Exhibit 13
SELECTED FINANCIAL AND OPERATING DATA
Year Ended December 31
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FIVE-YEAR
(Dollars in Thousands, COMPOUND
Except Per Share Data) 1997 1996 1995 1994/(1)/ 1993/(1)/ 1992/(1)/ GROWTH RATE
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INCOME STATEMENT DATA:
Interest income $ 717,985 $ 660,483 $ 457,409 $ 258,672 $ 259,857 $ 120,630 42.87%
Interest expense 334,847 294,999 249,396 93,695 67,994 29,888 62.13
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Net interest income 383,138 365,484 208,013 164,977 191,863 90,742 33.39
Provision for loan losses 262,837 167,246 65,895 30,727 34,030 55,012 36.72
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Net interest income after
provision for loan losses 120,301 198,238 142,118 134,250 157,833 35,730 27.48
Non-interest income 1,069,130 763,424 553,043 396,902 194,825 121,642 54.45
Non-interest expense/(2)/ 883,978 713,182 497,430 384,325 181,804 108,508 52.12
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Income before income taxes 305,453 248,480 197,731 146,827 170,854 48,864 44.27
Income taxes 116,072 93,213 71,220 51,564 60,369 16,614 47.52
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Net income $ 189,381 $ 155,267 $ 126,511 $ 95,263 $ 110,485 $ 32,250 42.48
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Dividend payout ratio 10.90% 13.24% 12.55%
PER COMMON SHARE:
Basic earnings/(3)(4)/ $ 2.87 $ 2.34 $ 1.93 $ 1.44 $ 1.67 $ .49
Diluted earnings/(3)(4)/ 2.80 2.32 1.91 1.44 1.67 .49
Dividends .32 .32 .24
Book value as of year-end 13.66 11.16 9.05 7.18
Average common shares 66,069,897 66,227,631 65,690,838 66,067,250
Average common and common
equivalent shares 67,650,864 67,025,233 66,392,284 66,067,250
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SELECTED AVERAGE
BALANCES:
Securities $ 1,650,961 $ 1,147,079 $ 962,624 $ 62,626
Allowance for loan losses (132,728) (83,573) (69,939) (66,434) $ (59,754) $ (43,767) 24.84%
Total assets 6,568,937 5,568,960 4,436,055 2,629,920 2,289,043 827,093 51.35
Deposits 958,885 1,046,122 769,688 36,248
Other borrowings 4,350,864 3,623,104 2,952,162 2,287,474 2,148,155 762,762 41.66
Preferred beneficial interests 89,529
Stockholders'/Division equity/(5)/ 824,077 676,759 543,364 239,616 113,815 51,454 74.14
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SELECTED YEAR-END
BALANCES:
Securities $ 1,475,354 $ 1,358,103 $ 1,244,195 $ 425,570
Consumer loans 4,861,687 4,343,902 2,921,679 2,228,455 $ 1,862,744 $1,304,560
Allowance for loan losses (183,000) (118,500) (72,000) (68,516) (63,516) (55,993)
Total assets 7,078,279 6,467,445 4,759,321 3,091,980 1,991,207 1,351,802
Deposits 1,313,654 943,022 696,037 452,201
Other borrowings 4,428,886 4,525,216 3,301,672 2,062,688 1,791,464 1,266,507
Preferred beneficial interests 97,664
Stockholders'/Division equity/(5)/ 893,259 740,391 599,191 474,557 168,879 69,294
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MANAGED CONSUMER
LOAN DATA:
Average reported loans $ 4,103,036 $ 3,651,908 $ 2,940,208 $ 2,286,684 $ 2,213,378 $ 772,742 39.64%
Average securitized loans 8,904,146 7,616,553 6,149,070 3,910,739 1,052,187 680,000 67.27
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Average total managed loans 13,007,182 11,268,461 9,089,278 6,197,423 3,265,565 1,452,742 55.02
Interest income 2,045,967 1,662,990 1,192,100 733,659 432,521 249,082 52.37
Year-end total managed loans 14,231,015 12,803,969 10,445,480 7,378,455 4,832,400 1,984,560 48.29
Year-end total accounts (000s) 11,747 8,586 6,149 5,049 3,118 1,672 47.69
Yield 15.73% 14.76% 13.12% 11.84% 13.24% 17.15%
Net interest margin 8.86 8.16 6.27 6.90 9.55 12.63
Delinquency rate 6.20 6.24 4.20 2.95 2.39 5.30
Net charge-off rate 6.59 4.24 2.25 1.48 2.09 5.18
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OPERATING RATIOS:
Return on average assets 2.88% 2.79% 2.85% 3.62% 4.83% 3.90%
Return on average equity 22.98 22.94 23.28 39.76 97.07 62.68
Equity to assets (average) 12.55 12.15 12.25 9.11 4.97 6.22
Allowance for loan losses to loans
as of year-end/(6)/ 3.76 2.73 2.85 3.07 3.41 4.29
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(1) The Company's results prior to November 22, 1994, reflect operations as a
division of Signet Bank. Prior to November 22, 1994, Signet Banking
Corporation, the parent of Signet Bank, had provided significant financial
and operational support to the Company.
(2) Non-interest expense includes a $49.0 million ($31.9 million after-tax)
nonrecurring charge for computer services termination expense in 1994.
(3) Assumes 66,067,250 shares outstanding prior to November 22, 1994.
(4) The earnings per share amounts prior to 1997 have been restated as required
to comply with Statement of Financial Accounting Standards No. 128,
Earnings Per Share. For further discussion of earnings per share and the
impact of Statement 128, see the Notes to Consolidated Financial
Statements.
(5) Division equity reflects an allocation of capital to Capital One Bank as a
division for purposes of preparation of the financial statements of the
Company. Such allocation is not subject to regulatory minimums.
(6) Excludes consumer loans held for securitization.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Introduction
Capital One Financial Corporation (the "Corporation") is a holding company whose
subsidiaries provide a variety of products and services to consumers. The
principal subsidiaries are Capital One Bank (the "Bank"), which offers credit
card products, and Capital One, F.S.B. (the "Savings Bank"), which provides
certain consumer lending and deposit services. The Corporation and its
subsidiaries are collectively referred to as the "Company." As of December 31,
1997, the Company had 11.7 million customers and $14.2 billion in managed
consumer loans outstanding and was one of the largest providers of MasterCard
and Visa credit cards in the world.
The Company's profitability is affected by the net interest margin and
non-interest income earned on earning assets, consumer usage patterns, credit
quality, the level of marketing expense and operating efficiency. The Company's
revenues consist primarily of interest income on consumer loans and securities,
and non-interest income consisting of gains on securitization of loans,
servicing income and fees (such as annual membership, cash advance, cross-sell,
interchange, overlimit, past-due and other fee income, collectively "fees"). The
Company's primary expenses are the costs of funding assets, credit losses,
operating expenses (including salaries and associate benefits), marketing
expense, processing expenses and income taxes.
Significant marketing expenses (e.g., advertising, printing, credit
bureau costs and postage) to implement the Company's new product strategies are
incurred and expensed prior to the acquisition of new accounts while the
resulting revenues are recognized over the life of the acquired accounts.
Revenues recognized are a function of the response rate of the initial marketing
program, usage and attrition patterns, credit quality of accounts, product
pricing and effectiveness of account management programs.
Earnings Summary
The following discussion provides a summary of 1997 results compared to 1996
results and 1996 results compared to 1995 results. Each component is discussed
in further detail in subsequent sections of this analysis.
[graph omitted]
Year Ended December 31, 1997 Compared to Year ended December 31, 1996
Net income of $189.4 million for the year ended December 31, 1997
increased $34.1 million, or 22%, over net income of $155.3 million in 1996. The
increase in net income is primarily the result of an increase in asset and
account volumes, offset by a decrease in net interest margin. Net interest
income increased $17.7 million, or 5%, as average earning assets increased 20%,
offset by a decrease in the net interest margin to 6.66% from 7.62%. The
provision for loan losses increased $95.6 million, or 57%, as average reported
loans (on-balance sheet loans and loans held for securitization, collectively
"reported" loans) increased 12% and the reported charge-off rate increased to
4.83% in 1997 from 3.63% in 1996, as a result of an increase in the average age
of the accounts (generally referred to as "seasoning") and general economic
trends in consumer credit performance. Non-interest income increased $305.7
million, or 40%, primarily as a result of the increase in average managed
accounts of 33%, a 17% increase in average securitized loans, a shift to more
fee-based accounts, a change in the timing and amount ("terms") of certain fees
charged and the incremental impact of securitization accounting. Increases in
salaries and benefits expense of $74.2 million, or 34%, and other non-interest
expenses of $96.6 million, or 19%, primarily reflected the incremental cost of
operations to manage the growth in the Company's accounts. Average managed
consumer loans grew 15% for the year ended December 31, 1997, to $13.0 billion
from $11.3 billion for the year ended December 31, 1996, and average managed
accounts grew 33% for the same period to 9.9 million from 7.5 million as a
result of the continued success of the Company's marketing and account
management strategies.
Year Ended December 31, 1996 Compared to Year Ended December 31, 1995
Net income of $155.3 million for the year ended December 31, 1996
increased $28.8 million, or 23%, over net income of $126.5 million in 1995. The
increase in net income is primarily a result of an increase in both asset
volumes and rates. Net interest income increased $157.5 million, or 76%, as
average
earning assets increased 23% and the net interest margin increased to
7.62% from 5.35%. The provision for loan losses increased $101.4 million, or
154%, as average reported consumer loans increased 24% and the reported net
charge-off rate increased to 3.63% in 1996 from 2.03% in 1995, the result of
seasoning. Non-interest income increased $210.4 million, or 38%, primarily due
to the increase in average managed consumer loans and a shift to more
fee-intensive products. Increases in marketing costs of $59.8 million, or 41%,
and other non-interest expenses of $155.9 million, or 44%, reflect the increase
in marketing investment in existing and new product opportunities and the cost
of operations to build infrastructure and manage the growth in accounts. Average
managed consumer loans grew 24% for the year ended December 31, 1996, to $11.3
billion from $9.1 billion for the year ended December 31, 1995, and average
managed accounts grew 30% for the same period to 7.5 million from 5.7 million as
a result of the continued success of the Company's marketing and account
management strategies.
Managed Consumer Loan Portfolio
The Company analyzes its financial performance on a managed consumer loan
portfolio basis. Managed consumer loan data adjusts the balance sheet and income
statement to add back the effect of securitizing consumer loans. The Company
also evaluates its interest rate exposure on a managed portfolio basis.
The Company's managed consumer loan portfolio is comprised of reported
and securitized loans. Securitized loans are not assets of the Company and,
therefore, are not shown on the balance sheet.
Table 1 summarizes the Company's managed consumer loan portfolio.
Table 1: Managed Consumer Loan Portfolio
Year Ended December 31
-------------------------------------------------------
(In Thousands) 1997 1996 1995 1994 1993
- -------------------------------------------------------------------------------------------------------------------------
Year-End Balances:
Consumer loans held for securitization $ 400,000
On-balance sheet consumer loans $ 4,861,687 $ 4,343,902 2,521,679 $2,228,455 $1,862,744
Securitized consumer loans 9,369,328 8,460,067 7,523,801 5,150,000 2,969,656
--------------------------------------------------------------------------------
Total managed consumer loan portfolio $14,231,015 $12,803,969 $10,445,480 $7,378,455 $4,832,400
- -------------------------------------------------------------------------------------------------------------------------
Average Balances:
Consumer loans held for securitization $ 98,838 $ 699,044 $ 402,602 $ 432,581 $ 393,835
On-balance sheet consumer loans 4,004,198 2,952,864 2,537,606 1,854,103 1,819,543
Securitized consumer loans 8,904,146 7,616,553 6,149,070 3,910,739 1,052,187
--------------------------------------------------------------------------------
Total managed consumer loan portfolio $13,007,182 $11,268,461 $ 9,089,278 $6,197,423 $3,265,565
- -------------------------------------------------------------------------------------------------------------------------
As of December 31, 1997, the managed consumer loan portfolio consisted
of 62% fixed and 38% variable interest rate loans. The Company's reported
consumer loan portfolio as of December 31, 1997 consisted of 58% fixed and 42%
variable interest rate loans.
Since 1990, the Company has actively engaged in consumer loan
securitization transactions. In June 1996, the Financial Accounting Standards
Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No.
125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities" ("SFAS 125"), which was effective January 1,
1997. Under SFAS 125, the Company records gains or losses on the securitization
of consumer loan receivables based on the estimated fair value of assets
obtained and liabilities incurred in the sale. Gains represent the present value
of estimated cash flows the Company has retained over the estimated outstanding
period of the receivables. This excess cash flow essentially represents an
"interest only" ("I/O") strip, consisting of the excess of finance charges and
past-due fees over the sum of the return paid to certificateholders, estimated
contractual servicing fees and credit losses. However, exposure to credit losses
on the securitized loans is contractually limited to these excess cash flows.
The incremental effect of applying the new requirements, was to increase
servicing and securitizations income in 1997 by $32.0 million ($19.8 million net
of tax). Certain estimates inherent in the determination of the fair value of
the I/O strip are influenced by factors outside the Company's control, and as a
result, such estimates could materially change in the near term.
Any future gains that will be recognized in accordance with SFAS 125 will be
dependent on the timing and amount of future securitizations. The Company will
continuously assess the performance of new and existing securitization
transactions as estimates of future cash flows change.
[graph omitted]
For securitized loans prior to 1997, interest income, interest expense,
service charges and provision for loan losses are included in non-interest
income as servicing and securitizations income.
A securitization generally involves the transfer by the Company of the
receivables generated by a pool of consumer loan accounts to an entity created
for the securitization, generally a trust or other special purpose entity ("the
trusts"). Certificates issued ($9.4 billion outstanding as of December 31, 1997)
by the trusts represent undivided ownership interests in those receivables
transferred into the trusts. The credit quality of the receivables is supported
by credit enhancement, which may be in various forms including a letter of
credit, a cash collateral guaranty or account, or a subordinated interest in the
receivables in the pool. The securitization results in the removal of the
receivables, other than the Company's retained interest ("seller's interest"),
from the Company's balance sheet for financial and regulatory accounting
purposes.
The receivables transferred to a securitization pool include those
outstanding in the selected accounts at the time the trusts are formed and those
arising under the accounts until the termination of the trusts. The Company also
transfers to the trusts the cash collected in payment of principal, interest and
fees received and the Company's interest in any collateral.
Certificates representing participation interests in the pool are sold
to the public through an underwritten offering or to private investors in
private placement transactions. The Company receives the proceeds of the sale.
The amount of receivables transferred to the trusts exceeds the initial
principal amount of the certificates issued by the trusts to investors. The
Company retains an interest in the trusts equal to the amount of the receivables
in excess of the principal balance of the certificates. The Company's interest
in the trusts varies as the amount of the excess receivables in the trusts
fluctuates as the accountholders make principal payments and incur new charges
on the selected accounts.
The Company acts as a servicing agent and receives loan servicing fees
ranging from .75% to 2.0% per annum of the securitized receivables. As a
servicing agent, the Company continues to provide customer service, to collect
past-due accounts and to provide all other services typically performed for its
customers. Accordingly, its relationship with its customers is not affected by
the securitization.
The certificateholders are entitled to receive periodic interest
payments at a fixed rate or a floating rate. In general, the Company's floating
rate issuances are based on the London InterBank Offered Rate ("LIBOR"). Amounts
collected in excess of that needed to pay the rate of interest are used to pay
the credit enhancement fee and servicing fee and are available to absorb the
investors' share of credit losses.
Certificateholders in the Company's securitization program are
generally entitled to receive principal payments either through monthly payments
during an amortization period or in one lump sum after an accumulation period.
Amortization may begin sooner in certain circumstances, including if the
annualized portfolio yield (consisting, generally, of interest and fees) for a
three-month period drops below the sum of the certificate rate payable to
investors, loan servicing fees and net credit losses during the period or if
certain other events occur.
Prior to the commencement of the amortization or accumulation period,
all principal payments received on the trusts' receivables are reinvested in new
receivables of the selected accounts for the benefit of the trusts. During the
amortization period, the investors' share of principal payments is paid to the
certificateholders until they are paid in full. During the accumulation period,
the investors' share of principal payments is paid into a principal funding
account designed to accumulate amounts so that the certificates can be paid in
full on the expected final payment date. The trusts continue in existence until
all amounts required to be paid to certificateholders of all series are repaid,
at which time any remaining receivables and funds held in the trusts will be
reassigned to the Company.
Table 2 indicates the impact of the consumer loan securitizations on
average earning assets, net interest margin and loan yield for the periods
presented. The Company intends to continue to securitize consumer loans.
Table 2: Operating Data and Ratios
Year Ended December 31
-------------------------------------------------
(Dollars in Thousands) 1997 1996 1995
-------------------------------------------------
Reported:
Average earning assets $ 5,753,997 $ 4,798,987 $ 3,902,832
Net interest margin(1) 6.66% 7.62% 5.33%
Loan yield 15.11 16.21 13.52
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Managed:
Average earning assets $14,658,143 $12,415,540 $10,051,902
Net interest margin(1) 8.86% 8.16% 6.27%
Loan yield 15.73 14.76 13.12
(1) Net interest margin is equal to net interest income divided by average
earning assets.
Risk Adjusted Revenue and Margin
In originating its consumer loan portfolio since the early 1990's, the Company
has pursued a low introductory interest rate strategy with accounts repricing to
higher rates after six to sixteen months from the date of origination ("first
generation products"). The amount of repricing is actively managed in an effort
to maximize return at the consumer level, reflecting the risk and expected
performance of the account. Separately, accounts also may be repriced upwards or
downwards based on individual consumer performance. Many of the Company's first
generation products have a balance transfer feature under which consumers can
transfer balances from their other obligations to the Company. The Company's
historic managed loan growth has been principally the result of this balance
transfer feature. Industry competitors have continuously solicited the Company's
customers with similar low introductory interest rate strategies. Management
believes that the competition has put, and will continue to put, additional
pressure on low introductory interest rate strategies.
In applying its information-based strategies ("IBS") and in response to
competitive pressures during late 1994, the Company began to shift a significant
amount of its marketing expense to second generation product opportunities.
Second generation products consist of secured card products and other customized
card products including affinity and co-branded cards, college student cards and
other cards targeted to certain markets that were underserved by the Company's
competitors. These products do not have the immediate impact on managed loan
balances of the first generation products but typically consist of lower credit
limit accounts and balances that build over time. The terms of the second
generation products tend to include annual membership fees and higher annual
finance charge rates. The profile of the consumers targeted for the second
generation products, in some cases, may also tend to result in higher
delinquency and consequently higher past-due and overlimit fees as a percentage
of loan receivables outstanding than the first generation products.
Although these second generation products have differing
characteristics than first generation products, both meet the Company's
objective of maximizing revenue for the level of risk undertaken. Management
believes that comparable measures for external analysis are the risk adjusted
revenue and risk adjusted margin of the portfolio. Risk adjusted revenue is
defined as net interest income and non-interest income (exclusive of the impact
resulting from the implementation of SFAS 125) less net charge-offs. Risk
adjusted margin measures risk adjusted revenue as a percentage of average
managed earning assets. It considers not only the loan yield and net interest
margin, but also the fee income associated with these products. By deducting net
charge-offs, consideration is given to the risk inherent in these differing
products.
In the fourth quarter of 1997, the Company modified its methodology for
charging off credit card loans (net of any collateral) to 180 days past-due from
the prior practice of charging off loans during the next billing cycle after
becoming 180 days past-due. As a result, managed net interest income was reduced
by $15.1 million and managed non-interest income was reduced by $8.0 million for
[graph omitted]
the reversal of previously accrued finance charges and fee income. In addition,
this modification increased managed net charge-offs by $47.4 million. Also, in
the fourth quarter of 1997, the Company recognized the estimated uncollectible
portion of finance charge and fee income receivables which decreased loans by
$50.2 million, managed net interest income by $19.8 million and managed
non-interest income by $30.4 million. Risk adjusted revenue and risk adjusted
margin, without these modifications, would have been $1.3 billion and 8.92%,
respectively, in 1997.
Table 3 provides income statement data and ratios for the Company's
managed consumer loan portfolio. The causes of increases and decreases in the
various components of risk adjusted revenue are discussed in further detail in
subsequent sections of this analysis.
Table 3: Managed Risk Adjusted Revenue
Year Ended December 31
(Dollars in Thousands) 1997 1996 1995
- ------------------------------------------------------------------------------------------
Managed Income Statement:
Net interest income $1,299,317 $1,013,557 $ 629,996
Non-interest income(1) 743,516 460,492 276,269
Net charge-offs (856,704) (477,732) (204,828)
- ------------------------------------------------------------------------------------------
Risk adjusted revenue $1,186,129 $996,317 $ 701,437
- ------------------------------------------------------------------------------------------
Ratios(2):
Net interest margin 8.86% 8.16% 6.27%
Non-interest income 5.07 3.71 2.75
Net charge-offs (5.84) (3.85) (2.04)
- ------------------------------------------------------------------------------------------
Risk adjusted margin 8.09% 8.02% 6.98%
- ------------------------------------------------------------------------------------------
(1) Excludes the $32 million pre-tax incremental impact on credit card
securitizations income resulting from the implementation of SFAS 125 in
1997.
(2) As a percentage of average managed earning assets.
[graph omitted]
Net Interest Income
Net interest income is interest and past-due fees earned from the Company's
consumer loans and securities less interest expense on borrowings, which include
interest-bearing deposits, other borrowings and borrowings from senior and
deposit notes.
Net interest income for the year ended December 31, 1997 was $383.1
million, compared to $365.5 million for 1996, representing an increase of $17.6
million, or 5%. Average earning assets increased 20% to $5.8 billion for the
year ended December 31, 1997 from $4.8 billion in 1996. The reported net
interest margin decreased to 6.66% in 1997 from 7.62% in 1996 and was primarily
attributable to a 110 basis point decrease in the yield on consumer loans to
15.11% for the year ended December 31, 1997 from 16.21% for 1996. The yield on
consumer loans decreased due to the securitization and, as a result, removal
from the balance sheet of higher yielding second generation products during the
fourth quarter of 1996 and a $24.4 million reduction in reported consumer loan
income as a result of modifications in the charge-off policy and finance charge
and fee income recognition previously discussed. These decreases were offset by
an increase in the amount of past-due fees charged from both a change in terms
and an increase in the delinquency rate as compared to 1996.
The managed net interest margin for the year ended December 31, 1997
increased to 8.86% from 8.16% for the year ended December 31, 1996. This
increase was primarily the result of a 97 basis point increase in consumer loan
yield for the year ended December 31, 1997 offset by an 11 basis point increase
in borrowing costs for the same period, as compared to 1996. The increase in
consumer loan yield to 15.73% for the year ended December 31, 1997 from 14.76%
in 1996 principally reflected the 1997
repricing of introductory rate loans, changes in product mix and the increase in
past-due fees charged on delinquent accounts noted above. The average rate paid
on borrowed funds increased slightly to 5.95% for the year ended December 31,
1997 from 5.84% in 1996 primarily reflecting a relatively steady short-term
interest rate environment during 1997 and 1996.
Net interest income for the year ended December 31, 1996 was $365.5
million compared to $208.0 million for 1995, representing an increase of $157.5
million, or 76%. Net interest income increased as a result of growth in earning
assets and an increase in the net interest margin. Average earning assets
increased 23% for the year ended December 31, 1996 to $4.8 billion from $3.9
billion for the year ended December 31, 1995. The reported net interest margin
increased to 7.62% in 1996 from 5.35% in 1995 primarily attributable to a 269
basis point increase in the yield on consumer loans and a 38 basis point
decrease in the cost of funds. The yield on consumer loans increased to 16.21%
for the year ended December 31, 1996 from 13.52% for the year ended December 31,
1995. The yield increase was impacted by the repricing of introductory rate
loans to higher rates in accordance with their respective terms, changes in
product mix to higher yielding, second generation products and the increase in
the amount of past-due fees from both a change in terms and an increase in the
delinquency rate. The average rate paid on borrowed funds decreased to 6.32% for
the year ended December 31, 1996 from 6.70% in 1995 primarily reflecting
decreases in short-term market rates from year to year.
The managed net interest margin for the year ended December 31, 1996
increased to 8.16% from 6.27% for the year ended December 31, 1995. This
increase was primarily the result of a 164 basis point increase in consumer loan
yield for the year ended December 31, 1996 and a reduction of 46 basis points in
borrowing costs for the same period, as compared to 1995. The increase in
consumer loan yield to 14.76% for the year ended December 31, 1996 from 13.12%
in 1995 principally reflected the 1996 repricing of introductory rate loans,
changes in product mix and the increase in past-due fees charged on delinquent
accounts as noted above. Additionally, the decrease in the average rate paid on
managed interest-bearing liabilities to 5.84% for the year ended December 31,
1996 versus 6.30% for the year ended December 31, 1995, reflected decreases in
short-term market rates from year to year.
Table 4 provides average balance sheet data, an analysis of net
interest income, net interest spread (the difference between the yield on
earning assets and the cost of interest-bearing liabilities) and net interest
margin for each of the years ended December 31, 1997, 1996 and 1995.
Table 4: Statements of Average Balances, Income and Expense, Yields and
Rates
Year Ended December 31
-------------------------------------------------------------------------------------------------
1997 1996 1995
-------------------------------------------------------------------------------------------------
Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/
(Dollars in Thousands) Balance Expense Rate Balance Expense Rate Balance Expense Rate
- ----------------------------------------------------------------------------------------------------------------------------------
Assets:
Earning assets
Consumer loans/(1)/ $4,103,036 $619,785 15.11% $3,651,908 $592,088 16.21% $2,940,208 $397,654 13.52%
Federal funds sold and
resale agreements 293,119 16,423 5.60 394,939 21,293 5.39 453,797 26,832 5.91
Other 1,357,842 81,777 6.02 752,140 47,102 6.26 508,827 32,923 6.47
-------------------------------------------------------------------------------------------------
Total earning assets 5,753,997 $717,985 12.48% 4,798,987 $660,483 13.76% 3,902,832 $457,409 11.72%
-------------------------------------------------------------------------------------------------
Cash and due from banks (2,636) 40,698 9,309
Allowance for loan losses (132,728) (83,573) (69,939)
Premises and equipment, net 181,610 156,441 123,472
Other assets 768,694 656,407 470,381
-------------------------------------------------------------------------------------------------
Total assets $6,568,937 $5,568,960 $4,436,055
- ----------------------------------------------------------------------------------------------------------------------------------
Liabilities and Equity:
Interest-bearing liabilities
Deposits $ 958,885 $ 41,932 4.37% $1,046,122 $56,272 5.38% $769,688 $49,547 6.44%
Other borrowings 631,876 39,066 6.18 454,899 28,509 6.27 1,028,075 66,214 6.44
Senior and deposit notes 3,718,988 253,849 6.83 3,168,205 210,218 6.64 1,924,087 133,635 6.95
-------------------------------------------------------------------------------------------------
Total interest-bearing
liabilities 5,309,749 $334,847 6.31% 4,669,226 $294,999 6.32% 3,721,850 $249,396 6.70%
Other liabilities 345,582 222,975 170,841
-------------------------------------------------------------------------------------------------
Total liabilities 5,655,331 4,892,201 3,892,691
Preferred beneficial interests 89,529
Equity 824,077 676,759 543,364
-------------------------------------------------------------------------------------------------
Total liabilities and equity $6,568,937 $5,568,960 $4,436,055
- ----------------------------------------------------------------------------------------------------------------------------------
Net interest spread 6.17% 7.44% 5.02%
-------------------------------------------------------------------------------------------------
Interest income to average
earning assets 12.48 13.76 11.72
Interest expense to average
earning assets 5.82 6.14 6.39
-------------------------------------------------------------------------------------------------
Net interest margin 6.66% 7.62% 5.33%
- ----------------------------------------------------------------------------------------------------------------------------------
(1) Interest income includes past-due fees on loans of approximately $132,297,
$94,393 and $50,384 for the years ended December 31, 1997, 1996 and 1995,
respectively.
Interest Variance Analysis
Net interest income is affected by changes in the average interest rate earned
on earning assets and the average interest rate paid on interest-bearing
liabilities. In addition, net interest income is affected by changes in the
volume of earning assets and interest-bearing liabilities. Table 5 sets forth
the dollar amount of the increases (decreases) in interest income and interest
expense resulting from changes in the volume of earning assets and
interest-bearing liabilities and from changes in yields and rates.
Table 5: Interest Variance Analysis
Year Ended December 31
-------------------------------------------------------------------------------------
1997 vs. 1996 1996 vs. 1995
------------------------------------------- --------------------------------------
Increase Change Due to/(1)/ Increase Change Due to/(1)/
(In Thousands) (Decrease) Volume Yield/Rate (Decrease) Volume Yield/Rate
- ------------------------------------------------------------------------------------------------------------------------------------
Interest Income:
Consumer loans $27,697 $ 69,924 $(42,227) $194,434 $106,761 $87,673
Federal funds sold and resale agreements (4,870) (5,676) 806 (5,539) (3,297) (2,242)
Other 34,675 36,545 (1,870) 14,179 16,127 (1,948)
-------------------------------------------------------------------------------------
Total interest income 57,502 123,085 (65,583) 203,074 117,398 85,676
-------------------------------------------------------------------------------------
Interest Expense:
Deposits (14,340) (4,422) (9,918) 6,725 15,788 (9,063)
Other borrowings 10,557 10,947 (390) (37,705) (35,967) (1,738)
Senior and deposit notes 43,631 37,446 6,185 76,583 82,799 (6,216)
-------------------------------------------------------------------------------------
Total interest expense 39,848 40,394 (546) 45,603 60,520 (14,917)
-------------------------------------------------------------------------------------
Net interest income/(1)/ $ 17,654 $ 67,129 $(49,475) $157,471 $ 55,920 $101,551
- ------------------------------------------------------------------------------------------------------------------------------------
(1) The change in interest due to both volume and yields/rates has been
allocated in proportion to the relationship of the absolute dollar amounts
of the change in each. The changes in income and expense are calculated
independently for each line in the table. The totals for the volume and
yield/rate columns are not the sum of the individual lines.
Servicing and Securitizations Income
Servicing and securitizations income in 1997 includes gains on sale of consumer
loans recognized under the provisions of SFAS125; the excess of interest and fee
income earned over loan losses and interest paid on investor certificates for
consumer loan balances securitized prior to January 1, 1997 and other fees
earned relating to securitized loans. In absence of new securitization
transactions, once the entire securitized consumer loan portfolio consists of
transfers measured under SFAS 125, the aggregate gains recognized under SFAS 125
will approximate the excess servicing income recognized under the accounting
method used prior to the implementation of SFAS 125. The incremental effect in
1997 of implementing SFAS 125 on servicing and securitizations income was $32.0
million.
The increase in servicing and securitizations income of $222.5 million,
or 48%, to $682.3 million for the year ended December 31, 1997 from $459.8
million for 1996 was due to a number of factors, including the incremental
effect of the implementation of SFAS 125 mentioned above, a 17% increase in
average securitized loans and increases in net interest income and non-interest
income, offset by increased charge-offs on securitized loans. Net interest
income on securitized loans increased $268.1 million, or 41%, for the year ended
December 31, 1997 as compared to the prior year, as a result of loan growth and
an increase in the securitized portfolio's net interest margin to 10.29% for the
year ended December 31, 1997 from 8.51% for 1996. This increase in net interest
margin is the result of an increase in the yield on securitized loans of 196
basis points for the year ended December 31, 1997, which was a result of the
securitization of second generation products and an increase in the amount of
past-due fees charged as a result of both a change in terms and an increase in
the delinquency rate on securitized loans from year to year. Non-interest income
on serviced and securitized loans, excluding the incremental impact of SFAS 125,
increased $199.8 million, or 127%, for the year ended December 31, 1997 from
1996, as a result of loan and account growth, the securitization of second
generation products and changes in the terms of overlimit fees charged.
Charge-offs of securitized loans for the year ended December 31, 1997 increased
$317.7 million, or 92%, compared to 1996 due to the increase in average
securitized loans, continued seasoning of accounts and general economic trends
in consumer credit performance.
Servicing and securitizations income increased $49.9 million, or 12%,
to $459.8 million for the year ended December 31, 1996 from $409.9 million in
1995, primarily due to increases in net interest income on securitized credit
card loans offset by increased charge-offs on such loans. Average securitized
credit card loans increased 24% for the year ended December 31, 1996 compared to
1995. Net interest income on securitized loans increased $226.1 million, or 54%,
to $648.1 million for the year ended December 31, 1996 from $422.0 million for
the year ended December 31, 1995, primarily as a result of loan growth and an
increase in the securitized portfolio's net interest margin to 8.51% in 1996
versus 6.86% in 1995. This increase in net interest margin was the result of an
increase in yield on securitized loans of 114 basis points for the year ended
December 31, 1996, which was a result of repricing introductory rate accounts,
and decreased cost of funds on securitized loans of 51 basis points as
short-term rates declined from the prior year. Charge-offs on securitized loans
for the year ended December 31, 1996 increased $199.9 million, or 138%, compared
to the prior year due to the increase in average securitized loans, worsening
consumer credit and seasoning of the portfolio.
Other Non-Interest Income
Interchange income decreased $2.4 million, or 5%, to $49.0 million for the year
ended December 31, 1997 from $51.4 million in 1996 as a result of the
securitization of a higher percentage of more fee-intensive second generation
products in 1997 compared with 1996.
Other reported non-interest income, excluding interchange, increased to
$337.8 million, or 34%, for the year ended December 31, 1997 compared to $252.2
million for the year ended December 31, 1996. This increase was due to a 33%
increase in the average number of accounts for the year ended December 31, 1997
from 1996 and changes in the terms of overlimit fees charged.
Managed other non-interest income increased $283.0 million, or 61%,
exclusive of the impact resulting from the implementation of SFAS 125, for the
year ended December 31, 1997, primarily due to loan and account growth of second
generation products and changes in the terms of overlimit fees charged.
Other reported non-interest income increased to $303.6 million, or
112%, for the year ended December 31, 1996 compared to $143.1 million for the
year ended December 31, 1995. The increase in other non-interest income was due
to a 30% increase in the average number of accounts for the year ended December
31, 1996 from 1995, an increase in charge volume, a shift to more fee intensive
second generation products and changes in the terms of overlimit fees charged.
Non-Interest Expense
Non-interest expense for the year ended December 31, 1997 increased $170.8
million, or 24%, to $884.0 million from $713.2 million for the year ended
December 31, 1996. Contributing to the increase in non-interest expense was
salaries and associate benefits expense, which increased $74.1 million, or 34%,
to $289.3 million in 1997 compared to $215.2 million in 1996. This increase
reflected additional staff associated with the cost of operations to manage the
growth in accounts and $17.0 million in additional expense associated with the
Company's associate stock plans. Also contributing to the increase in
non-interest expense was marketing expense which increased $18.2 million, or 9%,
to $224.8 million in 1997
from $206.6 million in 1996. Marketing expense represents the cost to select,
print and mail the Company's product offerings to potential and existing
consumers utilizing its IBS and account management techniques. All other non-
interest expenses increased $78.4 million, or 27%, to $369.8 million in 1997
compared to $291.4 million in 1996. The increase in other non-interest expenses
was primarily a result of a 33% increase in the average number of accounts for
the year ended December 31, 1997, which resulted in a corresponding increase in
infrastructure and other operational costs, offset by efficiencies gained from
improved processes and investments in information technology.
[graph omitted]
Non-interest expense for the year ended December 31, 1996 increased
$215.8 million, or 43%, to $713.2 million from $497.4 million for the year ended
December 31, 1995. Contributing to the increase in non-interest expense were
marketing expenses which increased $59.8 million, or 41%, to $206.6 million in
1996 from $146.8 million in 1995. All other non-interest expenses increased
$156.0 million, or 44%, to $506.6 million for the year ended December 31, 1996
from $350.6 million in 1995. The increase in other non-interest expense,
including salaries and associate benefits, was primarily a result of a 30%
increase in the average number of accounts for the year ended December 31, 1996.
Other factors impacting 1996 non-interest expense levels include a product mix
shift to more service-intensive, second generation accounts, additional staff
associated with building infrastructure, an increase in charge volume and an
increase in certain costs associated with information systems enhancements.
The Year 2000 compliance issue, which is common to most companies,
concerns the improper storage and manipulation of date fields within software
applications, systems, databases and hardware. In April 1996, the Company formed
a Year 2000 project team to identify software systems and computer-related
devices that require modification for the Year 2000. A project plan has been
developed, and is well under way, with goals and target dates. The Company
expects to have all systems and applications in place and fully tested by the
end of 1998, allowing time in 1999 for any systems refinements that may be
needed.
The Company could also be affected to the extent that other entities
not affiliated with the Company are impacted by the Year 2000 issue. The Company
has initiated formal communications with its critical third party service
providers to determine the extent to which the Company is vulnerable to those
third parties' failure to remediate their own Year 2000 issues. There is no
guarantee that these other companies will be successful in addressing their Year
2000 issues.
The Company has incurred expenses throughout 1997 and 1996 related to
this project and will continue to incur expenses over the next year. Costs to
modify computer systems have been, and will continue to be, expensed as incurred
and are not expected to have a material impact on the Company's future financial
results or condition.
Income Taxes
The Company's income tax rate was 38% for the year ended December 31, 1997 as
compared to 37.5% for 1996 and includes both state and federal income tax
components.
Asset Quality
The asset quality of a portfolio is generally a function of the initial
underwriting criteria used, seasoning of the accounts, levels of competition,
account management activities and demographic concentration, as well as general
economic conditions. The average age of the accounts is also an important
indicator of the delinquency and loss levels of the portfolio. Accounts tend to
exhibit a rising trend of delinquency and credit losses as they season. As of
December 31, 1997, 53% of managed accounts, representing 43% of the total
managed loan balance, were less than 18 months old. Accordingly, it is likely
that the Company's managed loan portfolio will experience increased levels of
delinquency and credit losses as the average age of the Company's accounts
increases.
Another factor contributing to the expectation of a rising rate of
delinquency and credit losses is a shift in the product mix. As discussed in
"Risk Adjusted Revenue and Margin," certain second generation products have, in
some cases, higher delinquency and higher charge-off rates. In the case of
secured card
loans, collateral, in the form of cash deposits, reduces any ultimate charge-
offs. The costs associated with higher delinquency and charge-off rates are
considered in the pricing of individual products.
During 1997, general economic conditions for consumer credit continued
to worsen as industry levels of charge-offs (including bankruptcies) and
delinquencies both increased. These trends have impacted the Company's 1997
results.
Delinquencies
Table 6 shows the Company's consumer loan delinquency trends for the years
presented as reported for financial statement purposes and on a managed basis.
The entire balance of an account is contractually delinquent if the minimum
payment is not received by the payment due date. However, the Company generally
continues to accrue interest considered to be collectible until the loan is
charged off. Delinquencies not only have the potential to impact earnings if the
account charges off, they also are costly in terms of the personnel and other
resources dedicated to resolving the delinquencies.
The 30-plus day delinquency rate for the reported consumer loan
portfolio decreased to 5.51% as of December 31, 1997, from 6.08% as of December
31, 1996. The decrease in 1997 reported delinquency reflects the modification in
the Company's methodology for charging off credit card loans (net of any
collateral) to 180 days past-due from the prior practice of charging off loans
during the next billing cycle after becoming 180 days past-due. In addition, in
the fourth quarter of 1997, the Company recognized the estimated uncollectible
portion of finance charge and fee income receivables. As of December 31, 1997,
the reported consumer loan portfolio's delinquency rate without these
modifications would have been 6.28%.
The 30-plus day delinquency rate for the managed consumer loan
portfolio was 6.20% as of December 31, 1997, down from 6.24% as of December 31,
1996, while the dollar amount of delinquent managed consumer loans increased
approximately $82.9 million. As of December 31, 1997, the managed consumer loan
portfolio's delinquency rate, without the modifications in charge-off policy and
finance charge and fee income recognition, would have been 6.97%. The managed
consumer loan portfolio's delinquency rate as of December 31, 1997 principally
reflected the continued seasoning of accounts and consumer loan balances, the
increased presence of second generation products, general economic trends in
consumer credit performance and the modifications in charge-off policy and
finance charge and fee income recognition.
Net Charge-Offs
Net charge-offs include the principal amount of losses (excluding accrued and
unpaid finance charges, fees and fraud losses) less current period recoveries.
In the fourth quarter of 1997, the Company
TABLE 6: DELINQUENCIES/(1)/
DECEMBER 31
---------------------------------------------------------------------
1997 1996 1995
---------------------- ---------------------- -----------------------
% of % of % of
Total Total Total
(DOLLARS IN THOUSANDS) Loans Loans Loans Loans Loans Loans
- ----------------------------------------------------------------------------------------------
REPORTED:
Loans outstanding $ 4,861,687 100.00% $ 4,343,902 100.00% $ 2,921,679 100.00%
Loans delinquent:
30-59 days 104,216 2.14 96,819 2.23 65,711 2.25
60-89 days 64,217 1.32 55,679 1.28 38,311 1.31
90 or more days 99,667 2.05 111,791 2.57 79,694 2.73
---------------------------------------------------------------------
Total $ 268,100 5.51% $ 264,289 6.08% $ 183,716 6.29%
- ----------------------------------------------------------------------------------------------
MANAGED:
Loans outstanding $14,231,015 100.00% $12,803,969 100.00% $10,445,480 100.00%
Loans delinquent:
30-59 days 327,407 2.30 279,787 2.19 165,306 1.58
60-89 days 213,726 1.50 162,668 1.27 92,665 .89
90 or more days 340,887 2.40 356,700 2.78 181,243 1.73
---------------------------------------------------------------------
Total $ 882,020 6.20% $ 799,155 6.24% $ 439,214 4.20%
- ----------------------------------------------------------------------------------------------
DECEMBER 31
----------------------------------------------
1994 1993
-------------------- -----------------------
% of % of
Total Total
(DOLLARS IN THOUSANDS) Loans Loans Loans Loans
- --------------------------------------------------------------------------
REPORTED:
Loans outstanding $2,228,455 100.00% $1,862,744 100.00%
Loans delinquent:
30-59 days 29,032 1.30 19,186 1.03
60-89 days 14,741 .66 10,618 .57
90 or more days 24,445 1.10 18,255 .98
----------------------------------------------
Total $ 68,218 3.06% $ 48,059 2.58%
- --------------------------------------------------------------------------
MANAGED:
Loans outstanding $7,378,455 100.00% $4,832,400 100.00%
Loans delinquent:
30-59 days 90,733 1.23 46,391 .96
60-89 days 45,277 .61 25,128 .52
90 or more days 81,720 1.11 43,975 .91
----------------------------------------------
Total $ 217,730 2.95% $ 115,494 2.39%
- --------------------------------------------------------------------------
(1)Includes consumer loans held for securitization.
modified its methodology for charging off credit card loans (net of any
collateral) to 180 days past-due from the prior practice of charging off loans
during the next billing cycle after becoming 180 days past-due. The impact of
this modification was to increase reported and managed charge-offs by $11.5
million and $47.4 million, respectively. For the year ended December 31, 1997,
net charge-offs of managed consumer loans increased 79% while average managed
consumer loans grew 15%. The increase in net charge-offs was the result of
continued seasoning of accounts and consumer loan balances, general economic
trends in consumer credit performance and the modification to the charge-off
policy described above. Table 7 shows the Company's net charge-offs for the
years presented on a reported and managed basis.
For the year ended December 31, 1997, the Company's managed net
charge-offs as a percentage of average managed loans was 6.59% and, without the
modification in charge-off policy, would have been 6.22%.The Company's objective
is to optimize the profitability of each account within acceptable risk
characteristics. The Company takes measures as necessary, including requiring
collateral on certain accounts and other marketing and account management
techniques, to maintain the Company's credit quality standards and to manage the
risk of loss on existing accounts. See "Risk Adjusted Revenue and Margin" for
further discussion.
[graph omitted]
TABLE 7: NET CHARGE-OFFS/(1)/
Year Ended December 31
-----------------------------------------------------------------------
(Dollars in Thousands) 1997 1996 1995 1994 1993
- ------------------------------------------------------------------------------------------------------------------------------------
REPORTED:
Average loans outstanding $ 4,103,036 $ 3,651,908 $2,940,208 $2,286,684 $2,213,378
Net charge-offs 198,192 132,590 59,618 25,727 26,307
Net charge-offs as a percentage of average loans outstanding 4.83% 3.63% 2.03% 1.13% 1.19%
- ------------------------------------------------------------------------------------------------------------------------------------
MANAGED:
Average loans outstanding $13,007,182 $11,268,461 $9,089,278 $6,197,423 $3,265,565
Net charge-offs 856,704 477,732 204,828 91,648 68,332
Net charge-offs as a percentage of average loans outstanding 6.59% 4.24% 2.25% 1.48% 2.09%
- ------------------------------------------------------------------------------------------------------------------------------------
(1) Includes consumer loans held for securitization.
Provision and Allowance for Loan Losses
The provision for loan losses is the periodic expense of maintaining an adequate
allowance at the amount estimated to be sufficient to absorb possible future
losses, net of recoveries (including recovery of collateral), inherent in the
existing on-balance sheet loan portfolio. In evaluating the adequacy of the
allowance for loan losses, the Company takes into consideration several factors
including economic trends and conditions, overall asset quality, loan seasoning
and trends in delinquencies and expected charge-offs. The Company's primary
guideline is a calculation which uses current delinquency levels and other
measures of asset quality to estimate net charge-offs. Consumer loans are
typically charged off (net of any collateral) at 180 days past-due, although
earlier charge-offs may occur on accounts of bankrupt or deceased consumers.
Bankrupt consumers' accounts are generally charged off within 30 days after
receipt of the bankruptcy petition. Once a loan is charged off, it is the
Company's policy to continue to pursue the collection of principal, interest and
fees for non-bankrupt accounts.
Management believes that the allowance for loan losses is adequate to
cover anticipated losses in the on-balance sheet consumer loan portfolio under
current conditions. There can be no assurance as to future credit losses that
may be incurred in connection with the Company's consumer loan portfolio, nor
can there be any assurance that the loan loss allowance that has been
established by the Company will be sufficient to absorb such future credit
losses. The allowance is a general allowance applicable to the on-balance sheet
consumer loan portfolio. Table 8 sets forth the activity in the allowance for
loan losses for the periods indicated. See "Asset Quality," "Delinquencies" and
"Net Charge-Offs" for a more complete analysis of asset quality.
For the year ended December 31, 1997, the provision for loan losses
increased to $262.8 million, or 57%, from the 1996 provision for loan losses of
$167.2 million. The allowance for loan losses as a
Table 8: Summary of Allowance for Loan Losses
Year Ended December 31
-----------------------------------------------------------------
(Dollars in Thousands) 1997 1996 1995 1994 1993
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at beginning of year $ 118,500 $ 72,000 $ 68,516 $ 63,516 $ 55,993
Provision for loan losses 262,837 167,246 65,895 30,727 34,030
Transfer to loans held for securitization (2,770) (27,887) (11,504) (4,869) (2,902)
Increase from consumer loan purchase 9,000
Charge-offs (223,029) (115,159) (64,260) (31,948) (39,625)
Recoveries 27,462 13,300 13,353 11,090 16,020
-----------------------------------------------------------------
Net charge-offs/(1)/ (195,567) (101,859) (50,907) (20,858) (23,605)
-----------------------------------------------------------------
Balance at end of year $ 183,000 $ 118,500 $ 72,000 $ 68,516 $ 63,516
- ------------------------------------------------------------------------------------------------------------------------------------
Allowance for loan losses to loans at end of year/(1)/ 3.76% 2.73% 2.85% 3.07% 3.41%
- ------------------------------------------------------------------------------------------------------------------------------------
(1) Excludes consumer loans held for securitization.
percentage of on-balance sheet consumer loans increased to 3.76% as of December
31, 1997 from 2.73% as of December 31, 1996 primarily due to increases in the
net charge-off rate to 4.83% for 1997 from 3.63% in 1996, resulting from
continued loan seasoning, general economic trends in consumer credit performance
and the modification in charge-off policy described earlier. The provision
increase also reflected the increase in on-balance sheet consumer loans to $4.9
billion as of December 31, 1997, an increase of 12% from December 31, 1996 and
the continued growth of second generation products. In consideration of these
factors, the Company increased the allowance for loan losses by $64.5 million
during 1997.
For the year ended December 31, 1996, the provision for loan losses
increased to $167.2 million, or 154%, from the 1995 provision for loan losses of
$65.9 million. The increase in the provision for loan losses resulted from
increases in average reported consumer loans of 24%, continued loan seasoning, a
shift in the composition of reported consumer loans and general economic trends
in consumer credit performance. Net charge-offs as a percentage of average
reported consumer loans increased to 3.63% for the year ended December 31, 1996
from 2.03% in the prior year. Additionally, growth in second generation
products, which in some cases have modestly higher charge-off rates than first
generation products, increased the amount of provision necessary to absorb
credit losses. In consideration of these factors, the Company increased the
allowance for loan losses by $46.5 million during 1996.
Funding
Table 9 reflects the costs of other borrowings of the Company as of and for each
of the years ended December 31, 1997, 1996 and 1995.
Table 9: Other Borrowings
Maximum
Outstanding as of Outstanding Average Average Year-end
(Dollars In Thousands) Any Month-end as of Year-end Outstanding Interest Rate Interest Rate
- ------------------------------------------------------------------------------------------------------------------------------------
1997
Federal funds purchased and resale agreements $ 999,200 $705,863 $ 503,843 5.54% 5.75%
Other 160,144 90,249 128,033 8.71 7.09
-----------------------------------------------------------
Total $796,112 $ 631,876 6.18% 5.90%
- ------------------------------------------------------------------------------------------------------------------------------------
1996
Federal funds purchased and resale agreements $ 617,303 $445,600 $ 342,354 5.63% 6.26%
Other 207,689 85,383 112,545 8.20 6.43
-----------------------------------------------------------
Total $530,983 $ 454,899 6.27% 6.29%
- ------------------------------------------------------------------------------------------------------------------------------------
1995
Federal funds purchased and resale agreements $1,146,678 $709,803 $ 747,350 6.14% 5.76%
Other 1,000,000 100,000 280,725 7.24 6.03
-----------------------------------------------------------
Total $809,803 $1,028,075 6.44% 5.79%
- ------------------------------------------------------------------------------------------------------------------------------------
Table 10 shows the maturation of certificates of deposit in
denominations of $100,000 or greater (large denomination CDs) as of December 31,
1997.
Table 10: Maturities of Domestic Large Denomination Certificates--$100,000 or
More
December 31, 1997
-----------------------
(Dollars in Thousands) Balance Percent
- -------------------------------------------------------------------
3 months or less $97,363 42.62%
Over 3 through 6 months 43,523 19.06%
Over 6 through 12 months 49,210 21.54%
Over 12 months 38,332 16.78%
-----------------------
Total $228,428 100.00%
In September 1997, the Savings Bank completed the purchase of the
national retail deposit franchise of JCPenney National Bank. Retail deposit
balances acquired under the agreement were approximately $421 million. The chart
on page 31 indicates that during 1997 the Company increased its interest-bearing
deposits to $1.3 billion as of December 31, 1997 from $.9 billion in the prior
year.
In November 1996, the Company entered into a four-year, $1.7 billion
unsecured revolving credit arrangement (the "Credit Facility"). The Credit
Facility is comprised of two tranches: a $1.375 billion Tranche A facility
available to the Bank and the Savings Bank, including an option for up to $225
million in multi-currency availability, and a $325 million Tranche B facility
available to the Corporation, the Bank and the Savings Bank, including an option
for up to $100 million in multi-currency availability. Each tranche under the
facility is structured as a four-year commitment and is available for general
corporate purposes. The borrowings of the Savings Bank are limited to $750
million. All borrowings under the Credit Facility are based on varying terms of
LIBOR. The Bank has irrevocably undertaken to honor any demand by the lenders to
repay any borrowings which are due and payable by the Savings Bank but which
have not been paid. Any borrowings under the Credit Facility will mature on
November 24, 2000; however, the final maturity of each tranche may be extended
for three additional one-year periods. As of December 31, 1997 and 1996, the
Company had no outstandings under the Credit Facility. The unused commitment is
available as funding needs arise.
In August 1997, the Company entered into a three-year, $350 million
equivalent unsecured revolving credit arrangement (the "UK/Canada Facility"),
which will be used to finance the Company's expansion in the United Kingdom and
Canada. The UK/Canada Facility is comprised of two tranches: a Tranche A
facility in the amount of (pound)156.5 million ($249.8 million equivalent based
on the exchange rate at closing) and a Tranche B facility in the amount of
C$139.6 million ($100.2 million equivalent based on the exchange rate at
closing). An amount of (pound)34.6 million or C$76.9 million ($55.2 million
equivalent based on the exchange rates at closing) may be transferred between
the Tranche A facility and the Tranche B facility, respectively, upon the
request of the Company. All borrowings under the UK/Canada Facility are based on
varying terms of LIBOR. Each tranche under the facility is structured as a
three-year commitment and will be available for general corporate purposes. The
Corporation serves as the guarantor of all borrowings under the UK/Canada
Facility. As of December 31, 1997, the Company had no outstandings under the
UK/Canada Facility.
In April 1997, the Bank increased the aggregate amount of bank notes
available under its bank note program. Under the program, the Bank from time to
time may issue up to $7.8 billion of senior bank notes with maturities from
thirty days to thirty years and up to $200 million of subordinated bank notes
(none issued as of December 31, 1997) with maturities from five to thirty years.
As of December 31, 1997, the Company had $3.2 billion in senior bank notes
outstanding, a 10% decrease from $3.6 billion outstanding as of December 31,
1996. As of December 31, 1997, bank notes issued totaling $2.1 billion have
fixed interest rates and mature from one to five years. The Company has entered
into interest rate swap agreements ("swaps") to effectively convert fixed rates
on senior notes to variable rates which match the variable rates earned on
consumer loans (see "Interest Rate Sensitivity").
In October 1997, the Bank established a program for the issuance of
debt instruments to be offered outside of the United States. Under this program,
the Bank from time to time may issue instruments in the aggregate principal
amount of $1.0 billion equivalent outstanding at any one time (none issued as of
December 31, 1997). Instruments under this program may be denominated in any
currency or currencies.
In September 1996, the Corporation filed a $200 million shelf
registration statement ($125 million of senior debt securities issued as of
December 31, 1997) with the Securities and Exchange Commission (the "SEC") under
which the Corporation from time to time may offer and sell (i) senior or
subordinated debt securities consisting of debentures, notes and/or other
unsecured evidences, (ii) preferred stock, which may be issued in the form of
depository shares evidenced by depository receipts and (iii) common stock. The
securities will be limited to $200 million aggregate public offering price or
its equivalent (based on the applicable exchange rate at the time of sale) in
one or more foreign currencies, currency units or composite currencies as shall
be designated by the Corporation.
In April 1996, the Bank established a deposit note program under which
the Bank from time to time may issue up to $2.0 billion of deposit notes with
maturities from thirty days to thirty years. As of December 31, 1997, the
Company had $300 million in deposit notes outstanding.
In January 1997, Capital One Capital I, a subsidiary of the Bank
created as a Delaware statutory business trust, issued $100 million aggregate
amount of Floating Rate Junior Subordinated Capital Income Securities that
mature on February 1, 2027. The securities represent a preferred beneficial
interest in the assets of the trust and qualify as Tier 1 capital at the
Corporation and Tier 2 capital at the Bank. The net proceeds of the offering of
$97.4 million were lent to the Bank for general corporate purposes. As of
December 31, 1997, the interest rate on these securities was 7.30%.
[graph omitted]
The Company's primary source of funding, securitization of consumer
loans, increased to $9.4 billion as of December 31, 1997 from $8.5 billion as of
December 31, 1996. In 1997, the Company securitized $2.1 billion of consumer
loans, consisting predominantly of LIBOR-based, variable-rate deals maturing
from 2001 through 2004.
In January 1996, the Company implemented a dividend reinvestment and
stock purchase plan (the "DRIP") to provide existing stockholders with the
opportunity to purchase additional shares of the Company's common stock by
reinvesting quarterly dividends or making optional cash investments. The Company
uses proceeds from the DRIP for general corporate purposes.
In July 1997, the Company's Board of Directors voted to repurchase up
to two million shares of the Company's common stock over the next two years in
order to mitigate the dilutive impact of shares issuable under its benefit
plans, including its dividend reinvestment and stock purchase plans, associate
stock purchase plan and incentive plans. During 1997, the Company repurchased
1,318,641 shares under this program. Certain treasury shares were reissued in
connection with the Company's benefit plans.
Although the Company expects to reinvest a substantial portion of its
earnings in its business, the Company intends to continue to pay regular
quarterly cash dividends on the Common Stock. The declaration and payment of
dividends, as well as the amount thereof, is subject to the discretion of the
Board of Directors of the Company and will depend upon the Company's results of
operations, financial condition, cash requirements, future prospects and other
factors deemed relevant by the Board of Directors. Accordingly, there can be no
assurance that the Company will declare and pay any dividends. As a holding
company, the ability of the Company to pay dividends is dependent upon the
receipt of dividends or other payments from its subsidiaries. Banking
regulations applicable to the Bank and the Savings Bank and provisions that may
be contained in borrowing agreements of the Company or its subsidiaries may
restrict the ability of the Company's subsidiaries to pay dividends to the
Company or the ability of the Company to pay dividends to its stockholders.
Capital Adequacy
The Bank and the Savings Bank are subject to capital adequacy guidelines adopted
by the Federal Reserve Board (the "Federal Reserve") and the Office of Thrift
Supervision (the "OTS") (collectively, the "regulators"), respectively. The
capital adequacy guidelines and the regulatory framework for prompt corrective
action require the Bank and the Savings Bank to maintain specific capital levels
based upon quantitative measures of their assets, liabilities and off-balance
sheet items as calculated under Regulatory Accounting Principles. The inability
to meet and maintain minimum capital adequacy levels could result in regulators
taking actions that could have a material effect on the Company's consolidated
financial statements. Additionally, the regulators have broad discretion in
applying higher capital requirements. Regulators consider a range of factors in
determining capital adequacy, such as an institution's size, quality and
stability of earnings, interest rate risk exposure, risk diversification,
management expertise, asset quality, liquidity and internal controls.
As of December 31, 1997 and 1996, notifications from the regulators
categorized the Bank and the Savings Bank as "well-capitalized." To be
categorized as "well-capitalized," the Bank and the Savings Bank must maintain
minimum capital ratios as set forth in the table below. As of December 31, 1997,
there are no conditions or events since the notifications discussed above that
management believes have changed either the Bank or the Savings Bank's capital
category. As of December 31, 1997, the Bank and the Savings Bank's ratios of
capital to managed assets were 5.10% and 8.67%, respectively.
Table 11 shows the Bank and Savings Bank's regulatory capital ratios as
of and for the years ended December 31, 1997 and 1996.
Table 11: Regulatory Capital Ratios
To Be "Well-
Capitalized"
Minimum for Under Prompt
Capital Corrective
Adequacy Action
Ratios Purposes Provisions
- --------------------------------------------------------------------------------
December 31, 1997
Capital One Bank
Tier 1 Capital 10.49% 4.00% 6.00%
Total Capital 13.26 8.00 10.00
Tier 1 Leverage 10.75 4.00 5.00
Capital One, F.S.B.(1)
Tangible Capital 11.26% 1.50% 6.00%
Total Capital 17.91 12.00 10.00
Core Capital 11.26 8.00 5.00
- --------------------------------------------------------------------------------
December 31, 1996
Capital One Bank
Tier 1 Capital 11.61% 4.00% 6.00%
Total Capital 12.87 8.00 10.00
Tier 1 Leverage 9.04 4.00 5.00
Capital One, F.S.B.(1)
Tangible Capital 9.18% 1.50% 6.00%
Total Capital 16.29 12.00 10.00
Core Capital 9.18 8.00 5.00
(1) Until June 30, 1999, the Savings Bank is subject to capital requirements
that exceed minimum capital adequacy requirements, including the requirement
to maintain a minimum Core Capital ratio of 8% and a Total Capital ratio of
12%.
During 1996, the Bank received regulatory approval and established a
branch office in the United Kingdom. In connection with such approval, the
Company committed to the Federal Reserve that, for so long as the Bank maintains
such branch in the United Kingdom, the Company will maintain a minimum Tier 1
Leverage ratio of 3.0%. As of December 31, 1997 and 1996, the Company's Tier 1
Leverage ratio was 13.83% and 11.13%, respectively.
Additionally, certain regulatory restrictions exist which limit the
ability of the Bank and the Savings Bank to transfer funds to the Corporation.
As of December 31, 1997, retained earnings of the Bank and the Savings Bank of
$99.6 million and $24.8 million, respectively, were available for payment of
dividends to the Corpo-
[graph omitted]
ration without prior approval by the regulators. The Savings Bank, however, is
required to give the OTS at least thirty days' advance notice of any proposed
dividend and the OTS, in its discretion, may object to such dividend.
Off-Balance Sheet Risk
The Company is subject to off-balance sheet risk in the normal course of
business including commitments to extend credit, excess servicing income from
securitization transactions and swaps. In order to reduce the interest rate
sensitivity and to match asset and liability repricings, the Company has entered
into swaps which involve elements of credit or interest rate risk in excess of
the amount recognized on the balance sheet. Swaps present the Company with
certain credit, market, legal and operational risks. The Company has established
credit policies for off-balance sheet instruments as it does for on-balance
sheet instruments.
Interest Rate Sensitivity
Interest rate sensitivity refers to the change in earnings that may result from
changes in the level of interest rates. To the extent that managed interest
income and managed interest expense do not respond equally to changes in
interest rates, or that all rates do not change uniformly, earnings could be
affected. The Company's managed net interest income is affected by changes in
short-term interest rates, primarily LIBOR, as a result of its issuance of
interest-bearing deposits, variable rate loans and variable rate
securitizations. However, due to the Company's use of swaps, the effects of
these interest rate changes are mitigated. The Company manages its interest rate
sensitivity through several techniques which include, but are not limited to,
changing the maturity and distribution of assets and liabilities, entering into
swaps and repricing of consumer loans.
The Company measures exposure to its interest rate risk through the use
of a simulation model. The model generates a distribution of possible
twelve-month managed net interest income outcomes based on (i) a set of
plausible interest rate scenarios, as determined by management based upon
historical trends and market expectations, (ii) all existing financial
instruments, including swaps, and (iii) an estimate of ongoing business activity
over the coming twelve months. The Company's asset/liability management policy
requires that based on this distribution there be at least a 95% probability
that managed net interest income achieved over the coming twelve months will be
no more than 4% below the mean managed net interest income of the distribution.
As of December 31, 1997, the Company was in compliance with the policy; more
than 95% of the outcomes generated by the model produced a managed net interest
income of no more than 3.3% below the mean outcome. The interest rate scenarios
evaluated as of December 31, 1997 included scenarios in which short-term
interest rates rose by as much as 450 basis points or fell by as much as 250
basis points over twelve months.
Implementation of this policy represents a change from the
asset/liability management policy in place as of December 31, 1996. At that
time, interest rate sensitivity was assessed on the basis of the percent change
in twelve-month managed net interest income for an instantaneous and sustained
100 basis point rate shock applied to an unchanging balance sheet. As of
December 31, 1996, the Company's policy required that such a rate shock not
result in an adverse change of more than 5% in managed net interest income; the
exposure at the time was 2.1%.
The analysis does not consider the effects of the changed level of
overall economic activity associated with various interest rate scenarios.
Further, in the event of a rate change of large magnitude, management would
likely take actions to further mitigate its exposure to any adverse impact. For
example, management may reprice interest rates on outstanding credit card loans
subject to the right of the consumers in certain states to reject such repricing
by giving timely written notice to the Company and thereby relinquishing
charging privileges. However, the repricing of credit card loans may be limited
by competitive factors as well as certain legal constraints.
Interest rate sensitivity at a point in time can also be analyzed by
measuring the mismatch in balances of earning assets and interest-bearing
liabilities that are subject to repricing in future periods. Table 12 reflects
the interest rate repricing schedule for earning assets and interest-bearing
liabilities as of December 31, 1997.
Table 12: Interest Rate Sensitivity
As of December 31, 1997 Subject to Repricing
--------------------------------------------------------------
greater than greater than
Within 180 Days- 1 Year- Over
(Dollars in Millions) 180 days 1 year 5 Years 5 Years
- --------------------------------------------------------------------------------------------------------------------------
Earning assets:
Federal funds sold $ 174
Interest-bearing deposits at other banks 59
Securities available for sale 438 $ 150 $ 604 $ 51
Consumer loans 2,454 213 2,195
--------------------------------------------------------------
Total earning assets 3,125 363 2,799 51
Interest-bearing liabilities:
Interest-bearing deposits 962 168 184
Other borrowings 561 235
Senior and other deposit notes 1,025 250 2,018 340
--------------------------------------------------------------
Total interest-bearing liabilities 2,548 653 2,202 340
Non-rate related assets (595)
--------------------------------------------------------------
Interest sensitivity gap 577 (290) 597 (884)
Impact of swaps 640 (215) 425
Impact of consumer loan securitizations (4,418) 121 4,297
--------------------------------------------------------------
Interest sensitivity gap adjusted for impact of
securitizations and swaps $(3,201) $ (169) $ 4,679 $(1,309)
Adjusted interest sensitivity gap percentage
of managed assets (19.48)% (1.03)% 28.47% (7.97)%
Cumulative interest sensitivity gap $(3,201) $(3,370) $ 1,309
--------------------------------------------------------------
Adjusted cumulative gap as a percentage of managed assets (19.48)% (20.51)% 7.97% 0.00
- --------------------------------------------------------------------------------------------------------------------------
The Company has entered into swaps to effectively convert certain of
the interest rates on bank notes from fixed to variable. The swaps, which had a
notional amount totaling $450 million as of December 31, 1997, will mature in
1998 and 2000 to coincide with maturities of fixed bank notes. In 1997, the
Company entered into swaps with notional amounts totaling $450 million to
effectively offset the swaps described above with matching maturities and terms
which pay fixed and receive variable rates. As of December 31, 1997, the
variable rate payments on the original and offsetting swaps were matched and
will continue to offset each other through maturity. As of December 31, 1997,
the weighted average fixed rate payment received on the original swaps was
7.39%, and the weighted average fixed rate payment paid on the offsetting swaps
was 6.50%.
The Company has also entered into swaps to reduce the interest rate
sensitivity associated with securitizations. The swaps, which had a notional
amount totaling $591 million as of December 31, 1997, will mature in 1998 and
1999 to coincide with the final payments of a 1995 securitization. In 1997, the
Company entered into swaps with notional amounts totaling $591 million to
effectively offset the swaps described above with matching maturities and terms
which pay fixed and receive variable rates. As of December 31, 1997, the
variable rate payments on the original and offsetting swaps were matched and
will continue to offset each other through maturity. As of December 31, 1997,
the weighted average fixed rate payment received on the original swaps was
7.68%, and the weighted average fixed rate payment paid on the offsetting swaps
was 6.52%.
Liquidity
Liquidity refers to the Company's ability to meet its cash needs. The Company
meets its cash requirements by securitizing assets and through issuing debt. As
discussed in "Managed Consumer Loan Portfolio," a significant source of
liquidity for the Company has been the securitization of consumer loans.
Maturity terms of the existing securitizations vary from 1998 to 2004 and
typically have accumulation periods during which principal payments are
aggregated to make payments to investors. As payments on the loans are
accumulated for the participants in the securitization and are no longer
reinvested in new loans, the Company's funding requirements for such new loans
increase accordingly. The occurrence of certain events may cause the
securitization transactions to amortize earlier than scheduled which would
accelerate the need for funding.
Table 13 shows the amounts of investor principal from securitized
consumer loans that will amortize or be otherwise paid over the periods
indicated based on outstanding securitized consumer loans as of January 1, 1998.
As of December 31, 1997 and 1996, 66% of the Company's total managed loans were
securitized.
As such loans amortize or are otherwise paid, the Company believes that
it can securitize consumer loans, purchase federal funds and establish other
funding sources to fund the amortization or other payment of the securitizations
in the future, although no assurance can be given to that effect. Additionally,
the Company maintains a portfolio of high-quality securities such as U.S.
Treasuries and other U.S. government obligations, commercial paper,
interest-bearing deposits with other banks, federal funds and other cash
equivalents in order to provide adequate liquidity and to meet its ongoing cash
needs. As of December 31, 1997, the Company had $1.5 billion of such securities.
Liability liquidity is measured by the Company's ability to obtain
borrowed funds in the financial markets in adequate amounts and at favorable
rates. As of December 31, 1997, the Company, the Bank and the Savings Bank
collectively had over $2.0 billion in unused commitments under its credit
facilities available for liquidity needs.
Table 13: Securitizations--Scheduled Amortization Table
(Dollars in Thousands) 1998 1999 2000 2001 2002-2004
- ---------------------------------------------------------------------------------------------------------------
Balance at beginning of year $ 9,369,328 $7,202,549 $ 6,471,428 $ 4,412,078 $ 872,790
Less repayment amounts (2,166,779) (731,121) (2,059,350) (3,539,288) (872,790)
----------------------------------------------------------------------------
Balance at end of year $ 7,202,549 $6,471,428 $ 4,412,078 $ 872,790 $ --
- ---------------------------------------------------------------------------------------------------------------
Business Outlook
This business outlook section summarizes the Company's expectations for earnings
for the year ending December 31, 1998, and its primary goals and strategies for
continued growth. The statements contained in this section are based on
management's current expectations. Certain of the statements are forward looking
statements and, therefore, actual results could differ materially. Factors which
could materially influence results are set forth throughout this section and in
the Company's Annual Report on Form 10-K for the year ended December 31, 1997
(Part I, Item 1, Cautionary Statements).
The Company has set an earnings target, dependent on the factors set
forth below, for its diluted earnings per share for the year ending December 31,
1998 to increase by more than 20% over its 1997 diluted earnings per share. As
discussed elsewhere in this report and below, the Company's actual earnings are
a function of its revenues (net interest income and non-interest income on its
earning assets), consumer usage and payment patterns, credit quality of its
earning assets (which affects fees and charge-offs), marketing expense and
operating expenses.
Product and Market Opportunities
The Company's strategy for future growth has been, and is expected to continue
to be, to apply its proprietary IBS to its credit card business as well as to
other businesses, both financial and non-financial, to identify new product
opportunities and to make informed investment decisions regarding its existing
products. Historically, credit card opportunities have included, and are
expected to continue to include, various first generation low-rate balance
transfer products, as well as second generation credit card products. In recent
years, the Company's second generation products have been distinguished by
several characteristics, including better response rates, less adverse
selection, higher margins (including fees), lower credit lines, less attrition
and a greater ability to reprice. However, second generation products have also
involved higher operational costs and, in some cases, higher delinquencies and
credit losses than the Company's traditional low rate balance transfer products.
More importantly, these second generation products continue to have overall
higher and less volatile returns than the traditional balance transfer products
in recent market conditions. Additionally, the Company has been applying, and
expects to continue to apply, its IBS to other financial and non-financial
products ("third generation products"). Third generation products and services
include selected non-card consumer lending products and the reselling of
telecommunication services. The Company has also expanded its existing credit
card operations outside of the United States, with an initial focus on the
United Kingdom and Canada. These second and third generation products are
subject to competitive pressures, which management anticipates will increase as
these markets mature.
The Company continues to apply its IBS in an effort to balance the mix
of first and second generation credit card products together with third
generation products and services, to optimize profitability within the context
of acceptable risk. The Company intends to remain flexible in the allocation of
marketing expenses to take advantage of market opportunities as they emerge
based on then current market conditions. As a result, the Company expects to
continue to offer a variety of first, second and third generation products but
the mix of such products in the Company's portfolio may vary significantly over
time. Management believes that, through the continued application of IBS, the
Company can develop product and service offerings in each of its product
generations to sustain growth and that it has the personnel, financial resources
and business strategy necessary for continued success. However, there can be no
assurance that the Company's historical financial information will necessarily
reflect its results of operations and financial condition in the future.
Marketing Investment
The Company anticipates that its 1998 marketing expenses will exceed such
expenses in 1997, as the Company continues to invest in existing and new first
and second generation products and services, and third generation products and
services. As stated above, the Company intends to continue a flexible approach
in its allocation of marketing expenses. The actual amount of marketing
investment is subject to a variety of external and internal factors, such as
competition in the credit card industry, general economic conditions affecting
consumer credit performance, the asset quality of the Company's portfolio and
market opportunities for third generation products. With competition affecting
the profitability of existing first generation products, the Company has been
allocating and expects to continue to allocate a greater portion of its
marketing expense to second and third generation products.
Moreover, the amount of marketing expense allocated to various product
generations will influence the characteristics of the Company's portfolio
because the various product generations are characterized by different account
growth, loan growth and asset quality characteristics. The Company currently
expects that its growth in consumer accounts and in managed consumer loans will
continue in 1998. Actual growth, however, may vary significantly depending on
the Company's actual product mix and the level of attrition on the Company's
managed portfolio, which is affected by competitive pressures.
Impact of Delinquencies, Charge-off Rates and Attrition
The Company's earnings are particularly sensitive to delinquencies and
charge-offs on the Company's portfolio and on the level of attrition due to
competition in the credit card industry. As delinquency levels fluctuate, the
resulting amount of past-due and overlimit fees, which are significant sources
of revenue for the Company, will also fluctuate. Further, the timing of revenues
from increasing or decreasing delinquencies precedes the related revenue impact
of higher or lower charge-offs that ultimately result from varying levels of
delinquencies. Delinquency and net charge-off rates are not only impacted by
general economic trends in consumer credit performance but also by the continued
seasoning of the Company's portfolio and the product mix. Charge-off rates are
also impacted by bankruptcies. The Company's expectations for 1998 earnings are
based on management's belief in a continued increase in revenues, together with
a moderating level of increases in charge-offs and attrition. Management,
however, cautions that delinquency and charge-off levels are not always
predictable and may vary from projections. In addition, competition in the
credit card industry, as measured by the volume of mail solicitations, remains
very high. Increased competition can affect the Company's earnings by increasing
attrition of the Company's outstanding loans (thereby reducing interest and fee
income) and by making it more difficult to retain and attract more profitable
customers.
Cautionary Factors
The Company's strategies and objectives outlined above and the other forward
looking statements contained in this section involve a number of risks and
uncertainties. The Company cautions readers that any forward looking information
is not a guarantee of future performance and that actual results could differ
materially. In addition to the factors discussed above, among the other factors
that could cause actual results to differ materially are the following:
continued intense competition from numerous providers of products and services
which compete with the Company's businesses; with respect to financial products,
changes in the Company's aggregate accounts or consumer loan balances and the
growth rate thereof, including changes resulting from factors such as shifting
product mix, amount of actual marketing expenses made by the Company and
attrition of accounts and loan balances; an increase in credit losses (including
increases due to a worsening of general economic conditions); difficulties or
delays in the development, production, testing and marketing of new products or
services; losses associated with new products or services; financial, legal,
regulatory or other difficulties that may affect investment in, or the overall
performance of, a product or business, including changes in existing laws to
regulate further the credit card and consumer loan industry and the financial
services industry, in general; the amount of, and rate of growth in, the
Company's expenses (including associate and marketing expenses) as the Company's
business develops or changes or as it expands into new market areas; the
availability of capital necessary to fund the Company's new businesses; the
ability of the Company to build the operational and organizational
infrastructure necessary to engage in new businesses or to expand
internationally; the ability of the Company to recruit experienced personnel to
assist in the management and operations of new products and services; and other
factors listed from time to time in the Company's SEC reports, including, but
not limited to, the Annual Report on Form 10-K for the year ended December 31,
1997 (Part I, Item 1, Cautionary Statements).
SELECTED QUARTERLY FINANCIAL DATA
1997 1996
------------------------------------------- -----------------------------------------
Fourth Third Second First Fourth Third Second First
(Unaudited) Quarter/(1)/ Quarter Quarter Quarter Quarter Quarter Quarter Quarter
- -------------------------------------------------------------------------------------------------------------------------
Summary Of Operations:
(In Thousands)
Interest income $203,551 $178,970 $166,870 $168,594 $201,353 $188,235 $137,753 $133,142
Interest expense 89,023 81,816 83,611 80,397 87,784 81,581 63,300 62,334
---------------------------------------------------------------------------------------
Net interest income 114,528 97,154 83,259 88,197 113,569 106,654 74,453 70,808
Provision for loan losses 94,356 72,518 46,776 49,187 63,035 53,933 25,110 25,168
---------------------------------------------------------------------------------------
Net interest income after
provision for loan losses 20,172 24,636 36,483 39,010 50,534 52,721 49,343 45,640
Non-interest income 316,098 280,933 229,042 243,057 214,961 206,716 170,599 171,148
Non-interest expense 242,373 226,003 202,055 213,547 200,575 196,823 159,334 156,450
---------------------------------------------------------------------------------------
Income before income taxes 93,897 79,566 63,470 68,520 64,920 62,614 60,608 60,338
Income taxes 35,680 30,236 24,118 26,038 24,670 23,793 22,425 22,325
---------------------------------------------------------------------------------------
Net income $ 58,217 $ 49,330 $ 39,352 $ 42,482 $ 40,250 $ 38,821 $ 38,183 $ 38,013
=========================================================================================================================
Per Common Share:
Basic earnings/(2)/ $ .89 $ .75 $ .59 $ .64 $ .61 $ .59 $ .58 $ .57
Diluted earnings/(2)/ .86 .73 .58 .63 .60 .58 .57 .57
Dividends .08 .08 .08 .08 .08 .08 .08 .08
Market prices
High 54 3/16 45 3/4 39 7/8 43 5/8 36 5/8 31 7/8 32 1/8 27 7/8
Low 44 1/8 32 13/16 31 3/8 33 1/4 29 7/8 25 7/8 25 21 7/8
=========================================================================================================================
Average common shares (000s) 65,535 66,185 66,428 66,336 66,287 66,250 66,210 66,157
Average common and common
equivalent shares (000s) 67,532 67,574 67,608 67,704 67,275 67,005 66,903 66,726
=========================================================================================================================
Average Balance Sheet Data:
(In Millions)
Consumer loans $ 4,508 $ 3,847 $ 3,997 $ 4,059 $ 4,648 $ 3,955 $ 3,249 $ 2,742
Allowance for loan losses (174) (123) (119) (120) (105) (81) (74) (74)
Securities 1,831 1,690 1,563 1,521 1,164 1,228 933 1,302
Other assets 899 1,143 1,117 939 929 990 793 721
---------------------------------------------------------------------------------------
Total assets $ 7,064 $ 6,557 $ 6,558 $ 6,399 $ 6,636 $ 6,092 $ 4,901 $ 4,691
=========================================================================================================================
Interest-bearing deposits $ 1,172 $ 852 $ 818 $ 993 $ 1,298 $ 1,234 $ 789 $ 859
Other borrowings 823 595 695 411 472 466 349 527
Senior and deposit notes 3,614 3,686 3,769 3,809 3,843 3,435 2,875 2,510
Other liabilities 465 485 380 357 290 259 244 164
Preferred beneficial interests 98 98 98 65
Stockholders' equity 892 841 798 764 733 698 644 631
---------------------------------------------------------------------------------------
Total liabilities and equity $ 7,064 $ 6,557 $ 6,558 $ 6,399 $ 6,636 $ 6,092 $ 4,901 $ 4,691
=========================================================================================================================
The above schedule is a tabulation of the Company's unaudited quarterly results
for the years ended December 31, 1997 and 1996. The Company's common shares are
traded on the New York Stock Exchange under the symbol COF. In addition, shares
may be traded in the over-the-counter stock market. There were 10,585 and
14,562 common stockholders of record as of December 31, 1997 and 1996,
respectively.
(1) Includes the effect of the modifications in charge-off policy and finance
charge and fee income recognition which reduced interest income by $24.4
million and non-interest income by $48.9 million, see Note A to
Consolidated Financial Statements.
(2) The earnings per share amounts for the first three quarters of 1997 and for
1996 have been restated as required to comply with Statement of Financial
Accounting Standards No. 128, Earnings Per Share. For further discussion of
earnings per share and the impact of Statement 128, see Note A to
Consolidated Financial Statements.
Report of Independent Auditors
The Board of Directors and Stockholders
Capital One Financial Corporation
We have audited the accompanying consolidated balance sheets of Capital One
Financial Corporation as of December 31, 1997 and 1996, and the related
consolidated statements of income, changes in stockholders' equity, and cash
flows for each of the three years in the period ended December 31, 1997.
These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Capital One
Financial Corporation at December 31, 1997 and 1996, and the consolidated
results of its operations and its cash flows for each of the three years in
the period ended December 31, 1997, in conformity with generally accepted
accounting principles.
As discussed in Note A to the consolidated financial statements, in 1997
the Company adopted Statement of Financial Accounting Standards No. 125,
"Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities."
/s/ Ernst & Young LLP
Washington, D.C.
January 15, 1998
CONSOLIDATED BALANCE SHEETS
DECEMBER 31
---------------------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) 1997 1996
- ---------------------------------------------------------------------------------------------
ASSETS:
Cash and due from banks $ 5,039 $ 48,724
Federal funds sold and resale agreements 173,500 450,000
Interest-bearing deposits at other banks 59,184 30,252
---------------------------
Cash and cash equivalents 237,723 528,976
Securities available for sale 1,242,670 877,851
Consumer loans 4,861,687 4,343,902
Less: Allowance for loan losses (183,000) (118,500)
---------------------------
Net loans 4,678,687 4,225,402
Premises and equipment, net 162,726 174,661
Interest receivable 51,883 78,590
Accounts receivable from securitizations 588,781 502,520
Other assets 115,809 79,445
---------------------------
Total assets $ 7,078,279 $ 6,467,445
- ---------------------------------------------------------------------------------------------
LIABILITIES:
Interest-bearing deposits $ 1,313,654 $ 943,022
Other borrowings 796,112 530,983
Senior notes 3,332,778 3,694,237
Deposit notes 299,996 299,996
Interest payable 68,448 80,362
Other liabilities 276,368 178,454
---------------------------
Total liabilities 6,087,356 5,727,054
---------------------------
COMMITMENTS AND CONTINGENCIES
GUARANTEED PREFERRED BENEFICIAL INTERESTS
IN CAPITAL ONE BANK'S FLOATING RATE
JUNIOR SUBORDINATED CAPITAL INCOME SECURITIES: 97,664
STOCKHOLDERS' EQUITY:
Preferred stock, par value $.01 per share; authorized
50,000,000 shares, none issued or outstanding
Common stock, par value $.01 per share; authorized
300,000,000 shares, 66,557,230 and 66,325,261
issued as of December 31, 1997 and 1996, respectively 666 663
Paid-in capital, net 513,561 481,383
Retained earnings 427,679 258,345
Less: Treasury stock, at cost; 1,188,134 shares (48,647)
---------------------------
Total stockholders' equity 893,259 740,391
---------------------------
Total liabilities and stockholders' equity $ 7,078,279 $ 6,467,445
- ---------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
CONSOLIDATED STATEMENTS OF INCOME
YEAR ENDED DECEMBER 31
----------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA) 1997 1996 1995
- ------------------------------------------------------------------------------------------------
INTEREST INCOME:
Consumer loans, including fees $ 619,785 $ 592,088 $ 397,654
Federal funds sold and resale agreements 16,423 21,293 26,832
Other 81,777 47,102 32,923
----------------------------------------
Total interest income 717,985 660,483 457,409
----------------------------------------
INTEREST EXPENSE:
Deposits 41,932 56,272 49,547
Other borrowings 39,066 28,509 66,214
Senior and deposit notes 253,849 210,218 133,635
----------------------------------------
Total interest expense 334,847 294,999 249,396
----------------------------------------
Net interest income 383,138 365,484 208,013
Provision for loan losses 262,837 167,246 65,895
----------------------------------------
Net interest income after provision for loan losses 120,301 198,238 142,118
----------------------------------------
NON-INTEREST INCOME:
Servicing and securitizations 682,345 459,833 409,927
Service charges 284,256 218,988 86,029
Interchange 49,030 51,399 33,457
Other 53,499 33,204 23,630
----------------------------------------
Total non-interest income 1,069,130 763,424 553,043
----------------------------------------
NON-INTEREST EXPENSE:
Salaries and associate benefits 289,322 215,155 135,833
Marketing 224,819 206,620 146,810
Communications and data processing 98,135 76,841 61,508
Supplies and equipment 82,874 60,053 42,081
Occupancy 37,548 22,330 13,655
Other 151,280 132,183 97,543
----------------------------------------
Total non-interest expense 883,978 713,182 497,430
----------------------------------------
Income before income taxes 305,453 248,480 197,731
Income taxes 116,072 93,213 71,220
----------------------------------------
Net income $ 189,381 $ 155,267 $ 126,511
- ------------------------------------------------------------------------------------------------
Basic earnings per share $ 2.87 $ 2.34 $ 1.93
- ------------------------------------------------------------------------------------------------
Diluted earnings per share $ 2.80 $ 2.32 $ 1.91
- ------------------------------------------------------------------------------------------------
Dividends paid per share $ .32 $ .32 $ .24
- ------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Common Stock Total
-------------------------- Paid-In Retained Treasury Stockholders'
(Dollars in Thousands, Except Per Share Data) Shares Amount Capital, Net Earnings Stock Equity
- -----------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1994 66,067,250 $661 $462,844 $ 11,052 $474,557
Net income 126,511 126,511
Cash dividends-$.24 per share (15,883) (15,883)
Issuances of common stock 65,645 1 1,256 1,257
Exercise of stock options 6,582 132 132
Tax benefit from stock awards 1,578 1,578
Restricted stock, net 35,090 4,020 4,020
Change in unrealized gains on
securities available for sale,
net of income taxes of $3,780 7,019 7,019
----------------------------------------------------------------------------------------
Balance, December 31, 1995 66,174,567 662 469,830 128,699 599,191
Net income 155,267 155,267
Cash dividends-$.32 per share (20,573) (20,573)
Issuances of common stock 139,858 1 3,108 3,109
Exercise of stock options 11,500 186 186
Tax benefit from stock awards 338 338
Restricted stock, net (664) 193 193
Common stock issuable under
incentive plan 7,728 7,728
Foreign currency translation (132) (132)
Change in unrealized gains on
securities available for sale,
net of income taxes of $2,647 (4,916) (4,916)
----------------------------------------------------------------------------------------
Balance, December 31, 1996 66,325,261 663 481,383 258,345 740,391
Net income 189,381 189,381
Cash dividends-$.32 per share (20,638) (20,638)
Purchases of treasury stock 1,552 $(52,314) (50,762)
Issuances of common stock 101,800 1 2,755 2,201 4,957
Exercise of stock options 130,290 2 2,614 1,466 4,082
Tax benefit from stock awards 379 379
Restricted stock, net (121) 106 106
Common stock issuable under
incentive plan 24,772 24,772
Foreign currency translation 59 59
Change in unrealized gains on
securities available for sale,
net of income taxes of $481 532 532
----------------------------------------------------------------------------------------
Balance, December 31, 1997 66,557,230 $666 $513,561 $427,679 $(48,647) $893,259
===================================================================================================================================
See Notes to Consolidated Financial Statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31
-------------------------------------------
(In Thousands) 1997 1996 1995
- ----------------------------------------------------------------------------------------------------------------
Operating Activities:
Net income $ 189,381 $ 155,267 $ 126,511
Adjustments to reconcile net income to cash
provided by operating activities:
Provision for loan losses 262,837 167,246 65,895
Depreciation and amortization, net 46,550 41,894 33,424
Stock compensation plans 24,878 7,921 4,020
Decrease (increase) in interest receivable 26,707 (23,017) (40,958)
Increase in accounts receivable from securitizations (86,261) (143,141) (122,364)
Increase in other assets (41,469) (24,795) (11,786)
(Decrease) increase in interest payable (11,914) 6,431 64,667
Increase (decrease) in other liabilities 97,914 89,964 (4,780)
-------------------------------------------
Net cash provided by operating activities 508,623 277,770 114,629
-------------------------------------------
Investing Activities:
Purchases of securities available for sale (1,275,900) (947,478) (400,117)
Proceeds from sales of securities available for sale 483,592 773
Proceeds from maturities of securities available for sale 450,787 490,040 100,000
Proceeds from securitization of consumer loans 2,114,695 2,695,000 3,525,000
Net increase in consumer loans (2,858,279) (4,251,269) (4,293,988)
Recoveries of loans previously charged off 27,462 13,300 13,353
Additions of premises and equipment, net (51,602) (74,871) (61,623)
-------------------------------------------
Net cash used for investing activities (1,109,245) (2,074,505) (1,117,375)
-------------------------------------------
Financing Activities:
Net increase in interest-bearing deposits 370,632 246,985 243,836
Net increase (decrease) in other borrowings 265,129 (278,820) (1,230,885)
Issuances of senior and deposit notes 529,977 2,105,864 2,469,869
Maturities of senior notes (891,436) (603,500)
Issuance of preferred beneficial interests 97,428
Proceeds from exercise of stock options 4,082 186 132
Net proceeds from issuances of common stock 4,957 3,109 1,257
Purchases of treasury stock (50,762)
Dividends paid (20,638) (20,573) (15,883)
-------------------------------------------
Net cash provided by financing activities 309,369 1,453,251 1,468,326
-------------------------------------------
(Decrease) increase in cash and cash equivalents (291,253) (343,484) 465,580
-------------------------------------------
Cash and cash equivalents at beginning of year 528,976 872,460 406,880
-------------------------------------------
Cash and cash equivalents at end of year $ 237,723 $ 528,976 $ 872,460
================================================================================================================
See Notes to Consolidated Financial Statements
Notes to Consolidated Financial Statements
(Currencies in Thousands, Except Per Share Data)
Note A: Significant Accounting Policies
Organization and Basis of Presentation
The Consolidated Financial Statements include the accounts of Capital One
Financial Corporation (the "Corporation") and its subsidiaries. The Corporation
is a holding company whose subsidiaries provide a variety of products and
services to consumers. The principal subsidiaries are Capital One Bank (the
"Bank"), which offers credit card products, and Capital One, F.S.B. (the
"Savings Bank"), which provides certain consumer lending and deposit services.
The Corporation and its subsidiaries are collectively referred to as the
"Company."
The accompanying Consolidated Financial Statements have been prepared in
accordance with generally accepted accounting principles ("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. All significant intercompany balances and transactions
have been eliminated. Certain prior years' amounts have been reclassified to
conform to the 1997 presentation.
The following is a summary of the significant accounting policies used in
preparation of the accompanying financial statements.
Cash and Cash Equivalents
Cash and cash equivalents includes cash and due from banks, federal funds sold
and resale agreements and interest-bearing deposits at other banks. Cash paid
for interest for the years ended December 31, 1997, 1996 and 1995, was $346,761,
$288,568 and $184,729, respectively. Cash paid for income taxes for the years
ended December 31, 1997, 1996 and 1995, was $131,052, $107,065 and $82,561,
respectively.
Securities Available for Sale
Debt securities for which the Company does not have the positive intent and
ability to hold to maturity are classified as securities available for sale.
These securities are stated at fair value, with the unrealized gains and losses,
net of tax, reported as a component of retained earnings. 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 other
interest income.
Consumer Loans Held for Securitization
Consumer loans held for securitization are loans which management intends to
securitize, generally within three to six months, and are carried at the lower
of aggregate cost or market value.
Consumer Loans
Interest income is generally recognized until a loan is charged off. The accrued
interest and fee portions of a charged off loan balance are deducted from
current period income with the remaining principal balance charged off against
the allowance for loan losses. In the fourth quarter of 1997, the Company
recognized the estimated uncollectible portion of finance charge and fee income
receivables, which decreased loans and pre-tax income by $50,200. In addition,
in the fourth quarter of 1997, the Company modified its methodology for charging
off credit card loans (net of any collateral) to 180 days past-due, from the
prior practice of charging off loans during the next billing cycle after
becoming 180 days past-due. As a result, pre-tax income was decreased by $23,141
for the reversal of previously accrued finance charges and fee income, and
reported charge-offs were increased by $11,477. Earlier charge-offs may occur on
accounts of bankrupt or deceased consumers. Bankrupt consumers' accounts are
generally charged off within thirty days of receipt of the bankruptcy petition.
Annual membership fees and direct loan origination costs are deferred and
amortized over one year on a straight-line basis. Deferred fees (net of deferred
costs) were $98,619 and $58,059 as of December 31, 1997 and 1996, respectively.
Allowance for Loan Losses
The allowance for loan losses is maintained at the amount estimated to be
sufficient to absorb possible future losses, net of recoveries (including
recovery of collateral), inherent in the existing on-balance sheet loan
portfolio. The provision for loan losses is the periodic cost of maintaining an
adequate allowance. In evaluating the adequacy of the allowance for loan losses,
management takes into consideration several of the following factors: historical
charge-off and recovery activity (noting any particular trend changes over
recent periods); trends in delinquencies; trends in loan volume and size of
credit risks; the degree of risk inherent in the composition of the loan
portfolio; current and anticipated economic conditions; credit evaluations and
underwriting policies.
Securitizations
In June 1996, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 125, "Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities"("SFAS
125"), which was effective January 1, 1997. The Company prospectively adopted
the requirements of SFAS 125 for the securitization of consumer loans. The
incremental effect of applying the new requirements, was to increase servicing
and securitizations income in 1997 by $32,000 ($19,840, net of tax). The Company
records gains or losses on the securitization of consumer loan receivables based
on the estimated fair value of assets obtained and liabilities incurred in the
sale. Gains represent the present value of estimated cash flows the Company has
retained over the estimated outstanding period of the receivables. This excess
cash flow essentially represents an "interest only"("I/O") strip, consisting of
the excess of finance charges and past-due fees over the sum of the return paid
to certificateholders, estimated contractual servicing fees and credit losses.
Certain estimates inherent in the determination of the fair value of the I/O
strip are influenced by factors outside the Company's control, and as a result,
such estimates could materially change in the near term. Prior to 1997, no gains
were recorded due to the relatively short average life of the consumer loans
securitized. Excess servicing fee income was recorded over the life of each sale
transaction.
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation and
amortization ($149,215 and $99,104 as of December 31, 1997 and 1996,
respectively). Depreciation and amortization expense are computed generally by
the straight-line method over the estimated useful lives of the assets.
Marketing
The Company expenses marketing costs as incurred.
Credit Card Fraud Losses
The Company experiences fraud losses from the unauthorized use of credit cards.
Transactions suspected of being fraudulent are charged to non-interest expense
after a sixty-day investigation period.
Income Taxes
Deferred tax assets and liabilities are determined based on differences between
the financial reporting and tax bases of assets and liabilities, and are
measured using the enacted tax rates and laws that will be in effect when the
differences are expected to reverse.
Earnings Per Share
In February 1997, the FASB issued SFAS No. 128, "Earnings per Share" ("SFAS
128"). SFAS 128 replaced the calculation of primary and fully diluted earnings
per share with basic and diluted earnings per share. Unlike primary earnings per
share, basic earnings per share is based only on the weighted average number of
common shares outstanding, excluding any dilutive effects of options and
restricted stock. Diluted earnings per share is similar to the previously
reported fully diluted earnings per share and is based on the weighted average
number of common and common equivalent shares, including dilutive stock options
and restricted stock outstanding during the year. Earnings per share amounts for
all periods have been restated to conform to SFAS 128 requirements.
Interest Rate Swap Agreements
The Company enters into interest rate swap agreements ("swaps") for purposes of
managing its interest rate sensitivity. The Company designates swaps to on-
balance sheet instruments to alter the interest rate characteristics of such
instruments and to modify interest rate sensitivity. The Company also designates
swaps to off-balance sheet items to reduce the interest rate sensitivity
associated with off-balance sheet cash flows (i.e., securitizations).
Swaps involve the periodic exchange of payments over the life of the
agreements. Amounts received or paid on swaps are recorded on an accrual basis
as an adjustment to the related income or expense of the item to which the
agreements are designated. The related amount receivable from counterparties of
$2,771 and $41,548 as of December 31, 1997 and 1996, respectively, was included
in other assets. Changes in the fair value of swaps are not reflected in the
accompanying financial statements, where designated to existing or anticipated
assets or liabilities and where swaps effectively modify or reduce interest rate
sensitivity.
Realized and unrealized gains or losses at the time of maturity,
termination, sale or repayment of a swap or designated item are recorded in a
manner consistent with the original designation of the swap. Amounts are
deferred and amortized as an adjustment to interest expense over the original
period of interest exposure, provided the designated asset or liability
continues to exist or is probable of occurring. Realized and unrealized changes
in fair value of swaps, designated with items that no longer exist or are no
longer probable of occurring, are recorded as a component of the gain or loss
arising from the disposition of the designated item.
The Company's credit exposure on swaps is limited to the value of the swaps
that have become favorable to the Company in the event of nonperformance by the
counterparties. Under the terms of certain swaps, each party may be required to
pledge collateral if the market value of the swaps exceeds an amount set forth
in the agreement or in the event of a change in its credit rating. The Company
actively monitors the credit ratings of counterparties and does not anticipate
nonperformance by the counterparties with which it transacts its swaps.
Note B: Securities Available for Sale
Securities available for sale as of December 31, 1997 and 1996 were
as follows:
Maturity Schedule
------------------------------------------------------------------------------------
Market Amortized
1 Year 1-5 5-10 Over 10 Value Cost
or Less Years Years Years Totals Totals
---------------------------------------------------------------------------------------------------------------------------------
December 31, 1997
Commercial paper $187,145 $ 187,145 $ 187,145
U.S. Treasury and other U.S. government
agency obligations 400,929 $589,899 $2,506 993,334 989,707
Collateralized mortgage obligations $18,969 18,969 18,629
Mortgage backed securities 13,278 9,960 23,238 22,966
Other 330 526 19,128 19,984 20,008
------------------------------------------------------------------------------------
$588,074 $603,507 $3,032 $48,057 $1,242,670 $1,238,455
---------------------------------------------------------------------------------------------------------------------------------
December 31, 1996
Commercial paper $ 84,297 $ 84,297 $ 84,297
U.S. Treasury and other U.S. government
agency obligations 393,583 $354,680 748,263 745,174
Collateralized mortgage obligations $20,834 20,834 20,479
Mortgage backed securities 11,607 11,607 11,849
Other 12,850 12,850 12,850
------------------------------------------------------------------------------------
$477,880 $354,680 $45,291 $ 877,851 $ 874,649
---------------------------------------------------------------------------------------------------------------------------------
Weighted Average Yields
-------------------------------------------------------------
1 Year 1-5 5-10 Over 10
or Less Years Years Years
--------------------------------------------------------------------------------------------------------
December 31, 1997
Commercial paper 6.05%
U.S. Treasury and other U.S. government
agency obligations 6.79 6.24% 8.69%
Collateralized mortgage obligations 6.96%
Mortgage backed securities 5.17 7.03
Other 6.03 6.39 6.22
-------------------------------------------------------------
6.55% 6.21% 8.29% 6.70%
--------------------------------------------------------------------------------------------------------
Securities available for sale as of December 31, 1995 consisted of U.S.
government agency obligations with an amortized cost of $402,250.
Note C: Allowance for Loan Losses
The following is a summary of changes in the allowance for loan losses:
Year Ended December 31
1997 1996 1995
- -------------------------------------------------------------------------------
Balance at beginning of year $ 118,500 $ 72,000 $ 68,516
Provision for loan losses 262,837 167,246 65,895
Transfer to loans held for
securitization (2,770) (27,887) (11,504)
Increase from consumer
loan purchase 9,000
Charge-offs (223,029) (115,159) (64,260)
Recoveries 27,462 13,300 13,353
--------------------------------------------
Net charge-offs (195,567) (101,859) (50,907)
--------------------------------------------
Balance at end of year $ 183,000 $ 118,500 $ 72,000
- -------------------------------------------------------------------------------
Note D: Borrowings
Borrowings as of December 31, 1997 and 1996 were as follows:
1997 1996
--------------------- ---------------------
Weighted Weighted
Average Average
Outstanding Rate Outstanding Rate
- ----------------------------------------------------------------------------
Interest-
bearing
deposits $1,313,654 4.49% $ 943,022 4.31%
- ----------------------------------------------------------------------------
Other
borrowings
Federal funds
purchased and
resale agreements $ 705,863 5.75% $ 445,600 6.26%
Other 90,249 7.09 85,383 6.43
- ----------------------------------------------------------------------------
Total $ 796,112 $ 530,983
- ----------------------------------------------------------------------------
Senior notes
Bank--fixed rate $2,793,778 7.03% $3,140,237 7.31%
Bank--variable rate 414,000 6.19 429,000 5.99
Corporation 125,000 7.25 125,000 7.25
Total $3,332,778 $3,694,237
- ----------------------------------------------------------------------------
Deposit notes
Fixed rate $224,996 6.71% $224,996 6.71%
Variable rate 75,000 6.15 75,000 5.86
============================================================================
Total $299,996 $299,996
- ----------------------------------------------------------------------------
As of December 31, 1997, the aggregate amount of interest-bearing
deposits with accounts exceeding $100 was $228,428. In September 1997, the
Savings Bank completed the purchase of the national retail deposit franchise of
JCPenney National Bank. Retail deposit balances acquired under the agreement
were approximately $421,000.
In November 1996, the Company entered into a four-year, $1,700,000
unsecured revolving credit arrangement (the "Credit Facility"). The Credit
Facility is comprised of two tranches: a $1,375,000 Tranche A facility available
to the Bank and the Savings Bank, including an option for up to $225,000 in
multi-currency availability, and a $325,000 Tranche B facility available to the
Corporation, the Bank and the Savings Bank, including an option for up to
$100,000 in multi-currency availability. Each tranche under the facility is
structured as a four-year commitment and is available for general corporate
purposes. The borrowings of the Savings Bank are limited to $750,000. All
borrowings under the Credit Facility are based on varying terms of the London
InterBank Offered Rate ("LIBOR"). The Bank has irrevocably undertaken to honor
any demand by the lenders to repay any borrowings which are due and payable by
the Savings Bank but which have not been paid. Any borrowings under the Credit
Facility will mature on November 24, 2000; however, the final maturity of each
tranche may be extended for three additional one-year periods. As of December
31, 1997 and 1996, the Company had no outstandings under the Credit Facility.
In August 1997, the Company entered into a three-year, $350,000
equivalent unsecured revolving credit arrangement (the "UK/Canada Facility"),
which will be used to finance the Company's expansion in the United Kingdom and
Canada. The UK/Canada Facility is comprised of two tranches: a Tranche A
facility in the amount of (pound)156,458 ($249,800 equivalent based on the
exchange rate at closing) and a Tranche B facility in the amount of C$139,609
($100,200 equivalent based on the exchange rate at closing). An amount of
(pound)34,574 or C$76,910 ($55,200 equivalent based on the exchange rates at
closing) may be transferred between the Tranche A facility and the Tranche B
facility, respectively, upon the request of the Company. Each tranche under the
facility is structured as a three-year commitment and will be available for
general corporate purposes. All borrowings under the UK/Canada Facility are
based on varying terms of LIBOR. The Corporation serves as the guarantor of all
borrowings under the UK/Canada Facility. As of December 31, 1997, the Company
had no outstandings under the UK/Canada Facility.
In April 1997, the Bank increased the aggregate amount of bank notes
available under its bank note program. Under the program, the Bank from time to
time may issue up to $7,800,000 of senior bank notes with maturities from thirty
days to thirty years and up to $200,000 of subordinated bank notes (none issued
as of December 31, 1997 and 1996) with maturities from five to thirty years.
In October 1997, the Bank established a program for the issuance of debt
instruments to be offered outside of the United States. Under this program, the
Bank from time to time may issue instruments in the aggregate principal amount
of $1,000,000 equivalent outstanding at any one time (none issued as of December
31, 1997). Instruments under this program may be denominated in any currency or
currencies.
In September 1996, the Corporation filed a $200,000 shelf registration
statement ($125,000 of senior debt securities issued as of December 31, 1997)
with the Securities and Exchange Commission under which the Corporation from
time to time may offer and sell (i) senior or subordinated debt securities,
consisting of debentures, notes and/or other unsecured evidences, (ii) preferred
stock, which may be issued in the form of depository shares evidenced by
depository receipts and (iii) common stock. The securities will be limited to a
$200,000 aggregate public offering price or its equivalent (based on the
applicable exchange rate at the time of sale) in one or more foreign currencies,
currency units or composite currencies as shall be designated by the
Corporation.
In April 1996, the Bank established a deposit note program under which
the Bank from time to time may issue up to $2,000,000 of deposit notes with
maturities from thirty days to thirty years.
In January 1997, Capital One Capital I, a subsidiary of the Bank created
as a Delaware statutory business trust, issued $100,000 aggregate amount of
Floating Rate Junior Subordinated Capital Income Securities that mature on
February 1, 2027. The securities represent a preferred beneficial interest in
the assets of the trust. The net proceeds of the offering of $97,428 were lent
to the Bank for general corporate purposes. As of December 31, 1997, the
interest rate on these securities was 7.30%.
The Company has entered into swaps to effectively convert certain
interest rates on bank notes from fixed to variable. The swaps, which had a
notional amount totaling $450,000 as of December 31, 1997, will mature in 1998
and 2000 to coincide with maturities of fixed bank notes. In 1997, the Company
entered into swaps with notional amounts totaling $450,000 to effectively offset
the swaps described above with matching maturities and terms which pay fixed and
receive variable rates. As of December 31, 1997, the variable rate payments on
the original and offsetting swaps were matched and will continue to offset each
other through maturity. As of December 31, 1997, the weighted average fixed rate
payment received on the original swaps was 7.39%, and the weighted average fixed
rate payment paid on the offsetting swaps was 6.50%.
As of December 31, 1996, swaps with a notional amount totaling $974,000,
with maturity dates from 1997 through 2000, paid three-month LIBOR at a weighted
average contractual rate of 5.59% and received a weighted average fixed rate of
7.71%. In 1995, the Bank entered into basis swaps (notional amounts totaling
$260,000) to effectively convert bank notes, with a variable rate based on six-
month LIBOR to a variable rate based on three-month LIBOR. These swaps and bank
notes matured in 1996.
Interest-bearing deposits, senior notes and deposit notes as of December
31, 1997, mature as follows (all other borrowings mature in 1998):
Interest-Bearing
Deposits Senior Notes Deposit Notes Total
- -----------------------------------------------------------------------------
1998 $1,129,742 $ 918,166 $299,996 $2,347,904
1999 95,901 789,978 885,879
2000 48,979 649,614 698,593
2001 4,898 523,114 528,012
2002 34,134 112,000 146,134
Thereafter 339,906 339,906
-----------------------------------------------------------------
Total $1,313,654 $3,332,778 $299,996 $4,946,428
- -----------------------------------------------------------------------------
Note E: Associate Benefit Plans
The Company sponsors a contributory Associate Savings Plan in which
substantially all full-time and certain part-time associates are eligible to
participate. The Company matches a portion of associate contributions and makes
discretionary contributions based upon the Company meeting a certain earnings
per share target. The Company's contributions to this plan were $10,264, $9,048
and $2,701 for the years ended December 31, 1997, 1996 and 1995, respectively.
Effective January 1, 1996, the Company is required to make additional
contributions for pay-based credits for eligible associates which were
previously provided under the Cash Balance Pension Plan.
Through December 31, 1995, the Company provided its associate pension
benefits through the Cash Balance Pension Plan and postretirement medical
coverage and life insurance benefits through the Associate Welfare Benefits
Plan. Effective December 31, 1995, the Company amended the Cash Balance Pension
Plan so that no future pay-based credits will accrue. Future pay-based credits
will accrue to the Associate Savings Plan discussed above. Neither the remaining
obligations under the Cash Balance Pension Plan nor the obligations under the
unfunded Associate Welfare Benefits Plan were material to the Company's
financial statements.
Note F: Stock Plans
The Company has three stock-based compensation plans which are described below.
The Company applies Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees" ("APB 25") and related Interpretations in accounting
for its stock-based compensation plans. In accordance with APB 25, no
compensation cost has been recognized for the Company's fixed stock options,
since the exercise price equals the market price of the underlying stock on the
measurement date of grant, nor for the stock purchase plan, which is considered
to be noncompensatory.
For the performance-based option plans discussed below, compensation cost is
measured as the difference between the exercise price and the target stock price
required for vesting and is recognized over the estimated vesting period.
SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123")
requires, for companies electing to continue to follow the recognition
provisions of APB 25, pro forma information regarding net income and earnings
per share, as if the recognition provisions of SFAS 123 were adopted for stock
options granted subsequent to December 31, 1994. For purposes of pro forma
disclosure, the fair value of the options was estimated at the date of grant
using a Black-Scholes option-pricing model with the following weighted-average
assumptions and is amortized to expense over the options' vesting period.
For the Years Ended December 31
Assumptions 1997 1996 1995
- -----------------------------------------------------------------------------
Dividend yield .82% .90% .90%
Volatility factors of expected
market price of stock 40% 32% 33%
Risk-free interest rate 6.27% 5.90% 6.30%
Expected option lives (in years) 4.5 6.0 4.0
Pro Forma Information
- -----------------------------------------------------------------------------
Net income $186,003 $151,853 $125,296
Basic earnings per share $ 2.82 $ 2.29 $ 1.91
Diluted earnings per share $ 2.74 $ 2.27 $ 1.89
- -----------------------------------------------------------------------------
Under the 1994 Stock Incentive Plan, the Company has reserved 7,370,880
common shares as of December 31, 1997 and 1996 (5,370,880 as of December 31,
1995) for issuance in the form of incentive stock options, nonstatutory stock
options, stock appreciation rights, restricted stock and incentive stock. The
exercise price of each stock option issued to date equals the market price of
the Company's stock on the date of grant. The option's maximum term is ten
years. The number of shares available for future grants was 97,814; 1,508,352
and 2,061,640 as of December 31, 1997, 1996 and 1995, respectively. Other than
the performance-based options discussed below, options generally vest annually
over three to five years and expire beginning November 2004 and all options vest
immediately upon a change in control. The restrictions on restricted stock (of
which 23,215 shares were issued in 1995 at the then fair value of $16.75 per
share) expire annually over three years.
In December 1997, the Company's Board of Directors approved a compensation
program under which senior management was given the opportunity to forego future
cash compensation in exchange for stock options. Under this program, the
Company's Chairman and Chief Executive Officer and its President and Chief
Operating Officer have agreed to forego all salary and any benefits under the
Associate Stock Purchase Plan (the "Purchase Plan"), Associate Savings Plan, and
the Company's unfunded excess savings plan benefits from 1998 through 2000 in
exchange for a one-time option grant. The options granted to these top two
executives are target stock price performance-based options to purchase a total
of 685,755 shares. These options will vest if the fair market value of the
common stock remains at or above $84.00 for at least ten trading days in any
thirty consecutive calendar day period by the third anniversary of the grant
date (December 18, 2000). In the event that these options do not meet this
vesting criteria on or before December 18, 2000, the options will terminate. In
addition, substantially all of the Company's top managers elected to forego a
portion of their annual cash bonuses and Associate Savings Plan benefits for the
next three years in exchange for options. Under this program, certain key
managers received target stock price performance-based options to purchase
457,466 shares with the same vesting provisions as the grant to the Company's
top two executives. In addition, other senior managers received fixed options to
purchase 223,900 shares, which vest in full on the third anniversary of the date
of grant. The above option grants provide for the purchase of common shares at
the December 18, 1997 market price of $48.75 per share. All of these awards are
subject to stockholder approval at the Company's next annual meeting of an
increase in shares available for issuance under the 1994 Stock Incentive Plan in
sufficient number to accommodate these awards.
In April 1996, stockholders approved an increase of 2,000,000 in shares
available for issuance under the 1994 Stock Incentive Plan. With this approval,
a September 15, 1995 grant to the Company's Chairman and Chief Executive Officer
and its President and Chief Operating Officer became effective. This grant was
for target stock price performance-based options to purchase 2,500,000 common
shares at the September 15, 1995 market price of $29.19 per share. Vesting of
the options was dependent on the fair market value of the common stock remaining
at or above specified levels for at least ten trading days in any thirty
consecutive calendar day period. Fifty percent of the options vested in January
1997 when the Company's stock reached $37.50 per share; 25% vested in October
1997 when the stock reached $43.75 per share; the remaining 25% vested in
January 1998 when the stock reached $50.00 per share. The Company recognized
$24,772 and $7,728 of compensation cost for these options for the years ended
December 31, 1997 and 1996, respectively.
In April 1995, the Company adopted the 1995 Non-associate Directors Stock
Incentive Plan. This plan authorizes a maximum of 500,000 shares of the
Company's common stock for the automatic grant of restricted stock and stock
options to eligible members of the Company's Board of Directors. As of December
31, 1997, 1996 and 1995, 382,500; 417,500 and 452,500 shares were available for
grant under this plan, respectively. The options vest after one year and their
maximum term is ten years. Restrictions on the restricted stock (of which 12,500
shares were issued in 1995 at the then fair value of $19.88 per share) expired
in 1996. The exercise price of each option equals the market price of the
Company's stock on the date of grant.
A summary of the status of the Company's options as of December 31, 1997,
1996 and 1995, and changes for the years then ended is presented below
(excluding the December 1997 grants subject to stockholder approval):
1997 1996 1995
------------------------ ------------------------ -------------------------
Weighted- Weighted- Weighted-
Average Average Average
Options Exercise Price Options Exercise Price Options Exercise Price
(000s) Per Share (000s) Per Share (000s) Per Share
- -----------------------------------------------------------------------------------------------------------------------------------
Outstanding at beginning of year 5,894 $23.92 3,315 $19.67 2,036 $16.00
Granted 1,590 40.88 2,694 29.04 1,361 25.08
Exercised (215) 20.76 (12) 16.40 (6) 16.00
Canceled (144) 30.16 (103) 21.82 (76) 18.25
-----------------------------------------------------------------------------------
Outstanding at end of year 7,125 $27.67 5,894 $23.92 3,315 $19.67
- -----------------------------------------------------------------------------------------------------------------------------------
Exercisable at end of year 3,815 $24.43 1,196 $18.98 454 $16.00
- -----------------------------------------------------------------------------------------------------------------------------------
Weighted-average fair value of options
granted during the year $16.03 $11.22 $ 8.19
------ ------ ------
The following table summarizes information about options outstanding as of
December 31, 1997:
Options Outstanding Options Exercisable
------------------------------------------------ -------------------------------
Number Weighted-Average Weighted-Average Number Weighted-Average
Range of Outstanding Remaining Exercise Price Exercisable Exercise Price
Exercise Prices (000s) Contractual Life Per Share (000s) Per Share
- --------------------------------------------------------------------------------------------------------------------------------
$16.00-$24.99 2,240 6.93 years $16.52 1,406 $16.38
$25.00-$33.99 3,352 7.73 29.08 2,409 29.13
$34.00-$47.99 1,533 9.52 40.90
Under the Company's Purchase Plan, associates of the Company are eligible to
purchase common stock through monthly salary deductions of a maximum of 15% and
a minimum of 1% of monthly base pay. The amounts deducted are applied to the
purchase of unissued common or treasury stock of the Company at 85% of the
current market price. An aggregate of 1,000,000 common shares have been
authorized for issuance under the Purchase Plan, of which 682,427; 822,001 and
934,355 shares were available for issuance as of December 31, 1997, 1996 and
1995, respectively.
Pursuant to a Marketing and Management Services Agreement between Signet Bank
(which has since been acquired by First Union Bank on November 30, 1997) and
Fairbank Morris, Inc. ("FMI"), a corporation controlled by members of the
Company's executive management, 464,400 shares of restricted stock, at the then
fair value of $16.00 per share, were awarded to FMI for services rendered for
the period from January 1, 1994 to December 31, 1995. In connection with this
award, $3,715 in compensation cost was recognized in 1995. The restrictions on
this stock expired on November 15, 1995, one year after the grant date.
On November 16, 1995, the Board of Directors of the Company declared a
dividend distribution of one Right for each outstanding share of common stock.
Each Right entitles a registered holder to purchase from the Company one one-
hundredth of a share of the Company's authorized Cumulative Participating Junior
Preferred Stock (the "Junior Preferred Shares") at a price of $150, subject to
adjustment. The Company has reserved 1,000,000 shares of its authorized
preferred stock for the Junior Preferred Shares. Because of the nature of the
Junior Preferred Shares' dividend and liquidation rights, the value of the one
one-hundredth interest in a Junior Preferred Share purchasable upon exercise of
each Right should approximate the value of one share of common stock. Initially,
the Rights are not exercisable and trade automatically with the common stock.
However, the Rights generally become exercisable and separate certificates
representing the Rights will be distributed, if any person or group acquires 15%
or more of the Company's outstanding common stock or a tender offer or exchange
offer is announced for the Company's common stock. The Rights expire on November
29, 2005, unless earlier redeemed by the Company at $0.01 per Right prior to the
time any person or group acquires 15% of the outstanding common stock. Until the
Rights become exercisable, the Rights have no dilutive effect on earnings per
share.
In July 1997, the Company's Board of Directors voted to repurchase up to two
million shares of the Company's common stock over the next two years in order to
mitigate the dilutive impact of shares issuable under its benefit plans,
including its Purchase Plan, dividend reinvestment and stock purchase plans and
other incentive plans. During 1997, the Company repurchased 1,318,641 shares
under this program. Certain treasury shares were reissued in connection with the
Company's benefit plans.
Note G: Other Non-Interest Expense
Year Ended December 31
1997 1996 1995
- --------------------------------------------------------------------------------
Professional services $ 47,671 $ 43,968 $28,787
Collections 23,216 9,783 7,193
Fraud losses 16,749 26,773 27,721
Bankcard association
assessments 16,074 15,045 13,116
Other 47,570 36,614 20,726
---------------------------------
Total $151,280 $132,183 $97,543
- --------------------------------------------------------------------------------
Note H: Income Taxes
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax assets and liabilities as of December 31, 1997 and
1996 were as follows:
December 31
1997 1996
- --------------------------------------------------------------------------------
Deferred tax assets:
Allowance for loan losses $ 60,900 $41,475
Finance charge and fee income receivables 17,570
Stock incentive plan 11,466 2,758
Unearned membership fees 5,600 310
State taxes, net of federal benefit 2,694
Other 11,290 7,232
- --------------------------------------------------------------------------------
Total deferred tax assets 109,520 51,775
Deferred tax liabilities:
Securitizations 26,822
Service charge accrual 10,167 5,368
Deferred issuance and replacement costs 4,442 3,119
Depreciation 4,235 2,546
Other 456 542
--------------------------
Total deferred tax liabilities 46,122 11,575
- --------------------------------------------------------------------------------
Net deferred tax assets before unrealized
gains on securities available for sale 63,398 40,200
Unrealized gains on securities available for sale (1,602) (1,121)
--------------------------
Net deferred tax assets $ 61,796 $39,079
- --------------------------------------------------------------------------------
Significant components of the provision for income taxes attributable to
continuing operations were as follows:
Year Ended December 31
1997 1996 1995
- --------------------------------------------------------------------------------
Federal taxes $138,877 $119,027 $63,162
State taxes 393 1,715 600
Deferred income taxes (23,198) (27,529) 7,458
----------------------------------------
Income taxes $116,072 $ 93,213 $71,220
- --------------------------------------------------------------------------------
The reconciliation of income tax attributable to continuing operations
computed at the U.S. federal statutory tax rate to income tax expense was:
Year Ended December 31
1997 1996 1995
- --------------------------------------------------------------------------------
Income tax at statutory
federal tax rate 35.00% 35.00% 35.00%
Other, primarily state taxes 3.00 2.50 1.00
----------------------------------
Income taxes 38.00% 37.50% 36.00%
- --------------------------------------------------------------------------------
Note I: Earnings Per Share
The following table sets forth the computation of basic and diluted earnings per
share:
Year Ended December 31
(Shares in Thousands) 1997 1996 1995
- --------------------------------------------------------------------------------
Numerator:
Net income $189,381 $155,267 $126,511
- --------------------------------------------------------------------------------
Denominator:
Denominator for basic earnings
per share--
Weighted-average shares 66,070 66,228 65,691
- --------------------------------------------------------------------------------
Effect of dilutive securities:
Stock options 1,578 790 391
Restricted stock 3 8 310
- --------------------------------------------------------------------------------
Dilutive potential
common shares 1,581 798 701
Denominator for diluted
earnings per share--
Adjusted weighted-average shares 67,651 67,026 66,392
------------------------------------------
Basic earnings per share $ 2.87 $ 2.34 $ 1.93
- --------------------------------------------------------------------------------
Diluted earnings per share $ 2.80 $ 2.32 $ 1.91
- --------------------------------------------------------------------------------
For additional disclosures regarding the outstanding stock options and
restricted stock, see Note F.
Options to purchase 949,484; 20,725 and 829,855 shares of common stock
during 1997, 1996 and 1995, respectively, at prices ranging from $23.38 to
$47.94 per share, were not included in the computation of diluted earnings per
share because the options' exercise prices were greater than the average market
price of the common shares and, therefore, their inclusion would be
antidilutive.
Note J: Regulatory Matters
The Bank and the Savings Bank are subject to capital adequacy guidelines adopted
by the Federal Reserve Board (the "Federal Reserve") and the Office of Thrift
Supervision (the "OTS") (collectively, the "regulators"), respectively. The
capital adequacy guidelines and the regulatory framework for prompt corrective
action require the Bank and the Savings Bank to maintain specific capital levels
based upon quantitative measures of their assets, liabilities and off-balance
sheet items as calculated under Regulatory Accounting Principles. The inability
to meet and maintain minimum capital adequacy levels could result in regulators
taking actions that could have a material effect on the Company's consolidated
financial statements. Additionally, the regulators have broad discretion in
applying higher capital requirements. Regulators consider a range of factors in
determining capital adequacy, such as an institution's size, quality and
stability of earnings, interest rate risk exposure, risk diversification,
management expertise, asset quality, liquidity and internal controls.
As of December 31, 1997 and 1996, notifications from the regulators
categorized the Bank and the Savings Bank as "well-capitalized." To be
categorized as "well-capitalized," the Bank and the Savings Bank must maintain
minimum capital ratios as set forth in the table below. As of December 31, 1997,
there were no conditions or events since the notifications discussed above that
management believes would have changed either the Bank or the Savings Bank's
capital category.
Minimum for To Be "Well-
Capital Capitalized" Under
Adequacy Prompt Corrective
Ratios Purposes Action Provisions
- --------------------------------------------------------------------------------
December 31, 1997
Capital One Bank
Tier 1 Capital 10.49% 4.00% 6.00%
Total Capital 13.26 8.00 10.00
Tier 1 Leverage 10.75 4.00 5.00
Capital One, F.S.B.(1)
Tangible Capital 11.26% 1.50% 6.00%
Total Capital 17.91 12.00 10.00
Core Capital 11.26 8.00 5.00
- --------------------------------------------------------------------------------
December 31, 1996
Capital One Bank
Tier 1 Capital 11.61% 4.00% 6.00%
Total Capital 12.87 8.00 10.00
Tier 1 Leverage 9.04 4.00 5.00
Capital One, F.S.B.(1)
Tangible Capital 9.18% 1.50% 6.00%
Total Capital 16.29 12.00 10.00
Core Capital 9.18 8.00 5.00
- --------------------------------------------------------------------------------
(1) Until June 30, 1999, the Savings Bank is subject to capital requirements
that exceed minimum capital adequacy requirements, including the requirement
to maintain a minimum Core Capital ratio of 8% and a Total Capital ratio of
12%.
During 1996, the Bank received regulatory approval and established a branch
office in the United Kingdom. In connection with such approval, the Company
committed to the Federal Reserve that, for so long as the Bank maintains such
branch in the United Kingdom, the Company will maintain a minimum Tier 1
Leverage ratio of 3.0%. As of December 31, 1997 and 1996, the Company's Tier 1
Leverage ratio was 13.83% and 11.13%, respectively.
Additionally, certain regulatory restrictions exist which limit the ability
of the Bank and the Savings Bank to transfer funds to the Corporation. As of
December 31, 1997, retained earnings of the Bank and the Savings Bank of $99,600
and $24,800, respectively, were available for payment of dividends to the
Corporation without prior approval by the regulators. The Savings Bank, however,
is required to give the OTS at least thirty days' advance notice of any proposed
dividend and the OTS, in its discretion, may object to such dividend.
Note K: Commitments and Contingencies
As of December 31, 1997, the Company had outstanding lines of credit of
approximately $33,800,000 committed to its customers. Of that total commitment,
approximately $19,600,000 was unused. While this amount represented the total
available lines of credit to customers, the Company has not experienced and does
not anticipate that all of its customers will exercise their entire available
line at any given point in time. The Company has the right to increase, reduce,
cancel, alter or amend the terms of these available lines of credit at any time.
Certain premises and equipment are leased under agreements that expire at
various dates through 2006, without taking into consideration available renewal
options. Many of these leases provide for payment by the lessee of property
taxes, insurance premiums, cost of maintenance and other costs. In some cases,
rentals are subject to increase in relation to a cost of living index. Total
rental expense amounted to $13,644, $12,603 and $5,394 for the years ended
December 31, 1997, 1996 and 1995, respectively.
Future minimum rental commitments as of December 31, 1997 for all non-
cancelable operating leases with initial or remaining terms of one year or more
are as follows:
- --------------------------------------------------------------------------------
1998 $15,362
1999 13,881
2000 12,720
2001 8,388
2002 3,298
Thereafter 4,798
---------
Total $58,447
- --------------------------------------------------------------------------------
In connection with the transfer of substantially all of Signet Bank's
credit card business to the Bank in November 1994, the Company and the Bank
agreed to indemnify Signet Bank for certain liabilities incurred in litigation
arising from that business, which may include liabilities, if any, incurred in
the purported class action case described below.
During 1995, the Company and the Bank became involved in a purported class
action suit relating to certain collection practices engaged in by Signet Bank
and, subsequently, by the Bank. The complaint in this case alleges that Signet
Bank and/or the Bank violated a variety of California state statutes and
constitutional and common law duties by filing collection lawsuits, obtaining
judgments and pursuing garnishment proceedings in the Virginia state courts
against defaulted credit card customers who were not residents of Virginia. This
case was filed in the Superior Court of California in the County of Alameda,
Southern Division, on behalf of a class of California residents. The complaint
in this case seeks unspecified statutory damages, compensatory damages, punitive
damages, restitution, attorneys' fees and costs, a permanent injunction and
other equitable relief.
In February 1997, the California court entered judgment in favor of the
Bank on all of the plaintiffs' claims. The plaintiffs have appealed the ruling
to the California Court of Appeal First Appellate District Division 4, and the
appeal is pending.
Because no specific measure of damages is demanded in the complaint of the
California case and the trial court entered judgement in favor of the Bank
before the parties completed any significant discovery, an informed assessment
of the ultimate outcome of this case cannot be made at this time. Management
believes, however, that there are meritorious defenses to this lawsuit and
intends to defend it vigorously.
The Company is commonly subject to various other pending and threatened
legal actions arising from the conduct of its normal business activities. In the
opinion of management, the ultimate aggregate liability, if any, arising out of
any pending or threatened action will not have a material adverse effect on the
consolidated financial condition of the Company. At the present time, however,
management is not in a position to determine whether the resolution of pending
or threatened litigation will have a material effect on the Company's results of
operations in any future reporting period.
Note L: Related Party Transactions
In the ordinary course of business, executive officers and directors of the
Company may have consumer loans issued by the Company. Pursuant to the Company's
policy, such loans are issued on the same terms as those prevailing at the time
for comparable loans to unrelated persons and do not involve more than the
normal risk of collectability.
Note M: Securitizations
The Company securitized $2,114,695, $2,695,000 and $3,525,000 of consumer loan
receivables in 1997, 1996 and 1995, respectively. As of December 31, 1997,
receivables under securitizations outstanding consisted of $1,257,869 of
retained ("seller's") interests and $9,369,328 of investors' undivided
interests, maturing from 1998 to 2004.The gains on securitizations and other
income from securitizations are included in servicing and securitizations
income.
The Company has entered into swaps to reduce the interest rate sensitivity
associated with these securitizations. The swaps, which had a notional amount
totaling $591,000 as of December 31, 1997, will mature in 1998 and 1999 to
coincide with the final payment of a 1995 securitization. In 1997, the Company
entered into swaps with notional amounts totaling $591,000 to effectively offset
the swaps described above with matching maturities and terms which pay fixed and
receive variable rates. As of December 31, 1997, the variable rate payments on
the original and offsetting swaps were matched and will continue to offset each
other through maturity. As of December 31, 1997, the weighted average fixed rate
payment received on the original swaps was 7.68%, and the weighted average fixed
rate payment paid on the offsetting swaps was 6.52%.
As of December 31, 1996, swaps with a notional amount totaling $1,130,000,
with maturity dates from 1997 through 1999, paid three-month LIBOR at a weighted
average contractual rate of 5.55% and received a weighted average fixed rate of
7.23%.
The terms of securitizations require the Company to maintain a certain
level of assets, retained by the trust, to absorb potential credit losses. The
amount available to absorb potential credit losses was included in accounts
receivable from securitization and was $231,809 and $266,813 as of December 31,
1997 and 1996, respectively.
Note N: Significant Concentration of Credit Risk
The Company is active in originating consumer loans primarily in the United
States. The Company reviews each potential customer's credit application and
evaluates the applicant's financial history and ability and willingness to
repay. Loans are made primarily on an unsecured basis; however, certain loans
require collateral in the form of cash deposits. Foreign denominated consumer
loans are included in the "Other" geographic region loan category. The
geographic distribution of the Company's consumer loans was as follows:
Year Ended December 31
- --------------------------------------------------------------------------------
1997 1996
- --------------------------------------------------------------------------------
Geographic
Region: Loans % Loans %
- --------------------------------------------------------------------------------
South $ 5,061,414 35.57% $ 4,615,596 36.05%
West 3,361,556 23.62 3,277,717 25.60
Northeast 2,835,256 19.92 2,465,237 19.25
Midwest 2,533,469 17.80 2,386,918 18.64
Other 439,320 3.09 58,501 .46
- --------------------------------------------------------------------------------
14,231,015 100.00% 12,803,969 100.00%
Less securitized
balances (9,369,328) (8,460,067)
-----------------------------------------------------
Total loans $ 4,861,687 $ 4,343,902
- --------------------------------------------------------------------------------
Note O: Disclosures About Fair Value of Financial Instruments
The following discloses the fair value of financial instruments as of December
31, 1997 and 1996, whether or not recognized in the balance sheets, for which it
is practical to estimate fair value. In cases where quoted market prices are not
available, fair values are based on estimates using present value or other
valuation techniques. Those techniques are significantly affected by the
assumptions used, including the discount rate and estimates of future cash
flows. In that regard, the derived fair value estimates cannot be substantiated
by comparison to independent markets and, in many cases, could not be realized
in immediate settlement of the instrument. As required under GAAP, these
disclosures exclude certain financial instruments and all nonfinancial
instruments. Accordingly, the aggregate fair value amounts presented do not
represent the underlying value of the Company.
The following methods and assumptions were used by the Company in
estimating the fair value as of December 31, 1997 and 1996, for its financial
instruments:
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 approximated fair value.
Securities Available for Sale
The fair value of securities available for sale was determined using current
market prices. See Note B.
Consumer Loans
The net carrying amount of consumer loans, including the Company's seller's
interest in securitized consumer loan receivables, approximated fair value due
to the relatively short average life and variable interest rates on a
substantial number of these loans. This amount excluded any value related to
account relationships.
Interest Receivable
The carrying amount approximated fair value.
Borrowings
The carrying amounts of interest-bearing deposits, other borrowings and deposit
notes approximated fair value. The fair value of senior notes was $3,351,000 and
$3,722,000 as of December 31, 1997 and 1996, respectively, determined based on
quoted market prices.
Interest Payable
The carrying amount approximated fair value.
Swaps
The fair value was the estimated amount that the Company would have received to
terminate the swaps at the respective dates, taking into account the forward
yield curve. As of December 31, 1997 and 1996, the estimated fair value was
$5,800 and $32,700, respectively.
Note P: Capital One Financial Corporation (Parent Company Only) Condensed
Financial Information
December 31
Balance Sheets 1997 1996
- -------------------------------------------------------------------------------
Assets:
Cash and cash equivalents $ 203 $ 16,073
Investment in subsidiaries 818,518 748,365
Loans to subsidiaries 207,507(1) 105,000
Other 5,001 2,333
-----------------------------
Total assets $1,031,229 $ 871,771
- -------------------------------------------------------------------------------
Liabilities:
Senior notes $ 125,000 $ 125,000
Other 12,970 6,380
- -------------------------------------------------------------------------------
Total liabilities 137,970 131,380
Stockholders' Equity: 893,259 740,391
Total liabilities and stockholders' equity $1,031,229 $ 871,771
- -------------------------------------------------------------------------------
(1) As of December 31, 1997, includes $143,500 of cash invested at the Bank
instead of the open market.
Year Ended December 31
Statements of Income 1997 1996 1995
- -------------------------------------------------------------------------------
Interest from temporary
investments $ 11,352 $ 2,296 $ 560
Interest expense 11,067 3,013
Dividends, principally from
bank subsidiaries 228,000 117,400 11,000
Non-interest income 56
Non-interest expense 409 571 456
- -------------------------------------------------------------------------------
Income before income taxes
and equity in undistributed
earnings of subsidiaries 227,932 116,112 11,104
Income taxes (25) (490) 37
- -------------------------------------------------------------------------------
227,957 116,602 11,067
Equity in undistributed
earnings of subsidiaries (38,576) 38,665 115,444
-----------------------------------------
Net income $ 189,381 $ 155,267 $ 126,511
- -------------------------------------------------------------------------------
Year Ended December 31
Statements of Cash Flows 1997 1996 1995
- --------------------------------------------------------------------------------
Operating Activities:
Net income $ 189,381 $ 155,267 $ 126,511
Adjustments to reconcile net
income to net cash provided
by operating activities:
Equity in undistributed
earnings of subsidiaries 38,576 (38,665) (115,444)
Amortization of deferred
compensation 62 4,020
(Increase) decrease in
other assets (2,183) 2,017 (3,161)
Increase (decrease) in
other liabilities 6,590 6,380 (1,054)
- --------------------------------------------------------------------------------
Net cash provided by
operating activities 232,364 125,061 10,872
Investing Activities:
Increase in investment in
subsidiaries (83,366) (119,502) (2,470)
Increase in loans to
subsidiaries (102,507) (105,000)
- --------------------------------------------------------------------------------
Net cash used for investing
activities (185,873) (224,502) (2,470)
Financing Activities:
Proceeds from issuances of
common stock 4,957 3,109 1,257
Proceeds from exercise of
stock options 4,082 186 132
Issuance of senior notes 125,000
Purchases of treasury stock (50,762)
Dividends paid (20,638) (20,573) (15,883)
-------------------------------------------
Net cash (used for) provided
by financing activities (62,361) 107,722 (14,494)
(Decrease) increase in cash
and cash equivalents (15,870) 8,281 (6,092)
Cash and cash equivalents
at beginning of year 16,073 7,792 13,884
-------------------------------------------
Cash and cash equivalents
at end of year $ 203 $ 16,073 $ 7,792
- --------------------------------------------------------------------------------