form10q.htm
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
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x
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
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For the quarterly period ended September 30, 2010
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OR
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¨
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
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For the transition period from _____ to ______
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Commission File No. 1-13300
_______________________________
CAPITAL ONE FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
_______________________________
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Delaware
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54-1719854
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(State or Other Jurisdiction of Incorporation or Organization)
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(I.R.S. Employer Identification No.)
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1680 Capital One Drive, McLean, Virginia
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22102
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(Address of Principal Executive Offices)
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(Zip Code)
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Registrant’s telephone number, including area code:
(703) 720-1000
(Not applicable)
(Former name, former address and former fiscal year, if changed since last report)
_______________________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
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Large accelerated filer T
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Accelerated filer o
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Non-accelerated filer o
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Smaller reporting company o
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Indicate by check mark whether the registrant is a Shell Company (as defined in Rule 12b-2 of the Exchange Act) Yes o No T
As of October 31, 2010, there were 456,926,449 shares of the registrant’s Common Stock, par value $.01 per share, outstanding.
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Item 2.
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1
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I.
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1
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II.
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4
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III.
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6
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IV.
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9
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V.
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11
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VI.
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12
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VII.
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12
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VIII.
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18
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IX.
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34
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X.
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42
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XI.
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45
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XII.
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46
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XIV.
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48
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XV.
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52
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XVI.
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52
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XVII.
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54
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Item 3.
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116
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Item 4.
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116
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116
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Item 1.
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116
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Item 1A.
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116
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Item 2.
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116
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Item 3.
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117
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Item 5.
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117
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Item 6.
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117
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118
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119
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INDEX OF MD&A TABLES AND SUPPLEMENTAL TABLES
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Table
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Description
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Page
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—
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MD&A Tables:
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1
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Consolidated Corporate Financial Summary and Selected Metrics
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2
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2
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Business Segment Results
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3
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3
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Net Interest Income
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13
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4
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Rate/Volume Analysis of Net Interest Income—Reported
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14
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5
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Rate/Volume Analysis of Net Interest Income—Reported 2010 vs. Managed 2009
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15
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6
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Non-Interest Income
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16
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7
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Non-Interest Expense
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17
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8
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Investment Securities
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19
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9
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Loan Portfolio Composition
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21
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10
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30+ Day Performing Delinquencies
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22
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11
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Aging of 30+ Day Delinquent Loans
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23
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12
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90+ Days Delinquent Loans Accruing Interest
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24
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13
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Nonperforming Loans and Other Nonperforming Assets
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25
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14
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Net Charge-Offs
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26
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15
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Loan Modifications and Restructurings
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27
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16
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Summary of Allowance for Loan and Lease Losses
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29
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17
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Allocation of the Allowance for Loan and Lease Losses
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30
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18
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Original Principal Balance of Mortgage Loans Originated and Sold to Third Parties
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32
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19
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Changes in Representation and Warranty Reserves
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33
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20
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Allocation of Representation and Warranty Reserves
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33
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21
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Credit Card Business Results
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35
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22
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Commercial Banking Business Results
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39
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23
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Consumer Banking Business Results
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41
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24
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Liquidity Reserves
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43
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25
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Deposits
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43
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26
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Borrowing Capacity
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44
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27
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Interest Rate Sensitivity Analysis
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46
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28
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Risk-Based Capital Components
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47
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29
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Capital Ratios
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47
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—
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Supplemental Statistical Table:
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A
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Statements of Average Balances, Income and Expense, Yields and Rates
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54
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PART I—FINANCIAL INFORMATION
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
You should read this Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) in conjunction with our unaudited condensed consolidated financial statements and related notes, and the more detailed information contained in our 2009 Annual Report on Form 10-K (“2009 Form 10-K”). This discussion contains forward-looking statements that are based upon management’s current expectations and are subject to significant uncertainties and changes in circumstances. For additional information, see “Forward-Looking Statements” below. Our actual results may differ materially from those included in these forward-looking statements due to a variety of factors including, but not limited to, those described in this report in “Part II —Item 1A. Risk Factors” and in our 2009 Form 10-K in “Part I—Item 1A. Risk Factors.”
Capital One Financial Corporation (the “Company”) is a diversified financial services company with banking and non-banking subsidiaries that market a variety of financial products and services. The Company and its subsidiaries are hereafter collectively referred to as “we”, “us” or “our.” We continue to deliver on our strategy of combining the power of national scale lending and local scale banking. Our principal subsidiaries include:
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·
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Capital One Bank (USA), National Association (“COBNA”) which currently offers credit and debit card products, other lending products and deposit products.
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·
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Capital One, National Association (“CONA”) which offers a broad spectrum of banking products and financial services to consumers, small businesses and commercial clients. On July 30, 2009, we merged Chevy Chase Bank, F.S.B. (“Chevy Chase Bank”) into CONA.
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CONA and COBNA are hereafter collectively referred to as the “Banks.”
Our revenues are primarily driven by lending to consumers and commercial customers and by deposit-taking activities, which generate net interest income, and by activities that generate non-interest income, including the sale and servicing of loans and providing fee-based services to customers. Customer usage and payment patterns, credit quality, levels of marketing expense and operating efficiency all affect our profitability. Our expenses primarily consist of the cost of funding our assets, our provision for loan and lease losses, operating expenses (including associate salaries and benefits, infrastructure maintenance and enhancements, and branch operations and expansion costs), marketing expenses and income taxes. We had $126.3 billion in total loans outstanding and $119.2 billion in deposits as of September 30, 2010, compared with $136.8 billion in total managed loans outstanding and $115.8 billion in deposits as of December 31, 2009.
We prepare our consolidated financial statements using generally accepted accounting principles in the U.S. (“U.S. GAAP”). We refer to the presentation as “reported basis.” Effective January 1, 2010, we prospectively adopted two new accounting standards that resulted in the consolidation of a substantial portion of our securitization trusts. Prior to January 1, 2010, we also presented and analyzed our results on a non-GAAP “managed basis.” Our managed basis presentation assumed that loans that had been securitized and accounted for as sold in accordance with U.S. GAAP remained on our consolidated balance sheets. As a result of the adoption of the new consolidation accounting standards, our reported and managed basis presentations are generally comparable for periods beginning after January 1, 2010. We provide more information on the impact from the adoption of the new consolidation accounting standards on our reported financial statements and our non-GAAP managed basis financial results below under “Impact from Adoption of New Consolidation Accounting Standards.”
Table 1 presents selected consolidated financial data and metrics for the three and nine months ended September 30, 2010 and 2009, and as of September 30, 2010 and 2009. We present both reported and managed basis financial information for periods prior to 2010.
Table 1: Consolidated Corporate Financial Summary and Selected Metrics
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Three Months Ended September 30,
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Nine Months Ended September 30,
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2010
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2009
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Change
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2010
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2009(1)
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Change
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(Dollars in millions)
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Reported
|
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|
Reported
|
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Managed
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Reported
|
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|
Managed
|
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|
Reported
|
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|
Reported
|
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|
Managed
|
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Reported
|
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|
Managed
|
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Income statement data:
|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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Net interest income
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|
$ |
3,109 |
|
|
$ |
2,005 |
|
|
$ |
3,212 |
|
|
|
55 |
% |
|
|
(3 |
)% |
|
$ |
9,434 |
|
|
$ |
5,743 |
|
|
$ |
8,919 |
|
|
|
64 |
% |
|
|
6 |
% |
|
Non-interest income
|
|
|
907 |
|
|
|
1,553 |
|
|
|
1,373 |
|
|
|
(42 |
) |
|
|
(34 |
) |
|
|
2,775 |
|
|
|
3,874 |
|
|
|
3,548 |
|
|
|
(28 |
) |
|
|
(22 |
) |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
Total revenue(2)
|
|
|
4,016 |
|
|
|
3,558 |
|
|
|
4,585 |
|
|
|
13 |
|
|
|
(12 |
) |
|
|
12,209 |
|
|
|
9,617 |
|
|
|
12,467 |
|
|
|
27 |
|
|
|
(2 |
) |
|
Provision for loan and lease losses
|
|
|
867 |
|
|
|
1,173 |
|
|
|
2,200 |
|
|
|
(26 |
) |
|
|
(61 |
) |
|
|
3,069 |
|
|
|
3,386 |
|
|
|
6,236 |
|
|
|
(9 |
) |
|
|
(51 |
) |
|
Non-interest expense(3)
|
|
|
1,996 |
|
|
|
1,802 |
|
|
|
1,802 |
|
|
|
11 |
|
|
|
11 |
|
|
|
5,843 |
|
|
|
5,469 |
|
|
|
5,469 |
|
|
|
7 |
|
|
|
7 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from continuing operations before taxes
|
|
|
1,153 |
|
|
|
583 |
|
|
|
583 |
|
|
|
98 |
|
|
|
98 |
|
|
|
3,297 |
|
|
|
762 |
|
|
|
762 |
|
|
|
333 |
|
|
|
333 |
|
|
Provision for income taxes
|
|
|
335 |
|
|
|
146 |
|
|
|
146 |
|
|
|
129 |
|
|
|
129 |
|
|
|
948 |
|
|
|
179 |
|
|
|
179 |
|
|
|
430 |
|
|
|
430 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from continuing operations, net of tax
|
|
|
818 |
|
|
|
437 |
|
|
|
437 |
|
|
|
87 |
|
|
|
87 |
|
|
|
2,349 |
|
|
|
583 |
|
|
|
583 |
|
|
|
303 |
|
|
|
303 |
|
|
Loss from discontinued operations, net of tax(4)
|
|
|
(15 |
) |
|
|
(43 |
) |
|
|
(43 |
) |
|
|
(65 |
) |
|
|
(65 |
) |
|
|
(303 |
) |
|
|
(75 |
) |
|
|
(75 |
) |
|
|
304 |
|
|
|
304 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$ |
803 |
|
|
$ |
394 |
|
|
$ |
394 |
|
|
|
104 |
% |
|
|
104 |
% |
|
$ |
2,046 |
|
|
$ |
508 |
|
|
$ |
508 |
|
|
|
303 |
% |
|
|
303 |
% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) available to common shareholders
|
|
$ |
803 |
|
|
$ |
394 |
|
|
$ |
394 |
|
|
|
104 |
% |
|
|
104 |
% |
|
$ |
2,046 |
|
|
$ |
(56 |
) |
|
$ |
(56 |
) |
|
|
** |
|
|
|
** |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Per common share data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic earnings per share
|
|
$ |
1.78 |
|
|
$ |
0.88 |
|
|
$ |
0.88 |
|
|
|
102 |
% |
|
|
102 |
% |
|
$ |
4.53 |
|
|
$ |
(0.13 |
) |
|
$ |
(0.13 |
) |
|
|
** |
|
|
|
** |
|
|
Diluted earnings per share
|
|
|
1.76 |
|
|
|
0.87 |
|
|
|
0.87 |
|
|
|
102 |
|
|
|
102 |
|
|
|
4.49 |
|
|
|
(0.13 |
) |
|
|
(0.13 |
) |
|
|
** |
|
|
|
** |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average balances:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans held for investment
|
|
$ |
126,307 |
|
|
$ |
99,354 |
|
|
$ |
143,540 |
|
|
|
27 |
% |
|
|
(12 |
)% |
|
$ |
129,565 |
|
|
$ |
101,491 |
|
|
$ |
145,311 |
|
|
|
28 |
% |
|
|
(11 |
)% |
|
Investment securities
|
|
|
39,872 |
|
|
|
37,377 |
|
|
|
37,377 |
|
|
|
7 |
|
|
|
7 |
|
|
|
38,979 |
|
|
|
36,378 |
|
|
|
36,378 |
|
|
|
7 |
|
|
|
7 |
|
|
Interest-bearing deposits
|
|
|
104,186 |
|
|
|
103,105 |
|
|
|
103,105 |
|
|
|
1 |
|
|
|
1 |
|
|
|
104,119 |
|
|
|
103,730 |
|
|
|
103,730 |
|
|
|
- |
|
|
|
- |
|
|
Total deposits
|
|
|
118,255 |
|
|
|
115,882 |
|
|
|
115,882 |
|
|
|
2 |
|
|
|
2 |
|
|
|
118,095 |
|
|
|
115,939 |
|
|
|
115,939 |
|
|
|
2 |
|
|
|
2 |
|
|
Other borrowings
|
|
|
6,483 |
|
|
|
8,553 |
|
|
|
8,553 |
|
|
|
(24 |
) |
|
|
(24 |
) |
|
|
6,932 |
|
|
|
9,205 |
|
|
|
9,205 |
|
|
|
(25 |
) |
|
|
(25 |
) |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selected metrics:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue margin(5)
|
|
|
9.31 |
% |
|
|
9.80 |
% |
|
|
9.87 |
% |
|
(49
|
)bps |
|
(56
|
)bps |
|
|
9.23 |
% |
|
|
8.79 |
% |
|
|
8.90 |
% |
|
44
|
bps |
|
33
|
bps |
|
Net interest margin(6)
|
|
|
7.21 |
|
|
|
5.52 |
|
|
|
6.91 |
|
|
|
169 |
|
|
|
30 |
|
|
|
7.13 |
|
|
|
5.25 |
|
|
|
6.37 |
|
|
|
188 |
|
|
|
76 |
|
|
Risk-adjusted margin(7)
|
|
|
5.78 |
|
|
|
6.69 |
|
|
|
5.23 |
|
|
|
(91 |
) |
|
|
55 |
|
|
|
5.26 |
|
|
|
5.70 |
|
|
|
4.45 |
|
|
|
(44 |
) |
|
|
81 |
|
|
Net charge-off rate(8)
|
|
|
4.82 |
|
|
|
4.54 |
|
|
|
6.00 |
|
|
|
28 |
|
|
|
(118 |
) |
|
|
5.41 |
|
|
|
4.44 |
|
|
|
5.72 |
|
|
|
97 |
|
|
|
(31 |
) |
|
Return on average assets(9)
|
|
|
1.66 |
|
|
|
1.01 |
|
|
|
0.81 |
|
|
|
65 |
|
|
|
85 |
|
|
|
1.56 |
|
|
|
0.45 |
|
|
|
0.36 |
|
|
|
111 |
|
|
|
120 |
|
|
Return on average equity(10)
|
|
|
12.93 |
|
|
|
6.72 |
|
|
|
6.72 |
|
|
|
621 |
|
|
|
621 |
|
|
|
12.78 |
|
|
|
2.92 |
|
|
|
2.92 |
|
|
|
986 |
|
|
|
986 |
|
|
Period-end 30+ day performing delinquency rate
|
|
|
3.71 |
|
|
|
4.12 |
|
|
|
4.55 |
|
|
|
(41 |
) |
|
|
(84 |
) |
|
|
3.71 |
|
|
|
4.12 |
|
|
|
4.55 |
|
|
|
(41 |
) |
|
|
(84 |
) |
______________
|
(1)
|
Effective February 27, 2009, we acquired Chevy Chase Bank. Accordingly, our results for the first nine months of 2009 include only a partial impact from Chevy Chase Bank.
|
|
(2)
|
The estimated uncollectible portion of billed finance charges and fees, which were not recognized as revenue, totaled $190 million and $517 million for the three months ended September 30, 2010 and 2009, respectively, and $805 million and $1.6 billion for the nine months ended September 30, 2010 and 2009, respectively.
|
|
(3)
|
In 2009, we completed the restructuring of our operations that was initiated in 2007 to reduce expenses and improve our competitive cost position. Non-interest expense includes restructuring expenses totaling $26 million for the three months ended September 30, 2009, and $87 million for the nine months ended September 30, 2009.
|
|
(4)
|
Discontinued operations reflect ongoing costs, which primarily consist of mortgage loan repurchase representation and warranty charges, related to the mortgage origination operations of Greenpoint and its wholesale mortgage banking unit, GreenPoint Mortgage Funding, Inc. (“GreenPoint”) which we closed in 2007.
|
|
(5)
|
Calculated by dividing annualized revenues for the period by average earning assets for the period.
|
|
(6)
|
Calculated by dividing annualized net interest income for the period by average interest-earning assets.
|
|
(7)
|
Calculated by dividing annualized total revenues less net charge-offs for the period by average interest-earning assets.
|
|
(8)
|
Calculated by dividing annualized net charge-offs for the period by average loans held for investment during the period.
|
|
(9)
|
Calculated by dividing annualized net income (loss) available to common stockholders for the period by average total assets.
|
|
(10)
|
Calculated by dividing annualized net income (loss) available to common stockholders for the period by average equity.
|
We evaluate our financial performance and report our results through three operating segments: Credit Card, Consumer Banking and Commercial Banking.
|
·
|
Credit Card: Consists of our domestic consumer and small business card lending, domestic small business lending, national closed end installment lending and the international card lending businesses in Canada and the United Kingdom.
|
|
·
|
Consumer Banking: Consists of our branch-based lending and deposit gathering activities for consumer and small businesses, national deposit gathering, national automobile lending and consumer mortgage lending and servicing activities.
|
|
·
|
Commercial Banking: Consists of our lending, deposit gathering and treasury management services to commercial real estate and middle market customers. Our Commercial Banking business results also include the results of a national portfolio of small-ticket commercial real-estate loans that are in run-off mode.
|
Table 2 summarizes our results by business segments for the three and nine months ended September 30, 2010 and 2009. We report our business segment results based on income from continuing operations, net of tax. In 2009, we realigned our organizational structure and business segment reporting to reflect our operating results by product type and customer segment and to integrate the operations of Chevy Chase Bank. We revised our reportable segments and the results for our segments for all periods presented to conform to the organizational and segment reporting changes.
Table 2: Business Segment Results (1)
| |
|
Three Months Ended September 30,
|
|
| |
|
2010
|
|
|
2009
|
|
| |
|
Total Revenue (2)
|
|
|
Net Income (Loss)
|
|
|
Total Revenue (2)
|
|
|
Net Income (Loss)
|
|
|
(Dollars in millions)
|
|
Amount
|
|
|
% of Total
|
|
|
Amount
|
|
|
% of Total
|
|
|
Amount
|
|
|
% of Total
|
|
|
Amount
|
|
|
% of Total
|
|
|
Credit Card
|
|
$ |
2,605 |
|
|
|
65 |
% |
|
$ |
631 |
|
|
|
77 |
% |
|
$ |
2,991 |
|
|
|
65 |
% |
|
$ |
292 |
|
|
|
67 |
% |
|
Consumer Banking
|
|
|
1,142 |
|
|
|
28 |
|
|
|
175 |
|
|
|
21 |
|
|
|
1,060 |
|
|
|
23 |
|
|
|
145 |
|
|
|
33 |
|
|
Commercial Banking
|
|
|
355 |
|
|
|
9 |
|
|
|
39 |
|
|
|
5 |
|
|
|
344 |
|
|
|
8 |
|
|
|
(128 |
) |
|
|
(29 |
) |
|
Other(3)
|
|
|
(86 |
) |
|
|
(2 |
) |
|
|
(27 |
) |
|
|
(3 |
) |
|
|
190 |
|
|
|
4 |
|
|
|
128 |
|
|
|
29 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total from continuing operations
|
|
$ |
4,016 |
|
|
|
100 |
% |
|
$ |
818 |
|
|
|
100 |
% |
|
$ |
4,585 |
|
|
|
100 |
% |
|
$ |
437 |
|
|
|
100 |
% |
| |
|
Nine Months Ended September 30,
|
|
| |
|
2010
|
|
|
2009
|
|
| |
|
Total Revenue (2)
|
|
|
Net Income (Loss)
|
|
|
Total Revenue (2)
|
|
|
Net Income (Loss)
|
|
|
(Dollars in millions)
|
|
Amount
|
|
|
% of Total
|
|
|
Amount
|
|
|
% of Total
|
|
|
Amount
|
|
|
% of Total
|
|
|
Amount
|
|
|
% of Total
|
|
|
Credit Card
|
|
$ |
8,072 |
|
|
|
66 |
% |
|
$ |
1,688 |
|
|
|
72 |
% |
|
$ |
8,363 |
|
|
|
67 |
% |
|
$ |
468 |
|
|
|
80 |
% |
|
Consumer Banking
|
|
|
3,451 |
|
|
|
28 |
|
|
|
785 |
|
|
|
33 |
|
|
|
2,999 |
|
|
|
24 |
|
|
|
252 |
|
|
|
43 |
|
|
Commercial Banking
|
|
|
1,088 |
|
|
|
9 |
|
|
|
67 |
|
|
|
3 |
|
|
|
959 |
|
|
|
8 |
|
|
|
(77 |
) |
|
|
(13 |
) |
|
Other(3)(4)
|
|
|
(397 |
) |
|
|
(3 |
) |
|
|
(191 |
) |
|
|
(8 |
) |
|
|
146 |
|
|
|
1 |
|
|
|
(60 |
) |
|
|
(10 |
) |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total from continuing operations
|
|
$ |
12,214 |
|
|
|
100 |
% |
|
$ |
2,349 |
|
|
|
100 |
% |
|
$ |
12,467 |
|
|
|
100 |
% |
|
$ |
583 |
|
|
|
100 |
% |
______________
|
(1)
|
See “Note 12 – Business Segments” for a reconciliation of our total business segment results to our consolidated GAAP results.
|
|
(2)
|
Total revenue consists of net interest income and non-interest income. Total company revenue displayed for 2009 is based on our non-GAAP managed basis results. For more information on this measure and a reconciliation to the comparable GAAP measure, see “Exhibit 99.3— Reconciliation to GAAP Financial Measures.”
|
|
(3)
|
Includes the residual impact of the allocation of our centralized Corporate Treasury group activities, such as management of our corporate investment portfolio and asset/liability management, to our business segments as well as other items as described in “Note 12 – Business Segments”.
|
|
(4)
|
During the first quarter of 2009, Chevy Chase Bank was included within the Other category.
|
Impact on Reported Financial Information
Effective January 1, 2010, we prospectively adopted two new accounting standards that had a significant impact on our accounting for entities previously considered to be off-balance sheet arrangements. The adoption of these new accounting standards resulted in the consolidation of our credit card securitization trusts, one of our installment loan trusts and certain option-adjustable rate mortgage (“option-ARM”) loan trusts originated by Chevy Chase Bank. Prior to January 1, 2010, transfers of our credit card receivables, installment loans and certain option-adjustable rate mortgage loans to our securitization trusts were accounted for as sales and treated as off-balance sheet. At the adoption of these new accounting standards on January 1, 2010, we added to our reported consolidated balance sheet $41.9 billion of assets, consisting primarily of credit card loan receivables underlying the consolidated securitization trusts, along with $44.3 billion of related debt issued by these trusts to third-party investors. We also recorded an after-tax charge to retained earnings on January 1, 2010 of $2.9 billion, reflecting the net cumulative effect of adopting these new accounting standards. This charge primarily related to the addition of $4.3 billion to our allowance for loan and lease losses for the newly consolidated loans and the recording of $1.6 billion in related deferred tax assets. The initial recording of these amounts on our reported balance sheet as of January 1, 2010 had no impact on our reported income. We provide additional information on the impact on our financial statements from the adoption of these new accounting standards in “Note 1—Summary of Significant Accounting Policies” and “Note 5—Variable Interest Entities and Securitizations.” We discuss the impact on our capital ratios below in “Capital.”
Although the adoption of these new accounting standards does not change the economic risk to our business, specifically our exposure to liquidity, credit and interest rate risks, the prospective adoption of these rules has a significant impact on our capital ratios and the presentation of our reported consolidated financial statements, including changes in the classification of specific consolidated statements of income line items. The most significant changes to our reported consolidated financial statements are outlined below:
|
Financial Statement
|
|
Accounting and Presentation Changes
|
|
|
|
|
|
|
Balance Sheet
|
|
·
|
Significant increase in restricted cash, securitized loans and securitized debt resulting from the consolidation of securitization trusts.
|
| |
|
|
|
| |
|
·
|
Significant increase in the allowance for loan and lease losses resulting from the establishment of a loan loss reserve for the loans underlying the consolidated securitization trusts.
|
| |
|
|
|
| |
|
·
|
Significant reduction in accounts receivable from securitizations resulting from the reversal of retained interests held in securitization trusts that have been consolidated.
|
| |
|
|
|
|
Statement of Income
|
|
·
|
Significant increase in interest income and interest expense attributable to the securitized loans and debt underlying the consolidated securitization trusts.
|
| |
|
|
|
| |
|
·
|
Changes in the amount recorded for the provision for loan and lease losses, resulting from the establishment of an allowance for loan and lease losses for the loans underlying the consolidated securitization trusts.
|
| |
|
|
|
| |
|
·
|
Amounts previously recorded as servicing and securitization income are now classified in our results of operations in the same manner as the earnings on loans not held in securitization trusts.
|
|
Financial Statement
|
|
Accounting and Presentation Changes
|
| |
|
|
|
|
Statement of Cash Flows
|
|
·
|
Significant change in the amounts of cash flows from investing and financing activities.
|
Beginning with the first quarter of 2010, our reported consolidated statements of income no longer reflect securitization and servicing income related to newly consolidated loans. Instead, we report interest income, net charge-offs and certain other income associated with securitized loan receivables and interest expense associated with the debt securities issued from the trust to third party investors in the same consolidated statements of income categories as loan receivables and corporate debt. Additionally, we no longer record initial gains on new securitization activity since the majority of our securitized loans will no longer receive sale accounting treatment. Because our securitization transactions are being accounted for under the new consolidation accounting rules as secured borrowings rather than asset sales, the cash flows from these transactions are presented as cash flows from financing activities rather than as cash flows from operating or investing activities. Notwithstanding this change in accounting, our securitization transactions are structured to legally isolate the receivables from the Company, and we do not expect to be able to access the assets of our securitization trusts. We do, however, continue to have the rights associated with our retained interests in the assets of these trusts.
Because we prospectively adopted the new consolidation accounting standards, our historical reported results and consolidated financial statements for periods prior to January 1, 2010 reflect our securitization trusts as off-balance sheet in accordance with the applicable accounting guidance in effect during this period. Accordingly, our reported results and consolidated financial statements subsequent to January 1, 2010 are not presented on a basis consistent with our reported results and consolidated financial statements for periods prior to January 1, 2010. This inconsistency limits the comparability of our post-January 1, 2010 reported results to our prior period reported results.
Impact on Non-GAAP Managed Financial Information
In addition to analyzing our results on a reported basis, management historically evaluated our total company and business segment results on a non-GAAP “managed” basis. Our managed presentations reflected the results from both our on-balance sheet loans and off-balance sheet loans and excluded the impact of card securitization activity. Our managed presentations assumed that our securitized loans had not been sold and that the earnings from securitized loans were classified in our results of operations in the same manner as the earnings on loans that we owned. Our managed results also reflected differences in accounting for the valuation of retained interests and the recognition of gains and losses on the sale of interest-only strips. Our managed results did not include the addition of an allowance for loan and lease losses for the loans underlying our off-balance sheet securitization trusts. Prior to January 1, 2010, we used our non-GAAP managed basis presentation to evaluate the credit performance and overall financial performance of our entire managed loan portfolio because the same underwriting standards and ongoing risk monitoring are used for both securitized loans and loans that we own. In addition, we used the managed presentation as the basis for making decisions about funding our operations and allocating resources, such as employees and capital. Because management used our managed basis presentation to evaluate our performance, we also provided this information to investors. We believed that our managed basis information was useful to investors because it portrayed the results of both on- and off-balance sheet loans that we managed, which enabled investors to understand the credit risks associated with the portfolio of loans reported on our consolidated balance sheet and our retained interests in securitized loans.
In periods prior to January 1, 2010, certain of our non-GAAP managed measures differed from the comparable reported measures. The adoption on January 1, 2010 of the new consolidation accounting standards resulted in accounting for the loans in our securitization trusts in our reported financial statements in a manner similar to how we account for these loans on a managed basis. As a result, our reported and managed basis presentations are generally comparable for periods beginning after January 1, 2010.
We believe that investors will be able to better understand our financial results and evaluate trends in our business if our period-over-period data are reflected on a more comparable basis. Accordingly, unless otherwise noted, this MD&A compares our reported GAAP financial information as of and for the three months and nine months ended September 30, 2010 with our non-GAAP managed based financial information as of and for the three months and nine months ended September 30, 2009 and as of December 31, 2009. We provide a reconciliation of our non-GAAP managed based information for periods prior to January 1, 2010 to the most comparable reported GAAP information in “Exhibit 99.3— Reconciliation to GAAP Financial Measures.”
Financial Highlights
We reported net income attributable to common shareholders of $803 million ($1.76 per diluted share) in the third quarter of 2010, with all of our business segments contributing to earnings. In comparison, we reported net income of $608 million ($1.33 per diluted share) in the second quarter of 2010 and net income of $394 million ($0.87 per diluted share) in the third quarter of 2009. We generated net income of $2.0 billion ($4.49 per diluted share) in the first nine months of 2010, compared with a net loss of $56 million ($(0.13) per diluted share) in the first nine months of 2009. As noted above, the presentation of our results on a non-GAAP managed basis prior to January 1, 2010 assumed that our securitized loans had not been sold and that the earnings from securitized loans were classified in our results of operations in the same manner as the earnings on loans that we owned. These classification differences resulted in differences in certain revenue and expense components of our results of operations on a reported basis and our results of operations on a managed basis, although net income for both bases was the same.
The increase in our net income of $195 million, or 32%, in the third quarter of 2010 from the second quarter of 2010 was attributable to an increase in total revenue and reduction in loss from discontinued operations, which were offset by an increase in our provision for loan and lease losses.
|
·
|
Increase in total revenue: Total revenue in the third quarter of 2010 increased by $112 million, or 3%, from the second quarter of 2010, reflecting a modest increase in net interest income and an increase in non-interest income of $100 million due to a significant reduction in the mortgage loan repurchase provision related to continuing operations recorded in the third quarter of 2010.
|
|
·
|
Decrease in loss from discontinued operations: The loss from discontinued operations decreased by $189 million from the second quarter of 2010 to $15 million in the third quarter of 2010, attributable to the absence of the prior quarter after-tax provision for mortgage loan repurchase losses of $199 million ($309 million pre-tax) related to discontinued operations in the third quarter of 2010 related to discontinued operations.
|
|
·
|
Increase in provision for loan and lease losses: The favorable impact from the increase in total revenue and decrease in loss from discontinued operations was partially offset by an increase in our provision for loan and lease losses of $144 million, driven by a smaller allowance release of $624 million in the third quarter of 2010, compared with a release of $1.0 billion in the second quarter of 2010. Although we reduced our allowance release, our credit quality indicators continued to show signs of improvement as a result of the slowly improving economy and actions taken by us over the past several years to improve underwriting standards and exit portfolios with unattractive credit metrics.
|
As a result of our earnings in the third quarter of 2010, our financial strength and capacity to absorb risk remained high. Our Tier 1 risk-based capital ratio of 11.1% as of September 30, 2010, was up 120 basis points from 9.9% at the end of the second quarter of 2010 and comfortably above the regulatory well-capitalized minimum. Our Tier 1 common equity ratio, a non-GAAP measure, increased to 8.2%, up 120 basis points from 7.0% at the end of the second quarter of 2010, and our tangible common equity to tangible managed assets (“TCE ratio”), also a non-GAAP measure, increased to 6.6%, up 50 basis points from 6.1% at the end of the second quarter of 2010. We provide a reconciliation of these non-GAAP measures to the comparable GAAP measures in the "Capital" section of this report and in “Exhibit 99.3— Reconciliation to GAAP Financial Measures.”
Below are additional highlights of our performance for the third quarter and first nine months of 2010. These highlights generally are based on a comparison of our reported results for the third quarter and first nine months of 2010 to our managed results for the third quarter and first nine months of 2009. The highlights of changes in our financial condition and credit performance are generally based on our reported financial condition and credit statistics as of September 30, 2010, compared with our financial condition and credit performance on a managed basis as of December 31, 2009. We provide a more detailed discussion of our results of operation, financial condition and credit performance in “Consolidated Financial Performance,” “Consolidated Balance Sheet Analysis and Credit Performance” and “Business Segment Financial Performance.”
|
·
|
Credit Card: Our Credit Card business generated net income of $631 million and $1.7 billion in the third quarter and first nine months of 2010, respectively, up from $292 million and $468 million in the third quarter and first nine months of 2009, respectively. The primary drivers of the improvement in our Credit Card business results were an increase in the net interest margin and a significant decrease in the provision for loan and lease losses. The increase in the net interest margin was attributable to the combined impact of higher asset yields and lower funding costs. The increase in the average yield on our credit card loan portfolio reflected the benefit of pricing changes that we implemented during 2009 and the continued benefit from rising collectability estimates due to favorable credit trends, while the decrease in our funding costs was attributable to the lower interest rate environment. The decrease in the provision for loan and lease losses was due to more favorable credit quality trends as well as a decline in outstanding loan balances. Of the $624 million and $2.2 billion reduction in the allowance in the third quarter and first nine months of 2010, respectively, $569 million and $1.8 billion, respectively, was attributable to our Credit Card business.
|
|
·
|
Consumer Banking: Our Consumer Banking business generated net income of $175 million and $785 million in the third quarter and first nine months of 2010, up from $145 million and $252 million in the third quarter and first nine months of 2009, respectively. The significant improvement in profitability in our Consumer Banking business was attributable to improved credit conditions and consumer credit performance, particularly within our auto loan portfolio, including reduced charge-offs. The decrease in charge-offs resulted in a substantial reduction in the provision for loan and lease losses and allowance releases. Our Consumer Banking business also benefited from deposit growth resulting from our continued strategy to leverage our bank outlets to attract lower cost funding sources and from improved deposit spreads, as we continue to shift the mix of our deposits to lower cost consumer savings and money market deposits from higher cost time deposits.
|
|
·
|
Commercial Banking: Our Commercial Banking business generated net income of $39 million and $67 million in the third quarter and first nine months of 2010, compared with a net loss of $128 million and $77 million in the third quarter and first nine months of 2009. The improvement in results for our Commercial Banking business was attributable to the stabilization in credit performance trends since the end of 2009, resulting in a significant reduction in the provision for loan and lease losses. Strong deposit growth resulting from our continued strategy to grow deposits as a lower cost funding source, as well as improved deposit spreads resulting from repricing of higher rate deposits to lower rates in response to the overall lower interest rate environment also provided a benefit to our Commercial Banking business. While our Commercial Banking credit metrics remain elevated, the commercial real estate market has exhibited signs of continuing improvement, including increasing leasing activity, declining vacancies and re-entry of traditional commercial real estate investors and sponsors into the market, particularly in New York where we have our most significant concentration.
|
|
·
|
Total Loans: Total loans held for investment decreased by $10.5 billion, or 8%, during the first nine months of 2010 to $126.3 billion as of September 30, 2010, from $136.8 billion as of December 31, 2009. This decrease was primarily due to the expected run-off of intallment loans in our Credit Card business and mortgage loans in our Consumer Banking business, elevated charge-offs and weak consumer demand.
|
|
·
|
Charge-off and Delinquency Statistics: Although net charge-off and delinquency rates remain elevated, these rates continued to show signs of improvement in the third quarter of 2010. The net charge-off rate decreased to 4.82% in the third quarter of 2010, from 5.36% in the second quarter of 2010, and the 30+ day performing delinquency rate decreased to 3.71%, from 3.81% in the second quarter of 2010. Based on strong credit performance trends, such as the significant decline in the 30+ day performing delinquency rate from 4.73% at the end of 2009, we believe our net-charge offs peaked in the first quarter of 2010.
|
|
·
|
Allowance for Loan and Lease Losses: As a result of the adoption of the new consolidation accounting guidance, we increased our allowance for loan and lease losses by $4.3 billion to $8.4 billion on January 1, 2010. The initial recording of this amount on our reported balance sheet as of January 1, 2010 reduced our stockholders’ equity but had no impact on our reported results of operations. After taking into consideration the $4.3 billion addition to our allowance for loan and lease losses on January 1, 2010, our allowance for loan and lease losses decreased by $2.2 billion during the first nine months of 2010, to $6.2 billion as of September 30, 2010. The decrease was attributable to an overall improvement in credit quality trends, as well as the decrease in loan balances. The allowance as a percentage of our total reported loans held for investment was 4.89% as of September 30, 2010, compared with 5.35% as of June 30, 2010 and 4.55% as of December 31, 2009.
|
|
·
|
Representation and Warranty Reserve: We have established reserves for our mortgage loan repurchase exposure related to the sale of mortgage loans to various parties under contractual provisions that include various representations and warranties. These reserves reflect inherent losses as of each balance sheet date that we consider to be both probable and estimable. We recorded a provision for this exposure of $16 million in the third quarter of 2010, all of which was included in non-interest income, compared with $404 million in the second quarter of 2010, of which $95 million was included in non-interest income and $309 million was included in discontinued operations. We recorded a provision of $644 million for the first nine months of 2010, of which $211 million was included in non-interest income and $433 million was included in discontinued operations. The significant decrease in the mortgage loan repurchase provision in the third quarter of 2010 was attributable to refinements we made during the first and second quarters of 2010 in estimating our mortgage representation and warranty reserves, which resulted in a much higher expense for the second quarter of 2010. These refinements included extending the timeframe over which we estimate our repurchase liability, in most cases to the full life of the mortgage loans sold by our subsidiaries for groups of loans for which we believe repurchases are probable. Our representation and warranty reserves totaled $836 million as of September 30, 2010, compared with $238 million as of December 31, 2009.
|
Business Environment and Significant Recent Developments
We continue to operate in an environment of elevated economic and regulatory uncertainty. The overall economic recovery remains modest and fragile, which has been reflected in the assumptions we have applied in our underwriting standards and in determining our allowance for loan and lease losses for several quarters. Recent labor market statistics indicate continuing stagnation. The unemployment rate continues to be persistently high, remaining close to ten percent. We also continue to see risks in the housing market, due in part to the large backlog of homes in the foreclosure process and high rate of delinquent loans, which could be exacerbated if recent disruptions in industry foreclosure practices continue. Regulatory uncertainty remains elevated with the ongoing and expected development of new regulations and regulatory organizations resulting from the recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act. We provide more information on recent regulatory developments in “Supervision and Regulation.”
Business Outlook
We discuss below our current expectations regarding our total company performance and the performance of each of our business segments over the near-term based on market conditions, the regulatory environment and our business strategies as of the time we filed this Quarterly Report on Form 10-Q. The statements contained in this section are based on our current expectations regarding our outlook for our financial results and business strategies. Our expectations take into account, and should be read in conjunction with, our expectations regarding economic trends and analysis of our business as discussed in “Item 1. Business” and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our 2009 Form 10-K. Certain statements are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual results could differ materially from those in our forward-looking statements. Forward-looking statements do not reflect (i) any change in current dividend or repurchase strategies, (ii) the effect of any acquisitions, divestitures or similar transactions or (iii) any changes in laws, regulations or regulatory interpretations, in each case after the date as of which such statements are made. See “Forward-Looking Statements” in this Quarterly Report on Form 10-Q and “Item 1A. Risk Factors” of our 2009 Form 10-K for factors that could materially influence our results.
Total Company Expectations
|
·
|
Total Loans: The pace of loan balance decline has slowed, reflecting the decline in charge-offs, gradual abatement of expected portfolio run-offs and seasonal consumer spending trends. We expect loan balances to reach a bottom over the next few quarters, stabilize and begin to grow modestly in 2011. The timing and pace of expected growth will depend on broader economic trends that impact overall consumer and commercial demand. As consumer demand returns, we believe our Domestic Card business is well positioned to gain market share in the new more level playing field created by the CARD Act, due in part to recent product innovations and partnership growth opportunities, such as the expected launching of the recently announced Kohl’s Corp. private-label credit card partnership.
|
|
·
|
Securitization Liability: We expect the securitized debt obligation to decline to approximately $27 billion by the end of 2010, which represents a decrease of 44% from the balance as of January 1, 2010.
|
|
·
|
Earnings: We expect our quarterly revenue margins, which remain at elevated levels, to decline, driven primarily by a decline in our Domestic Card revenue margin from the current level as the factors keeping it elevated normalize over time. We expect our marketing expenses to increase to more normal levels. Based on current trends, we believe our quarterly “pre-provision” earnings (earnings excluding our provision for loan and lease losses) will decline heading into 2011 and stabilize in 2011.
|
Based on the underlying credit trends we are experiencing, we believe our allowance for loan and lease losses will likely continue to decline in the near-term.
|
·
|
Capital: As permitted under the capital rules issued by banking regulators in January 2010, we elected to phase in the impact from the adoption of the new consolidation accounting standards on risk-based capital over 2010 and the first quarter of 2011. We expect our Tier 1 risk-based capital ratio and our non-GAAP Tier 1 common equity ratio to decline into the first quarter of 2011, primarily due to two factors that affect the numerator and denominator used in calculating these ratios: (i) a decrease in the numerator resulting from the disallowance of a portion of the deferred tax assets and (ii) an increase in the denominator due to the remaining phase-in during the first quarter of 2011 of risk-weighted assets resulting from the new consolidation accounting standards. The disallowance of the deferred tax asset is expected to peak in the first quarter of 2011. As we reduce our allowance for loan and lease losses and generate earnings, we expect our disallowed deferred tax asset amount will decrease and contribute to an increase in our Tier 1 capital ratios in 2011. Despite the near-term decline in our Tier 1 risk-based capital ratio, we expect our Tier 1 risk-based capital ratio will remain above well-capitalized minimum levels throughout the regulatory capital phase-in period for the new consolidation standards. Because the phase-in of the new consolidation accounting standards does not impact the TCE ratio, we expect our TCE ratio to reflect our underlying business performance and balance sheet growth.
|
Based on the current definitions proposed by the Basel Committee, we expect to reach the Basel III minimum common equity ratio, including the capital conservation buffer, in 2011.
Business Segment Expectations
Credit Card Business
We experienced a partial quarter impact in the third quarter of 2010 from the reduction in late fees resulting from the August 22, 2010 implementation of the Federal Reserve “reasonable and proportional” fee regulations related to the CARD Act. Although the major impacts from the Credit CARD Act and cyclical forces will be fully absorbed in the fourth quarter of 2010, our Domestic Card revenue margin remains elevated because of better than expected credit performance and lower than expected account balances with low introductory promotional interest rates due to weak consumer demand. We expect both of these factors to normalize over time, resulting in a decline in our quarterly Domestic Card revenue margin from the current level.
After the CARD Act revenue impacts are absorbed, we believe that Domestic Card revenue margin will be driven by market pricing, the competitive environment and credit performance. Purchase volume and loan growth from increased origination, portfolio acquisitions or partnerships, including the expected launch of the Kohl’s partnership in early 2011, will also affect revenue margins.
Consumer Banking Business
In our Consumer Banking business, we expect the balance of loans in our mortgage portfolio, which largely remains in a run-off mode, to continue to decline during 2010.
Commercial Banking Business
In our Commercial Banking business, nonperforming asset rates and criticized loans improved modestly for two consecutive quarters. We believe, however, that the charge-off rate for our Commercial Banking business will fluctuate over the next several quarters, consistent with typical quarterly variability in commercial banking charge-off rates.
The preparation of financial statements in accordance with GAAP requires management to make a number of judgments, estimates and assumptions that affect the reported amount of assets, liabilities, income and expenses in the consolidated financial statements. Understanding our accounting policies and the extent to which we use management judgment and estimates in applying these policies is integral to understanding our financial statements. We provide a summary of our significant accounting policies in “Note 1—Significant Accounting Policies” of our 2009 Form 10-K.
We have identified the following accounting policies as our most critical accounting policies and estimates because they involve significant judgments and assumptions about highly complex and inherently uncertain matters, and the use of reasonably different estimates and assumptions could have a material impact on our reported results of operations or financial condition.
|
|
·
|
Fair value measurement, including the assessment of other-than-temporary impairment of available-for-sale securities;
|
|
|
·
|
Representation and warranty reserve;
|
|
|
·
|
Allowance for loan and lease losses;
|
|
|
·
|
Valuation of goodwill and other intangibles;
|
|
|
·
|
Finance charge, interest and fee revenue recognition;
|
|
|
·
|
Derivative and hedge accounting; and
|
We evaluate our critical accounting estimates and judgments on an ongoing basis and update them as necessary based on changing conditions. The use of fair value to measure our financial instruments is fundamental to the preparation of our consolidated financial statements because we account for and record a significant portion of our assets and liabilities at fair value. Accordingly, we provide information below on financial instruments recorded at fair value in our consolidated balance sheets. We also discuss below refinements we made during the first nine months of 2010 in estimating our loss contingency reserves for mortgage loan repurchase claims pursuant to representation and warranty provisions. Management has discussed significant changes in the judgments or assumptions involved in applying our critical accounting policies with the Audit and Risk Committee of the Board of Directors.
Fair Value
Fair value is defined as the price that would be received for an asset or paid to transfer a liability in an orderly transaction between market participants on the measurement date (also referred to as an exit price). The fair value accounting rules provide a three-level fair value hierarchy for classifying financial instruments. This hierarchy is based on whether the inputs to the valuation techniques used to measure fair value are observable or unobservable. Each financial asset or liability is assigned to a level based on the lowest level of any input that is significant to its fair value measurement. The three levels of the fair value hierarchy are described below:
Level 1: Quoted prices (unadjusted) in active markets for identical assets or liabilities.
Level 2: Observable market-based inputs, other than quoted prices in active markets for identical assets or liabilities.
Level 3: Unobservable inputs.
In the determination of the classification of financial instruments in Level 2 or Level 3 of the fair value hierarchy, we consider all available information, including observable market data, indications of market liquidity and orderliness, and our understanding of the valuation techniques and significant inputs used. Based upon the specific facts and circumstances of each instrument or instrument category, judgments are made regarding the significance of the Level 3 inputs to the instruments’ fair value measurement in its entirety. If Level 3 inputs are considered significant, the instrument is classified as Level 3. The process for determining fair value using unobservable inputs is generally more subjective and involves a high degree of management judgment and assumptions.
Our financial instruments recorded at fair value on a recurring basis represented approximately 21% of our total reported assets of $196.9 billion as of September 30, 2010, compared with 26% of our total reported assets of $169.6 billion as of December 31, 2009. Financial assets for which the fair value was determined using significant Level 3 inputs represented approximately 3% of these financial instruments (1% of total assets) as of September 30, 2010, and approximately 14% (4% of total assets) as of December 31, 2009. The decreases in the percentage of financial instruments measured at a fair value on a recurring basis and in the percentage of financial instruments measured using Level 3 inputs were primarily attributable to the increase in our assets from the adoption of the new consolidation accounting standards, as the consolidated loans are generally classified as held for investment and are therefore not measured at fair value on a recurring basis. We discuss changes in the valuation inputs and assumptions used in determining the fair value of our financial instruments, including the extent to which we have relied on significant unobservable inputs to estimate fair value and our process for corroborating these inputs, in “Note 11—Fair Value of Financial Instruments.”
Representation and Warranty Reserve
We sell mortgage loans to various parties, including government sponsored enterprises (“GSEs”), under contractual provisions that include various representations and warranties which typically cover the ownership of the loan, the validity of the lien securing the loan, the loan's compliance with any applicable loan criteria established by the purchaser, including underwriting guidelines and the ongoing existence of mortgage insurance, and the loan's compliance with applicable federal, state and local laws. We may be required to repurchase the mortgage loan, indemnify the investor or insurer, or reimburse the investor for credit losses incurred on the loan in the event of a material breach of contractual representations or warranties.
We have established a mortgage repurchase reserve related to various representations and warranties that reflects management’s estimate of probable losses as of each balance sheet date. We regularly evaluate our process for estimating our representation and warranty reserve and assess the adequacy of the reserve on a quarterly basis based on a combination of factors. Factors we consider in establishing the representation and warranty reserve include without limitation: identity of counterparty and the nature of the representation and warranties made to it, trends in repurchase requests, the number and amount of currently open repurchase requests, the status of any litigation arising from repurchase requests, current and future levels of estimated lifetime loan losses to the extent the losses can reasonably be determined, trends in success rates (i.e. the probability that repurchase requests lead to payments), estimated future success rates, estimated gross loss per claim, and estimated value of the underlying collateral. The reserve-setting process relies heavily on estimates, which are inherently uncertain and require the application of judgment.
During the first and second quarters of 2010, we refined our process for estimating our representation and warranty reserve due primarily to counterparty activity and our ability to extend the timeframe over which we estimate our repurchase liability, in most cases, to the full life of the mortgage loans sold by our subsidiaries for groups of loans for which we believe repurchases are probable.
Our representation and warranty mortgage repurchase reserve, which we report as a component of other liabilities in our consolidated balance sheets, totaled $836 million as of September 30, 2010, compared with $238 million as of December 31, 2009. We provide additional information on our representation and warranty reserves below in “Consolidated Balance Sheet Analysis and Credit Performance—Representation and Warranty Reserve” and in “Note 13—Commitments Contingencies and Guarantees.”
See our 2009 Form 10-K in “Part I—Item 7. MD&A—Critical Accounting Estimates” for an additional discussion of our critical accounting policies and estimates.
New accounting pronouncements or changes in existing accounting pronouncements may have a significant effect on our results of operations, financial condition, stockholders’ equity, capital ratios or business operations. As discussed above, effective January 1, 2010, we adopted two new accounting standards that had a significant impact on the manner in which we account for our securitization transactions, our consolidated financial statements and our capital ratios. These new accounting standards eliminated the concept of qualified special purpose entities (“QSPEs”), revised the accounting for transfers of financial assets and changed the consolidation criteria for variable interest entities (“VIEs”). Under the new accounting guidance, the determination to consolidate a VIE is based on a qualitative assessment of which party to the VIE has “power” combined with potentially significant benefits or losses, instead of the previous quantitative risks and rewards model. Consolidation is required when an entity has the power to direct matters which significantly impact the economic performance of the VIE, together with either the obligation to absorb losses or the rights to receive benefits that could be significant to the VIE. The prospective adoption of this new accounting guidance resulted in our consolidating substantially all our existing securitization trusts that had previously been off-balance sheet and eliminated sales treatment for new transfers of loans to securitization trusts.
We provide additional information on the impact of these new accounting standards above in “Impact from Adoption of New Consolidation Accounting Standards” and in “Note 1—Summary of Significant Accounting Policies.” We also identify and discuss the impact of other significant recently issued accounting pronouncements, including those not yet adopted, in “Note 1—Summary of Significant Accounting Policies.”
In the ordinary course of business, we are involved in various types of transactions with limited liability companies, partnerships or trusts that often involve special purpose entities (“SPEs”) and VIEs. Some of these arrangements are not recorded on our consolidated balance sheets or may be recorded in amounts different from the full contract or notional amount of the transaction, depending on the nature or structure of, and accounting required to be applied to, the arrangement. Because these arrangements involve separate legal entities that have significant limitations on their activities, they are commonly referred to as “off-balance sheet arrangements.” These arrangements may expose us to potential losses in excess of the amounts recorded in the consolidated balance sheets. Our involvement in these arrangements can take many forms, including securitization and servicing activities, the purchase or sale of mortgage-backed or other asset-backed securities in connection with our mortgage portfolio, and loans to VIEs that hold debt, equity, real estate or other assets. Under previous accounting guidance, we were not required to consolidate the majority of our securitization trusts because they were QSPEs. Accordingly, we considered these trusts to be off-balance sheet arrangements.
In June 2009, the Financial Accounting Standards Board (“FASB”) issued two new accounting standards that eliminated the concept of QSPEs, revised the accounting for transfers of financial assets and changed the consolidation criteria for VIEs. As discussed above in “Impact from Adoption of New Consolidation Accounting Standards,” these standards were effective January 1, 2010 and adopted prospectively, which resulted in the consolidation of our credit card securitization trusts, one installment loan trust and certain option-ARM loan trusts originated by Chevy Chase Bank for which we provide servicing.
Our continuing involvement in unconsolidated VIEs primarily consists of certain mortgage loan trusts and community reinvestment and development entities. The carrying amount of assets and liabilities of these unconsolidated VIEs was $2.2 billion and $801 million, respectively, as of September 30, 2010, and our maximum exposure to loss was $2.3 billion. We provide a discussion of our activities related to these VIEs in “Note 5—Variable Interest Entities and Securitizations.”
The section below provides a comparative discussion of our consolidated corporate financial performance for the three and nine months ended September 30, 2010 and 2009. Following this section, we provide a discussion of our business segment results. You should read this section together with our “Executive Summary and Business Outlook” where we discuss trends and other factors that we expect will affect our future results of operations.
Net Interest Income
Net interest income represents the difference between the interest income and applicable fees earned on our interest-earning assets, which includes loans held for investment and investment securities, and the interest expense on our interest-bearing liabilities, which includes interest-bearing deposits, senior and subordinated notes, securitized debt and other borrowings. We include in interest income any past due fees on loans that we deem are collectible. Our net interest margin represents the difference between the yield on our interest-earning assets and the cost of our debt, including the impact of non-interest bearing funding. Prior to the adoption of the new consolidation accounting standards on January 1, 2010, our reported net interest income did not include interest income from loans in our off-balance sheet securitization trusts or the interest expense on third-party debt issued by these securitization trusts. Beginning January 1, 2010, servicing fees, finance charges, other fees, net charge-offs and interest paid to third party investors related to consolidated securitization trusts are included in net interest income.
Table 3 below displays the major sources of our interest income and interest expense for the three and nine months ended September 30, 2010 and 2009. We present for each major category of our interest-earning assets and interest-bearing liabilities, the average outstanding balances, the interest earned or paid and the average yield or cost during the period in Table A under “Supplemental Statistical Tables.” We expect net interest income and our net interest margin to fluctuate based on changes in interest rates and changes in the amount and composition of our interest-earning assets and interest-bearing liabilities.
Table 3: Net Interest Income
| |
|
Three Months Ended September 30,
|
|
|
Nine Months Ended September 30,
|
|
| |
|
2010
|
|
|
2009
|
|
|
2010
|
|
|
2009 (1)
|
|
|
(Dollars in millions)
|
|
Reported
|
|
|
Reported
|
|
|
Managed
|
|
|
Reported
|
|
|
Reported
|
|
|
Managed
|
|
|
Interest income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans held-for-investment:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consumer loans(2)
|
|
$ |
3,148 |
|
|
$ |
1,839 |
|
|
$ |
3,369 |
|
|
$ |
9,594 |
|
|
$ |
5,509 |
|
|
$ |
9,657 |
|
|
Commercial loans
|
|
|
299 |
|
|
|
381 |
|
|
|
381 |
|
|
|
988 |
|
|
|
1,140 |
|
|
|
1,140 |
|
|
Total loans held for investment, including past-due fees
|
|
|
3,447 |
|
|
|
2,220 |
|
|
|
3,750 |
|
|
|
10,582 |
|
|
|
6,649 |
|
|
|
10,797 |
|
|
Investment securities
|
|
|
347 |
|
|
|
399 |
|
|
|
399 |
|
|
|
1,037 |
|
|
|
1,206 |
|
|
|
1,206 |
|
|
Other
|
|
|
21 |
|
|
|
83 |
|
|
|
18 |
|
|
|
60 |
|
|
|
214 |
|
|
|
51 |
|
|
Total interest income
|
|
|
3,815 |
|
|
|
2,702 |
|
|
|
4,167 |
|
|
|
11,679 |
|
|
|
8,069 |
|
|
|
12,054 |
|
|
Interest expense:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deposits
|
|
|
358 |
|
|
|
479 |
|
|
|
479 |
|
|
|
1,125 |
|
|
|
1,666 |
|
|
|
1,666 |
|
|
Securitized debt obligations
|
|
|
191 |
|
|
|
63 |
|
|
|
321 |
|
|
|
644 |
|
|
|
228 |
|
|
|
1,037 |
|
|
Senior and subordinated notes
|
|
|
72 |
|
|
|
74 |
|
|
|
74 |
|
|
|
211 |
|
|
|
189 |
|
|
|
189 |
|
|
Other borrowings
|
|
|
85 |
|
|
|
81 |
|
|
|
81 |
|
|
|
265 |
|
|
|
243 |
|
|
|
243 |
|
|
Total interest expense
|
|
|
706 |
|
|
|
697 |
|
|
|
955 |
|
|
|
2,245 |
|
|
|
2,326 |
|
|
|
3,135 |
|
|
Net interest income
|
|
$ |
3,109 |
|
|
$ |
2,005 |
|
|
$ |
3,212 |
|
|
$ |
9,434 |
|
|
$ |
5,743 |
|
|
$ |
8,919 |
|
______________
|
(1)
|
Effective February 27, 2009, we acquired Chevy Chase Bank. Accordingly, our results for the first nine months of 2009 include only a partial impact from Chevy Chase Bank.
|
|
(2)
|
Interest income on credit card, auto, mortgage and retail banking loans is reflected in consumer loans. Interest income generated from small business credit cards also is included in consumer loans.
|
Table 4 presents the changes in our reported net interest income for the three and nine months ended September 30, 2010 from our reported net interest income for the three and nine months ended September 30, 2009, and the extent to which those changes were attributable to: (i) changes in the volume of our interest-earning assets and interest-bearing liabilities or (ii) changes in the interest rates of these assets and liabilities.
Table 4: Rate/Volume Analysis of Net Interest Income—Reported
| |
|
Three Months Ended September 30,
2010 vs. 2009(1)
|
|
|
Nine Months Ended September 30,
2010 vs. 2009(1)
|
|
| |
|
Total
|
|
|
Variance Due to(2)
|
|
|
Total
|
|
|
Variance Due to (2)
|
|
|
(Dollars in millions)
|
|
Variance
|
|
|
Volume
|
|
|
Rate
|
|
|
Variance
|
|
|
Volume
|
|
|
Rate
|
|
|
Interest income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans held-for-investment:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consumer loans
|
|
$ |
1,309 |
|
|
$ |
837 |
|
|
$ |
472 |
|
|
$ |
4,085 |
|
|
$ |
2,538 |
|
|
$ |
1,547 |
|
|
Commercial loans
|
|
|
(82 |
) |
|
|
(7 |
) |
|
|
(75 |
) |
|
|
(152 |
) |
|
|
(19 |
) |
|
|
(133 |
) |
|
Total loans held for investment, including past-due fees
|
|
|
1,227 |
|
|
|
676 |
|
|
|
551 |
|
|
|
3,933 |
|
|
|
2,079 |
|
|
|
1,854 |
|
|
Investment securities
|
|
|
(52 |
) |
|
|
25 |
|
|
|
(77 |
) |
|
|
(169 |
) |
|
|
82 |
|
|
|
(251 |
) |
|
Other
|
|
|
(62 |
) |
|
|
(18 |
) |
|
|
(44 |
) |
|
|
(154 |
) |
|
|
(6 |
) |
|
|
(148 |
) |
|
Total interest income
|
|
|
1,113 |
|
|
|
554 |
|
|
|
559 |
|
|
|
3,610 |
|
|
|
1,856 |
|
|
|
1,754 |
|
|
Interest expense:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deposits
|
|
|
(121 |
) |
|
|
5 |
|
|
|
(126 |
) |
|
|
(541 |
) |
|
|
7 |
|
|
|
(548 |
) |
|
Securitized debt obligations
|
|
|
128 |
|
|
|
(27 |
) |
|
|
156 |
|
|
|
416 |
|
|
|
598 |
|
|
|
(182 |
) |
|
Senior and subordinated notes
|
|
|
(2 |
) |
|
|
(7 |
) |
|
|
5 |
|
|
|
22 |
|
|
|
3 |
|
|
|
19 |
|
|
Other borrowings
|
|
|
4 |
|
|
|
(23 |
) |
|
|
27 |
|
|
|
22 |
|
|
|
(69 |
) |
|
|
91 |
|
|
Total interest expense
|
|
|
9 |
|
|
|
4 |
|
|
|
5 |
|
|
|
(81 |
) |
|
|
467 |
|
|
|
(548 |
) |
|
Net interest income
|
|
$ |
1,104 |
|
|
$ |
419 |
|
|
$ |
685 |
|
|
$ |
3,691 |
|
|
$ |
1,358 |
|
|
$ |
2,333 |
|
______________
|
(1)
|
Certain prior period amounts have been reclassified to conform to the current period presentation.
|
|
(2)
|
We calculate the change in interest income and interest expense separately for each item. The change in net interest income attributable to both volume and rates is allocated based on the relative dollar amount of each item.
|
Table 5 presents the changes in our reported net interest income for the three and nine months ended September 30, 2010 from our managed net interest income for the three and nine months ended September 30, 2009, and the extent to which those changes were attributable to: (i) changes in the volume of our interest-earning assets and interest-bearing liabilities or (ii) changes in the interest rates of these assets and liabilities.
Table 5: Rate/Volume Analysis of Net Interest Income—Reported 2010 vs. Managed 2009
| |
|
Three Months Ended September 30,
2010 vs. 2009(1)
|
|
|
Nine Months Ended September 30,
2010 vs. 2009(1)
|
|
| |
|
Total
|
|
|
Variance Due to(2)
|
|
|
Total
|
|
|
Variance Due to (2)
|
|
|
(Dollars in millions)
|
|
Variance
|
|
|
Volume
|
|
|
Rate
|
|
|
Variance
|
|
|
Volume
|
|
|
Rate
|
|
|
Interest income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans held-for-investment:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consumer loans
|
|
$ |
(221 |
) |
|
$ |
(521 |
) |
|
$ |
300 |
|
|
$ |
(63 |
) |
|
$ |
(1,365 |
) |
|
$ |
1,302 |
|
|
Commercial loans
|
|
|
(82 |
) |
|
|
(7 |
) |
|
|
(75 |
) |
|
|
(152 |
) |
|
|
(19 |
) |
|
|
(133 |
) |
|
Total loans held for investment, including past-due fees
|
|
|
(303 |
) |
|
|
(465 |
) |
|
|
162 |
|
|
|
(215 |
) |
|
|
(1,230 |
) |
|
|
1,015 |
|
|
Investment securities
|
|
|
(52 |
) |
|
|
25 |
|
|
|
(77 |
) |
|
|
(169 |
) |
|
|
82 |
|
|
|
(251 |
) |
|
Other
|
|
|
3 |
|
|
|
5 |
|
|
|
(2 |
) |
|
|
9 |
|
|
|
24 |
|
|
|
(15 |
) |
|
Total interest income
|
|
|
(352 |
) |
|
|
(297 |
) |
|
|
(55 |
) |
|
|
(375 |
) |
|
|
(679 |
) |
|
|
304 |
|
|
Interest expense:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deposits
|
|
|
(121 |
) |
|
|
5 |
|
|
|
(126 |
) |
|
|
(541 |
) |
|
|
7 |
|
|
|
(548 |
) |
|
Securitized debt obligations
|
|
|
(130 |
) |
|
|
(99 |
) |
|
|
(31 |
) |
|
|
(393 |
) |
|
|
(213 |
) |
|
|
(180 |
) |
|
Senior and subordinated notes
|
|
|
(2 |
) |
|
|
(7 |
) |
|
|
5 |
|
|
|
22 |
|
|
|
3 |
|
|
|
19 |
|
|
Other borrowings
|
|
|
4 |
|
|
|
(23 |
) |
|
|
27 |
|
|
|
22 |
|
|
|
(69 |
) |
|
|
91 |
|
|
Total interest expense
|
|
|
(249 |
) |
|
|
(93 |
) |
|
|
(156 |
) |
|
|
(890 |
) |
|
|
(220 |
) |
|
|
(670 |
) |
|
Net interest income
|
|
$ |
(103 |
) |
|
$ |
(237 |
) |
|
$ |
134 |
|
|
$ |
515 |
|
|
$ |
(513 |
) |
|
$ |
1,028 |
|
______________
|
(1)
|
Certain prior period amounts have been reclassified to conform to the current period presentation.
|
|
(2)
|
We calculate the change in interest income and interest expense separately for each item. The change in net interest income attributable to both volume and rates is allocated based on the relative dollar amount of each item.
|
Our reported net interest income of $3.1 billion for the third quarter of 2010 decreased by 3% from managed net interest income of $3.2 billion for the third quarter of 2009, driven by a 4% (30 basis points) expansion of our net interest margin to 7.21%, which was more than offset by a 7% decrease in our average interest-earning assets.
Our reported net interest income of $9.4 billion for the first nine months of 2010 increased by 6% from managed net interest income of $8.9 billion for the first nine months of 2009, driven by a 12% (76 basis points) expansion of our net interest margin to 7.13%, which was partially offset by a 6% decrease in our average interest-earning assets.
The increase in net interest margin in the third quarter and first nine months of 2010 was primarily attributable to a significant reduction in our average cost of funds. In addition, the average yield on interest-earning assets increased during the first nine months of 2010. Our cost of funds continued to benefit from the shift in the mix of our funding to lower cost consumer and commercial banking deposits from higher cost wholesale sources. Also, the overall interest rate environment, combined with our disciplined pricing, drove a decrease in our average deposit interest rates. The increase in the average yield on our interest-earning assets during the first nine months of 2010 reflected the benefit of pricing changes that we implemented during 2009, which contributed to an increase in the average yield on our loan portfolio, as well as improved credit conditions, which has allowed us to recognize a greater proportion of previously reserved uncollected finance charges into income.
The decrease in our average interest-earning assets in the third quarter and first nine months of 2010 reflected the combined impact of the run-off of our installment loan and mortgage loan portfolios, elevated charge-offs and a decline in credit card account loan balances.
Non-Interest Income
Non-interest income consists of servicing and securitizations income, service charges and other customer-related fees, interchange income and other non-interest income. We also record the mortgage loan repurchase provision related to continuing operations in non-interest income. Prior to the adoption of the new consolidation accounting standards on January 1, 2010, our reported non-interest income included servicing fees, finance charges, other fees, net charge-offs and interest paid to third party investors related to our securitization trusts as a component of non-interest income. In addition, when we created securitization trusts, we recognized gains or losses on the transfer of loans to these trusts and recorded our initial retained interests in the trusts. Beginning January 1, 2010, unless we qualify for sale accounting under the new consolidation accounting standards, we will no longer recognize a gain or loss or record retained interests when we transfer loans into securitization trusts. The servicing fees, finance charges, other fees, net of charge-offs and interest paid to third party investors related to our consolidated securitization trusts are now reported as a component of net interest income instead of as a component of non-interest income.
Table 6 displays the components of non-interest income for the three and nine months ended September 30, 2010 and 2009.
Table 6: Non-Interest Income
| |
|
Three Months Ended September 30,
|
|
|
Nine Months Ended September 30,
|
|
| |
|
2010
|
|
|
2009
|
|
|
2010
|
|
|
2009(1)
|
|
|
(Dollars in millions)
|
|
Reported
|
|
|
Reported
|
|
|
Managed
|
|
|
Reported
|
|
|
Reported
|
|
|
Managed
|
|
|
Non-interest income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Servicing and securitizations
|
|
$
|
13
|
|
|
$
|
721
|
|
|
$
|
24
|
|
|
$
|
(3
|
)
|
|
$
|
1,537
|
|
|
$
|
(235
|
)
|
|
Service charges and other customer-related fees
|
|
|
496
|
|
|
|
496
|
|
|
|
766
|
|
|
|
1,577
|
|
|
|
1,494
|
|
|
|
2,271
|
|
|
Interchange
|
|
|
346
|
|
|
|
123
|
|
|
|
370
|
|
|
|
991
|
|
|
|
389
|
|
|
|
1,058
|
|
|
Net other-than-temporary impairment
|
|
|
(5
|
)
|
|
|
(11
|
)
|
|
|
(11
|
)
|
|
|
(62
|
)
|
|
|
(22
|
)
|
|
|
(22
|
)
|
|
Other
|
|
|
57
|
|
|
|
224
|
|
|
|
224
|
|
|
|
272
|
|
|
|
476
|
|
|
|
476
|
|
|
Total non-interest income
|
|
$
|
907
|
|
|
$
|
1,553
|
|
|
$
|
1,373
|
|
|
$
|
2,775
|
|
|
$
|
3,874
|
|
|
$
|
3,548
|
|
______________
|
(1)
|
Effective February 27, 2009, we acquired Chevy Chase Bank. Accordingly, our results for the first nine months of 2009 include only a partial impact from Chevy Chase Bank.
|
Non-interest income of $907 million for the third quarter of 2010 decreased by $466 million, or 34%, from managed non-interest income of $1.4 billion for the third quarter of 2009. Non-interest income of $2.8 billion for the first nine months of 2010 decreased by $773 million, or 22%, from managed non-interest income of $3.5 billion for the third quarter of 2009.
The decrease in non-interest income in the third quarter and first nine months of 2010 was primarily attributable to a reduction in over-limit fees as result of provisions under the CARD Act, a decline in the fair value of our mortgage servicing rights due to the run-off of our mortgage portfolio, and an increase in the provision for mortgage loan repurchases.
We recorded a provision for mortgage loan repurchase exposure of $16 million in the third quarter of 2010, all of which was included in non-interest income, and a provision of $644 million in the first nine months of 2010, of which $211 million was included in non-interest income. We provide additional information on representation and warranty claims in “Critical Accounting Polices and Estimates” and in “Consolidated Balance Sheet Analysis and Credit Performance—Potential Mortgage Representation and Warranty Liabilities.”
The net other-than-temporary losses of $5 million and $62 million recorded in the third quarter and first nine months of 2010, respectively, primarily resulted from the deterioration in the credit quality of certain non-agency mortgage-related securities due to the continued weakness in the housing market and high unemployment. We also recorded other-than-temporary impairment on certain other non-agency mortgage-related securities in the first and second quarters of 2010 because of our intent to sell the securities. We provide additional information on other-than-temporary recognized on our available-for-sale securities in “Note 3—Investment Securities.”
Provision for Loan and Lease Losses
We build our allowance for loan and lease losses through the provision for loan and lease losses. Our provision for loan and lease losses in each period is driven by charge-offs and the level of allowance for loan and lease losses that we determine is necessary to provide for probable credit losses inherent in our loan portfolio as of each balance sheet date. Table 16 below under “Consolidated Balance Sheet Analysis—Summary of Allowance for Loan and Lease Losses” summarizes changes in our allowance for loan and lease losses and details the provision for loan and lease losses recognized in our consolidated statements of income and the charge-offs recorded against our allowance for loan and lease losses for the three and nine months ended September 30, 2010 and 2009.
We recorded a provision for loan and lease losses of $867 million and $3.1 billion for the third quarter and first nine months of 2010, respectively, compared with a provision for loan and lease losses on a managed basis of $2.2 billion and $6.2 billion for the third quarter and first nine months of 2009, respectively. The decrease in our provision expense for loan and lease losses reflected the significant reduction in our allowance for loan and lease losses during the third quarter and first nine months of 2010, attributable to the overall continued improvement in credit performance trends.
Non-Interest Expense
Non-interest expense consists of ongoing operating costs, such as salaries and associated employee benefits, communications and other technology expenses, supplies and equipment and occupancy costs, and miscellaneous expenses. Marketing expenses also are included in non-interest expense. Table 7 displays the components of non-interest expense for the three and nine months ended September 30, 2010 and 2009.
Table 7: Non-Interest Expense
| |
|
Three Months Ended
September 30,
|
|
|
Nine Months Ended
September 30,
|
|
| |
|
2010
|
|
|
2009
|
|
|
2010
|
|
|
2009
|
|
|
(Dollars in millions)
|
|
Reported
|
|
|
Reported/
Managed(1)
|
|
|
Reported
|
|
|
Reported/
Managed(1)
|
|
|
Non-interest expense:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Salaries and associated benefits
|
|
$ |
641 |
|
|
$ |
648 |
|
|
$ |
1,937 |
|
|
$ |
1,837 |
|
|
Marketing
|
|
|
250 |
|
|
|
104 |
|
|
|
650 |
|
|
|
400 |
|
|
Communications and data processing
|
|
|
178 |
|
|
|
176 |
|
|
|
512 |
|
|
|
569 |
|
|
Supplies and equipment
|
|
|
129 |
|
|
|
123 |
|
|
|
381 |
|
|
|
370 |
|
|
Occupancy
|
|
|
135 |
|
|
|
114 |
|
|
|
371 |
|
|
|
329 |
|
|
Restructuring expense
|
|
|
— |
|
|
|
26 |
|
|
|
— |
|
|
|
87 |
|
|
Other(2)
|
|
|
663 |
|
|
|
611 |
|
|
|
1,992 |
|
|
|
1,877 |
|
|
Total non-interest expense
|
|
$ |
1,996 |
|
|
$ |
1,802 |
|
|
$ |
5,843 |
|
|
$ |
5,469 |
|
______________
|
(1)
|
There were no differences in reported and managed non-interest expense amounts for the three and nine months ended September 30, 2009.
|
|
(2)
|
Consists of professional services expenses, credit collection costs, fee assessments and intangible amortization expense.
|
Non-interest expense of $2.0 billion for the third quarter of 2010 was up $194 million, or 11%, from the third quarter of 2009, and non-interest expense of $5.8 billion for the first nine months of 2010 was up $374 million, or 7%, from the first nine months of 2009. The increase in non-interest expense in both periods was primarily attributable to higher marketing costs, legal reserves and non-income tax-related accruals.
Income Taxes
Our effective income tax rate on income from continuing operations was 29.1% in the third quarter of 2010, up from 25.0% in the third quarter of 2009, and 28.8% for the first nine months of 2010, up from 23.5% for the first nine months of 2009. The variance in our effective tax rate between periods is due, in part, to fluctuations in our pre-tax earnings, which affects the relative tax benefit of tax-exempt income, tax credits and permanent tax items. The increase in our effective tax rate in the third quarter and first nine months of 2010 reflected the reduced relative benefit of tax-exempt income and tax credits as a result of the increase in our pre-tax earnings. We recorded a $71 million tax benefit primarily from the settlement of certain pre-acquisition tax liabilities related to North Fork and resolution of certain tax issues before the U.S. Tax Court in the first nine months of 2010, which partially offset the increase in our effective tax rate for this period.
We provide additional information on items affecting our income taxes and effective tax rate in our 2009 Form 10-K under “Note 18—Income Taxes.”
Loss from Discontinued Operations, Net of Tax
Loss from discontinued operations reflect ongoing costs, which primarily consist of mortgage loan repurchase representation and warranty charges, related to the mortgage origination operations of GreenPoint’s wholesale mortgage banking unit, which we closed in 2007. We recorded a loss from discontinued operations, net of tax of $15 million in the third quarter of 2010, compared with a loss of $43 million in the third quarter of 2009. Loss from discontinued operations totaled $303 million in the first nine months of 2010, compared with a loss of $75 million in the first nine months of 2009.
The significant increase in loss from discontinued operations in the first nine months of 2010 was attributable to the increase in our mortgage loan repurchase representation and warranty reserves. We recorded a provision for mortgage loan repurchase exposure of $644 million in the first nine months of 2010, of which $433 million was included in discontinued operations. We provide additional information on representation and warranty claims in “Critical Accounting Polices and Estimates” and in “Consolidated Balance Sheet Analysis and Credit Performance—Potential Mortgage Representation and Warranty Liabilities.”
Total assets of $196.9 billion as of September 30, 2010, after taking into consideration the $41.9 billion of assets added to our balance sheet on January 1, 2010 as a result of the adoption of the new consolidation standards, decreased by $14.6 billion, or 9%, during the first nine months of 2010. Total liabilities of $170.9 billion as of September 30, 2010, after taking into consideration the $44.3 billion of securitization debt added to our balance sheet on January 1, 2010 as a result of the adoption of the new consolidation standards, decreased by $16.5 billion, or 12%, during the first nine months of 2010. Our stockholders’ equity, after taking into account the cumulative effect after-tax charge of $2.9 billion to retained earnings on January 1, 2010 from the adoption of the new consolidation accounting standards, increased by $2.4 billion during the first nine months of 2010, to $26.1 billion as of September 30, 2010. The increase in stockholders’ equity was primarily attributable to our net income of $2.0 billion for the first nine months of 2010.
Following is a discussion of material changes, excluding the impact from our January 1, 2010 adoption of the new consolidation accounting standards, in the major components of our assets and liabilities during the first nine months of 2010.
Investment Securities
Our investment securities portfolio, which had a fair value of $39.9 billion and $38.9 billion, as of September 30, 2010 and December 31, 2009, respectively, consists of the following: U.S. Treasury and U.S. agency debt obligations; agency and non-agency mortgage related securities; other asset-backed securities collateralized primarily by credit card loans, auto loans, student loans, auto dealer floor plan inventory loans, equipment loans and home equity lines of credit; municipal securities; and limited Community Reinvestment Act (“CRA”) equity securities. Our investment securities portfolio continues to be heavily concentrated in securities that generally have lower credit risk and high credit ratings, such as securities issued and guaranteed by the U.S. Treasury and government sponsored enterprises or agencies. Our investments in U.S. Treasury and agency securities, based on fair value, represented approximately 69% of our total investment securities portfolio as of September 30, 2010, compared with 75% as of December 31, 2009.
All of our investment securities were classified as available for sale as of September 30, 2010 and reported in our consolidated balance sheet at fair value. Table 8 presents, for the major categories of our investment securities, the amortized cost and fair value as of September 30, 2010 and December 31, 2009.
Table 8: Investment Securities
| |
|
September 30, 2010
|
|
|
December 31, 2009
|
|
|
(Dollars in millions)
|
|
Amortized Cost
|
|
|
Fair Value
|
|
|
Amortized Cost
|
|
|
Fair Value
|
|
|
Securities available for sale:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury debt obligations
|
|
$ |
374 |
|
|
$ |
390 |
|
|
$ |
379 |
|
|
$ |
392 |
|
|
U.S. Agency debt obligations(1)
|
|
|
351 |
|
|
|
368 |
|
|
|
455 |
|
|
|
477 |
|
|
Collateralized mortgage obligations (“CMO”):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Agency(2)
|
|
|
11,845 |
|
|
|
12,231 |
|
|
|
8,174 |
|
|
|
8,300 |
|
|
Non-agency
|
|
|
1,182 |
|
|
|
1,084 |
|
|
|
1,608 |
|
|
|
1,338 |
|
|
Total CMOs
|
|
|
13,027 |
|
|
|
13,315 |
|
|
|
9,782 |
|
|
|
9,638 |
|
|
Mortgage-backed securities (“MBS”):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Agency(2)
|
|
|
14,278 |
|
|
|
14,755 |
|
|
|
19,429 |
|
|
|
19,858 |
|
|
Non-agency
|
|
|
794 |
|
|
|
734 |
|
|
|
1,011 |
|
|
|
826 |
|
|
Total MBS
|
|
|
15,072 |
|
|
|
15,489 |
|
|
|
20,440 |
|
|
|
20,684 |
|
|
Asset-backed securities(3)
|
|
|
9,821 |
|
|
|
9,916 |
|
|
|
7,043 |
|
|
|
7,192 |
|
|
Other securities(4)
|
|
|
394 |
|
|
|
448 |
|
|
|
440 |
|
|
|
447 |
|
|
Total securities available for sale
|
|
$ |
39,039 |
|
|
$ |
39,926 |
|
|
$ |
38,539 |
|
|
$ |
38,830 |
|
|
Securities held to maturity:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total securities held to maturity
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
80 |
(5) |
|
$ |
80 |
(5) |
______________
|
(1)
|
Consists of debt securities issued by Fannie Mae and Freddie Mac with amortized costs of $350 million and $454 million, as of September 30, 2010 and December 31, 2009, respectively, and fair values of $367 million and $476 million, as of September 30, 2010 and December 31, 2009, respectively.
|
|
(2)
|
Consists of mortgage-related securities issued by Fannie Mae and Freddie Mac with amortized cost of $16.0 billion and $8.0 billion, respectively, and fair value of $16.5 billion and $8.3 billion, respectively, as of September 30, 2010. Our Fannie Mae, Freddie Mac and Ginnie Mae investments exceeded 10% of stockholders’ equity as of September 30, 2010.
|
|
(3)
|
Consists of securities collateralized by credit card loans, auto loans, student loans, auto dealer floor plan inventory loans, equipment loans and home equity lines of credit. The distribution among these asset types was approximately 79.3% credit card loans, 5.8% auto loans, 7.6% student loans, 5.1% auto dealer floor plan inventory loans, 2.0% equipment loans and 0.2% home equity lines of credit as of September 30, 2010. In comparison, the distribution was approximately 76.3% credit card loans, 14.0% auto loans, 6.9% student loans, 1.7% auto dealer floor plan inventory loans, 0.8% equipment loans and 0.3% home equity lines of credit as of December 31, 2009. Approximately 90.7% of the securities in our asset-backed security portfolio were rated AAA or its equivalent as of September 30, 2010, compared with 84.2% as of December 31, 2009.
|
|
(4)
|
Consists of municipal securities and equity investments, primarily related to CRA activities.
|
|
(5)
|
Consists of negative amortization mortgage-backed securities.
|
Unrealized gains and losses on our available-for-sale securities are recorded net of tax as a component of accumulated other comprehensive income (“AOCI”). We had gross unrealized gains of $1.1 billion and gross unrealized losses of $179 million on available-for sale securities as of September 30, 2010, compared with gross unrealized gains of $840 million and gross unrealized losses of $549 million as of December 31, 2009. The increase in gross unrealized gains and decrease in gross unrealized losses in the first nine months of 2010 was primarily driven by a tightening of credit spreads, attributable to the improvement in credit performance and increased liquidity, and lower interest rates. Of the $179 million gross unrealized losses as of September 30, 2010, $167 million related to securities that had been in a loss position for more than 12 months.
We evaluate available-for-sale securities in an unrealized loss position as of the end of each quarter for other-than-temporary impairment based on a number of criteria, including the extent and duration of the decline in value, the severity and duration of the impairment, recent events specific to the issuer and/or industry to which the issuer belongs, the payment structure of the security, external credit ratings and the failure of the issuer to make scheduled interest or principal payments, the value of underlying collateral, our intent and ability to hold the security and current market conditions.
Other-than-temporary impairment is recognized in earnings if one of the following conditions exists: (1) a decision to sell the security has been made; (2) it is more likely than not that we will be required to sell the security before the impairment is recovered; or (3) the amortized cost basis is not expected to be recovered. If, however, we have not made a decision to sell the security and we do not expect that we will be required to sell prior to recovery of the amortized cost basis, only the credit component of other-than-temporary impairment is recognized in earnings. The noncredit component is recorded in other comprehensive income (“OCI”). The credit component is the difference between the security’s amortized cost basis and the present value of its expected future cash flows discounted based on the original yield, while the noncredit component is the remaining difference between the security’s fair value and amortized cost.
We recognized net OTTI on debt securities of $5 million and $62 million in the third quarter and first nine months of 2010, respectively, due in part to deterioration in the credit performance of certain securities resulting from the continued weakness in the housing market and high unemployment and our decision to sell certain other securities before recovery of the impairment amount.
We provide additional information on our available-for-sale securities in “Note 3—Investment Securities.”
Total Loans
Total loans that we manage consist of held-for-investment loans recorded on our balance sheet and loans held in our securitization trusts. Prior to our January 1, 2010 adoption of the new consolidation standards, a portion of our managed loans were accounted for as off-balance sheet. Loans underlying our securitization trusts are now reported on our consolidated balance sheets in restricted loans for securitization investors. Table 9 presents the composition of our total loan portfolio, by business segments, as of September 30, 2010 and December 31, 2009.
Table 9: Loan Portfolio Composition
| |
|
September 30, 2010
|
|
|
December 31, 2009
|
|
|
(Dollars in millions)
|
|
Reported On-Balance Sheet
|
|
|
% of
Total Loans
|
|
|
Reported On-Balance Sheet
|
|
|
Off-Balance Sheet
|
|
|
Total Managed
|
|
|
% of
Total Loans
|
|
|
Credit Card business:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Credit card loans:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Domestic credit card loans
|
|
$ |
49,324 |
|
|
|
39 |
% |
|
$ |
13,374 |
|
|
$ |
39,827 |
|
|
$ |
53,201 |
|
|
|
39 |
% |
|
International credit card loans
|
|
|
7,473 |
|
|
|
6 |
|
|
|
2,229 |
|
|
|
5,951 |
|
|
|
8,180 |
|
|
|
6 |
|
|
Total credit card loans
|
|
|
56,797 |
|
|
|
45 |
|
|
|
15,603 |
|
|
|
45,778 |
|
|
|
61,381 |
|
|
|
45 |
|
|
Installment loans:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Domestic installment loans
|
|
|
4,515 |
|
|
|
4 |
|
|
|
6,693 |
|
|
|
406 |
|
|
|
7,099 |
|
|
|
5 |
|
|
International installment loans
|
|
|
14 |
|
|
|
— |
|
|
|
44 |
|
|
|
— |
|
|
|
44 |
|
|
|
— |
|
|
Total installment loans
|
|
|
4,529 |
|
|
|
4 |
|
|
|
6,737 |
|
|
|
406 |
|
|
|
7,143 |
|
|
|
5 |
|
|
Total credit card
|
|
|
61,326 |
|
|
|
49 |
|
|
|
22,340 |
|
|
|
46,184 |
|
|
|
68,524 |
|
|
|
50 |
|
|
Consumer Banking business:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Automobile
|
|
|
17,643 |
|
|
|
14 |
|
|
|
18,186 |
|
|
|
— |
|
|
|
18,186 |
|
|
|
13 |
|
|
Mortgage
|
|
|
12,763 |
|
|
|
10 |
|
|
|
14,893 |
|
|
|
— |
|
|
|
14,893 |
|
|
|
11 |
|
|
Other retail
|
|
|
4,591 |
|
|
|
4 |
|
|
|
5,135 |
|
|
|
— |
|
|
|
5,135 |
|
|
|
4 |
|
|
Total consumer banking
|
|
|
34,997 |
|
|
|
28 |
|
|
|
38,214 |
|
|
|
— |
|
|
|
38,214 |
|
|
|
28 |
|
|
Total consumer(1)
|
|
|
96,323 |
|
|
|
77 |
|
|
|
60,554 |
|
|
|