FORM 10-Q
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


FORM 10-Q

 


(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

  For the quarterly period ended September 30, 2007.

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED).

  For the transition period from              to             

Commission File No. 1-13300

 


CAPITAL ONE FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

 


 

Delaware   54-1719854

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

 

1680 Capital One Drive McLean, Virginia   22102
(Address of Principal Executive Offices)   (Zip Code)

(703) 720-1000

Registrant’s telephone number, including area code:

(Not applicable)

(Former name, former address and former fiscal year, if changed since last report)

 


Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes   x     No   ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b of the Exchange Act. (Check One):

Large accelerated filer   x    Accelerated filer  ¨    Non-accelerated filer  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act.)    Yes  ¨    No  x

As of October 31, 2007 there were 418,512,173 shares of the registrant’s Common Stock, par value $.01 per share, outstanding.

 



Table of Contents

CAPITAL ONE FINANCIAL CORPORATION

FORM 10-Q

INDEX

September 30, 2007

 

          Page
PART 1. FINANCIAL INFORMATION    1

Item 1

   Reported Financial Statements (unaudited):    1
            Condensed Reported Consolidated Balance Sheets    1
            Condensed Reported Consolidated Statements of Income    2
            Condensed Reported Consolidated Statements of Changes in Stockholders’ Equity    3
            Condensed Reported Consolidated Statements of Cash Flows    5
            Notes to Condensed Reported Consolidated Financial Statements    6

Item 2

   Management’s Discussion and Analysis of Financial Condition and Results of Operations    21

Item 3

   Quantitative and Qualitative Disclosure of Market Risk    51

Item 4

   Controls and Procedures    51
PART 2. OTHER INFORMATION    51

Item 1

   Legal Proceedings    51

Item 1A

   Risk Factors    51

Item 2

   Unregistered Sales of Equity Securities and Use of Proceeds    51

Item 6

   Exhibits    52
   Signatures    55


Table of Contents

Part 1. Financial Information

Item 1. Financial Statements

CAPITAL ONE FINANCIAL CORPORATION

Condensed Reported Consolidated Balance Sheets (unaudited)

(Dollars in thousands, except share and per share data)

 

    

September 30

2007

   

December 31

2006

 

Assets:

    

Cash and due from banks

   $ 1,819,121     $ 2,817,519  

Federal funds sold and resale agreements

     1,922,735       1,099,156  

Interest-bearing deposits at other banks

     703,805       743,821  
                

Cash and cash equivalents

     4,445,661       4,660,496  

Securities available for sale

     19,959,247       15,246,887  

Mortgage loans held for sale

     1,454,457       10,435,295  

Loans held for investment

     95,405,217       96,512,139  

Less: Allowance for loan and lease losses

     (2,320,000 )     (2,180,000 )
                

Net loans held for investment

     93,085,217       94,332,139  

Accounts receivable from securitizations

     6,905,859       4,589,235  

Premises and equipment, net

     2,268,034       2,203,280  

Interest receivable

     793,693       816,426  

Goodwill

     12,952,838       13,635,435  

Other

     5,289,829       3,820,092  
                

Total assets

   $ 147,154,835     $ 149,739,285  
                

Liabilities:

    

Non-interest-bearing deposits

   $ 10,840,189     $ 11,648,070  

Interest-bearing deposits

     72,502,625       74,122,822  
                

Total deposits

     83,342,814       85,770,892  

Senior and subordinated notes

     10,784,182       9,725,470  

Other borrowings

     22,722,519       24,257,007  

Interest payable

     552,674       574,763  

Other

     4,965,794       4,175,947  
                

Total liabilities

     122,367,983       124,504,079  
                

Stockholders’ Equity:

    

Preferred Stock, par value $.01 per share; authorized 50,000,000 shares, none issued or outstanding

       —    

Common stock, par value $.01 per share; authorized 1,000,000,000 shares, 418,346,994 and 412,219,973 issued as of September 30, 2007 and December 31, 2006, respectively

     4,183       4,122  

Paid-in capital, net

     15,768,525       15,333,137  

Retained earnings

     11,049,042       9,760,184  

Cumulative other comprehensive income

     346,184       266,180  

Less: Treasury stock, at cost; 32,923,076 and 2,294,586 shares as of September 30, 2007 and December 31, 2006, respectively

     (2,381,082 )     (128,417 )
                

Total stockholders’ equity

     24,786,852       25,235,206  
                

Total liabilities and stockholders’ equity

   $ 147,154,835     $ 149,739,285  
                

See Notes to Condensed Reported Consolidated Financial Statements.

 

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Table of Contents

CAPITAL ONE FINANCIAL CORPORATION

Condensed Reported Consolidated Statements of Income

(Dollars in thousands, except per share data) (unaudited)

 

    

Three Months Ended

September 30

  

Nine Months Ended

September 30

     2007     2006    2007     2006

Interest Income:

         

Loans held for investment, including past-due fees

   $ 2,381,096     $ 1,814,803    $ 6,963,349     $ 5,044,362

Securities available for sale

     252,550       151,616      694,608       483,078

Other

     133,321       98,652      460,005       313,370
                             

Total interest income

     2,766,967       2,065,071      8,117,962       5,840,810

Interest Expense:

         

Deposits

     740,091       442,571      2,220,177       1,262,412

Senior and subordinated notes

     144,643       96,300      417,250       275,361

Other borrowings

     257,759       231,685      712,937       604,563
                             

Total interest expense

     1,142,493       770,556      3,350,364       2,142,336
                             

Net interest income

     1,624,474       1,294,515      4,767,598       3,698,474

Provision for loan and lease losses

     595,534       430,566      1,342,292       963,281
                             

Net interest income after provision for loan and lease losses

     1,028,940       863,949      3,425,306       2,735,193

Non-Interest Income:

         

Servicing and securitizations

     1,354,303       1,071,091      3,569,281       3,250,201

Service charges and other customer-related fees

     522,374       459,125      1,484,820       1,308,254

Mortgage servicing and other

     52,661       44,520      172,476       118,378

Interchange

     103,799       150,474      347,889       401,503

Other

     116,525       36,175      321,417       251,213
                             

Total non-interest income

     2,149,662       1,761,385      5,895,883       5,329,549

Non-Interest Expense:

         

Salaries and associate benefits

     627,358       554,504      1,970,433       1,607,113

Marketing

     332,693       368,498      989,654       1,048,964

Communications and data processing

     194,551       183,020      569,405       524,958

Supplies and equipment

     134,639       111,625      384,971       322,837

Restructuring expense

     19,354       —        110,428       —  

Occupancy

     77,597       49,710      230,835       151,840

Other

     548,029       459,272      1,687,077       1,325,293
                             

Total non-interest expense

     1,934,221       1,726,629      5,942,803       4,981,005
                             

Income from continuing operations before income taxes

     1,244,381       898,705      3,378,386       3,083,737

Income taxes

     428,010       310,866      1,108,279       1,059,972
                             

Income from continuing operations, net of tax

     816,371       587,839      2,270,107       2,023,765

(Loss) from discontinued operations, net of tax

     (898,029 )     —        (926,343 )     —  
                             

Net (loss) income

   $ (81,658 )   $ 587,839    $ 1,343,764     $ 2,023,765
                             

Basic earnings per share:

         

Income from continuing operations

   $ 2.11     $ 1.95    $ 5.74     $ 6.73

(Loss) from discontinued operations

     (2.32 )     —        (2.34 )     —  
                             

Net (loss) income

   $ (0.21 )   $ 1.95    $ 3.40     $ 6.73
                             

Diluted earnings per share

         

Income from continuing operations

   $ 2.09     $ 1.89    $ 5.66     $ 6.53

Loss from discontinued operations

     (2.30 )     —        (2.31 )     —  
                             

Net (loss) income

   $ (0.21 )   $ 1.89    $ 3.35     $ 6.53
                             

Dividends paid per share

   $ 0.03     $ 0.03    $ 0.08     $ 0.08
                             

See Notes to Condensed Reported Consolidated Financial Statements.

 

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CAPITAL ONE FINANCIAL CORPORATION

Condensed Reported Consolidated Statements of Changes in Stockholders’ Equity

(Dollars in thousands, except share and per share data) (unaudited)

 

     Common Stock   

Paid-In

Capital, Net

  

Retained

Earnings

   

Cumulative

Other

Comprehensive

Income (Loss)

   

Treasury

Stock

   

Total

Stockholders’

Equity

 

(In thousands, except share and per share data)

   Shares    Amount            

Balance, December 31, 2005

   302,786,444    $ 3,028    $ 6,848,544    $ 7,378,015     $ 6,129     $ (106,802 )   $ 14,128,914  

Comprehensive income:

                 

Net income

   —        —        —        2,023,765       —         —         2,023,765  
                                                   

Other comprehensive income, net of income tax:

                 

Unrealized gains on securities, net of income taxes of $10,619

   —        —        —        —         19,206       —         19,206  

Foreign currency translation adjustments

   —        —        —        —         161,342       —         161,342  

Unrealized losses on cash flow hedging instruments, net of income tax benefit of $6,553

   —        —        —        —         (12,743 )     —         (12,743 )
                                                   

Other comprehensive income

   —        —        —        —         167,805       —         167,805  
                                                   

Comprehensive income

                    2,191,570  

Cash dividends - $.008 per share

   —        —        —        (24,210 )     —         —         (24,210 )

Purchase of treasury stock

   —        —        —        —         —         (8,575 )     (8,575 )

Issuances of common stock and restricted stock, net of forfeitures

   689,489      7      27,670      —         —         —         27,677  

Exercise of stock options and related tax benefits

   3,079,235      30      233,058      —         —         —         233,088  

Compensation expense for restricted stock awards and stock options

           128,513      —         —         —         128,513  
                                                   

Balance, September 30, 2006

   306,555,168    $ 3,065    $ 7,237,785    $ 9,377,570     $ 173,934     $ (115,377 )   $ 16,676,977  
                                                   

Balance, December 31, 2006

   412,219,973    $ 4,122    $ 15,333,137    $ 9,760,184     $ 266,180     $ (128,417 )   $ 25,235,206  

Cumulative effect from adoption of FIN 48

              (31,830 )         (31,830 )

Cumulative effect from adoption of FAS 156, net of income taxes of $6,378

              8,809           8,809  

Comprehensive income:

                 

Net income

              1,343,764           1,343,764  

Other comprehensive income, net of income tax:

                 

Unrealized loss on securities, net of income taxes benefit of $5,436

                (1,560 )       (1,560 )

Defined benefit pension plans, net of income tax benefit of $1,092

                (2,028 )       (2,028 )

 

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     Common Stock    

Paid-In

Capital, Net

   

Retained

Earnings

   

Cumulative

Other

Comprehensive

Income (Loss)

   

Treasury

Stock

   

Total

Stockholders’

Equity

 

(In thousands, except share and per share data)

   Shares     Amount            

Foreign currency translation adjustments

             127,754         127,754  

Unrealized losses on cash flow hedging instruments, net of income tax benefit of $22,833

             (44,162 )       (44,162 )
                                                      

Other comprehensive income

   —         —         —           80,004       —         80,004  
                                                      

Comprehensive income

                 1,423,768  

Cash dividends - $.08 per share

           (31,885 )         (31,885 )

Purchase of treasury stock

               (2,252,665 )     (2,252,665 )

Issuances of common stock and restricted stock, net of forfeitures

   1,234,190       13       28,023             28,036  

Exercise of stock options and related tax benefits of exercises and restricted stock vesting

   5,030,089       49       273,708             273,757  

Compensation expense for restricted stock awards and stock options

         139,379             139,379  

Adjustment to issuance of common stock for acquisition

   (137,258 )     (1 )     (10,463 )           (10,464 )

Allocation of ESOP shares

         4,741             4,741  
                                                      

Balance, September 30, 2007

   418,346,994     $ 4,183     $ 15,768,525     $ 11,049,042     $ 346,184     $ (2,381,082 )   $ 24,786,852  
                                                      

See Notes to Condensed Reported Consolidated Financial Statements.

 

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CAPITAL ONE FINANCIAL CORPORATION

Condensed Consolidated Statements of Cash Flows

(Dollars in thousands) (unaudited)

 

    

Nine Months Ended

September 30,

 
     2007     2006  

Operating Activities:

    

Income from continuing operations, net of tax

   $ 2,270,107     $ 2,023,765  

(Loss) from discontinued operations, net of tax

     (926,343 )     —    
                

Net income

     1,343,764       2,023,765  

Adjustments to reconcile net income to cash provided by operating activities:

    

Provision for loan and lease losses

     1,342,292       963,281  

Depreciation and amortization, net

     482,595       382,968  

(Gains) losses on sales of securities available for sale

     (68,306 )     25,150  

Gains on sales of auto loans

     (10,927 )     (27,455 )

Gains on extinguishment of debt

     (17,444 )     —    

Mortgage loans held for sale:

    

Transfers and originations

     729,458       (113,725 )

Loss on sales

     7,712       —    

Proceeds from sales

     4,905,876       —    

Stock plan compensation expense

     309,969       150,443  

Changes in assets and liabilities:

    

Decrease in interest receivable

     32,234       34,438  

Increase in accounts receivable from securitizations

     (2,318,418 )     (715,296 )

Increase in other assets

     (1,378,508 )     (91,084 )

(Decrease) increase in interest payable

     (22,429 )     15,319  

Increase (decrease) in other liabilities

     838,475       (100,999 )

Net cash provided by operating activities attributable to discontinued operations

     2,196,050       —    
                

Net cash provided by operating activities

     8,372,393       2,546,805  
                

Investing Activities:

    

Purchases of securities available for sale

     (10,880,031 )     (5,034,885 )

Proceeds from maturities of securities available for sale

     5,258,692       2,915,064  

Proceeds from sales of securities available for sale

     965,185       2,513,479  

Proceeds from securitizations of loans

     9,875,362       9,907,624  

Net increase in loans held for investment

     (8,921,503 )     (15,068,945 )

Principal recoveries of loans previously charged off

     469,392       418,581  

Additions of premises and equipment, net

     (314,063 )     (530,995 )

Net payments for companies acquired

     (10,464 )     —    
                

Net cash used in investing activities

     (3,557,430 )     (4,880,077 )
                

Financing Activities:

    

Net decrease in deposits

     (2,428,078 )     (320,117 )

Net increase in other borrowings

     515,093       2,088,027  

Issuances of senior notes

     1,495,740       3,188,372  

Maturities of senior notes

     (462,500 )     (1,226,882 )

Repurchases of senior notes

     —         (31,296 )

Purchases of treasury stock

     (2,252,665 )     (8,575 )

Dividends paid

     (31,885 )     (24,210 )

Net proceeds from issuances of common stock

     32,777       27,677  

Proceeds from share based payment activities

     133,499       168,658  

Net cash used in financing activities attributable to discontinued operations

     (2,031,779 )     —    
                

Net cash (used in) provided by financing activities

     (5,029,798 )     3,861,654  
                

(Decrease) increase in cash and cash equivalents

     (214,835 )     1,528,382  

Cash and cash equivalents at beginning of year

     4,660,496       4,071,267  
                

Cash and cash equivalents at end of period

   $ 4,445,661     $ 5,599,649  
                

See Notes to Condensed Reported Consolidated Financial Statements.

 

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CAPITAL ONE FINANCIAL CORPORATION

Notes to Condensed Reported Consolidated Financial Statements

(in thousands, except per share data) (unaudited)

Note 1

Summary of Significant Accounting Policies

Business

Capital One Financial Corporation (the “Corporation”) is a diversified financial services company whose banking and non-banking subsidiaries market a variety of financial products and services. The Corporation’s principal subsidiaries are:

 

   

Capital One Bank (the “Bank”) which currently offers credit and debit card products, deposit products, and also engages in a wide variety of lending and other financial activities.

 

   

Capital One, National Association (“CONA”) which offers a broad spectrum of banking products and financial services to consumers, small businesses and commercial clients.

 

   

Capital One Auto Finance, Inc. (“COAF”) which offers automobile and other motor vehicle financing products.

Another subsidiary of the Corporation, Superior Savings of New England, N.A. (“Superior”) focuses on telephonic and media-based generation of deposits.

In the third quarter of 2007, the Company shutdown the mortgage origination operations of its wholesale mortgage banking unit, GreenPoint Mortgage (“GreenPoint”), an operating subsidiary of CONA. Additional information is included in this Quarterly Report under the heading “Notes to Condensed Reported Consolidated Financial Statements – Note 2 – Discontinued Operations.”

The Corporation and its subsidiaries are hereafter collectively referred to as the “Company”.

Basis of Presentation

The accompanying unaudited condensed reported consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete consolidated financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from these estimates.

All significant intercompany balances and transactions have been eliminated. Certain prior years’ amounts have been reclassified to conform to the 2007 presentation. All amounts in the following notes, excluding share and per share data, are presented in thousands.

The notes to the reported consolidated financial statements contained in the Annual Report on Form 10-K for the year ended December 31, 2006 should be read in conjunction with these condensed reported consolidated financial statements.

Recent Accounting Pronouncements

In February 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard No. 159, The Fair Value Option for Financial Assets and Liabilities, (“SFAS 159”). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value with changes in fair value included in current earnings. The election is made on specified election dates, can be made on an instrument by instrument basis, and is irrevocable. SFAS 159 is effective for financial statements issued for fiscal years beginning after November 15, 2007. Management is currently evaluating the impact of adoption of SFAS 159 on the consolidated earnings and financial position of the Company.

In September 2006, the FASB issued Statement of Financial Accounting Standard No. 157, Fair Value Measurements (“SFAS 157”). This statement defines fair value, establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007. Management is currently evaluating the impact of adoption of SFAS 157 on the consolidated earnings and financial position of the Company.

 

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In September 2006, the FASB issued Statement of Financial Accounting Standard No. 156, Accounting for Servicing of Financial Assets, and (“SFAS 156”), which amends Statement of Financial Accounting Standards No. 140 – Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (“SFAS 140”). SFAS 156 changes the accounting for, and reporting of, the recognition and measurement of separately recognized servicing assets and liabilities. Effective January 1, 2007, the Company adopted SFAS 156 resulting in an $8.8 million cumulative effect, net of taxes, increase to the beginning balance of retained earnings.

In February 2006, the FASB issued Statement of Financial Accounting Standard No. 155, Accounting for Certain Hybrid Financial Instruments-an amendment of FASB Statements No. 133 and 140, (“SFAS 155”). SFAS 155 amends FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, (“SFAS 133”) and SFAS 140. SFAS 155 resolves issues addressed in SFAS 133 Implementation Issue No. D1, “Application of Statement 133 to Beneficial Interests in Securitized Financial Assets.” SFAS 155 permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation, clarifies which interest-only strips and principal-only strips are not subject to the requirements of SFAS 133, establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation, clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives, and amends SFAS 140 to eliminate the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. The adoption of SFAS 155 did not have a material impact on the consolidated earnings or financial position of the Company.

Adoption of FIN 48

In June 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109 (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in accordance with SFAS No. 109, Accounting for Income Taxes, and prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition.

The Company adopted the provisions of FIN 48 effective January 1, 2007. As a result of adoption, the Company recorded a $31.8 million reduction in retained earnings. The reduction in retained earnings upon adoption is the net impact of a $48.7 million increase in the liability for unrecognized tax benefits and a $16.8 million increase in deferred tax assets. In addition, the Company reclassified $471.1 million of unrecognized tax benefits from deferred tax liabilities to current taxes payable to conform to the deferred tax measurement and balance sheet presentation requirements of FIN 48.

The balance of unrecognized tax benefits at January 1, 2007 was $661.6 million. Included in the balance at January 1, 2007, are $83.5 million of tax positions which, if recognized, would affect the effective tax rate and $58.0 million of tax positions which, if recognized, would result in a reduction in goodwill. Also included in the balance is $466.4 million of tax positions related to items of income and expense for which the ultimate taxability or deductibility is highly certain, but for which there is uncertainty about the timing of recognition. Because of the impact of deferred tax accounting, other than interest and penalties, the acceleration of taxability or deferral of deductibility of these items would not affect the annual effective tax rate but may accelerate the payment of taxes to an earlier period.

The Company continues to recognize accrued interest and penalties related to unrecognized tax benefits as a component of income tax expense, consistent with its policy prior to adoption of FIN 48. The accrued balance of interest and penalties related to unrecognized tax benefits at January 1, 2007 is $119.1 million.

The Company is subject to examination by the Internal Revenue Service (“IRS”) and other tax authorities in certain countries and states in which the Company has significant business operations. The tax years subject to examination vary by jurisdiction. The IRS is currently examining the Company’s federal income tax returns for the years 2003 and 2004 as well as the tax returns of certain acquired subsidiaries for the year 2004. During 2006, the IRS concluded its examination of the Company’s federal income tax returns for the years 2000-2002. Tax issues for years 1995-1999 are pending in the U.S. Tax Court and the conclusion of those matters could impact tax years after 1999.

As of September 30, 2007, the IRS has proposed adjustments with respect to the timing of recognition of items of income and expense derived from the Company’s credit card business in various tax years. The ultimate resolution of these issues is not expected to have a material effect on the Company’s operations or financial condition. However, the Company anticipates that it is reasonably possible that a payment of up to $250 million, principally related to these timing issues, will be made within twelve months of the reporting date resulting in a significant reduction to the Company’s liability for unrecognized tax benefits.

 

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Significant Accounting Policies

See the Company’s Annual Report on Form 10-K for the year ended December 31, 2006, Item 8 “Notes to Condensed Reported Financial Statements – Note 1 – Summary of Significant Accounting Policies” for a summary of the Company’s accounting policies. Refer also to the discussion below for accounting policies that may supplement or modify the discussion of accounting policies in the Company’s Form 10-K for the year December 31, 2006.

Consumer Loan Securitizations

The Company primarily securitizes credit card loans, auto loans and installment loans. Securitization provides the Company with a significant source of liquidity and favorable capital treatment for securitizations accounted for as off-balance sheet arrangements. See Item 8 “Notes to Condensed Reported Financial Statements – Note 22 – Off-Balance Sheet Securitizations” in the Company’s Form 10-K for the year ended December 31, 2006 for additional detail.

Loan securitization involves the transfer of a pool of loan receivables to a trust or other special purpose entity. The trust sells an undivided interest in the pool of loan receivables to third-party investors through the issuance of asset backed securities and distributes the proceeds to the Company as consideration for the loans transferred. The Company removes loans from the Reported Consolidated Balance Sheets for securitizations that qualify as sales in accordance with SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities – a Replacement of SFAS No. 125 (“SFAS 140”). Alternatively, when the transfer would not be considered a sale but rather a financing, the assets will remain on the Company’s Reported Consolidated Balance Sheet with an offsetting liability recognized in the amount of proceeds received.

Interests in the securitized and sold loans may be retained in the form of subordinated interest-only strips, subordinated tranches, cash collateral and spread accounts. The Company also retains a seller’s interest in the credit card receivables transferred to the trusts which is carried on a historical cost basis and classified as loans held for investment on the Reported Consolidated Balance Sheet.

Gains on securitization transactions, fair value adjustments related to residual interests in securitizations are recognized in income in the Consolidated Statements of Income and amounts due from the trusts are included in accounts receivable from securitizations on the Reported Consolidated Balance Sheets. As of September 30, 2007 and December 31, 2006, the retained interest on the Reported Consolidated Balance Sheet was $2.4 billion and $2.2 billion, respectively. See Note 22 in the Company’s Form 10-K for the year December 31, 2006 for additional detail.

The gain on sale recorded from off-balance sheet securitizations is recorded based on the estimated fair value of the assets sold and retained and liabilities incurred, and is recorded at the time of sale, net of transaction costs, in Servicing and securitizations income on the Reported Consolidated Statements of Income. The related receivable is the interest-only strip, which is based on the present value of the estimated future cash flows from excess finance charges and past-due fees over the sum of the return paid to security holders, estimated contractual servicing fees and credit losses. The interest-only strip is accounted for as a trading security with changes in the estimated fair value recorded in Servicing and securitizations income. To the extent assumptions used by management do not prevail, fair value estimates of the interest-only strip could differ significantly, resulting in either higher or lower future servicing and securitization income, as applicable.

The Company does not recognize servicing assets or servicing liabilities for servicing rights retained from consumer loan securitizations since the servicing fee approximates just adequate compensation to the Company for performing the servicing.

Loans Held for Investment

Loans held for investment include consumer and commercial loans. Consumer loans include credit card, installment, auto and mortgage loans. Credit card loans are reported at their principal amounts outstanding and include uncollected billed interest and fees. Certain mortgage loans associated with the GreenPoint shut down, which were previously categorized as held for sale and marked at the lower of aggregate cost or fair value, were transferred to held for investment at September 30, 2007. All other loans are reported at their principal amounts outstanding.

All new originations of consumer and commercial loans, except for certain mortgage loans previously originated under GreenPoint, are deemed to be held for investment at origination because management has the intent and ability to hold them for the foreseeable future or until maturity or payoff. See Item 8 “Notes to Condensed Reported Financial Statements—Note 1—Summary of Significant Accounting Policies,” in the Company’s Form 10-K for the year ended December 31, 2006 for additional detail on Mortgage Loans Held for Sale. Management believes the foreseeable future is relatively short based on the weighted average life of the consumer loans and the homogeneous nature of the receivables. In determining the amount of loans held for investment, management makes judgments about the Company’s ability to fund these loans through means other than securitization, such as deposits and other borrowings. Management assesses whether loans can continue to be held for investment on a quarterly basis by considering capital levels and scheduled maturities of funding instruments used.

 

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Consumer loan balances that are expected to be securitized in the next three months are accounted for as held for sale. The loans that have been identified as held for sale are carried at the lower of aggregate cost or fair value and an allowance for loan losses is not provided for these loans. Management believes its ability to reasonably forecast the amount of existing consumer loans that should be accounted for as held for sale is limited to three months from the balance sheet date because of the short-term nature of the assets, the revolving nature of the securitization structures and the fact that securitizations that occur beyond three months will involve a significant proportion of consumer loans that have not yet been originated. The Company continues to include these loans in loans held for investment because separate classification in the Reported Consolidated Balance Sheets and related impacts to the Reported Consolidated Statements of Income is considered immaterial to the Company’s financial statements. Cash flows associated with loans that are originated with the intent to hold for investment are classified as investing cash flow, regardless of a subsequent change of intent.

Note 2

Discontinued Operations

Shutdown of Mortgage Origination Operations of Wholesale Mortgage Banking Unit

In the third quarter of 2007, the Company shutdown the mortgage origination operations of its wholesale mortgage banking unit, GreenPoint, realizing an after-tax loss of $898.0 million. GreenPoint was acquired by the Company in December 2006 as part of the North Fork acquisition. The results of the mortgage origination operations of GreenPoint have been accounted for as a discontinued operation and have been removed from the Company’s results of continuing operations for 2007.

The results of GreenPoint’s mortgage servicing business continue to be reported as part of the Company’s continuing operations. The mortgage servicing function was moved into the Local Banking Segment in conjunction with the shutdown of the mortgage origination operation and the results of the Local Banking Segment were restated to include the mortgage servicing results for each period of 2007.

Major components of the $898.0 million after-tax loss associated with the shut down of GreenPoint’s origination operations include approximately $646.0 million from the non-cash write-down of goodwill associated with the acquisition of GreenPoint as part of the North Fork Bancorporation in December 2006, $177.8 million of valuation adjustments, $59.0 million in restructuring charges associated with severance benefits and facilities closure and $15.2 million in loss from operations. The vast majority of charges associated with the shutdown of GreenPoint’s mortgage origination operations were incurred in the third quarter of 2007.

Due to turmoil in the secondary mortgage markets in the third quarter of 2007, the Company decided to retain certain GreenPoint loans and has reclassified them to held for investment at September 30, 2007. Continuing cash flows from the held for investment loan portfolios are considered indirect cash flows of the origination operation. The Company will have no significant continuing involvement in the operations of the originate and sell business of GreenPoint.

The following is summarized financial information for discontinued operations related to the closure of the Company’s wholesale mortgage banking unit:

 

     Three Months Ended
September 30, 2007
    Nine Months Ended
September 30, 2007
 

Net interest income

   $ 22,621     $ 62,437  

Non-interest income

     (205,281 )     (134,812 )

Provision for loan and lease losses

     75,829       80,151  

Non-interest expense

     790,929       940,601  

Income tax benefit

     (151,389 )     (166,784 )
                

Loss from discontinued operations, net of taxes

   $ (898,029 )   $ (926,343 )
                

The Company’s wholesale mortgage banking unit had assets of approximately $3.3 billion as of September 30, 2007 consisting primarily of $1.2 billion of mortgage loans held for sale and $1.6 billion of mortgage loans held for investment. The related liabilities consisted of obligations to fund these assets.

 

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Note 3

Business Combinations

North Fork Bancorporation

On December 1, 2006, the Company acquired 100% of the outstanding common stock of North Fork Bancorporation (“North Fork”), a regional bank holding company headquartered in New York conducting commercial and retail banking from branch locations in New York, New Jersey, and Connecticut, with a complementary national mortgage banking business.

The acquisition was accounted for under the purchase method of accounting, and, as such, the assets and liabilities of North Fork were recorded at their respective fair values as of December 1, 2006. The results of North Fork’s operations were included in the Company’s Consolidated Reported Statement of Income commencing December 1, 2006.

The total consideration of $13.2 billion, which includes the value of outstanding stock options, was settled through the issuance of 103.8 million shares of the Company’s common stock and payment of $5.2 billion in cash. Under the terms of the transaction, each share of North Fork common stock was exchanged for $28.14 in cash or 0.3692 shares of the Company’s common stock or a combination of common stock and cash based on the aforementioned conversion rates, based on the average of the closing prices on the NYSE of the Company’s common stock during the five trading days ending the day before the completion of the merger, which was $76.24.

 

Costs to acquire North Fork:

  

Capital One common stock issued

   $ 7,914,463

Cash consideration paid

     5,200,500

Fair value of employee stock options

     83,633

Investment banking, legal, and consulting fees

     31,547
      

Total consideration paid for North Fork

   $ 13,230,143
      

The allocation of the final purchase price is still subject to refinement as the integration process continues and additional information becomes available.

The following unaudited pro forma condensed statements of income assume that the Company and North Fork were combined at the beginning of 2006. Discontinued Operations in the proformas represent the proforma results for the mortgage origination operation of GreenPoint Mortgage that was shutdown in the third quarter of 2007.

 

    

Three Months Ended

September 30, 2006

  

Nine Months Ended

September 30, 2006

Net interest income

   $ 1,654,782    $ 4,726,929

Non-interest income

     1,824,653      5,518,216

Provision for loan and lease losses

     439,566      990,281

Non-interest expense

     1,896,832      5,653,624

Income taxes

     390,769      1,226,288
             

Income from continuing operations

     752,268      2,374,952

Income from discontinued operations

     49,130      112,345
             

Net income

   $ 801,398    $ 2,487,297
             

Basic earnings per share:

     

Income from continuing operations

   $ 1.86    $ 5.87

Income from discontinued operations

     0.12      0.28
             

Net income

   $ 1.98    $ 6.15
             

Diluted earnings per share:

     

Income from continuing operations

   $ 1.81    $ 5.73

Income from discontinued operations, net of tax

     0.12      0.27
             

Net income

   $ 1.93    $ 6.00
             

(1) Pro forma adjustments include the following adjustments: accretion for loan fair value discount, reduction of interest income for amounts used to fund the acquisition, amortization for interest-bearing deposits fair value premium, accretion for subordinated notes fair value premium, addition of interest expense for borrowings used to fund the acquisition, and related amortization for intangibles acquired, net of North Fork’s historical intangible amortization expense.

 

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Note 4

Segments

With the Company’s diversification into banking through the acquisition of Hibernia Corporation in late 2005 and the acquisition of North Fork in fourth quarter 2006, the Company strategically manages its business at two operating segment levels: Local Banking and National Lending. Local Banking includes consumer, small business and commercial deposits and lending conducted within its branch network. The National Lending segment consists of the following three sub-segments:

 

   

U.S. Card sub-segment which consists of domestic consumer credit and debit card activities.

 

   

Auto Finance sub-segment which includes automobile and other motor vehicle financing activities.

 

   

Global Financial Services sub-segment consisting of international lending activities, small business lending, installment loans, home loans, healthcare financing and other diversified activities.

In the third quarter of 2007, the Company shutdown mortgage origination operations of its wholesale mortgage banking unit, GreenPoint. The results of the mortgage origination operations are being reported as discontinued operations for each period presented, and are not included in segment results of the Company. The results of GreenPoint’s mortgage servicing business continue to be reported as part of the Company’s continuing operations. The mortgage servicing function was moved into the Local Banking Segment in conjunction with the shutdown of the mortgage origination operation, and the results of the Local Banking Segment were restated to include the mortgage servicing results for each period of 2007.

The Local Banking and National Lending Banking segments are considered reportable segments based on quantitative thresholds applied to the managed loan portfolio for reportable segments provided by SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, and are disclosed separately. The Other category includes the Company’s liquidity portfolio, emerging businesses not included in the reportable segments, and various non-lending activities. The Other category also includes the net impact of transfer pricing, certain unallocated expenses, gains/losses related to the securitization of assets, and restructuring charges related to the Company’s 2007 cost initiative.

The Company maintains its books and records on a legal entity basis for the preparation of financial statements in conformity with GAAP. The following tables present information prepared from the Company’s internal management information system, which is maintained on a line of business level through allocations from the consolidated financial results.

See Note 1, Summary of Significant Accounting Policies in the Annual Report on Form 10-K for the accounting policies of the reportable segments.

The following tables present certain information regarding our continuing operations by segment:

 

Total Company

   Three Months Ended September 30, 2007
  

National

Lending

  

Local

Banking

    Other    

Total

Managed

  

Securitization

Adjustments (1)

   

Total

Reported

Net interest income

   $ 2,279,763    $ 584,925     $ (61,250 )   $ 2,803,438    $ (1,178,964 )   $ 1,624,474

Non-interest income

     1,312,146      195,204       10,639       1,517,989      631,673       2,149,662

Provision for loan and lease losses

     1,196,087      (58,285 )     5,023       1,142,825      (547,291 )     595,534

Restructuring expenses

     —        —         19,354       19,354      —         19,354

Other non-interest expenses

     1,367,607      543,390       3,870       1,914,867      —         1,914,867

Income tax provision (benefit)

     352,847      102,693       (27,530 )     428,010      —         428,010
                                            

Net income (loss)

   $ 675,368    $ 192,331     $ (51,328 )   $ 816,371      —       $ 816,371
                                            

Loans held for investment

   $ 102,556,271    $ 42,233,665     $ (21,375 )   $ 144,768,561    $ (50,980,053 )   $ 93,788,508

Total deposits

   $ 2,295,131    $ 73,419,558     $ 7,628,125     $ 83,342,814      —       $ 83,342,814

 

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Table of Contents

Total Company

   Three Months Ended September 30, 2006
  

National

Lending

  

Local

Banking

   Other    

Total

Managed

  

Securitization

Adjustments (1)

   

Total

Reported

Net interest income

   $ 1,988,818    $ 258,198    $ (29,194 )   $ 2,217,822    $ (923,307 )   $ 1,294,515

Non-interest income

     1,213,924      115,526      (54,041 )     1,275,409      485,976       1,761,385

Provision for loan and lease losses

     862,375      5,495      27       867,897      (437,331 )     430,566

Restructuring expenses

     —        —        —         —        —         —  

Other non-interest expenses

     1,411,882      297,080      17,667       1,726,629      —         1,726,629

Income tax provision (benefit)

     324,366      24,902      (38,402 )     310,866      —         310,866
                                           

Net income (loss)

   $ 604,119    $ 46,247    $ (62,527 )   $ 587,839      —       $ 587,839
                                           

Loans held for investment

   $ 98,909,970    $ 13,326,088    $ 2,488     $ 112,238,546    $ (48,626,377 )   $ 63,612,169

Total deposits

   $ 2,461,941    $ 35,163,849    $ 9,987,360     $ 47,613,150      —       $ 47,613,150

 

National Lending sub-segment detail

   Three Months Ended September 30, 2007
   U.S. Card   

Auto

Finance

   

Global

Financial

Services

  

Total

National

Lending

Net interest income

   $ 1,357,200    $ 377,522     $ 545,041    $ 2,279,763

Non-interest income

     975,502      13,514       323,130      1,312,146

Provision for loan and lease losses

     662,428      244,537       289,122      1,196,087

Non-interest expenses

     815,470      152,275       399,862      1,367,607

Income tax provision

     294,053      (1,987 )     60,781      352,847
                            

Net income

   $ 560,751    $ (3,789 )   $ 118,406    $ 675,368
                            

Loans held for investment

   $ 49,573,279    $ 24,335,242     $ 28,647,750    $ 102,556,271

 

     Three Months Ended September 30, 2006

National Lending sub-segment detail

   U.S. Card   

Auto

Finance

  

Global

Financial

Services

  

Total

National

Lending

Net interest income

   $ 1,179,751    $ 348,323    $ 460,744    $ 1,988,818

Non-interest income

     881,304      21,181      311,439      1,213,924

Provision for loan and lease losses

     451,782      161,145      249,448      862,375

Non-interest expenses

     899,062      154,014      358,806      1,411,882

Income tax provision

     248,574      19,021      56,771      324,366
                           

Net income

   $ 461,637    $ 35,324    $ 107,158    $ 604,119
                           

Loans held for investment

   $ 51,127,654    $ 21,158,797    $ 26,623,519    $ 98,909,970

(1) Income statement adjustments for the three months ended September 30, 2007 reclassify the net of finance charges of $1,659.5 million, past due fees of $262.7 million, other interest income of $(42.7) million and interest expense of $700.5 million; and net charge-offs of $547.3 million to non-interest income from net interest income and provision for loan and lease losses, respectively.

Income statement adjustments for the three months ended September 30, 2006 reclassify the net of finance charges of $1,357.3 million, past due fees of $229.0 million, other interest income of $(55.5) million and interest expense of $607.5 million; and net charge-offs of $437.3 million to non-interest income from net interest income and provision for loan losses, respectively.

 

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Table of Contents

Total Company

   Nine Months Ended September 30, 2007
  

National

Lending

  

Local

Banking

   

Other

   

Total

Managed

  

Securitization

Adjustments (1)

   

Total

Reported

Net interest income

   $ 6,414,011    $ 1,742,959     $ (137,733 )   $ 8,019,237    $ (3,251,639 )   $ 4,767,598

Non-interest income

     3,627,784      605,926       (34,174 )     4,199,536      1,696,347       5,895,883

Provision for loan and lease losses

     2,914,452      (10,580 )     (6,288 )     2,897,584      (1,555,292 )     1,342,292

Restructuring expenses

     —        —         110,428       110,428      —         110,428

Other non-interest expenses

     4,156,058      1,646,450       29,867       5,832,375      —         5,832,375

Income tax provision (benefit)

     1,022,271      248,853       (162,845 )     1,108,279      —         1,108,279
                                            

Net income (loss)

   $ 1,949,014    $ 464,162     $ (143,069 )   $ 2,270,107    $ —       $ 2,270,107
                                            

Loans held for investment

   $ 102,556,271    $ 42,233,665     $ (21,375 )   $ 144,768,561    $ (50,980,053 )   $ 93,788,508

Total deposits

   $ 2,295,131    $ 73,419,558     $ 7,628,125     $ 83,342,814      —       $ 83,342,814

Total Company

   Nine Months Ended September 30, 2006
  

National

Lending

  

Local

Banking

    Other    

Total

Managed

  

Securitization

Adjustments (1)

   

Total

Reported

Net interest income

   $ 5,887,279    $ 752,350     $ (46,008 )   $ 6,593,621    $ (2,895,147 )   $ 3,698,474

Non-interest income

     3,418,912      334,050       (56,027 )     3,696,935      1,632,614       5,329,549

Provision for loan and lease losses

     2,197,012      21,948       6,854       2,225,814      (1,262,533 )     963,281

Restructuring expenses

     —        —         —         —        —         —  

Other non-interest expenses

     4,096,576      860,063       24,366       4,981,005      —         4,981,005

Income tax provision (benefit)

     1,054,750      71,536       (66,314 )     1,059,972      —         1,059,972
                                            

Net income (loss)

   $ 1,957,853    $ 132,853     $ (66,941 )   $ 2,023,765    $ —       $ 2,023,765
                                            

Loans held for investment

   $ 98,909,970    $ 13,326,088     $ 2,488     $ 112,238,546    $ (48,626,377 )   $ 63,612,169

Total deposits

   $ 2,461,941    $ 35,163,849     $ 9,987,360     $ 47,613,150    $ —       $ 47,613,150

 

National Lending sub-segment detail

   Nine Months Ended September 30, 2007
   U.S. Card   

Auto

Finance

  

Global

Financial

Services

  

Total

National

Lending

Net interest income

   $ 3,757,975    $ 1,123,613    $ 1,532,423    $ 6,414,011

Non-interest income

     2,596,536      97,373      933,875      3,627,784

Provision for loan and lease losses

     1,438,853      626,873      848,726      2,914,452

Non-interest expenses

     2,485,259      474,267      1,196,532      4,156,058

Income tax provision

     836,057      41,227      144,987      1,022,271
                           

Net income

   $ 1,594,342    $ 78,619    $ 276,053    $ 1,949,014
                           

Loans held for investment

   $ 49,573,279    $ 24,335,242    $ 28,647,750    $ 102,556,271

 

National Lending sub-segment detail

   Nine Months Ended September 30, 2006
   U.S. Card   

Auto

Finance

  

Global

Financial

Services

  

Total

National

Lending

Net interest income

   $ 3,521,274    $ 1,021,560    $ 1,344,445    $ 5,887,279

Non-interest income

     2,459,800      67,241      891,871      3,418,912

Provision for loan and lease losses

     1,089,921      343,664      763,427      2,197,012

Non-interest expenses

     2,604,665      437,784      1,054,127      4,096,576

Income tax provision

     800,272      107,573      146,905      1,054,750
                           

Net income

   $ 1,486,216    $ 199,780    $ 271,857    $ 1,957,853
                           

Loans held for investment

   $ 51,127,654    $ 21,158,797    $ 26,623,519    $ 98,909,970

(1)

Income statement adjustments for the nine months ended September 30, 2007 reclassify the net of finance charges of $4,686.1 million, past due fees of $703.0 million, other interest income of $(120.6) million and interest expense of $2,016.9 million; and net charge-offs of $1,555.3 million to non-interest income from net interest income and provision for loan and lease losses, respectively.

 

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Income statement adjustments for the nine months ended September 30, 2006 reclassify the net of finance charges of $4,062.6 million, past due fees of $722.5, other interest income of $(178.8) million and interest expense of $1,711.2 million; and net charge-offs of $1,262.5 million to non-interest income from net interest income and provision for loan losses, respectively.

Note 5

Comprehensive Income

Comprehensive income for the three months ended September 30, 2007 and 2006, respectively was as follows:

 

     Three Months Ended
September 30
     2007     2006

Comprehensive Income:

    

Net (loss) income

   $ (81,658 )   $ 587,839

Other comprehensive income, net of tax

     100,753       113,807
              

Total comprehensive income

   $ 19,095     $ 701,646
              

Note 6

Earnings Per Share

The following table sets forth the computation of basic and diluted earnings per share:

 

     Three Months Ended
September 30
  

Nine Months Ended

September 30

     2007     2006    2007     2006

Numerator:

         

Income from continuing operations, net of tax

   $ 816,371     $ 587,839    $ 2,270,107     $ 2,023,765

(Loss) from discontinued operations, net of tax

     (898,029 )     —        (926,343 )     —  
                             

Net (loss) income

   $ (81,658 )   $ 587,839    $ 1,343,764     $ 2,023,765
                             

Denominator:

         

Denominator for basic earnings per share - Weighted-average shares

     386,133       301,571      395,199       300,524

Effect of dilutive securities:

         

Stock options

     3,772       7,520      5,088       8,056

Contingently issuable shares

     —         —        255       —  

Restricted stock

     939       1,294      710       1,223
                             

Dilutive potential common shares

     4,711       8,814      6,053       9,279

Denominator for diluted earnings per share - Adjusted weighted-average shares

     390,844       310,385      401,252       309,803
                             

Basic earnings per share

         

Income from continuing operations

     2.11       1.95      5.74       6.73

(Loss) from discontinued operations

     (2.32 )     —        (2.34 )     —  
                             

Net (loss) income

   $ (0.21 )   $ 1.95    $ 3.40     $ 6.73
                             

Diluted earnings per share

         

Income from continuing operations

     2.09       1.89      5.66       6.53

(Loss) from discontinued operations

     (2.30 )     —        (2.31 )     —  
                             

Net (loss) income

   $ (0.21 )   $ 1.89    $ 3.35     $ 6.53
                             

 

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Note 7

Goodwill and Other Intangible Assets

The following table provides a summary of goodwill.

 

Total Company

  

National

Lending

  

Local

Banking

    Other     Discontinued
Operations
    Total  

Balance at December 31, 2006

   $ 2,278,880    $ 1,623,928     $ 9,732,627     $ —       $ 13,635,435  

Transfers

     4,804,007      4,278,620       (9,732,627 )     650,000       —    

Additions

     —        —         —         —         —    

Adjustments

     —        (28,924 )     —         —         (28,924 )

Disposals

     —        (9,151 )     —         (650,000 )     (659,151 )

Foreign Currency Translation

     5,478      —         —         —         5,478  
                                       

Balance at September 30, 2007

   $ 7,088,365    $ 5,864,473     $ —       $ —       $ 12,952,838  
                                       

 

National Lending Detail

   U.S. Card   

Auto

Finance

  

Global

Financial

Services

   National
Lending Total

Balance at December 31, 2006

   $ 762,284    $ 763,648    $ 752,948    $ 2,278,880

Transfers

     2,368,716      1,341,339      1,093,952      4,804,007

Additions

     —        —        —        —  

Adjustments

     —        —        —        —  

Disposals

     —        —        —        —  

Foreign Currency Translation

     —        —        5,478      5,478
                           

Balance at September 30, 2007

   $ 3,131,000    $ 2,104,987    $ 1,852,378    $ 7,088,365
                           

As of December 1, 2006, the Company acquired North Fork Bancorporation, Inc., a commercial and retail bank in New York, which created $9.7 billion of goodwill. The goodwill associated with the acquisition of North Fork was held in the Other category at December 31, 2006. The North Fork acquisition goodwill was allocated across the operating segments during the first quarter of 2007, based on an increase in the relative fair value of each respective segment resulting from the acquisition.

For the nine months ended September 30, 2007, purchase accounting adjustments to assets of $29.3 million, liabilities of $(39.2) million and to equity of $(10.4) million associated with the acquisition of North Fork in 2006, and adjustments to liabilities of $(7.3) million and to equity of $(1.3) million associated with the acquisition of Hibernia in 2005, were made to the Local Banking segment. In addition, $9.2 million of goodwill associated with the divestiture of one its subsidiaries, Hibernia Insurance Agency, was removed from the Local Banking segment.

Goodwill impairment is tested at the reporting unit level, which is an operating segment or one level below on an annual basis in accordance with Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets. In the third quarter of 2007, the Company shutdown the mortgage origination operations of its wholesale mortgage banking unit, GreenPoint. As a result of the closure of the mortgage originations business, a goodwill impairment loss of $650.0 million ($646.0 million after tax) was recognized as part of discontinued operations.

For the nine months ended September 30, 2007, no additional impairment on goodwill was required to be recognized.

In connection with the acquisitions of Hibernia and North Fork, the Company recorded intangible assets that consisted of core deposit intangibles, trust intangibles, lease intangibles, and other intangibles, which are subject to amortization. The core deposit and trust intangibles reflect the estimated value of deposit and trust relationships. The lease intangibles reflect the difference between the contractual obligation under current lease contracts and the fair market value of the lease contracts at the acquisition date. The other intangible items relate to customer lists, brokerage relationships and insurance contracts. The following table summarizes the Company’s purchase accounting intangible assets subject to amortization.

 

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     September 30, 2007
    

Gross

Carrying

Amount

  

Accumulated

Amortization

   

Net Carrying

Amount

  

Amortization

Period

Core deposit intangibles

   $ 1,320,000    $ (254,504 )   $ 1,065,496    10.4 years

Lease intangibles

     46,527      (8,600 )     37,927    7.8 years

Trust intangibles

     10,500      (2,071 )     8,429    16.3 years

Other intangible

     8,576      (2,546 )     6,030    10.3 years
                          

Total

   $ 1,385,603    $ (267,721 )   $ 1,117,882   
                          

Intangibles are amortized on an accelerated basis over their respective estimated useful lives. Intangible assets are recorded in Other assets on the balance sheet. Amortization expense related to purchase accounting intangibles totaled $55.0 million and $167.8 million for the three months and nine months ended September 30, 2007. Amortization expense for intangibles is recorded to non-interest expense. The weighted average amortization period for all purchase accounting intangibles is 10.3 years.

Note 8

Mortgage Servicing Rights

Mortgage Servicing Rights (“MSRs”), are recognized when mortgage loans are sold in the secondary market and the right to service these loans are retained for a fee, and are carried at fair value; changes in fair value are recognized in mortgage servicing and other. The Company continues to operate the mortgage servicing business and to report the changes in the fair value of MSRs in continuing operations. To evaluate and measure fair value, the underlying loans are stratified based on certain risk characteristics, including loan type, note rate and investor servicing requirements. The following table sets forth the changes in the fair value of mortgage servicing rights:

 

Mortgage Servicing Rights:

 

Three Months Ended

September 30, 2007

   

Nine Months Ended

September 30, 2007

 

Balance, Beginning of period

  $ 316,031     $ 252,295  

Cumulative effect adjustment for the adoption of FAS 156

    —         15,187  

Originations

    18,342       64,503  

Sales

    (961 )     (2,676 )

Change in fair value

    (34,133 )     (30,030 )
               

Balance at September 30, 2007

  $ 299,279     $ 299,279  
               

Ratio of Mortgage Servicing Rights to Related Loans Serviced for Others

    1.00 %     1.00 %

Weighted Average Service Fee

    0.28       0.28  

The significant assumptions used in estimating the fair value of the servicing assets at September 30, 2007 were as follows:

 

    

September 30,

2007

 

Weighted average prepayment rate (includes default rate)

   23.91 %

Weighted average life (in years)

   4.0  

Discount rate

   10.47 %

At September 30, 2007, the sensitivities to immediate 10% and 20% increases in the weighted average prepayment rates would decrease the fair value of mortgage servicing rights by $14.1 million and $26.6 million, respectively.

As of September 30, 2007, the Company’s mortgage loan servicing portfolio consisted of mortgage loans with an aggregate unpaid principal balance of $45.0 billion, of which $30.8 billion was serviced for investors other than the Company.

Note 9

Commitments, Contingencies and Guarantees

Letters of Credit and Financial Guarantees

The Company issues letters of credit (both standby and commercial) and financial guarantees to meet the financing needs of its customers. Standby letters of credit and financial guarantees written are conditional commitments issued by the Company to guarantee the performance of a customer to a third party in a borrowing arrangement. Commercial letters of credit are

 

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short-term commitments issued primarily to facilitate trade finance activities for customers and are generally collateralized by the goods being shipped to the client. Collateral requirements are similar to those for funded transactions and are established based on management’s credit assessment of the customer. Management conducts regular reviews of all outstanding standby letters of credit and customer acceptances, and the results of these reviews are considered in assessing the adequacy of the Company’s allowance for loan and lease losses.

The Company had contractual amounts of standby letters of credit, commercial letters of credit, and financial guarantees of $1.2 billion at September 30, 2007. As of September 30, 2007, financial guarantees had expiration dates ranging from 2007 to 2009. The fair value of the guarantees outstanding at September 30, 2007 that have been issued since January 1, 2003, was $3.0 million and was included in other liabilities.

Industry Litigation

Over the past several years, MasterCard International and Visa U.S.A., Inc., as well as several of their member banks, have been involved in several different lawsuits challenging various practices of MasterCard and Visa.

In 1998, the United States Department of Justice filed an antitrust lawsuit against the MasterCard and Visa membership associations composed of financial institutions that issue MasterCard or Visa credit or debit cards (“associations”), alleging, among other things, that the associations had violated antitrust law and engaged in unfair practices by not allowing member banks to issue cards from competing brands, such as American Express and Discover Financial Services. In 2001, a New York district court entered judgment in favor of the Department of Justice and ordered the associations to repeal these policies. The United States Court of Appeals for the Second Circuit affirmed the district court and, on October 4, 2004, the United States Supreme Court denied certiorari in the case. In November 2004, American Express filed an antitrust lawsuit (the “Amex lawsuit”) against MasterCard and Visa and several member banks alleging, among other things, that the defendants jointly and severally implemented and enforced illegal exclusionary agreements that prevented member banks from issuing American Express cards. The complaint requests civil monetary damages, which could be trebled. The Corporation, the Bank, and the Savings Bank are named defendants in this lawsuit.

Separately, a number of entities, each purporting to represent a class of retail merchants, have also filed antitrust lawsuits (the “Interchange lawsuits”) against MasterCard and Visa and several member banks, including the Corporation and its subsidiaries, alleging among other things, that the defendants conspired to fix the level of interchange fees. The complaints request civil monetary damages, which could be trebled. In October 2005, the Interchange lawsuits were consolidated before the United States District Court for the Eastern District of New York for certain purposes, including discovery.

Finally, a number of individual plaintiffs, each purporting to represent a class of cardholders, have filed antitrust lawsuits (the “Fee Antitrust lawsuits”) against several issuing banks, including the Corporation, alleging among other things that the defendants conspired to fix the level of late fees and over-limit fees charged to cardholders, and that these fees are excessive. The complaint requests civil monetary damages, which could be trebled.

We believe that we have meritorious defenses with respect to these cases and intend to defend these cases vigorously. At the present time, management is not in a position to determine whether the resolution of these cases will have a material adverse effect on either the consolidated financial position of the Corporation or the Corporation’s results of operations in any future reporting period.

In addition, several merchants filed class action antitrust lawsuits, which were subsequently consolidated, against the associations relating to certain debit card products. In April 2003, the associations agreed to settle the lawsuit in exchange for payments to plaintiffs and for changes in policies and interchange rates for debit cards. Certain merchant plaintiffs have opted out of the settlements and have commenced separate lawsuits. Additionally, consumer class action lawsuits with claims mirroring the merchants’ allegations have been filed in several courts. Finally, MasterCard and Visa, as well as certain member banks, continue to face additional lawsuits regarding policies, practices, products and fees.

With the exception of the Fee Antitrust lawsuits, the Interchange lawsuits and the Amex lawsuit, the Corporation and its subsidiaries are not parties to the lawsuits against MasterCard and Visa described above and therefore will not be directly liable for any amount related to any possible or known settlements of such lawsuits. However, the Corporation’s subsidiary banks are member banks of MasterCard and Visa and thus may be affected by settlements or lawsuits relating to these issues, including changes in interchange payments. In addition, it is possible that the scope of these lawsuits may expand and that other member banks, including the Corporation’s subsidiary banks, may be brought into the lawsuits or future lawsuits. In part as a result of such litigation, MasterCard and Visa are expected to continue to evolve as corporate entities, including by changing their governance structures as previously announced. During the second quarter of 2006, MasterCard successfully completed its initial public offering and Visa revised its governance structure. Both entities now rely upon independent directors for certain decisions, including the setting of interchange rates.

 

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Given the complexity of the issues raised by these lawsuits and the uncertainty regarding: (i) the outcome of these suits, (ii) the likelihood and amount of any possible judgments, (iii) the likelihood, amount and validity of any claim against the member banks, including the Corporation and its subsidiary banks, (iv) changes in industry structure that may result from the suits and (v) the effects of these suits, in turn, on competition in the industry, member banks, and interchange fees, the Company cannot determine at this time the long-term effects of these suits.

Other Pending and Threatened Litigation

In addition, the Company is commonly subject to various pending and threatened legal actions relating to the conduct of its normal business activities. In the opinion of management, the ultimate aggregate liability, if any, arising out of any such pending or threatened legal actions will not be material to its consolidated financial position or its results of operations.

Tax issues for years 1995-1999 are pending in the U.S. Tax Court. The ultimate resolution of these issues is not expected to have a material effect upon the Company’s operations or financial condition.

Note 10

Restructuring

During the second quarter of 2007, the Company announced a broad-based initiative to reduce expenses and improve the competitive cost position of the Company. The 2007 cost initiative includes actions already taken during the second and third quarters of 2007 across the Company.

Restructuring initiatives leverage the capabilities of recently completed infrastructure projects in several of the Company’s businesses. The scope and timing of the expected cost reductions are the result of an ongoing, comprehensive review of operations within and across the Company’s businesses, which began earlier in 2007.

The Company anticipates recording charges of approximately $300.0 million pre-tax over the course of the cost reduction initiative. Approximately $150.0 million of these charges are related to severance benefits, while the remaining charges are associated with items such as contract and lease terminations and consolidation of facilities and infrastructure.

In 2007, expected pre-tax charges related to the cost restructuring initiative are approximately $150.0 million.

Restructuring expenses associated with continuing operations were comprised of the following:

 

    

Three months

ended

September 30,

2007

  

Nine months

ended

September 30,

2007

Restructuring Expenses:

     

Employee termination benefits

   $ 16,620    $ 65,463

Occupancy

     —        4,012

Supplies and equipment

     —        17,207

Marketing

     —        1,372

Other

     2,734      22,374
             

Total Restructuring Expenses

   $ 19,354    $ 110,428
             

Employee termination benefits include charges for executives of the Company for the three and nine months ended September 30, 2007 of $5.2 million and $12.8 million, respectively. Employee termination benefits include charges for associates of the Company for the three and nine months ended September 30, 2007 of $11.4 million and $52.7 million, respectively.

Included in the $22.4 million of other restructuring expenses for the nine months ended September 30, 2007 are $15.0 million of contract termination costs and $4.6 million of software impairment.

 

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Expenses related to the Company’s 2007 cost initiative for the three and nine months ended September 30, 2007 were recorded as part of non-interest expense in continuing operations. $10.1 million of the second quarter’s restructuring expenses relating to GreenPoint’s origination business has been reclassified from restructuring expenses to loss from discontinued operations. These charges consisted of employee termination benefits of $4.7 million, occupancy of $4.4 million, and supplies and equipment of $1.0 million. The restructuring accrual included $4.4 million of charges related to GreenPoint at June 30, 2007, which was adjusted during the third quarter.

The Company made $7.2 million and $10.9 million in cash payments for restructuring charges during the three and nine months ended September 30, 2007 that related to employee termination benefits. Restructuring accrual activity associated with the Company’s 2007 cost initiative for the three and nine months ended September 30, 2007 was as follows:

 

    

Three months

ended

September 30,

2007

   

Nine months

ended

September 30,

2007

 

Restructuring accrual activity:

    

Balance, beginning of period

   $ 69,937     $ —    

Restructuring charges

     19,354       110,428  

Cash payments

     (7,165 )     (10,871 )

Noncash write-downs and other adjustments

     (13,704 )     (31,135 )
                

Balance, end of period

   $ 68,422     $ 68,422  
                

Note 11

Accelerated Share Repurchase Program

On March 12, 2007, the Company entered into a $1.5 billion accelerated share repurchase (“ASR”) agreement with Credit Suisse, New York Branch (“CSNY”). The ASR agreement was entered into pursuant to the Company’s $3.0 billion stock repurchase program announced on January 25, 2007. Under the ASR agreement, the Company purchased $1.5 billion dollars of its $.01 par value common stock at an initial price of $73.57 per share, the closing price of the Company’s common stock on the New York Stock Exchange on April 2, 2007, the effective date of the agreement. The ASR program was accounted for as an initial treasury stock transaction and a forward stock purchase contract. The initial repurchase of shares resulted in an immediate reduction of the outstanding shares used to calculate the weighted-average common shares outstanding for basic and diluted EPS on the effective date of the agreement. The forward stock purchase contract was classified as an equity instrument and was deemed to have a fair value of $0 at the effective date. The impact of the ASR on basic and diluted EPS for the three months ended September 30, 2007 was $(0.01). The impact on basic and diluted EPS for the nine months ended September 30, 2007 was $0.11. The impact of the ASR on basic and diluted EPS from continuing operations for the three months ended September 30, 2007 was $0.11 and $0.10, respectively. The impact on basic and diluted EPS from continuing operations for the nine months ended September 30, 2007 was $0.18.

An ASR combines the immediate share retirement benefits of a tender offer with the market impact and pricing benefits of an open stock repurchase program. The ASR agreement provided that the Company or CSNY would be obligated to make certain additional payments upon final settlement of the ASR agreement. Most significantly, the Company would receive from, or be required to pay, CSNY a purchase price adjustment based on the daily volume weighted average market price of the Company’s common stock over a period beginning after the effective date of the agreement through on or around August 22, 2007. These additional payments to be satisfied in shares of the Company’s common stock. On August 27, 2007, the ASR program terminated with the delivery of 343,512 shares back to CSNY for a net share retirement of 20,045,233 shares.

The arrangements were intended to comply with Rules 10b5-1(c)(1)(i) and 10b-18 of the Securities Exchange Act of 1934, as amended. In addition to the $1.5 billion ASR, the Company repurchased $0.48 billion and $0.73 billion of shares in an open market repurchase, during the three months and nine months ended September 30, 2007, respectively.

Additional share repurchase information is included in Part 1, Item 2. Section V, Management Summary, Q3 2007 Significant Events and Part 2, Item 2. “Unregistered Sales of Equity Securities and Uses of Proceeds.”

 

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Note 12

Subsequent Events

Sale of interest in Spanish Market

On October 1, 2007 the Company completed the sale of its interest in a relationship agreement to develop and market consumer credit products in the Spanish Market. The gain related to this sale was approximately $30 million and will be recorded in non-interest income in the fourth quarter.

 

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

(Dollars in thousands) (yields and rates presented on an annualized basis)

I. Introduction

We are a diversified financial services company whose banking and non-banking subsidiaries market a variety of financial products and services.

We are delivering on our strategy of combining the power of national scale lending and local scale banking. As of September 30, 2007, we had $83.3 billion in deposits and $146.4 billion in managed loans held for investment.

Our earnings are primarily driven by lending to consumers, small business and commercial customers and by deposit-taking activities which generate net interest income, and by activities that generate non-interest income, including the servicing of loans and providing fee-based services to customers. Customer usage and payment patterns, credit quality, levels of marketing expense, operating efficiency all affect our profitability.

Our primary expenses are the costs of funding assets, 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.

II. Critical Accounting Estimates

See our Annual Report on Form 10-K for the year ended December 31, 2006, Part I, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for a summary of our critical accounting estimates.

The methodology applied to our estimate for income taxes has changed due to the implementation of a new accounting pronouncement as described below.

Income Taxes

In June 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109 (“FIN 48”), which we adopted on January 1, 2007. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in accordance with SFAS No. 109, Accounting for Income Taxes, and prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return.

Under FIN 48, we may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained upon examination by the taxing authorities, including resolution of any related appeals or litigation processes, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured at the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. The impact of the reassessment of our tax positions in accordance with FIN 48 did not have a material impact on the results of operations, financial position, or liquidity.

Additional information is included in this Quarterly Report under the heading “Notes to Condensed Reported Consolidated Financial Statements – Note 1 – Summary of Significant Accounting Policies.”

III. Off-Balance Sheet Arrangements

See our Annual Report on Form 10-K for the year ended December 31, 2006, Part III, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for a summary of our off-balance sheet arrangements.

Of our total managed loans, 35% and 43% were included in off-balance sheet securitizations for the periods ended September 30, 2007 and September 30, 2006, respectively.

IV. Reconciliation to GAAP Financial Measures

Our consolidated reported financial statements are prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) are referred to as our “reported” financial statements. Loans included in securitization transactions which qualify as sales under GAAP have been removed from our “reported” balance sheet. However, servicing fees, finance charges, and other fees, net of charge-offs, and interest paid to investors of securitizations are recognized as servicing and securitizations income on the “reported” income statement.

 

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Our “managed” consolidated financial statements reflect adjustments made related to effects of securitization transactions qualifying as sales under GAAP. We generate earnings from our “managed” loan portfolio which includes both the on-balance sheet loans and off-balance sheet loans. Our “managed” income statement takes the components of the servicing and securitizations income generated from the securitized portfolio and distributes the revenue and expense to appropriate income statement line items from which it originated. For this reason, we believe the “managed” consolidated financial statements and related managed metrics to be useful to stakeholders.

 

     As of and for the three months ended September 30, 2007

(Dollars in thousands)

   Total Reported   

Securitization

Adjustments(1)

    Total Managed(2)

Income Statement Measures (3)

       

Net interest income

   $ 1,624,474    $ 1,178,964     $ 2,803,438

Non-interest income

     2,149,662      (631,673 )     1,517,989
                     

Total revenue

     3,774,136      547,291       4,321,427

Provision for loan losses

     595,534      547,291       1,142,825

Net charge-offs

   $ 480,065    $ 547,291     $ 1,027,356
                     

Balance Sheet Measures

       

Loans Held for Investment

   $ 95,405,217    $ 50,980,053     $ 146,385,270

Total assets

   $ 147,154,835    $ 50,135,190     $ 197,290,025

Average loans Held for Investment

   $ 92,450,865    $ 52,036,422     $ 144,487,287

Average earning assets

   $ 121,169,771    $ 49,884,042     $ 171,053,813

Average total assets

   $ 147,884,578    $ 51,237,294     $ 199,121,872

Delinquencies

   $ 3,077,211    $ 2,020,368     $ 5,097,579
                     

(1) Income statement adjustments reclassify the net of finance charges of $1,659.5 million, past-due fees of $262.7 million, other interest income of $(42.7) million and interest expense of $700.5 million; and net charge-offs of $547.3 million from Non-interest income to Net interest income and Provision for loan losses, respectively.
(2) The managed loan portfolio does not include auto loans which have been sold in whole loan sale transactions where the Company has retained servicing rights.
(3) Based on continuing operations.

V. Management Summary

In the third quarter of 2007, the Company shutdown the mortgage origination operations of its wholesale mortgage banking unit, GreenPoint. The results of the mortgage origination operations are being reported as discontinued operations for each period presented. The results of operations of GreenPoint’s mortgage servicing business are reported as continuing operations for each period presented. Additional information is included in this Quarterly Report under the heading “Notes to Condensed Reported Consolidated Financial Statements – Note 2 – Discontinued Operations.”

We recorded a loss of $81.6 million for the third quarter of 2007, $816.4 million in income from continuing operations, and a $898.0 million loss from discontinued operations, net of tax.

The following discussion provides a summary of the third quarter of 2007 results compared to the same period in the prior year. All the comparisons are based on continuing operations.

Three Months Ended September 30, 2007 Compared to Three Months Ended September 30, 2006

We had net income for the quarter of $816.4 million, an increase of $228.5 million from the third quarter of 2006. Diluted EPS increased 11% to $2.09 per share. 2007 results include the impact of the North Fork Bank acquisition that was completed on December 1, 2006.

 

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Key factors in the third quarter 2007 results compared to the third quarter of 2006 include:

 

   

Net interest income grew 25% or $330.0 million as a result of increased margins driven mainly by selective pricing changes in the U.S. Card portfolio, modest loan volume growth, and the acquisition of North Fork in 2006.

 

   

Provision for loan and lease losses increased by 38%, due primarily to the continued normalization of charge-offs.

 

   

Non interest income for the quarter increased 22%, driven by a combination of increases in servicing and securitization income, service charges and other customer-related fees, mortgage servicing and other, and other non interest income, offset by a decrease in interchange.

 

   

Non-interest expense increased $207.6 million for the three months ended September 30, 2007. The increase in operating expense was driven by the addition of North Fork Bank’s operating expenses, CDI amortization and integration expenses associated with our bank acquisitions, and restructuring charges associated with our 2007 cost initiative.

 

   

The change in EPS was positively impacted by an increase in income from continuing operations and the impact of share repurchases that were executed in the second and third quarters of 2007 offset by the net of the incremental shares that were issued as part of the North Fork Bank acquisition.

Managed loans held for investment as of September 30, 2007 were $144.8 billion, up 29% or $32.5 billion from September 30, 2006. This increase in loan growth is primarily attributable to the acquisition of North Fork in December 2006.

We ended the third quarter of 2007 with $83.3 billion in total deposits, up $35.7 billion, or 75% from September 30, 2006. These deposits represent 48% of the total managed liabilities. The increase in deposits is attributable to the acquisition of North Fork in December 2006.

Q3 2007 Significant Events

Share Repurchase

During the third quarter the $1.5 billion ASR agreement terminated with the delivery of 343,512 shares back to CSNY for a net share retirement of 20,045,233 shares. During the third quarter we also executed $0.48 billion of shares in an open market repurchase. Additional information is included in this Quarterly Report under the heading “Notes to Condensed Reported Consolidated Financial Statements – Note 11 – Accelerated Share Repurchase Program” and Part 2, Item 2. “Unregistered Sales of Equity Securities and Uses of Proceeds”.

Senior Note Issuance

During the third quarter, we closed the public offering of $1,500,000,000 aggregate principal amount of our Senior Notes Due 2017 (the “Notes”). The Notes were issued pursuant to a Senior Indenture dated as of November 1, 1996 (the “Indenture”) between the Corporation and The Bank of New York Trust Company, N.A. (as successor to Harris Trust and Savings Bank), as Indenture Trustee. Proceeds from the sale of the notes will be used for general corporate purposes, which may include repurchases of shares of our common stock.

Restructuring Associated with 2007 Cost Initiative

During the second quarter of 2007, we announced a broad-based initiative to reduce expenses and improve our competitive cost position. We recognized $19.4 million in restructuring charges in the third quarter of 2007. Additional information is included in this Quarterly Report under the heading “Notes to Condensed Reported Consolidated Financial Statements – Note 10 – Restructuring”.

Shutdown of Mortgage Origination Operations of Wholesale Mortgage Banking Unit

In the third quarter of 2007, the Company shutdown the mortgage origination operations of its wholesale mortgage banking unit, GreenPoint realizing an after-tax loss of $898.0 million. GreenPoint was acquired by the Company in December 2006 as part of the North Fork acquisition. The results of the mortgage origination operations of GreenPoint have been accounted for as a discontinued operation and have been removed from the Company’s results of continuing operations for 2007.

 

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The results of GreenPoint’s mortgage servicing business continue to be reported as part of the Company’s results of continuing operations. These results are included in the Company’s Local Banking Segment for each period presented in 2007.

Summary of the Reported Income Statement

The following is a detailed description of the financial results reflected in Table 1 – Financial Summary. Additional information is provided in section XIII, Tabular Summary as detailed in sections below.

All quarterly comparisons are made between the three month period ended September 30, 2007 and the three month period ended September 30, 2006, unless otherwise indicated.

All year to date comparisons are made between the nine month period ended September 30, 2007 and the nine month period ended September 30, 2006, unless otherwise indicated.

Net interest income

Net interest income is comprised of interest income and past-due fees earned and deemed collectible from loans and income earned on securities, less interest expense on interest-bearing deposits, senior and subordinated notes and other borrowings.

For the three months ended September 30, 2007, reported net interest income increased 25%, or $330.0 million. For the nine months ended September 30, 2007, reported net interest income increased 29%, or $1,069.1 million. The increase in Net Interest Income was driven by the acquisition of North Fork Bank, modest loan growth, and increased margins in the U.S. Card sub-segment due to selective pricing changes implemented after the completion of our card holder system conversion. Net interest margin decreased 84 and 86 basis points for the three and nine months ended September 30, 2007, respectively, primarily due to the addition of the North Fork portfolio.

For additional information, see section XIII, Tabular Summary, Table A (Statements of Average Balances, Income and Expense, Yields and Rates) and Table B (Interest Variance Analysis).

Non-interest income

Non-interest income is comprised of servicing and securitizations income, service charges and other customer-related fees, mortgage servicing and other income, interchange income and other non-interest income.

For the three and nine months ended September 30, 2007, non-interest income increased 22% and 11%, respectively. See detailed discussion of the components of non-interest income below.

Servicing and Securitizations Income

Servicing and securitizations income represents servicing fees, excess spread and other fees resulting from the off-balance sheet loan portfolio, adjustments to the fair value of retained interests resulting from securitization transactions, as well as gains and losses resulting from securitization and other sales transactions.

Servicing and securitizations income increased 26% and 10%, respectively, for the three and nine months ended September 30, 2007. For the three months ended September 30, 2007, the increase was primarily driven by an increase in off-balance sheet funding activity partially offset by an increase in charge-offs. The increase of servicing and securitizations income for the nine months ended September 30, 2007 was due to higher gains on sales from an increase in off-balance sheet funding activity and an increase of finance charge income offset by continued normalization of credit losses.

Service Charges and Other Customer-Related Fees

For the three and nine months ended September 30, 2007, service charges and other customer-related fees grew 14%, due to the inclusion of North Fork and pricing changes in the U.S. Card sub-segment.

Mortgage Servicing and Other

Mortgage servicing and other is comprised of non-interest income related to our continuing mortgage servicing business and other mortgage related income. For the three months ended September 30, 2007, mortgage servicing and other income grew 18%, or $8.1 million. For the nine months ended September 30, 2007, mortgage servicing and other income grew 46%, or $54.1 million, driven by the acquisition of North Fork in 2006.

 

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Interchange

Interchange income, net of rewards expense, decreased 31% and 13%, respectively, for the three and nine months ended September 30, 2007. Costs associated with our rewards programs increased 29% and decreased 10%, respectively, for the three and nine months ended September 30, 2007. Purchase volumes increased 0.3% and 4% for the three and nine months ended September 30, 2007, respectively.

Other Non-Interest Income

Other non-interest income includes, among other items, gains and losses on sales of securities, gains and losses associated with hedging transactions, service provider revenue generated by our healthcare finance business, gains on the sale of auto loans and income earned related to purchased charged-off loan portfolios.

Other non-interest income for the three and nine months ended September 30, 2007, increased $80.4 million and $70.2 million, respectively. The increase in Other Non-Interest income for the three months ended September 30, 2007 is primarily driven by the acquisition of North Fork in December 2006. Additionally, the increase in Other Non-Interest income for the nine months ended September 30, 2007 is due to a $46.2 million gain from the sale of a stake in DealerTrack Holding Inc. in the first quarter of 2007, offset by a $59.8 million gain from the sale of purchased charged-off loan portfolios in 2006.

Provision for loan and lease losses

Provision for loan and lease losses increased 38% and 39%, respectively, for the three and nine months ended September 30, 2007. The increases in the provision are as a result of the continued normalization of consumer credit, the mix effects of the our planned decline in prime revolving credit card loans and continued elevated losses in our auto finance sub-segment, and the increase in our coverage ratio of allowance to loans held for investment in anticipation of future credit losses.

Non-interest expense

Non-interest expense consists of marketing, operating, and restructuring expenses.

For the three months ended September 30, 2007, non-interest expense increased 12%, reflecting a 18% increase in operating expenses and a 10% decrease in marketing expense. Non-interest expense increased $207.6 million to $1.9 billion for the three months ended September 30, 2007. For the nine months ended September 30, 2007, non-interest expense increased 19%, reflecting a 26% increase in operating expenses and a 6% decrease in marketing expenses. Non-interest expense increased $961.8 million to $5.9 billion for the nine months ended September 30, 2007. The increase in operating expense was driven by the addition of North Fork Bank’s operating expenses, CDI amortization and integration expenses associated with our bank acquisitions, restructuring charges associated with our 2007 cost initiative, and the accelerated vesting of restricted stock related to the transition to new management in our Banking business.

Income taxes

The Company’s effective income tax rate on income from continuing operations was 34.4% and 32.8% for the three and nine month periods ended September 30, 2007, respectively, compared to 34.6% and 34.4% for the same periods in the prior year. The effective rate includes state, federal and international income tax components. The decrease in the rate for the nine month period ended September 30, 2007 compared to the same period in the prior year was primarily due to changes in the Company’s international tax positions and increases in certain tax credits during the second quarter of 2007.

Loan Portfolio Summary

We analyze our financial performance on a managed loan portfolio basis. The managed loan portfolio is comprised of on-balance sheet and off-balance sheet loans. We have retained servicing rights for our securitized loans and receive servicing fees in addition to the excess spread generated from the off-balance sheet loan portfolio.

Average managed loans held for investment from continuing operations grew $33.2 billion, or 30%, and $36.4 billion, or 34%, respectively, for the three and nine months ended September 30, 2007. The increases in average managed loans held for investment for the three and nine months ended September 30, 2007 was driven by loan growth in the Local Banking segment as a result of the North Fork acquisition in 2006.

 

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For additional information, see section XIII, Tabular Summary, Table C (Managed Consumer Loan Portfolio) and Table D (Composition of Reported Loan Portfolio).

Delinquencies

We believe delinquencies to be an indicator of loan portfolio credit quality at a point in time. The entire balance of an account is contractually delinquent if the minimum payment is not received by the statement cycle date. Delinquencies not only have the potential to impact earnings if the account charges off, but they also result in additional costs in terms of the personnel and other resources dedicated to resolving the delinquencies.

For additional information, see section XIII, Tabular Summary, Table E (Delinquencies).

Net Charge-Offs

Net charge-offs include the principal amount of losses (excluding accrued and unpaid finance charges and fees and fraud losses) less current period principal recoveries. We charge off credit card loans at 180 days past the statement cycle date and generally charge off other consumer loans at 120 days past the due date or upon repossession of collateral. Non-collateralized consumer bankruptcies are typically charged-off within 2-7 days upon notification and in any event within 30 days of notification. Commercial loans are charged-off when the amounts are deemed uncollectible. Costs to recover previously charged-off accounts are recorded as collection expenses in other non-interest expense.

For the three months ended September 30, 2007, the reported and managed net charge-off rates decreased 27 and 6 basis points, respectively, with net charge-off dollars increasing 30% and 27% on a reported and managed basis, respectively, compared to the same period in the prior year. For the nine months ended September 30, 2007, the reported and managed net charge-off rates decreased 25 and 11 basis points, respectively, with net charge-off dollars increasing 36% and 29% on a reported and managed basis, respectively, compared to the same period in the prior year. The increases in net charge-off dollars are due to the normalization of consumer credit from historically low levels in the third quarter of 2006. The decrease in charge-off rates are due to the acquisition of North Fork’s higher credit quality loans.

For additional information, see section XIII, Tabular Summary, Table F (Net Charge-offs).

Nonperforming Assets

Nonperforming loans consist of nonaccrual loans (loans on which interest income is not currently recognized) and restructured loans (loans with below-market interest rates or other concessions due to the deteriorated financial condition of the borrower). Commercial, small business, mortgage and some auto loans are generally placed in nonaccrual status at 90 days past due or sooner if, in management’s opinion, there is doubt concerning the ability to fully collect both principal and interest.

For additional information, see section XIII, Tabular Summary, Table G (Nonperforming Assets).

Allowance for loan and lease losses

The allowance for loan and lease losses is maintained at the amount estimated to be sufficient to absorb probable principal losses, net of principal recoveries (including recovery of collateral), inherent in the existing reported loan portfolios. The provision for loan and lease losses is the periodic cost of maintaining an adequate allowance. The amount of allowance necessary is based on distinct allowance methodologies depending on the type of loans which include specifically identified criticized loans, migration analysis, forward loss curves and historical loss trends. In evaluating the sufficiency of the allowance for loan and lease losses, management takes into consideration the following factors: recent trends in delinquencies and charge-offs; forecasting uncertainties and size of credit risks; the degree of risk inherent in the composition of the loan portfolio; economic conditions; legal and regulatory guidance; credit evaluations and underwriting policies; seasonality; and the value of collateral supporting the loans. To the extent credit experience is not indicative of future performance or other assumptions used by management do not prevail, loss experience could differ significantly, resulting in either higher or lower future provision for loan and lease losses, as applicable. The evaluation process for determining the adequacy of the allowance for loan and lease losses and the periodic provisioning for estimated losses is undertaken on a quarterly basis, but may increase in frequency should conditions arise that would require our prompt attention. Conditions giving rise to such action are business combinations or other acquisitions or dispositions of large quantities of loans, dispositions of non-performing and marginally performing loans by bulk sale or any development which may indicate an adverse trend.

The allowance for loan and lease losses related to Loans held for investment from continuing operations increased $124.2 million since June 30, 2007, excluding the $75.8 million allowance related to certain GreenPoint mortgage loans transferred to held for investment at September 30, 2007. The increase is driven primarily by an increase in Loans held for investment

 

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and continued normalization of charge offs. The coverage ratio of allowance to Loans held for investment increased 7 basis points in the third quarter.

For additional information, see section XIII, Tabular Summary, Table H (Summary of Allowance for Loan and Lease Losses).

VI. Financial Summary

Table 1 provides a summary view of the consolidated income statement and selected metrics for the three and nine month periods ended September 30, 2007 and 2006. Impacts of the North Fork acquisition are included in the Q3 2007 balances.

Table 1: Financial Summary

 

   

As of and for the Three Months Ended

September 30

   

As of and for the Nine Months Ended

September 30

 

(Dollars in thousands)

  2007     2006   Change     2007     2006   Change  

Earnings (Reported):

           

Net interest income

  $ 1,624,474     $ 1,294,515   $ 329,959     $ 4,767,598     $ 3,698,474   $ 1,069,124  

Non-interest income:

           

Servicing and securitizations

    1,354,303       1,071,091     283,212       3,569,281       3,250,201     319,080  

Service charges and other customer-related fees

    522,374       459,125     63,249       1,484,820       1,308,254     176,566  

Mortgage servicing and other

    52,661       44,520     8,141       172,476       118,378     54,098  

Interchange

    103,799       150,474     (46,675 )     347,889       401,503     (53,614 )

Other

    116,525       36,175     80,350       321,417       251,213     70,204  
                                           

Total non-interest income

    2,149,662       1,761,385     388,277       5,895,883       5,329,549     566,334  
                                           

Total Revenue(1)

    3,774,136       3,055,900     718,236       10,663,481       9,028,023     1,635,458  

Provision for loan and lease losses

    595,534       430,566     164,968       1,342,292       963,281     379,011  

Marketing

    332,693       368,498     (35,805 )     989,654       1,048,964     (59,310 )

Restructuring expenses

    19,354       —       19,354       110,428       —       110,428  

Operating expenses

    1,582,174       1,358,131     224,043       4,842,721       3,932,041     910,680  
                                           

Income before taxes

    1,244,381       898,705     345,676       3,378,386       3,083,737     294,649  

Income taxes

    428,010       310,866     117,144       1,108,279       1,059,972     48,307  
                                           

Income from continuing operations, net of tax

    816,371       587,839     228,532       2,270,107       2,023,765     246,342  

(Loss) from discontinued operations, net of tax

    (898,029 )     —       (898,029 )     (926,343 )     —       (926,343 )
                                           

Net (loss) income

  $ (81,658 )   $ 587,839   $ (669,497 )   $ 1,343,764     $ 2,023,765   $ (680,001 )
                                           

Common Share Statistics:

           

Basic EPS:

           

Income from continuing operations

  $ 2.11     $ 1.95   $ 0.16     $ 5.74     $ 6.73   $ (0.99 )

(Loss) from discontinued operations

    (2.32 )     —       (2.32 )     (2.34 )     —       (2.34 )
                                           

(Loss) income

  $ (0.21 )   $ 1.95   $ (2.16 )   $ 3.40     $ 6.73   $ (3.33 )

Diluted EPS

           

Income from continuing operations

  $ 2.09     $ 1.89   $ 0.20     $ 5.66     $ 6.53   $ (0.87 )

(Loss) from discontinued operations

    (2.30 )     —       (2.30 )     (2.31 )     —       (2.31 )
                                           

Net (loss) income

  $ (0.21 )   $ 1.89   $ (2.10 )   $ 3.35     $ 6.53   $ (3.18 )

 

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As of and for the Three Months Ended

September 30

   

As of and for the Nine Months Ended

September 30

 

(Dollars in thousands)

  2007     2006     Change     2007     2006     Change  

Selected Balance Sheet Data(2):

           

Reported loans held for investment (period end)

  $ 93,788,507     $ 63,612,169     $ 30,176,338     $ 93,788,507     $ 63,612,169     $ 30,176,338  

Managed loans held for investment (period end)

    144,768,560       112,238,546       32,530,014       144,768,560       112,238,546       32,530,014  

Reported loans held for investment (average)

    91,744,846       62,428,789       29,316,057       92,111,953       59,816,239       32,295,714  

Managed loans held for investment (average)

    143,781,268       110,512,266       33,269,002       143,501,913       107,091,416       36,410,497  

Allowance for loan and lease losses (period end)

    2,237,046       1,840,000       397,046       2,237,046       1,840,000       397,046  

Interest Bearing Deposits (period end)

    72,502,625       43,467,977       29,034,648       72,502,625       43,467,977       29,034,648  

Total Deposits (period end)

    83,342,814       47,613,150       35,729,664       83,342,814       47,613,150       35,729,664  

Interest Bearing Deposits (average)

    73,555,174       42,983,875       30,571,299       74,542,104       43,044,338       31,497,766  

Total Deposits (average)

  $ 84,884,480     $ 47,195,887     $ 37,688,593     $ 85,874,407     $ 47,421,596     $ 38,452,811  
                                               

Selected Company Metrics (Reported) (2):

           

Return on average assets (ROA)

    2.28 %     2.55 %     -0.27 %     2.12 %     2.99 %     -0.87 %

Return on average equity (ROE) (3)

    12.89 %     14.42 %     -1.53 %     11.94 %     19.40 %     -7.46 %

Net charge-off rate(2)

    2.09 %     2.36 %     -0.27 %     1.90 %     2.15 %     -0.25 %

Net interest margin

    5.52 %     6.36 %     -0.84 %     5.33 %     6.19 %     -0.86 %

Revenue margin

    12.83 %     15.01 %     -2.18 %     11.92 %     15.10 %     -3.18 %
                                               

Selected Company Metrics (Managed) (2):

           

Return on average assets (ROA)

    1.68 %     1.68 %     0.00 %     1.56 %     1.97 %     -0.41 %

Net charge-off rate

    2.86 %     2.92 %     -0.06 %     2.66 %     2.77 %     -0.11 %

Net interest margin

    6.69 %     6.94 %     -0.25 %     6.34 %     7.01 %     -0.67 %

Revenue margin

    10.31 %     10.94 %     -0.63 %     9.67 %     10.94 %     -1.27 %
                                               

(1) In accordance with the Company’s finance charge and fee revenue recognition policy, the amounts billed to customers but not recognized as revenue were $310.5 million and $226.3 million for the three months ended September 30, 2007 and 2006, respectively, and $760.5 million and $612.2 million for the nine months ended September 30, 2007 and 2006, respectively.
(2) Based on continuing operations.
(3) Return on average equity is based on the Company’s stockholder’s equity.

VII. Reportable Segment Summary For Continuing Operations

We manage our business as two distinct operating segments: Local Banking and National Lending. The Local Banking and National Lending segments are considered reportable segments based on quantitative thresholds applied to the managed loan portfolio for reportable segments provided by SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information.

As management makes decisions on a managed basis within each segment, information about reportable segments is provided on a managed basis.

In the third quarter of 2007, the Company shutdown mortgage origination operations of its wholesale mortgage banking unit, GreenPoint. The results of the mortgage origination operations are being reported as discontinued operations for each period presented, and are not included in segment results of the Company. The results of GreenPoint’s mortgage servicing business continue to be reported as part of the Company’s continuing operations. The mortgage servicing function was

 

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moved into the Local Banking Segment in conjunction with the shutdown of the mortgage origination operation, and the results of the Local Banking Segment were restated to include the mortgage servicing results for each period of 2007.

We maintain our books and records on a legal entity basis for the preparation of financial statements in conformity with GAAP. The following table presents information prepared from our internal management information system, which is maintained on a line of business level through allocations from legal entities.

 

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Local Banking Segment

Table 2: Local Banking

 

    

Three Months Ended

September 30, 2007

   

Nine Months Ended

September 30, 2007

 

(Dollars in thousands)

   2007     2006     2007     2006  

Earnings (Managed Basis)

        

Interest income

   $ 1,746,683     $ 719,207     $ 5,211,054     $ 2,052,871  

Interest expense

     1,161,758       461,009       3,468,095       1,300,521  
                                

Net interest income

     584,925       258,198       1,742,959       752,350  

Non-interest income

     195,204       115,526       605,926       334,050  
                                

Total revenue

     780,129       373,724       2,348,885       1,086,400  

Provision for loan and lease losses

     (58,285 )     5,495       (10,580 )     21,948  

Non-interest expense

     543,390       297,080       1,646,450       860,063  
                                

Income before taxes

     295,024       71,149       713,015       204,389  

Income taxes

     102,693       24,902       248,853       71,536  
                                

Net income

   $ 192,331     $ 46,247     $ 464,162     $ 132,853  
                                

Selected Metrics (Managed Basis)

        

Period end loans held for investment

   $ 42,233,665     $ 13,326,088     $ 42,233,665     $ 13,326,088  

Average loans held for investment

   $ 41,992,618     $ 13,171,414     $ 41,983,812     $ 13,190,067  

Core deposits (1)

   $ 63,118,580     $ 26,997,345     $ 63,118,580     $ 26,997,345  

Total deposits

   $ 73,419,558     $ 35,163,849     $ 73,419,558     $ 35,163,849  

Loans held for investment yield

     7.13 %     8.02 %     7.05 %     7.68 %

Net interest margin - loans

     1.79 %     3.30 %     1.86 %     3.25 %

Net interest margin - deposits

     2.09 %     1.62 %     2.03 %     1.58 %

Net charge-off rate

     0.19 %     0.48 %     0.18 %     0.44 %

Non performing loans

   $ 112,794     $ 79,042     $ 112,794     $ 79,042  

Non performing loans as a % of loans held for investment

     0.27 %     0.59 %     0.27 %     0.59 %

Number of active ATMs

     1,282       623       1,282       623  

Number of locations

     732       342       732       342  
                                

(1) Includes domestic non-interest bearing deposits, NOW accounts, money market deposit accounts, savings accounts, certificates of deposit of less than $100,000 and other consumer time deposits.

Beginning in 2006, we added a Banking segment following the acquisition of Hibernia Corporation in late 2005. Banking segment results for the period ended September 30, 2006 include the results of the legacy Hibernia business lines except for the indirect auto business, and the results of our branchless deposit business which were previously included as part of the Other segment. On December 1, 2006, we completed our acquisition of North Fork. Beginning with the results for the quarter ended March 31, 2007, the Banking segment also includes the results of the legacy North Fork business lines except for the indirect auto business and GreenPoint.

The Banking segment contributed $192.3 million and $464.2 million of income for the three and nine months ended September 30, 2007, respectively, compared to $46.2 million and $132.9 million in the comparable periods of the prior year. At September 30, 2007, Loans held for investment in the Banking segment totaled $42.2 billion while deposits outstanding totaled $73.4 billion. Banking segment profits are primarily generated from net interest income, which represents the spread between loan yields and the internal cost of funds charged to the business for those loans, plus the spread between deposit interest costs and the funds transfer price credited to the business for those deposits. Increases in Loans held for investment, deposits and banking segment income over the prior year are a result of the acquisition of North Fork. Loans held for investment interest margins are down from comparable periods in 2006 due primarily to the addition of the North Fork loan portfolio, which contained a higher percentage of lower yielding mortgage loans than the Hibernia portfolio. Deposit interest margins are up over comparable periods in 2006 due to the addition of the lower cost North Fork deposits to the existing Hibernia and Capital One deposits. During the third quarter, the Banking Segment received a higher internal funds transfer cost on certain portions of its loan portfolio while underlying loan yields were relatively flat from the second quarter of 2007.

 

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Likewise, the Banking Segment received a higher internal funds transfer credit during the quarter while underlying deposit costs were relatively flat from the second quarter. These changes in internal funds transfer resulted in slightly lower lending margins but slightly higher deposit margins in the quarter ended September 30, 2007.

Non-interest expenses for the three and nine months ended September 30, 2007 were $543.4 million and $1,646.5 million, respectively, compared to $297.1 million and $860.1 million in the comparable periods of the prior year. Banking segment non-interest expenses include the costs of operating the branch network and commercial and consumer loan businesses, marketing expenses, and certain Company wide expenses allocated to the banking segment. In addition, banking segment non-interest expenses include the amortization of core deposit intangibles related to the acquisitions of both Hibernia and North Fork, as well as the costs of integrating banking segment activities. Non-interest expenses were slightly higher in the quarter ended September 30, 2007 than in the quarter ended June 30, 2007 due primarily to an increase in integration related expenses.

During the quarter ended September 30, 2007, we added a net total of 8 new banking locations and 29 ATMs to our network. These new locations were spread across our New York, New Jersey, Louisiana and Texas footprints.

National Lending Segment

Table 3: National Lending

 

    

Three Months Ended

September 30, 2007

   

Nine Months Ended

September 30, 2007

 

(Dollars in thousands)

   2007     2006     2007     2006  

Earnings (Managed Basis)

        

Interest income

   $ 3,511,878     $ 3,078,097     $ 10,027,516     $ 8,906,863  

Interest expense

     1,232,115       1,089,279       3,613,505       3,019,584  
                                

Net interest income

     2,279,763       1,988,818       6,414,011       5,887,279  

Non-interest income

     1,312,146       1,213,924       3,627,784       3,418,912  
                                

Total revenue

     3,591,909       3,202,742       10,041,795       9,306,191  

Provision for loan and lease losses

     1,196,087       862,375       2,914,452       2,197,012  

Non-interest expense

     1,367,607       1,411,882       4,156,058       4,096,576  
                                

Income before taxes

     1,028,215       928,485       2,971,285       3,012,603  

Income taxes

     352,847       324,366       1,022,271       1,054,750  
                                

Net income

   $ 675,368     $ 604,119     $ 1,949,014     $ 1,957,853  
                                

Selected Metrics (Managed Basis)

        

Period end loans held for investment

   $ 102,556,271     $ 98,909,970     $ 102,556,271     $ 98,909,970  

Average loans held for investment

   $ 101,805,584     $ 97,309,087     $ 101,532,192     $ 93,884,932  

Core deposits (1)

   $ 470     $ 137,602     $ 470     $ 137,602  

Total deposits

   $ 2,295,131     $ 2,461,941     $ 2,295,131     $ 2,461,941  

Loans held for investment yield

     13.77 %     12.63 %     13.14 %     12.63 %

Net charge-off rate

     3.96 %     3.25 %     3.69 %     3.11 %

30+ day delinquency rate

     4.70 %     3.70 %     4.70 %     3.70 %

Number of accounts (000s)

     48,473       49,176       48,473       49,176  
                                

(1) Includes domestic non-interest bearing deposits, NOW accounts, money market deposit accounts, savings accounts, certificates of deposit of less than $100,000 and other consumer time deposits.

The National Lending segment consists of three sub-segments: U.S. Card, Auto Finance and Global Financial Services.

 

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The National Lending segment contributed $675.4 million and $1,949.0 million of income for the three and nine months ended September 30, 2007, respectively, compared to $604.1 million and $1,957.9 million in the corresponding prior year periods ended September 30, 2006. At September 30, 2007, Loans held for investment in the National Lending segment totaled $102.6 billion while deposits outstanding totaled $2.3 billion. Profits are primarily generated from net interest income and past-due fees earned and deemed collectible from our loans, income earned on securities, and non-interest income including the sale and servicing of loans and fee-based services to customers. Total revenue increased 12% for the three months ended September 30, 2007 primarily due to growth in the average managed Loans held for investment portfolio of 5% and selective pricing and fee changes following conversion of our cardholder system. For the nine months ended September 30, 2007 revenue increased 8%. Credit normalization drove the increase in provision for loan and lease losses for the National Lending segment.

Non-interest expenses for the three and nine months ended September 30, 2007 were $1.4 billion and $4.2 billion, respectively, compared to $1.4 billion and $4.1 billion in the corresponding prior year periods ended September 30, 2006. The increase was largely driven by additional expenses to support managed loan growth.

U.S. Card Sub-Segment

Table 4: U.S. Card

 

     Three Months Ended
September 30, 2007
    Nine Months Ended
September 30, 2007
 

(Dollars in thousands)

   2007     2006     2007     2006  

Earnings (Managed Basis)

        

Interest income

   $ 1,953,967     $ 1,734,459     $ 5,547,483     $ 5,077,162  

Interest expense

     596,767       554,708       1,789,508       1,555,888  
                                

Net interest income

     1,357,200       1,179,751       3,757,975       3,521,274  

Non-interest income

     975,502       881,304       2,596,536       2,459,800  
                                

Total revenue

     2,332,702       2,061,055       6,354,511       5,981,074  

Provision for loan and lease losses

     662,428       451,782       1,438,853       1,089,921  

Non-interest expense

     815,470       899,062       2,485,259       2,604,665  
                                

Income before taxes

     854,804       710,211       2,430,399       2,286,488  

Income taxes

     294,053       248,574       836,057       800,272  
                                

Net income

   $ 560,751     $ 461,637     $ 1,594,342     $ 1,486,216  
                                

Selected Metrics (Managed Basis)

        

Period end loans held for investment

   $ 49,573,279     $ 51,127,654     $ 49,573,279     $ 51,127,654  

Average loans held for investment

   $ 49,682,666     $ 50,131,562     $ 50,370,801     $ 48,742,187  

Loans held for investment yield

     15.73 %     13.84 %     14.68 %     13.89 %

Net charge-off rate

     4.13 %     3.39 %     3.95 %     3.21 %

30+ day delinquency rate

     4.46 %     3.53 %     4.46 %     3.53 %

Purchase volume (1)

   $ 21,522,104     $ 21,450,024     $ 62,650,378     $ 60,344,425  

Number of total accounts (000s)

     36,504       37,483       36,504       37,483  
                                

(1) Includes purchase transactions net of returns and excludes cash advance transactions.

The U.S. Card sub-segment consists of domestic consumer credit and debit card activities.

Managed loans decreased 3% compared to September 30, 2006. Year-over-year growth was negatively impacted by portfolio sale of a co-branded credit card partnership at the end of the first quarter of 2007 and a reduction in our already-low marketing of balance transfer teaser products. We are also experiencing increased asset attrition as a result of repricing parts of the portfolio where original funding had expired. Purchase volume increased a modest 0.3% over the prior year. Purchase volume growth was compressed by the closing of two retail partnerships in 2007 as well as by deliberate strategy choices. Additionally, retail sales have been soft in recent months despite the increase in September, adding to the pressure on purchase volume growth.

For the three months ended September 30, 2007, net income was $560.8 million, an increase of $99.1 million, or 21%, compared to the three months ended September 30, 2006. The increase was mainly a result of a 13%, or $271.6 million increase in revenues, driven by increased margins. Primary drivers of the increase in revenue margin include reductions in the amount of teaser-based acquisitions as well as selective pricing and fee changes following the conversion of our card holder system. For the nine months ended September 30, 2007, U.S. Card sub-segment net income increased 7% compared to the same period last year due to higher revenues, partially off-set by higher net provision due to the normalization of consumer credit.

 

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Net provision increased $210.6 million for the three months ended September 30, 2007 compared to the three months ended September 30, 2006. For the nine months ended September 30, 2007 net provision increased by $348.9 million, driven by continued normalization of U.S. Consumer credit following the bankruptcy legislation impact. The net charge-off rate for the three and nine months ending September 30, 2007 both increased 74 basis points from same period last year, reflecting the above mentioned credit normalization effect. The net charge-off rate for the three months ended September 30, 2007 increased 40 basis points from previous quarter as the previous quarter was compressed due to the implementation of a change in customer statement generation from a 30 day to a 25 day grace period.

Non-interest expenses decreased 9% and 5%, respectively, for three and nine months ended September 30, 2007 due to lower marketing spend as a result of our evolving marketing strategy and increased operational efficiency.

Auto Finance Sub-Segment

Table 5: Auto Finance

 

     Three Months Ended
September 30, 2007
    Nine Months Ended
September 30, 2007
 

(Dollars in thousands)

   2007     2006     2007     2006  

Earnings (Managed Basis)

        

Interest income

   $ 661,471     $ 575,376     $ 1,950,901     $ 1,643,937  

Interest expense

     283,949       227,053       827,288       622,377  
                                

Net interest income

     377,522       348,323       1,123,613       1,021,560  

Non-interest income

     13,514       21,181       97,373       67,241  
                                

Total revenue

     391,036       369,504       1,220,986       1,088,801  

Provision for loan and lease losses

     244,537       161,145       626,873       343,664  

Non-interest expense

     152,275       154,014       474,267       437,784  
                                

Income before taxes

     (5,776 )     54,345       119,846       307,353  

Income taxes

     (1,987 )     19,021       41,227       107,573  
                                

Net income

   $ (3,789 )   $ 35,324     $ 78,619     $ 199,780  
                                

Selected Metrics (Managed Basis)

        

Period end loans held for investment

   $ 24,335,242     $ 21,158,797     $ 24,335,242     $ 21,158,797  

Average loans held for investment

   $ 24,170,047     $ 20,812,533     $ 23,890,694     $ 20,151,468  

Loans held for investment yield

     10.95 %     11.06 %     10.89 %     10.88 %

Net charge-off rate

     3.56 %     2.34 %     2.74 %     2.08 %

30+ day delinquency rate

     7.15 %     5.18 %     7.15 %     5.18 %

Auto loan originations (1)

   $ 3,248,747     $ 3,158,481     $ 9,553,042     $ 9,206,430  

Number of total accounts (000s)

     1,731       1,558       1,731       1,558  
                                

(1) Includes all organic auto loan originations and excludes auto loans added through acquisitions.

The Auto Finance sub-segment consists of automobile and other motor vehicle financing activities.

Auto Finance sub-segment’s loans held for investment portfolio increased 15% over prior year quarter as a result of the transfer of $1.8 billion of North Fork Bank’s auto loans to the Auto Finance sub-segment on January 1, 2007, and strong organic originations growth within our dealer and direct marketing channels. Originations in the third quarter of 2007 were $3.2 billion, 3% higher than prior year quarter despite industry sales levels declining in that period. As a result of this portfolio growth, net interest income increased 8% in the three months ended September 30, 2007 compared to the same period in the prior year, and 10% in the nine months ended September 30, 2007 compared to the same period prior year.

Non-interest income for the nine months ended September 30, 2007 included a one-time gain of $46.2 million related to the sale of 1.8 million shares of DealerTrack stock during the first quarter of 2007.

 

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For the three and nine months ended September 30, 2007, the Auto Finance sub-segment’s net charge-off rate was up 122 basis points and 66 basis points, respectively, compared with the very low charge off rates seen in the same periods in the prior year. Net charge-offs of auto loans increased $93.6 million and $177.3 million for the three and nine months ended September 30, 2007, respectively. The provision for loan losses increased $83.4 million and $283.2 million for the three and nine month periods ended September 30, 2007, respectively. The 30-plus day delinquency rate for the Auto Finance sub-segment increased 197 basis points over prior year quarter. Compared to the second quarter of 2007 the biggest driver of credit performance is normal credit seasonality. Compared to the third quarter in 2006, several factors are contributing to higher loss levels. First, we are experiencing across the board worsening compared to the very low loss levels of 2006. Second, we continue to have elevated losses from our recent Dealer Prime originations. While the Dealer Prime loans we are originating today have better credit characteristics, loss levels from prior originations will remain elevated until those loans amortize. The third factor is elevated losses in our Dealer Subprime business as a result of industry-wide risk and underwriting expansions of the past several years. While losses on these loans have increased, the business remains profitable and we are comfortable with the returns of the Subprime business.

Non-interest expense in the third quarter of 2007 decreased 1% when compared third quarter 2006, compared to 6% revenue growth in that time period. Operating costs on a percent of loan basis have declined versus prior year as the Auto Finance sub-segment realized the initial benefits of the integration of the dealer programs of the legacy Capital One, Onyx, Hibernia, and North Fork auto lending businesses.

Global Financial Services Sub-Segment

Table 6: Global Financial Services

 

     Three Months Ended
September 30, 2007
    Nine Months Ended
September 30, 2007
 

(Dollars in thousands)

   2007     2006     2007     2006  

Earnings (Managed Basis)

        

Interest income

   $ 896,440     $ 768,262     $ 2,529,132     $ 2,185,764  

Interest expense

     351,399       307,518       996,709       841,319  
                                

Net interest income

     545,041       460,744       1,532,423       1,344,445  

Non-interest income

     323,130       311,439       933,875       891,871  
                                

Total revenue

     868,171       772,183       2,466,298       2,236,316  

Provision for loan and lease losses

     289,122       249,448       848,726       763,427  

Non-interest expense

     399,862       358,806       1,196,532       1,054,127  
                                

Income before taxes

     179,187       163,929       421,040       418,762  

Income taxes

     60,781       56,771       144,987       146,905  
                                

Net income

   $ 118,406     $ 107,158     $ 276,053     $ 271,857  
                                

Selected Metrics (Managed Basis)

        

Period end loans held for investment

   $ 28,647,750     $ 26,623,519     $ 28,647,750     $ 26,623,519  

Average loans held for investment

   $ 27,952,871     $ 26,364,992     $ 27,270,697     $ 24,991,277  

Loans held for investment yield

     12.72 %     11.58 %     12.26 %     11.59 %

Net charge-off rate

     4.00 %     3.70 %     4.05 %     3.74 %

30+ day delinquency rate

     3.02 %     2.86 %     3.02 %     2.86 %

Number of total accounts (000s)

     10,238       10,135       10,238       10,135  
                                

Global Financial Services businesses extend Capital One’s national scale lending franchise and provide geographic diversification. The segment consists of international (UK and Canada) lending, small business lending, installment loans, home loans, healthcare finance and other consumer financial service activities.

Global Financial Services net income increased 11% for the quarter ended September 30, 2007 vs. the quarter ended September 30, 2006. The increase in the portfolio’s net income was largely driven by strong revenue growth in North America and a favorable credit outlook in Europe.

Total revenue increased 12% for the quarter ended September 30, 2007, higher than the 6% growth in average loans for the same period mainly driven by strong growth in North American businesses.

 

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The provision for loan losses increased 16% for the quarter ended September 30, 2007, as benefits related to U.S. bankruptcy legislation implemented in 2005 subsided. This normalization impacts both current period charge-offs as well as the allowance for loan losses expected in the future.

Non-interest expense increased 11% for the quarter ended September 30, 2007. Marketing expenses increased 23% vs. the year-ago quarter, driving higher growth in the personal lending, Canada, and Home Loan businesses. Operating costs were 7% higher in the third quarter 2007, growing at a slower rate than revenue.

VIII. Funding

Funding Availability

We have established access to a variety of funding sources.

Table 7 illustrates our unsecured funding sources and our two auto loan secured warehouses.

Table 7: Funding Availability

 

(Dollars or dollar equivalents in millions)

  

Effective/

Issue Date

   Availability(1)(6)    Outstanding(4)   

Final

Maturity(5)

Senior and Subordinated Global Bank Note Program(2)

   1/03    $ 1,800    $ 3,190    —  

Senior Domestic Bank Note Program(3)

   4/97      —        168    —  

Capital One Auto Loan Facility I

   3/02      1,295      2,505    —  

Capital One Auto Loan Facility II

   3/05      1,362      388    —  

Corporation Automatic Shelf Registration Statement

   5/06      *      N/A    **
                       

(1) All funding sources are non-revolving except for the Credit Facility and the Capital One Auto Loan Facilities. Funding availability under the credit facilities and auto loan secured warehouses is subject to compliance with certain representations, warranties and covenants. Funding availability under all other sources is subject to market conditions.
(2) The notes issued under the Senior and Subordinated Global Bank Note Program may have original terms of thirty days to thirty years from their date of issuance. This program was updated in June 2005.
(3) The notes issued under the Senior Domestic Bank Note Program have original terms of one to ten years. The Senior Domestic Bank Note Program is no longer available for issuances.
(4) Amounts outstanding are as of September 30, 2007.
(5) Maturity date refers to the date the facility terminates, where applicable.
(6) Availability does not include unused conduit capacity related to off-balance sheet securitization structures of $10.3 billion at September 30, 2007.
* The Corporation and certain of its subsidiaries have registered an indeterminate amount of securities pursuant to the Automatic Shelf Registration Statement that are available for future issuance.
** Under SEC rules, the Automatic Shelf Registration Statement expires three years after filing. Accordingly, the Corporation must file a new Automatic Shelf Registration Statement at least once every three years.

Senior and Subordinated Notes

The Senior and Subordinated Global Bank Note Program gives the Bank the ability to issue securities to both U.S. and non-U.S. lenders and to raise funds in U.S. and foreign currencies, subject to conditions customary in transactions of this nature.

Prior to the establishment of the Senior and Subordinated Global Bank Note Program, the Bank issued senior unsecured debt through its $8.0 billion Senior Domestic Bank Note Program, of which $167.5 million was outstanding at September 30, 2007. The Bank did not renew the Senior Domestic Bank Note Program for future issuances following the establishment of the Senior and Subordinated Global Bank Note Program.

Other Short-Term Borrowings

Revolving Credit Facility

In June 2004, we terminated our Domestic Revolving and Multicurrency Credit Facilities and replaced them with a new revolving credit facility (“Credit Facility”) providing for an aggregate of $750.0 million in unsecured borrowings from various lending institutions to be used for general corporate purposes. On April 30, 2007 the Credit Facility was terminated.

 

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Collateralized Revolving Credit Facilities

In March 2002, COAF entered into a revolving warehouse credit facility collateralized by a security interest in certain auto loan assets (the “Capital One Auto Loan Facility I”). As of September 30, 2007, the Capital One Auto Loan Facility I had the capacity to issue up to $3.8 billion in secured notes. The Capital One Auto Loan Facility I has multiple participants each with separate renewal dates. The facility does not have a final maturity date. Instead, each participant may elect to renew the commitment for another set period of time. Interest on the facility is largely based on commercial paper rates.

In March 2005, COAF entered into a second revolving warehouse credit facility collateralized by a security interest in certain auto loan assets (the “Capital One Auto Loan Facility II”). As of September 30, 2007, the Capital One Auto Loan Facility II had the capacity to issue up to $1.8 billion in secured notes. The facility does not have a final maturity date. Instead, the participant may elect to renew the commitment for another set period of time. Interest on the facility is based on commercial paper rates.

Corporation Shelf Registration Statement

As of September 30, 2007, we had an effective shelf registration statement under which we from time to time may offer and sell an indeterminate aggregate amount of senior or subordinated debt securities, preferred stock, depositary shares representing preferred stock, common stock, trust preferred securities, junior subordinated debt securities, guarantees of trust preferred securities and certain back-up obligations, purchase contracts and units. There is no limit under this shelf registration statement to the amount or number of such securities that we may offer and sell.

In September 2007, the Company issued $1.5 billion aggregate principal amount of 6.750% Senior Notes due September 15, 2017.

Table 8 shows the maturities of domestic time certificates of deposit in denominations of $100 thousand or greater (large denomination CDs) as of September 30, 2007.

Table 8: Maturities of Large Denomination Certificates—$100,000 or More

 

     September 30, 2007  

(Dollars in thousands)

   Balance    Percent  

Three months or less

   $ 3,097,061    30.22 %

Over 3 through 6 months

     1,805,109    17.62 %

Over 6 through 12 months

     2,000,272    19.52 %

Over 12 months through 10 years

     3,344,193    32.64 %
             

Total

   $ 10,246,635    100.00 %
             

Table 9 shows the composition of average deposits for the periods presented.

Table 9: Deposit Composition and Average Deposit Rates

 

     Three Months Ended September 30,     Nine Months Ended September 30,  
    

Average

Balance

  

% of

Deposits

   

Average

Deposit

Rate

   

Average

Balance

  

% of

Deposits

   

Average

Deposit

Rate

 

Non-interest bearing - domestic

   $ 11,296,184    13.31 %   N/A     $ 11,301,888    13.16 %   N/A  

NOW accounts

     4,759,665    5.61 %   2.86 %     4,979,470    5.80 %   2.84 %

Money market deposit accounts

     28,696,735    33.81 %   4.11 %     27,277,008    31.76 %   4.01 %

Savings Accounts

     8,345,638    9.83 %   1.80 %     8,379,961    9.76 %   1.74 %

Other consumer time deposits

     17,203,453    20.26 %   4.52 %     18,421,268    21.45 %   4.52 %
                                      

Total core deposits

     70,301,675    82.82 %   3.19 %     70,359,595    81.93 %   3.15 %

Public fund certificate of deposits of $100,000 or more

     1,884,767    2.22 %   4.90 %     1,967,915    2.29 %   4.90 %

Certificates of deposit of $100,000 or more

     8,673,860    10.22 %   4.76 %     9,535,152    11.11 %   4.66 %

Foreign time deposits

     4,024,178    4.74 %   5.28 %     4,011,745    4.67 %   5.10 %
                                      

Total deposits

   $ 84,884,480    100.00 %   3.49 %   $ 85,874,407    100.00 %   3.45 %
                                      

 

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IX. Capital

Capital Adequacy

The Company and the Bank are subject to capital adequacy guidance adopted by the Federal Reserve Board (the “Federal Reserve”), and CONA and Superior are subject to capital adequacy guidelines adopted by the Office of the Comptroller of the Currency (the “OCC”, and with the Federal Reserve, collectively, the “regulators”). The capital adequacy guidelines set minimum risk-based and leverage capital requirements that are based on quantitative and qualitative measures of their assets and off-balance sheet items. The Federal Reserve holds the Corporation to similar minimum capital requirements.

As of September 30, 2007, the Bank, CONA, and Superior (collectively, the “Banks”) each exceeded the minimum regulatory requirements to which it was subject. The Banks all were considered “well-capitalized” under applicable capital adequacy guidelines. Also as of September 30, 2007, the Corporation was considered “well-capitalized” under Federal Reserve capital standards for bank holding companies and, therefore, exceeded all minimum capital requirements. There have been no conditions or events since that we believe would have changed the capital category of the Corporation or any of the Banks.

The Bank treats a portion of its loans as “subprime” under the “Expanded Guidance for Subprime Lending Programs” (the “Subprime Guidance”) issued by the four federal banking agencies that comprise the Federal Financial Institutions Examination Council (“FFIEC”), and have assessed its capital and allowance for loan and lease losses accordingly. Under the Subprime Guidance, the Bank exceeds the minimum capital adequacy guidelines as of September 30, 2007. Failure to meet minimum capital requirements can result in mandatory and possible additional discretionary actions by a federal banking agency that, if undertaken, could have a material effect on the Corporation’s consolidated financial statements.

For purposes of the Subprime Guidance, the Corporation has treated as subprime all loans in the Bank’s targeted “subprime” programs to customers either with a FICO score of 660 or below or with no FICO score. The Bank holds on average 200% of the total risk-based capital charge that would otherwise apply to such assets. This results in higher levels of regulatory capital at the Bank.

Additionally, regulatory restrictions exist that limit the ability of the Bank, CONA, and Superior to transfer funds to the Corporation. As of September 30, 2007, retained earnings of the Bank, CONA, and Superior of $193.1 million, zero million, and $3.2 million, respectively, were available for payment of dividends to the Corporation without prior approval by the regulators.

 

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Table 10 – REGULATORY CAPITAL RATIOS

 

    

Regulatory

Filing

Basis

Ratios

   

Applying

Subprime

Guidance

Ratios

   

Minimum for

Capital

Adequacy

Purposes

   

To Be

“Well Capitalized”

Under

Prompt Corrective

Action

Provisions

 

September 30, 2007

        

Capital One Financial Corp. (1)

        

Tier 1 Capital

   10.70 %   10.10 %   4.00 %   N/A  

Total Capital

   13.79     13.08     8.00     N/A  

Tier 1 Leverage

   9.51     9.51     4.00     N/A  

Capital One Bank

        

Tier 1 Capital

   12.95 %   10.26 %   4.00 %   6.00 %

Total Capital

   16.08     12.95     8.00     10.00  

Tier 1 Leverage

   12.16     12.16     4.00     5.00  

Capital One National Bank

        

Tier 1 Capital

   10.82 %   N/A     4.00 %   6.00 %

Total Capital

   12.05     N/A     8.00     10.00  

Tier 1 Leverage

   8.52     N/A     4.00     5.00  

Superior Bank

        

Tier 1 Capital

   15.06 %   N/A     4.00 %   6.00 %

Total Capital

   16.32     N/A     8.00     10.00  

Tier 1 Leverage

   5.99     N/A     4.00     5.00  
                        

September 30, 2006

        

Capital One Financial Corp. (1)

        

Tier 1 Capital

   16.98 %   15.08 %   4.00 %   N/A  

Total Capital

   20.40     18.24     8.00     N/A  

Tier 1 Leverage

   15.27     15.27     4.00     N/A  

Capital One Bank

        

Tier 1 Capital

   13.22 %   10.32 %   4.00 %   6.00 %

Total Capital

   16.92     13.45     8.00     10.00  

Tier 1 Leverage

   12.24     12.24     4.00     5.00  

Capital One National Bank

        

Tier 1 Capital

   10.31 %   N/A     4.00 %   6.00 %

Total Capital

   11.56     N/A     8.00     10.00  

Tier 1 Leverage

   7.34     N/A     4.00     5.00  

(1) The regulatory framework for prompt corrective action is not applicable for bank holding companies.

Dividend Policy

The declaration and payment of dividends, as well as the amount thereof, are subject to the discretion of the Board of Directors of the Company and will depend upon our results of operations, financial condition, cash requirements, future prospects and other factors deemed relevant by the Board of Directors. The company recently announced that it expects to continue to experience strong capital generation that will enable the Board of Directors to declare dividends on its common stock at a fixed dollar amount that approximates 25% of expected net income after tax.

As a holding company, our ability to pay dividends is dependent upon the receipt of dividends or other payments from our subsidiaries. Applicable banking regulations and provisions that may be contained in our borrowing agreements or the

 

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borrowing agreements of our subsidiaries may limit our subsidiaries’ ability to pay dividends to us or our ability to pay dividends to our stockholders. There can be no assurance that the company will declare and pay any dividends.

X. Business Outlook

This business outlook section summarizes our primary goals, expectations and strategies for continued growth. The statements contained in this section are based on our current expectations. Certain statements are forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward looking statements involve risks and uncertainties and actual results could differ materially from those in our forward looking statements as a result of various factors including those set forth in Item 1A “Risk Factors.”

Our outlook should be viewed against the backdrop of the global economy, financial markets activity and the regulatory environment. Weakness in the global economy, credit deterioration, inflation, movements in interest rates, and regulatory changes are examples of risks that could adversely impact our business and earnings. In addition, recent unusual volatility in the capital markets could expose the company to wholesale funding and liquidity risk.

We expect to deliver prudent and profitable growth in our operating segments in the context of the current credit environment. In addition, we remain committed to sustained capital generation in our core businesses and to maintaining a strong, diversified balance sheet. We also expect to deliver long-term value by leveraging infrastructure and streamlining processes to increase operating efficiency.

On October 18th, 2007, we affirmed that we expect earnings per share for the full year 2007 to be approximately $5.00. This guidance was as of the date it was given. Included in this guidance is the impact of the completion of our $3 billion share repurchase program.

Our target is to operate within a Tangible Common Equity range of between 5.5% and 6% in 2008. Given current trends in revenues, loan growth, credit metrics and operating efficiency, we expect to deliver in 2008 (on a managed basis) low to mid single digit growth in loans and deposits; revenue growth in line with or slightly above asset growth; operating efficiency in the mid 40 percent range; and charge-off dollars of approximately $4.9 billion.

Our charge-off outlook assumes that credit normalization largely runs its course by the end of 2007, that we experience a “full year effect” of normalized charge-off levels in 2008, and that the elevated U.S. Card delinquencies that we experienced in the third quarter of 2007 begin to subside during the fourth quarter and return to more normal seasonal levels by the second quarter of 2008. If delinquency rates do not subside, actual charge-offs for 2008 could be greater than $4.9 billion. Further, our charge-off outlook assumes that employment and interest rates remain largely at current levels. However, given current uncertainties in the outlook for domestic credit markets and the broader economy, our 2008 charge-off outlook could vary significantly relative to our current expectations.

Operating Segments

In addition to the factors described above, we expect results in our Local Banking segment to continue to be pressured by the flat yield curve in the U.S., as well as a competitive pricing environment. Integration efforts will accelerate over the next two quarters, as we move to convert our deposit platform and brand in the first quarter of 2008.

Given our weighting toward consumer lending, we face several challenges that may pressure results in our National Lending segment, including degrading consumer credit and uncertainty regarding the consumer economy.

In our US Card sub-segment, we expect the competitive environment to remain challenging. We will continue to focus on product and marketing strategies with the most attractive risk-adjusted returns and resilience, including transactor products for prime and super-prime customers, and attractively priced revolver products across the risk spectrum. We expect revenue dollars to grow in 2008, largely as a result of the full year impact of the revenue margin increases in the second and third quarters of 2007. We expect revenue margin to remain near its current level in the fourth quarter of 2007, and to moderate somewhat through 2008. Based on these trends, we expect average full-year 2008 revenue margin to be higher than average full-year revenue margin in 2007. Given current delinquency trends, we expect charge-off dollars to rise in the fourth quarter and into 2008. Our charge-off outlook for US Card assumes that credit normalization largely runs its course by the end of 2007, that we experience a “full year effect” of normalized charge-off levels in 2008, and that the elevated delinquencies that the US Card business experienced in the third quarter of 2007 begin to subside during the fourth quarter and return to more normal seasonal levels by the second quarter of 2008. If delinquency rates do not subside, actual charge-offs for 2008 could be greater. Further, our charge-off outlook assumes that employment and interest rates remain largely at current levels. However, given current uncertainties in the outlook for domestic credit markets and the broader economy, our 2008 charge-off outlook could vary significantly relative to our current expectations.

In our Auto Finance sub-segment, we continue to see the impacts of industry-wide risk and underwriting expansion, as well as continuing charge-off normalization. In addition, as a result of our recent integration of the dealer prime platform, we continue to experience elevated loss levels in certain vintages. However, based on our integrated dealer strategy, recent originations and improving operating efficiency, we expect to deliver stronger returns in 2008 than in 2007.

In our Global Financial Services (GFS) sub-segment, North American GFS businesses generally will experience similar trends as in our U.S. Card sub-segment. In addition, we expect credit in our UK card business will remain stable based on recent performance.

 

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XI. Supervision and Regulation

We have consolidated several of our subsidiary banks into one of our existing national banks, CONA, and moved the headquarters of CONA from New Orleans, Louisiana to McLean, Virginia. On July 1, 2007, the Savings Bank merged with and into CONA. On August 1, 2007, North Fork Bank merged with and into CONA, and North Fork Bank’s mortgage lending subsidiary, GreenPoint, became an operating subsidiary of CONA. In addition, the OCC has approved the Bank’s application to convert from a Virginia-state chartered bank to a national association. The conversion of the Bank to a national charter is scheduled to take place in the first quarter of 2008. We are planning other reorganization and consolidation actions to further streamline our operations.

For additional information on our Supervision and Regulation activities, see our Annual Report on Form 10-K for the year ended December 31, 2006, Part I, Item 1 “Supervision and Regulation” for a summary of our regulatory issues and activities.

XII. Enterprise Risk Management

Risk is an inherent part of our business activities. We have an Enterprise Risk Management (ERM) program designed to ensure appropriate and comprehensive oversight and management of risk. The ERM program has three components. First, the Board of Directors and senior management committees oversee risk and risk management practices. Second, the centralized department headed by the Chief Risk Officer establishes risk management methodologies, processes and standards. Third, the individual business areas throughout the Company are responsible for managing risk in their businesses and performing ongoing identification, assessment and response to risks. Our ERM framework includes eight categories of risk: credit, liquidity, market, operational, legal, strategic, reputation, and compliance.

For additional information on the Company’s ERM program, see the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2006, Part I. Item 1, Enterprise Risk Management.

XIII. Tabular Summary

TABLE A—STATEMENTS OF REPORTED AVERAGE BALANCES, INCOME AND EXPENSE, YIELDS AND RATES

Table A provides average balance sheet data and an analysis of net interest income, net interest spread (the difference between the yield on earning assets and the cost of interest-bearing liabilities) and net interest margin for the three and nine months ended September 30, 2007 and 2006.

 

     Three Months Ended September 30  
     2007     2006  

(Dollars in Thousands)

  

Average

Balance

   

Income/

Expense

  

Yield/

Rate

   

Average

Balance

   

Income/

Expense

   Yield/
Rate
 

Assets:

              

Earning assets

              

Consumer loans (1)

              

Domestic

   $ 55,774,139     $ 1,657,942    11.89 %   $ 47,739,155     $ 1,477,230    12.38 %

International

     3,559,446       119,258    13.40 %     4,079,951       113,411    11.12 %
                                          

Total consumer loans

     59,333,585       1,777,200    11.98 %     51,819,106       1,590,641    12.28 %

Commercial loans

     32,411,261       603,896    7.45 %     10,609,683       224,162    8.45 %
                                          

Total Loans Held for Investment

     91,744,846       2,381,096    10.38 %     62,428,789       1,814,803    11.63 %
                                          

Securities available for sale (3)

     20,041,177       252,550    5.04 %     14,259,073       151,616    4.25 %

Other

              

Domestic (2) (3)

     4,934,790       121,693    9.86 % &n