UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
September 30, 2011 For the quarterly period ended September 30, 2011
OR
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File No. 1-13300
CAPITAL ONE FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Delaware | 54-1719854 | |
(State or Other Jurisdiction of Incorporation or Organization) |
(I.R.S. Employer Identification No.) | |
1680 Capital One Drive, McLean, Virginia |
22102 | |
(Address of Principal Executive Offices) | (Zip Code) |
Registrants telephone number, including area code:
(703) 720-1000
(Former name, former address and former fiscal year, if changed since last report)
(Not applicable)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
Large accelerated filer | x | Accelerated filer | ¨ | |||
Non-accelerated filer | ¨ | Smaller reporting company | ¨ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) Yes ¨ No x
As of October 31, 2011, there were 459,677,105 shares of the registrants Common Stock, par value $.01 per share, outstanding.
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PART IFINANCIAL INFORMATION |
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Item 1. |
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Condensed Consolidated Statements of Changes in Stockholders Equity |
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Item 2. |
Managements Discussion and Analysis of Financial Condition and Results of Operations (MD&A) |
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Off-Balance Sheet Arrangements and Variable Interest Entities |
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Item 3. |
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Item 4. |
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PART IIOTHER INFORMATION |
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Item 1. |
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Item 1A. |
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Item 2. |
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Item 3. |
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Item 5. |
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Item 6. |
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INDEX OF MD&A TABLES AND SUPPLEMENTAL TABLES
Table |
Description |
Page |
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MD&A Tables: |
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1 |
1 | |||||
2 |
5 | |||||
3 |
Average Balances, Net Interest Income and Net Interest Yield |
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4 |
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5 |
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6 |
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7 |
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7.1 |
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7.2 |
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8 |
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9 |
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10 |
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11 |
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12 |
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13 |
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14 |
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22 |
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24 |
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25 |
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26 |
Expected Maturity Profile of Short-term Borrowings and Long-term Debt |
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27 |
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28 |
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29 |
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30 |
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31 |
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Supplemental Tables: |
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A |
Reconciliation of Non-GAAP Measures and Calculation of Regulatory Capital Measures |
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B |
68 |
ii
PART IFINANCIAL INFORMATION
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
This Managements Discussion and Analysis of Financial Condition and Results of Operations (MD&A) should be read in conjunction with our unaudited condensed consolidated financial statements and related notes in this Report and the more detailed information contained in our 2010 Annual Report on Form 10-K (2010 Form 10-K). This discussion contains forward-looking statements that are based upon managements current expectations and are subject to significant uncertainties and changes in circumstances. Please review Forward-Looking Statements for more information on the forward-looking statements in this Report. Our actual results may differ materially from those included in these forward-looking statements due to a variety of factors including, but not limited to, those described in this Report in Part IIItem 1A. Risk Factors, in our 2010 Form 10-K in Part IItem 1A. Risk Factors and in Exhibit 99.5 to our Current Report on Form 8-K filed on July 13, 2011.
SUMMARY OF SELECTED FINANCIAL DATA
Below we provide selected consolidated financial data from our results of operations for the three and nine months ended September 30, 2011 and 2010, and selected comparative consolidated balance sheet data as of September 30, 2011, and December 31, 2010. We also provide selected key metrics we use in evaluating our performance.
Table 1: Consolidated Financial Highlights (Unaudited)
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||||||
(Dollars in millions) | 2011 | 2010 | Change | 2011 | 2010 | Change | ||||||||||||||||||
Income statement |
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Net interest income(1) |
$ | 3,283 | $ | 3,109 | 6 | % | $ | 9,559 | $ | 9,434 | 1 | % | ||||||||||||
Non-interest income |
871 | 907 | (4 | ) | 2,670 | 2,775 | (4 | ) | ||||||||||||||||
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Total revenue |
4,154 | 4,016 | 3 | 12,229 | 12,209 | ** | ||||||||||||||||||
Provision for loan and lease losses(1) |
622 | 867 | (28 | ) | 1,499 | 3,069 | (51 | ) | ||||||||||||||||
Non-interest expense |
2,297 | 1,996 | 15 | 6,714 | 5,843 | 15 | ||||||||||||||||||
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Income from continuing operations before income taxes |
1,235 | 1,153 | 7 | 4,016 | 3,297 | 22 | ||||||||||||||||||
Income tax provision |
370 | 335 | 10 | 1,174 | 948 | 24 | ||||||||||||||||||
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Income from continuing operations, net of taxes |
865 | 818 | 6 | 2,842 | 2,349 | 21 | ||||||||||||||||||
Loss from discontinued operations, net of taxes(2) |
(52 | ) | (15 | ) | 247 | (102 | ) | (303 | ) | (66 | ) | |||||||||||||
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Net income |
$ | 813 | $ | 803 | 1 | % | $ | 2,740 | $ | 2,046 | 34 | % | ||||||||||||
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Common share statistics |
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Earnings per common share: |
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Basic earnings per common share |
$ | 1.78 | $ | 1.78 | ** | % | $ | 6.02 | $ | 4.53 | 33 | % | ||||||||||||
Diluted earnings per common share |
1.77 | 1.76 | 1 | 5.95 | 4.49 | 33 | ||||||||||||||||||
Weighted average common shares outstanding: |
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Basic earnings per common share |
456.0 | 452.5 | 1 | 455.2 | 451.9 | 1 | ||||||||||||||||||
Diluted earnings per common share |
460.4 | 456.6 | 1 | 461.0 | 456.0 | 1 | ||||||||||||||||||
Dividends per common share |
0.05 | 0.05 | ** | 0.15 | 0.15 | ** | ||||||||||||||||||
Stock price per common share at period end |
39.63 | 39.55 | ** | 39.63 | 39.55 | ** | ||||||||||||||||||
Total market capitalization at period end |
18,075 | 17,900 | 1 | 18,075 | 17,900 | 1 |
1
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||||||
2011 | 2010 | Change | 2011 | 2010 | Change | |||||||||||||||||||
Average balances |
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Loans held for investment |
$ | 129,043 | $ | 126,307 | 2 | % | $ | 127,360 | $ | 129,565 | (2 | )% | ||||||||||||
Interest-earning assets |
177,710 | 172,473 | 3 | 175,147 | 176,332 | (1 | ) | |||||||||||||||||
Total assets |
201,611 | 196,598 | 3 | 199,616 | 200,931 | (1 | ) | |||||||||||||||||
Interest-bearing deposits |
110,750 | 104,186 | 6 | 109,552 | 104,119 | 5 | ||||||||||||||||||
Total deposits |
128,268 | 118,255 | 8 | 126,102 | 118,095 | 7 | ||||||||||||||||||
Borrowings |
37,366 | 45,910 | (19 | ) | 39,107 | 52,044 | (25 | ) | ||||||||||||||||
Stockholders equity |
29,316 | 25,307 | 16 | 28,202 | 24,498 | 15 | ||||||||||||||||||
Performance metrics |
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Purchase volume(3) |
$ | 34,918 | $ | 27,039 | 29 | % | $ | 96,941 | $ | 77,533 | 25 | % | ||||||||||||
Revenue margin (1) (4) |
9.35 | % | 9.31 | % | 4 | bps | 9.31 | % | 9.23 | % | 8 | bps | ||||||||||||
Net interest margin (1) (5) |
7.39 | 7.21 | 18 | 7.28 | 7.13 | 15 | ||||||||||||||||||
Net charge-off rate (1) (6) |
2.52 | 4.82 | (230 | ) | 3.02 | 5.41 | (239 | ) | ||||||||||||||||
Return on average assets(7) |
1.72 | 1.66 | 6 | 1.90 | 1.56 | 34 | ||||||||||||||||||
Return on average equity(8) |
11.80 | 12.93 | (113 | ) | 13.44 | 12.78 | 66 | |||||||||||||||||
Non-interest expense as a % of average loans held for investment(9) |
7.12 | 6.32 | 80 | 7.03 | 6.01 | 102 | ||||||||||||||||||
Efficiency ratio(10) |
55.30 | 49.70 | 560 | 54.90 | 47.86 | 704 | ||||||||||||||||||
Effective income tax rate |
29.96 | 29.05 | 91 | 29.23 | 28.75 | 48 | ||||||||||||||||||
September 30, 2011 |
December 31, 2010 |
Change | ||||||||||||||||||||||
Balance sheet (period end) |
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Loans held for investment |
$ | 129,952 | $ | 125,947 | 3 | % | ||||||||||||||||||
Interest-earning assets |
174,308 | 172,024 | 1 | |||||||||||||||||||||
Total assets |
200,148 | 197,503 | 1 | |||||||||||||||||||||
Interest-bearing deposits |
110,777 | 107,162 | 3 | |||||||||||||||||||||
Total deposits |
128,318 | 122,210 | 5 | |||||||||||||||||||||
Borrowings |
34,315 | 41,796 | (18 | ) | ||||||||||||||||||||
Total liabilities |
170,770 | 170,962 | ** | |||||||||||||||||||||
Stockholders equity |
29,378 | 26,541 | 11 | |||||||||||||||||||||
Tangible common equity (TCE)(11) |
15,425 | 12,558 | 23 | |||||||||||||||||||||
Credit quality metrics (period end) |
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Allowance for loan and lease losses |
$ | 4,280 | $ | 5,628 | (24 | )% | ||||||||||||||||||
Allowance as a % of loans held for investment |
3.29 | % | 4.47 | % | (118 | )bps | ||||||||||||||||||
30+ day performing delinquency rate(12) |
3.13 | 3.52 | (39 | ) | ||||||||||||||||||||
30+ day delinquency rate |
3.81 | 4.23 | (42 | ) | ||||||||||||||||||||
Capital ratios |
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Tier 1 common equity ratio(13) |
10.0 | % | 8.8 | % | 120 | bps | ||||||||||||||||||
Tier 1 risk-based capital ratio(14) |
12.4 | 11.6 | 80 | |||||||||||||||||||||
Total risk-based capital ratio(15) |
15.4 | 16.8 | (140 | ) | ||||||||||||||||||||
Tangible common equity ratio (TCE ratio)(16) |
8.3 | 6.9 | 140 |
** | Change is less than one percent. |
(1) | Interest income was reduced by $206 million and $421 million in the third quarter and first nine months of 2011, respectively, for amounts earned by Kohls Department Stores (Kohls). The reduction in the provision for loan and lease losses attributable to Kohls was $236 million for the first nine months of 2011. Loss-sharing amounts attributable to Kohls reduced net charge-offs by $39 million and $80 million in the third quarter and first nine |
2
months of 2011, respectively. The expected loss reimbursement from Kohls netted in our allowance for loan and lease losses was approximately $156 million as of September 30, 2011. See Note 2Acquisitions for additional information. |
(2) | Discontinued operations reflect ongoing costs related to the mortgage origination operations of GreenPoints wholesale mortgage banking unit, GreenPoint Mortgage Funding, Inc. (GreenPoint), which we closed in 2007. |
(3) | Consists of credit card purchase transactions for the period, net of returns. Excludes cash advance transactions. |
(4) | Calculated based on annualized total revenue for the period divided by average interest-earning assets for the period. |
(5) | Calculated based on annualized net interest income for the period divided by average interest-earning assets for the period. |
(6) | Calculated based on annualized net charge-offs for the period divided by average loans held for investment for the period. Average loans held for investment include purchased credit-impaired loans acquired as part of the Chevy Chase Bank acquisition. |
(7) | Calculated based on annualized income from continuing operations, net of tax, for the period divided by average total assets for the period. |
(8) | Calculated based on annualized income from continuing operations, net of tax, for the period divided by average stockholders equity for the period. |
(9) | Calculated based on annualized non-interest expense, excluding restructuring and goodwill impairment charges, for the period divided by average loans held for investment for the period. |
(10) | Calculated based on non-interest expense, excluding restructuring and goodwill impairment charges, for the period divided by total revenue for the period. |
(11) | Tangible common equity is a non-GAAP measure consisting of total assets less assets from discontinued operations and intangible assets. See Supplemental TablesTable A: Reconciliation of Non-GAAP Measures and Calculation of Regulatory Capital Measures for the calculation of this measure and reconciliation to the comparative GAAP measure. |
(12) | See Consolidated Balance Sheet Analysis and Credit PerformanceCredit PerformanceNonperforming Assets for our policies for classifying loans as nonperforming by loan category. |
(13) | Tier 1 common equity ratio is a non-GAAP measure calculated based on Tier 1 common equity divided by risk-weighted assets. See Liquidity and Capital ManagementCapital Management and Supplemental TablesTable A: Reconciliation of Non-GAAP Measures and Calculation of Regulatory Capital Measures for additional information, including the calculation of this ratio and non-GAAP reconciliation. |
(14) | Tier 1 risk-based capital ratio is a regulatory measure calculated based on Tier 1 capital divided by risk-weighted assets. See Liquidity and Capital ManagementCapital Management and Supplemental TablesTable A: Reconciliation of Non-GAAP Measures and Calculation of Regulatory Capital Measures for additional information, including the calculation of this ratio. |
(15) | Total risk-based capital ratio is a regulatory measure calculated based on total risk-based capital divided by risk-weighted assets. See Liquidity and Capital ManagementCapital Management and Supplemental TablesTable A: Reconciliation of Non-GAAP Measures and Calculation of Regulatory Capital Measures for additional information, including the calculation of this ratio. |
(16) | Tangible common equity ratio (TCE ratio) is a non-GAAP measure calculated based on tangible common equity divided by tangible assets. See Supplemental TablesTable A: Reconciliation of Non-GAAP Measures and Calculation of Regulatory Capital Measures for the calculation of this measure and reconciliation to the comparative GAAP measure. |
3
Capital One Financial Corporation (the Company) is a diversified financial services holding company with banking and non-banking subsidiaries that offer a broad array of financial products and services to consumers, small businesses and commercial clients through branches, the internet and other distribution channels. Our principal subsidiaries include:
| Capital One Bank (USA), National Association (COBNA), which currently offers credit and debit card products, other lending products and deposit products; and |
| Capital One, National Association (CONA), which offers a broad spectrum of banking products and financial services to consumers, small businesses and commercial clients. |
The Company and its subsidiaries are collectively referred to as we, us or our in this Report. CONA and COBNA are collectively referred to as the Banks in this Report.
We had $130.0 billion in total loans outstanding and $128.3 billion in deposits as of September 30, 2011, compared with $125.9 billion in total loans outstanding and $122.2 billion in deposits as of December 31, 2010.
Our revenues are primarily driven by lending to consumers and commercial customers and by deposit-taking activities, which generate net interest income, and by activities that generate non-interest income, including the sale and servicing of loans and providing fee-based services to customers. Customer usage and payment patterns, credit quality, levels of marketing expense and operating efficiency all affect our profitability. Our expenses primarily consist of the cost of funding our assets, our provision for loan and lease losses, operating expenses (including associate salaries and benefits, infrastructure maintenance and enhancements and branch operations and expansion costs), marketing expenses and income taxes.
Our principal operations are currently organized, for management reporting purposes, into three major business segments, which are defined based on the products and services provided or the type of customer served: Credit Card, Consumer Banking and Commercial Banking. The operations of acquired businesses have been integrated into our existing business segments.
| Credit Card: Consists of our domestic consumer and small business card lending, national small business lending, national closed end installment lending and the international card lending businesses in Canada and the United Kingdom. |
| Consumer Banking: Consists of our branch-based lending and deposit gathering activities for consumers and small businesses, national deposit gathering, national automobile lending and consumer home loan lending and servicing activities. |
| Commercial Banking: Consists of our lending, deposit gathering and treasury management services to commercial real estate and middle market customers. Our middle market customers typically include commercial and industrial companies with annual revenues between $10 million to $1.0 billion. |
Certain activities that are not part of a segment are included in our Other category.
Table 2 summarizes our business segment results, which we report based on income from continuing operations, net of tax, for the three and nine months ended September 30, 2011 and 2010. We provide a reconciliation of our total business segment results to our consolidated results using generally accepted accounting principles in the U.S. (U.S. GAAP) in Note 14Business Segments of this Report.
4
Table 2: Business Segment Results
Three Months Ended September 30, | ||||||||||||||||||||||||||||||||
2011 | 2010 | |||||||||||||||||||||||||||||||
Total Revenue(1) | Net Income (Loss)(2) | Total Revenue(1) | Net Income (Loss)(2) | |||||||||||||||||||||||||||||
(Dollars in millions) | Amount | % of Total |
Amount | % of Total |
Amount | % of Total |
Amount | % of Total |
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Credit Card |
$ | 2,720 | 65 | % | $ | 663 | 76 | % | $ | 2,605 | 65 | % | $ | 631 | 77 | % | ||||||||||||||||
Consumer Banking |
1,285 | 31 | 190 | 22 | 1,142 | 28 | 175 | 21 | ||||||||||||||||||||||||
Commercial Banking |
415 | 10 | 145 | 17 | 355 | 9 | 39 | 5 | ||||||||||||||||||||||||
Other(3) |
(266 | ) | (6 | ) | (133 | ) | (15 | ) | (86 | ) | (2 | ) | (27 | ) | (3 | ) | ||||||||||||||||
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Total from continuing operations |
$ | 4,154 | 100 | % | $ | 865 | 100 | % | $ | 4,016 | 100 | % | $ | 818 | 100 | % | ||||||||||||||||
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Nine Months Ended September 30, | ||||||||||||||||||||||||||||||||
2011 | 2010 | |||||||||||||||||||||||||||||||
Total Revenue(1) | Net Income (Loss)(2) | Total Revenue(1) | Net Income (Loss)(2) | |||||||||||||||||||||||||||||
(Dollars in millions) | Amount | % of Total |
Amount | % of Total |
Amount | % of Total |
Amount | % of Total |
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Credit Card |
$ | 7,844 | 64 | % | $ | 1,924 | 68 | % | $ | 8,072 | 66 | % | $ | 1,688 | 72 | % | ||||||||||||||||
Consumer Banking |
3,699 | 30 | 692 | 24 | 3,451 | 28 | 785 | 33 | ||||||||||||||||||||||||
Commercial Banking |
1,202 | 10 | 435 | 15 | 1,088 | 9 | 67 | 3 | ||||||||||||||||||||||||
Other(3) |
(516 | ) | (4 | ) | (209 | ) | (7 | ) | (397 | ) | (3 | ) | (191 | ) | (8 | ) | ||||||||||||||||
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Total from continuing operations |
$ | 12,229 | 100 | % | $ | 2,842 | 100 | % | $ | 12,214 | 100 | % | $ | 2,349 | 100 | % | ||||||||||||||||
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(1) | Total revenue consists of net interest income and non-interest income. |
(2) | Net income (loss) for our business segments reflects income from continuing operations, net of tax. |
(3) | Includes the residual impact of the allocation of our centralized Corporate Treasury group activities, such as management of our corporate investment portfolio and asset/liability management, to our business segments as well as other items as described in Note 14Business Segments. |
5
EXECUTIVE SUMMARY AND BUSINESS OUTLOOK
Financial Highlights
We reported net income of $813 million ($1.77 per diluted share) in the third quarter of 2011, with each of our three business segments contributing to our earnings. In comparison, we reported net income of $911 million ($1.97 per diluted share) in the second quarter of 2011 and net income of $803 million ($1.76 per diluted share) in the third quarter of 2010. Net income totaled $2.7 billion ($5.95 per diluted share) for the first nine months of 2011, compared with net income of $2.0 billion ($4.49 per diluted share) for the first nine months of 2010.
Our capital levels continued to increase during the third quarter of 2011, with total stockholders equity up $2.8 billion from year-end 2010. Our Tier 1 risk-based capital ratio under Basel I was 12.4% and our Tier 1 common equity ratio, a non-GAAP measure, was 10.0% as of September 30, 2011, both up 60 basis points from the end of the second quarter of 2011, reflecting strong internal capital generation as well as the continued decline in the amount of disallowed deferred tax assets. Based on our current understanding of the Basel III framework, which has not been implemented by the U.S. banking agencies and is subject to change, we estimate that our Tier 1 common equity ratio was 10.1% as of September 30, 2011. Our stockholders equity and capital ratios do not reflect any impact from the equity forward sale agreements executed in July 2011 referenced below, as they have not been settled in whole or in part as of the date of this Report. We present the calculation of our regulatory capital ratios and a reconciliation of our supplemental non-GAAP capital measures below under Supplemental Tables.
Our strategies and actions are designed to deliver profitable long-term growth through the acquisition and retention of franchise-enhancing customer relationships across our businesses. We believe that franchise-enhancing customer relationships produce strong long-term economics through low credit costs, low customer attrition and a gradual build in loan balances and revenues over time. Examples of franchise-enhancing customer relationships include rewards customers and new partnerships in our Credit Card business, long-term retail deposit customers in our Consumer Banking business and primary banking relationships with commercial customers in our Commercial Banking business. We intend to grow these customer relationships by continuing to invest in our bank infrastructure to allow us to provide more convenient and flexible customer banking options, including a broader range of fee-based and credit products and services, by leveraging our direct bank customer franchise with national reach and by continued marketing investments to further strengthen our brand. We believe our actions have created a well-positioned balance sheet and strong capital and liquidity levels which have provided us with investment flexibility to take advantage of attractive opportunities and adjust, where we believe appropriate, to changing market conditions.
As previously announced, in June 2011, we entered into a definitive agreement with ING Groep N.V., ING Bank N.V., ING Direct N.V., ING Direct Bancorp, collectively, the Sellers, under which we will acquire substantially all of the Sellers ING Direct business in the United States (ING Direct), in exchange for $6.2 billion in cash and approximately 55.9 million shares of our common stock, subject to certain adjustments. We continue to expect the ING Direct acquisition to close in late 2011 or early 2012, subject to customary closing conditions, including certain governmental clearances and approvals. In the third quarter of 2011, we closed a public underwritten offering of our senior notes, from which we received total proceeds of approximately $3.0 billion, and a public underwritten offering of 40 million shares of our common stock at a price per share of $50.00, subject to forward sale agreements. After underwriters discounts and commissions, the net proceeds to us from the equity offering will be at an initial forward sale price per share of $48.50. The forward sale price is subject to adjustment under the forward sale agreements. We have not received any proceeds from this public offering of our shares of common stock yet. Under the terms of the forward sale agreements, we must settle the forward sale agreements on or before February 15, 2012. We expect to settle the forward sale agreements entirely by physical delivery of shares of common stock in exchange for cash proceeds from the forward purchasers of approximately $1.9 billion based on the initial forward price. However, we may, subject to certain conditions, elect cash or net share settlement of all or a portion of our obligation to deliver shares of common stock. We expect to
6
use the net proceeds from the debt and equity offerings, along with cash sourced from our current liquidity, to fund the $6.2 billion in cash consideration payable in connection with the ING Direct acquisition.
In addition to the pending ING Direct acquisition, we announced in August 2011 that we had entered into a purchase agreement with HSBC Finance Corporation, HSBC USA Inc. and HSBC Technology and Services (USA) Inc. (collectively, HSBC), to acquire substantially all of the assets and assume liabilities of HSBCs credit card and private-label credit card business in the United States for a premium estimated at $2.6 billion as of June 30, 2011. We currently expect the HSBC acquisition to close in the second quarter of 2012, subject to customary closing conditions, including certain governmental clearances and approvals.
We took several actions during the quarter to manage the anticipated impact of the pending ING Direct acquisition on our market risk exposure and regulatory capital requirements. Since the date we entered into the agreement to acquire ING Direct, interest rates have declined substantially, and our current estimate of the fair value of the ING Direct net assets and liabilities has increased correspondingly. In order to capture some of the anticipated benefits to regulatory capital on the closing date attributable to this decline in interest rates, in August 2011, we entered into various pay-fixed/receive-floating interest-rate swap transactions with a total notional principal amount of approximately $23.8 billion. These swap transactions are designed to mitigate the effect of a rise in interest rates on the fair values of a significant portion of the ING Direct assets and liabilities during the period from when we entered into the swap transactions to the anticipated closing date of the ING Direct acquisition in late 2011 or early 2012. Although the interest-rate swaps represent economic hedges, they are not designated for hedge accounting. Accordingly, changes in the fair value are recorded in earnings. Our results for the third quarter of 2011 include a mark-to-market loss of $266 million related to these interest-rate swaps, which was attributable to a decline in interest rates as of the end of the quarter. Changes in the fair value of these interest-rate swaps will continue to be recorded in earnings until the swaps are terminated. We also sold approximately $6.4 billion of investment securities, consisting predominantly of agency mortgage-backed securities (MBS). We recorded a gain of $239 million on the sale of these securities, which largely offsets the mark-to-market loss recognized on the interest-rate swaps. We will continue to evaluate market conditions and may take additional balance sheet management actions, such as entering into similar swap transactions or selling additional investment securities, to manage the anticipated impact of the pending ING Direct and HSBC acquisitions on our market risk exposure and regulatory capital requirements. For additional detail, see Market Risk Management section of this Report and Note 10Derivative Instruments and Hedging Activities.
Below are additional highlights of our performance for the third quarter and first nine months of 2011. These highlights generally are based on a comparison to the same prior year periods. The changes in our financial condition and credit performance are generally based on our financial condition and credit performance as of September 30, 2011, compared with our financial condition and credit performance as of December 31, 2010. We provide a more detailed discussion of our financial performance in the sections following this Executive Summary and Business Outlook.
Total Company
| Earnings: Our earnings of $813 million in the third quarter of 2011 increased by $10 million, or 1%, from the third quarter of 2010, while our earnings of $2.7 billion for the first nine months of 2011 increased by $694 million, or 34%, from the first nine months of 2010. The increase in net income for each period was primarily attributable to significantly lower credit costs due to improvements in loan credit quality. The increase in net income for the first nine months of 2011 also reflected a substantial reduction in the provision for mortgage repurchase losses for legacy mortgage-related representation and warranty claims. These factors were partially offset by higher operating expenses related to our recent acquisitions and increased marketing expenditures. |
| Total Loans: Period-end loans held for investment increased by $4.0 billion, or 3%, during the first nine months of 2011, to $130.0 billion as of September 30, 2011, from $125.9 billion as of December 31, 2010. The increase was primarily attributable to the additions of the $3.7 billion private-label credit card loan |
7
portfolio of Kohls in the second quarter of 2011 and the $1.4 billion credit card loan portfolio of Hudsons Bay Company (HBC) in the first quarter of 2011, as well as growth in our auto finance, commercial and revolving domestic card balances. Excluding the impact of the addition of the Kohls and HBC portfolios, total loans decreased by $1.1 billion, or 1%, in the first nine months of 2011, due to the continued expected run-off of installment loans in our Credit Card business and legacy home loans in our Consumer Banking business, other loan paydowns and charge-offs. The impact from these factors more than offset the strong purchase volume growth across the Domestic Card business, a significant increase in auto loan originations and steady loan growth in our Commercial Banking business. |
| Charge-off and Delinquency Statistics: Net charge-off rates continued to decline during the third quarter of 2011. The net charge-off rate decreased to 2.52%, from 2.91% in the second quarter of 2011 and 4.82% in the third quarter of 2010. The net charge-off rate was 3.02% for the first nine months of 2011, a decrease of 239 basis points from the first nine months of 2010. The 30+ day delinquency rate was 3.81% as of September 30, 2011, compared with 3.57% as of June 30, 2011, and 4.23% as of December 31, 2010. As overall credit trends are stabilizing after almost two years of rapidly declining charge-offs, our quarterly credit metrics are increasingly driven by seasonal patterns. |
| Allowance for Loan and Lease Losses: We reduced our allowance by $208 million in the third quarter of 2011 and by $1.3 billion in the first nine months of 2011 to $4.3 billion as of September 30, 2011. In comparison, we reduced our allowance by $624 million in the third quarter of 2010 and by $2.0 billion in the first nine months of 2010. The significant reductions in our allowance releases in the third quarter and first nine months of 2011 from the same prior year periods reflect the impact of stabilizing credit trends. While our net-charge off rate improved by 239 basis points in the first nine months of 2011, compared with the same prior year period, the allowance coverage ratio fell by only 118 basis points to 3.29% as of September 30, 2011, from 4.47% as of December 31, 2010. |
| Representation and Warranty Reserve: Our representation and warranty reserve totaled $892 million as of September 30, 2011, compared with $816 million as of December 31, 2010. This reserve relates to our mortgage loan repurchase exposure for legacy mortgage loans sold by our subsidiaries to various parties under contractual provisions that include various representations and warranties. The reserve reflects losses as of each balance sheet date that we consider to be both probable and reasonably estimable. We recorded a provision for this exposure of $72 million and $153 million in the third quarter and first nine months of 2011, respectively, compared with a provision of $16 million and $644 million in the third quarter and first nine months of 2010, respectively. |
Business Segments
| Credit Card Business: Our Credit Card business generated net income from continuing operations of $663 million and $1.9 billion in the third quarter and first nine months of 2011, respectively, compared with net income from continuing operations of $631 million and $1.7 billion in the third quarter and first nine months of 2010, respectively. The improvement in credit performance was the primary driver of the improvement in our Credit Card business, resulting in a significant decrease in the provision for loan and lease losses. The provision decrease for the first nine months of 2011 was partially offset by an increase in non-interest expense attributable to increased operating and integration costs related to the acquisitions of the credit card loan portfolios of Sony, HBC and Kohls and increased marketing expenditures. New account originations have continued to grow in our Credit Card business. |
| Consumer Banking Business: Our Consumer Banking business generated net income from continuing operations of $190 million and $692 million in the third quarter and first nine months of 2011, respectively, compared with net income from continuing operations of $175 million and $785 million in the third quarter and first nine months of 2010, respectively. The increase in net income for the third quarter of 2011 was primarily due to revenue growth resulting from improved loan margins attributable to an increase in average loan yields, coupled with a decrease in the cost of funds. The decrease in net income for the first nine months of 2011 reflected the impact of the absence of a one-time pre-tax gain of $128 million recorded in |
8
the first quarter of 2010 from the deconsolidation of certain option-adjustable rate mortgage trusts and an increase in the provision for loan and lease losses due to growth in auto loans. These factors were partially offset by an increase in total revenue due to a shift in our loan product mix toward higher priced auto loan originations, coupled with deposit growth resulting from our continued strategy to leverage our bank outlets to attract lower cost deposit funding. Strong growth in auto loan originations during the third quarter and first nine months of 2011 has more than offset the continued run-off in legacy home loans. |
| Commercial Banking: Our Commercial Banking business generated net income from continuing operations of $145 million and $435 million in the third quarter and first nine months of 2011, respectively, compared with net income from continuing operations of $39 million and $67 million in the third quarter and first nine months of 2010, respectively. The improvement in results for our Commercial Banking business reflected an increase in revenues, a decrease in non-interest expense and a decrease in the provision for loan and lease losses due to the improvement in credit quality. As a result of this improvement, we reduced our allowance for loan and lease losses and recorded a negative provision for loan and lease losses of $10 million and $43 million in the third quarter and first nine months of 2011, respectively. In comparison, we recorded a provision for loan and lease losses of $95 million and $395 million in the third quarter and first nine months of 2010, respectively, related to our Commercial Banking business. We continued to experience steady loan growth in our Commercial Banking business, with loan demand expanding beyond refinancing to include demand for new credit to finance growth for our commercial customers. |
Business Environment and Recent Developments
Recent Business and Regulatory Developments
The challenging economic environment intensified during the third quarter of 2011, due to concerns about the U.S. debt ceiling and subsequent downgrade of the U.S. debt, the continued elevated U.S. unemployment rate and the European debt crisis. These concerns resulted in increased economic uncertainty and market volatility. We have continued to monitor our portfolio credit performance for signs that these difficult market conditions are causing deterioration in our credit results. Our credit metrics are stabilizing with normal seasonality re-emerging after a long period of cyclical improvement. We believe actions we made in underwriting and managing our business through the recession, including focusing on our most resilient businesses, have continued to drive our strong credit performance. In addition, our recent partnerships and acquisitions have contributed to new account originations and a continued increase in purchase volumes in our Credit Card business.
Recent Acquisitions and Related Developments
During the past several years, we have explored opportunities to acquire financial services companies and financial assets and enter into strategic partnerships as part of our growth strategy. Our financial strength and flexibility and our experience in the credit card and direct banking businesses are key factors that we believe have enabled us to take advantage of our recent investment opportunities, including the acquisition of HBCs existing credit card loan portfolio in the first quarter of 2011, the acquisition of Kohls existing credit card loan portfolio in the second quarter of 2011 and our pending acquisitions of ING Direct and HSBCs U.S. credit card business. We continue to evaluate and anticipate engaging in additional strategic partnerships and selected acquisitions of financial institutions and other financial assets, including credit card and other loan portfolios. We may issue common stock or debt in connection with future acquisitions, including in public offerings, to fund such acquisitions.
Business Outlook
We discuss below our current expectations regarding our total company performance and the performance of each of our business segments over the near-term based on market conditions, the regulatory environment and our business strategies as of the time we filed this Report. The statements contained in this section are based on our current expectations regarding our outlook for our financial results and business strategies. Our expectations take into account, and should be read in conjunction with, our expectations regarding economic trends and
9
analysis of our business as discussed in Part IItem 1. Business and Part IItem 7. Managements Discussion and Analysis of Financial Condition and Results of Operations in our 2010 Form 10-K. Certain statements are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual results could differ materially from those in our forward-looking statements. Forward-looking statements do not reflect (i) any change in current dividend or repurchase strategies, (ii) the effect of any acquisitions, divestitures or similar transactions or (iii) any changes in laws, regulations or regulatory interpretations, in each case after the date as of which such statements are made. See Forward-Looking Statements in this Report, Item 1A. Risk Factors in our 2010 Form 10-K and the risk factors set forth in Exhibit 99.5 to our Current Report on Form 8-K filed on July 13, 2011, for factors that could materially influence our results.
Total Company Expectations
Our third quarter results continue to demonstrate the impact of our strategy to deliver profitable long-term growth through the acquisition and retention of franchise-enhancing customer relationships across our businesses. We believe we remain well-positioned to win in the marketplace and deliver shareholder value. We expect that the combined acquisitions of ING Direct and the HSBC U.S. credit card business will deliver attractive financial results in the near-term and put us in an even stronger position to enhance and sustain the value we can deliver to our customers, our communities and our shareholders over the long-term. We believe strong earnings will enable us to maintain strong capital levels and trajectory and that deep access to deposits will bolster our already-strong liquidity. Based on recent trends, including modest loan growth, and our targeted initiatives to attract new business and develop franchise-enhancing customer relationships, we believe the period of shrinking loans during the recession has come to an end. We expect modest year-over-year growth in ending loan balances in 2011. Although we expect an increase in period- end loans, we expect that average loan balances for 2011 will be comparable to average loan balances for 2010 given the lower loan balance starting point in 2011. Following the completion of the planned acquisitions of ING Direct and the HSBC U.S. credit card business, we expect our loan growth rate trajectory will be muted by the larger base of loans and the expected run-off of several of our legacy and acquired business loan portfolios.
Business Segments Expectations
Credit Card Business
We believe that our Domestic Card loan balances reached a low point in the first quarter of 2011. We expect seasonal loan growth in the fourth quarter of 2011. We believe we remain well positioned to gain market share in the new level playing field resulting from the CARD Act. We believe the credit results in our Domestic Card business are stabilizing and exhibiting expected seasonal patterns.
Consumer Banking Business
In our Consumer Banking business, we expect that auto originations and returns will remain strong and drive growth in auto loans for 2011. We expect that the continuing run-off of the legacy home loan portfolio will largely offset the growth in auto loans. We believe we have reached a cyclical low point for auto finance charge-offs. We expect that the auto finance charge-off rate will increase in the fourth quarter of 2011, driven by seasonal patterns. Over the long run, competitive factors and moderation in auction prices for used vehicles is likely to create higher charge-off rates.
Commercial Banking Business
In our Commercial Banking business, we believe that the worst of the commercial credit downturn is behind us and there is positive credit performance trajectory. However, we continue to expect some quarterly uncertainty and variability in commercial charge-offs and nonperforming loans. We have been growing commercial loans with lower credit risk and expect further modest growth to continue in the fourth quarter of 2011.
10
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements in accordance with U.S. GAAP requires management to make a number of judgments, estimates and assumptions that affect the reported amount of assets, liabilities, income and expenses in the consolidated financial statements. Understanding our accounting policies and the extent to which we use management judgment and estimates in applying these policies is integral to understanding our financial statements. We provide a summary of our significant accounting policies in Note 1Summary of Significant Accounting Policies of our 2010 Form 10-K.
We have identified the following accounting policies as critical because they require significant judgments and assumptions about highly complex and inherently uncertain matters and the use of reasonably different estimates and assumptions could have a material impact on our reported results of operations or financial condition. These critical accounting policies govern:
| Fair value |
| Allowance for loan and lease losses |
| Asset impairment |
| Representation and warranty reserve |
| Revenue recognition |
| Derivative and hedge accounting |
| Income taxes |
We evaluate our critical accounting estimates and judgments on an ongoing basis and update them as necessary based on changing conditions. The use of fair value to measure our financial instruments is fundamental to the preparation of our consolidated financial statements because we account for and record a significant portion of our assets and liabilities at fair value. Accordingly, we provide information below on financial instruments recorded at fair value in our consolidated balance sheets. We also discuss below refinements we made in the third quarter of 2011 in determining the estimated amount of uncollectible finance charges and fees for credit card loans. Management has discussed our critical accounting policies and estimates with the Audit and Risk Committee of the Board of Directors.
Fair Value
Fair value is defined as the price that would be received for an asset or paid to transfer a liability in an orderly transaction between market participants on the measurement date (also referred to as an exit price). The fair value accounting guidance provides a three-level fair value hierarchy for classifying financial instruments. This hierarchy is based on whether the inputs to the valuation techniques used to measure fair value are observable or unobservable. Fair value measurement of a financial asset or liability is assigned to a level based on the lowest level of any input that is significant to the fair value measurement in its entirety. The three levels of the fair value hierarchy are described below:
Level 1: |
Quoted prices (unadjusted) in active markets for identical assets or liabilities. | |
Level 2: |
Observable market-based inputs, other than quoted prices in active markets for identical assets or liabilities. | |
Level 3: |
Unobservable inputs. |
The degree of management judgment involved in determining the fair value of a financial instrument is dependent upon the availability of quoted prices in active markets or observable market parameters. When quoted prices and observable data in active markets are not fully available, management judgment is necessary to estimate fair value. Changes in market conditions, such as reduced liquidity in the capital markets or changes in secondary market activities, may reduce the availability and reliability of quoted prices or observable data used to determine fair value.
11
We have developed policies and procedures to determine when markets for our financial assets and liabilities are inactive if the level and volume of activity has declined significantly relative to normal conditions. If markets are determined to be inactive, it may be appropriate to adjust price quotes received. When significant adjustments are required to price quotes or inputs, it may be appropriate to utilize an estimate based primarily on unobservable inputs.
Significant judgment may be required to determine whether certain financial instruments measured at fair value are included in Level 2 or Level 3. In making this determination, we consider all available information that market participants use to measure the fair value of the financial instrument, including observable market data, indications of market liquidity and orderliness, and our understanding of the valuation techniques and significant inputs used. Based upon the specific facts and circumstances of each instrument or instrument category, judgments are made regarding the significance of the Level 3 inputs to the instruments fair value measurement in its entirety. If Level 3 inputs are considered significant, the instrument is classified as Level 3. The process for determining fair value using unobservable inputs is generally more subjective and involves a high degree of management judgment and assumptions.
Our financial instruments recorded at fair value on a recurring basis represented approximately 20% of our total assets of $200.1 billion as of September 30, 2011, compared with 22% of our total assets of $197.5 billion as of December 31, 2010. Financial assets for which the fair value was determined using significant Level 3 inputs represented approximately 2% of these financial instruments (less than 1% of total assets) as of September 30, 2011, and approximately 2% of these financial instruments (less than 1% of total assets) as of December 31, 2010.
We discuss changes in the valuation inputs and assumptions used in determining the fair value of our financial instruments, including the extent to which we have relied on significant unobservable inputs to estimate fair value and our process for corroborating these inputs, in Note 13Fair Value of Financial Instruments.
Key Controls Over Fair Value Measurement
We have a governance framework and a number of key controls that are intended to ensure that our fair value measurements are appropriate and reliable. Our governance framework provides for independent oversight and segregation of duties. Our control processes include review and approval of new transaction types, price verification and review of valuation judgments, methods, models, process controls and results. Groups independent from our trading and investing functions, including our Valuations Group and Valuations Advisory Committee, participate in the review and validation process. The Valuation Advisory Committee includes senior representation from business areas, our Enterprise Risk Oversight division and our Finance division.
Our Valuations Group performs monthly independent verification of fair value measurements by comparing the methodology driven price to other market source data (to the extent available), and uses independent analytics to determine if assigned fair values are reasonable. The Valuations Advisory Committee regularly reviews and approves our valuation methodologies to ensure that our methodologies and practices are consistent with industry standards and adhere to regulatory and accounting guidance.
Revenue Recognition
We recognize finance charges and fees on credit card loans when the amounts are billed to the customer and include these amounts in the loan balance, net of the estimated uncollectible amount of finance charges and fees. Our process for estimating the uncollectible amount of billed finance charges and fees is consistent with the process we use to estimate the allowance for incurred principal losses on our credit card loan receivables.
We determine the adequacy of the uncollectible finance charge and fee reserve on a quarterly basis, primarily based on the use of a roll-rate methodology. We refine our estimation process and key assumptions used in
12
determining our loss reserves as additional information becomes available. In the third quarter of 2011, we revised the manner in which we estimate expected recoveries of finance charge and fee amounts previously considered to be uncollectible. Our revised recovery assumptions better reflect the post-recession pattern of relatively low delinquency roll-rates combined with increased recoveries of finance charges and fees previously considered uncollectible. This reduced the uncollectible finance charge and fee reserves by approximately $83 million as of September 30, 2011, and resulted in a corresponding increase in revenues of $83 million in the third quarter of 2011. We also applied these revised assumptions to the estimated recovery of principal charge-offs in determining our allowance for loan and lease losses. The revision, however, had an insignificant impact on the overall determination of our allowance for lease and loan losses as of September 30, 2011.
For additional information on our critical accounting policies and estimates, see Part IIItem 7. MD&ACritical Accounting Policies and Estimates of our 2010 Form 10-K.
CONSOLIDATED RESULTS OF OPERATIONS
The section below provides a comparative discussion of our consolidated financial performance for the three and nine months ended September 30, 2011 and 2010. Following this section, we provide a discussion of our business segment results. You should read this section together with our Executive Summary and Business Outlook where we discuss trends and other factors that we expect will affect our future results of operations.
Net Interest Income
Net interest income represents the difference between the interest income and applicable fees earned on our interest-earning assets, which include loans held for investment and investment securities, and the interest expense on our interest-bearing liabilities, which include interest-bearing deposits, senior and subordinated notes, securitized debt and other borrowings. We include in interest income any past due fees on loans that we deem are collectible. Our net interest margin represents the difference between the yield on our interest-earning assets and the cost of our interest-bearing liabilities, including the impact of non-interest bearing funding. We expect net interest income and our net interest margin to fluctuate based on changes in interest rates and changes in the amount and composition of our interest-earning assets and interest-bearing liabilities.
Table 3 below presents, for each major category of our interest-earning assets and interest-bearing liabilities, the average outstanding balances, interest income earned or interest expense incurred, and the average yield or cost for the three and nine months ended September 30, 2011 and 2010.
13
Table 3: Average Balances, Net Interest Income and Net Interest Yield
Three Months Ended September 30, | ||||||||||||||||||||||||
2011 | 2010 | |||||||||||||||||||||||
(Dollars in millions) | Average Balance |
Interest Income/ Expense(1) |
Yield/ Rate |
Average Balance |
Interest Income/ Expense(1) |
Yield/ Rate |
||||||||||||||||||
Assets: |
||||||||||||||||||||||||
Interest-earning assets: |
||||||||||||||||||||||||
Consumer loans:(2) |
||||||||||||||||||||||||
Domestic(3) |
$ | 88,995 | $ | 2,828 | 12.71 | % | $ | 89,530 | $ | 2,767 | 12.36 | % | ||||||||||||
International |
8,703 | 354 | 16.27 | 7,342 | 302 | 16.45 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Total consumer loans(3) |
97,698 | 3,182 | 13.03 | 96,872 | 3,069 | 12.67 | ||||||||||||||||||
Commercial loans(3) |
31,345 | 368 | 4.69 | 29,435 | 378 | 5.13 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Total loans held for investment |
129,043 | 3,550 | 11.00 | 126,307 | 3,447 | 10.92 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Investment securities |
37,189 | 264 | 2.84 | 39,872 | 347 | 3.48 | ||||||||||||||||||
Other interest-earning assets: |
||||||||||||||||||||||||
Domestic |
10,711 | 18 | 0.67 | 5,793 | 20 | 1.38 | ||||||||||||||||||
International |
767 | 3 | 1.56 | 501 | 1 | 0.80 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Total other interest-earning assets |
11,478 | 21 | 0.73 | 6,294 | 21 | 1.33 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Total interest-earning assets(4) |
$ | 177,710 | $ | 3,835 | 8.63 | % | $ | 172,473 | $ | 3,815 | 8.85 | % | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Cash and due from banks |
1,742 | 2,014 | ||||||||||||||||||||||
Allowance for loan and lease losses |
(4,488 | ) | (6,803 | ) | ||||||||||||||||||||
Premises and equipment, net |
2,731 | 2,709 | ||||||||||||||||||||||
Other assets |
23,916 | 26,205 | ||||||||||||||||||||||
|
|
|
|
|||||||||||||||||||||
Total assets |
$ | 201,611 | $ | 196,598 | ||||||||||||||||||||
|
|
|
|
|||||||||||||||||||||
Liabilities and equity: |
||||||||||||||||||||||||
Interest-bearing liabilities: |
||||||||||||||||||||||||
Deposits |
$ | 110,750 | $ | 294 | 1.06 | % | $ | 104,186 | $ | 358 | 1.37 | % | ||||||||||||
Securitized debt obligations: |
||||||||||||||||||||||||
Domestic |
14,734 | 73 | 1.98 | 25,928 | 159 | 2.45 | ||||||||||||||||||
International |
3,744 | 16 | 1.71 | 4,822 | 32 | 2.65 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Total securitized debt obligations |
18,478 | 89 | 1.93 | 30,750 | 191 | 2.48 | ||||||||||||||||||
Senior and subordinated notes |
10,519 | 84 | 3.19 | 8,677 | 72 | 3.32 | ||||||||||||||||||
Other borrowings |
8,369 | 85 | 4.06 | 6,483 | 85 | 5.24 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Total interest-bearing liabilities |
$ | 148,116 | $ | 552 | 1.49 | % | $ | 150,096 | $ | 706 | 1.88 | % | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Non-interest bearing deposits |
17,518 | 14,069 | ||||||||||||||||||||||
Other liabilities |
6,661 | 7,126 | ||||||||||||||||||||||
|
|
|
|
|||||||||||||||||||||
Total liabilities |
172,295 | 171,291 | ||||||||||||||||||||||
Stockholders equity |
29,316 | 25,307 | ||||||||||||||||||||||
|
|
|
|
|||||||||||||||||||||
Total liabilities and stockholders equity |
$ | 201,611 | $ | 196,598 | ||||||||||||||||||||
|
|
|
|
|||||||||||||||||||||
Net interest income/spread(4) |
$ | 3,283 | 7.14 | % | $ | 3,109 | 6.97 | % | ||||||||||||||||
|
|
|
|
|
|
|
|
|||||||||||||||||
Interest income to average interest-earning assets |
8.63 | % | 8.85 | % | ||||||||||||||||||||
Interest expense to average interest-earning assets |
1.24 | 1.64 | ||||||||||||||||||||||
|
|
|
|
|||||||||||||||||||||
Net interest margin |
7.39 | % | 7.21 | % | ||||||||||||||||||||
|
|
|
|
14
Nine Months Ended September 30, | ||||||||||||||||||||||||
2011 | 2010 | |||||||||||||||||||||||
(Dollars in millions) | Average Balance |
Interest Income/ Expense(1) |
Yield/ Rate |
Average Balance |
Interest Income/ Expense(1) |
Yield/ Rate |
||||||||||||||||||
Assets: |
||||||||||||||||||||||||
Interest-earning assets: |
||||||||||||||||||||||||
Consumer loans:(2) |
||||||||||||||||||||||||
Domestic(3) |
$ | 88,129 | $ | 8,194 | 12.40 | % | $ | 92,476 | $ | 8,563 | 12.35 | % | ||||||||||||
International |
8,741 | 1,056 | 16.11 | 7,526 | 903 | 16.00 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Total consumer loans(3) |
96,870 | 9,250 | 12.73 | 100,002 | 9,466 | 12.62 | ||||||||||||||||||
Commercial loans(3) |
30,490 | 1,084 | 4.74 | 29,563 | 1,116 | 5.03 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Total loans held for investment |
127,360 | 10,334 | 10.82 | 129,565 | 10,582 | 10.89 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Investment securities |
39,684 | 893 | 3.00 | 38,979 | 1,037 | 3.55 | ||||||||||||||||||
Other interest-earning assets: |
||||||||||||||||||||||||
Domestic |
7,388 | 49 | 0.88 | 7,216 | 58 | 1.07 | ||||||||||||||||||
International |
715 | 10 | 1.86 | 572 | 2 | 0.47 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Total other interest-earning assets |
8,103 | 59 | 0.97 | 7,788 | 60 | 1.03 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Total interest-earning assets(4) |
$ | 175,147 | $ | 11,286 | 8.59 | % | $ | 176,332 | $ | 11,679 | 8.83 | % | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Cash and due from banks |
1,851 | 2,214 | ||||||||||||||||||||||
Allowance for loan and lease losses |
(5,058 | ) | (7,623 | ) | ||||||||||||||||||||
Premises and equipment, net |
2,722 | 2,719 | ||||||||||||||||||||||
Other assets |
24,954 | 27,289 | ||||||||||||||||||||||
|
|
|
|
|||||||||||||||||||||
Total assets |
$ | 199,616 | $ | 200,931 | ||||||||||||||||||||
|
|
|
|
|||||||||||||||||||||
Liabilities and equity: |
||||||||||||||||||||||||
Interest-bearing liabilities: |
||||||||||||||||||||||||
Deposits |
$ | 109,552 | $ | 923 | 1.12 | % | $ | 104,119 | $ | 1,125 | 1.44 | % | ||||||||||||
Securitized debt obligations: |
||||||||||||||||||||||||
Domestic |
18,214 | 281 | 2.06 | 31,275 | 548 | 2.34 | ||||||||||||||||||
International |
3,827 | 61 | 2.13 | 5,092 | 96 | 2.51 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Total securitized debt obligations |
22,041 | 342 | 2.07 | 36,367 | 644 | 2.36 | ||||||||||||||||||
Senior and subordinated notes |
8,910 | 211 | 3.16 | 8,731 | 211 | 3.22 | ||||||||||||||||||
Other borrowings |
8,156 | 251 | 4.10 | 6,946 | 265 | 5.09 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Total interest-bearing liabilities |
$ | 148,659 | $ | 1,727 | 1.55 | % | $ | 156,163 | $ | 2,245 | 1.92 | % | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Non-interest bearing deposits |
16,550 | 13,976 | ||||||||||||||||||||||
Other liabilities |
6,205 | 6,294 | ||||||||||||||||||||||
|
|
|
|
|||||||||||||||||||||
Total liabilities |
171,414 | 176,433 | ||||||||||||||||||||||
Stockholders equity |
28,202 | 24,498 | ||||||||||||||||||||||
|
|
|
|
|||||||||||||||||||||
Total liabilities and stockholders equity |
$ | 199,616 | $ | 200,931 | ||||||||||||||||||||
|
|
|
|
|||||||||||||||||||||
Net interest income/spread(4) |
$ | 9,559 | 7.04 | % | $ | 9,434 | 6.91 | % | ||||||||||||||||
|
|
|
|
|
|
|
|
|||||||||||||||||
Interest income to average interest-earning assets |
8.59 | % | 8.83 | % | ||||||||||||||||||||
Interest expense to average interest-earning assets |
1.31 | 1.70 | ||||||||||||||||||||||
|
|
|
|
|||||||||||||||||||||
Net interest margin |
7.28 | % | 7.13 | % | ||||||||||||||||||||
|
|
|
|
15
(1) | Past due fees included in interest income totaled approximately $303 million and $249 million for the three months ended September 30, 2011 and 2010, respectively, and approximately $793 million and $893 million for the nine months ended September 30, 2011 and 2010, respectively. |
(2) | Interest income on credit card, auto, home and retail banking loans is reflected in consumer loans. Interest income generated from small business credit cards also is included in consumer loans. |
(3) | In the first quarter of 2011, we revised previously reported interest income on interest-earning assets and average yield on loans held for investment for 2010 to conform to the internal management accounting methodology used in our segment reporting. The interest income and average loan yields presented reflect this revision. The previously reported interest income and average yields for the third quarter of 2010 were as follows: domestic consumer loans ($2,846 million and 12.72%); total consumer loans ($3,148 million and 13.00%); and commercial loans ($299 million and 4.06%). The previously reported interest income and average yields for the first nine months of 2010 were as follows: domestic consumer loans ($8,691 million and 12.53%); total consumer loans ($9,594 million and 12.79%); and commercial loans ($988 million and 4.46%). |
(4) | Interest income was reduced by $206 million and $421 million in the third quarter and first nine months of 2011, respectively, for amounts earned by Kohls. |
Table 4 presents the variance between our net interest income for the three months ended September 30, 2011 and 2010, and for the nine months ended September 30, 2011 and 2010, and the extent to which the variance was attributable to: (i) changes in the volume of our interest-earning assets and interest-bearing liabilities or (ii) changes in the interest rates of these assets and liabilities.
Table 4: Rate/Volume Analysis of Net Interest Income(1)
Three Months Ended September 30, 2011 vs. 2010 |
Nine Months Ended September 30, 2011 vs. 2010 |
|||||||||||||||||||||||
(Dollars in millions) |
Total Variance |
Variance Due to | Total Variance |
Variance Due to | ||||||||||||||||||||
Volume | Rate | Volume | Rate | |||||||||||||||||||||
Interest income: |
||||||||||||||||||||||||
Loans held for investment: |
||||||||||||||||||||||||
Consumer loans |
$ | 113 | $ | 26 | $ | 87 | $ | (216 | ) | $ | (299 | ) | $ | 83 | ||||||||||
Commercial loans |
(10 | ) | 24 | (34 | ) | (32 | ) | 35 | (67 | ) | ||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Total loans held for investment, including past-due fees |
103 | 50 | 53 | (248 | ) | (264 | ) | 16 | ||||||||||||||||
Investment securities |
(83 | ) | (22 | ) | (61 | ) | (144 | ) | 18 | (162 | ) | |||||||||||||
Other |
| 12 | (12 | ) | (1 | ) | 2 | (3 | ) | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Total interest income |
20 | 40 | (20 | ) | (393 | ) | (244 | ) | (149 | ) | ||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Interest expense: |
||||||||||||||||||||||||
Deposits |
(64 | ) | 21 | (85 | ) | (202 | ) | 56 | (258 | ) | ||||||||||||||
Securitized debt obligations |
(102 | ) | (65 | ) | (37 | ) | (302 | ) | (230 | ) | (72 | ) | ||||||||||||
Senior and subordinated notes |
12 | 15 | (3 | ) | | 5 | (5 | ) | ||||||||||||||||
Other borrowings |
| 22 | (22 | ) | (14 | ) | 42 | (56 | ) | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Total interest expense |
(154 | ) | (7 | ) | (147 | ) | (518 | ) | (127 | ) | (391 | ) | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Net interest income |
$ | 174 | $ | 47 | $ | 127 | $ | 125 | $ | (117 | ) | $ | 242 | |||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
(1) | We calculate the change in interest income and interest expense separately for each item. The change in net interest income attributable to both volume and rates is allocated based on the relative dollar amount of each item. |
16
Our net interest income of $3.3 billion for the third quarter of 2011 increased by $174 million, or 6%, from the third quarter of 2010, driven by a 2% (18 basis points) expansion in our net interest margin to 7.39% and a 3% increase in average interest-earning assets.
| Net Interest Margin: The increase in our net interest margin in the third quarter of 2011 was primarily attributable to a reduction in our cost of funds, which was partially offset by a decline in the yield on our interest-earning assets. Our cost of funds continued to benefit from the shift in the mix of our funding to lower cost consumer and commercial banking deposits from higher cost wholesale sources. In addition, the prevailing low interest rate environment, combined with our disciplined pricing, contributed to the decrease in our average deposit interest rates. |
| Average Interest-Earning Assets: The increase in average interest-earning assets in the third quarter of 2011 was attributable to the additions of the existing HBC credit card loan portfolio of $1.4 billion in the first quarter of 2011 and the $3.7 billion Kohls credit card loan portfolio in the second quarter of 2011, coupled with growth in auto loan originations, commercial loans and revolving credit card purchase volumes. The impact of these factors more than offset the continued run-off of businesses that we exited or repositioned, including our installment, home loan and small-ticket commercial real estate loan portfolios. |
Our net interest income of $9.6 billion for the first nine months of 2011 increased by $125 million, or 1%, from the first nine months of 2010, driven by a 2% (15 basis points) expansion in our net interest margin to 7.28%, which was partially offset by a 1% decrease in average interest-earning assets.
| Net Interest Margin: The increase in our net interest margin in the first nine months of 2011 reflected the benefit from the improvement in our cost of funds, as we shifted the mix of our funding to lower cost consumer and commercial banking deposits from higher cost wholesale sources and the decline in deposit interest rates as a result of the overall interest rate environment. The decrease in yield on interest-earning assets was attributable to a reduction in late payment fees resulting from the Federal Reserve guidelines regarding reasonable fees that went into effect in the third quarter of 2010 and the addition of the Kohls portfolio. Under our partnership agreement with Kohls, we share a fixed percentage of revenues, consisting of finance charges and late fees. We report revenues related to Kohls credit card loans on a net basis in our consolidated financial statements, which has the effect of reducing the yield on our average interest-earning assets. The impact of these factors was partially offset by the run-off of lower margin installment loans, a reduced level of new accounts with low introductory promotional rates, and an increase in the recognition of billed finance charges and fees due to the improvement in credit performance as well as the change we made in the third quarter of 2011 in our estimation of non-principal recoveries used in determining our uncollectible finance charge and fee reserve. |
| Average Interest-Earning Assets: The decrease in average interest-earning assets in the first nine months of 2011 reflected the continued run-off of businesses that we exited or repositioned, including our installment, home loan and small-ticket commercial real estate loan portfolios, which more than offset the impact of modest revolving credit card loan growth and the addition of the existing HBC credit card loan portfolio of $1.4 billion in the first quarter of 2011 and the addition of the existing Kohls private-label credit card loan portfolio of $3.7 billion in the second quarter of 2011. |
Non-Interest Income
Non-interest income consists of servicing and securitizations income, service charges and other customer-related fees, interchange income (net of rewards expense) and other non-interest income. The servicing fees, finance charges, other fees, net of charge-offs and interest paid to third party investors related to our consolidated securitization trusts are reported as a component of non-interest income. We also record the provision for mortgage repurchase losses related to continuing operations in non-interest income. The other component of non-interest income includes gains and losses on derivatives not accounted for in hedge accounting relationships
17
and gains and losses from the sale of investment securities, which we generally do not allocate to our business segments because they relate to centralized asset/liability and market risk management activities undertaken by our Corporate Treasury group.
Table 5 displays the components of non-interest income for the three and nine months ended September 30, 2011 and 2010.
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
(Dollars in millions) | 2011 | 2010 | 2011 | 2010 | ||||||||||||
Servicing and securitizations |
$ | 12 | $ | 13 | $ | 35 | $ | (3 | ) | |||||||
Service charges and other customer-related fees |
542 | 496 | 1,527 | 1,577 | ||||||||||||
Interchange |
321 | 346 | 972 | 991 | ||||||||||||
Net other-than-temporary impairment |
(6 | ) | (5 | ) | (15 | ) | (62 | ) | ||||||||
Provision for mortgage repurchase losses(1) |
3 | (16 | ) | (5 | ) | (211 | ) | |||||||||
Other(2) |
(1 | ) | 73 | 156 | 483 | |||||||||||
|
|
|
|
|
|
|
|
|||||||||
Total non-interest income |
$ | 871 | $ | 907 | $ | 2,670 | $ | 2,775 | ||||||||
|
|
|
|
|
|
|
|
(1) | We recorded a total provision for mortgage repurchase losses of $72 million and $16 million for the three months ended September 30, 2011 and 2010, respectively, and $153 million and $644 million for the nine months ended September 30, 2011 and 2010, respectively. The remaining portion of the provision for repurchase losses is included in discontinued operations. |
(2) | Other for the three and nine months ended September 30, 2011 includes a gain of $239 million recognized on the sale of investment securities and a mark-to-market derivative loss of $266 million related to interest-rate swaps we entered into in August 2011 to partially hedge the interest rate risk of the net assets associated with the pending ING acquisition. |
Non-interest income of $871 million for the third quarter of 2011 decreased by $36 million, or 4%, from non-interest income of $907 million for the third quarter of 2010. The decrease in non-interest income for the third quarter of 2011 reflects the net impact of two significant items recorded during the quarter resulting from actions taken to reposition our balance sheet and manage the anticipated impact of the pending ING Direct acquisition on our market risk exposure and regulatory capital requirements.
First, in August 2011, we entered into various pay-fixed/receive-floating interest-rate swap transactions with a total notional principal amount of approximately $23.8 billion. Since the date we entered into the agreement to acquire ING Direct, interest rates have declined substantially, and our current estimate of the fair value of the ING Direct net assets and liabilities has increased correspondingly. These swap transactions are intended to capture some of the anticipated benefits to regulatory capital on the closing date attributable to this decline in interest rates and designed to mitigate the effect of a rise in interest rates on the fair values of a significant portion of the ING Direct assets and liabilities during the period from when we entered into the swap transactions to the anticipated closing date of the ING Direct acquisition in late 2011 or early 2012. Although the interest-rate swaps represent economic hedges, they are not designated for hedge accounting. Accordingly, changes in the fair value are recorded in earnings. We recognized a mark-to-market loss of $266 million on these interest-rate swaps in the third quarter of 2011, which was attributable to the decline in interest rates as of the end of the quarter. Changes in the fair value of these interest-rate swaps will continue to be recorded in earnings until the swaps are terminated.
Second, we sold approximately $6.4 billion of investment securities, consisting predominantly of agency MBS, during the third quarter of 2011. We recorded a gain of $239 million on the sale of these securities. The combined impact of the mark-to-market derivative loss and the gain on the sale of investment securities accounted for $27 million of the reduction in non-interest income in the third quarter of 2011.
18
Non-interest income of $2.7 billion for the first nine months of 2011 decreased by $105 million, or 4%, from non-interest income of $2.8 billion for the first nine months of 2010. This decrease was primarily due to the absence of a one-time pre-tax gain of $128 million recorded in the first quarter of 2010 and net gains on the sale of securities in 2010.
We provide additional information on the reserve for representation and warranty claims below in Consolidated Balance Sheet Analysis and Credit PerformancePotential Mortgage Representation and Warranty Liabilities.
Provision for Loan and Lease Losses
We build our allowance for loan and lease losses through the provision for loan and lease losses. Our provision for loan and lease losses in each period is driven by charge-offs and the level of allowance for loan and lease losses that we determine is necessary to provide for probable credit losses inherent in our loan portfolio as of each balance sheet date. Our provision for loan and lease losses declined by $245 million to $622 million in the third quarter of 2011 and by $1.6 billion in the first nine months of 2011 to $ 1.5 billion, relative to the same prior year periods. The decrease in the provision was largely driven by a substantial decline in net charge-offs across all of our business segments, reflecting the improvement in the credit performance of our loan portfolio. The net charge-off rate was 2.52% and 3.02% for the third quarter and first nine months of 2011, respectively, compared with 4.82% and 5.41% for the third quarter and first nine months of 2010, respectively. As charge-offs declined, we recorded an allowance release of $208 million and $1.3 billion in the third quarter and first nine months of 2011, respectively. Our allowance releases have been significantly lower in 2011 relative to 2010, reflecting a stabilization of the improvement in credit trends.
See Consolidated Balance Sheet Analysis and Credit PerformanceAllowance for Loan and Lease Losses for a discussion of changes in our allowance for loan and lease losses and details of our provision for loan and lease losses and charge-offs by loan category for the three and nine months ended September 30, 2011 and 2010.
Non-Interest Expense
Non-interest expense consists of ongoing operating costs, such as salaries and associated employee benefits, communications and other technology expenses, supplies and equipment, occupancy costs and miscellaneous expenses. Marketing expenses also are included in non-interest expense. Table 6 displays the components of non-interest expense for the three and nine months ended September 30, 2011 and 2010.
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
(Dollars in millions) | 2011 | 2010 | 2011 | 2010 | ||||||||||||
Salaries and associated benefits |
$ | 750 | $ | 641 | $ | 2,206 | $ | 1,937 | ||||||||
Marketing |
312 | 250 | 917 | 650 | ||||||||||||
Communications and data processing |
178 | 178 | 504 | 512 | ||||||||||||
Supplies and equipment |
143 | 129 | 402 | 381 | ||||||||||||
Occupancy |
122 | 135 | 359 | 371 | ||||||||||||
Other(1) |
792 | 663 | 2,326 | 1,992 | ||||||||||||
|
|
|
|
|
|
|
|
|||||||||
Total non-interest expense |
$ | 2,297 | $ | 1,996 | $ | 6,714 | $ | 5,843 | ||||||||
|
|
|
|
|
|
|
|
(1) | Consists of professional services expenses, credit collection costs, fee assessments and intangible amortization expense. |
Non-interest expense of $2.3 billion for the third quarter of 2011 was up $301 million, or 15%, from the third quarter of 2010. Non-interest expense of $6.7 billion for the first nine months of 2011 was up $871 million, or 15%, from the first nine months of 2010. The increase reflects the recognition of expense of $60 million and $90 million in the third quarter and first nine months of 2011, respectively, for contingent payments related to
19
acquisitions and partnership agreements. In addition, our operating costs have increased due in part to the integration of the recent acquisitions of the Sony, HBC and Kohls loan portfolios, as well as higher marketing costs. We have expanded our marketing efforts to attract and support targeted customers and new business volume through a variety of channels. We provide additional information on contingent payment arrangements in Note 15Commitments, Contingencies and Guarantees.
Income Taxes
We recorded an income tax provision based on income from continuing operations of $370 million (30.0% effective income tax rate) in the third quarter of 2011, compared with an income tax provision of $335 million (29.1 % effective income tax rate) in the third quarter of 2010, and $1.2 billion (29.2% effective income tax rate) for the first nine months of 2011, compared with $948 million (28.8% effective income tax rate) for the first nine months of 2010.
We recorded tax benefits of $98 million in the first nine months of 2011, which were related to the release of a valuation allowance against certain state deferred tax assets and net operating loss carryforwards and the resolution of certain tax issues and audits. We monitor the status of our deferred tax assets on a regular basis. The release of the deferred tax valuation allowance reflects our projected ability to utilize the deferred tax assets to offset future taxable income based on our achieving sustained profitability in certain tax jurisdictions. We recorded tax benefits of $71 million in the first nine months of 2010, which were related to adjustments for the resolution of certain tax issues and audits.
Our effective income tax rate excluding the benefit from these discrete tax benefit items was 31.7% and 30.9% for the first nine months of 2011 and 2010, respectively. The higher effective income tax rate for the first nine months of 2011 was primarily attributable to the recognition of expense for non-deductible contingent payments related to certain acquisitions.
We provide additional information on items affecting our income taxes and effective tax rate in our 2010 Form 10-K under Note 18Income Taxes.
Loss from Discontinued Operations, Net of Tax
Loss from discontinued operations reflects ongoing costs, which primarily consist of mortgage loan repurchase representation and warranty charges, related to the mortgage origination operations of GreenPoints wholesale mortgage banking unit, which we closed in 2007. We recorded a loss from discontinued operations, net of tax, of $52 million and $102 million in the third quarter and first nine months of 2011, respectively. In comparison, we recorded a loss from discontinued operations, net of tax, of $15 million and $303 million in the third quarter and first nine months of 2010, respectively.
The increase in the loss from discontinued operations in the third quarter of 2011 was attributable to the recognition of an additional provision for mortgage repurchase losses due to an increase in repurchase activity with respect to certain uninsured investors. The decrease in the loss from discontinued operations in the first nine months of 2011 was attributable to a significant reduction in the provision for mortgage repurchase losses. We provide information on our reserve for representation and warranty claims in Consolidated Balance Sheet Analysis and Credit PerformancePotential Mortgage Representation and Warranty Liabilities.
BUSINESS SEGMENT FINANCIAL PERFORMANCE
Our principal operations are currently organized into three major business segments, which are defined based on the products and services provided or the type of customer served: Credit Card, Consumer Banking and Commercial Banking. The operations of acquired businesses have been integrated into our existing business segments.
20
The results of our individual businesses, which we report on a continuing operations basis, reflect the manner in which management evaluates performance and makes decisions about funding our operations and allocating resources. Our business segment results are intended to reflect each segment as if it were a stand-alone business. We use an internal management and reporting process to derive our business segment results. Our internal management and reporting process employs various allocation methodologies, including funds transfer pricing, to assign certain balance sheet assets, deposits and other liabilities and their related revenue and expenses directly or indirectly attributable to each business segment. We may periodically change our business segments or reclassify business segment results based on modifications to our management reporting methodologies and changes in organizational alignment. Certain activities that are not part of a segment, such as management of our corporate investment portfolio and asset/liability management by our centralized Corporate Treasury group are included in the Other category. See Note 20Business Segments of our 2010 Form 10-K for information on the allocation methodologies used to derive our business segment results.
We summarize our business segment results for the three and nine months ended September 30, 2011 and 2010 in the tables below and provide a comparative discussion of these results. We also discuss changes in our financial condition and credit performance statistics as of September 30, 2011, compared with December 31, 2010. See Note 14Business Segments of this Report for a reconciliation of our business segment results to our consolidated U.S. GAAP results. Information on the outlook for each of our business segments is presented above under Executive Summary and Business Outlook.
Credit Card Business
Our Credit Card business generated net income from continuing operations of $663 million and $1.9 billion in the third quarter and first nine months of 2011, respectively, compared with net income from continuing operations of $631 million and $1.7 billion in the third quarter and first nine months of 2010, respectively. The primary sources of revenue for our Credit Card business are net interest income and non-interest income from customer and interchange fees. Expenses primarily consist of ongoing operating costs, such as salaries and associated benefits, communications and other technology expenses, supplies and equipment, occupancy costs and marketing expenses.
Table 7 summarizes the financial results of our Credit Card business, which is comprised of the Domestic Card and International Card operations, and displays selected key metrics for the periods indicated. Our Credit Card business results for 2011 reflect the impact of the acquisitions of the existing portfolio credit card loan portfolios of Kohls and HBC. The results related to the Kohls loan portfolio, which totaled approximately $3.7 billion at acquisition on April 1, 2011, are included in our Domestic Card business. The results related to the HBC loan portfolio, which totaled approximately $1.4 billion at acquisition on January 7, 2011, are included in our International Card business.
Under the terms of the partnership agreement with Kohls, we share a fixed percentage of revenues, consisting of finance charges and late fees, with Kohls, and Kohls is required to reimburse us for a fixed percentage of credit losses incurred. Revenues and losses related to the Kohls credit card program are reported on a net basis in our consolidated financial statements. The revenue sharing amounts earned by Kohls are reflected as an offset against our revenues in our consolidated statements of income, which has the effect of reducing our net interest income and revenue margins. The loss sharing amounts from Kohls are reflected as a reduction in our provision for loan and lease losses in our consolidated statements of income. We also report the related allowance for loan and lease losses attributable to the Kohls portfolio in our consolidated balance sheets net of the loss sharing amount due from Kohls.
Interest income was reduced by $206 million and $421 million in the third quarter and first nine months of 2011, respectively, for amounts earned by Kohls. Loss sharing amounts attributable to Kohls reduced charge-offs by $39 million and $80 million in the third quarter and first nine months of 2011, respectively. In addition, the
21
expected reimbursement from Kohls netted in our allowance for loan and lease losses was approximately $156 million as of September 30, 2011. The reduction in the provision for loan and lease losses attributable to Kohls was $236 million for the first nine months of 2011.
We provide additional information on the acquisition of the existing credit card loan portfolios of Kohls and HBC in Note 2Acquisitions.
Table 7: Credit Card Business Results
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||||||
(Dollars in millions) | 2011 | 2010 |
Change | 2011 | 2010 | Change | ||||||||||||||||||
Selected income statement data: |
||||||||||||||||||||||||
Net interest income |
$ | 2,042 | $ | 1,934 | 6 | % | $ | 5,873 | $ | 6,024 | (3 | )% | ||||||||||||
Non-interest income |
678 | 671 | 1 | 1,971 | 2,048 | (4 | ) | |||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Total revenue |
2,720 | 2,605 | 4 | 7,844 | 8,072 | (3 | ) | |||||||||||||||||
Provision for loan and lease losses |
511 | 660 | (23 | ) | 1,270 | 2,600 | (51 | ) | ||||||||||||||||
Non-interest expense |
1,188 | 978 | 21 | 3,604 | 2,894 | 25 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Income from continuing operations before income taxes |
1,021 | 967 | 6 | 2,970 | 2,578 | 15 | ||||||||||||||||||
Income tax provision |
358 | 336 | 7 | 1,046 | 890 | 18 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Income from continuing operations, net of tax |
$ | 663 | $ | 631 | 5 | % | $ | 1,924 | $ | 1,688 | 14 | % | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Selected performance metrics: |
||||||||||||||||||||||||
Average loans held for investment |
$ | 62,371 | $ | 61,391 | 2 | % | $ | 61,889 | $ | 63,314 | (2 | )% | ||||||||||||
Average yield on loans held for investment(1) |
14.84 | % | 14.65 | % | 19 | bps | 14.45 | % | 14.74 | % | (29 | )bps | ||||||||||||
Revenue margin(2) |
17.44 | 16.97 | 47 | 16.90 | 17.00 | (10 | ) | |||||||||||||||||
Net charge-off rate(3) |
4.23 | 8.16 | (393 | ) | 5.13 | 9.30 | (417 | ) | ||||||||||||||||
Purchase volume(4) |
$ | 34,918 | $ | 27,039 | 29 | % | $ | 96,941 | $ | 77,533 | 25 | % | ||||||||||||
September 30, 2011 |
December 31, 2010 |
Change | ||||||||||||||||||||||
Selected period-end data: |
||||||||||||||||||||||||
Loans held for investment |
$ | 62,030 | $ | 61,371 | 1 | % | ||||||||||||||||||
30+ day delinquency rate(5) |
3.87 | % | 4.29 | % | (42 | )bps | ||||||||||||||||||
Allowance for loan and lease losses |
$ | 2,915 | $ | 4,041 | (28 | )% |
(1) | Average yield on loans held for investment is calculated by dividing annualized interest income for the period by average loans held for investment during the period. In preparing our Report on Form 10-Q for the first quarter of 2011, we determined that beginning in the second quarter of 2010, our management accounting processes excluded certain accounts that should have been included in the calculation of the average yield on loans held for investment. The mapping error was limited to the average yields on loans held for investment for our Credit Card business and had no impact on income statement amounts or the yields reported for any of our other business segments or for the total company. The previously reported average loan yield for our Credit Card business was 14.27% and 14.48% for the three and nine months ended September 30, 2010, respectively. |
(2) | Revenue margin is calculated by dividing annualized revenues for the period by average loans held for investment during the period for the specified loan category. |
(3) | The net charge-off rate is calculated by loan category by dividing annualized net charge-offs for the period by average loans held for investment during the period for the specified loan category. |
(4) | Consists of purchase transactions for the period, net of returns. Excludes cash advance transactions. |
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(5) | The delinquency rate is calculated by loan category by dividing 30+ day delinquent loans as of the end of the period by period-end loans held for investment for the specified loan category. The 30+ day performing delinquency rate is the same as the 30+ day delinquency rate for our Credit Card business, as credit card loans remain on accrual status until the loan is charged-off. |
Key factors affecting the results of our Credit Card business for the third quarter and first nine months of 2011, compared with the third quarter and first nine months of 2010 included the following:
| Net Interest Income: Net interest income increased by $108 million, or 6%, in the third quarter of 2011, due in part to a 2% increase in average loan balances coupled with an increase in the average yield on loans held for investment. The growth in average loan balances reflect the additions of the HBC and Kohls portfolios, which were partially offset by the continued expected run-off of the installment loan portfolio. The average yield for the third quarter of 2011 reflects the benefit from a revision we made in the third quarter of 2011 in estimating non-principal recoveries to determine the uncollectible finance charge and fee reserve, which we discuss above in Critical Accounting Policies and Estimates. This revision accounted for approximately $83 million of the increase in net interest income. Net interest income decreased by $151 million, or 3%, in the first nine months of 2011, reflecting the impact of a 2% decline in average loan balances. The expected run-off of the installment loan portfolio was the primary driver of the decline in average loan balances in the first nine months of 2011, more than offsetting modest revolving card loan growth and the additions of the HBC and Kohls portfolios. The decrease in the average loan yields in the first nine months of 2011 reflects the impact of the Kohls revenue-sharing agreement. |
| Non-Interest Income: Non-interest income was relatively stable in the third quarter of 2011, compared with the third quarter of 2010. Non-interest income, however, decreased by $77 million, or 4%, in the first nine months of 2011. The decrease in the first nine months of 2011 reflects the impact of contra-revenue amounts recorded in the second quarter of 2011, including a provision of $52 million for anticipated refunds to U.K. customers related to retrospective regulatory requirements pertaining to payment protection insurance (PPI) in our U.K. business and the recognition of expense of $21 million related to the periodic adjustment of our customer rewards points liability to reflect the estimated cost of points earned to date that are ultimately expected to be redeemed. These decreases were partially offset by higher interchange fees during the first nine months of 2011, attributable to increased purchase volume from our higher spend customer segments. |
| Provision for Loan and Lease Losses: The provision for loan and lease losses related to our Credit Card business decreased by $149 million in the third quarter of 2011, to $511 million and by $1.3 billion in the first nine months of 2011, to $1.3 billion. The significant reduction in the provision was primarily attributable to the continued improvement in credit performance, including reduced delinquency rates, lower bankruptcy losses and higher recoveries. As a result of the reduction in charge-offs and improvement in the net charge-off rate, we recorded an allowance release for the Credit Card business of $178 million and $1.1 billion in the third quarter and first nine months of 2011, respectively. |
| Non-Interest Expense: Non-interest expense increased by $210 million, or 21%, in the third quarter of 2011 and $710 million, or 25%, in the first nine months of 2011. The increase was attributable to increased operating and integration costs related to the acquisitions of the credit card loan portfolios of Sony, HBC and Kohls, coupled with increased marketing expenditures. We have expanded our marketing efforts to drive new business volume through a variety of channels. |
| Total Loans: Period-end loans in our Credit Card business increased by $659 million, or 1%, in the first nine months of 2011, to $62.0 billion as of September 30, 2011, from $61.4 billion as of December 31, 2010. The increase was primarily attributable to the acquisitions of the Kohls credit card portfolio of $3.7 billion and the HBC credit card portfolio of $1.4 billion, which were partially offset by the continued run-off of the installment loan portfolio and seasonal paydowns from year-end levels. |
| Charge-off and Delinquency Statistics: Net charge-off and delinquency rates continued to improve in the third quarter and first nine months of 2011. The net charge-off rate decreased to 4.23% and 5.13% in the |
23
third quarter and first nine months of 2011, respectively, from 8.16% and 9.30% in the third quarter and first nine months of 2010, respectively. The 30+ day delinquency rate decreased to 3.87% as of September 30, 2011, from 4.29% as of December 31, 2010. The improvement in the net charge-off and delinquency rates reflects the impact of improved credit quality across our credit card portfolio, tighter underwriting standards implemented over the last several years, and ongoing normalization of credit performance in the portfolio. |
Domestic Credit Card Business
Table 7.1 summarizes the financial results for Domestic Card and displays selected key metrics for the periods indicated. Domestic Card accounted for 86% of total revenues for our Credit Card business in both the third quarter and first nine months of 2011, compared with 87% in both the third quarter and first nine months of 2010. Because our Domestic Card business currently accounts for the substantial majority of our Credit Card business, the key factors driving the results for this division are similar to the key factors affecting our total Credit Card business.
Table 7.1: Domestic Card Business Results
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||||||
(Dollars in millions) | 2011 | 2010 | Change | 2011 | 2010 | Change | ||||||||||||||||||
Selected income statement data: |
||||||||||||||||||||||||
Net interest income |
$ | 1,753 | $ | 1,691 | 4 | % | $ | 5,011 | $ | 5,291 | (5 | )% | ||||||||||||
Non-interest income |
588 | 575 | 2 | 1,755 | 1,753 | ** | ||||||||||||||||||
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Total revenue |
2,341 | 2,266 | 3 | 6,766 | 7,044 | (4 | ) | |||||||||||||||||
Provision for loan and lease losses |
381 | 577 | (34 | ) | 798 | 2,348 | (66 | ) | ||||||||||||||||
Non-interest expense |
972 | 844 | 15 | 2,970 | 2,522 | 18 | ||||||||||||||||||
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Income from continuing operations before income taxes |
988 | 845 | 17 | 2,998 | 2,174 | 38 | ||||||||||||||||||
Income tax provision |
351 | 301 | 17 | 1,065 | 775 | 37 | ||||||||||||||||||
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Income from continuing operations, net of tax |
$ | 637 | $ | 544 | 17 | % | $ | 1,933 | $ | 1,399 | 38 | % | ||||||||||||
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Selected performance metrics: |
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Average loans held for investment |
$ | 53,668 | $ | 54,049 | (1 | )% | $ | 53,148 | $ | 55,788 | (5 | )% | ||||||||||||
Average yield on loans held for investment(1) |
14.62 | % | 14.40 | % | 22 | bps | 14.18 | % | 14.57 | % | (39 | )bps | ||||||||||||
Revenue margin(2) |
17.45 | 16.77 | 68 | 16.97 | 16.84 | 13 | ||||||||||||||||||
Net charge-off rate(3) |
3.92 | 8.23 | (431 | ) | 4.94 | 9.43 | (449 | ) | ||||||||||||||||
Purchase volume(4) |
$ | 31,686 | $ | 24,858 | 27 | % | $ | 87,780 | $ | 71,359 | 23 | % | ||||||||||||
September 30, 2011 |
December 31, 2010 |
Change | ||||||||||||||||||||||
Selected period-end data: |
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Loans held for investment |
$ | 53,820 | $ | 53,849 | ** | % | ||||||||||||||||||
30+ day delinquency rate(5) |
3.65 | % | 4.09 | % | (44 | )bps | ||||||||||||||||||
Allowance for loan and lease losses |
$ | 2,409 | $ | 3,581 | (33 | )% |
** | Change is less than one percent. |
(1) | Average yield on loans held for investment is calculated by dividing annualized interest income for the period by average loans held for investment during the period. As indicated above, in preparing our Report on Form 10-Q for the first quarter of 2011, we determined that beginning in the second quarter of 2010, our management accounting processes excluded certain accounts that affected the calculation of the average yield on loans held for investment for our Credit Card business. The previously reported average loan yield for our Domestic Credit Card business was 13.95% and 14.25% for three and nine months ended September 30, 2010, respectively. |
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(2) | Revenue margin is calculated by dividing annualized revenues for the period by average loans held for investment during the period for the specified loan category. |
(3) | The net charge-off rate is calculated by loan category by dividing annualized net charge-offs for the period by average loans held for investment during the period for the specified loan category. |
(4) | Consists of purchase transactions for the period, net of returns. Excludes cash advance transactions. |
(5) | The delinquency rate is calculated by loan category by dividing 30+ day delinquent loans as of the end of the period by period-end loans held for investment for the specified loan category. The 30+ day performing delinquency rate is the same as the 30+ day delinquency rate for our Credit Card business, as credit card loans remain on accrual status until the loan is charged-off. The September 30, 2011 30+ day delinquency rate for Domestic Card reflects the impact of a revision in the way we estimate recoveries in determining the uncollectible amount of finance charges and fees, which resulted in an increase of 11 basis points as of September 30, 2011. See Critical Accounting Policies and Estimates above for additional information. |
Domestic Card generated net income from continuing operations of $637 million and $1.9 billion in the third quarter and first nine months of 2011, respectively, compared with net income from continuing operations of $544 million and $1.4 billion in the third quarter and first nine months of 2010, respectively.
The increase in Domestic Card net income from continuing operations in the third quarter of 2011, compared with the third quarter of 2010 was driven by: (1) an increase in total revenue attributable to a benefit of approximately $78 million in the third quarter of 2011 from the revision we made in the way we estimate recoveries in determining the uncollectible amount of finance charges and fees; (2) a significant reduction in the provision for loan and lease losses due to the improvement in credit performance metrics, including decreases in delinquency and charge-off rates; and (3) an increase in non-interest expense attributable to higher operating and integration costs related to the acquisitions of the credit card loan portfolios of Sony and Kohls, coupled with increased marketing expenditures.
The increase in Domestic Card net income from continuing operations in the first nine months of 2011, compared with the first nine months of 2010 was driven by: (1) a decline in total revenue attributable to lower average loan balances and a decrease in average loan yields as a result of reduced fees and the impact of the addition of the Kohls loan portfolio; (2) a significant reduction in the provision for loan and lease losses due to the improvement in credit performance metrics, including decreases in delinquency and charge-off rates; and (3) an increase in non-interest expense attributable to increased operating costs associated with higher purchase volumes and higher legal expenses and increased marketing expenditures.
International Credit Card Business
Table 7.2 summarizes the financial results for International Card and displays selected key metrics for the periods indicated. International Card accounted for 14% of total revenues for our Credit Card business in the third quarter and first nine months of 2011, compared with 13% in both the third quarter and first nine months of 2010.
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Table 7.2: International Card Business Results
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||||||
(Dollars in millions) | 2011 | 2010 | Change | 2011 | 2010 | Change | ||||||||||||||||||
Selected income statement data: |
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Net interest income |
$ | 289 | $ | 243 | 19 | % | $ | 862 | $ | 733 | 18 | % | ||||||||||||
Non-interest income |
90 | 96 | (6 | ) | 216 | 295 | (27 | ) | ||||||||||||||||
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Total revenue |
379 | 339 | 12 | 1,078 | 1,028 | 5 | ||||||||||||||||||
Provision for loan and lease losses |
130 | 83 | 57 | 472 | 252 | 87 | ||||||||||||||||||
Non-interest expense |
216 | 134 | 61 | 634 | 372 | 70 | ||||||||||||||||||
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Income from continuing operations before income taxes |
33 | 122 | (73 | ) | (28 | ) | 404 | (107 | ) | |||||||||||||||
Income tax provision |
7 | 35 | (80 | ) | (19 | ) | 115 | (117 | ) | |||||||||||||||
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Income from continuing operations, net of tax |
$ | 26 | $ | 87 | (70 | )% | $ | (9 | ) | $ | 289 | (103 | )% | |||||||||||
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Selected performance metrics: |
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Average loans held for investment |
$ | 8,703 | $ | 7,342 | 19 | % | $ | 8,741 | $ | 7,526 | 16 | % | ||||||||||||
Average yield on loans held for investment(1) |
16.24 | % | 16.40 | % | (16 | )bps | 16.09 | % | 16.02 | % | 7 | bps | ||||||||||||
Revenue margin(2) |
17.42 | 18.47 | (105 | ) | 16.44 | 18.21 | (177 | ) | ||||||||||||||||
Net charge-off rate(3) |
6.15 | 7.60 | (145 | ) | 6.31 | 8.28 | (197 | ) | ||||||||||||||||
Purchase volume(4) |
$ | 3,232 | $ | 2,181 | 48 | % | $ | 9,161 | $ | 6,174 | 48 | % | ||||||||||||
Selected period-end data: |
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September 30, 2011 |
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December 31, 2010 |
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Change | |||||||||||||||||
Loans held for investment |
$ | 8,210 | $ | 7,522 | 9 | % | ||||||||||||||||||
30+ day delinquency rate(5) |
5.35 | % | 5.75 | % | (40 | )bps | ||||||||||||||||||
Allowance for loan and lease losses |
$ | 506 | $ | 460 | 10 | % |
(1) | Average yield on loans held for investment is calculated by dividing annualized interest income for the period by average loans held for investment during the period. As indicated above, in preparing our Report on Form 10-Q for the first quarter of 2011, we determined that beginning in the second quarter of 2010, our management accounting processes excluded certain accounts that affected the calculation of the average yield on loans held for investment for our Credit Card business. The previously reported average loan yield for our International Credit Card business was 16.62% and 16.16% for the three and nine months ended September 30, 2010, respectively. |
(2) | Revenue margin is calculated by dividing annualized revenues for the period by average loans held for investment during the period for the specified loan category. |
(3) | The net charge-off rate is calculated by loan category by dividing annualized net charge-offs for the period by average loans held for investment during the period for the specified loan category. |
(4) | Consists of purchase transactions for the period, net of returns. Excludes cash advance transactions. |
(5) | The delinquency rate is calculated by loan category by dividing delinquent loans as of the end of the period by period-end loans held for investment for the specified loan category. The 30+ day performing delinquency rate is the same as the 30+ day delinquency rate for our Credit Card business, as credit card loans remain on accrual status until the loan is charged-off. |
Our International Card division generated net income from continuing operations of $26 million in the third quarter of 2011 and a net loss of $9 million in the first nine months of 2011, compared with net income from continuing operations of $87 million and $289 million in the third quarter and first nine months of 2010, respectively.
The decrease in International Card net income from continuing operations in the third quarter of 2011, compared with the third quarter of 2010 was driven by: (1) an increase in the provision for loan losses due to the addition of
26
the HBC loan portfolio and lower allowance releases relative to the same prior year periods and (2) an increase in non-interest expense attributable to increased operating costs associated with HBC associates who joined us as a result of the acquisition. These factors were partially offset by an increase in non-interest income attributable to higher loan balances.
The International Card net loss from continuing operations in the first nine months of 2011, compared with net income in the first nine months of 2010 was driven by: (1) a decrease in non-interest income due to the contra-revenue provision of $52 million recorded in the second quarter of 2011 for the anticipated refunds to U.K. customers related to retrospective regulatory requirements pertaining to PPI insurance in our U.K. business; (2) an increase in the provision for loan losses due to the addition of the HBC loan portfolio and lower allowance releases relative to the same prior year periods; and (3) an increase in non-interest expense attributable to increased operating costs associated with HBC associates who joined us as a result of the acquisition. These factors were partially offset by an increase in interest income attributable to higher loan balances.
Consumer Banking Business
Our Consumer Banking business generated net income from continuing operations of $190 million and $692 million in the third quarter and first nine months of 2011, respectively, compared with $175 million and $785 million in the third quarter and first nine months of 2010, respectively. The primary sources of revenue for our Consumer Banking business are net interest income from loans and deposits and non-interest income from customer fees. Expenses primarily consist of ongoing operating costs, such as salaries and associated benefits, communications and other technology expenses, supplies and equipment and occupancy costs.
Table 8 summarizes the financial results of our Consumer Banking business and displays selected key metrics for the periods indicated.
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Table 8: Consumer Banking Business Results
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||||||
(Dollars in millions) | 2011 | 2010 | Change | 2011 | 2010 | Change | ||||||||||||||||||
Selected income statement data: |
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Net interest income |
$ | 1,097 | $ | 946 | 16 | % | $ | 3,131 | $ | 2,777 | 13 | % | ||||||||||||
Non-interest income |
188 | 196 | (4 | ) | 568 | 674 | (16 | ) | ||||||||||||||||
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Total revenue |
1,285 | 1,142 | 13 | 3,699 | 3,451 | 7 | ||||||||||||||||||
Provision for loan and lease losses |
136 | 114 | 19 | 272 | 52 | 423 | ||||||||||||||||||
Non-interest expense |
853 | 757 | 13 | 2,351 | 2,180 | 8 | ||||||||||||||||||
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Income from continuing operations before income taxes |
296 | 271 | 9 | 1,076 | 1,219 | (12 | ) | |||||||||||||||||
Income tax provision |
106 | 96 | 10 | 384 | 434 | (12 | ) | |||||||||||||||||
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Income from continuing operations, net of tax |
$ | 190 | $ | 175 | 9 | % | $ | 692 | $ | 785 | (12 | )% | ||||||||||||
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Selected performance metrics: |
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Average loans held for investment: |
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Auto |
$ | 19,757 | $ | 17,397 | 14 | % | $ | 18,851 | $ | 17,479 | 8 | % | ||||||||||||
Home loan |
11,126 | 13,024 | (15 | ) | 11,537 | 14,002 | (18 | ) | ||||||||||||||||
Retail banking |
3,979 | 4,669 | (15 | ) | 4,127 | 4,840 | (15 | ) | ||||||||||||||||
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Total consumer banking |
$ | 34,862 | $ | 35,090 | (1 | )% | $ | 34,515 | $ | 36,321 | (5 | )% | ||||||||||||
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Average yield on loans held for investment |
9.83 | % | 9.28 | % | 55 | bps | 9.65 | % | 9.07 | % | 58 | bps | ||||||||||||
Average deposits |
$ | 88,266 | $ | 78,224 | 13 | % | $ | 86,375 | $ | 76,818 | 12 | % | ||||||||||||
Average interest rate on deposits |
0.95 | % | 1.18 | % | (23 | )bps | 0.98 | % | 1.21 | % | (23 | )bps | ||||||||||||
Core deposit intangible amortization |
$ | 32 | $ | 36 | (11 | )% | $ | 100 | $ | 110 | (9 | )% | ||||||||||||
Net charge-off rate(1)(2) |
1.32 | % | 1.79 | % | (47 | )bps | 1.30 | % | 1.77 | % | (47 | )bps | ||||||||||||
Automobile loan originations |
$ | 3,409 | $ | 2,439 | 40 | % | $ | 8,890 | $ | 5,547 | 60 | % |
Selected period-end data: |
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September 30, 2011 |
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December 31, 2010 |
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Change | |||||||||||
Loans held for investment: |
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Auto |
$ | 20,422 | $ | 17,867 | 14 | % | ||||||||||||
Home loan |
10,916 | 12,103 | (10 | ) | ||||||||||||||
Retail banking |
4,014 | 4,413 | (9 | ) | ||||||||||||||
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Total consumer banking |
$ | 35,352 | $ | 34,383 | 3 | % | ||||||||||||
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30+ day performing delinquency rate(1)(3) |
4.01 | % | 4.28 | % | (27 | )bps | ||||||||||||
30+ day delinquency rate(1)(3) |
5.57 | 5.96 | (29 | ) | ||||||||||||||
Nonperforming loan rate(1)(4) |
1.88 | 1.97 | (9 | ) | ||||||||||||||
Nonperforming asset rate(1)(5) |
2.04 | 2.17 | (13 | ) | ||||||||||||||
Allowance for loan and lease losses |
$ | 620 | $ | 675 | (8 | )% | ||||||||||||
Deposits |
88,589 | 82,959 | 7 | |||||||||||||||
Loans serviced for others |
18,624 | 20,689 | (10 | ) |
(1) | Average loans held for investment used in the denominator in calculating net charge-off, delinquency and nonperforming loan and nonperforming asset rates includes the impact of loans acquired as part of the Chevy Chase Bank acquisition, which were considered purchased credit-impaired (PCI) loans. However, we separately track and report PCI loans and exclude these loans from our net charge-off, delinquency, nonperforming loan and nonperforming asset rates. |
28
(2) | The net charge-off rate is calculated by loan category by dividing annualized net charge-offs for the period by average loans held for investment during the period for the specified loan category. The net charge-off rate, excluding loans acquired from Chevy Chase Bank from the denominator, was 1.51% and 2.11% for the three months ended September 30, 2011 and 2010, respectively, and 1.50% and 2.10% for the nine months ended September 30, 2011 and 2010, respectively. |
(3) | The delinquency rate is calculated by loan category by dividing delinquent loans as of the end of the period by period-end loans held for investment for the specified loan category. The 30+ day performing delinquency rate, excluding loans acquired from Chevy Chase Bank from the denominator, was 4.57% as of September 30, 2011 and 5.01% as of December 31, 2010. The 30+ day delinquency rate, excluding loans acquired from Chevy Chase Bank from the denominator, was 6.36% as of September 30, 2011 and 6.98% as of December 31, 2010. |
(4) | Nonperforming loans generally include loans that have been placed on nonaccrual status and certain restructured loans whose contractual terms have been restructured in a manner that grants a concession to a borrower experiencing financial difficulty. The nonperforming loan rate is calculated by loan category by dividing nonperforming loans as of the end of the period by period-end loans held for investment for the specified loan category. The nonperforming loan rate, excluding the impact of loans acquired from Chevy Chase Bank from the denominator, was 2.15% and 2.30% as of September 30, 2011 and December 31, 2010, respectively. |
(5) | Nonperforming assets consist of nonperforming loans and real estate owned (REO). The nonperforming asset rate is calculated by loan category by dividing nonperforming assets as of the end of the period by period-end loans held for investment and REO for the specified loan category. The nonperforming asset rate, excluding loans acquired from Chevy Chase Bank from the denominator, was 2.33% and 2.54% as of September 30, 2011 and December 31, 2010, respectively. |
Key factors affecting the results of our Consumer Banking business for the third quarter and first nine months of 2011, compared with the third quarter and first nine months of 2010 included the following:
| Net Interest Income: Net interest income increased by $151 million, or 16%, in the third quarter of 2011, and $354 million, or 13%, in the first nine months of 2011. The primary drivers of the increase in net interest income were improved loan margins attributable to an increase in average loan yields, coupled with a decrease in the cost of funds. The increase in loan yields reflects the shift in product mix as we replace the legacy home loan run-off with higher yielding auto loans. The decrease in the cost of funds reflects reduced deposit interest rates due to the prevailing low interest rate environment, combined with our disciplined pricing. Although average deposit rates have declined, we experienced strong deposit growth. |
| Non-Interest Income: Non-interest income decreased by $8 million, or 4%, in the third quarter of 2011 and decreased by $106 million, or 16%, in the first nine months of 2011. The decrease in non-interest income in the first nine months of 2011 from the same prior year period was primarily attributable to the combined impact of the absence of a net gain of $128 million recorded in the first quarter of 2010 related to the deconsolidation of certain option-adjustable rate mortgage trusts that were consolidated on January 1, 2010 as a result of our adoption of the new consolidation accounting standards and the absence of the impairment charge on mortgage servicing rights recorded in the second quarter of 2010. |
| Provision for Loan and Lease Losses: The provision for loan and lease losses increased by $22 million in the third quarter of 2011 to $136 million, and by $220 million in the first nine months of 2011 to $272 million. Although we experienced continued improvement in credit performance in our Consumer Banking business, including reduced delinquency and net charge-off rates, we recorded a higher provision for loan and lease losses in the third quarter and first nine months of 2011 relative to the same prior year periods due to the absence of significant allowance releases that we experienced in 2010, growth in our auto loan portfolio and an increase in the allowance for home equity loans we acquired from Chevy Chase Bank. |
| Non-Interest Expense: Non-interest expense increased by $96 million, or 13%, in the third quarter and by $171 million, or 8%, in the first nine months of 2011. The increases over the same prior year periods were largely attributable to the recognition of expense for contingent payments related to recent acquisitions, higher infrastructure expenditures resulting from investments in our mortgage business and growth in auto originations. |
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| Total Loans: Period-end loans in the Consumer Banking business increased by $969 million, or 3%, in the first nine months of 2011 to $35.4 billion as of September 30, 2011, from $34.4 billion as of December 31, 2010, primarily due to growth in auto loans that was partially offset by the continued run-off of our legacy home loan portfolios. |
| Deposits: Period-end deposits in the Consumer Banking business increased by $5.6 billion, or 7%, in the first nine months of 2011 to $88.6 billion as of September 30, 2011, reflecting the impact of our strategy to replace maturing higher cost wholesale funding sources with lower cost funding sources and our continued retail marketing efforts to attract new business to meet this objective. |
| Charge-off and Delinquency Statistics: The net charge-off rate decreased to 1.32% and 1.30% in the third quarter and first nine months of 2011, respectively, from 1.79% and 1.77% in the third quarter and first nine months of 2010, respectively. The 30+ day delinquency rate was 5.57% as of September 30, 2011, compared with 5.96% as of December 31, 2010. The improvement in the net charge-off and delinquency rates reflects the impact from strong underlying credit performance trends and the higher credit quality of our more recent auto loan vintages, as well as current favorable benefits from elevated auction prices. |
Commercial Banking Business
Our Commercial Banking business generated net income from continuing operations of $145 million and $435 million for the third quarter and first nine months of 2011, respectively, compared with a net income from continuing operations of $39 million and $67 million in the third quarter and first nine months of 2010, respectively. The primary sources of revenue for our Commercial Banking business are net interest income from loans and deposits and non-interest income from customer fees. Expenses primarily consist of ongoing operating costs, such as salaries and associated benefits, communications and other technology expenses, supplies and equipment and occupancy costs.
Table 9 summarizes the financial results of our Commercial Banking business and displays selected key metrics for the periods indicated.
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Table 9: Commercial Banking Business Results
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||||||
(Dollars in millions) | 2011 | 2010 | Change | 2011 | 2010 | Change | ||||||||||||||||||
Selected income statement data: |
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Net interest income |
$ | 353 | $ | 325 | 9 | % | $ | 1,007 | $ | 956 | 5 | % | ||||||||||||
Non-interest income |
62 | 30 | 107 | 195 | 132 | 48 | ||||||||||||||||||
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Total revenue |
415 | 355 | 17 | 1,202 | 1,088 | 10 | ||||||||||||||||||
Provision (Benefit) for loan and lease losses |
(10 | ) | 95 | (111 | ) | (43 | ) | 395 | (111 | ) | ||||||||||||||
Non-interest expense |
200 | 199 | 1 | 569 | 589 | (3 | ) | |||||||||||||||||
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Income from continuing operations before income taxes |
225 | 61 | 269 | 676 | 104 | 550 | ||||||||||||||||||
Income tax provision |
80 | 22 | 264 | 241 | 37 | 551 | ||||||||||||||||||
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Income from continuing operations, net of tax |
$ | 145 | $ | 39 | 272 | % | $ | 435 | $ | 67 | 549 | % | ||||||||||||
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Selected performance metrics: |
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Average loans held for investment: |
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Commercial and multifamily real estate |
$ | 14,021 | $ | 13,411 | 5 | % | $ | 13,657 | $ | 13,556 | 1 | % | ||||||||||||
Middle market |
11,572 | 10,352 | 12 | 11,075 | 10,317 | 7 | ||||||||||||||||||
Specialty lending |
4,154 | 3,715 | 12 | 4,045 | 3,660 | 11 | ||||||||||||||||||
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Total commercial lending |
29,747 | 27,478 | 8 | 28,777 | 27,533 | 5 | ||||||||||||||||||
Small-ticket commercial real estate |
1,598 | 1,957 | (18 | ) | 1,713 | 2,030 | (16 | ) | ||||||||||||||||
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Total commercial banking |
$ | 31,345 | $ | 29,435 | 6 | % | $ | 30,490 | $ | 29,563 | 3 | % | ||||||||||||
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Average yield on loans held for investment |
4.69 | % | 5.13 | % | (44 | )bps | 4.74 | % | 5.03 | % | (29 | )bps | ||||||||||||
Average deposits |
$ | 25,227 | $ | 21,899 | 15 | % | $ | 24,553 | $ | 21,976 | 12 | % | ||||||||||||
Average interest rate on deposits |
0.48 | % | 0.67 | % | (19 | )bps | 0.50 | % | 0.71 | % | (21 | )bps | ||||||||||||
Core deposit intangible amortization |
$ | 10 | $ | 14 | (29 | )% | $ | 31 | $ | 42 | (26 | )% | ||||||||||||
Net charge-off rate(1)(2) |
0.37 | % | 1.27 | % | (90 | )bps | 0.55 | % | 1.28 | % | (73 | )bps |
Selected period-end data: |
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September 30, 2011 |
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December 31, 2010 |
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Change | |||||||||||
Loans held for investment: |
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Commercial and multifamily real estate |
$ | 14,389 | $ | 13,396 | 7 | % | ||||||||||||
Middle market |
11,924 | 10,484 | 14 | |||||||||||||||
Specialty lending |
4,221 | 4,020 | 5 | |||||||||||||||
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Total commercial lending |
30,534 | 27,900 | 9 | |||||||||||||||
Small-ticket commercial real estate |
1,571 | 1,842 | (15 | ) | ||||||||||||||
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Total commercial banking |
$ | 32,105 | $ | 29,742 | 8 | % | ||||||||||||
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Nonperforming loan rate(1)(3) |
1.43 | % | 1.66 | % | (23 | )bps | ||||||||||||
Nonperforming asset rate(1)(4) |
1.55 | 1.80 | (25 | ) | ||||||||||||||
Allowance for loan and lease losses |
$ | 700 | $ | 826 | (15 | )% | ||||||||||||
Deposits |
25,282 | 22,630 | 12 |
(1) | Average loans held for investment used in the denominator in calculating net charge-off, delinquency and nonperforming loan and nonperforming asset rates includes the impact of loans acquired as part of the Chevy Chase Bank acquisition, which were considered purchased credit-impaired (PCI) loans. However, we separately track and report PCI loans and exclude these loans from our net charge-off, delinquency, nonperforming loan and nonperforming asset rates. |
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(2) | The net charge-off rate is calculated by loan category by dividing annualized net charge-offs for the period by average loans held for investment during the period for the specified loan category. The net charge-off rate, excluding loans acquired from Chevy Chase Bank from the denominator, was 0.38% and 1.30% for the three months ended September 30, 2011 and 2010, respectively, and 0.56% and 1.32% for the nine months ended September 30, 2011 and 2010, respectively. |
(3) | The nonperforming loan rate is calculated by loan category by dividing nonperforming loans as of the end of the period by period-end loans held for investment for the specified loan category. The nonperforming loan rate, excluding the impact of loans acquired from Chevy Chase Bank from the denominator, was 1.45% and 1.69% as of September 30, 2011 and December 31, 2010, respectively. |
(4) | The nonperforming asset rate is calculated by loan category by dividing nonperforming assets as of the end of the period by period-end loans held for investment and REO for the specified loan category. The nonperforming asset rate, excluding loans acquired from Chevy Chase Bank from the denominator, was 1.57% and 1.83% as of September 30, 2011 and December 31, 2010, respectively. |
Key factors affecting the results of our Commercial Banking business for the third quarter and first nine months of 2011, compared with the third quarter and first nine months of 2010 included the following:
| Net Interest Income: Net interest income increased by $28 million, or 9%, in the third quarter of 2011, and by $51 million, or 5%, in the first nine months of 2011. The primary drivers of the increase in net interest income from the same prior year periods were an increase in loans and deposits and continued downward pricing on deposits while growing loan yields. |
| Non-Interest Income: Non-interest income increased by $32 million, or 107%, in the third quarter of 2011 and $63 million, or 48%, in the first nine months of 2011. The increase in non-interest income from the same prior year periods was largely attributable to increased customer fees related to treasury management and public financing activities and the absence of a loss of $18 million recognized in the third quarter of 2010 from the sale of a legacy portfolio of small-ticket commercial real estate loans. |
| Provision for Loan and Lease Losses: The Commercial Banking business recorded a negative provision for loan and lease losses of $10 million and $43 million in the third quarter and first nine months of 2011, respectively, compared with provision expense of $95 million and $395 million in the third quarter and first nine months of 2010, respectively. The negative provision in the third quarter and first nine months of 2011 was attributable to lower loss severities resulting from improvements in underlying collateral asset values. As a result, we reduced the allowance related to the Commercial Banking business by $30 million and $126 million in the third quarter and first nine months of 2011, respectively. In comparison, we increased the allowance by $9 million in the third quarter of 2010 and by $106 million in the first nine months of 2010. |
| Non-Interest Expense: Non-interest expense of $200 million in the third quarter of 2011 was flat relative to the third quarter of 2010 despite an increase in loan volume, reflecting operational efficiency improvements. Non-interest expense decreased by $20 million, or 3%, in the first nine months of 2011 to $569 million, primarily due to a reduction in integration costs related to the Chevy Chase Bank acquisition. |
| Total Loans: Period-end loans increased by $2.4 billion, or 8%, in the first nine months of 2011 to $32.1 billion as of September 30, 2011, from $29.7 billion as of December 31, 2010. The increase was driven by stronger loan originations in the middle market and commercial real estate businesses, which was partially offset by the run-off and sale of a portion of the small-ticket commercial real estate loan portfolio. |
| Deposits: Period-end deposits in the Commercial Banking business increased by $2.7 billion, or 12%, in the first nine months of 2011 to $25.3 billion as of September 30, 2011, driven by our strategy to strengthen existing relationships and increase liquidity from commercial customers. |
| Charge-off and Nonperforming Loan Statistics: The net charge-off rate decreased to 0.37% and 0.55% in the third quarter and first nine months of 2011, respectively, from 1.27% and 1.28% in the third quarter and first nine months of 2010, respectively. The nonperforming loan rate decreased to 1.43% as of September 30, 2011, from 1.66% as of December 31, 2010. The improvement in the net charge-off and nonperforming loan rates was attributable to slowly improving underlying credit trends and improvements in underlying collateral asset values. |
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CONSOLIDATED BALANCE SHEET ANALYSIS AND CREDIT PERFORMANCE
Total assets of $200.1 billion as of September 30, 2011 increased by $2.6 billion, or 1%, from $197.5 billion as of December 31, 2010. Total liabilities of $170.8 billion as of September 30, 2011, decreased by $192 million, or less than 1%, from $171.0 billion as of December 31, 2010. Stockholders equity increased by $2.8 billion during the first nine months of 2011, to $29.4 billion as of September 30, 2011 from $26.5 billion as of December 31, 2010. The increase in stockholders equity was primarily attributable to our net income of $2.7 billion in the first nine months of 2011. Following is a discussion of material changes in the major components of our assets and liabilities during the first nine months of 2011.
Investment Securities
Our investment securities portfolio, which had a fair value of $38.4 billion and $41.5 billion, as of September 30, 2011 and December 31, 2010, respectively, consists of the following: U.S. Treasury and U.S. agency debt obligations; agency and non-agency mortgage-backed securities; other asset-backed securities collateralized primarily by credit card loans, auto loans, student loans, auto dealer floor plan inventory loans and leases, equipment loans and home equity lines of credit; municipal securities; and limited Community Reinvestment Act (CRA) equity securities. Our investments in U.S. Treasury and agency securities, based on fair value, represented approximately 69% and 70% of our total investment securities portfolio as of September 30, 2011, and December 31, 2010, respectively.
All of our investment securities were classified as available for sale as of September 30, 2011 and December 31, 2010, and reported in our consolidated balance sheet at fair value. Table 10 presents the amortized cost and fair value of our investment securities, by investment type, as of September 30, 2011 and December 31, 2010.
Table 10: Investment Securities
September 30, 2011 | December 31, 2010 | |||||||||||||||
(Dollars in millions) | Amortized Cost |
Fair Value |
Amortized Cost |
Fair Value |
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U.S. Treasury debt obligations |
$ | 115 | $ | 125 | $ | 373 | $ | 386 | ||||||||
U.S. Agency debt obligations(1) |
166 | 175 | 301 | 314 | ||||||||||||
Residential mortgage-backed securities (RMBS): |
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Agency(2) |
25,139 | 25,747 | 27,980 | 28,504 | ||||||||||||
Non-agency |
1,405 | 1,273 | 1,826 | 1,700 | ||||||||||||
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Total RMBS |
26,544 | 27,020 | 29,806 | 30,204 | ||||||||||||
Commercial mortgage-backed securities (CMBS): |
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Agency(2) |
418 | 429 | 44 | 45 | ||||||||||||
Non-agency |
400 | 398 | 0 | 0 | ||||||||||||
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Total CMBS |
818 | 827 | 44 | 45 | ||||||||||||
Asset-backed securities (ABS)(3) |
9,691 | 9,734 | 9,901 | 9,966 | ||||||||||||
Other securities(4) |
467 | 519 | 563 | 622 | ||||||||||||
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Total securities available for sale |
$ | 37,801 | $ | 38,400 | $ | 40,988 | $ | 41,537 | ||||||||
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(1) | Consists of debt securities issued by Fannie Mae and Freddie Mac with an amortized cost of $165 million and $200 million, as of September 30, 2011 and December 31, 2010, respectively, and fair value of $174 million and $213 million, as of September 30, 2011 and December 31, 2010, respectively. |
(2) | Consists of MBS issued by Fannie Mae, Freddie Mac and Ginnie Mae with an amortized cost of $12.9 billion, $8.4 billion and $4.3 billion, respectively, and fair value of $13.2 billion, $8.6 billion and $4.4 billion, respectively, as of September 30, 2011. The book value of Fannie Mae, Freddie Mac and Ginnie Mae investments each exceeded 10% of our stockholders equity as of September 30, 2011. |
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(3) | Consists of securities collateralized by credit card loans, auto dealer and floor plan inventory loans and leases, student loans, auto loans, equipment loans and other. The distribution among these asset types was approximately 73.2% credit card loans, 11.3% auto dealer floor plan inventory loans and leases, 6.8% auto loans, 4.6% student loans, 2.3% equipment loans, and 1.8% of other loans as of September 30, 2011. In comparison, the distribution was approximately 77.8% credit card loans, 5.6% auto dealer floor plan inventory loans and leases, 6.7% auto loans, 7.2% student loans, 2.5% equipment loans and 0.2% home equity lines of credit as of December 31, 2010. Approximately 89% of the securities in our asset-backed security portfolio were rated AAA or its equivalent as of September 30, 2011, compared with 90% as of December 31, 2010. |
(4) | Consists of municipal securities and equity investments, primarily related to CRA activities. |
We sold approximately $6.4 billion of investment securities, consisting predominantly of agency MBS, in the third quarter of 2011. We recorded a gain of $239 million on the sale of these securities. We provide additional information in Market Risk Management.
Unrealized gains and losses on our available-for-sale securities are recorded net of tax as a component of accumulated other comprehensive income (AOCI). We had gross unrealized gains of $776 million and gross unrealized losses of $177 million on available-for-sale securities as of September 30, 2011, compared with gross unrealized gains of $830 million and gross unrealized losses of $281 million as of December 31, 2010. Of the $177 million in gross unrealized losses as of September 30, 2011, $134 million related to securities that had been in a loss position for more than 12 months.
We evaluate available-for-sale securities in an unrealized loss position as of the end of each quarter for other-than-temporary impairment (OTTI) based on a number of criteria, including the extent and duration of the decline in value, the severity and duration of the impairment, recent events specific to the issuer and/or