Annual Reports

 
Quarterly Reports

  • 10-Q (Aug 5, 2014)
  • 10-Q (May 6, 2014)
  • 10-Q (Nov 6, 2013)
  • 10-Q (Aug 8, 2013)
  • 10-Q (May 9, 2013)
  • 10-Q (Nov 8, 2012)

 
8-K

 
Other

Capital One Financial 10-Q 2011

Documents found in this filing:

  1. 10-Q
  2. Ex-12.2
  3. Ex-31.1
  4. Ex-31.2
  5. Ex-32.1
  6. Ex-32.2
  7. Ex-32.2
Form 10Q
Table of Contents

 

 

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

For the quarterly period ended June 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)

Registrant’s 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 July 31, 2011, there were 459,374,369 shares of the registrant’s Common Stock, par value $.01 per share, outstanding.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

          Page  

PART I—FINANCIAL INFORMATION

     1   
Item 1.   

Financial Statements

     66   
  

Condensed Consolidated Statements of Income

     66   
  

Condensed Consolidated Balance Sheets

     67   
  

Condensed Consolidated Statements of Changes in Stockholders’ Equity

     68   
  

Condensed Consolidated Statements of Cash Flows

     69   
  

Notes to Condensed Consolidated Financial Statements

     70   
  

Note   1—Summary of Significant Accounting Policies

     70   
  

Note   2—Acquisitions

     72   
  

Note   3—Discontinued Operations

     74   
  

Note   4—Investment Securities

     74   
  

Note   5—Loans

     82   
  

Note   6—Allowance for Loan and Lease Losses

     100   
  

Note   7—Variable Interest Entities and Securitizations

     102   
  

Note   8—Goodwill and Other Intangible Assets

     110   
  

Note   9—Deposits and Borrowings

     113   
  

Note 10—Derivative Instruments and Hedging Activities

     116   
  

Note 11—Stockholders’ Equity

     122   
  

Note 12—Earnings Per Common Share

     122   
  

Note 13—Fair Value of Financial Instruments

     123   
  

Note 14—Business Segments

     134   
  

Note 15—Commitments, Contingencies and Guarantees

     138   
  

Note 16—Subsequent Events

     148   
Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations      1   
  

Summary of Selected Financial Data

     1   
  

Introduction

     4   
  

Executive Summary and Business Outlook

     6   
  

Critical Accounting Policies and Estimates

     11   
  

Consolidated Results of Operations

     13   
  

Business Segment Financial Performance

     20   
  

Consolidated Balance Sheet Analysis and Credit Performance

     32   
  

Off-Balance Sheet Arrangements and Variable Interest Entities

     50   
  

Risk Management

     51   
  

Liquidity and Capital Management

     51   
  

Market Risk Management

     58   
  

Supervision and Regulatory Developments

     60   
  

Accounting Changes and Developments

     62   
  

Forward-Looking Statements

     62   
  

Supplemental Tables

     64   
Item 3.   

Quantitative and Qualitative Disclosures about Market Risk

     149   
Item 4.   

Controls and Procedures

     149   

PART II—OTHER INFORMATION

     150   
Item 1.   

Legal Proceedings

     150   
Item 1A.   

Risk Factors

     150   
Item 2.   

Unregistered Sales of Equity Securities and Use of Proceeds

     150   
Item 3.   

Defaults upon Senior Securities

     150   
Item 5.   

Other Information

     150   
Item 6.   

Exhibits

     150   

SIGNATURES

     151   

INDEX TO EXHIBITS

     152   

 

i


Table of Contents

INDEX OF MD&A TABLES AND SUPPLEMENTAL TABLES

 

Table

  

Description

  

Page

 
  

MD&A Tables:

  
1   

Consolidated Financial Highlights (Unaudited)

     1   
2   

Business Segments Results

     5   
3   

Average Balances, Net Interest Income and Net Interest Yield

     14   
4   

Rate/Volume Analysis of Net Interest Income

     16   
5   

Non-Interest Income

     17   
6   

Non-Interest Expense

     19   
7   

Credit Card Business Results

     22   
7.1   

Domestic Credit Card Business Results

     24   
7.2   

International Credit Card Business Results

     25   
8   

Consumer Banking Business Results

     27   
9   

Commercial Banking Business Results

     30   
10   

Investment Securities

     32   
11   

Loan Portfolio Composition

     34   
12   

30+ Day Delinquencies

     36   
13   

Aging of 30+ Day Delinquent Loans

     37   
14   

90+ Day Delinquent Loans Accruing Interest

     37   
15   

Nonperforming Loans and Other Nonperforming Assets

     38   
16   

Net Charge-Offs

     39   
17   

Loan Modifications and Restructurings

     40   
18   

Allowance for Loan and Lease Losses Activity

     43   
19   

Allocation of the Allowance for Loan and Lease Losses

     44   
20   

Unpaid Principal Balance of Mortgage Loans Originated and Sold to Third Parties Based on Category of Purchaser

     46   
21   

Open Pipeline All Vintages (all entities)

     47   
22   

Changes in Representation and Warranty Reserve

     49   
23   

Allocation of Representation and Warranty Reserve

     50   
24   

Liquidity Reserves

     51   
25   

Deposits

     52   
26   

Expected Maturity Profile of Short-term Borrowings and Long-term Debt

     53   
27   

Borrowing Capacity

     54   
28   

Senior Unsecured Debt Credit Ratings

     55   
29   

Capital Ratios Under Basel I

     56   
30   

Risk-Based Capital Components Under Basel I

     57   
31   

Interest Rate Sensitivity Analysis

     60   
  

Supplemental Tables:

  
A   

Reconciliation of Non-GAAP Measures and Calculation of Regulatory Capital Measures

     64   

 

ii


Table of Contents

PART I—FINANCIAL INFORMATION

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This Management’s 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 management’s 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 II—Item 1A. Risk Factors,” in our 2010 Form 10-K in “Part I—Item 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 six months ended June 30, 2011 and 2010, and selected comparative consolidated balance sheet data as of June 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 June 30,     Six Months Ended June 30,  
(Dollars in millions)    2011     2010     Change     2011     2010     Change  

Income statement

            

Net interest income(17)

   $ 3,136      $ 3,097        1   $ 6,276      $ 6,325        (1 )% 

Non-interest income

     857        807        6        1,799        1,868        (4
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

     3,993        3,904        2        8,075        8,193        (1 )

Provision for loan and lease losses(17)

     343        723        (53     877        2,201        (60

Non-interest expense

     2,255        2,000        13        4,417        3,847        15   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations before income taxes

     1,395        1,181        18        2,781        2,145        30   

Income tax provision

     450        369        22        804        613        31   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations, net of taxes

     945        812        16        1,977        1,532        29   

Loss from discontinued operations, net of taxes(1)

     (34     (204     83        (50     (288     83   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 911      $ 608        50      $ 1,927      $ 1,244        55   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Common share statistics

            

Earnings per common share:

            

Basic earnings per common share

   $ 2.00      $ 1.34        49   $ 4.24      $ 2.75        54

Diluted earnings per common share

     1.97        1.33        48        4.18        2.73        53   

Weighted average common shares outstanding:

            

Basic earnings per common share

     455.6        452.1        1        454.9        451.6        1   

Diluted earnings per common share

     462.2        456.4        1        461.3        455.9        1   

Dividends per common share

     0.05        0.05               0.10        0.10          

Stock price per common share at period end

     51.67        40.30        28        51.67        40.30        28   

Total market capitalization at period end

     23,551        18,228        29        23,551        18,228        29   

 

1


Table of Contents
     Three Months Ended June 30,     Six Months Ended June 30,  
(Dollars in millions)    2011     2010     Change     2011     2010     Change  

Average balances

            

Loans held for investment

   $ 127,916      $ 128,203        **   $ 126,504      $ 131,222        (4 )% 

Interest-earning assets

     174,143        174,672        **        173,844        178,296        (2

Total assets

     199,229        199,357        **        198,612        203,159        (2

Interest-bearing deposits

     109,251        104,163        5        108,944        104,083        5   

Total deposits

     125,834        118,484        6        125,001        118,011        6   

Borrowings

     39,451        50,404        (22     39,991        55,162        (28

Stockholders’ equity

     28,255        24,526        15        27,636        24,091        15   

Performance metrics

            

Purchase volume(2)

   $ 34,226      $ 26,570        29   $ 62,023      $ 50,494        23

Revenue margin(3)(17)

     9.17     8.94     23 bps      9.29     9.19     10 bps 

Net interest margin(4)(17)

     7.20        7.09        11        7.22        7.09        13   

Net charge-off rate(5)(17)

     2.91        5.36        (245     3.28        5.69        (241

Risk-adjusted margin(6)

     7.03        5.01        202        6.90        5.00        190   

Return on average assets(7)

     1.90        1.63        27        1.99        1.51        48   

Return on average equity(8)

     13.38        13.24        14        14.31        12.71        160   

Non-interest expense as a % of average loans held for investment(9)

     7.05        6.24        81        6.98        5.86        112   

Efficiency ratio(10)

     56.47        51.23        524        54.70        46.95        775   

Effective income tax rate

     32.26        31.24        102        28.91        28.58        33   
(Dollars in millions)    June 30,
2011
    December 31,
2010
    Change                    

Balance sheet (period end)

            

Loans held for investment

   $ 128,965      $ 125,947        2      

Interest-earning assets

     174,302        172,024        1         

Total assets

     199,753        197,503        1         

Interest-bearing deposits

     109,278        107,162        2         

Total deposits

     126,117        122,210        3         

Borrowings

     37,735        41,796        (10      

Total liabilities

     171,072        170,962        **         

Stockholders’ equity

     28,681        26,541        8         

Tangible common equity (“TCE”)(11)

     14,675        12,558        17         

Credit quality metrics (period end)

            

Allowance for loan and lease losses(17)

   $ 4,488      $ 5,628        (20 )%       

Allowance as a % of loans held of investment

     3.48     4.47     (99 )bps       

30+ day performing delinquency rate(12)

     2.90        3.52        (62      

30+ day delinquency rate

     3.57        4.23        (66      

Capital ratios

            

Tier 1 common equity ratio(13)

     9.4     8.8     40 bps       

Tier 1 risk-based capital ratio(14)

     11.8        11.6                

Total risk-based capital ratio(15)

     15.0        16.8        (200      

Tangible common equity ratio (“TCE ratio”)(16)

     7.9        6.9        100         

 

** Change is less than one percent.
(1) 

Discontinued operations reflect ongoing costs related to the mortgage origination operations of GreenPoint’s wholesale mortgage banking unit, GreenPoint Mortgage Funding, Inc. (“GreenPoint”), which we closed in 2007.

 

2


Table of Contents
(2) 

Consists of credit card purchase transactions for the period, net of returns. Excludes cash advance transactions.

(3) 

Calculated based on annualized total revenue for the period divided by average interest-earning assets for the period.

(4) 

Calculated based on annualized net interest income for the period divided by average interest-earning assets for the period.

(5) 

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.

(6) 

Calculated based on annualized total revenue less net charge-offs for the period divided by average interest-earning assets for the period.

(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 Tables—Table 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 Performance—Credit Performance—Nonperforming 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 Management—Capital Management” and “Supplemental Tables—Table 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 Management—Capital Management” and “Supplemental Tables—Table 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 Management—Capital Management” and “Supplemental Tables—Table 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 Tables—Table 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.

(17) 

Interest income was reduced by $215 million in the second quarter and first six months of 2011 for amounts earned by Kohl’s. The reduction in the provision for loan and lease losses attributable to Kohl’s was $212 million for the second quarter and first six months of 2011. Loss sharing amounts attributable to Kohl’s reduced charge-offs by $42 million in the second quarter and first six months of 2011. The expected reimbursement from Kohl’s netted in our allowance for loan and lease losses was approximately $170 million as of June 30, 2011.

 

3


Table of Contents

 

INTRODUCTION

 

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.

Our revenues are primarily driven by lending to consumers and commercial customers and by deposit-taking activities, which generate net interest income, and by activities that generate non-interest income, including the sale and servicing of loans and providing fee-based services to customers. Customer usage and payment patterns, credit quality, levels of marketing expense and operating efficiency all affect our profitability. Our expenses primarily consist of the cost of funding our assets, our provision for loan and lease losses, operating expenses (including associate salaries and benefits, infrastructure maintenance and enhancements and branch operations and expansion costs), marketing expenses and income taxes. We had $129.0 billion in total loans outstanding and $126.1 billion in deposits as of June 30, 2011, compared with $125.9 billion in total loans outstanding and $122.2 billion in deposits as of December 31, 2010.

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 six months ended June 30, 2011 and 2010. We provide a reconciliation of our total business segment results to our consolidated U.S. GAAP results in “Note 14—Business Segments” of this Report.

 

4


Table of Contents

Table 2: Business Segment Results

 

     Three Months Ended June 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
 

Credit Card

   $ 2,509        63   $ 618        66   $ 2,636        67   $ 568        70

Consumer Banking

     1,245        31        287        30        1,097        28        305        38   

Commercial Banking

     395        10        142        15        379        10        77        9   

Other(3)

     (156     (4     (102     (11     (206     (5     (138     (17
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total from continuing operations

   $ 3,993        100   $ 945        100   $ 3,906        100   $ 812        100
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

     Six Months Ended June 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
 

Credit Card

   $ 5,124        63   $ 1,261        64   $ 5,467        67   $ 1,057        69

Consumer Banking

     2,414        30        502        25        2,309        28        610        40   

Commercial Banking

     787        10        290        15        733        9        28        2   

Other(3)

     (250     (3     (76     (4     (311     (4     (163     (11
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total from continuing operations

   $ 8,075        100   $ 1,977        100   $ 8,198        100   $ 1,532        100
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(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 14—Business Segments.”

 

5


Table of Contents

 

EXECUTIVE SUMMARY AND BUSINESS OUTLOOK

 

Financial Highlights

We reported net income of $911 million ($1.97 per diluted share) in the second quarter of 2011. In comparison, we reported net income of $1.0 billion ($2.21 per diluted share) in the first quarter of 2011 and net income of $608 million ($1.33 per diluted share) in the second quarter of 2010. Net income totaled $1.9 billion ($4.18 per diluted share) for the first six months of 2011, compared with net income of $1.2 billion ($2.73 per diluted share) for the first six months of 2010.

Our earnings in the second quarter of 2011 further bolstered our Tier 1 risk-based capital ratio under Basel I to 11.8% as of June 30, 2011, up 90 basis points from 10.9% as of March 31, 2011, and comfortably above the current minimum regulatory requirement of 4.0%. Our Tier 1 common equity ratio, a non-GAAP measure, rose to 9.4% as of June 30, 2011, up 100 basis points from 8.4% as of March 31, 2011. See “Supplemental Tables” below for a calculation of our regulatory capital ratios and a reconciliation of our supplemental non-GAAP capital measures.

We grew loans and deposits in the second quarter of 2011. 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 transactor 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.

Our recent investments and partnership alliances include our September 2010 acquisition of the $807 million Sony Card legacy portfolio associated with our partnership alliance with Sony Corporation of America (“Sony”) and our January 2011 acquisition of the existing $1.4 billion credit card loan portfolio of Hudson’s Bay Company (“HBC”), one of the largest retailers in Canada. In April 2011, we acquired the existing $3.7 billion private-label credit card loan portfolio of Kohl’s Department Stores (“Kohl’s”) from JPMorgan Chase & Co, which consists of more than 20 million Kohl’s customer accounts. 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, for an estimated price of $9.0 billion at announcement. We expect the ING Direct transaction to close in late 2011 or early 2012, subject to customary closing conditions, including certain governmental clearances and approvals.

In conjunction with the announcement of the ING Direct acquisition, we announced that we expected to finance a portion of the cash consideration through a public equity raise prior to the close of the transaction. On July 19, 2011, we closed a public underwritten offering of 40 million shares of our common stock, subject to forward sale agreements. We also closed a public offering of our senior notes for total proceeds of approximately $3.0 billion. Each of these offerings is described in more detail below under “Recent Acquisitions and Related Developments—Equity and Debt Offerings.” In addition to these public offerings, we may seek to rebalance our investment portfolio prior to the close of the ING Direct acquisition.

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. We believe these factors will help us deliver attractive financial results as well as compelling value creation over time.

 

6


Table of Contents

Below are additional highlights of our performance for the second quarter and first six 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 June 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: We reported earnings of $911 million in the second quarter of 2011 and $1.9 billion in the first six months of 2011. Our earnings increased by $303 million, or 50%, in the second quarter of 2011, and by $683 million, or 55%, in the first six months of 2011, compared with the same prior year periods. The increase in net income was attributable to lower credit costs and strong underlying credit improvement trends, including lower provision for loan and lease losses compared to the prior year periods, as well as a substantial reduction in the provision for mortgage repurchase losses for legacy mortgage related representation and warranty claims in the second quarter and first six months of 2011 as compared to the prior year periods. The impact of these factors was 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 $3.0 billion, or 2%, during the first six months of 2011, to $129.0 billion as of June 30, 2011, from $125.9 billion as of December 31, 2010. The increase was primarily attributable to the additions of the Kohl’s portfolio of $3.7 billion and the HBC portfolio of $1.4 billion. Excluding the impact of the addition of the Kohl’s and HBC portfolios, total loans decreased by $2.1 billion, or 2%, in the first six months of 2011, due to the continued expected run-off of installment loans in our Credit Card business and home loans in our Consumer Banking business, other loan paydowns and charge-offs. The impact from these factors more than offset the strong growth in purchase volume across the Domestic Card business.

 

   

Charge-off and Delinquency Statistics: Net charge-off and delinquency rates continued to improve during the second quarter of 2011. The net charge-off rate decreased to 2.91% from 3.66% in the first quarter of 2011 and 5.36% in the second quarter of 2010. The 30+ day delinquency rate decreased to 3.57% as of June 30, 2011, from 3.79% as of March 31, 2011, and 4.23% as of December 31, 2010.

 

   

Allowance for Loan and Lease Losses: As a result of the continued improvement in credit performance, we reduced our allowance by $579 million in the second quarter of 2011 and by $1.1 billion in the first six months of 2011 to $4.5 billion as of June 30, 2011. In comparison, we reduced our allowance by $1.0 billion in the second quarter of 2010 and by $1.6 billion in the first six months of 2010. The allowance as a percentage of our total loans held for investment decreased to 3.48% as of June 30, 2011, from 4.47% as of December 31, 2010.

 

   

Representation and Warranty Reserve: Our representation and warranty reserve totaled $869 million as of June 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 $37 million and $81 million in the second quarter and first six months of 2011, respectively, compared with a provision of $404 million and $628 million in the second quarter and first six months of 2010, respectively.

Business Segments

 

   

Credit Card Business: Our Credit Card business generated net income from continuing operations of $618 million and $1.3 billion in the second quarter and first six months of 2011, respectively, compared with net income from continuing operations of $568 million and $1.1 billion in the second quarter and first six months of 2010, respectively. Continued favorable 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 was partially offset by an increase in non-interest expense attributable to increased operating and legal costs related to the acquisitions of the private-label credit card loan portfolios of Sony, HBC and Kohl’s and increased marketing expenditures.

 

7


Table of Contents
   

Consumer Banking Business: Our Consumer Banking business generated net income from continuing operations of $287 million and $502 million in the second quarter and first six months of 2011, respectively, compared with net income from continuing operations of $305 million and $610 million in the second quarter and first six months of 2010, respectively. The decrease in net income reflected the impact of a one-time pre-tax gain of $128 million recorded in 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 higher pricing for new auto loan originations and deposit growth resulting from our continued strategy to leverage our bank outlets to attract lower cost funding sources.

 

   

Commercial Banking: Our Commercial Banking business generated net income from continuing operations of $142 million and $290 million in the second quarter and first six months of 2011, respectively, compared with net income from continuing operations of $77 million and $28 million in the second quarter and first six 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 continued improvement in our Commercial Banking credit performance metrics. 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 $18 million and $33 million in the second quarter and first six months of 2011, respectively. In comparison, we recorded a provision for loan and lease losses of $62 million and $300 million in the second quarter and first six months of 2010, respectively, related to our Commercial Banking business.

Business Environment and Recent Developments

Recent Business and Regulatory Developments

During the second quarter, the operating environment continued to be challenging and uncertain given global macroeconomic concerns and fragile U.S. economic conditions. The banking industry continues to face a difficult and increasingly complex environment in which economic uncertainty, regulation and changes in customer and competitor behavior impact how we allocate resources and manage operations, as well as how we position ourselves for future earnings growth. Despite these challenges, our recent partnerships and acquisitions have contributed to new account originations and an increase in purchase volumes.

We are continuing to assess the potential impact of proposed rules promulgated by the agencies charged with implementing the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), including rules relating to resolution plans and credit exposure reports, the FDIC’s orderly liquidation authority, derivatives, risk retention and other securitization matters. These rules may result in modifications to our business models and organizational structure and may subject us to escalating costs associated with any such changes.

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. In the first six months of 2011, we acquired the existing credit card loan portfolios of HBC and Kohl’s and announced our planned acquisition of ING Direct. 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.

Hudson’s Bay Company

On January 7, 2011, we acquired the existing $1.4 billion credit card loan portfolio of HBC, one of the largest retailers in Canada, from GE Capital Retail Finance. The acquisition and partnership with HBC significantly expand our credit card customer base in Canada, tripling the number of customer accounts, and provide an additional distribution channel. The acquisition included a transfer of approximately 400 employees directly involved in managing HBC’s loan portfolio.

 

8


Table of Contents

Kohl’s

On April 1, 2011, we acquired Kohl’s existing $3.7 billion private-label credit card loan portfolio from JPMorgan Chase & Co., which consists of more than 20 million Kohl’s customer accounts. Under the related partnership agreement with Kohl’s, we share a fixed percentage of revenues, consisting of finance charges and late fees, with Kohl’s, and Kohl’s is responsible for reimbursing us for a fixed percentage of credit losses incurred. The revenue-sharing arrangement with Kohl’s has the effect of reducing our overall revenue margins for our Domestic Card business, while the loss-sharing arrangement has the effect of reducing the net charge-off rate. However, because we replaced lower yielding cash and other investments with the Kohl’s receivables, we do not expect that the addition of the Kohl’s portfolio will have a material impact on our total company revenue margin or net interest margin.

Interest income was reduced by $215 million in the second quarter and first six months of 2011 for amounts earned by Kohl’s. Loss sharing amounts attributable to Kohl’s reduced charge-offs by $42 million in the second quarter and first six months of 2011. In addition, the expected reimbursement from Kohl’s netted in our allowance for loan and lease losses was approximately $170 million as of June 30, 2011. The reduction in the provision for loan and lease losses attributable to Kohl’s for the second quarter and first six months of 2011 was $212 million.

ING Direct

On June 16, 2011, we entered into a purchase and sale 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 in exchange for $6.2 billion in cash and approximately 55.9 million shares of our common stock, subject to certain adjustments described in the purchase and sale agreement. We will effect the transaction through (i) the acquisition of the equity interests of ING Bank, fsb, (ii) the acquisition of the equity interests of each of WS Realty, LLC and ING Direct Community Development LLC and (iii) the acquisition of certain assets and the assumption of certain liabilities of ING Direct Bancorp. We expect the ING Direct transaction to close in late 2011 or early 2012, subject to customary closing conditions, including certain governmental clearances and approvals.

Equity and Debt Offerings

On July 19, 2011, we closed a public offering of shares of our common stock, subject to forward sale agreements that we entered into with certain counterparties acting as forward purchasers. The forward purchasers agreed to borrow and sell to the public, through the underwriters, 40 million shares of our common stock at a price per share of $50.00. After underwriter’s discounts and commissions, the net proceeds to the company will be at an initial forward sale price per share of $48.50. We did not receive any proceeds from this public offering of our shares of common stock. 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 $1.9 billion based on the initial forward price. The forward sale price is subject to adjustment under the forward sale agreements. 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. In addition, we granted the underwriters a 30-day option to purchase an additional 6 million shares of our common stock to cover any over-allotments, which shares are not subject to the forward sale agreements.

We also closed a public offering of four different series of our senior notes on July 19, 2011, for total proceeds of approximately $3.0 billion. The offering of senior notes included $250 million aggregate principal amount of our Floating Rate Senior Notes due 2014, $750 million aggregate principal amount of our 2.125% Senior Notes due 2014, $750 million aggregate principal amount of our 3.150% Senior Notes due 2016 and $1.25 billion aggregate principal amount of our 4.750% Senior Notes due 2021.

 

9


Table of Contents

We expect to use the net proceeds of these offerings, along with cash sourced from current liquidity, to fund the $6.2 billion in cash consideration payable in connection with the ING Direct acquisition.

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 analysis of our business as discussed in “Part I—Item 1. Business” and “Part I—Item 7. Management’s 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 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

We continue to gain traction across all of our businesses as a result of our focus on franchise-enhancing customer relationships. We believe the recently announced ING Direct acquisition will deliver strong financial results in the near-term as well as compelling long-term value creation. As a result, we believe we are in a strong position to deliver attractive and sustainable results over the long-term, including moderate growth and attractive risk-adjusted returns on assets in our Credit Card and Auto Finance businesses, moderate growth in low-risk loans in our Commercial Banking business and strong growth in low-cost deposits and high-quality commercial and retail customer relationships. Based on recent trends and our targeted initiatives to attract new business and develop customer relationships, we expect modest year-over-year growth in ending loan balances in 2011. Although we expect growth in our period-end loan balances in 2011, we expect that our average loan balances for 2011 will be comparable to our average loan balances for 2010 given the lower starting point for our loan balances in 2011.

Business Segments Expectations

Credit Card Business

Based on the traction we are gaining in our Domestic Card business, we believe that our Domestic Card loan balances reached a low point in the first quarter of 2011. We expect modest loan growth in the second half of 2011, as the headwinds of elevated charge-offs and the run-off of the installment loan portfolio continue to diminish. We believe we are well positioned to gain market share in the new level playing field resulting from the CARD Act. We believe the credit performance improvement in our Credit Card business will continue despite elevated unemployment.

Consumer Banking Business

In our Consumer Banking business, we expect that auto originations and returns will remain strong and drive growth in auto loans in 2011. We expect that the continuing run-off of the mortgage portfolio will largely offset the growth in auto loans. While we expect that our Auto Finance business will continue to deliver strong credit performance and economic results, we believe that we have likely experienced the low point for the Auto Finance charge-off rate. We expect the Auto Finance charge-off rate will increase in the second half of 2011, driven by seasonal patterns, competitive factors and expected changes in auction prices for used vehicles. We

 

10


Table of Contents

believe loan pricing in some loan portfolio categories is approaching historic highs and is likely to moderate or decline over time.

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 trajectory. However, we continue to expect some quarterly uncertainty and volatility 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 2011. Growth in treasury management and capital market services is driving higher fee revenues and deepening relationships with our commercial customers.

 

 

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 1—Summary 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. Management has discussed our critical accounting policies and estimates with the Audit and Risk Committee of the Board of Directors.

 

11


Table of Contents

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.

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 21% of our total assets of $199.8 billion as of June 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 June 30, 2011, and approximately 2% of these financial instruments (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 13—Fair Value of Financial Instruments.”

 

12


Table of Contents

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 function, 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.

For additional information on our critical accounting policies and estimates, see “Part II—Item 7. MD&A—Critical 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 six months ended June 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 six months ended June 30, 2011 and 2010.

 

13


Table of Contents

Table 3: Average Balances, Net Interest Income and Net Interest Yield

 

     Three Months Ended June 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)

   $ 88,777      $ 2,658         11.98   $ 91,243      $ 2,815         12.34

International

     8,823        349         15.82        7,427        296         15.94   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total consumer loans(3)

     97,600        3,007         12.32        98,670        3,111         12.61   

Commercial loans(3)

     30,316        360         4.75        29,533        365         4.94   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total loans held for investment

     127,916        3,367         10.53        128,203        3,476         10.85   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Investment securities

     40,381        313         3.10        39,022        342         3.51   

Other interest-earning assets:

              

Domestic

     5,148        16         1.24        6,933        17         0.98   

International

     698        3         1.72        514        —           0.00   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total other interest-earning assets

     5,846        19         1.30        7,447        17         0.91   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total interest-earning assets

   $ 174,143      $ 3,699         8.50   $ 174,672      $ 3,835         8.78
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Cash and due from banks

     1,870             2,413        

Allowance for loan and lease losses

     (5,069          (7,735     

Premises and equipment, net

     2,715             2,723        

Other assets

     25,570             27,284        
  

 

 

        

 

 

      

Total assets

   $ 199,229           $ 199,357        
  

 

 

        

 

 

      

Liabilities and equity:

              

Interest-bearing liabilities:

              

Deposits

   $ 109,251      $ 307         1.12   $ 104,163      $ 368         1.41

Securitized debt obligations:

              

Domestic

     18,384        91         1.98        30,333        182         2.40   

International

     3,807        22         2.31        4,915        30         2.44   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total securitized debt obligations

     22,191        113         2.04        35,248        212         2.41   

Senior and subordinated notes

     8,093        63         3.11        8,760        72         3.29   

Other borrowings

     9,167        80         3.49        6,396        86         5.38   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total interest-bearing liabilities

   $ 148,702      $ 563         1.51   $ 154,567      $ 738         1.91
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Non-interest bearing deposits

     16,583             14,321        

Other liabilities

     5,689             5,943        
  

 

 

        

 

 

      

Total liabilities

     170,974             174,831        

Stockholders’ equity

     28,255             24,526        
  

 

 

        

 

 

      

Total liabilities and stockholders’ equity

   $ 199,229           $ 199,357        
  

 

 

        

 

 

      

Net interest income/spread

     $ 3,136         6.99     $ 3,097         6.87
    

 

 

    

 

 

     

 

 

    

 

 

 

Interest income to average interest-earning assets

          8.50          8.78

Interest expense to average interest-earning assets

          1.30             1.69   
       

 

 

        

 

 

 

Net interest margin

          7.20          7.09
       

 

 

        

 

 

 

 

14


Table of Contents
     Six Months Ended June 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)

   $ 87,687      $ 5,364         12.23   $ 93,975      $ 5,795         12.33

International

     8,761        703         16.05        7,619        601         15.78   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total consumer loans(3)

     96,448        6,067         12.58        101,594        6,396         12.59   

Commercial loans(3)

     30,056        717         4.77        29,627        738         4.98   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total loans held for investment

     126,504        6,784         10.73        131,221        7,134         10.87   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Investment securities

     40,953        629         3.07        38,525        691         3.59   

Other interest-earning assets:

              

Domestic

     5,698        32         1.12        7,942        39         0.98   

International

     689        6         1.74        608        1         0.33   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total other interest-earning assets

     6,387        38         1.19        8,550        40         0.94   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total interest-earning assets

   $ 173,844      $ 7,451         8.57   $ 178,296      $ 7,865         8.82
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Cash and due from banks

     1,912             2,338        

Allowance for loan and lease losses

     (5,348          (8,040     

Premises and equipment, net

     2,717             2,724        

Other assets

     25,487             27,841        
  

 

 

        

 

 

      

Total assets

   $ 198,612           $ 203,159        
  

 

 

        

 

 

      

Liabilities and equity:

              

Interest-bearing liabilities:

              

Deposits

   $ 108,944      $ 629         1.15   $ 104,083      $ 767         1.47

Securitized debt obligations:

              

Domestic

     19,983        208         2.08        34,253        390         2.28   

International

     3,869        45         2.33        5,230        64         2.45   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total securitized debt obligations

     23,852        253         2.12        39,483        454         2.30   

Senior and subordinated notes

     8,091        127         3.14        8,758        140         3.20   

Other borrowings

     8,048        166         4.13        6,921        179         5.17   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total interest-bearing liabilities

   $ 148,935      $ 1,175         1.58   $ 159,245      $ 1,540         1.93
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Non-interest bearing deposits

     16,057             13,928        

Other liabilities

     5,984             5,895        
  

 

 

        

 

 

      

Total liabilities

     170,976             179,068        

Stockholders’ equity

     27,636             24,091        
  

 

 

        

 

 

      

Total liabilities and stockholders’ equity

   $ 198,612           $ 203,159        
  

 

 

        

 

 

      

Net interest income/spread

     $ 6,276         6.99     $ 6,325         6.89
    

 

 

    

 

 

     

 

 

    

 

 

 

Interest income to average interest-earning assets

          8.57          8.82

Interest expense to average interest-earning assets

          1.35             1.73   
       

 

 

        

 

 

 

Net interest margin

          7.22          7.09
       

 

 

        

 

 

 

 

15


Table of Contents

 

(1) 

Past due fees included in interest income totaled approximately $245 million and $312 million for the three months ended June 30, 2011 and 2010, respectively, and approximately $490 million and $644 million for the six months ended June 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 our 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 second quarter of 2010 were as follows: domestic consumer loans ($2,882 million and 12.63%); total consumer loans ($3,178 million and 12.88%); and commercial loans ($298 million and 4.04%). The previously reported interest income and average yields for the first six months were as follows: domestic consumer loans ($5,844 million and 12.44%); total consumer loans ($6,445 million and 12.69%); and commercial loans ($689 million and 4.65%).

Table 4 presents the variance between our net interest income for the three months ended June 30, 2011 and 2010, and for the six months ended June 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 June 30,
2011 vs. 2010
    Six Months Ended June 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

  $ (104 )   $ (34 )   $ (70 )   $ (329 )   $ (325 )   $ (4

Commercial loans

    (5     10        (15     (21     11        (32
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans held for investment, including past-due fees

    (109     (24     (85     (350     (314     (36

Investment securities

    (29     12        (41     (62     42        (104

Other

    2        (4     6        (2     (11     9   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest income

    (136     (16     (120     (414     (283     (131
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest expense:

           

Deposits

    (61     17        (78     (138     34        (172

Securitized debt obligations

    (99     (70     (29     (201     (168     (33

Senior and subordinated notes

    (9     (5     (4     (13     (11     (2

Other borrowings

    (6     30        (36     (13     27        (40
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest expense

    (175 )     (28     (147 )     (365     (118 )     (247
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

  $ 39      $ 12      $ 27      $ (49 )   $ (165 )   $ 116   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(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.

Our net interest income of $3.1 billion for the second quarter of 2011 increased slightly from the second quarter of 2010, driven by an 11 basis points expansion of our net interest margin to 7.20%, which was partially offset by a modest decline in average interest-earning assets.

Our net interest income of $6.3 billion for the first six months of 2011 decreased slightly from the first six months of 2010, driven by a 2% decrease in average interest-earning assets, which was offset by a 13 basis points expansion of our net interest margin to 7.22%.

 

16


Table of Contents

The decrease in average interest-earning assets in the second quarter and first six 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 Kohl’s private-label credit card loan portfolio of $3.7 billion in the second quarter of 2011.

The increase in our net interest margin in the second quarter of 2011 and first six months of 2011 was primarily attributable to an improvement 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 overall interest rate environment, combined with our disciplined pricing, contributed to the decrease in our average deposit interest rates.

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 info effect in the third quarter of 2010 and the addition of the Kohl’s portfolio. Under our partnership agreement with Kohl’s, we share a fixed percentage of revenues, consisting of finance charges and late fees. We report revenues related to Kohl’s 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.

Non-Interest Income

Non-interest income consists of servicing and securitizations income, service charges and other customer-related fees, interchange income and other non-interest income. We also record the provision for mortgage repurchase losses related to continuing operations in 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 net interest income.

Table 5 displays the components of non-interest income for the three and six months ended June 30, 2011 and 2010.

Table 5: Non-Interest Income

 

     Three Months Ended June 30,     Six Months Ended June 30,  

(Dollars in millions)

           2011                     2010                     2011                     2010          

Servicing and securitizations

   $ 12      $ 21      $ 23      $ (15

Service charges and other customer-related fees

     460        496        985        1,081   

Interchange

     331        333        651        644   

Net other-than-temporary impairment

     (6 )     (26     (9     (57

Provision for mortgage repurchase losses(1)

     (4     (95     (9     (195

Other

     64        78        158        410   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total non-interest income

   $ 857      $ 807      $ 1,799      $ 1,868   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) 

We recorded a total provision for mortgage repurchase losses of $37 million and $404 million in the second quarter of 2011 and 2010, respectively. The remaining portion of the provision for repurchase losses is included in discontinued operations.

Non-interest income of $857 million for the second quarter of 2011 increased by $50 million, or 6%, from non-interest income of $807 million for the second quarter of 2010. This increase was primarily due to a

 

17


Table of Contents

reduction in the provision for mortgage repurchase losses and a decline in other-than-temporary impairment, which was partially offset by a decrease in service charges and other customer-related fees due to the reduction in penalty fees as a result of the CARD Act. In the second quarter of 2010, we significantly increased our reserve for mortgage representation and warranty claims for legacy mortgage loans sold by our subsidiaries to various parties. The increase was primarily attributable to a refinement we made in estimating our reserve for representation and warranty claims to extend the timeframe, in most instances, over which we estimated our repurchase liability to the full life of the mortgage loans sold by our subsidiaries. We provide additional information on our reserve for representation and warranty claims in “Consolidated Balance Sheet Analysis and Credit Performance—Potential Mortgage Representation and Warranty Liabilities.” The other-than-temporary losses recorded in the second quarter of 2010 were attributable to certain non-agency mortgage-backed securities that had deteriorated in credit quality due to the continued weakness in the housing market and elevated unemployment.

Non-interest income of $1.8 billion for the first six months of 2011 decreased by $69 million, or 4%, from non-interest income of $1.9 billion from the first six months of 2010. This decrease reflected the impact of a one-time pre-tax gain of $128 million recorded in the first quarter of 2010 as result of the deconsolidation of certain option-adjustable rate mortgage trusts and the reduction in penalty fees as a result of the CARD Act. The impact of these factors was partially offset by the decreases in the provision for mortgage repurchase losses and other-than-temporary impairment losses.

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 fell by $380 million to $343 million in the second quarter of 2011 and by $1.3 billion in the first six months of 2011 to $877 million, compared with 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, as underlying credit trends and credit performance continued to improve. The net charge-off rate was 2.91% and 3.28% for the second quarter and first six months of 2011, respectively, compared with 5.36% and 5.69% for the second quarter and first six months of 2010, respectively. As charge-offs declined, we recorded an allowance release of $579 million and $1.1 billion in the second quarter and first six months of 2011, respectively.

See “Consolidated Balance Sheet Analysis and Credit Performance—Allowance 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 six months ended June 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 six months ended June 30, 2011 and 2010.

 

18


Table of Contents

Table 6: Non-Interest Expense

 

       Three Months Ended June 30,        Six Months Ended June 30,  

(Dollars in millions)

         2011                2010                2011                2010      

Salaries and associated benefits

     $ 715         $ 650         $ 1,456         $ 1,296   

Marketing

       329           219           605           399   

Communications and data processing

       162           164           326           333   

Supplies and equipment

       124           129           259           253   

Occupancy

       118           117           237           237   

Other(1)

       807           721           1,534           1,329   
    

 

 

      

 

 

      

 

 

      

 

 

 

Total non-interest expense

     $ 2,255         $ 2,000         $ 4,417         $ 3,847   
    

 

 

      

 

 

      

 

 

      

 

 

 

 

(1) 

Consists of professional services expenses, credit collection costs, fee assessments and intangible amortization expense.

Non-interest expense of $2.3 billion for the second quarter of 2011 was up $255 million, or 13%, from the second quarter of 2010. Non-interest expense of $4.4 billion for the first six months of 2011 was up $570 million, or 15%, from the first six months of 2010. The increase was attributable to higher operating costs associated with increased purchase volumes and with the recent acquisitions of the Sony, HBC and Kohl’s loan portfolios, higher legal fees and increased marketing costs. We have expanded our marketing efforts to attract and support targeted customers and new business volume through a variety of channels.

Income Taxes

Our effective tax rate may vary between periods due, in part, to fluctuations in our pre-tax earnings, which affects the relative tax benefit of tax-exempt income, tax credits and permanent tax items.

We recorded an income tax provision based on income from continuing operations of $450 million (32.3% effective income tax rate) in the second quarter of 2011, compared with an income tax provision of $369 million (31.2% effective income tax rate) in the second quarter of 2010, and $804 million (28.9% effective income tax rate) for the first six months of 2011 compared with $613 million (28.6% effective income tax rate) for the first six months of 2010.

We recorded tax benefits of $45 million and $50 million for the first six months of 2011 and 2010, respectively, related to the resolution of certain tax issues and audits, which lowered our effective income tax rate for those periods. Our effective income tax rate excluding the benefit from these discrete tax items was 30.5% and 30.9% for the first six months of 2011 and 2010, respectively.

We provide additional information on items affecting our income taxes and effective tax rate in our 2010 Form 10-K under “Note 18—Income 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 GreenPoint’s wholesale mortgage banking unit, which we closed in 2007. We recorded a loss from discontinued operations, net of tax, of $34 million and $50 million in the second quarter and first six months of 2011, respectively. In comparison, we recorded a loss from discontinued operations, net of tax, of $204 million and $288 million in the second quarter and first six months of 2010, respectively.

 

19


Table of Contents

The decrease in the loss from discontinued operations in the second quarter and first six months of 2011 was attributable to a significant reduction in the provision for mortgage repurchase losses. We recorded a pre-tax provision for mortgage repurchase losses of $37 million in the second quarter of 2011, of which $33 million ($22 million, net of tax) was included in discontinued operations, and a pre-tax provision of $81 million in the first six months of 2011, of which $72 million ($51 million, net of tax) was included in discontinued operations. In comparison, we recorded a pre-tax provision for mortgage repurchase losses of $404 million in the second quarter of 2010, of which $309 million ($212 million, net of tax) was included in discontinued operations, and a pre-tax provision of $628 million in the first six months of 2010, of which $433 million ($309 million, net of tax) was included in discontinued operations.

In the second quarter of 2010, we significantly increased our reserve for mortgage representation and warranty claims for legacy mortgage loans sold by our subsidiaries to various parties. The increase was primarily attributable to a refinement we made in estimating our reserve for representation and warranty claims to extend the timeframe, in most instances, over which we estimated our repurchase liability to the full life of the mortgage loans sold by our subsidiaries. We provide additional information on our reserve for representation and warranty claims in “Consolidated Balance Sheet Analysis and Credit Performance—Potential 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.

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. See “Note 20—Business 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 six months ended June 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 June 30, 2011, compared with December 31, 2010. See “Note 14—Business 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.”

 

20


Table of Contents

Credit Card Business

Our Credit Card business generated net income from continuing operations of $618 million and $1.3 billion in the second quarter and first six months of 2011, respectively, compared with net income from continuing operations of $568 million and $1.1 billion in the second quarter and first six 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 Kohl’s and HBC. The results related to the Kohl’s 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 Kohl’s, we share a fixed percentage of revenues, consisting of finance charges and late fees, with Kohl’s, and Kohl’s is required to reimburse us for fixed percentage of credit losses incurred. Revenues and losses related to the Kohl’s credit card program are reported on a net basis in our consolidated financial statements. The revenue sharing amounts earned by Kohl’s 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 Kohl’s 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 Kohl’s portfolio in our consolidated balance sheets net of the loss sharing amount due from Kohl’s.

Interest income was reduced by $215 million in the second quarter and first six months of 2011 for amounts earned by Kohl’s. Loss sharing amounts attributable to Kohl’s reduced charge-offs by $42 million in the second quarter and first six months of 2011. In addition, the expected reimbursement from Kohl’s netted in our allowance for loan and lease losses was approximately $170 million as of June 30, 2011. The reduction in the provision for loan and lease losses attributable to Kohl’s was $212 million for the second quarter and first six months of 2011.

We provide additional information on the acquisition of the existing credit card loan portfolios of Kohl’s and HBC in “Note 2—Acquisitions.”

 

21


Table of Contents

Table 7: Credit Card Business Results

 

     Three Months Ended June 30,     Six Months Ended June 30,  

(Dollars in millions)

   2011    

    2010    

    Change     2011     2010     Change  

Selected income statement data:

            

Net interest income

   $ 1,890      $ 1,977        (4 )%    $ 3,831      $ 4,090        (6 )% 

Non-interest income

     619        659        (6     1,293        1,377        (6
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

     2,509        2,636        (5     5,124        5,467        (6 )

Provision for loan and lease losses

     309        765        (60     759        1,940        (61

Non-interest expense

     1,238        1,002        24        2,416        1,916        26   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations before income taxes

     962        869        11        1,949        1,611        21   

Income tax provision

     344        301        14        688        554        24   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations, net of tax

   $ 618      $ 568        9   $ 1,261      $ 1,057        19
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Selected performance metrics:

            

Average loans held for investment

   $ 62,691      $ 62,679          **%    $ 61,644      $ 64,292        (4 )% 

Average yield on loans held for investment(1)

     13.83     14.67     (84 )bps      14.25     14.78     (53 )bps 

Revenue margin(2)

     16.01        16.82        (81 )     16.62        17.01        (39 )

Net charge-off rate(3)

     5.06        9.36        (430     5.59        9.84        (425 )

Purchase volume(4)

   $ 34,226      $ 26,570        29   $ 62,023      $ 50,494        23

(Dollars in millions)

   June 30,
2011
    December 31,
2010
    Change                    

Selected period-end data:

            

Loans held for investment

   $ 62,705      $ 61,371        2      

30+ day delinquency rate(5)

     3.60     4.29     (69 )bps       

Allowance for loan and lease losses

   $ 3,093      $ 4,041        (23 )%       

 

** 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. 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 revised average loan yields for our Credit Card business were 14.67%, 14.65%, 14.28% for the second quarter, third quarter and fourth quarter of 2010, respectively, and 14.78% for the six months ended June 30, 2010, 14.74% for the nine months ended September 30, 2010 and 14.63% for full year 2010. The previously reported average loan yields for our Credit Card business were 14.25%, 14.27%, 13.97% for the second quarter, third quarter and fourth quarter of 2010, respectively, and 14.57% for the six months ended June 30, 2010, 14.48% for the nine months ended September 30, 2010 and 14.36% for full year 2010.

(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.

 

22


Table of Contents

Key factors affecting the results of our Credit Card Banking business for the second quarter and first six months of 2011, compared with the second quarter and first six months of 2010 included the following.

 

   

Net Interest Income: Net interest income decreased by $87 million, or 4%, in the second quarter of 2011, reflecting the impact of a 4% decrease in the average yield on loans held for investment coupled with relatively stable average loan balances. The decrease in the average yield on loans was primarily driven by the impact from the addition of the Kohl’s portfolio. The expected run-off of the installment loan portfolio and seasonal credit card balance paydowns resulted in a decrease in loan balances, which was offset by the addition of the HBC and Kohl’s portfolios. Net interest income decreased by $259 million, or 6%, in the first six months of 2011, reflecting the impact of a 2% decrease in the average yield on loans held for investment and a 4% decrease in average loan balances. The decrease in the average yield in the first six months of 2011 was also due to a reduction in late fees and addition of the HBC and Kohl’s portfolios. The expected run-off of the installment loan portfolio was the primary driver of the decline in average loan balances in the first six months of 2011, more than offsetting the impact of modest revolving card loan growth and the addition of the HBC and Kohl’s portfolios.

 

   

Non-Interest Income: Non-interest income decreased by $40 million, or 6%, in the second quarter of 2011 and $84 million, or 6%, in the first six months of 2011. The decrease 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 a provision 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 in the second quarter of 2011 resulting from increased purchase volume attributable to growth in 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 $456 million in the second quarter of 2011, to $309 million and by $1.2 billion in the first six months of 2011, to $759 million. The significant reduction in the provision was primarily attributable to the continued improvement in underlying credit trends, including reduced delinquency rates, lower bankruptcy losses and higher recoveries. As estimated net charge-offs declined, we recorded an allowance release of $483 million and $948 million in the second quarter and first six months of 2011, respectively.

 

   

Non-Interest Expense: Non-interest expense increased by $236 million, or 24%, in the second quarter of 2011 and $500 million, or 26%, in the first six months of 2011. The increase was attributable to higher operating costs associated with increased purchase volumes and with the recent acquisitions of the Sony, HBC and Kohl’s loan portfolios, higher legal fees and increased marketing costs. We have expanded our marketing efforts to attract and support targeted customers and new business volume through a variety of channels.

 

   

Total Loans: Period-end loans in the Credit Card business increased by $1.3 billion, or 2%, in the first six months of 2011, to $62.7 billion as of June 30, 2011, from $61.4 billion as of December 31, 2010. The increase was primarily attributable to the acquisitions of the Kohl’s 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 credit card balance paydowns.

 

   

Charge-off and Delinquency Statistics: Net charge-off and delinquency rates continued to improve in the second quarter and first six months of 2011. The net charge-off rate decreased to 5.06% and 5.59% in the second quarter and first six months of 2011, respectively, from 9.36% and 9.84% in the second quarter and first six months of 2010, respectively. The 30+ day delinquency rate decreased to 3.60% as of June 30, 2011, from 3.88% as of March 31, 2011 and 4.29% as of December 31, 2010. The improvement in net charge-off and delinquency rates reflects the impact of tighter underwriting standards since the recession.

 

23


Table of Contents

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 87% of total revenues for our Credit Card business in the second quarter of 2011 and 86% in the first six months of 2011, compared with 87% in both the second quarter and first six 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 June 30,     Six Months Ended June 30,  

(Dollars in millions)

   2011    

    2010    

    Change     2011     2010     Change  

Selected income statement data:

            

Net interest income

   $ 1,607      $ 1,735        (7 )%    $ 3,258      $ 3,600        (10 )% 

Non-interest income

     584        560        4        1,167        1,178        (1
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

     2,191        2,295        (5     4,425        4,778        (7

Provision for loan and lease losses

     187        675        (72     417        1,771        (76

Non-interest expense

     1,008        869        16        1,998        1,678        19   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations before income taxes

     996        751        33        2,010        1,329        51   

Income tax provision

     354        268        32        714        474        51   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations, net of tax

   $ 642      $ 483        33   $ 1,296      $ 855        52
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Selected performance metrics:

            

Average loans held for investment

   $ 53,868      $ 55,252        (3 )%    $ 52,884      $ 56,672        (7 )% 

Average yield on loans held for investment(1)

     13.52     14.49     (97 )bps      13.96     14.64     (68 )bps 

Revenue margin(2)

     16.27        16.61        (34 )     16.73        16.86        (13 )

Net charge-off rate(3)

     4.74        9.49        (475     5.45        10.00        (455 )

Purchase volume(4)

   $ 31,070      $ 24,513        27   $ 56,094      $ 46,501        21

(Dollars in millions)

   June 30,
2011
    December 31,
2010
    Change                    

Selected period-end data:

            

Loans held for investment

   $ 53,994      $ 53,849          **%       

30+ day delinquency rate(5)

     3.33     4.09     (76 )bps       

Allowance for loan and lease losses

   $ 2,555      $ 3,581        (29 )%       

 

** 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 revised average loan yields for our Domestic Credit Card business were 14.49%, 14.40%, 13.96% for the second quarter, third quarter and fourth quarter of 2010, respectively, and 14.64% for the six months ended June 30, 2010, 14.57% for the nine months ended September 30, 2010 and 14.42% for full year 2010. The previously reported average loan yields for our Domestic Credit Card business were 13.98%, 13.95%, 13.57% for the second quarter, third quarter and fourth quarter of 2010, respectively, and 14.39% for the six months ended June 30, 2010, 14.25% for the nine months ended September 30, 2010 and 14.09% for full year 2010.

(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.

 

24


Table of Contents
(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.

Our Domestic Card division generated net income from continuing operations of $642 million and $1.3 billion in the second quarter and first six months of 2011, respectively, compared with net income from continuing operations of $483 million and $855 million in the second quarter and first six months of 2010, respectively.

The primary factors affecting Domestic Card results for the second quarter and the first six months of 2011, compared with the second quarter and the first six months of 2010 include: (1) a decline in total revenue attributable to a decrease in average loan yields as a result of reduced fees and the impact of the addition of the Kohl’s loan portfolio and lower average loan balances; (2) a significant reduction in the provision for loan and lease losses due to the continued 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 with the acquisitions of the Sony and Kohl’s loan portfolios, 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 13% of total revenues for our Credit Card business in the second quarter of 2011 and 14% in the first six months of 2011, compared with 13% in both the second quarter and first six months of 2010.

Table 7.2: International Card Business Results

 

     Three Months Ended June 30,     Six Months Ended June 30,  

(Dollars in millions)

   2011     2010     Change     2011     2010     Change  

Selected income statement data:

            

Net interest income

   $ 283      $ 242        17   $ 573      $ 490        17

Non-interest income

     35        99        (65     126        199        (37