UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. |
For the quarterly period ended September 30, 2009.
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED). |
For the transition period from to
Commission File No. 1-13300
CAPITAL ONE FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Delaware |
54-1719854 | |
(State or Other Jurisdiction of Incorporation or Organization) |
(I.R.S. Employer Identification No.) | |
1680 Capital One Drive McLean, Virginia | 22102 | |
(Address of Principal Executive Offices) | (Zip Code) |
(703) 720-1000
Registrants telephone number, including area code:
(Not applicable)
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
Large accelerated filer x Accelerated filer ¨ Non-accelerated filer ¨ Smaller reporting company ¨
As of October 31, 2009 there were 449,924,631 shares of the registrants Common Stock, par value $.01 per share, outstanding.
CAPITAL ONE FINANCIAL CORPORATION
FORM 10-Q
INDEX
September 30, 2009
Page | ||||
PART 1. FINANCIAL INFORMATION | 3 | |||
Item 1 | 3 | |||
3 | ||||
4 | ||||
6 | ||||
7 | ||||
9 | ||||
Item 2 | Managements Discussion and Analysis of Financial Condition and Results of Operations |
53 | ||
Item 3 | 95 | |||
Item 4 | 95 | |||
PART 2. OTHER INFORMATION | 95 | |||
Item 1 | 95 | |||
Item 1A | 95 | |||
Item 2 | 95 | |||
Item 6 | 96 | |||
99 |
2
Item 1. | Financial Statements |
CAPITAL ONE FINANCIAL CORPORATION
Consolidated Balance Sheets
(Dollars in thousands, except share and per share data) (unaudited)
September 30, 2009 |
December 31, 2008 |
|||||||
Assets: |
||||||||
Cash and due from banks |
$ | 2,719,100 | $ | 2,047,839 | ||||
Federal funds sold and resale agreements |
544,793 | 636,752 | ||||||
Interest-bearing deposits at other banks |
863,310 | 4,806,752 | ||||||
Cash and cash equivalents |
4,127,203 | 7,491,343 | ||||||
Securities available for sale |
37,693,001 | 31,003,271 | ||||||
Securities held to maturity |
83,608 | | ||||||
Mortgage loans held for sale |
141,158 | 68,462 | ||||||
Loans held for investment |
96,783,165 | 101,017,771 | ||||||
Less: Allowance for loan and lease losses |
(4,513,493 | ) | (4,523,960 | ) | ||||
Net loans held for investment |
92,269,672 | 96,493,811 | ||||||
Accounts receivable from securitizations |
6,985,200 | 6,342,754 | ||||||
Premises and equipment, net |
2,773,173 | 2,313,106 | ||||||
Interest receivable |
947,738 | 827,909 | ||||||
Goodwill |
13,524,978 | 11,964,487 | ||||||
Other |
9,958,190 | 9,408,309 | ||||||
Total assets |
$ | 168,503,921 | $ | 165,913,452 | ||||
Liabilities: |
||||||||
Non-interest-bearing deposits |
$ | 12,734,589 | $ | 11,293,852 | ||||
Interest-bearing deposits |
101,768,522 | 97,326,937 | ||||||
Total deposits |
114,503,111 | 108,620,789 | ||||||
Senior and subordinated notes |
9,208,769 | 8,308,843 | ||||||
Other borrowings |
12,126,181 | 14,869,648 | ||||||
Interest payable |
582,969 | 676,398 | ||||||
Other |
5,860,739 | 6,825,341 | ||||||
Total liabilities |
142,281,769 | 139,301,019 | ||||||
Stockholders Equity: |
||||||||
Preferred stock, par value $.01 per share; authorized 50,000,000 shares, zero and 3,555,199 issued or outstanding as of September 30, 2009 and December 31, 2008, respectively |
| 3,096,466 | ||||||
Common stock, par value $.01 per share; authorized 1,000,000,000 shares, 502,097,580 and 438,434,235 issued as of September 30, 2009 and December 31, 2008, respectively |
5,021 | 4,384 | ||||||
Paid-in capital, net |
18,928,719 | 17,278,102 | ||||||
Retained earnings |
10,404,255 | 10,621,164 | ||||||
Cumulative other comprehensive income (loss) |
56,524 | (1,221,796 | ) | |||||
Less: Treasury stock, at cost; 47,014,878 and 46,637,241 shares as of September 30, 2009 and December 31, 2008, respectively |
(3,172,367 | ) | (3,165,887 | ) | ||||
Total stockholders equity |
26,222,152 | 26,612,433 | ||||||
Total liabilities and stockholders equity |
$ | 168,503,921 | $ | 165,913,452 | ||||
See Notes to Consolidated Financial Statements.
3
CAPITAL ONE FINANCIAL CORPORATION
Consolidated Statements of Income
(Dollars in thousands, except per share data) (unaudited)
Three Months Ended September 30 |
Nine Months Ended September 30 |
|||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Interest Income: |
||||||||||||||||
Loans held for investment, including past-due fees |
$ | 2,265,720 | $ | 2,347,480 | $ | 6,689,859 | $ | 7,153,582 | ||||||||
Investment securities |
398,835 | 317,268 | 1,206,460 | 856,093 | ||||||||||||
Other |
83,195 | 107,048 | 214,294 | 333,503 | ||||||||||||
Total interest income |
2,747,750 | 2,771,796 | 8,110,613 | 8,343,178 | ||||||||||||
Interest Expense: |
||||||||||||||||
Deposits |
479,178 | 624,319 | 1,666,605 | 1,827,284 | ||||||||||||
Senior and subordinated notes |
74,032 | 96,568 | 189,189 | 352,335 | ||||||||||||
Other borrowings |
143,860 | 244,264 | 470,802 | 817,241 | ||||||||||||
Total interest expense |
697,070 | 965,151 | 2,326,596 | 2,996,860 | ||||||||||||
Net interest income |
2,050,680 | 1,806,645 | 5,784,017 | 5,346,318 | ||||||||||||
Provision for loan and lease losses |
1,173,165 | 1,093,917 | 3,386,340 | 3,002,119 | ||||||||||||
Net interest income after provision for loan and lease losses |
877,515 | 712,728 | 2,397,677 | 2,344,199 | ||||||||||||
Non-Interest Income: |
||||||||||||||||
Servicing and securitizations |
720,698 | 875,718 | 1,536,751 | 2,793,520 | ||||||||||||
Service charges and other customer-related fees |
496,404 | 576,762 | 1,494,292 | 1,675,032 | ||||||||||||
Mortgage servicing and other |
8,656 | 39,183 | 45,199 | 90,990 | ||||||||||||
Interchange |
122,585 | 148,076 | 389,378 | 432,708 | ||||||||||||
Net impairment losses recognized in earnings(1) |
(11,173 | ) | | (21,567 | ) | | ||||||||||
Other |
215,210 | 57,152 | 430,348 | 383,435 | ||||||||||||
Total non-interest income |
1,552,380 | 1,696,891 | 3,874,401 | 5,375,685 | ||||||||||||
Non-Interest Expense: |
||||||||||||||||
Salaries and associate benefits |
648,180 | 571,686 | 1,836,430 | 1,761,538 | ||||||||||||
Marketing |
103,698 | 267,372 | 400,380 | 853,265 | ||||||||||||
Communications and data processing |
175,575 | 176,720 | 569,257 | 559,065 | ||||||||||||
Supplies and equipment |
122,777 | 126,781 | 370,160 | 389,649 | ||||||||||||
Occupancy |
113,913 | 96,483 | 329,049 | 264,700 | ||||||||||||
Restructuring expense |
26,357 | 15,306 | 87,358 | 81,625 | ||||||||||||
Other |
611,978 | 555,858 | 1,876,692 | 1,542,242 | ||||||||||||
Total non-interest expense |
1,802,478 | 1,810,206 | 5,469,326 | 5,452,084 | ||||||||||||
Income from continuing operations before income taxes |
627,417 | 599,413 | 802,752 | 2,267,800 | ||||||||||||
Income tax provision |
158,191 | 213,624 | 190,246 | 786,958 | ||||||||||||
Income from continuing operations, net of tax |
469,226 | 385,789 | 612,506 | 1,480,842 | ||||||||||||
Loss from discontinued operations, net of tax |
(43,587 | ) | (11,650 | ) | (74,543 | ) | (105,294 | ) | ||||||||
Net income |
$ | 425,639 | $ | 374,139 | $ | 537,963 | $ | 1,375,548 | ||||||||
Net income (loss) available to common shareholders |
$ | 425,639 | $ | 374,139 | $ | (25,945 | ) | $ | 1,375,548 | |||||||
Basic earnings per common share: |
||||||||||||||||
Income from continuing operations |
$ | 1.04 | $ | 1.03 | $ | 0.12 | $ | 3.98 | ||||||||
Loss from discontinued operations |
(0.09 | ) | (0.03 | ) | (0.18 | ) | (0.28 | ) | ||||||||
Net income (loss) |
$ | 0.95 | $ | 1.00 | $ | (0.06 | ) | $ | 3.70 | |||||||
Diluted earnings per common share: |
||||||||||||||||
Income (loss) from continuing operations |
$ | 1.03 | $ | 1.03 | $ | 0.12 | $ | 3.96 | ||||||||
Loss from discontinued operations |
(0.09 | ) | (0.03 | ) | (0.18 | ) | (0.28 | ) | ||||||||
Net income (loss) |
$ | 0.94 | $ | 1.00 | $ | (0.06 | ) | $ | 3.68 | |||||||
Dividends paid per common share |
$ | 0.05 | $ | 0.375 | $ | 0.475 | $ | 1.125 | ||||||||
4
(1) | For the three and nine months ended September 30, 2009, the Company recorded other-than-temporary impairment losses of $11.2 million and $21.6 million, respectively. Total unrealized losses on these securities recognized in other comprehensive income as a component of stockholders equity at September 30, 2009 was $158.8 million. |
See Notes to Consolidated Financial Statements.
5
CAPITAL ONE FINANCIAL CORPORATION
Consolidated Statements of Changes in Stockholders Equity
(Dollars in thousands, except per share data) (unaudited)
Common Stock | Preferred Stock | Paid-In Capital, Net |
Retained Earnings |
Cumulative Other Comprehensive Income (Loss) |
Treasury Stock |
Total Stockholders Equity |
||||||||||||||||||||||
(In Thousands, Except Per Share Data) |
Shares | Amount | ||||||||||||||||||||||||||
Balance, December 31, 2007 |
419,224,900 | $ | 4,192 | $ | | $ | 15,860,490 | $ | 11,267,568 | $ | 315,248 | $ | (3,153,386 | ) | $ | 24,294,112 | ||||||||||||
Adjustment to initially apply the measurement date provision for post retirement benefits of ASC 715-20 of the Codification, net of income tax benefit of $317 |
| | | | 572 | (1,161 | ) | | (589 | ) | ||||||||||||||||||
Comprehensive income: |
||||||||||||||||||||||||||||
Net income |
| | | | 1,375,548 | | | 1,375,548 | ||||||||||||||||||||
Other comprehensive income, net of income tax: |
||||||||||||||||||||||||||||
Unrealized losses on securities, net of income tax benefit of $144,858 |
| | | | | (269,022 | ) | | (269,022 | ) | ||||||||||||||||||
Defined benefit pension plans, net of income tax benefit of $2,089 |
| | | | | (4,032 | ) | | (4,032 | ) | ||||||||||||||||||
Foreign currency translation adjustments |
| | | | | (253,790 | ) | | (253,790 | ) | ||||||||||||||||||
Unrealized loss on cash flow hedging instruments, net of income tax benefit of $5,964 |
| | | | | 11,077 | | 11,077 | ||||||||||||||||||||
Other comprehensive income (loss) |
| | | | | (515,767 | ) | | (515,767 | ) | ||||||||||||||||||
Comprehensive income |
859,781 | |||||||||||||||||||||||||||
Cash dividendsCommon stock $1.125 per share |
| | | | (421,518 | ) | | | (421,518 | ) | ||||||||||||||||||
Purchase of treasury stock |
| | | | | | (12,025 | ) | (12,025 | ) | ||||||||||||||||||
Issuances of common stock and restricted stock, net of forfeitures |
17,170,062 | 172 | | 758,602 | | | | 758,774 | ||||||||||||||||||||
Exercise of stock options and tax benefits of exercises and restricted stock vesting |
1,910,252 | 19 | | 60,699 | | | | 60,718 | ||||||||||||||||||||
Compensation expense for restricted stock awards and stock options |
| | | 67,576 | | | | 67,576 | ||||||||||||||||||||
Allocation of ESOP shares |
| | | 4,711 | | | | 4,711 | ||||||||||||||||||||
Balance, September 30, 2008 |
438,305,214 | $ | 4,383 | | $ | 16,752,078 | $ | 12,222,170 | $ | (201,680 | ) | $ | (3,165,411 | ) | $ | 25,611,540 | ||||||||||||
Balance, December 31, 2008 |
438,434,235 | $ | 4,384 | $ | 3,096,466 | $ | 17,278,102 | $ | 10,621,164 | $ | (1,221,796 | ) | $ | (3,165,887 | ) | $ | 26,612,433 | |||||||||||
Comprehensive income: |
||||||||||||||||||||||||||||
Net income |
| | | | 537,963 | | | 537,963 | ||||||||||||||||||||
Other comprehensive income (loss), net of income tax: |
||||||||||||||||||||||||||||
Unrealized gains on securities, net of income taxes of $544,333 |
| | | | | 1,026,279 | | 1,026,279 | ||||||||||||||||||||
Defined benefit pension plans, net of net income tax benefit of $1,641 |
| | | | | (2,944 | ) | | (2,944 | ) | ||||||||||||||||||
Foreign currency translation adjustments |
| | | | | 177,489 | | 177,489 | ||||||||||||||||||||
Unrealized gains in cash flow hedging instruments, net of income taxes of $51,792 |
| | | | | 77,496 | | 77,496 | ||||||||||||||||||||
Other comprehensive income (loss) |
| | | | | 1,278,320 | | 1,278,320 | ||||||||||||||||||||
Comprehensive income (loss) |
1,816,283 | |||||||||||||||||||||||||||
Cash dividends-Common stock $0.475 per share |
| | | | (190,964 | ) | | | (190,964 | ) | ||||||||||||||||||
Cash dividends-Preferred stock 5% per annum |
| | (22,714 | ) | | (82,461 | ) | | | (105,175 | ) | |||||||||||||||||
Purchase of treasury stock |
| | | | | | (6,480 | ) | (6,480 | ) | ||||||||||||||||||
Issuances of common stock and restricted stock, net of forfeitures |
61,009,827 | 610 | | 1,528,688 | | | | 1,529,298 | ||||||||||||||||||||
Exercise of stock options and tax benefits of exercises and restricted stock vesting |
92,917 | 1 | | 894 | | | | 895 | ||||||||||||||||||||
Accretion of preferred stock discount |
| | 33,554 | | (33,554 | ) | | | | |||||||||||||||||||
Redemption of preferred stock |
| | (3,107,306 | ) | | (447,893 | ) | | | (3,555,199 | ) | |||||||||||||||||
Compensation expense for restricted stock awards and stock options |
| | | 88,972 | | | | 88,972 | ||||||||||||||||||||
Issuance of common stock for acquisition |
2,560,601 | 26 | | 30,830 | | | | 30,856 | ||||||||||||||||||||
Allocation of ESOP shares |
| | | 1,233 | | | | 1,233 | ||||||||||||||||||||
Balance, September 30, 2009 |
502,097,580 | $ | 5,021 | $ | | $ | 18,928,719 | $ | 10,404,255 | $ | 56,524 | $ | (3,172,367 | ) | $ | 26,222,152 | ||||||||||||
See Notes to Consolidated Financial Statements.
6
CAPITAL ONE FINANCIAL CORPORATION
Consolidated Statements of Cash Flows
(Dollars in thousands) (unaudited)
Nine Months Ended September 30, |
||||||||
2009 | 2008 | |||||||
Operating Activities: |
||||||||
Income from continuing operations, net of tax |
$ | 612,506 | $ | 1,480,842 | ||||
Loss from discontinued operations, net of tax |
(74,543 | ) | (105,294 | ) | ||||
Net Income |
537,963 | 1,375,548 | ||||||
Adjustments to reconcile net income to cash provided by operating activities: |
||||||||
Provision for loan and lease losses |
3,386,340 | 3,002,119 | ||||||
Depreciation and amortization, net |
585,874 | 536,436 | ||||||
Gain on sales of securities available for sale |
(217,044 | ) | (13,713 | ) | ||||
Gain on sales of auto loans |
| (2,428 | ) | |||||
Gain on repurchase of senior notes |
| (53,860 | ) | |||||
Mortgage loans held for sale: |
||||||||
Transfers and originations |
(6,765,798 | ) | (1,639,636 | ) | ||||
Loss (Gain) on sales |
399 | (26,062 | ) | |||||
Proceeds from sales |
6,924,248 | 1,864,311 | ||||||
Stock plan compensation expense |
102,036 | 81,239 | ||||||
Changes in assets and liabilities: |
||||||||
(Increase) Decrease in interest receivable |
(119,829 | ) | 88,600 | |||||
Increase in accounts receivable from securitizations |
(642,446 | ) | (262,944 | ) | ||||
Decrease (Increase) in other assets |
1,105,795 | (960,113 | ) | |||||
Decreases in interest payable |
(93,429 | ) | (123,518 | ) | ||||
(Decreases) Increase in other liabilities |
(1,712,839 | ) | 85,499 | |||||
Net cash used in operating activities attributable to discontinued operations |
39,984 | 129,659 | ||||||
Net cash provided by operating activities |
3,131,254 | 4,081,137 | ||||||
Investing Activities: |
||||||||
Purchases of securities available for sale |
(22,368,668 | ) | (15,266,177 | ) | ||||
Proceeds from maturities of securities available for sale |
7,710,694 | 5,189,006 | ||||||
Proceeds from sales of securities available for sale |
10,977,685 | 2,504,289 | ||||||
Proceeds from securitizations of loans |
8,816,378 | 8,446,956 | ||||||
Net (increase) decrease in loans held for investment |
375,936 | (7,649,922 | ) | |||||
Principal recoveries of loans previously charged off |
592,514 | 501,970 | ||||||
Additions of premises and equipment, net |
(213,799 | ) | (270,064 | ) | ||||
Net payment for companies acquired |
(448,151 | ) | | |||||
Net cash provided by investing activities attributable to discontinued operations |
451 | 11,659 | ||||||
Net cash provided by (used in) investing activities |
5,443,040 | (6,532,283 | ) | |||||
Financing Activities: |
||||||||
Net (decrease) increase in deposits |
(7,674,317 | ) | 16,151,798 | |||||
Net decreases in other borrowings |
(4,748,368 | ) | (10,834,872 | ) | ||||
Maturities of senior notes |
(1,447,365 | ) | (1,318,694 | ) | ||||
Repurchases of senior notes |
| (1,120,724 | ) | |||||
Redemptions of acquired company debt and noncontrolling interest |
(464,915 | ) | | |||||
Issuance of junior subordinated notes |
1,000,000 | | ||||||
Issuance of senior notes |
1,000,000 | | ||||||
Issuance of subordinated notes |
1,500,000 | | ||||||
Redemption of preferred stock |
(3,555,199 | ) | | |||||
Purchases of treasury stock |
(6,480 | ) | (12,025 | ) | ||||
Dividends paid-common stock |
(190,964 | ) | (421,518 | ) | ||||
Dividends paid-preferred stock |
(105,175 | ) | | |||||
Net proceeds from issuances of common stock |
1,530,531 | 763,485 | ||||||
Proceeds from share based payment activities |
895 | 60,718 | ||||||
Net cash used in financing activities attributable to discontinued operations |
(3,394 | ) | (17,690 | ) | ||||
Net cash (used in) provided by financing activities |
(13,164,751 | ) | 3,250,478 | |||||
Net (decrease) increase in cash and cash equivalents |
(4,590,457 | ) | 799,332 |
7
Nine Months Ended September 30, | ||||||
2009 | 2008 | |||||
Cash and cash equivalents at beginning of year |
7,491,343 | 4,821,409 | ||||
Cash and cash equivalents of acquired companies |
1,226,317 | | ||||
Cash and cash equivalents at end of period |
$ | 4,127,203 | $ | 5,620,741 | ||
See Notes to Consolidated Financial Statements.
8
CAPITAL ONE FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
(in thousands, except per share data) (unaudited)
Note 1
Significant Accounting Policies
Business
Capital One Financial Corporation (the Corporation) is a diversified financial services company whose banking and non-banking subsidiaries market a variety of financial products and services. The Corporations principal subsidiaries are:
| Capital One Bank (USA), National Association (COBNA) which currently offers credit and debit card products, other lending products and deposit products. |
| Capital One, National Association (CONA) which offers a broad spectrum of banking products and financial services to consumers, small businesses and commercial clients. |
On February 27, 2009, the Corporation acquired Chevy Chase Bank, F.S.B. (Chevy Chase Bank) for $475.9 million comprised of cash of $445.0 million and 2.56 million shares of common stock valued at $30.9 million. Chevy Chase Bank has the largest retail branch presence in the Washington D.C. region. See Note 2 for more information regarding the acquisition.
On July 30, 2009 the Company merged Chevy Chase Bank with and into CONA.
During the third quarter of 2009, the Company realigned its business segment reporting structure to better reflect the manner in which the performance of the Companys operations are evaluated. The Company now reports the results of its business through three operating segments: Credit Card, Commercial Banking and Consumer Banking.
Segment and sub-segment results where presented have been recast for all periods presented. The three segments consist of the following:
| Credit Card includes the Companys domestic consumer and small business card lending, domestic national small business lending, national closed end installment lending and the international card lending businesses in Canada and the United Kingdom. |
| Commercial Banking includes the Companys lending, deposit gathering and treasury management services to commercial real estate and middle market customers. The Commercial segment also includes the financial results of a national portfolio of small ticket commercial real estate loans that are in run-off mode. |
| Consumer Banking includes the Companys branch based lending and deposit gathering activities for small business customers as well as its branch based consumer deposit gathering and lending activities, national deposit gathering, consumer mortgage lending and servicing activities and national automobile lending. |
The segment reorganization includes the allocation of Chevy Chase Bank to the appropriate segments. Chevy Chase Banks operations are included in the Commercial Banking and Consumer Banking segments beginning in the second quarter 2009. Chevy Chase Banks operations for the first quarter of 2009 remain in the Other category due to the short duration since acquisition. The Other category includes GreenPoint originated consumer mortgages originated for sale but held for investment since originations were suspended in 2007, the results of corporate treasury activities, including asset-liability management and the investment portfolio, the net impact of transfer pricing, brokered deposits, certain unallocated expenses, gains/losses related to the securitization of assets, and restructuring charges related to the Companys cost initiative and to the Chevy Chase Bank acquisition.
During 2008, the Corporation completed several reorganizations and consolidations to streamline operations and regulatory relationships. On January 1, Capital One Auto Finance Inc. (COAF) moved from a direct subsidiary of the Corporation to become a direct operating subsidiary of CONA. In connection with the COAF move, one of COAFs direct operating subsidiaries, Onyx Acceptance Corporation (Onyx), became a direct subsidiary of the Corporation. On March 1, the Corporation converted Capital One Bank from a Virginia-state chartered bank to a national association called Capital One Bank (USA), National Association (COBNA). On March 8, Superior Savings of New England, N.A. (Superior) merged with and into CONA. Both COBNA and CONA are primarily regulated by the Office of the Comptroller of the Currency (the OCC). In May 2008, we consolidated the business and operations of two registered broker-dealers, Capital One Securities, LLC (dba Capital One Investments, LLC) and Capital One Investment Services Corporation (formerly NFB Investment Services Corporation), into Capital One Investments Services Corporation. In addition, in May 2008, we consolidated the business and operations of three insurance agencies, Capital One Agency Corp., GreenPoint Agency, Inc. and Hibernia Insurance Agency, LLC into Green Point Agency, Inc., which is now known as Capital One Agency LLC.
The Corporation and its subsidiaries are hereafter collectively referred to as the Company.
9
CONA and COBNA are hereafter collectively referred to as the Banks.
Basis of Presentation
The accompanying Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States (GAAP) that require management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from these estimates. In the opinion of management, all adjustments, consisting only of normal recurring adjustments, which are necessary for a fair presentation of the results of operations in these financial statements, have been made.
The Consolidated Financial Statements include the accounts of the Company in which it has a controlling financial interest. Investments in unconsolidated entities where we have the ability to exercise significant influence over the operations of the investee are accounted for using the equity method of accounting. This includes interests in variable interest entities (VIEs) where we are not the primary beneficiary. Investments not meeting the criteria for equity method accounting are accounted for using the cost method of accounting. Investments in unconsolidated entities are included in other assets, and our share of income or loss is recorded in other non-interest income. All significant intercompany balances and transactions have been eliminated. Certain prior year amounts have been reclassified to conform to the 2009 presentation. All amounts in the following notes, excluding per share data, are presented in thousands unless noted otherwise.
During the second quarter of 2009, the Financial Accounting Standards Board (FASB) issued SFAS No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principlesa replacement of FASB Statement No. 162 (ASC 105-10-65/SFAS 168). This standard establishes the Accounting Standards Codification for the FASB (Codification or ASC) as the single source of authoritative U.S. GAAP. The Codification does not change GAAP, but rather how the guidance is organized and presented to users. Effective July 1, 2009, changes to the source of authoritative U.S. GAAP are communicated through an Accounting Standards Update (ASU). ASUs will be published for all authoritative U.S. GAAP promulgated by the FASB, regardless of the form in which such guidance may have been issued prior to release of the FASB Codification (e.g., FASB Statements, EITF Abstracts, FASB Staff Positions, etc.). ASUs also will be issued for amendments to the SEC content in the FASB Codification as well as for editorial changes. Subsequently, the Codification will require companies to change how they reference GAAP throughout the financial statements. The Company has adopted the Codification for the third quarter of 2009 and has provided the pre-Codification references along with the related ASC references to allow readers an opportunity to see the impact of the Codification on our financial statements and disclosures.
Special Purpose Entities and Variable Interest Entities
Special purpose entities (SPEs) are broadly defined as legal entities structured for a particular purpose. There are two different accounting frameworks applicable to SPEs: the qualifying SPE (QSPE) framework under Statement of Financial Accounting Standard (SFAS) No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (ASC 860-10/SFAS 140) and the VIE framework under Financial Accounting Standards Board Interpretation No. 46 (Revised 2003), Consolidation of Variable Interest Entities (VIE), (ASC 810-10/FIN 46(R)).
QSPEs are passive entities that are commonly used in mortgage, credit card, auto and installment loan securitization transactions. ASC 860-10/SFAS 140 establishes the criteria an entity must satisfy to be a QSPE which includes restrictions on the types of assets a QSPE may hold, limits on repurchase of assets, the use of derivatives and financial guarantees, and the level of discretion a servicer may exercise to collect receivables. SPEs that meet the criteria for QSPE status are not required to be consolidated. The Company uses the QSPE model to conduct off-balance sheet securitization activities. See Note 14 for more information on the Companys off-balance sheet securitization activities.
In June 2009, the FASB issued Statement of Financial Accounting Standards No. 166, An Amendment of FASB Statement No. 140 (SFAS 166), and Statement of Financial Accounting Standards No. 167, Amendments to FASB Interpretation No. 46(R) (SFAS 167). SFAS 166 removes the concept of a qualifying special-purpose entity (QSPE) from SFAS 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities and removes the exception from applying FASB Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities (ASC 810-10/FIN 46(R)), to variable interest entities that are qualifying special-purpose entities. SFAS 167 retains the scope of FIN 46(R) with the addition of entities previously considered qualifying special-purpose entities. SFAS 166 and SFAS 167 are effective for the Companys annual reporting period beginning January 1, 2010. The adoption of SFAS 166 and SFAS 167 could have a significant impact on the Companys consolidated financial statements because the Company expects it will be required to consolidate at least some of its special purpose entities to which pools of loan receivables have been transferred in transactions previously qualifying as sales. Holding more of these assets on the Companys balance sheet may require it to take various actions, including raising additional capital, in order to meet regulatory capital requirements. Such capital may not be available on terms favorable to the Company, if at all, and could have a negative impact on the Companys financial results. As of September 30, 2009, the Company had approximately $44.3 billion of credit card receivables held by QSPEs of which $41.3 billion are backed securities held by external investors; and $4.8 billion in mortgage receivables that are considered at risk for consolidation. Additionally, the Company has mortgage loans, HELOCs and manufactured housing loans serviced for others that the Company does not believe will be consolidated under the new guidance.
10
VIEs Special purpose entities that are not QSPEs are considered for consolidation in accordance with ASC 810-10/FIN 46(R), which defines a VIE as an entity that (1) lacks sufficient equity to finance its activities without additional subordinated financial support; (2) has equity owners that lack the ability to make significant decisions about the entity; or (3) has equity owners that do not have the obligation to absorb expected losses or the right to receive expected returns. In general, a VIE may be formed as a corporation, partnership, limited liability corporation, or any other legal structure used to conduct activities or hold assets. A VIE often holds financial assets, including loans or receivables, real estate or other property.
The Company consolidates a VIE if the Company is considered to be its primary beneficiary. The primary beneficiary is subject to absorbing the majority of the expected losses from the VIEs activities, is entitled to receive a majority of the entitys residual returns, or both.
The Company, in the ordinary course of business, has involvement with or retains interests in VIEs in connection with some of its securitization activities, servicing activities and the purchase or sale of mortgage-backed and other asset-backed securities in connection with its investment portfolio. The Company also makes loans to VIEs that hold debt, equity, real estate or other assets. In certain instances, the Company provides guarantees to VIEs or holders of variable interests in VIEs. The adoption of SFAS 167 could have an impact on the Companys consolidated financial statements because the Corporation expects it will consolidate certain VIEs as a result of applying the qualitative considerations called for in SFAS 167 versus the quantitative requirements under FIN 46(R). We are currently assessing the impact of SFAS 167 on our VIE structures at this time. See Note 11Mortgage Servicing Rights; Note 14Securitizations; Note 15Commitments, Contingencies and Guarantees; and Note 16Other Variable Interest Entities for more detail on the Companys involvement and exposure related to non-consolidated VIEs.
Derivative Instruments and Hedging Activities
The Company recognizes all of its derivative instruments as either assets or liabilities in the balance sheet at fair value. These instruments are recorded in other assets or other liabilities on the Consolidated Balance Sheets and in the operating section of the Statements of Cash Flows as increases (decreases) of other assets and other liabilities. The Companys policy is not to offset fair value amounts recognized for derivative instruments and fair value amounts recognized for the right to reclaim cash collateral or the obligation to return cash collateral arising from derivative instruments recognized at fair value executed with the same counterparty under netting arrangements. As of September 30, 2009 the Company had recorded $343.9 million for the right to reclaim cash collateral and $406.9 million for the obligation to return cash collateral under master netting arrangements.
Loans Acquired
Loans acquired in connection with acquisitions are accounted for under SFAS 141(R), Business Combinations (ASC 805-10/SFAS 141(R)) or Statement of Position 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer (ASC 310-10/SOP 03-3) if the loan has experienced a deterioration of credit quality at the time of acquisition. Under both statements, acquired loans are recorded at fair value and the carry-over of the related allowance for loan and lease losses is prohibited. Fair value of the loans involves estimating the principal and interest cash flows expected to be collected on the loans and discounting those cash flows at a market rate of interest. During the evaluation of whether a loan was considered impaired under ASC 310-10/SOP 03-3 or performing under ASC 805-10/SFAS 141(R), the Company considered a number of factors, including the delinquency status of the loan, payment options and other loan features (i.e. reduced documentation or stated income loans, interest only, or negative amortization features), the geographic location of the borrower or collateral, the loan-to-value ratio and the risk rating assigned to the loans. Based on the criteria, the Company considered the entire Chevy Chase Bank option arm portfolio to be impaired and accounted for under ASC 310-10/SOP 03-3. Portions of the Chevy Chase Bank commercial loan portfolio, HELOC portfolio and the fixed mortgage portfolio were also considered impaired.
The excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable yield and is recognized into interest income over the remaining life of the loan. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition, considering the impact of prepayments, is referred to as the nonaccretable difference. The nonaccretable difference includes estimated future credit losses expected to be incurred over the life of the loan. Subsequent decreases to the expected cash flows will require the Company to evaluate the need for an additional allowance for loan and lease losses. Subsequent improvement in cash flows will result in the reversal of the nonaccretable difference which will then get reclassified as accretable yield and have a positive impact on interest income. In addition, net charge-offs on such loans are applied to the nonaccretable difference recorded at acquisition for the estimated future credit losses.
Loans acquired that were previously classified as nonaccrual are considered performing, regardless of whether the customer is contractually delinquent. The Company expects to fully collect the new carrying value of the loans. As such, the Company no longer considers the loans to be nonaccrual or nonperforming because we will continue to accrue interest on these loans because of the establishment of an accretable yield in accordance with ASC 805-10/SFAS 141(R) and ASC 310-10/SOP 03-3.
11
Securities Available for Sale
The Company considers debt securities in its investment portfolio as available for sale. These securities are stated at fair value, with the unrealized gains and losses, net of tax, reported as a component of cumulative other comprehensive income. The fair values of securities is based on quoted market prices, or if quoted market prices are not available, then the fair value is estimated using the quoted market prices for similar securities, pricing models or discounted cash flow analyses, using observable market data where available. The amortized cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization or accretion is included in interest income. Realized gains and losses on sales of securities are determined using the specific identification method. The Company evaluates its unrealized loss positions for impairment in accordance with ASC 320-10/SFAS 115, Accounting for Certain Investments in Debt and Equity Securities, as amended by FSP No. 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairment. As such, when there is other-than-temporary impairment, the Company recognizes credit related impairments in earnings while other impairments are recorded in other comprehensive income. See Note 6 for additional details.
Income Taxes
The Company accounts for income taxes in accordance with SFAS 109, Accounting for Income Taxes (ASC740-10/SFAS 109), recognizing the current and deferred tax consequences of all transactions that have been recognized in the financial statements using the provisions of the enacted tax laws.
The Company recorded income tax expense of $158.2 million and $190.2 million for the three and nine month periods ended September 30, 2009. The related effective income tax rates were 25.2% and 23.7% for the three month and nine month periods ended September 30, 2009, respectively, compared to 35.6% and 34.7% for the same periods in the prior year. The decrease in the tax rates were primarily due to increases in permanent tax preferences, including tax-exempt interest and business tax credits, relative to the lower net income before tax in 2009.
On September 21, 2009, the U.S. Tax Court issued a decision with respect to certain tax issues for the years 1995-1999, with both parties prevailing on certain issues. At issue were proposed adjustments by the IRS with respect to the timing of recognition of items of income and expense derived from the Companys credit card business in various tax years. As a result of the Tax Court decision, the Company reduced the amount of unrecognized tax benefits by approximately $69.3 million. The time period for an appeal by each party of the Tax Court decision is pending and the ultimate outcome may also impact tax years after 1999. It is reasonably possible that a settlement related to these timing issues may be made within twelve months of the reporting date. At this time, an estimate of the potential change to the amount of unrecognized tax benefits resulting from such a settlement cannot be made.
Also during the third quarter of 2009, the IRS concluded its examination of the Companys federal income tax returns for the years 2005 and 2006 and the Company made cash payments to the IRS related to these concluded examinations which resulted in a reduction of approximately $220.6 million to the balance of net unrecognized tax benefits.
Primarily as a result of the U.S. Tax Court decision, the Company recorded a $30.3 million discrete tax benefit during the third quarter.
Recent Accounting Pronouncements
In September 2009, the FASB issued ASU No. 2009-08, Earnings per Share- Amendments to Section 260-10-S99 (SEC Update) (ASU 2009-08), which provided corrections to various parts of the Codification regarding EPS. ASU 2009-08 is effective immediately upon being issued. The initial adoption of ASU 2009-08 did not have an impact on the consolidated earnings or financial position of the Company as the update amended the reference between the Codification and pre-Codification references.
In September 2009, the FASB issued ASU No. 2009-07, Accounting for Various Topics- Technical Corrections to SEC Paragraphs (SEC Update) (ASU 2009-07), which provided corrections to various parts of the Codification including Regulation S-X. ASU 2009-07 is effective immediately upon being issued. The initial adoption of ASU 2009-07 did not have an impact on the consolidated earnings or financial position of the Company as the update amended the reference between the Codification and pre-Codification references.
In August 2009, the FASB issued ASU No. 2009-05, Fair Value Measurements and Disclosures (Topic 820)- Measuring Liabilities at Fair Value (ASU 2009-05), which provided additional details on calculating the fair value of liabilities. ASU 2009-05 is effective immediately upon being issued. The initial adoption of ASU 2009-05 did not have an impact on the consolidated earnings or financial position of the Company as the Company already uses the prescribed valuation techniques within ASU 2009-05.
12
In August 2009, the FASB issued ASU No. 2009-03, SEC Update- Amendments to Various Topics Containing SEC Staff Accounting Bulletins (SEC Update) (ASU 2009-03), which provided corrections to various parts of the Codification. ASU 2009-03 is effective immediately upon being issued. The initial adoption of ASU 2009-03 did not have an impact on the consolidated earnings or financial position of the Company as the update amended the reference between the Codification and pre-Codification references.
On June 30, 2009, the FASB issued ASU No. 2009-02, Omnibus Update- Amendments to Various Topics for Technical Corrections (ASU 2009-02), which provided corrections to various parts of the Codification. ASU 2009-02 is effective immediately upon being issued. The initial adoption of ASU 2009-02 did not have an impact on the consolidated earnings or financial position of the Company as the update amended the reference between the Codification and pre-Codification references.
On June 30, 2009, the FASB issued ASU No. 2009-01, Topic 105- Generally Accepted Accounting Principles- amendments based on- Statement of Financial Accounting Standards No. 168- The FASB Accounting Standards Codification and Hierarchy of Generally Accepted Accounting Principles (ASU 2009-01), which made the Codification effective for interim and annual periods ending after September 15, 2009, and will supersede all existing non-SEC accounting and reporting standards. All non-grandfathered non-SEC accounting literature not included in the Codification will become nonauthoritative. Once ASU 2009-01 is effective, the FASB will no longer issue updates in the form of statements, FASB Staff Positions, or Emerging Issues Task Force Abstracts; rather it will issue ASUs. The initial adoption of the FASBs Accounting Standards Codification did not have an impact on the consolidated earnings or financial position of the Company because it only amends the referencing to existing accounting standards.
On June 12, 2009, the FASB issued SFAS No. 167, Determining Amendments to FASB Interpretation No. 46(R), which provides additional guidance on how a company determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. SFAS 167 will be effective for interim and annual reporting periods beginning after November 15, 2009, and early adoption is prohibited. On June 12, 2009, the FASB issued SFAS No. 166, Accounting for Transfers of Financial Assets (SFAS 166), which will require more information about transfers of financial assets, including securitization transactions, and where companies have continuing exposure to the risks related to transferred financial assets. It eliminates the concept of a QSPE, changes the requirements for derecognizing financial assets, and requires additional disclosures. SFAS 166 will be effective for interim and annual reporting periods beginning after November 15, 2009, and early adoption is prohibited. The adoption of SFAS 166 and SFAS 167 could have a significant impact on the Companys consolidated financial statements because the Company expects it will be required to consolidate at least some of its special purpose entities to which pools of loan receivables have been transferred in transactions previously qualifying as sales. Holding more of these assets on the Companys balance sheet may require it to take various actions, including raising additional capital, in order to meet regulatory capital requirements. Such capital may not be available on terms favorable to the Company, if at all, and could have a negative impact on the Companys financial results. As of September 30, 2009, the Company had approximately $44.3 billion of credit card receivables held by QSPEs of which $41.3 billion are backed securities held by external investors; and $4.8 billion in mortgage receivables that are considered at risk for consolidation. Additionally, the Company has mortgage loans, HELOCs and manufactured housing loans serviced for others that the Company does not believe will be consolidated.
On May 28, 2009, the FASB issued SFAS No. 165, Subsequent Events (ASC 855-10/SFAS 165). This Statement establishes general standards of accounting for and disclosing events that occur after the balance sheet date, but prior to the issuance of financial statements. The Statement requires companies to disclose subsequent events as defined within ASC 855-10/SFAS 165 and disclose the date through which subsequent events have been evaluated. The Statement is effective for interim and annual periods ending after June 15, 2009. The adoption of ASC 855-10/SFAS 165 occurred during the second quarter of 2009 and did not have a material effect on consolidated earnings or financial position of the Company. See Note 17 for additional details.
On April 9, 2009, the FASB issued FASB Staff Position (FSP) No. FAS 157-4, Determining Whether a Market Is Not Active and a Transaction is Not Distressed (ASC 820-10-65-4/FSP 157-4), which provides additional guidance on determining whether a market for a financial asset is not active and a transaction is not distressed for fair value measurements under SFAS No. 157, Fair Value Measurements (ASC 820-10/SFAS 157). The adoption of ASC 820-10-65-4/FSP 157-4 occurred during the second quarter of 2009, and did not have a material effect on the consolidated earnings and financial position of the Company.
On April 9, 2009, the FASB issued FASB Staff Position No. FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairment (ASC 320-10-65/FSP 115-2 and FAS 124-2), which eliminates the Companys requirement to assert its intent and ability to hold an investment until its forecasted recovery to avoid recognizing an impairment loss. The FSP requires the Company to recognize an other-than-temporary impairment when the Company intends to sell the security or it is more likely than not that it will be required to sell the security before recovery. Credit related impairments are recorded in income while other impairments are recorded in other comprehensive income. ASC 320-10-65/FSP 115-2 and FAS 124-2are effective for interim and annual reporting periods ending after June 15, 2009. The adoption of ASC 320-10-65/FSP 115-2 and FAS 124-2occurred during the second quarter of 2009. See Note 6 for additional detail.
On April 9, 2009, the FASB issued FASB Staff Position No. FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments (ASC 825-10-65/FSP 107-1 and APB 28-1), which will require the Company to include fair value disclosures of financial instruments for each interim and annual period that financial statements are prepared. ASC 825-10-65/FSP 107-1 and APB 28-1 is effective for interim and annual reporting periods ending after June 15, 2009. The adoption of ASC 825-10-65/FSP 107-1 and APB 28-1 occurred during the second quarter of 2009, and did not have a material effect on the consolidated earnings and financial position of the Company because it only amends the disclosure requirements. See Note 7 for additional details.
13
In January 2009, the FASB issued FASB Staff Position No. EITF 99-20-1, Recognition of Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests That Continue to Be Held by a Transferor in Securitized Financial Assets (ASC 325-40-65/FSP EITF 99-20). The FSP was issued to achieve more consistent determination of whether an other-than-temporary impairment has occurred. The FSP also retains and emphasizes the objective of an other-than-temporary impairment assessment and the related disclosure requirements in SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, (ASC 320-10/SFAS 115) and other related guidance. ASC 325-40-65/FSP EITF 99-20 emphasizes that any other-than-temporary impairment resulting from the application of ASC 320-10/SFAS 115 or ASC 325-40-65/FSP EITF 99-20 shall be recognized in earnings equal to the entire difference between the investments cost and its fair value at the balance sheet date of the reporting period for which the assessment is made. ASC 325-40-65/FSP EITF 99-20 is effective for interim and annual reporting periods ending after December 15, 2008, and shall be applied prospectively. Retrospective application to a prior interim or annual reporting period is not permitted. The adoption of ASC 325-40-65/FSP EITF 99-20 did not have impact on consolidated earnings or financial position of the Company.
In June 2008, the FASB issued FSP EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities (ASC 260-10-65/FSP EITF 03-6-1) The FSP addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and therefore need to be included in the earnings allocation in calculating earnings per share under the two-class method described in SFAS No. 128, Earnings per Share (ASC 260-10/SFAS 128). The FSP requires companies to treat unvested share-based payment awards that have non-forfeitable rights to dividend or dividend equivalents as a separate class of securities in calculating earnings per share. The FSP is effective for fiscal years beginning after December 15, 2008; earlier application is not permitted. The adoption of ASC 260-10-65/FSP EITF 03-6-1 did not have a material effect on our results of operations or earnings per share.
In September 2008, the FASB issued FSP No. FAS 133-1 and FIN 45-4, Disclosures about Credit Derivatives and Certain Guarantees: An Amendment of FASB Statement No. 133 and FASB Interpretation No. 45; and Clarification of the Effective Date of FASB Statement No. 161 (ASC 815-10/FSP FAS 133-1 and FIN 45-4). ASC 815-10/FSP FAS 133-1 and FIN 45-4 requires enhanced disclosures about credit derivatives and guarantees and amends FASB Interpretation No. 45, Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (ASC 460-10/FIN 45) to exclude credit derivative instruments accounted for at fair value under SFAS 133. The FSP is effective for financial statements issued for reporting periods ending after November 15, 2008. The adoption of ASC 815-10/FSP FAS 133-1 and FIN 45-4 did not have a material impact on the consolidated earnings or financial position of the Company. ASC 460-10/FIN 45 only requires additional disclosures concerning guarantees, which did not have an impact on the consolidated earnings or financial position of the Company because it only amends the disclosure requirements. See Note 15 for additional detail.
Effective January 1, 2008, the Company adopted ASC 820-10/SFAS 157 for all financial assets and liabilities measured at fair value; and for nonfinancial assets and liabilities measured at fair value on a recurring basis. ASC 820-10/SFAS 157 defines fair value, establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements. The initial adoption of ASC 820-10/SFAS 157 did not have a material impact on the consolidated earnings and financial position of the Company. There are no material assets or liabilities recognized or disclosed at fair value for which the Company has not applied the provisions of SFAS 157. See Note 7 for additional detail.
Effective January 1, 2008, the Company adopted SFAS No. 159, The Fair Value Option for Financial Assets and Liabilities (ASC 825-10/SFAS 159). ASC 825-10/SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value with changes in fair value included in current earnings. The election is made on specified election dates, can be made on an instrument by instrument basis, and is irrevocable. The initial adoption of ASC 825-10/SFAS 159 did not have a material impact on the consolidated earnings and financial position of the Company. See Note 7 for additional detail.
In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities-an amendment of FASB Statement No. 133, (ASC 815-10-65/SFAS 161). This Statement changes the disclosure requirements for derivative and hedging activities. Entities are required to provide enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under ASC 815-10-65/SFAS 161 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entitys financial position, financial performance, and cash flows. This Statement is effective for fiscal years, and interim periods within those fiscal years, beginning after November 15, 2008. The adoption of ASC 815-10-65/SFAS 161 did not have an impact on the consolidated earnings or financial position of the Company because it only amends the disclosure requirements for derivatives and hedged items. See Note 13 for derivatives disclosures under ASC 815-10-65/SFAS 161.
In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statementsan amendment of ARB No. 51, (ASC 810-10-65/SFAS 160). This Statement applies to all entities that prepare consolidated financial statements, except not-for-profit organizations, but will affect only those entities that have an outstanding noncontrolling interest in one or more subsidiaries or that deconsolidate a subsidiary. This Statement amends ASC810-10/ARB 51 to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial
14
statements. This Statement is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. The adoption of ASC 810-10-65/SFAS 160 did not have a material impact on the consolidated earnings or financial position of the Company.
In December 2007, the FASB issued ASC 805-10/SFAS No. 141(R), which applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. This Statement replaces SFAS 141, Business Combinations. It retains the fundamental requirements in SFAS 141; however, the scope is broader than that of SFAS 141 by applying to all transactions and other events in which one entity obtains control over one or more other businesses. ASC 805-10/SFAS No. 141(R) requires an acquirer to recognize the assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date, at their fair values as of that date, with limited exceptions, thereby replacing SFAS 141s cost-allocation process. This Statement also changes the requirements for recognizing acquisition related costs, restructuring costs, and assets acquired and liabilities assumed arising from contingencies. It also changes the accounting for step acquisitions. The Company applied the provisions of ASC 805-10/SFAS No. 141(R) to the Chevy Chase Bank acquisition.
Note 2
Acquisitions
Chevy Chase Bank
On February 27, 2009, the Company acquired all of the outstanding common stock of Chevy Chase Bank in exchange for Capital One common stock and cash with a total value of $475.9 million. Under the terms of the stock purchase agreement, Chevy Chase Bank common shareholders received $445.0 million in cash and 2.56 million shares of Capital One common stock. In addition, to the extent that losses on certain of Chevy Chase Banks mortgage loans are less than the level reflected in the net credit mark estimated at the time the deal was signed, the Company will share a portion of the benefit with the former Chevy Chase Bank common shareholders (the earn-out). The maximum payment under the earn-out is $300.0 million and would occur after December 31, 2013. As of September 30, 2009, the Company has not recognized a liability nor does it expect to make any payments associated with the earn-out based on our expectations for credit losses on the portfolio. Subsequent to the closing of the acquisition all of the outstanding shares of preferred stock of Chevy Chase Bank and the subordinated debt of its wholly-owned REIT subsidiary, were redeemed. This acquisition improves the Companys core deposit funding base, increases readily available and committed liquidity, adds additional scale in bank operations, and brings a strong customer base in an attractive banking market. Chevy Chase Banks results of operations are included in the Companys results after the acquisition date of February 27, 2009.
The Chevy Chase Bank acquisition is being accounted for under the acquisition method of accounting. Accordingly, the purchase price was allocated to the acquired assets and liabilities based on their estimated fair values at the Chevy Chase Bank acquisition date, as summarized in the following table. Preliminary goodwill of $1.6 billion is calculated as the purchase premium after adjusting for the fair value of net assets acquired and represents the value expected from the synergies created through the scale, operational and product enhancement benefits that will result from combining the operations of the two companies. During the third quarter of 2009, the Company continued the analysis of the fair values and purchase price allocation of Chevy Chase Banks assets and liabilities. The Company recorded an increase to goodwill of $146.9 million as a result. The change was predominantly related to a reduction in the fair value of net loans. The Company has not finalized the analysis and still considers goodwill to be preliminary, except as it relates to deposits and borrowings. Upon completion of the analysis, the Company expects to recast previously presented information as if all adjustments to the purchase price allocation had occurred at the date of acquisition. The Company has not recast previously presented information as adjustments to the initial purchase price allocation made during the second and third quarters of 2009 have not been considered material. The fair value of the non-controlling interest was calculated based on the redemption price of the interests, as well as any accrued but unpaid dividends. The shares of preferred stock of Chevy Chase Bank have been redeemed as noted above, and therefore, there is no longer a non-controlling interest.
Previous Allocation | Adjustments | Revised Allocation |
||||||||
Costs to acquire Chevy Chase Bank: |
||||||||||
Cash consideration paid |
$ | 445,000 | $ | 445,000 | ||||||
Capital One common stock issued (2,560,601 shares) |
30,855 | 30,855 | ||||||||
Fair value of contingent consideration |
| | ||||||||
Transfer taxes paid on behalf of Chevy Chase Bank |
3,151 | 3,151 | ||||||||
Total consideration paid for Chevy Chase Bank |
$ | 479,006 | $ | 479,006 | ||||||
Fair value of noncontrolling interest |
283,900 | 283,900 | ||||||||
Fair value of Chevy Chase Bank |
$ | 762,906 | $ | 762,906 | ||||||
Chevy Chase Banks net assets at fair value: |
||||||||||
Chevy Chase Banks stockholders equity at February 27, 2009 |
641,537 | 641,537 | ||||||||
Elimination of Chevy Chase Banks intangible assets (including goodwill) |
(18,383 | ) | (18,383 | ) |
15
Previous Allocation | Adjustments | Revised Allocation |
||||||||||
Adjustments to reflect assets and liabilities acquired at fair value: |
||||||||||||
Net loans |
(1,895,741 | ) | $ | (73,129 | ) | (1,968,870 | ) | |||||
Investment securities |
(51,263 | ) | | (51,263 | ) | |||||||
Intangible assets |
286,750 | (8,500 | ) | 278,250 | ||||||||
Other assets |
563,834 | (39,571 | ) | 524,263 | ||||||||
Deposits |
(109,861 | ) | | (109,861 | ) | |||||||
Borrowings |
(12,871 | ) | | (12,871 | ) | |||||||
Other liabilities |
(46,244 | ) | (25,668 | ) | (71,912 | ) | ||||||
Less: Adjusted identifiable net liabilities acquired |
(642,242 | ) | (146,868 | ) | (789,110 | ) | ||||||
Total preliminary goodwill(1) |
$ | 1,405,148 | $ | 146,868 | $ | 1,552,016 | ||||||
(1) | No goodwill is expected to be deductible for federal income tax purposes. The goodwill has been allocated to the appropriate segments during the third quarter of 2009, along with the operations of Chevy Chase Bank. |
The following condensed balance sheet of Chevy Chase Bank discloses the amount assigned to each major asset and liability caption as of September 30, 2009. The allocation of the final purchase price is still subject to refinement as the integration process continues and additional information becomes available.
Previous Allocation | Adjustments | Revised Allocation |
||||||||||
Assets: |
||||||||||||
Cash and cash equivalents |
$ | 1,217,837 | $ | | $ | 1,217,837 | ||||||
Interest-bearing deposits |
8,480 | | 8,480 | |||||||||
Investment securities |
1,425,611 | | 1,425,611 | |||||||||
Net loans |
9,373,098 | (73,129 | ) | 9,299,969 | ||||||||
Other Intangible assets |
44,830 | (8,500 | ) | 36,330 | ||||||||
Core deposit intangibles |
241,920 | | 241,920 | |||||||||
Other assets |
2,372,357 | (39,571 | ) | 2,332,786 | ||||||||
Total assets |
$ | 14,684,133 | $ | (121,200 | ) | $ | 14,562,933 | |||||
Liabilities: |
||||||||||||
Deposits |
$ | 13,556,639 | $ | | $ | 13,556,639 | ||||||
Securities sold under repurchase agreements |
806,575 | | 806,575 | |||||||||
Other borrowings |
376,600 | | 376,600 | |||||||||
Other liabilities |
586,561 | 25,668 | 612,229 | |||||||||
Total liabilities |
15,326,375 | 25,668 | 15,352,043 | |||||||||
Net liabilities acquired |
$ | (642,242 | ) | $ | (146,868 | ) | $ | (789,110 | ) | |||
The following table discloses the impact of Chevy Chase Bank since the acquisition on February 27, 2009, through the end of the third quarter 2009. The table also presents what the pro-forma Company results would have been had the acquisition taken place on January 1, 2009 and January 1, 2008. The pro forma financial information includes the impact of purchase accounting adjustments and the amortization of certain intangible assets. The pro-forma does not include the impact of possible business model changes nor does it consider any potential impacts of current market conditions or revenues, reduction of expenses, asset dispositions, or other factors.
Chevy Chase Bank Actual since acquisition for the period ending September 30, 2009 |
Total Company | ||||||||
Pro-Forma results for the nine months ending September 30, | |||||||||
2009 | 2008 | ||||||||
Revenue |
$ | 336,379 | $ | 9,706,523 | $ | 11,359,410 | |||
Income from continuing operations, net of tax |
$ | 20,555 | $ | 586,723 | $ | 1,595,251 |
Note 3
Loans Acquired in a Transfer
The Companys acquired loans from the Chevy Chase Bank acquisition, subject to ASC 805-10/SFAS 141(R), are recorded at fair value and no separate valuation allowance is recorded at the date of acquisition. The Company is required to review each loan at acquisition to determine if it should be accounted for under ASC 310-10/SOP 03-3 and if so, determines whether each such loan is to be accounted for individually or whether such loans will be aggregated into pools of loans based on common risk characteristics. The
16
Company has performed its analysis of the loans to be accounted for as impaired under ASC 310-10/SOP 03-3 (Impaired Loans in the tables below). The loans acquired with the Chevy Chase Bank acquisition not accounted for under ASC 310-10/SOP 03-3 have been accounted for under ASC 805-10/SFAS 141(R) (Non-Impaired Loans in the tables below) and are considered performing. The accounting treatment is essentially the same under both standards. The disclosure requirements under ASC 310-10/SOP 03-3 are more extensive, though the Company has elected to provide such disclosures for all of the acquired Chevy Chase Bank loans. During the evaluation of whether a loan was considered impaired under ASC 310-10/SOP 03-3 or performing under ASC 805-10/SFAS 141(R), the Company considered a number of factors, including the delinquency status of the loan, payment options and other loan features (i.e. reduced documentation, interest only, or negative amortization features), the geographic location of the borrower or collateral and the risk rating assigned to the loans. Based on the criteria, the Company considered the entire Chevy Chase Bank option arm, hybrid arm and construction to permanent portfolios to be impaired and accounted for under ASC 310-10/SOP 03-3. Portions of the Chevy Chase Bank commercial loan, auto, HELOC and other consumer loan portfolios and the fixed mortgage portfolio were also considered impaired.
The Company makes an estimate of the total cash flows it expects to collect from the loans (or pools of loans), which includes undiscounted expected principal and interest. The excess of that amount over the fair value of the loans is referred to as accretable yield. Accretable yield is recognized as interest income on a constant yield basis over the life of the loans. The Company also determines the loans contractual principal and contractual interest payments. The excess of that amount over the total cash flows it expects to collect from the loans is referred to as nonaccretable difference, which is not accreted into income. Judgmental prepayment assumptions are applied to both contractually required payments and cash flows expected to be collected at acquisition. The Company continues to estimate cash flows expected to be collected over the life of the loans. Subsequent increases in total cash flows it expects to collect are recognized as an adjustment to the accretable yield with the amount of periodic accretion adjusted over the remaining life of the loans. Subsequent decreases in cash flows expected to be collected over the life of the loans are recognized as impairment in the current period through allowance for loan loss. Adjustments to the acquisition date fair value of the acquired loans made during the refinement of the allocation of purchase price could impact accretable yield and/or nonaccretable difference.
In conjunction with the Chevy Chase Bank acquisition, the acquired loan portfolio was accounted for under ASC 310-10/SOP 03-3 or ASC 805-10/SFAS 141(R) at fair value and they are as follows:
At Acquisition | |||||||||
(In Thousands) |
Impaired Loans |
Non-Impaired Loans |
Total Loans | ||||||
Contractually required principal and interest at acquisition |
$ | 11,141,180 | $ | 3,353,188 | $ | 14,494,368 | |||
Nonaccretable difference (expected losses of $2,205,853 and foregone interest of $760,958) (1) |
2,792,107 | 174,704 | 2,966,811 | ||||||
Cash flows expected to be collected at acquisition |
$ | 8,349,073 | $ | 3,178,484 | $ | 11,527,557 | |||
Accretable yield (interest component of expected cash flows) |
1,952,129 | 510,243 | 2,462,372 | ||||||
Basis in acquired loans at acquisition(2) |
$ | 6,396,944 | $ | 2,668,241 | $ | 9,065,185 | |||
(1) | Expected losses and foregone interest on the ASC 310-10/SOP 03-3 loans are $2,052,151 and $739,956, respectively. Expected losses and foregone interest on the non ASC 310-10/SOP 03-3 loans are $153,702 and $21,002, respectively. |
(2) | A portion of the acquired loans from Chevy Chase Bank acquisition were held for sale and are not included in these tabular disclosures. These held for sale loans were assigned a fair value of $235.1 million through purchase price allocation. |
The carrying amount of these loans is included in the balance sheet amounts of loans receivable at September 30, 2009 and is as follows:
Impaired Loans |
Non-Impaired Loans |
Total Loans | ||||||||||
Outstanding Balance |
$ | 7,613,196 | $ | 2,504,756 | $ | 10,117,952 | ||||||
Carrying Amount |
$ | 5,647,290 | $ | 2,240,528 | $ | 7,887,818 | ||||||
Accretable Yield | ||||||||||||
Impaired Loans |
Non-Impaired Loans |
Total Loans | ||||||||||
Balance at January 1, 2009 |
$ | | $ | | $ | | ||||||
Additions |
1,952,129 | 510,243 | 2,462,372 | |||||||||
Accretion |
(200,394 | ) | (73,709 | ) | (274,103 | ) | ||||||
Balance at September 30, 2009 |
$ | 1,751,735 | $ | 463,534 | $ | 2,188,269 | ||||||
Credit Mark | ||||||||||||
Impaired Loans |
Non-Impaired Loans |
Total Loans | ||||||||||
Balance at January 1, 2009 |
$ | | $ | | $ | |
17
Credit Mark | ||||||||||||
Impaired Loans |
Non-Impaired Loans |
Total Loans | ||||||||||
Additions |
(2,052,151 | ) | (153,702 | ) | (2,205,853 | ) | ||||||
Principal and nonprincipal losses |
297,071 | 28,841 | 325,912 | |||||||||
Balance at September 30, 2009 |
$ | (1,755,080 | ) | $ | (124,861 | ) | $ | (1,879,941 | ) | |||
Note 4
Discontinued Operations
Shutdown of Mortgage Origination Operations of Wholesale Mortgage Banking Unit
In the third quarter of 2007, the Company shut down the mortgage origination operations of its wholesale mortgage banking unit, GreenPoint Mortgage (GreenPoint). GreenPoint was acquired by the Company in December 2006 as part of the North Fork acquisition. The results of the mortgage origination operations of GreenPoint have been accounted for as a discontinued operation and have been removed from the Companys results from continuing operations for the three and nine months ended September 30, 2009 and 2008. The Company will have no significant continuing involvement in the operations of the originate and sell business of GreenPoint.
The loss from discontinued operations for the three and nine months ended September 30, 2009 includes an expense of $83.0 million and $109.0 million, respectively, recorded in non-interest expense, for representations and warranties provided by the Company on loans previously sold to third parties by GreenPoints mortgage origination operation. The expense for representations and warranties is offset by a valuation adjustment for expected returns of spread account funding for certain securitization transactions.
The following is summarized financial information for discontinued operations related to the closure of the Companys wholesale mortgage banking unit:
Three Months Ended September 30 |
Nine Months Ended September 30 |
|||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Net interest income |
$ | | $ | 1,612 | $ | 776 | $ | 5,332 | ||||||||
Non-interest income |
2,150 | 2,287 | 2,275 | 5,517 | ||||||||||||
Non-interest expense |
69,853 | 22,125 | 118,837 | 175,577 | ||||||||||||
Income tax benefit |
(24,116 | ) | (6,576 | ) | (41,243 | ) | (59,434 | ) | ||||||||
Loss from discontinued operations, net of taxes |
$ | (43,587 | ) | $ | (11,650 | ) | $ | (74,543 | ) | $ | (105,294 | ) | ||||
The Companys wholesale mortgage banking unit had assets of approximately $31.5 million as of September 30, 2009 consisting of $15.8 million of mortgage loans held for sale and other related assets. The related liabilities consisted of obligations to fund these assets, and obligations for representations and warranties provided by the Company on loans previously sold to third parties.
Note 5
Segments
During the third quarter of 2009, the Company realigned its business segment reporting structure to better reflect the manner in which the performance of the Companys operations are evaluated. The Company now reports the results of its business through three operating segments: Credit Card, Commercial Banking and Consumer Banking.
Segment and sub-segment results where presented have been recast for all periods presented. The three segments consist of the following:
| Credit Card includes the Companys domestic consumer and small business card lending, domestic national small business lending, national closed end installment lending and the international card lending businesses in Canada and the United Kingdom. |
| Commercial Banking includes the Companys lending, deposit gathering and treasury management services to commercial real estate and middle market customers. The Commercial segment also includes the financial results of a national portfolio of small ticket commercial real estate loans that are in run-off mode. |
| Consumer Banking includes the Companys branch based lending and deposit gathering activities for small business customers as well as its branch based consumer deposit gathering and lending activities, national deposit gathering, consumer mortgage lending and servicing activities and national automobile lending. |
18
The segment reorganization includes the allocation of Chevy Chase Bank to the appropriate segments. Chevy Chase Banks operations are included in the Commercial Banking and Consumer Banking segments beginning in the second quarter 2009. Chevy Chase Banks operations for the first quarter of 2009 remain in the Other category due to the short duration since acquisition. The Other category includes GreenPoint originated consumer mortgages originated for sale but held for investment since originations were suspended in 2007, the results of corporate treasury activities, including asset-liability management and the investment portfolio, the net impact of transfer pricing, brokered deposits, certain unallocated expenses, gains/losses related to the securitization of assets, and restructuring charges related to the Companys cost initiative and Chevy Chase Bank acquisition.
The Company maintains its books and records on a legal entity basis for the preparation of financial statements in conformity with GAAP. The following tables present information prepared from the Companys internal management information systems, which is maintained on a line of business level through allocations from the consolidated financial results.
Three Months Ended September 30, 2009 | ||||||||||||||||||||||||
Credit Card | Commercial Banking |
Consumer Banking |
Other | Total Managed (Non-GAAP) |
Securitization Adjustments |
Total Reported | ||||||||||||||||||
Net interest income |
$ | 2,024,250 | $ | 297,484 | $ | 908,744 | $ | 27,069 | $ | 3,257,547 | $ | (1,206,867 | ) | $ | 2,050,680 | |||||||||
Non-interest income |
966,862 | 43,299 | 212,716 | 149,803 | 1,372,680 | 179,700 | 1,552,380 | |||||||||||||||||
Provisions for loan and lease losses |
1,643,721 | 375,095 | 156,052 | 25,464 | 2,200,332 | (1,027,167 | ) | 1,173,165 | ||||||||||||||||
Restructuring expenses |
| | | 26,357 | 26,357 | | 26,357 | |||||||||||||||||
Core deposit intangible amortization |
| 9,664 | 45,856 | | 55,520 | | 55,520 | |||||||||||||||||
Other non-interest expenses |
897,578 | 156,379 | 635,535 | 31,109 | 1,720,601 | | 1,720,601 | |||||||||||||||||
Income tax provision (benefit) |
158,074 | (70,125 | ) | 99,406 | (29,164 | ) | 158,191 | | 158,191 | |||||||||||||||
Net income (loss) |
$ | 291,739 | $ | (130,230 | ) | $ | 184,611 | $ | 123,106 | $ | 469,226 | $ | | $ | 469,226 | |||||||||
Loans held for investment |
$ | 70,368,809 | $ | 29,862,418 | $ | 40,479,805 | $ | 347,483 | $ | 141,058,515 | $ | (44,275,350 | ) | $ | 96,783,165 | |||||||||
Total deposits |
$ | | $ | 18,617,112 | $ | 72,252,596 | $ | 23,633,403 | $ | 114,503,111 | $ | | $ | 114,503,111 | ||||||||||
Three Months Ended September 30, 2008 | ||||||||||||||||||||||||
Credit Card | Commercial Banking |
Consumer Banking |
Other | Total Managed (Non-GAAP) |
Securitization Adjustments |
Total Reported | ||||||||||||||||||
Net interest income |
$ | 1,862,034 | $ | 238,641 | $ | 754,439 | $ | 34,216 | $ | 2,889,330 | $ | (1,082,685 | ) | $ | 1,806,645 | |||||||||
Non-interest income |
1,181,015 | 35,608 | 194,741 | (85,805 | ) | 1,325,559 | 371,332 | 1,696,891 | ||||||||||||||||
Provisions for loan and lease losses |
1,434,435 | 41,706 | 283,424 | 45,705 | 1,805,270 | (711,353 | ) | 1,093,917 | ||||||||||||||||
Restructuring expenses |
| | | 15,306 | 15,306 | | 15,306 | |||||||||||||||||
Core deposit intangible amortization |
| 9,614 | 37,637 | | 47,251 | | 47,251 | |||||||||||||||||
Other non-interest expenses |
1,059,641 | 111,944 | 577,103 | (1,039 | ) | 1,747,649 | | 1,747,649 | ||||||||||||||||
Income tax provision (benefit) |
192,461 | 38,845 | 17,856 | (35,538 | ) | 213,624 | | 213,624 | ||||||||||||||||
Net income (loss) |
$ | 356,512 | $ | 72,140 | $ | 33,160 | $ | (76,023 | ) | $ | 385,789 | $ | | $ | 385,789 | |||||||||
Loans held for investment |
$ | 79,616,456 | $ | 29,095,313 | $ | 38,077,606 | $ | 556,371 | $ | 147,345,746 | $ | (49,380,395 | ) | $ | 97,965,351 | |||||||||
Total deposits |
$ | | $ | 16,764,330 | $ | 57,492,140 | $ | 24,656,504 | $ | 98,912,974 | $ | | $ | 98,912,974 | ||||||||||
Nine Months Ended September 30, 2009 | ||||||||||||||||||||||||
Credit Card | Commercial Banking |
Consumer Banking |
Other | Total Managed (Non-GAAP) |
Securitization Adjustments |
Total Reported | ||||||||||||||||||
Net interest income |
$ | 5,513,241 | $ | 817,870 | $ | 2,471,702 | $ | 157,681 | $ | 8,960,494 | $ | (3,176,477 | ) | $ | 5,784,017 | |||||||||
Non-interest income |
2,849,783 | 133,556 | 601,600 | (37,093 | ) | 3,547,846 | 326,555 | 3,874,401 | ||||||||||||||||
Provisions for loan and lease losses |
4,846,799 | 614,896 | 626,340 | 148,227 | 6,236,262 | (2,849,922 | ) | 3,386,340 | ||||||||||||||||
Restructuring expenses |
| | | 87,358 | 87,358 | | 87,358 | |||||||||||||||||
Core deposit intangible amortization |
| 28,731 | 128,896 | | 157,627 | | 157,627 | |||||||||||||||||
Other non-interest expenses |
2,795,802 | 434,708 | 1,856,979 | 136,852 | 5,224,341 | | 5,224,341 | |||||||||||||||||
Income tax provision (benefit) |
252,727 | (44,419 | ) | 161,380 | (179,442 | ) | 190,246 | | 190,246 | |||||||||||||||
Net income (loss) |
$ | 467,696 | $ | (82,490 | ) | $ | 299,707 | $ | (72,407 | ) | $ | 612,506 | $ | | $ | 612,506 | ||||||||
Loans held for investment |
$ | 70,368,809 | $ | 29,862,418 | $ | 40,479,805 | $ | 347,483 | $ | 141,058,515 | $ | (44,275,350 | ) | $ | 96,783,165 | |||||||||
Total deposits |
$ | | $ | 18,617,112 | $ | 72,252,596 | $ | 23,633,403 | $ | 114,503,111 | $ | | $ | 114,503,111 |
19
Nine Months Ended September 30, 2008 | ||||||||||||||||||||||||
Credit Card | Commercial Banking |
Consumer Banking |
Other | Total Managed (Non-GAAP) |
Securitization Adjustments |
Total Reported | ||||||||||||||||||
Net interest income |
$ | 5,646,995 | $ | 712,459 | $ | 2,228,246 | $ | 66,475 | $ | 8,654,175 | $ | (3,307,857 | ) | $ | 5,346,318 | |||||||||
Non-interest income |
3,540,158 | 101,423 | 568,874 | 23,763 | 4,234,218 | 1,141,467 | 5,375,685 | |||||||||||||||||
Provisions for loan and lease losses |
3,943,432 | 100,723 | 1,015,709 | 108,645 | 5,168,509 | (2,166,390 | ) | 3,002,119 | ||||||||||||||||
Restructuring expenses |
| | | 81,625 | 81,625 | | 81,625 | |||||||||||||||||
Core deposit intangible amortization |
| 29,626 | 115,978 | | 145,604 | | 145,604 | |||||||||||||||||
Other non-interest expenses |
3,317,525 | 329,937 | 1,707,402 | (130,009 | ) | 5,224,855 | | 5,224,855 | ||||||||||||||||
Income tax provision (benefit) |
671,961 | 123,759 | (14,689 | ) | 5,927 | 786,958 | | 786,958 | ||||||||||||||||
Net income (loss) |
$ | 1,254,235 | $ | 229,837 | $ | (27,280 | ) | $ | 24,050 | $ | 1,480,842 | $ | | $ | 1,480,842 | |||||||||
Loans held for investment |
$ | 79,616,456 | $ | 29,095,313 | $ | 38,077,606 | $ | 556,371 | $ | 147,345,746 | $ | (49,380,395 | ) | $ | 97,965,351 | |||||||||
Total deposits |
$ | | $ | 16,764,330 | $ | 57,492,140 | $ | 24,656,504 | $ | 98,912,974 | $ | | $ | 98,912,974 |
Note 6
Securities Available for Sale
Expected maturities aggregated by investment category, gross unrealized gains and gross unrealized losses on securities available-for sale as of September 30, 2009 and December 31, 2008 were as follows:
Expected Maturity Schedule | |||||||||||||||||||||||||
1 Year or Less |
15 Years |
510 Years |
Over 10 Years |
Market Value Totals |
Gross Unrealized Gains |
Gross Unrealized Losses |
Amortized Cost Totals | ||||||||||||||||||
September 30, 2009 |
|||||||||||||||||||||||||
U.S. Treasury and other U.S. government agency obligations |
|||||||||||||||||||||||||
U.S. Treasury |
$ | 30,000 | $ | 394,301 | $ | | $ | | $ | 424,301 | $ | 14,096 | $ | | $ | 410,205 | |||||||||
FNMA |
77,914 | 161,150 | | | 239,064 | 10,645 | | 228,419 | |||||||||||||||||
FHLMC |
| 214,063 | | | 214,063 | 14,425 | | 199,638 | |||||||||||||||||
Other GSE and FDIC Debt Guaranteed Program (DGP) |
| 1,073 | | | 1,073 | 77 | | 996 | |||||||||||||||||
Total U.S. Treasury and other U.S. government agency obligations |
107,914 | 770,587 | | | 878,501 | 39,243 | | 839,258 | |||||||||||||||||
Collateralized mortgage obligations (CMO) |
|||||||||||||||||||||||||
FNMA |
51,163 | 2,493,631 | 671,825 | | 3,216,619 | 102,484 | (12,912 | ) | 3,127,047 | ||||||||||||||||
FHLMC |
74,583 | 1,977,531 | 696,389 | | 2,748,503 | 85,969 | (10,108 | ) | 2,672,642 | ||||||||||||||||
GNMA |
7,023 | 179,671 | 809,158 | | 995,852 | 17,428 | (88 | ) | 978,512 | ||||||||||||||||
Non GSE |
50,807 | 1,144,781 | 165,746 | 125,789 | 1,487,123 | | (304,221 | ) | 1,791,344 | ||||||||||||||||
Total CMO |
183,576 | 5,795,614 | 2,343,118 | 125,789 | 8,448,097 | 205,881 | (327,329 | ) | 8,569,545 | ||||||||||||||||
Mortgage backed securities (MBS) |
|||||||||||||||||||||||||
FNMA |
27,909 | 3,241,173 | 4,603,616 | 103,953 | 7,976,651 | 257,054 | (1,311 | ) | 7,720,908 | ||||||||||||||||
FHLMC |
75,087 | 1,951,156 | 2,678,215 | 546 | 4,705,004 | 136,690 | (11,956 | ) | 4,580,270 | ||||||||||||||||
GNMA |
48 | 70,971 | 7,962,608 | | 8,033,627 | 115,079 | (667 | ) | 7,919,215 | ||||||||||||||||
Other GSE |
| 843 | | | 843 | 1 | (3 | ) | 845 | ||||||||||||||||
Non GSE |
| 141,290 | 656,028 | 60,825 | 858,143 | | (210,231 | ) | 1,068,374 | ||||||||||||||||
Total MBS |
103,044 | 5,405,433 | 15,900,467 | 165,324 | 21,574,268 | 508,824 | (224,168 | ) | 21,289,612 | ||||||||||||||||
20
Expected Maturity Schedule | |||||||||||||||||||||||||
1 Year or Less |
15 Years |
510 Years |
Over 10 Years |
Market Value Totals |
Gross Unrealized Gains |
Gross Unrealized Losses |
Amortized Cost Totals | ||||||||||||||||||
Asset backed securities |
2,324,220 | 3,844,643 | 192,097 | | 6,360,960 | 162,349 | (7,070 | ) | 6,205,681 | ||||||||||||||||
Other |
137,634 | 133,282 | 40,613 | 119,646 | 431,175 | 9,922 | (3,827 | ) | 425,080 | ||||||||||||||||
Total |
$ | 2,856,388 | $ | 15,949,559 | $ | 18,476,295 | $ | 410,759 | $ | 37,693,001 | $ | 926,219 | $ | (562,394 | ) | $ | 37,329,176 | ||||||||
Expected Maturity Schedule | |||||||||||||||||||||||||
1 Year or Less |
15 Years |
510 Years |
Over 10 Years |
Market Value Totals |
Gross Unrealized Gains |
Gross Unrealized Losses |
Amortized Cost Totals | ||||||||||||||||||
December 31, 2008 |
|||||||||||||||||||||||||
U.S. Treasury and other U.S. government agency obligations |
|||||||||||||||||||||||||
U.S. Treasury |
$ | 40,751 | $ | 181,925 | $ | | $ | | $ | 222,676 | $ | 21,371 | $ | | $ | 201,305 | |||||||||
FNMA |
86,584 | 245,427 | | | 332,011 | 15,262 | | 316,749 | |||||||||||||||||
FHLMC |
30,097 | 109,219 | | | 139,316 | 9,567 | (821 | ) | 130,570 | ||||||||||||||||
Other GSE and FDIC Debt Guaranteed Program (DGP) |
265,733 | 650,593 | | | 916,326 | 16,099 | (272 | ) | 900,499 | ||||||||||||||||
Total U.S. Treasury and other U.S. government agency obligations |
423,165 | 1,187,164 | | | 1,610,329 | 62,299 | (1,093 | ) | 1,549,123 | ||||||||||||||||
Collateralized mortgage obligations (CMO) |
|||||||||||||||||||||||||
FNMA |
836,826 | 2,830,452 | 78,555 | | 3,745,833 | 55,582 | (21,699 | ) | 3,711,950 | ||||||||||||||||
FHLMC |
467,790 | 4,745,804 | | | 5,213,594 | 79,673 | (27,851 | ) | 5,161,772 | ||||||||||||||||
GNMA |
63,168 | 74,852 | 138,020 | 1,584 | (224 | ) | 136,660 | ||||||||||||||||||
Other GSE |
| 78,860 | | | 78,860 | 3,753 | | 75,107 | |||||||||||||||||
Non GSE |
167,221 | 1,750,758 | 730 | 7,209 | 1,925,918 | | (604,306 | ) | 2,530,224 | ||||||||||||||||
Total CMO |
1,535,005 | 9,480,726 | 79,285 | 7,209 | 11,102,225 | 140,592 | (654,080 | ) | 11,615,713 | ||||||||||||||||
Mortgage backed securities (MBS) |
|||||||||||||||||||||||||
FNMA |
29,206 | 7,651,869 | 18,976 | | 7,700,051 | 93,591 | (11,600 | ) | 7,618,060 | ||||||||||||||||
FHLMC |
80,504 | 4,619,503 | 1,295 | | 4,701,302 | 54,917 | (24,056 | ) | 4,670,441 | ||||||||||||||||
GNMA |
617 | 486,294 | | | 486,911 | 14,580 | (1,120 | ) | 473,451 | ||||||||||||||||
Other GSE |
| 1,389 | | | 1,389 | | (14 | ) | 1,403 | ||||||||||||||||
Non GSE |
40,118 | 783,098 | | | 823,216 | | (430,936 | ) | 1,254,152 | ||||||||||||||||
Total MBS |
150,445 | 13,542,153 | 20,271 | | 13,712,869 | 163,088 | (467,726 | ) | 14,017,507 | ||||||||||||||||
Asset backed securities |
1,508,087 | 2,369,443 | 218,527 | | 4,096,057 | 2,123 | (339,494 | ) | 4,433,428 | ||||||||||||||||
Other |
162,975 | 128,267 | 44,566 | 145,983 | 481,791 | 5,166 | (19,235 | ) | 495,860 | ||||||||||||||||
Total |
$ | 3,779,677 | $ | 26,707,753 | $ | 362,649 | $ | 153,192 | $ | 31,003,271 | $ | 373,268 | $ | (1,481,628 | ) | $ | 32,111,631 | ||||||||
At September 30, 2009, the expected maturities of the Companys mortgage-backed and asset-backed securities and the contractual maturities of the Companys other debt securities were used to assign the securities into the above maturity groupings. The Company believes that the use of expected maturities aligns with how the securities will actually perform and provides information regarding liquidity needs and potential impacts on portfolio yields. The maturity distribution based solely on contractual maturities is: 1 Year or Less - $302.1 million, 1-5 Years - $6,121.7 million, 5-10 Years - $1,879.9 million, and Over 10 Years - $29,389.4 million. Actual maturities may differ from the contractual or expected maturities since borrowers may have the right to prepay obligations with or without prepayment penalties.
21
The following table shows the weighted average yield by investment category as of September 30, 2009 and December 31, 2008:
Weighted Average Yield Schedule | ||||||||||||
1 Year or Less |
15 Years |
510 Years |
Over 10 Years |
|||||||||
September 30, 2009 |
||||||||||||
U.S. Treasury and other U.S. government agency obligations |
||||||||||||
U.S. Treasury |
0.59 | % | 2.37 | % | | % | | % | ||||
FNMA |
4.30 | 4.47 | | | ||||||||
FHLMC |
| 4.63 | | | ||||||||
Other GSE and FDIC Debt Guaranteed Program (DGP) |
| 5.44 | | | ||||||||
Total U.S. Treasury and other U.S. government agency obligations |
3.25 | 3.43 | | | ||||||||
Collateralized mortgage obligations (CMO) |
||||||||||||
FNMA |
4.96 | 5.44 | 4.66 | | ||||||||
FHLMC |
5.18 | 5.35 | 4.98 | | ||||||||
GNMA |
4.76 | 4.58 | 4.38 | | ||||||||
Non GSE |
5.53 | 5.69 | 4.93 | 5.53 | ||||||||
Total CMO |
5.22 | 5.44 | 4.68 | 5.53 | ||||||||
Mortgage backed securities (MBS) |
||||||||||||
FNMA |
5.18 | 5.16 | 4.93 | 4.70 | ||||||||
FHLMC |
5.60 | 4.21 | 5.02 | 5.18 | ||||||||
GNMA |
7.11 | 6.11 | 4.87 | | ||||||||
Other GSE |
| 3.44 | | | ||||||||
Non GSE |
| 5.61 | 6.07 | 5.59 | ||||||||
Total MBS |
5.27 | 5.16 | 4.93 | 5.30 | ||||||||
Asset backed securities |
3.77 | 4.20 | 5.21 | | ||||||||
Other |
3.14 | 4.27 | 4.52 | 6.12 | ||||||||
Total |
3.85 | % | 4.84 | % | 4.94 | % | 5.58 | % | ||||
Weighted Average Yield Schedule | ||||||||||||
1 Year or Less |
15 Years |
510 Years |
Over 10 Years |
|||||||||
December 31, 2008 |
||||||||||||
U.S. Treasury and other U.S. government agency obligations |
||||||||||||
U.S. Treasury |
4.04 | % | 4.15 | % | | % | | % | ||||
FNMA |
4.68 | 4.41 | | | ||||||||
FHLMC |
4.00 | 4.59 | | | ||||||||
Other GSE and FDIC Debt Guaranteed Program (DGP) |
4.81 | 3.13 | | | ||||||||
Total U.S. Treasury and other U.S. government agency obligations |
4.65 | 3.67 | | | ||||||||
Collateralized mortgage obligations (CMO) |
||||||||||||
FNMA |
4.98 | 5.53 | 5.50 | | ||||||||
FHLMC |
5.23 | 5.22 | | | ||||||||
GNMA |
4.61 | 4.89 | | | ||||||||
Other GSE |
| 5.27 | | | ||||||||
Non GSE |
5.72 | 5.51 | 6.10 | 6.58 | ||||||||
Total CMO |
5.14 | 5.37 | 5.51 | 6.58 | ||||||||
Mortgage backed securities (MBS) |
||||||||||||
FNMA |
4.05 | 5.31 | 5.48 | | ||||||||
FHLMC |
6.00 | 4.79 | 5.89 | | ||||||||
GNMA |
7.08 | 5.65 | | | ||||||||
Other GSE |
| 3.43 | | | ||||||||
Non GSE |
6.30 | 5.96 | | | ||||||||
Total MBS |
5.76 | 5.21 | 5.50 | | ||||||||
Asset backed securities |
4.07 | 4.72 | 5.16 | | ||||||||
Other |
3.74 | 4.21 | 4.75 | 5.49 | ||||||||
Total |
4.63 | % | 5.15 | % | 5.20 | % | 5.53 | % | ||||
22
The available for sale portfolio continues to be heavily concentrated in high credit quality assets like government-sponsored enterprise (GSE) mortgage-backed securities and AAA rated asset-backed securities. In addition to debt securities held in the investment portfolio, the Company reports certain equity securities related to Community Reinvestment Act (CRA) investments as available for sale securities.
At September 30, 2009, the portfolio was 90% rated AAA, 4% rated other investment grade (AA to BBB), and 6% non investment grade or not rated.
The following table shows the fair value of investments and amount of unrealized losses segregated by those investments that have been in a continuous unrealized loss position for less than twelve months and those that have been in a continuous unrealized loss position for twelve months or longer as of September 30, 2009 and December 31, 2008.
Less than 12 Months | Greater than 12 Months | Total | ||||||||||||||||
Fair Value | Unrealized Losses |
Fair Value | Unrealized Losses |
Fair Value | Unrealized Losses | |||||||||||||
September 30, 2009 |
||||||||||||||||||
Collateralized mortgage obligations |
||||||||||||||||||
FNMA |
$ | 36,483 | $ | 70 | $ | 334,796 | $ | 12,842 | $ | 371,279 | $ | 12,912 | ||||||
FHLMC |
660 | 2 | 427,454 | 10,106 | 428,114 | 10,108 | ||||||||||||
Other GSE |
| | 4,943 | 88 | 4,943 | 88 | ||||||||||||
Non GSE |
3,013 | 339 | 1,466,948 | 303,882 | 1,469,961 | 304,221 | ||||||||||||
Total CMO |
40,156 | 411 | 2,234,141 | 326,918 | 2,274,297 | 327,329 | ||||||||||||
Mortgage backed securities |
||||||||||||||||||
FNMA |
219,667 | 1,088 | 21,944 | 223 | 241,611 | 1,311 | ||||||||||||
FHLMC |
278,706 | 2,363 | 327,499 | 9,593 | 606,205 | 11,956 | ||||||||||||
GNMA |
153,463 | 498 | 10,829 | 169 | 164,292 | 667 | ||||||||||||
Other GSE |
808 | 3 | | | 808 | 3 | ||||||||||||
Non GSE |
36,812 | 5,991 | 810,243 | 204,240 | 847,055 | 210,231 | ||||||||||||
Total MBS |
689,456 | 9,943 | 1,170,515 | 214,225 | 1,859,971 | 224,168 | ||||||||||||
Asset backed securities |
158,545 | 110 | 191,521 | 6,960 | 350,066 | 7,070 | ||||||||||||
Other |
25,361 | 86 | 120,405 | 3,741 | 145,766 | 3,827 | ||||||||||||
Total |
$ | 913,518 | $ | 10,550 | $ | 3,716,582 | $ | 551,844 | $ | 4,630,100 | $ | 562,394 | ||||||
Less than 12 Months | Greater than 12 Months | Total | ||||||||||||||||
Fair Value | Unrealized Losses |
Fair Value | Unrealized Losses |
Fair Value | Unrealized Losses | |||||||||||||
December 31, 2008 |
||||||||||||||||||
U.S. Treasury and other U.S. government agency obligations |
||||||||||||||||||
Freddie Mac |
$ | | $ | | $ | 30,097 | $ | 821 | $ | 30,097 | $ | 821 | ||||||
Other GSE and DGP |
179,728 | 272 | | | 179,728 | 272 | ||||||||||||
Total U.S. Treasury and other U.S. government agency obligations |
179,728 | 272 | 30,097 | 821 | 209,825 | 1,093 | ||||||||||||
Collateralized mortgage obligations |
||||||||||||||||||
FNMA |
266,344 | 8,125 | 367,472 | 13,574 | 633,816 | 21,699 | ||||||||||||
FHLMC |
307,667 | 2,445 | 729,283 | 25,406 | 1,036,950 | 27,851 | ||||||||||||
GNMA |
| | 11,159 | 224 | 11,159 | 224 | ||||||||||||
Non GSE |
1,652,139 | 523,952 | 265,608 | 80,354 | 1,917,747 | 604,306 | ||||||||||||
Total CMO |
2,226,150 | 534,522 | 1,373,522 | 119,558 | 3,599,672 | 654,080 | ||||||||||||
Mortgage backed securities |
||||||||||||||||||
FNMA |
982,232 | 10,782 | 160,456 | 818 | 1,142,688 | 11,600 | ||||||||||||
FHLMC |
721,443 | 20,671 | 155,234 | 3,385 | 876,677 | 24,056 | ||||||||||||
GNMA |
24,876 | 957 | 7,108 | 163 | 31,984 | 1,120 | ||||||||||||
Other GSE |
1,389 | 14 | | | 1,389 | 14 | ||||||||||||
Non GSE |
668,837 | 349,753 | 158,870 | 81,183 | 827,707 | 430,936 | ||||||||||||
Total MBS |
2,398,777 | 382,177 | 481,668 | 85,549 | 2,880,445 | 467,726 | ||||||||||||
23
Less than 12 Months | Greater than 12 Months | Total | ||||||||||||||||
Fair Value | Unrealized Losses |
Fair Value | Unrealized Losses |
Fair Value | Unrealized Losses | |||||||||||||
Asset backed securities |
2,660,798 | 194,024 | 692,928 | 145,470 | 3,353,726 | 339,494 | ||||||||||||
Other |
107,126 | 2,705 | 120,183 | 16,530 | 227,309 | 19,235 | ||||||||||||
Total |
$ | 7,572,579 | $ | 1,113,700 | $ | 2,698,398 | $ | 367,928 | $ | 10,270,977 | $ | 1,481,628 | ||||||
The Company monitors securities in its available for sale investment portfolio for other-than-temporary impairment based on a number of criteria, including the size of the unrealized loss position, the duration for which that security has been in a loss position, credit rating, the nature of the investments, and current market conditions. For debt securities, the Company also considers any intent to sell the security and the likelihood it will be required to sell the security before its anticipated recovery. The Company continually monitors the ratings of its security holdings and conducts regular reviews of the Companys credit sensitive assets to monitor collateral performance by tracking collateral trends and looking for any potential collateral degradation.
Based on the evaluation, the Company recognized other-than-temporary impairment of $11.2 million and $21.2 million related to credit through earnings for the three and nine months ended September 30, 2009, respectively. For these impaired securities, unrealized losses not related to credit and therefore recognized in other comprehensive income was $158.8 million (net of tax was $101.8 million) as of September 30, 2009. Cumulative other-than-temporary impairment related to credit losses recognized in earnings for available-for-sale securities is as follows:
OTTI credit losses recognized for AFS debt |
Beginning balance of OTTI credit losses recognized for securities held at the beginning of the period for which a portion of OTTI was recognized in OCI |
Additional increases to the amount related to credit loss for which an OTTI was previously recognized |
Additions for the amount related to credit loss for which OTTI was not previously recognized |
Reductions for securities sold during the period |
Ending balance of the amount related to credit losses held at the end of the period for which a portion of OTTI was recognized in OCI | ||||||||||
Three months ended September 30, 2009 |
|||||||||||||||
CMO |
$ | 3,622 | $ | 674 | $ | 5,003 | $ | | $ | 9,299 | |||||
MBS |
5,592 | 2,023 | 3,473 | | 11,088 | ||||||||||
Other-Home equity |
817 | | | | 817 | ||||||||||
Total |
$ | 10,031 | $ | 2,697 | $ | 8,476 | $ | | $ | 21,204 | |||||
Nine months ended September 30, 2009 |
|||||||||||||||
CMO |
$ | | $ | | $ | 9,299 | $ | | $ | 9,299 | |||||
MBS |
| | 11,088 | | 11,088 | ||||||||||
Other-Home equity |
| | 817 | | 817 | ||||||||||
Total |
$ | | $ | | $ | 21,204 | $ | | $ | 21,204 | |||||
Collateralized Mortgage Obligations The Companys portfolio includes investments in GSE collateralized mortgage obligations and prime non-agency collateralized mortgage obligations. The unrealized losses on the Companys investment in collateralized mortgage obligations were primarily caused by higher credit spreads and interest rates. As of September 30, 2009, the majority of the unrealized losses in this category are due to prime non-agency collateralized mortgage obligations, of which 6% are rated AAA, 23% are rated other investment grade and 71% are non investment grade or not rated.
The Company recognized credit related other-than-temporary impairment of $5.7 million and $9.3 million through earnings for the three and nine months ended September 30, 2009, respectively, for seven prime non-agency collateralized mortgage obligations. For these impaired securities, unrealized losses not related to credit and therefore recognized in other comprehensive income was $66.2 million (net of tax was $42.4 million) as of September 30, 2009. While these securities experienced significant decreases in fair value due to deteriorating credit fundamentals and elevated liquidity premiums in the second half of 2008, there has been substantial improvement in fair value as market has stabilized, risk premiums have fallen and interest rates have declined. The credit related impairment was calculated based on internal forecasts using security specific delinquencies, product specific delinquency roll rates and expected severities, using industry standard third party modeling tools. The significant key assumptions used to measure the credit related component of securities deemed to be other-than-temporary impaired in the third quarter are as follows: a weighted average credit default rate of 6.86% and a weighted average expected severity of 49%. Based on its view of each securitys current credit performance along with the sufficiency of subordination to protect cash flows, the Company expects to recover the entire amortized cost basis of its remaining collateralized mortgage obligations. However, future declines could result in other-than-temporary impairment being recognized. Furthermore, since the Company does not have the intent to sell nor will it more likely than not be required to sell before anticipated recovery, it does not consider any of its remaining collateralized mortgage obligations in unrealized loss positions to be other-than-temporarily impaired at September 30, 2009.
24
Mortgage-Backed Securities The Companys portfolio includes investments in GSE mortgage-backed securities and prime non-agency mortgage-backed securities. As of September 30, 2009, the unrealized losses on the Companys investment in GSE mortgage-backed securities were primarily caused by higher credit spreads and interest rates. However, since the contractual cash flows of these investments are guaranteed by a GSE of the U.S. government, it is expected that the securities will not be settled at a price less than the Companys amortized cost. However, future declines could result in other-than-temporary impairment being recognized. Furthermore, since the Company does not have the intent to sell nor will it more likely than not be required to sell before anticipated recovery, it does not consider any of its GSE mortgage-backed securities in unrealized loss positions to be other-than-temporarily impaired at September 30, 2009.
As of September 30, 2009, the majority of unrealized losses is due to prime non-agency mortgage-backed securities of which 11% are rated AAA, 8% are rated other investment grade and 81% are non investment grade or not rated.
The Company recognized credit related other-than-temporary impairment of $5.5 million and $11.1 million through earnings for the three and nine months ended September 30, 2009, respectively, for twelve prime non-agency mortgage-backed securities. For these impaired securities, unrealized losses not related to credit and therefore recognized in other comprehensive income was $92.1 million (net of tax was $59.0 million) as of September 30, 2009. While these securities experienced significant decreases in fair value due to deteriorating credit fundamentals and elevated liquidity premiums in the second half of 2008, there has been substantial improvement in fair value as market has stabilized, risk premiums have fallen and interest rates have declined. The credit related impairment was calculated based on internal forecasts using security specific delinquencies, product specific delinquency roll rates and expected severities, using industry standard third party modeling tools. The significant key assumptions used to measure the credit related component of securities deemed to be other-than-temporary impaired in the third quarter of 2009 are as follows: a weighted average credit default rate of 6.49% and a weighted average expected severity of 47%. Based on its view of each securitys current credit performance along with the sufficiency of subordination to protect cash flows, the Company expects to recover the entire amortized cost basis of its remaining non GSE mortgage backed securities. Furthermore, since the Company does not have the intent to sell nor will it more likely than not be required to sell before anticipated recovery, it does not consider any of its remaining non-agency mortgage backed securities in unrealized loss positions to be other-than-temporarily impaired at September 30, 2009.
Asset-Backed Securities This category is comprised of investments backed by credit card, auto and student loans; commercial mortgage backed loans; and minor investments backed by home equity lines of credit. As of September 30, 2009, the portfolio is 85.1% rated AAA and is comprised of 71.3% credit card, 19.0% auto, 8.1% student loans, 1.2% dealer floor securities, 0.3% home equity lines of credit, and 0.1% equipment-backed securities. The unrealized losses on the Companys investments in asset-backed securities were primarily caused by higher credit spreads and interest rates.
The Company recognized $0.8 million in credit related other-than-temporary impairment through earnings for the three and nine months ended September 30, 2009 related to one home equity line of credit security. For this security, unrealized losses not related to credit and therefore recognized in other comprehensive income was $0.5 million (net of tax was $0.3 million) as of September 30, 2009.
The Company did not recognize any credit related other-than-temporary impairment in the third quarter of 2009. Based on its view of each securitys current credit performance along with the sufficiency of subordination to protect cash flows, the Company expects to recover the entire amortized cost basis of its remaining asset backed securities. Furthermore, since the Company does not have the intent to sell nor will it more likely than not be required to sell before anticipated recovery, it does not consider any of its remaining asset-backed securities in unrealized loss positions to be other-than-temporarily impaired at September 30, 2009.
Other This category consists primarily of municipal securities and limited investments in equity securities, primarily related to CRA activities. The unrealized losses on the Companys investments in other items were primarily caused by higher risk premiums and interest rates. The Company expects to recover the entire amortized cost basis of the securities in this category. Furthermore, since the Company does not have the intent to sell nor will it more likely than not be required to sell before anticipated recovery, it does not consider any of the securities in unrealized loss positions to be other-than-temporarily impaired at September 30, 2009.
Gross realized gains on sales and calls of securities were $157.7 million and $210.5 million for the three and nine months ended September 30, 2009, respectively. Gross realized losses on sales and calls of securities were $11.8 million and $12.8 million for the three and nine months ended September 30, 2009, respectively. Tax expense on net realized gains was $51.6 million and $70.4 million for the three and nine months ended September 30, 2009, respectively.
The Companys sale of securities resulted in the reclassification of $49.2 million and $59.5 million of net gains after tax, from cumulative other comprehensive income into earnings, for the three and nine months ended September 30, 2009, respectively.
Securities available for sale included pledged securities of $11.4 billion at September 30, 2009.
25
Note 7
Fair Values of Assets and Liabilities
ASC 820-10/SFAS 157 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. ASC 820-10/SFAS 157 requires that valuation techniques maximize the use of observable inputs and minimize the use of unobservable inputs. ASC 820-10/SFAS 157 also establishes a fair value hierarchy which prioritizes the valuation inputs into three broad levels. Based on the underlying inputs, each fair value measurement in its entirety is reported in one of the three levels. These levels are:
| Level 1Valuation is based upon quoted prices for identical instruments traded in active markets. Level 1 assets and liabilities include debt and equity securities traded in an active exchange market, as well as U.S. Treasury securities. |
| Level 2Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by observable market data for substantially the full term of the assets or liabilities. |
| Level 3Valuation is determined using model-based techniques with significant assumptions not observable in the market. These unobservable assumptions reflect the Companys own estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include the use of third party pricing services, option pricing models, discounted cash flow models and similar techniques. |
ASC 825-10/SFAS 159 allows an entity the irrevocable option to elect fair value for the initial and subsequent measurement for certain financial assets and liabilities on a contract-by-contract basis. The Company has not made any material ASC 825-10/SFAS 159 elections as of the end of the third quarter of 2009.
Assets and Liabilities Measured at Fair Value on a Recurring Basis
September 30, 2009 | ||||||||||||
Fair Value Measurements Using (3) | Assets/Liabilities at Fair Value | |||||||||||
Level 1 | Level 2 | Level 3 | ||||||||||
Assets |
||||||||||||
Securities available for sale |
||||||||||||
U.S. Treasury and other U.S. Govt agency |
424,301 | 454,200 | | 878,501 | ||||||||
Collateralized mortgage obligations |
| 7,204,977 | 1,243,120 | 8,448,097 | ||||||||
Mortgage-backed securities |
| 21,007,992 | 566,276 | 21,574,268 | ||||||||
Asset-backed securities |
| 6,285,960 | 75,000 | 6,360,960 | ||||||||
Other |
70,019 | 335,909 | 25,247 | 431,175 | ||||||||
Total securities available for sale |
$ | 494,320 | $ | 35,289,038 | $ | 1,909,643 | $ | 37,693,001 | ||||
Other assets |
||||||||||||
Mortgage servicing rights |
| | 271,518 | 271,518 | ||||||||
Derivative receivables(1) |
10,514 | 877,022 | 537,137 | 1,424,673 | ||||||||
Retained interests in securitizations |
| | 3,871,050 | 3,871,050 | ||||||||
Total Assets |
$ | 504,834 | $ | 36,166,060 | $ | 6,589,348 | $ | 43,260,242 | ||||
Liabilities |
||||||||||||
Other liabilities |
||||||||||||
Derivative payables(1) |
$ | 2,899 | $ | 925,503 | $ | 40,175 | $ | 968,577 | ||||
Total Liabilities |
$ | 2,899 | $ | 925,503 | $ | 40,175 | $ | 968,577 | ||||
December 31, 2008 | ||||||||||||
Fair Value Measurements Using | Assets/Liabilities at Fair Value | |||||||||||
Level 1 | Level 2 | Level 3 | ||||||||||
Assets |
||||||||||||
Securities available for sale(2) |
$ | 291,907 | $ | 28,331,103 | $ | 2,380,261 | $ | 31,003,271 | ||||
Other assets |
||||||||||||
Mortgage servicing rights |
| | 150,544 | 150,544 | ||||||||
Derivative receivables(1) |
8,020 | 1,768,902 | 59,895 | 1,836,817 | ||||||||
Retained interests in securitizations |
| | 1,470,385 | 1,470,385 | ||||||||
Total Assets |
$ | 299,927 | $ | 30,100,005 | $ | 4,061,085 | $ | 34,461,017 | ||||
26
September 30, 2009 | ||||||||||||
Fair Value Measurements Using (3) | Assets/Liabilities at Fair Value | |||||||||||
Level 1 | Level 2 | Level 3 | ||||||||||
Derivative payables(1) |
$ | 937 | $ | 1,260,062 | $ | 60,672 | $ | 1,321,671 | ||||
Total Liabilities |
$ | 937 | $ | 1,260,062 | $ | 60,672 | $ | 1,321,671 | ||||
(1) | The Company does not offset the fair value of derivative contracts in a loss position against the fair value of contracts in a gain position. The Company also does not offset fair value amounts recognized for derivative instruments and fair value amounts recognized for the right to reclaim cash collateral or the obligation to return cash collateral arising from derivative instruments executed with the same counterparty under a master netting arrangement. |
(2) | Securities available for sale were not broken-out by security type as of December 31, 2008, as ASC 820-10-65-4/FSP FAS 157-4 is applied prospectively. |
(3) | The above table does not reflect ($0.5) million of counterparty credit risk. Counterparty credit risk is reflected in other assets/liabilities on the balance sheet and offset through the income statement in other income. |
Financial instruments are considered Level 3 when their values are determined using pricing models, which include comparison of prices from multiple sources, discounted cash flow methodologies or similar techniques and at least one significant model assumption or input is unobservable or there is significant variability among pricing sources. Level 3 financial instruments also include those for which the determination of fair value requires significant management judgment or estimation. The table below presents a reconciliation for all assets and liabilities measured and recognized at fair value on a recurring basis using significant unobservable inputs (Level 3) during 2009. All Level 3 instruments presented in the table were carried at fair value prior to the adoption of ASC 825-10/SFAS 159.
Level 3 Instruments Only
Three Months Ended September 30, 2009 | ||||||||||||||||||||
Securities Available for Sale |
Mortgage Servicing Rights(1) |
Derivative Receivables(2) |
Retained Interests in Securitizations(3) |
Derivative Payables(2) |
||||||||||||||||
Balance, June 30, 2009 |
$ | 1,969,423 | $ | 280,742 | $ | 541,052 | $ | 3,939,213 | $ | 37,095 | ||||||||||
Total realized and unrealized gains (losses): |
||||||||||||||||||||
Included in earnings |
47 | (7,868 | ) | 16,995 | 22,846 | 3,212 | ||||||||||||||
Included in other comprehensive income |
147,508 | | | 40,644 | | |||||||||||||||
Purchases, issuances and settlements, net |
(32,250 | ) | (1,356 | ) | 7,807 | (131,653 | ) | 57 | ||||||||||||
Transfers in/out of Level 3(4) |
(175,085 | ) | | (28,717 | ) | | (189 | ) | ||||||||||||
Balance, September 30, 2009 |
$ | 1,909,643 | $ | 271,518 | $ | 537,137 | $ | 3,871,050 | $ | 40,175 | ||||||||||
Change in unrealized gains (losses) included in earnings related to financial instruments held at September 30, 2009 |
$ | 47 | $ | (7,868 | ) | $ | 16,995 | $ | 54,612 | $ | 3,212 |
Three Months Ended September 30, 2009 | |||||||||||||||||||||||
Securities Available for Sale |
U.S. Treasury & other U.S. Govt agency |
Collateralized mortgage obligations |
Mortgage- backed securities |
Asset- backed securities |
Other | Total | |||||||||||||||||
Balance, June 30, 2009 |
$ | | $ | 1,309,089 | $ | 629,322 | $ | 1,716 | $ | 29,296 | $ | 1,969,423 | |||||||||||
Total realized and unrealized gains (losses): |
|||||||||||||||||||||||
Included in earnings |
| 47 | | | | 47 | |||||||||||||||||
Included in other comprehensive income |
| 102,865 | 44,643 | | | 147,508 | |||||||||||||||||
Purchases, issuances and settlements, net |
| (103,201 | ) | | 75,000 | (4,049 | ) | (32,250 | ) | ||||||||||||||
Transfers in/out of Level 3(4) |
| (65,680 | ) | (107,689 | ) | (1,716 | ) | | (175,085 | ) | |||||||||||||
Balance, September 30, 2009 |
$ | | 1,243,120 | 566,276 | 75,000 | 25,247 | $ | 1,909,643 | |||||||||||||||
Change in unrealized gains (losses) included in earnings related to financial instruments held at September 30, 2009 |
$ | | $ | 47 | $ | | $ | | $ | | $ | 47 |
27
Nine Months Ended September 30, 2009 | |||||||||||||||||||
Securities Available for Sale |
Mortgage Servicing Rights(1) |
Derivative Receivables(2) |
Retained Interests in Securitizations(3) |
Derivative Payables(2) |
|||||||||||||||
Balance, January 1, 2009 |
$ | 2,380,261 | $ | 150,544 | $ | 59,895 | $ | 1,470,385 | $ | 60,672 | |||||||||
Total realized and unrealized gains (losses): |
|||||||||||||||||||
Included in earnings |
55 | 19,588 | (136,564 | ) | (195,620 | ) | (19,855 | ) | |||||||||||
Included in other comprehensive income |
(105,757 | ) | | | 91,851 | | |||||||||||||
Purchases, issuances and settlements, net |
(62,508 | ) | 101,386 | 53,385 | 2,504,434 | 595 | |||||||||||||
Transfers in/out of Level 3(4) |
(302,408 | ) | | 560,421 | | (1,237 | ) | ||||||||||||
Balance, September 30, 2009 |
$ | 1,909,643 | $ | 271,518 | $ | 537,137 | $ | 3,871,050 | $ | 40,175 | |||||||||
Change in unrealized gains (losses) included in earnings related to financial instruments held at September 30, 2009 |
$ | 55 | $ | 19,588 | $ | (136,564 | ) | $ | 70,651 | $ | (19,855 | ) |
Nine Months Ended September 30, 2009 | |||||||||||||||||||||||
Securities Available for Sale |
U.S. Treasury & other U.S. Govt agency |
Collateralized mortgage obligations |
Mortgage- backed securities |
Asset- backed securities |
Other | Total | |||||||||||||||||
Balance, January 1, 2009 |
$ | | $ | 1,579,909 | $ | 773,200 | $ | | $ | 27,152 | $ | 2,380,261 | |||||||||||
Total realized and unrealized gains (losses): |
|||||||||||||||||||||||
Included in earnings |
| 169 | | (114 | ) | | 55 | ||||||||||||||||
Included in other comprehensive income |
| (119,415 | ) | 13,658 | | | (105,757 | ) | |||||||||||||||
Purchases, issuances and settlements, net |
| (183,151 | ) | 48,347 | 74,201 | (1,905 | ) | (62,508 | ) | ||||||||||||||
Transfers in/out of Level 3(4) |
| (34,392 | ) | (268,929 | ) | 913 | | (302,408 | ) | ||||||||||||||