangibles

     10,500      (3,800     6,700    14.4 years

Other intangibles

     43,647      (8,322     35,325    3.5 years
                          

Total

   $ 1,670,060    $ (635,740   $ 1,034,320   
                        

Intangibles are amortized on an accelerated basis using the sum of digits methodology over their respective estimated useful lives. Intangible assets are recorded in other assets on the balance sheet. Amortization expense for intangibles is recorded to non-interest expense. The weighted average amortization period for all purchase accounting intangibles is 8.9 years.

The following table summarizes the Company’s current period and estimated future amortization expense for intangible assets as of June 30, 2009:

 

(in thousands)

   Current Period Amortization Amount

Six months ended June 30, 2009

   $ 115,706
     Estimated Future Amortization Amounts

Years ended December 31,

  

2009 (remaining six months)

   $ 120,715

2010

   $ 220,323

2011

   $ 184,780

2012

   $ 150,731

2013

   $ 121,790

2014

   $ 93,791

Thereafter

   $ 142,192
      

Total

   $ 1,034,320
      

Note 9

Deposits and Borrowings

Borrowings as of June 30, 2009 and December 31, 2008 were as follows:

 

     June 30, 2009     December 31, 2008  
     Outstanding    Weighted
Average
Rate
    Outstanding    Weighted
Average
Rate
 

Deposits

          

Non-interest bearing deposits

   $ 12,603,548    N/A      $ 11,293,852    N/A   

Interest-bearing deposits

     104,120,642    2.17     97,326,937    2.64
                          

Total deposits

   $ 116,724,190      $ 108,620,789   
                  

Senior and subordinated notes

          

Bank notes:

          

Senior-Fixed, interest rates ranging from 5.00% to 5.75%, due 2010 to 2014

   $ 806,291    5.53   $ 1,234,712    5.35

Subordinated-Fixed, interest rates ranging from 6.50% to 9.25%, due 2010 to 2019

     2,204,945    8.30     688,714    7.13

Corporation notes:

          

Senior-Fixed, interest rates ranging from 4.80% to 7.375%, due 2013 to 2017

     4,462,206    6.34     3,580,923    6.04

Subordinated-Fixed, interest rates ranging from 5.35% to 6.15%, due 2012 to 2016

     1,589,351    6.03     1,774,668    6.03

Senior-Variable, interest rate of LIBOR plus 0.28% per annum, due 2009

     1,029,826    0.93     1,029,826    2.47
                          

Total senior and subordinated notes

   $ 10,092,619      $ 8,308,843   
                  

 

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Table of Contents
     June 30, 2009     December 31, 2008  
     Outstanding    Weighted
Average
Rate
    Outstanding    Weighted
Average
Rate
 

Other borrowings

          

Secured borrowings

          

Fixed, interest rates ranging from 4.34% to 5.76%, due 2009 to 2011

     1,641,718    5.07     2,698,381    5.06

Variable, interest rates ranging from 0.319% to 1.705%, due 2010 to 2011

     3,628,649    0.36     4,812,457    1.24

Junior subordinated debentures

          

Fixed, interest rates ranging from 3.648% to 8.17%, due 2027 to 2066

     1,649,988    7.37     1,648,268    7.38

FHLB advances

          

Fixed, interest rates ranging from 2.785% to 8.25%, due 2009 to 2019

     2,396,801    3.02     2,777,179    3.20

Variable, interest rates ranging from 0.64% to 3.435% due 2009

     1,800,000    0.68     2,100,000    2.38

Federal funds purchased and resale agreements

          

Fixed, interest rates ranging from 0.10% to 0.45% due 2009

     559,714    0.40     —      N/A   

Variable, interest rates ranging from 0.188% to 0.24%, due 2009

     1,583,410    0.01     832,961    0.01

Other short-term borrowings

     309    N/A        402    N/A   
                          

Total other borrowings

   $ 13,260,589      $ 14,869,648   
                  

Deposits

Interest-Bearing Deposits

As of June 30, 2009, the Company had $104.1 billion in interest-bearing deposits of which $11.5 billion represents large denomination certificates of $100 thousand or more. As of December 31, 2008, the Company had $97.3 billion in interest-bearing deposits of which $11.3 billion represents large denomination certificates of $100 thousand or more.

Borrowings

Senior and Subordinated Notes

The Senior and Subordinated Global Bank Note Program gives COBNA the ability to issue securities to both U.S. and non-U.S. lenders and to raise funds in U.S. and foreign currencies. The Senior and Subordinated Global Bank Note Program had $2.9 billion and $1.8 billion outstanding at June 30, 2009 and December 31, 2008, respectively.

The Company issued senior and subordinated notes that as of June 30, 2009 had a par amount outstanding of $9.8 billion. The outstanding balance of senior and subordinated bank notes in the table above include $316.4 million and $607.7 million related to fair value accounting hedges at June 30, 2009 and December 31, 2008, respectively. See Note 13 for a further discussion of fair value interest rate hedges. The weighted average stated rate included in the table above is before the impact of these interest rate derivatives.

During the second quarter of 2009, securities totaling $0.7 million were called or matured.

During the second quarter of 2009, the Corporation issued $1.0 billion of 7.375% senior notes due May 23, 2014 and COBNA issued $1.5 billion of 8.8% subordinated notes due July 15, 2019.

Corporation Shelf Registration Statement

As of June 30, 2009, the Corporation had an effective shelf registration statement under which the Corporation may offer and sell an indeterminate aggregate amount of senior or subordinated debt securities, preferred stock, depositary shares representing preferred stock, common stock, warrants, trust preferred securities, junior subordinated debt securities, guarantees of trust preferred securities and certain back-up obligations, purchase contracts and units. There is no limit under this shelf registration statement to the amount or number of such securities that the Corporation may offer and sell. Under SEC rules, the Automatic Shelf Registration Statement expires three years after filing. Accordingly, the Corporation must file a new Automatic Shelf Registration Statement at least once every three years. The Automatic Shelf Registration Statement is effective through May 2012.

Other Borrowings

Secured Borrowings

The Company issued securitizations in which it transfers pools of auto loans that are accounted for as secured borrowings at June 30, 2009. The agreements were entered into between 2005 and 2007, relating to the transfers of pools of auto loans initially totaling $25.1 billion. Principal payments on the borrowings are based on principal collections, net of losses, on the transferred auto loans. The secured borrowings accrue interest at fixed and variable rates and mature between September 2009 and June 2011, or earlier depending upon the repayment of the underlying auto loans. At June 30, 2009 and December 31, 2008, $5.3 billion and $7.5 billion, respectively, of the secured borrowings were outstanding. See Note 14 for further discussion of secured borrowings.

 

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Table of Contents

Junior Subordinated Debentures

At both June 30, 2009 and December 31, 2008, the Company had junior subordinated debentures outstanding with a par amount of $1.6 billion.

The Company had previously established special purpose trusts for the purpose of issuing trust preferred securities. The proceeds from such issuances, together with the proceeds of the related issuances of common securities of the trusts, were invested by the trusts in junior subordinated deferrable interest debentures issued by the Company. Prior to FIN 46(R), these trusts were consolidated subsidiaries of the Company. As a result of the adoption of FIN 46(R), the Company deconsolidated all such special purpose trusts, as the Company is not considered to be the primary beneficiary.

For the six months ended June 30, 2009, no securities were called or matured and there were no new issuances. On July 29, 2009 the Company issued $1.0 billion of 10.25% trust preferred securities, due 2039.

FHLB Advances

The Company utilizes FHLB advances which are secured by the Company’s investment in FHLB stock and by a blanket floating lien on portions of the Company’s residential mortgage loan portfolio. FHLB advances outstanding were $4.2 billion and $4.9 billion at June 30, 2009 and December 31, 2008, respectively and include fixed and variable rate advances. FHLB stock totaled $310.2 million and $267.5 million at June 30, 2009 and December 31, 2008, respectively and is included in Other assets.

Note 10

Shareholders’ Equity, Comprehensive Income and Earnings Per Common Share

Preferred Shares

On June 17, 2009, the Company repurchased all 3,555,199 preferred shares, at par, issued in the fourth quarter of 2008 to the U.S. Treasury Department under the TARP Capital Purchase Program with a book value of $3.1 billion for approximately $3.57 billion, including accrued dividends. The warrants to purchase common shares, which were issued together with preferred shares in the fourth quarter of 2008 and with an allocated fair value of $491.5 million, remain outstanding and are included in paid-in capital on the balance sheet. With the repurchase of the preferred shares the remaining accretion of the discount of $461.7 million was accelerated into the second quarter and treated as a dividend and reduced income available to common shareholders.

Common Shares

On May 11, 2009, the Company raised $1.5 billion through the issuance of 56,000,000 shares of common stock at $27.75 per share.

Comprehensive Income

Comprehensive income for the three months ended June 30, 2009 and 2008, respectively was as follows:

 

     Three Months Ended
June 30
 
     2009    2008  

Comprehensive Income:

     

Net income (loss)

   $ 224,203    $ 452,905   

Other comprehensive income (loss), net of tax

     453,268      (56,970
               

Total comprehensive income

   $ 677,471    $ 395,935   
               

Earnings Per Common Share

The following table sets forth the computation of basic and diluted earnings per common share:

 

     Three Months Ended June 30     Six Months Ended June 30  
(Shares in Thousands)    2009     2008     2009     2008  

Numerator:

        

Income (loss) from continuing operations, net of tax

   $ 230,201      $ 462,498      $ 143,280      $ 1,095,053   

Loss from discontinued operations, net of tax

     (5,998     (9,593     (30,956     (93,644
                                

Net income (loss)

   $ 224,203      $ 452,905      $ 112,324      $ 1,001,409   
                                

Preferred stock dividends and accretion of discount (2)

   $ (499,718   $ —        $ (563,908   $ —     
                                

Net income (loss) available to common shareholders

   $ (275,515   $ 452,905      $ (451,584   $ 1,001,409   
                                

Denominator:

        

Denominator for basic earnings per share-weighted-average shares

     421,851        372,348        406,240        371,545   

Effect of dilutive securities (1):

        

Stock options

     —          501        —          572   

Restricted stock and units

     —          804        —          845   
                                

 

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     Three Months Ended June 30     Six Months Ended June 30  
(Shares in Thousands)    2009     2008     2009     2008  

Dilutive potential common shares

           1,305              1,417   
                                

Denominator for diluted earnings per share-adjusted weighted-average shares

     421,851        373,653        406,240        372,962   

Basic earnings per share

        

Income (loss) from continuing operations

   $ (0.64   $ 1.24      $ (1.03   $ 2.95   

Loss from discontinued operations

     (0.01     (0.03     (0.08     (0.25
                                

Net income (loss)

   $ (0.65   $ 1.21      $ (1.11   $ 2.70   
                                

Diluted earnings per share

        

Income (loss) from continuing operations

   $ (0.64   $ 1.24      $ (1.03   $ 2.94   

Loss from discontinued operations

     (0.01     (0.03     (0.08     (0.25
                                

Net income (loss)

   $ (0.65   $ 1.21      $ (1.11   $ 2.69   
                                

 

(1) Antidilutive weighted shares excluded from the computation of diluted earnings per share were 36.7 million and 25.1 million for the three months ended June 30, 2009 and 2008, respectively, and 38.0 million and 24.7 million for the six months ended June 30, 2009 and 2008, respectively.
(2) In connection with the repurchase of the preferred shares from the U.S. Treasury, the remaining accretion of the discount rate was accelerated and treated as a dividend in the second quarter of 2009.

Note 11

Mortgage Servicing Rights

MSRs are recognized when purchased and in conjunction with loan sales and securitization transactions when servicing rights are retained by the Company; changes in fair value are recognized in mortgage servicing and other income. The Company may enter into derivatives to economically hedge changes in fair value of MSRs. The Company has sold mortgage loans through whole loan sales transactions, and in some instances the loans were subsequently securitized by the third party purchaser and transferred into a VIE, and also through securitization transactions. The Company records the MSR at estimated fair value and has no other loss exposure over and above the recorded fair value.

The Company continues to operate the mortgage servicing business and to report the changes in the fair value of MSRs in continuing operations. To evaluate and measure fair value, the underlying loans are stratified based on certain risk characteristics, including loan type, note rate and investor servicing requirements. The following table sets forth the changes in the fair value of mortgage servicing rights during the three and six months ended June 30, 2009 and June 30, 2008:

 

     Three Months Ended
June 30
    Six Months Ended
June 30
 

Mortgage Servicing Rights:

   2009     2008     2009     2008  

Balance, beginning of period

   $ 258,663      $ 206,110      $ 150,544      $ 247,589   

Acquired in acquisitions (1)

     —          —          109,538        —     

Originations

     4,898        —          7,240        —     

Sales

     —          (267 )     —          (273

Change in fair value, net

     17,181        26,580        13,420        (14,893
                                

Balance, end of period

   $ 280,742      $ 232,423      $ 280,742      $ 232,423   
                                

Ratio of mortgage servicing rights to related loans serviced for others