Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

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

For the quarterly period ended September 30, 2012

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission File No. 1-13300

 

 

CAPITAL ONE FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   54-1719854

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

1680 Capital One Drive,

McLean, Virginia

  22102
(Address of Principal Executive Offices)   (Zip Code)

Registrant’s telephone number, including area code:

(703) 720-1000

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

(Not applicable)

 

 

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨    Smaller reporting company   ¨

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

As of October 31, 2012, there were 581,684,101 shares of the registrant’s Common Stock, par value $.01 per share, outstanding.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

         Page  

PART I—FINANCIAL INFORMATION

     1   

Item 1.

 

Financial Statements

     66   
 

Condensed Consolidated Statements of Income

     67   
 

Condensed Consolidated Statements of Comprehensive Income

     68   
 

Condensed Consolidated Balance Sheets

     69   
 

Condensed Consolidated Statement of Changes in Stockholders’ Equity

     70   
 

Condensed Consolidated Statements of Cash Flows

     71   
 

Notes to Condensed Consolidated Financial Statements

     72   
 

Note   1—Summary of Significant Accounting Policies

     72   
 

Note   2—Acquisitions

     74   
 

Note   3—Discontinued Operations

     79   
 

Note   4—Investment Securities

     80   
 

Note   5—Loans

     90   
 

Note   6—Allowance for Loan and Lease Losses

     114   
 

Note   7—Variable Interest Entities and Securitizations

     117   
 

Note   8—Goodwill and Other Intangible Assets

     124   
 

Note   9—Deposits and Borrowings

     126   
 

Note 10—Derivative Instruments and Hedging Activities

     129   
 

Note 11—Stockholders’ Equity

     135   
 

Note 12—Earnings Per Common Share

     136   
 

Note 13—Fair Value of Financial Instruments

     137   
 

Note 14—Business Segments

     152   
 

Note 15—Commitments, Contingencies and Guarantees

     155   
 

Note 16—Subsequent Events

     167   

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”)

     1   
 

Summary of Selected Financial Data

     1   
 

Introduction

     5   
 

Executive Summary and Business Outlook

     6   
 

Critical Accounting Policies and Estimates

     12   
 

Consolidated Results of Operations

     12   
 

Business Segment Financial Performance

     20   
 

Consolidated Balance Sheet Analysis

     32   
 

Off-Balance Sheet Arrangements and Variable Interest Entities

     36   
 

Capital Management

     36   
 

Risk Management

     41   
 

Credit Risk Profile

     41   
 

Liquidity Risk Profile

     55   
 

Market Risk Profile

     58   
 

Supervision and Regulation

     61   
 

Accounting Changes and Developments

     61   
 

Forward-Looking Statements

     61   
 

Supplemental Tables

     64   

Item 3.

 

Quantitative and Qualitative Disclosures about Market Risk

     168   

Item 4.

 

Controls and Procedures

     168   

PART II—OTHER INFORMATION

     169   

Item 1.

 

Legal Proceedings

     169   

Item 1A.

 

Risk factors

     169   

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

     169   

Item 3.

 

Defaults upon Senior Securities

     169   

Item 5.

 

Other Information

     169   

Item 6.

 

Exhibits

     169   

SIGNATURES

     170   

EXHIBIT INDEX

     171   

 

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Table of Contents

INDEX OF MD&A TABLES AND SUPPLEMENTAL TABLES

 

Table

 

Description

   Page  

 

MD&A Tables:

  

1

 

Consolidated Financial Highlights (Unaudited)

     2   

2

 

Business Segment Results

     6   

3

 

Average Balances, Net Interest Income and Net Interest Yield

     13   

4

 

Rate/Volume Analysis of Net Interest Income

     15   

5

 

Non-Interest Income

     16   

6

 

Non-Interest Expense

     18   

7

 

Credit Card Business Results

     21   

7.1

 

Domestic Card Business Results

     24   

7.2

 

International Card Business Results

     25   

8

 

Consumer Banking Business Results

     26   

9

 

Commercial Banking Business Results

     29   

10

 

Investment Securities Available for Sale

     32   

11

 

Non-Agency Investment Securities Credit Ratings

     34   

12

 

Net Loans Held for Investment

     34   

13

 

Changes in Representation and Warranty Reserve

     36   

14

 

Capital Ratios Under Basel I

     38   

15

 

Risk-Based Capital Components Under Basel I

     39   

16

 

Loan Portfolio Composition

     43   

17

 

30+ Day Delinquencies

     45   

18

 

Aging and Geography of 30+ Day Delinquent Loans

     46   

19

 

90+ Days Delinquent Loans Accruing Interest

     46   

20

 

Nonperforming Loans and Other Nonperforming Assets

     47   

21

 

Net Charge-Offs

     48   

22

 

Loan Modifications and Restructurings

     50   

23

 

Summary of Allowance for Loan and Lease Losses

     53   

24

 

Allocation of the Allowance for Loan and Lease Losses

     54   

25

 

Liquidity Reserves

     55   

26

 

Deposits

     56   

27

 

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

     57   

28

 

Senior Unsecured Debt Credit Ratings

     58   

29

 

Interest Rate Sensitivity Analysis

     60   

 

Supplemental Tables:

  

A

 

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

     64   

 

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PART I—FINANCIAL INFORMATION

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”)

This MD&A should be read in conjunction with our unaudited condensed consolidated financial statements and related notes in this Report and the more detailed information contained in our 2011 Annual Report on Form 10-K (“2011 Form 10-K”). This discussion contains forward-looking statements that are based upon management’s current expectations and are subject to significant uncertainties and changes in circumstances. Please review “Forward-Looking Statements” for more information on the forward-looking statements in this Report. Our actual results may differ materially from those included in these forward-looking statements due to a variety of factors including, but not limited to, those described in “Part II—Item 1A. Risk Factors” in this Report and in “Part I—Item 1A. Risk Factors” in our 2011 Form 10-K.

 

 

SUMMARY OF SELECTED FINANCIAL DATA

 

Below we provide selected consolidated financial data from our results of operations for the three and nine months ended September 30, 2012 and 2011, and selected comparative consolidated balance sheet data as of September 30, 2012, and December 31, 2011. We also provide selected key metrics we use in evaluating our performance.

On February 17, 2012, we completed the acquisition of substantially all of the ING Direct business in the United States (“ING Direct”) from ING Groep N.V., ING Bank N.V., ING Direct N.V. and ING Direct Bancorp “(the “ING Direct acquisition”). The ING Direct acquisition resulted in the addition of loans of $40.4 billion, other assets of $53.9 billion and deposits of $84.4 billion as of the acquisition date. On May 1, 2012, pursuant to the agreement with HSBC Finance Corporation, HSBC USA Inc. and HSBC Technology and Services (USA) Inc. (collectively, “HSBC”), we closed the acquisition of substantially all of the assets and assumed liabilities of HSBC’s credit card and private-label credit card business in the United States (other than the HSBC Bank USA, National Association consumer credit card program and certain other retained assets and liabilities) (the “HSBC U.S. card acquisition”). The HSBC U.S. card acquisition included (i) the acquisition of HSBC’s U.S. credit card portfolio, (ii) its on-going private label and co-branded partnerships, and (iii) other assets, including infrastructure and capabilities. At closing, we acquired approximately 27 million new active accounts, approximately $27.8 billion in outstanding credit card receivables designated as held for investment and approximately $327 million in other net assets. The ING Direct and HSBC U.S. card acquisitions had a significant impact on our results and selected metrics for the three and nine months ended September 30, 2012 and our financial condition as of September 30, 2012.

We use the term “acquired loans” to refer to a limited portion of the credit card loans acquired in the HSBC U.S. card acquisition and the substantial majority of consumer and commercial loans acquired in the ING Direct and Chevy Chase Bank (“CCB”) acquisitions, which were recorded at fair value at acquisition and subsequently accounted for based on expected cash flows to be collected (under the accounting standard formerly known as “Statement of Position 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer,” commonly referred to as “SOP 03-3”). HSBC U.S. card loans accounted for based on expected cash flows consisted of loans with a fair value at acquisition of approximately $651 million that were deemed to be credit impaired because they were delinquent and revolving cardholder privileges had been revoked. The difference between the fair value and initial expected cash flows represents the accretable yield, which is recognized into interest income over the life of the loans. The difference between the contractual payments on the loans and the expected cash flows represents the nonaccretable difference or the amount not considered collectible, which approximates what we refer to as the “credit mark.” The credit mark established under the accounting for these loans takes into consideration future expected credit losses over the life of the loans. Accordingly, there are no charge-offs or an allowance associated with these loans unless the estimated cash flows expected to be collected decrease subsequent to acquisition. In addition, these loans are not classified as delinquent or nonperforming

 

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even though the customer may be contractually past due because we expect that we will fully collect the carrying value of these loans. The accounting and classification of these loans may significantly alter some of our reported credit quality metrics. We therefore supplement certain reported credit quality metrics with metrics adjusted to exclude the impact of these acquired loans.

Of the $27.8 billion in outstanding HSBC U.S. card loans that we acquired that were designated as held for investment, $26.2 billion had existing revolving privileges at acquisition and were therefore excluded from the acquired loan accounting guidance applied to the loans described above. These loans were recorded at fair value of $26.9 billion at acquisition, which resulted in a net premium of $705 million that is being amortized against interest income over the remaining life of the loans. In the second quarter of 2012, we recorded provision expense of $1.2 billion to establish an allowance related to these loans. We recorded additional provision expense related to HSBC U.S. card loans of $107 million in the third quarter of 2012. The total provision expense related to HSBC U.S. card loans of $1.3 billion is included in the provision for credit losses of $3.3 billion recorded in the first nine months of 2012. For additional information, see “Credit Risk Profile” and “Note 5—Loans—Acquired Loans.”

Table 1: Consolidated Financial Highlights (Unaudited)

 

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

(Dollars in millions)

  2012     2011         Change         2012     2011         Change      

Income statement

           

Net interest income(1)

  $ 4,646      $ 3,283        42   $ 12,061      $ 9,559        26

Non-interest income(2)

    1,136        871        30        3,711        2,670        39   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total net revenue(3)

    5,782        4,154        39        15,772        12,229        29   

Provision for credit losses(4)

    1,014        622        63        3,264        1,499        118   

Non-interest expense(5)

    3,045        2,297        33        8,691        6,714        29   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations before income taxes

    1,723        1,235        40        3,817        4,016        (5 )

Income tax provision

    535        370        45        931        1,174        (21 )
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations, net of taxes

    1,188        865        37        2,886        2,842        2   

Loss from discontinued operations, net of taxes(6)

    (10     (52     81        (212     (102     (108
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

    1,178        813        45        2,674        2,740        (2

Dividends and undistributed earnings allocated to participating securities

    (5            **        (12            **   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income available to common shareholders

  $ 1,173      $ 813        44   $ 2,662      $ 2,740        (3 )% 
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Common share statistics

           

Earnings per common share:

           

Basic earnings per common share

  $ 2.03      $ 1.78        14   $ 4.80      $ 6.02        (20 )% 

Diluted earnings per common share

    2.01        1.77        14        4.75        5.95        (20

Weighted average common shares outstanding:

           

Basic earnings per common share

    578.3        456.0        27        555.0        455.2        22   

Diluted earnings per common share

    584.1        460.4        27        560.1        461.0        21   

Dividends per common share

  $ 0.05      $ 0.05        **      $ 0.15      $ 0.15        **   

Average balances

           

Loans held for investment(7)

  $ 202,856      $ 129,043        57   $ 182,870      $ 127,360        44

Interest-earning assets

    266,803        177,531        50        247,462        175,044        41   

Total assets

    297,154        201,611        47        279,527        199,616        40   

Interest-bearing deposits

    193,700        110,750        75        180,372        109,552        65   

Total deposits

    213,323        128,268        66        199,565        126,102        58   

Borrowings

    36,451        37,366        (2     35,956        39,107        (8

Stockholders’ equity

    38,535        29,316        31        36,358        28,202        29   

 

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

(Dollars in millions)

  2012     2011         Change         2012     2011         Change      

Selected performance metrics

           

Purchase volume(8)

  $ 48,020      $ 34,918        38   $ 127,746      $ 96,941        32

Total net revenue margin(9)

    8.67     9.36     (69 )bps      8.50     9.31     (81 )bps 

Net interest margin(10)

    6.97        7.40        (43     6.50        7.28        (78

Net charge-offs

  $ 887      $ 812        9   $ 2,405      $ 2,888        (17 )% 

Net charge-off rate(11)

    1.75     2.52     (77 )bps      1.75     3.02     (127 )bps 

Net charge-off rate (excluding acquired loans)(12)

    2.18        2.62        (44     2.17        3.15        (98

Return on average assets(13)

    1.60        1.72        (12     1.38        1.90        (52

Return on average stockholders’ equity(14)

    12.33        11.80        53        10.58        13.44        (286

Non-interest expense as a % of average loans held for investment(15)

    6.00        7.12        (112     6.34        7.03        (69

Efficiency ratio(16)

    52.66        55.30        (264     55.10        54.90        20   

Effective income tax rate

    31.1        30.0        110        24.4        29.2        (480
(Dollars in millions)   September 30,
2012
    December 31,
2011
    Change              

Balance sheet (period end)

           

Loans held for investment(7)

  $ 203,132      $ 135,892        49      

Interest-earning assets

    270,661        179,878        50         

Total assets

    301,989        206,019        47         

Interest-bearing deposits

    192,488        109,945        75         

Total deposits

    213,255        128,226        66         

Borrowings

    38,377        39,561        (3      

Total liabilities

    262,317        176,353        49         

Stockholders’ equity

    39,672        29,666        34         

Credit quality metrics (period end)

           

Allowance for loan and lease losses

  $ 5,154      $ 4,250        21      

Allowance as a  % of loans held for investment

    2.54     3.13     (59 )bps       

Allowance as a  % of loans held for investment (excluding acquired loans)(12)

    3.11        3.24        (13      

30+ day performing delinquency rate

    2.54        3.35        (81      

30+ day performing delinquency rate (excluding acquired loans)(12)

    3.15        3.47        (32      

30+ day delinquency rate

    2.92        3.95        (103      

30+ day delinquency rate (excluding acquired loans)(12)

    3.62        4.09        (47      

Capital ratios(17)

           

Tier 1 common ratio(18)

    10.7     9.7     100 bps       

Tier 1 risk-based capital ratio(19)

    12.7        12.0        70         

Total risk-based capital ratio(20)

    15.0        14.9        10         

Tangible common equity ratio (“TCE ratio”)(21)

    8.2        8.2        **         

Associates

           

Full-time equivalent employees (in thousands)

    37.6        30.5        23      

 

** Change is less than one percent or not meaningful.
(1) 

Premium amortization related to the ING Direct and HSBC U.S. card acquisitions reduced net interest income by $133 million and $267 million for the three and nine months ended September 30, 2012, respectively.

(2) 

Includes a bargain purchase gain of $594 million attributable to the ING Direct acquisition recognized in non-interest income in the first quarter of 2012. The bargain purchase gain represents the excess of the fair value of the net assets acquired from ING Direct as of the acquisition date over the consideration transferred. See “Note 2—Acquisitions” for additional information.

 

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(3) 

Total net revenue was reduced by $185 million and $24 million for the three months ended September 30, 2012 and 2011, respectively, and by $619 million and $241 million for the nine months ended September 30, 2012 and 2011, respectively, for the estimated uncollectible amount of billed finance charges and fees.

(4) 

Provision for credit losses includes provision expense of $107 million and $1.3 billion for the three and nine months ended September 30, 2012, respectively, to establish an allowance for acquired HSBC U.S. card loans accounted for based on contractual cash flows.

(5) 

Includes merger-related expenses, including transaction costs, attributable to acquisitions of $48 million and $18 million for the three months ended September 30, 2012 and 2011, respectively, and $267 million and $18 million for the nine months ended September 30, 2012 and 2011, respectively. Also includes intangible amortization expense related to purchased credit card relationships (“PCCR”) from the HSBC U.S. card acquisition of $127 million and $212 million for the three and nine months ended September 30, 2012, respectively, and other asset and intangible amortization expense related to the ING Direct and HSBC U.S. card acquisitions of $42 million and $99 million for the three and nine months ended September 30, 2012, respectively.

(6) 

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

(7) 

Loans held for investment includes loans acquired in the ING Direct, HSBC U.S. card and Chevy Chase Bank acquisitions. The carrying value of acquired loans accounted for subsequent to acquisition based on expected cash flows to be collected was $39.4 billion and $4.7 billion as of September 30, 2012 and December 31, 2011, respectively. The average balance of loans held for investment, excluding the carrying value of acquired loans, was $162.7 billion and $124.0 billion for the three months ended September 30, 2012 and 2011, respectively, and $147.7 billion and $122.2 billion for the nine months ended September 30, 2012 and 2011, respectively. See “Note 5—Loans” for additional information.

(8) 

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

(9) 

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

(10) 

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

(11) 

Calculated based on annualized net charge-offs for the period divided by average loans held for investment for the period.

(12)

Calculation of ratio adjusted to exclude from the denominator acquired loans accounted for subsequent to acquisition based on expected cash flows to be collected. See “Business Segment Financial Performance,” “Credit Risk Profile” and “Note 5—Loans—Credit Quality” for additional information on the impact of acquired loans on our credit quality metrics.

(13)

Calculated based on annualized income from continuing operations, net of tax, for the period divided by average total assets for the period.

(14) 

Calculated based on annualized income from continuing operations, net of tax, for the period divided by average stockholders’ equity for the period.

(15) 

Calculated based on annualized non-interest expense, excluding goodwill impairment charges, for the period divided by average loans held for investment for the period.

(16) 

Calculated based on non-interest expense, excluding goodwill impairment charges, for the period divided by total net revenue for the period.

(17)

Regulatory capital ratios as of September 30, 2012 are preliminary and therefore subject to change.

(18)

Tier 1 common ratio is a regulatory capital measure calculated based on Tier 1 common capital divided by risk-weighted assets. See “Capital Management” and “Supplemental Tables—Table A: Reconciliation of Non-GAAP Measures and Calculation of Regulatory Capital Measures” for additional information, including the calculation of this ratio.

(19)

Tier 1 risk-based capital ratio is a regulatory measure calculated based on Tier 1 capital divided by risk-weighted assets. See “Capital Management” and “Supplemental Tables—Table A: Reconciliation of Non-GAAP Measures and Calculation of Regulatory Capital Measures” for additional information, including the calculation of this ratio.

(20)

Total risk-based capital ratio is a regulatory measure calculated based on total risk-based capital divided by risk-weighted assets. See “Capital Management” and “Supplemental Tables—Table A: Reconciliation of Non-GAAP Measures and Calculation of Regulatory Capital Measures” for additional information, including the calculation of this ratio.

(21)

TCE ratio is a non-GAAP measure calculated based on tangible common equity divided by tangible assets. See “Supplemental Tables—Table A: Reconciliation of Non-GAAP Measures and Calculation of Regulatory Capital Measures” for the calculation of this measure and reconciliation to the comparative GAAP measure.

 

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INTRODUCTION

 

We are a diversified financial services holding company with banking and non-banking subsidiaries that offer a broad array of financial products and services to consumers, small businesses and commercial clients through branches, the internet and other distribution channels. Our principal subsidiaries included Capital One Bank (USA), National Association (“COBNA”), Capital One, National Association (“CONA”), and ING Bank, fsb as of September 30, 2012. On November 1, 2012, we merged ING Bank, fsb into CONA, with CONA surviving the merger. The Company and its subsidiaries are hereafter collectively referred to as “we,” “us” or “our.” CONA and COBNA are hereafter collectively referred to as the “Banks.” We continue to deliver on our strategy of combining the power of national scale lending and local scale banking.

The closing of the ING Direct acquisition in the first quarter of 2012 resulted in the addition of loans of $40.4 billion and other assets of $53.9 billion at acquisition. The ING Direct acquisition, which added over seven million customers and approximately $84.4 billion in deposits to our Consumer Banking business segment as of the acquisition date, strengthens our customer franchise. With the ING Direct acquisition, we have grown to become the sixth largest depository institution and the largest direct banking institution in the United States. The closing of the HSBC U.S. card acquisition in the second quarter of 2012 added approximately 27 million new active accounts and approximately $27.8 billion in outstanding credit card receivables as of the acquisition date that we designated as held for investment. Period-end loans held for investment increased to $203.1 billion and deposits increased to $213.3 billion as of September 30, 2012, up from period-end loans of $135.9 billion and deposits of $128.2 billion as of December 31, 2011.

Our revenues are primarily driven by lending to consumers and commercial customers and by deposit-taking activities, which generate net interest income, and by activities that generate non-interest income, such as fee-based services provided to customers, merchant interchange fees with respect to certain credit card transactions, and gains and losses, as well as fees associated with the sale and servicing of loans. Our expenses primarily consist of the cost of funding our assets, our provision for credit losses, operating expenses (including associate salaries and benefits, infrastructure maintenance and enhancements and branch operations and expansion costs), marketing expenses and income taxes.

Our principal operations are currently organized for management reporting purposes into three primary business segments, which are defined primarily based on the products and services provided or the type of customer served: Credit Card, Consumer Banking and Commercial Banking. The operations of acquired businesses have been integrated into our existing business segments. The acquired HSBC U.S. card business is reflected in our Credit Card business, while the acquired ING Direct business is primarily reflected in our Consumer Banking business. Certain activities that are not part of a segment are included in our “Other” category.

 

   

Credit Card: Consists of our domestic consumer and small business card lending, national small business lending, national closed end installment lending and the international card lending businesses in Canada and the United Kingdom.

 

   

Consumer Banking: Consists of our branch-based lending and deposit gathering activities for consumers and small businesses, national deposit gathering, national auto lending and consumer home loan lending and servicing activities.

 

   

Commercial Banking: Consists of our lending, deposit gathering and treasury management services to commercial real estate and commercial and industrial customers. Our commercial and industrial customers typically include companies with annual revenues between $10 million to $1.0 billion.

In the first quarter of 2012, we re-aligned the reporting of our Commercial Banking business to reflect the operations on a product basis rather than by customer type. Table 2 summarizes our business segment results, which we report based on income from continuing operations, net of tax, for the three and nine months ended September 30, 2012 and 2011. We provide additional information on the realignment of our Commercial

 

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Banking business segment below under “Business Segment Results” and in “Note 14—Business Segments” of this Report. We also provide a reconciliation of our total business segment results to our consolidated U.S. GAAP results in “Note 14—Business Segments.”

Table 2: Business Segment Results

 

      Three Months Ended September 30,  
     2012     2011  
     Total Net  Revenue(1)     Net Income
(Loss)(2)
    Total Net  Revenue(1)     Net Income
(Loss)(2)
 

(Dollars in millions)

   Amount     % of
Total
    Amount     % of
Total
    Amount     % of
Total
    Amount     % of
Total
 

Credit Card

   $ 3,817        66   $ 741        62   $ 2,720        65   $ 663        76

Consumer Banking

     1,761        30        376        32        1,285        31        190        22   

Commercial Banking

     519        9        228        19        470        11        157        19   

Other(3)

     (315     (5     (157     (13     (321     (7     (145     (17
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total from continuing operations

   $ 5,782        100   $ 1,188        100   $ 4,154        100   $ 865        100
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

      Nine Months Ended September 30,  
     2012     2011  
     Total Net  Revenue(1)     Net Income
(Loss)(2)
    Total Net  Revenue(1)     Net Income
(Loss)(2)
 

(Dollars in millions)

     Amount       % of
  Total  
    Amount      % of
Total
      Amount       % of
  Total  
     Amount      % of
Total
 

Credit Card

   $ 9,528        60   $ 1,010         35   $ 7,844        64   $ 1,924        68

Consumer Banking

     4,906        31        1,038         36        3,699        30        692        24   

Commercial Banking

     1,544        10        666         23        1,367        11        478        17   

Other(3)

     (206     (1     172         6        (681     (5     (252     (9
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total from continuing operations

   $ 15,772        100   $ 2,886         100   $ 12,229        100   $ 2,842        100
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) 

Total net revenue consists of net interest income and non-interest income.

(2) 

Net income for our business segments is reported based on income from continuing operations, net of tax.

(3) 

Includes the residual impact of the allocation of our centralized Corporate Treasury group activities, such as management of our corporate investment portfolio and asset/liability management, to our business segments as well as other items as described in “Note 14—Business Segments.”

 

 

EXECUTIVE SUMMARY AND BUSINESS OUTLOOK

 

In the third quarter of 2012, we experienced continued momentum and strong earnings performance across all three of our business segments, including strong contributions from our acquired ING Direct and HSBC U.S. card businesses. Third quarter results, together with the issuance of $853 million in perpetual preferred securities, further bolstered our regulatory capital position. The third quarter was the first to include a full-quarter impact of the operations of both the ING Direct and HSBC U.S. card acquisitions. Our results for the quarter reflected some continuing impact from the accounting for these acquisitions and merger-related expenses. The impact, however, was considerably smaller than in the first two quarters of 2012. We are continuing to devote significant effort to integrating the operations of these acquired businesses. The combination of ING Direct and HSBC’s U.S. card business with Capital One has shifted the mix of our interest-earning assets and driven substantial growth in our total net revenues, putting us in a position that we believe will sustain strong returns and capital generation, even in an environment with low industry growth and prolonged low interest rates.

Financial Highlights

We reported net income of $1.2 billion ($2.01 per diluted share) on total net revenue of $5.8 billion in the third quarter of 2012, with each of our three business segments contributing to our earnings. In comparison, we

 

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reported net income of $92 million ($0.16 per diluted share) on total net revenue of $5.1 billion in the second quarter of 2012, and net income of $813 million ($1.77 per diluted share) on total net revenue of $4.2 billion in the third quarter of 2011. Net income was $2.7 billion ($4.75 per diluted share) on total net revenue of $15.8 billion for the first nine months of 2012, compared with net income of $2.7 billion ($5.95 per diluted share) on total net revenue of $12.2 billion for the first nine months of 2011.

Our regulatory capital ratios, which declined in the second quarter of 2012 due to the significant increase in risk-weighted assets from the HSBC U.S. card acquisition and related purchase accounting adjustments, increased in the third quarter.

Our Tier 1 risk-based capital ratio under Basel I was 12.7% as of September 30, 2012, up from 11.6% as of June 30, 2012, while our Tier 1 common ratio increased to 10.7% as of September 30, 2012, from 9.9% as of June 30, 2012. The increases in our capital ratios reflected strong internal capital generation, as well as the issuance of $853 million in fixed-rate, non-cumulative perpetual preferred stock, which qualifies as Tier 1 capital. We provide additional information on recent capital issuances in “Capital Management—Recent Equity and Debt Offerings and Transactions.”

Below are additional highlights of our performance for the third quarter and first nine months of 2012. These highlights generally are based on a comparison to the same prior year periods, except as otherwise noted. The changes in our financial condition and credit performance are generally based on our financial condition and credit performance as of September 30, 2012, compared with our financial condition and credit performance as of December 31, 2011. We provide a more detailed discussion of our financial performance in the sections following this “Executive Summary and Business Outlook.”

Total Company

 

   

Earnings: Our earnings of $1.2 billion in the third quarter of 2012 increased by $360 million, or 44%, from the third quarter of 2011, while our earnings of $2.7 billion for the first nine months of 2012 decreased by $78 million, or 3%, from the first nine months of 2011. The increase in net income in the third quarter of 2012 was driven primarily by an increase in total net revenues resulting from the addition of customer accounts and loans related to the ING Direct and HSBC U.S. card acquisitions, which more than offset the increase in the provision for credit losses and non-interest expense, largely attributable to these acquisitions. The decrease in net income in the first nine months of 2012 reflected post-acquisition charges related to the HSBC U.S. card business of approximately $1.4 billion recorded in the second quarter of 2012, including a provision for credit losses of $1.2 billion to establish an allowance for approximately $26.2 billion in outstanding acquired HSBC U.S. credit card receivables designated as held for investment that had existing revolving privileges at acquisition as well as a charge of $174 million to establish a reserve for estimated uncollectible billed finance charges and fees for these loans. Merger-related expenses and higher operating expenses related to our recent acquisitions as well as higher infrastructure costs related to our home loan business and growth in auto originations also had an unfavorable impact on our results for the first nine months of 2012. The impact of these items was partially offset by the favorable impact from the bargain purchase gain of $594 million attributable to the ING Direct acquisition recorded in the first quarter of 2012, higher revenue from our legacy businesses as well as increased revenue associated with the acquisitions.

 

   

Total Loans: Period-end loans held for investment increased by $67.2 billion, or 49%, during the first nine months of 2012, to $203.1 billion as of September 30, 2012, from $135.9 billion as of December 31, 2011. The increase was primarily attributable to the addition of the acquired ING Direct loan portfolio of $40.4 billion and acquired HSBC U.S. card loans designated as held for investment of $27.8 billion. Excluding the impact of the addition of the acquired ING Direct and HSBC U.S. card loan portfolios designated as held for investment, period-end loans held for investment decreased by $1.0 billion, or 1%. The decrease was largely due to the continued expected run-off of installment loans in our Credit Card business and home loans in our Consumer Banking business, which was partially offset by auto loan growth in our Consumer Banking business and commercial loan growth.

 

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Charge-off and Delinquency Statistics: The net charge-off rate increased to 1.75% in the third quarter of 2012, from 1.53% in the second quarter of 2012. The net charge-off rate was 2.52% in the third quarter of 2011. The net charge-off rate was 1.75% for the first nine months of 2012, compared with 3.02% for the first nine months of 2011. The 30+ day delinquency rate increased to 2.92% as of September 30, 2012, from 2.43% as of June 30, 2012. The 30+ day delinquency rate was 3.95% as of December 31, 2011. As discussed above, the accounting and classification of acquired loans accounted for based on estimated cash flows expected to be collected may significantly alter some of our reported credit quality metrics. The “credit mark” established in conjunction with acquired loans from the ING Direct and HSBC U.S. card acquisitions absorbed a significant portion of the uncollectible amounts that we would have recorded as charge-offs on these portfolios in the second and third quarters of 2012, resulting in unusually low net-charge off rates for the second and third quarters. We provide information on our credit quality metrics, excluding the impact of acquired loans accounted for based on estimated cash flows expected to be collected, below under “Business Segments” and “Credit Risk Profile.”

 

   

Allowance for Loan and Lease Losses: We increased our allowance by $156 million in the third quarter of 2012 and by $904 million in the first nine months of 2012 to $5.2 billion as of September 30, 2012. The increase in each period was primarily attributable to the $26.2 billion in acquired HSBC U.S. card loans that had existing revolving privileges at acquisition. We recorded an allowance build and provision for credit losses for HSBC U.S. card loans of $107 million in the third quarter of 2012 and $1.2 billion in the second quarter. Although the allowance increased, the coverage ratio of the allowance to total loans held for investment fell to 2.54% as of September 30, 2012, from 3.13% as of December 31, 2011. The decrease in the allowance coverage ratio was largely due to the addition of the acquired ING Direct and HSBC U.S. card loans accounted for based on estimated cash flows expected to be collected, for which we have not recorded an allowance in accordance with the required accounting guidance for these loans. We expect the credit mark determined at acquisition to absorb the estimated uncollectible contractual amounts over the life of the acquired loans.

 

   

Representation and Warranty Provision: We did not record a provision for repurchase losses in the third quarter of 2012. We recorded a provision for repurchase losses of $349 million in the first nine months of 2012. In comparison, we recorded a provision for repurchase losses of $72 million and $153 million in the third quarter and first nine months of 2011, respectively. The increase in the provision for repurchase losses in the first nine months of 2012 was primarily driven by updated estimates of anticipated outcomes from various litigation and threatened litigation in the insured securitization segment based on relevant factual and legal developments and a first quarter settlement between a subsidiary and a GSE to resolve present and future claims. The mortgage representation and warranty reserve was $919 million as of September 30, 2012, compared with $943 million as of December 31, 2011. We provide additional information on the representation and warranty reserve in “Note 15—Commitments, Contingencies and Guarantees.”

Business Segments

 

   

Credit Card: Our Credit Card business generated net income from continuing operations of $741 million and $1.0 billion in the third quarter and first nine months of 2012, respectively, compared with net income from continuing operations of $663 million and $1.9 billion in the third quarter and first nine months of 2011, respectively. The increase in earnings in the third quarter of 2012 over the same period last year was primarily attributable to growth in total net revenue, largely due to the addition of credit card receivables from the HSBC U.S. card acquisition. The increase in net revenue was partially offset by higher non-interest expense due to the operating expenses of the HSBC U.S. card business and amortization of intangible and other assets recorded at acquisition, including PCCR amortization expense of $127 million in the third quarter of 2012, and an increase in the provision for credit losses due to the addition of HSBC U.S. card loans, coupled with the absence of an allowance release of $178 million recorded in the third quarter of 2011. The decrease in earnings in the first nine months of 2012 from the same period last year was largely due to significant charges related to the HSBC U.S. card acquisition, including a provision for credit losses

 

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of $1.3 billion in the first nine months of 2012 to establish an allowance for acquired HSBC U.S. credit card receivables with revolving credit card privileges and PCCR amortization expense of $212 million in the first nine months of 2012. The unfavorable impact of these charges diminished the favorable impact from the increase in total net revenue resulting from the addition of credit card receivables from the HSBC U.S. card acquisition.

 

   

Consumer Banking: Our Consumer Banking business generated net income from continuing operations of $376 million and $1.0 billion in the third quarter and first nine months of 2012, respectively, compared with net income from continuing operations of $190 million and $692 million in the third quarter and first nine months of 2011, respectively. The increase in earnings was attributable to growth in total net revenue, which was partially offset by higher non-interest expense and an increase in the provision for credit losses. Growth in revenue stemmed from higher average loan balances resulting from increased auto loan originations over the last two years and added home loans from the ING Direct acquisition, coupled with the significant increase in deposits from the ING Direct acquisition. The increase in non-interest expense was largely due to operating expenses associated with ING Direct, higher infrastructure expenditures related to our home loan business and growth in auto originations and modestly higher marketing expenditures in our retail banking operations. The increase in the provision for credit losses was largely due to higher auto loan balances resulting from growth in auto loan originations.

 

   

Commercial Banking: Our Commercial Banking business generated net income from continuing operations of $228 million and $666 million in the third quarter and first nine months of 2012, respectively, compared with net income from continuing operations of $157 million and $478 million in the third quarter and first nine months of 2011, respectively. The improvement in results for Commercial Banking was attributable to an increase in revenues driven by increased average loan balances as well as a decrease in the provision for credit losses due to improving credit trends. These factors were partially offset by higher non-interest expense resulting from operating costs associated with the increased volume of loan originations in our commercial real estate and commercial and industrial businesses, increased infrastructure expenditures and the expansion into new markets.

Recent Developments

Hurricane Sandy

On October 29, 2012, Hurricane Sandy made landfall on the New Jersey coast. The Federal Emergency Management Agency (“FEMA”) has given a Major Disaster Declaration to coastal counties in Connecticut, New Jersey and New York. Other counties in those states and in other states in the Northeast and Mid-Atlantic also experienced varying, although lesser, damage and disruption from the storm. We have significant consumer and commercial loan exposure in Connecticut, New Jersey and New York, the states with the most severe FEMA disaster declarations. Note that some of these exposures are not in the counties that received the most damage. See “Note 16—Subsequent Events” for more information.

The storm and its aftermath expose these loans to an elevated risk of loss. Due to the recency of events, we have not completed our evaluation of the impact of the storm and do not know the extent of disruption to the individuals, businesses, or properties that support these loans. Consequently, it is too early to estimate the potential financial impact on our future earnings. Historically, insurance proceeds and government support that follow natural disasters have significantly mitigated our losses. However, we cannot give assurance that those historical patterns will apply in this case, particularly given our concentration of Commercial Real Estate exposure in the hardest hit areas.

ING Bank, fsb Merger

On November 1, 2012, we effected the merger of ING Bank, fsb with CONA, with CONA surviving the merger. See “Supervision and Regulation” for more information.

 

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Senior Notes Offering

We closed a public offering of two different series of our senior notes on November 6, 2012, for total proceeds of approximately $1.0 billion. The offering of senior notes included $250 million aggregate principal amount of our Floating Rate Senior Notes due 2015 and $750 million aggregate principal amount of our 1.000% Senior Notes due 2015.

Business Outlook

We discuss below our current expectations regarding our total company performance and the performance of each of our business segments over the near-term based on market conditions, the regulatory environment and our business strategies as of the time we filed this Quarterly Report on Form 10-Q. The statements contained in this section are based on our current expectations regarding our outlook for our financial results and business strategies. Our expectations take into account, and should be read in conjunction with, our expectations regarding economic trends and analysis of our business as discussed in “Part I—Item 1. Business” and “Part I—Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our 2011 Form 10-K. Certain statements are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual results could differ materially from those in our forward-looking statements. Forward-looking statements do not reflect: (i) any change in current dividend or repurchase strategies, (ii) the effect of any acquisitions, divestitures or similar transactions, except for the forward-looking statements specifically discussing the acquisitions of ING Direct and HSBC’s U.S. credit card business, or (iii) any changes in laws, regulations or regulatory interpretations, in each case after the date as of which such statements are made. See “Forward-Looking Statements” in this Quarterly Report on Form 10-Q for more information on the forward-looking statements in this report and “Item 1A. Risk Factors” in our 2011 Form 10-K for factors that could materially influence our results.

Total Company Expectations

Our strategies and actions are designed to deliver and sustain strong returns and capital generation through the acquisition and retention of franchise-enhancing customer relationships across our businesses. We believe that franchise-enhancing customer relationships create and sustain significant long-term value through low credit costs, long and loyal customer relationships and a gradual build in loan balances and revenues over time. Examples of franchise-enhancing customer relationships include rewards customers and new partnerships in our Credit Card business, retail deposit customers in our Consumer Banking business and primary banking relationships with commercial customers in our Commercial Banking business. We intend to grow these customer relationships by continuing to invest in scalable infrastructure and operating platforms that are appropriate for a bank of our size and business mix so that we can meet the rising regulatory and compliance requirements facing all banks and deliver a “brand-defining” customer experience that builds and sustains a valuable, long-term customer franchise. The acquisitions of ING Direct and HSBC’s U.S. credit card business strengthened and expanded our customer base, and, over time, we expect to expand and deepen our customer relationships with new products and services.

We expect our average loans for the full-year 2013 to decline modestly from third quarter 2012 average loan balances, as significant run-off of mortgage and card loans we acquired is partially offset by growth in our businesses. We expect run-off of approximately $11 billion in ending loan balances in 2013, primarily comprised of approximately $9 billion in mortgage loans acquired from ING Direct and Chevy Chase Bank, and approximately $2 billion in credit card loans acquired from HSBC. We expect this run-off to be partially offset by growth in certain of our businesses, including parts of Domestic Card, Auto and Commercial Banking. However, we expect continued weak consumer demand across our Credit Card and auto lending businesses, as well as intensifying competition in several businesses, particularly auto and commercial and industrial lending.

 

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We expect average quarterly non-interest expense, excluding marketing costs, through 2013 to be approximately equal to non-interest expense, excluding marketing costs, for the third quarter of 2012. We also expect our marketing expense for 2013 to be approximately $1.5 billion.

We believe our actions have created a well-positioned balance sheet with strong capital and liquidity levels, and a strong capital generation trajectory. We expect to exceed an assumed Basel III Tier 1 common ratio internal target of 8 percent in 2013. Our estimated Basel III capital trajectory includes the estimated impact of implementing the Basel II Advanced Approaches to calculate regulatory capital, which we expect will apply to us in 2016 or later. The assumed 8 percent Basel III Tier 1 common ratio target assumes a buffer of 50 basis points for a systemically important financial institution (SIFI) under applicable rules and regulations and a further buffer of 50 basis points. It is estimated based on our current interpretation, expectations and understanding of the Basel III capital rules and other capital regulations proposed by U.S. regulators and the application of such rules to our businesses as currently conducted. Basel III calculations are necessarily subject to change based on, among other things, the scope and terms of the final rules and regulations, model calibration and other implementation guidance, changes in our businesses and certain actions of management, including those affecting the composition of our balance sheet. The actual target will depend on regulatory expectations and business judgments. We believe this ratio provides useful information to investors and others by measuring our progress against expected future regulatory capital standards.

Business Segment Expectations

Credit Card Business

As noted above, in Domestic Card, the closing of the HSBC U.S. card acquisition has impacted and will continue to affect quarterly trends in loan growth, revenue margin and credit metrics. We anticipate that the run-off of parts of the portfolios acquired in the HSBC U.S. card acquisition as well as anticipated run-off of in our installment loan portfolio will more than offset the underlying growth trajectory in other parts of our Domestic Card business resulting in a modest decline in full-year average loan balances in 2013 from average loan balances in the third quarter of 2012. The credit mark on the non-revolving credit card loans acquired in the HSBC U.S. card acquisition has already absorbed a significant portion of the credit losses on those loans. We expect that virtually all future net charge-offs on the accounts acquired in the HSBC U.S. card acquisition will be covered by the allowance for loan and lease losses, and the Domestic Card charge-off rate will increase accordingly in the fourth quarter of 2012. Thereafter, we expect charge-off levels to remain relatively stable with normal seasonal patterns.

As we have disclosed in the past, we are taking actions that we believe will enhance our franchise, such as aligning HSBC customer practices with our own, and ending the sale of products like payment protection. By the fourth quarter of 2013, we expect that these moves will result in a 50 basis point reduction from the third quarter 2012 revenue margin, adjusted for seasonality and the impact of post-acquisition HSBC U.S. card purchase accounting adjustments. And, in 2014, the run-off of another year of payment protection products is expected to reduce revenue margin by another 10 basis points from 2013. We also expect the run-off of higher-margin, higher-loss HSBC U.S. card loans will change the mix of loans in our Domestic Card business, driving another 15 basis points of reduction from third quarter revenue margin by the fourth quarter of 2013. Other factors which we are unable to accurately predict will also affect revenue margin. These factors, which include market and pricing dynamics, credit trends, and competitive intensity, could have positive or negative impacts on the Domestic Card revenue margin.

Consumer Banking Business

In our Consumer Banking business, we expect the ING Direct acquisition to continue to have a significant impact on Consumer Banking loan volumes as we anticipate that run-off in the acquired Home Loans portfolio will more than offset growth in auto loans.

 

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Commercial Banking Business

Our Commercial Banking business continues to grow loans, deposits, and revenues as we attract new customers and deepen relationships with existing customers. Although we anticipate some quarterly fluctuations in nonperforming loan and charge-off rates, we expect our Commercial Banking business to continue strong and relatively steady performance trends throughout 2012 and into 2013.

 

 

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

 

The preparation of financial statements in accordance with U.S. Generally Accepted Accounting Principles (“GAAP”) requires management to make a number of judgments, estimates and assumptions that affect the reported amount of assets, liabilities, income and expenses in the consolidated financial statements. Understanding our accounting policies and the extent to which we use management judgment and estimates in applying these policies is integral to understanding our financial statements. We provide a summary of our significant accounting policies in “Note 1—Summary of Significant Accounting Policies” of our 2011 Form 10-K.

In the “MD&A—Critical Accounting Policies and Estimates” section of our 2011 Form 10-K, we identified the following accounting policies as critical because they require significant judgments and assumptions about highly complex and inherently uncertain matters and the use of reasonably different estimates and assumptions could have a material impact on our reported results of operations or financial condition.

 

   

Loan loss reserves

   

Representation and warranty reserve

   

Asset impairment

   

Fair value

   

Derivative and hedge accounting

   

Income taxes

We evaluate our critical accounting estimates and judgments on an ongoing basis and update them as necessary based on changing conditions. Management has reviewed and approved these critical accounting policies and has discussed our judgments and assumptions with the Audit and Risk Committee of the Board of Directors. There have been no material changes in the methods used to formulate these critical accounting estimates from those discussed in the “MD&A—Critical Accounting Policies and Estimates” section of our 2011 Form 10-K.

 

 

CONSOLIDATED RESULTS OF OPERATIONS

 

The section below provides a comparative discussion of our consolidated financial performance for the three and nine months ended September 30, 2012 and 2011. Following this section, we provide a discussion of our business segment results. You should read this section together with our “Executive Summary and Business Outlook” where we discuss trends and other factors that we expect will affect our future results of operations.

Net Interest Income

Net interest income represents the difference between the interest income and applicable fees earned on our interest-earning assets, which include loans held for investment and investment securities, and the interest expense on our interest-bearing liabilities, which include interest-bearing deposits, senior and subordinated notes, securitized debt and other borrowings. We include in interest income any past due fees on loans that we deem are collectible. Our net interest margin represents the difference between the yield on our interest-earning assets and the cost of our interest-bearing liabilities, including the impact of non-interest bearing funding. We expect net interest income and our net interest margin to fluctuate based on changes in interest rates and changes in the amount and composition of our interest-earning assets and interest-bearing liabilities.

 

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Table 3 below presents, for each major category of our interest-earning assets and interest-bearing liabilities, the average outstanding balances, interest income earned or interest expense incurred, and average yield or cost for the three and nine months ended September 30, 2012 and 2011.

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

 

     Three Months Ended September 30,  
     2012     2011  

(Dollars in millions)

   Average
Balance
    Interest
Income/
Expense(1)
     Yield/
Rate
    Average
Balance
    Interest
Income/
Expense(1)
     Yield/
Rate
 

Assets:

              

Interest-earning assets:

              

Loans held for investment:

              

Credit card:(2)

              

Domestic

   $ 80,502      $ 2,995         14.88   $ 53,668      $ 1,961         14.62

International

     8,154        336         16.47        8,703        353         16.24   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Credit card

     88,656        3,331         15.03        62,371        2,314         14.84   

Consumer banking(3)

     77,271        1,168         6.05        34,862        857         9.83   

Commercial banking

     36,767        381         4.14        31,615        372         4.71   

Other

     162        21         51.85        195        7         14.36   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total loans held for investment

     202,856        4,901         9.66        129,043        3,550         11.00   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Investment securities

     57,928        335         2.31        37,189        264         2.84   

Other interest-earning assets

     6,019        18         1.20        11,299        21         0.74   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total interest-earning assets

   $ 266,803      $ 5,254         7.88   $ 177,531      $ 3,835         8.64
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Cash and due from banks

     2,285             1,742        

Allowance for loan and lease losses

     (5,003          (4,488     

Premises and equipment, net

     3,561             2,731        

Other assets

     29,508             24,095        
  

 

 

        

 

 

      

Total assets

   $ 297,154           $ 201,611        
  

 

 

        

 

 

      

Liabilities and stockholders’ equity:

              

Interest-bearing liabilities:

              

Deposits

   $ 193,700      $ 371         0.77   $ 110,750      $ 294         1.06

Securitized debt obligations

     13,331        64         1.92        18,478        89         1.93   

Senior and subordinated notes

     11,035        85         3.08        10,519        84         3.19   

Other borrowings

     12,085        88         2.91        8,369        85         4.06   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total interest-bearing liabilities

   $ 230,151      $ 608         1.06   $ 148,116      $ 552         1.49
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Non-interest bearing deposits

     19,623             17,518        

Other liabilities

     8,845             6,661        
  

 

 

        

 

 

      

Total liabilities

     258,619             172,295        

Stockholders’ equity

     38,535             29,316        
  

 

 

        

 

 

      

Total liabilities and stockholders’ equity

   $ 297,154           $ 201,611        
  

 

 

        

 

 

      

Net interest income/spread

     $ 4,646         6.82     $ 3,283         7.15
    

 

 

        

 

 

    

Impact of non-interest bearing funding

          0.15             0.25   
       

 

 

        

 

 

 

Net interest margin

          6.97          7.40
       

 

 

        

 

 

 

 

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     Nine Months Ended September 30,  
     2012     2011  

(Dollars in millions)

   Average
Balance
    Interest
Income/
Expense(1)
     Yield/
Rate
    Average
Balance
    Interest
Income/
Expense(1)
     Yield/
Rate
 

Assets:

              

Interest-earning assets:

              

Loans held for investment:

              

Credit card:(2)

              

Domestic

   $ 68,744      $ 7,286         14.13   $ 53,148      $ 5,651         14.18

International

     8,216        966         15.68        8,741        1,055         16.09   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Credit card

     76,960        8,252         14.30        61,889        6,706         14.45   

Consumer banking(3)

     70,405        3,379         6.40        34,515        2,497         9.65   

Commercial banking

     35,347        1,137         4.29        30,746        1,096         4.75   

Other

     158        43         36.29        210        35         22.22   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total loans held for investment

     182,870        12,811         9.34        127,360        10,334         10.82   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Investment securities

     55,158        968         2.34        39,685        893         3.00   

Other interest-earning assets

     9,434        70         0.99        7,999        59         0.98   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total interest-earning assets

   $ 247,462      $ 13,849         7.46   $ 175,044      $ 11,286         8.60
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Cash and due from banks

     5,413             1,851        

Allowance for loan and lease losses

     (4,470          (5,058     

Premises and equipment, net

     3,259             2,722        

Other assets

     27,863             25,057        
  

 

 

        

 

 

      

Total assets

   $ 279,527           $ 199,616        
  

 

 

        

 

 

      

Liabilities and stockholders’ equity:

              

Interest-bearing liabilities:

              

Deposits

   $ 180,372      $ 1,055         0.78   $ 109,552      $ 923         1.12

Securitized debt obligations

     14,816        213         1.92        22,041        342         2.07   

Senior and subordinated notes

     10,839        260         3.20        8,910        211         3.16   

Other borrowings

     10,301        260         3.37        8,156        251         4.10   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total interest-bearing liabilities

   $ 216,328      $ 1,788         1.10   $ 148,659      $ 1,727         1.55
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Non-interest bearing deposits

     19,193             16,550        

Other liabilities

     7,648             6,205        
  

 

 

        

 

 

      

Total liabilities

     243,169             171,414        

Stockholders’ equity

     36,358             28,202        
  

 

 

        

 

 

      

Total liabilities and stockholders’ equity

   $ 279,527           $ 199,616        
  

 

 

        

 

 

      

Net interest income/spread

     $ 12,061         6.36     $ 9,559         7.05
    

 

 

        

 

 

    

Impact of non-interest bearing funding

          0.14             0.23   
       

 

 

        

 

 

 

Net interest margin

          6.50          7.28
       

 

 

        

 

 

 

 

(1) 

Past due fees included in interest income totaled approximately $530 million and $303 million for the three months ended September 30, 2012 and 2011, respectively, and approximately $1.2 billion and $793 million for the nine months ended September 30, 2012 and 2011, respectively. Premium amortization related to the ING Direct and HSBC U.S. card acquisitions reduced net interest income by $133 million and $267 million for the three and nine months ended September 30, 2012, respectively.

(2) 

Credit card loans consist of domestic and international credit card loans and installment loans.

(3) 

Consumer banking loans consist of auto, home and retail banking loans.

 

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Table 4 presents the variances between our net interest income for the three and nine months ended September 30, 2012 and 2011, and the extent to which the variance was attributable to: (i) changes in the volume of our interest-earning assets and interest-bearing liabilities or (ii) changes in the interest rates of these assets and liabilities.

Table 4: Rate/Volume Analysis of Net Interest Income(1)

 

(Dollars in millions)

   Three Months Ended September 30,
2012 vs. 2011
    Nine Months Ended September 30,
2012 vs. 2011
 
   Total
    Variance   
    Variance Due to     Total
   Variance  
    Variance Due to  
        Volume           Rate            Volume         Rate    

Interest income:

            

Loans held for investment:

            

Credit card

   $ 1,017      $ 987      $ 30      $ 1,546      $ 1,617      $ (71

Consumer banking

     311        738        (427     882        1,936        (1,054

Commercial banking

     9        56        (47     41        154        (113

Other

     14        (1     15        8        (10     18   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans held for investment

     1,351        1,780        (429     2,477        3,697        (1,220

Investment securities

     71        127        (56     75        299        (224

Other

     (3     (13     10        11        11          
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest income

     1,419        1,894        (475     2,563        4,007        (1,444
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest expense:

            

Deposits

     77        175        (98     132        473        (341

Securitized debt obligations

     (25     (25            (129     (105     (24

Senior and subordinated notes

     1        4        (3     49        46        3   

Other borrowings

     3        32        (29     9        59        (50
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest expense

     56        186        (130     61        473        (412
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

   $ 1,363      $ 1,708      $ (345   $ 2,502      $ 3,534      $ (1,032
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1)

We calculate the change in interest income and interest expense separately for each item. The change in net interest income attributable to both volume and rates is allocated based on the relative dollar amount of each item.

Net interest income of $4.6 billion for the third quarter of 2012 increased by $1.4 billion, or 42%, from the third quarter of 2011, driven by a 50% increase in average interest-earning assets, which was partially offset by a 6% decline in our net interest margin to 6.97%.

Net interest income of $12.1 billion for the first nine months of 2012 increased by $2.5 billion, or 26%, from the first nine months of 2011, driven by a 41% increase in average interest-earning assets, which was partially offset by an 11% decline in our net interest margin to 6.50%.

 

   

Average Interest-Earning Assets: The significant increase in average interest-earning assets reflects the addition of the ING Direct loan portfolio of $40.4 billion in the first quarter of 2012, the addition of the $27.8 billion in outstanding HSBC U.S. card loans that we acquired and designated as held for investment in the second quarter of 2012. The third quarter of 2012 was the first quarter that included a full-quarter impact of both the ING Direct and HSBC U.S. card acquisitions. Growth in average-interest earning assets was also driven by strong auto loan originations over the past twelve months and commercial loan growth. The growth in loan balances from acquisitions was partially offset by the expected run-off of higher-margin, higher loss HSBC U.S. card loans and the expected continuing run-off of installment loan and acquired home loan portfolios. The run-off of home loans has accelerated slightly as a result of the low mortgage interest rate environment.

 

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Net Interest Margin: The decrease in our net interest margin was attributable to a decline in the average yield on our interest-earning assets, largely due to the shift in the mix of our interest-earning assets to a larger proportion of lower yielding assets resulting from the acquired ING Direct home loan and investment security portfolios and temporarily higher cash balances from the recent equity and debt offerings. The ING Direct interest-earning assets generally have lower yields than our legacy loan and the investment security portfolios. In addition, the establishment of a finance charge and fee reserve of $174 million in the second quarter of 2012 for the acquired HSBC U.S. card loan portfolio and premium amortization expense related to the ING Direct and HSBC U.S. card acquisitions of $133 million and $267 million in the third quarter and first nine months of 2012, respectively, contributed to the reduction in the average yield on interest-earning assets. The decrease in the average yield on interest-earnings assets was partially offset by a reduction in our cost of funds. We have continued to benefit from the shift in the mix of our funding to lower cost consumer and commercial banking deposits from higher cost wholesale sources and a decline in deposit interest rates as a result of the continued overall low interest rate environment.

Non-Interest Income

Non-interest income primarily consists of service charges and other customer-related fees, interchange income (net of rewards expense) and other non-interest income. The servicing fees, finance charges, other fees, net of charge-offs and interest paid to third-party investors related to our consolidated securitization trusts are reported as a component of non-interest income. We also record the provision for repurchase losses related to continuing operations in non-interest income. The “other” component of non-interest income includes gains and losses on derivatives not accounted for in hedge accounting relationships and gains and losses from the sale of investment securities, which we generally do not allocate to our business segments because they relate to centralized asset/liability and market risk management activities undertaken by our Corporate Treasury group.

Table 5 displays the components of non-interest income for the three and nine months ended September 30, 2012 and 2011.

Table 5: Non-Interest Income

 

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

(Dollars in millions)

       2012             2011             2012             2011      

Service charges and other customer-related fees

   $ 557      $ 542      $ 1,511      $ 1,527   

Interchange fees, net

     452        321        1,188        972   

Bargain purchase gain(1)

                   594          

Net other-than-temporary impairment (“OTTI”)

     (13     (6     (40     (15

Other non-interest income:

        

Provision for repurchase losses(2)

            3        (42     (5

Other

     140        11        500        191   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other non-interest income

     140        14        458        186   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total non-interest income

   $ 1,136      $ 871      $ 3,711      $ 2,670   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) 

Represents the excess of the fair value of the net assets acquired in the ING Direct acquisition as of the acquisition date of February 17, 2012 over the consideration transferred.

(2) 

We did not record a provision for repurchase losses for the three months ended September 30, 2012. We recorded a total provision for repurchase losses of $72 million for the three months ended September 30, 2011, and $349 million and $153 million for the nine months ended September 30, 2012 and 2011, respectively. The remaining portion of the provision for repurchase losses is included, net of tax, in discontinued operations.

Non-interest income of $1.1 billion for the third quarter of 2012 increased by $265 million, or 30%, from non-interest income of $871 million for the third quarter of 2011. The increase was largely attributable to

 

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increased fees resulting from continued growth and market share from new account originations and the acquisition of ING Direct in the first quarter of 2012 and the HSBC U.S. card acquisition in the second quarter of 2012. In addition, we recognized mark-to-market gains on retained interests in interest-only strips and negative amortization mortgage securities of $75 million in the third quarter of 2012, attributable to lower market interest rates.

Non-interest income of $3.7 billion for the first nine months of 2012 increased by $1.0 billion, or 39%, from non-interest income of $2.7 billion for the first nine months of 2011. This increase reflected the combined impact of the bargain purchase gain of $594 million recognized in the first quarter of 2012 at acquisition of ING Direct, income of $162 million recorded in the first quarter of 2012 from the sale of Visa stock shares, the increased fees resulting from continued growth and market share from new account originations, due in part to the acquisitions of ING Direct and the HSBC U.S. card portfolio and the mark-to-market gains of $75 million recognized on retained interests in mortgage-related securities in the third quarter of 2012. The favorable impact of these items was partially offset by cross-sell activities related to expected customer refunds of approximately $114 million recorded in the first nine months of 2012, a mark-to-market derivative loss of $78 million recognized in the first quarter of 2012 related to the settlement of interest-rate swaps we entered into in 2011 to partially hedge the interest rate risk of the net assets associated with the ING Direct acquisition and an increase in the provision for repurchase losses.

We also recorded higher other-than-temporary impairment losses of $13 million and $40 million in the third quarter and first nine months of 2012, respectively, compared with $6 million and $15 million in the third quarter and first nine months of 2011, respectively. The impairment losses stemmed from deterioration in the credit quality of certain non-agency mortgage-backed securities due to the persistent weakness in the housing market. We provide additional information on other-than-temporary impairment recognized on our available-for-sale securities in “Note 4—Investment Securities.”

Provision for Credit Losses

We build our allowance for loan and lease losses and unfunded lending commitment reserves through the provision for credit losses. Our provision for credit losses in each period is driven by charge-offs and the level of allowance for loan and lease losses that we determine is necessary to provide for probable credit losses inherent in our loan portfolio as of each balance sheet date.

We recorded a provision for credit losses of $1.0 billion and $3.3 billion in the third quarter and first nine months of 2012, respectively, compared with $622 million and $1.5 billion in the third quarter and first nine months of 2011, respectively. The significant increase in our provision for credit losses was primarily related to the addition of the $26.2 billion in outstanding HSBC U.S. card loans designated as held for investment that had existing revolving privileges at acquisition. These loans were recorded at a fair value of $26.9 billion, resulting in a net premium of $705 million at acquisition. Fair value was determined by discounting all expected cash flows (contractual principal, interest, finance charges and fees of $33.3 billion less those amounts not expected to be collected of $3.0 billion) at a market discount rate.

Under applicable accounting guidance, we are required to amortize the net premium of $705 million over the contractual principal amount as an adjustment to interest income over the remaining life of the loans. Given the guidance applicable to revolving loans, it is necessary to record an allowance through provision for credit losses to properly recognize an estimate of incurred losses on the existing principal balances, which represents a portion of the total amounts not expected to be collected described above. In the second quarter of 2012, we recorded provision for credit losses of $1.2 billion to establish an allowance primarily related to these loans. We recorded an additional allowance and provision for credit losses for these loans of $107 million in the third quarter of 2012. The allowance was calculated using the same methodology utilized for determining the allowance for our existing credit card loan portfolio. The provision for credit losses of $107 million and $1.3 billion for the third

 

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quarter and first nine months of 2012, respectively, is included in the total provision for credit losses recorded for each period. The provision for credit losses, excluding the allowance build related to acquired HSBC U.S. card loans, was $907 million and $2.0 billion for the third quarter and the first nine months of 2012, respectively. The increase in the provision for credit losses excluding the impact of the allowance build for acquired HSBC U.S. card loans was largely attributable to the growth in auto loan originations, coupled with the absence of the allowance for loan losses release for our credit card business in 2011.

We provide additional information on the provision for credit losses and changes in the allowance for loan and lease losses under the “Credit Risk Profile—Summary of Allowance for Loan and Lease Losses” and “Note 6—Allowance for Loan and Lease Losses.” For information on the allowance methodology for our credit card loan portfolio, see “Note 1—Summary of Significant Accounting Policies” in our 2011 Form 10-K.

Non-Interest Expense

Non-interest expense consists of ongoing operating costs, such as salaries and associated employee benefits, communications and other technology expenses, supplies and equipment, occupancy costs, and miscellaneous expenses. Marketing expenses are also included in non-interest expense. Table 6 displays the components of non-interest expense for the three and nine months ended September 30, 2012 and 2011.

Table 6: Non-Interest Expense

 

(Dollars in millions)

   Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
       2012              2011              2012              2011      

Salaries and associate benefits

   $ 1,002       $ 750       $ 2,837       $ 2,206   

Marketing

     316         312         971         917   

Communications and data processing

     198         178         573         504   

Supplies and equipment

     209         143         534         402   

Occupancy

     145         122         413         359   

Merger-related expense

     48         18         267         18   

Other non-interest expense:

           

Professional services

     310         269         916         820   

Collections

     139         137         417         431   

Fraud losses

     52         32         129         89   

Bankcard association assessments

     149         103         396         289   

Amortization of intangibles

     197         53         414         165   

Other

     280         180         824         514   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total other non-interest expense

     1,127         774         3,096         2,308   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total non-interest expense

   $ 3,045       $ 2,297       $ 8,691       $ 6,714   
  

 

 

    

 

 

    

 

 

    

 

 

 

Non-interest expense of $3.0 billion for the third quarter of 2012 increased by $748 million, or 33%, from the third quarter of 2011. The increase was primarily due to higher operating expenses and merger-related costs related to our recent acquisitions, higher infrastructure costs from our continued investments in our home loan business and growth in auto originations, and increased amortization of intangibles resulting from the ING Direct and HSBC U.S. card acquisitions. We recorded intangible amortization expense related to purchased credit card relationships (“PCCR”) from the HSBC U.S. card acquisition of $127 million in the third quarter of 2012. We recorded other asset and intangible amortization expense related to the ING Direct and HSBC U.S. card acquisitions of $42 million in the third quarter of 2012.

Non-interest expense of $8.7 billion for the first nine months of 2012 increased by $2.0 billion, or 29%, from the first nine months of 2011. The increase was primarily due to higher operating expenses and merger-related costs related to our recent acquisitions, increased marketing expenditures, higher infrastructure costs from our

 

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continued investments in our home loan business and growth in auto originations, and increased amortization on intangibles. We recorded PCCR intangible amortization expense related to the HSBC U.S. card acquisition of $212 million in the first nine months of 2012. We recorded other asset and intangible amortization expense related to the ING Direct and HSBC U.S. card acquisitions of $99 million in the first nine months of 2012. Our results for the first nine months of 2012 also reflect the unfavorable impact of civil penalties of $60 million related to cross-sell activities and net legal costs of $98 million related to interchange and other litigation developments.

Income Taxes

Our effective tax rate on income from continuing operations varies between periods due, in part, to fluctuations in our pre-tax earnings, which affect the relative impact tax benefits from tax-exempt income, tax credits and other tax items.

We recorded an income tax provision based on income from continuing operations of $535 million (31.1% effective income tax rate) in the third quarter of 2012, compared with an income tax provision of $370 million (30.0% effective income tax rate) in the third quarter of 2011. The increase in the effective tax rate in the third quarter of 2012 compared to the third quarter of 2011 was attributable to the release of a valuation allowance against certain state deferred tax assets, which was recorded in the third quarter of 2011 and contributed to a reduction in the effective tax rate for the period.

We recorded an income tax provision based on income from continuing operations of $931 million (24.4% effective income tax rate) for the first nine months of 2012, compared with an income tax provision of $1.2 billion (29.2% effective income tax rate) for the first nine months of 2011. Our effective income tax rate for the first nine months of 2012 reflects the impact of discrete tax benefits of $213 million primarily related to the non-taxable ING Direct bargain purchase gain of $594 million, recognition of a deferred tax benefit due to changes in our state tax position as a result of the acquisition of the HSBC U.S. card business and the resolution of certain tax issues and audits. Our effective tax rate for the first nine months of 2011 reflects the impact of tax benefits of $98 million related to the release of a valuation allowance against certain state deferred tax assets and net operating loss carryforwards and the resolution of certain tax issues and audits. Our effective income tax rate, excluding the benefit from these discrete tax items, was 30.0% and 31.7% for the first nine months of 2012 and 2011, respectively. The decrease in our effective income tax rate, excluding the impact of discrete items, for the first nine months of 2012 relative to the same period in the prior year was primarily due to an increase in affordable housing and other business tax credits.

We provide additional information on items affecting our income taxes and effective tax rate in our 2011 Form 10-K under “Note 18—Income Taxes.”

Loss from Discontinued Operations, Net of Tax

Loss from discontinued operations reflects ongoing costs, which primarily consist of mortgage loan repurchase representation and warranty charges related to the mortgage origination operations of GreenPoint’s wholesale mortgage banking unit that we closed in 2007.

We did not record a provision for repurchase losses in the third quarter of 2012. We recorded a pre-tax provision for repurchase losses of $349 million in the first nine months of 2012, of which $307 million ($194 million, net of tax) was included in discontinued operations. In comparison, we recorded a pre-tax provision for repurchase losses of $72 million in the third quarter of 2011, of which $75 million ($53 million, net of tax) was included in discontinued operations, and a pre-tax provision of $153 million in the first nine months of 2011, of which $147 million ($104 million, net of tax) was included in discontinued operations.

The increase in the provision for repurchase losses in the first nine months of 2012 was primarily driven by updated estimates in the first and second quarters of anticipated outcomes from various litigation and threatened

 

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litigation in the insured securitization segment based on relevant factual and legal developments and an increased reserve associated with a first quarter settlement between a subsidiary and a GSE to resolve present and future claims.

We provide additional information on the provision for repurchase losses and the related reserve for potential representation and warranty claims in “Consolidated Balance Sheet Analysis—Potential Mortgage Representation and Warranty Liabilities” and “Note 15—Commitments, Contingencies and Guarantees.”

 

 

BUSINESS SEGMENT FINANCIAL PERFORMANCE

 

Our principal operations are currently organized into three major business segments, which are defined based on the products and services provided or the type of customer served: Credit Card, Consumer Banking and Commercial Banking. The operations of acquired businesses have been integrated into our existing business segments. Certain activities that are not part of a segment, such as management of our corporate investment portfolio and asset/liability management by our centralized Corporate Treasury group, are included in the “Other” category.

The results of our individual businesses, which we report on a continuing operations basis, reflect the manner in which management evaluates performance and makes decisions about funding our operations and allocating resources. Our business segment results are intended to reflect each segment as if it were a stand-alone business. We use an internal management and reporting process to derive our business segment results. Our internal management and reporting process employs various allocation methodologies, including funds transfer pricing, to assign certain balance sheet assets, deposits and other liabilities and their related revenue and expenses directly or indirectly attributable to each business segment. Total interest income and net fees are directly attributable to the segment in which they are reported. The net interest income of each segment reflects the results of our funds transfer pricing process, which is primarily based on a matched maturity method that takes into consideration market rates. Our funds transfer pricing process provides a funds credit for sources of funds, such as deposits generated by our Consumer Banking and Commercial Banking businesses, and a funds charge for the use of funds by each segment. The allocation process is unique to each business segment and acquired businesses. See “Note 20—Business Segments” of our 2011 Form 10-K for information on the allocation methodologies used to derive our business segment results.

We may periodically change our business segments or reclassify business segment results based on modifications to our management reporting methodologies and changes in organizational alignment. In the first quarter of 2012, we re-aligned the reporting of our Commercial Banking business to reflect the operations on a product basis rather than by customer type. As a result of this re-alignment, we now report three product categories: commercial and multifamily real estate, commercial and industrial loans and small-ticket commercial real estate, which is a run-off portfolio. We previously reported four categories within our Commercial Banking business: commercial and multifamily real estate, middle market, specialty lending and small-ticket commercial real estate. Middle market and specialty lending related products are included in commercial and industrial loans. All affordable housing tax-related investments, some of which were previously included in the “Other” segment, are now included in the commercial and multifamily real estate category of our Commercial Banking business. Prior period amounts have been recast to conform to the current period presentation.

We summarize our business segment results for the three and nine months ended September 30, 2012 and 2011 in the tables below and provide a comparative discussion of these results. We also discuss changes in our financial condition and credit performance statistics as of September 30, 2012, compared with December 31, 2011. See “Note 14—Business Segments” of this Report for a reconciliation of our business segment results to our consolidated results. Information on the outlook for each of our business segments is presented above under “Executive Summary and Business Outlook.”

 

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Credit Card Business

Our Credit Card business generated net income from continuing operations of $741 million and $1.0 billion in the third quarter and first nine months of 2012, respectively, compared with net income from continuing operations of $663 million and $1.9 billion in the third quarter and first nine months of 2011, respectively. The primary sources of revenue for our Credit Card business are interest income and non-interest income from customers and interchange fees. Expenses primarily consist of ongoing operating costs, such as salaries and associate benefits, communications and other technology expenses, supplies and equipment, occupancy costs, as well as marketing expenses.

Table 7 summarizes the financial results of our Credit Card business, which is comprised of Domestic Card, including installment loans, and International Card operations, and displays selected key metrics for the periods indicated. The closing on May 1, 2012 of the HSBC U.S. card acquisition, which added approximately $27.8 billion in outstanding credit card receivables designated as held for investment to our Credit Card business, had a significant impact on the results of our Credit Card business for the third quarter and first nine months of 2012.

Table 7: Credit Card Business Results

 

(Dollars in millions)

  Three Months Ended September 30,     Nine Months Ended September 30,  
      2012             2011             Change             2012             2011             Change      

Selected income statement data:

           

Net interest income(1)

  $ 2,991      $ 2,042        46   $ 7,333      $ 5,873        25

Non-interest income

    826        678        22        2,195        1,971        11   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total net revenue(2)

    3,817        2,720        40        9,528        7,844        21   

Provision for credit losses

    892        511        75        3,061        1,270        141   

Non-interest expense

    1,790        1,188        51        4,921        3,604        37   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations before income taxes

    1,135        1,021        11        1,546        2,970        (48 )

Income tax provision

    394        358        10        536        1,046        (49
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations, net of tax

  $ 741      $ 663        12   $ 1,010      $ 1,924        (48 )% 
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Selected performance metrics:

           

Average loans held for investment

  $ 88,656      $ 62,371        42   $ 76,960      $ 61,889        24

Average yield on loans held for investment(3)

    15.03     14.84     19 bps      14.30     14.45     (15 )bps 

Total net revenue margin(4)

    17.22        17.44        (22 )     16.51        16.90        (39 )

PCCR intangible amortization(5)

  $ 127                    $ 212                 

Net charge-off rate(6)

    3.22        4.23        (101     3.43        5.13        (170 )

Net charge-off rate (excluding acquired loans)(7)

    3.23        4.23        (100     3.45        5.13        (168

Purchase volume(8)

  $ 48,020      $ 34,918        38   $ 127,746      $ 96,941        32

(Dollars in millions)

  September 30,
2012
    December 31,
2011
    Change                    

Selected period-end data:

           

Loans held for investment

  $ 89,033      $ 65,075        37      

30+ day delinquency rate(9)

    3.65     3.86     (21 )bps       

30+ day delinquency rate (excluding acquired loans)(7)

    3.67     3.86     (19 )bps       

Allowance for loan and lease losses

  $ 3,944      $ 2,847        39      

 

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** Change is less than one percent or not meaningful.
(1)

Includes premium amortization expense related to the HSBC U.S. card acquisition of $65 million and $111 million for the three and nine months ended September 30, 2012.

(2)

Total net revenue was reduced by $185 million and $24 million for the three months ended September 30, 2012 and 2011, respectively and $619 million and $241 million for the nine months ended September 30, 2012 and 2011, respectively, for the estimated uncollectible amount of billed finance charges and fees.

(3) 

Calculated by dividing annualized interest income for the period by average loans held for investment during the period.

(4) 

Calculated by dividing annualized total revenue for the period by average loans held for investment during the period for the specified loan category.

(5) 

Represents amortization expense related to the purchased credit card relationships intangible asset of $2.2 billion recorded in connection with the closing on May 1, 2012 of the HSBC U.S. card acquisition.

(6) 

Calculated by dividing annualized net charge-offs for the period by average loans held for investment during the period for the specified loan category.

(7) 

Calculation of ratio adjusted to exclude from the denominator acquired loans accounted for subsequent to acquisition based on expected cash flows to be collected. See “Summary of Selected Financial Data,” “Credit Risk Profile” and “Note 5—Loans—Credit Quality” for additional information on the impact of acquired loans on our credit quality metrics.

(8) 

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

(9) 

Calculated by loan category by dividing 30+ day delinquent loans as of the end of the period by period-end loans held for investment for the specified loan category. The 30+ day performing delinquency rate is the same as the 30+ day delinquency rate for our Credit Card business, as credit card loans remain on accrual status until the loan is charged-off.

Key factors affecting the results of our Credit Card business for the third quarter and first nine months of 2012, compared with the third quarter and first nine months of 2011 included the following:

 

   

Net Interest Income: Net interest income increased by $949 million, or 46%, in the third quarter of 2012 and by $1.5 billion, or 25%, in the first nine months of 2012. The increase in each period was primarily attributable to a substantial increase in average loans held for investment resulting from the HSBC U.S. card acquisition in the second quarter of 2012.

 

   

Non-Interest Income: Non-interest income increased by $148 million, or 22%, in the third quarter of 2012 and by $224 million, or 11%, in the first nine months of 2012. The increase in each period was primarily driven by higher net interchange generated from purchase volume growth and customer-related fees resulting from the addition of customer accounts associated with the HSBC U.S. card acquisition in the second quarter of 2012. This increase for the first nine months of 2012 was partially offset by charges of $75 million and $24 million in the first and second quarter of 2012, respectively, for expected refunds to customers affected by cross-sell activities in our Domestic Card business as well as the discontinuance of the recognition of revenue for any amounts billed for cross-sell customers affected.

 

   

Provision for Credit Losses: The provision for credit losses related to our Credit Card business totaled $892 million in the third quarter of 2012, compared with $511 million in the third quarter of 2011. The increase in the provision in the third quarter of 2012 was primarily driven by provision for credit losses of $107 million recorded to increase the allowance for HSBC U.S. card receivables with revolving privileges, coupled with the absence of an allowance release of $178 million recorded in the third quarter of 2011. The provision for credit losses totaled $3.1 billion in the first nine months of 2012, compared with $1.3 billion in the first nine months of 2011. The significant increase in the provision in the first nine months of 2012 was primarily driven by provision for credit losses of $1.2 billion recorded in the second quarter of 2012 to establish an allowance for HSBC U.S. card receivables with revolving privileges. The allowance releases recorded in 2011 reflected the significant improvement in credit performance, which began to stabilize in 2012. The provision for credit losses, excluding the allowance build related to HSBC U.S. card loans, totaled $785 million and $1.8 billion for the third quarter and first nine months of 2012.

 

   

Non-Interest Expense: Non-interest expense increased by $602 million, or 51%, in the third quarter of 2012 and by $1.3 billion, or 37% in the first nine months of 2012. The increase was largely due to higher operating expenses resulting from addition of the HSBC U.S. card business and the amortization of intangibles and other assets associated with the HSBC U.S. card acquisition, including intangible

 

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amortization of purchased credit card relationships of $127 million and $212 million in the third quarter and first nine months of 2012, respectively. Other items contributing to the increase in non-interest expense in the first nine months of 2012 include merger-related expenses associated with the HSBC U.S. card acquisition, regulatory fines of $60 million related to cross-sell activities in the Domestic Card business and litigation expense of $98 million to cover interchange and other legal matters in the second quarter of 2012.

 

   

Total Loans: Period-end loans in our Credit Card business increased by $24.0 billion, or 37%, to $89.0 billion as of September 30, 2012, from $65.1 billion as of December 31, 2011, primarily due to the addition of the $27.8 billion in outstanding HSBC U.S. card loans classified as held for investment, which was partially offset by the continued run-off of our installment loan portfolio and expected third quarter seasonal run-off of credit card receivables.

 

   

Charge-off and Delinquency Statistics: The net charge-off rate decreased to 3.22% and 3.43% in the third quarter and first nine months of 2012, respectively, from 4.23% and 5.13% in the third quarter and first nine months of 2011, respectively. Our reported charge-offs reflect the absence of charge-offs for the acquired HSBC U.S. card loans accounted for based on estimated cash flows expected to be collected over the life of the loans as the credit mark established at acquisition is expected to absorb uncollectible contractual amounts. The decreases in the net-charge off rates was due in part to the addition of the HSBC U.S. card portfolio to the denominator in calculating our reported charge-off and the lag in the impact of charge-offs related to this portfolio. The 30+ day delinquency rate decreased to 3.65% as of September 30, 2012, from 3.86% as of December 31, 2011.

Domestic Card Business

Domestic Card generated net income from continuing operations of $673 million and $924 million in the third quarter and first nine months of 2012, respectively, compared with net income from continuing operations of $637 million and $1.9 billion in the third quarter and first nine months of 2011, respectively. Because our Domestic Card business currently accounts for the substantial majority of our Credit Card business, the key factors driving the results for this division are similar to the key factors affecting our total Credit Card business.

The increase of $36 million in Domestic Card net income from continuing operations in the third quarter of 2012 from the same prior year period was driven by an increase in total net revenue largely due to the addition of the HSBC U.S. card portfolio. The increase in total net revenue was partially offset by a higher provision for credit losses, largely attributable to the allowance build for the HSBC U.S. card loan portfolio, an increase in non-interest expense due to higher operating expenses resulting from the acquisition of the HSBC U.S. card business and the amortization of intangibles and other assets associated with the HSBC U.S. card acquisition, including intangible amortization expense related to purchased credit card relationships of $127 million in the third quarter of 2012.

The decrease of $1.0 billion in Domestic Card net income from continuing operations in the first nine months of 2012 from the same prior year period was driven by an increase in total net revenue largely due to the addition of the HSBC U.S. card portfolio, which was more than offset by the unfavorable impact of several items related to the HSBC U.S. card acquisition. These items included a significant increase in the provision for credit losses resulting from an allowance build of $1.3 billion for the HSBC U.S. card loan portfolio and an increase in non-interest expense due to higher operating expenses resulting from the acquisition of the HSBC U.S. card business and the amortization of intangibles and other assets associated with the HSBC U.S. card acquisition, including intangible amortization expense related to purchased credit card relationships of $212 million in the first nine months of 2012. The regulatory fine related to cross-sell activities of $60 million and litigation expenses to cover interchange and other settlements recorded in the second quarter of 2012 also contributed to the increase in non-interest expense in the first nine months of 2012.

 

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Table 7.1 summarizes the financial results for Domestic Card and displays selected key metrics for the periods indicated.

Table 7.1: Domestic Card Business Results

 

(Dollars in millions)

   Three Months Ended September 30,     Nine Months Ended September 30,  
   2012     2011         Change         2012     2011         Change      

Selected income statement data:

            

Net interest income(1)

   $ 2,715      $ 1,753        55   $ 6,546      $ 5,011        31

Non-interest income

     722        588        23        1,927        1,755        10   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total net revenue

     3,437        2,341        47        8,473        6,766        25   

Provision for credit losses

     811        381        113        2,772        798        247   

Non-interest expense

     1,584        972        63        4,270        2,970        44   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations before income taxes

     1,042        988        5        1,431        2,998        (52 )

Income tax provision

     369        351        5        507        1,065        (52 )
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations, net of tax

   $ 673      $ 637        6   $ 924      $ 1,933        (52 )% 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Selected performance metrics:

            

Average loans held for investment

   $ 80,502      $ 53,668        50   $ 68,744      $ 53,148        29

Average yield on loans held for investment(2)

     14.88     14.62     26 bps      14.13     14.18     (5 )bps 

Total net revenue margin(3)

     17.08        17.45        (37 )     16.43        16.97        (54 )

PCCR intangible amortization(4)

   $ 127                    $ 212                 

Net charge-off rate(5)

     3.04        3.92        (88     3.21        4.94        (173 )

Purchase volume(6)

   $ 44,552      $ 31,686        41   $ 117,776      $ 87,780        34

(Dollars in millions)

   September 30,
2012
    December 31,
2011
        Change        

 

   

 

   

 

 

Selected period-end data:

            

Loans held for investment

   $ 80,621      $ 56,609        42      

30+ day delinquency rate(7)

     3.52     3.66     (14 )bps       

Allowance for loan and lease losses

   $ 3,494      $ 2,375        47      

 

(1)

Includes premium amortization expense related to the HSBC U.S. card acquisition of $65 million and $111 million for the three and nine months ended September 30, 2012.

(2) 

Calculated by dividing annualized interest income for the period by average loans held for investment during the period.

(3) 

Calculated by dividing annualized total revenue for the period by loans held for investment during the period for the specified loan category.

(4)

Represents amortization expense related to the purchased credit card relationships intangible asset of $2.2 billion recorded in connection with the closing on May 1, 2012 of the HSBC U.S. card acquisition.

(5) 

Calculated by dividing annualized net charge-offs for the period by average loans held for investment during the period for the specified loan category.

(6) 

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

(7) 

Calculated by loan category by dividing 30+ day delinquent loans as of the end of the period by period-end loans held for investment for the specified loan category. The 30+ day performing delinquency rate is the same as the 30+ day delinquency rate for our Credit Card business, as credit card loans remain on accrual status until the loan is charged-off.

International Card Business

Our International Card business generated net income from continuing operations of $68 million and $86 million in the third quarter and first nine months of 2012, respectively, compared with net income from continuing operations of $26 million in the third quarter of 2011 and a net loss of $9 million in the first nine months of 2011.

 

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The primary driver of the improvement in results in the third quarter and first nine months of 2012 was a decrease in the provision for credit losses, attributable to lower net-charge offs resulting from an improvement in the credit environment in Canada and the U.K. and the absence of an allowance build for the Hudson’s Bay Company loan portfolio of approximately $105 million that we acquired in January 2011.

Table 7.2 summarizes the financial results for International Card and displays selected key metrics for the periods indicated.

Table 7.2: International Card Business Results

 

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

(Dollars in millions)

  2012     2011         Change              2012               2011              Change      

Selected income statement data:

           

Net interest income

  $ 276      $ 289        (4 )%    $ 787      $ 862        (9 )% 

Non-interest income

    104        90        16        268        216        24   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total net revenue

    380        379        **        1,055        1,078        (2 )

Provision for credit losses

    81        130        (38     289        472        (39

Non-interest expense

    206        216        (5 )     651        634        3   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations before income taxes

    93        33        182        115        (28 )     511   

Income tax provision

    25        7        257        29        (19 )     253   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations, net of tax

  $ 68      $ 26        162   $ 86      $ (9 )     1,056
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Selected performance metrics:

           

Average loans held for investment

  $ 8,154      $ 8,703        (6 )%    $ 8,216      $ 8,741        (6 )% 

Average yield on loans held for investment(1)

    16.47     16.24     23 bps      15.68     16.09     (41 )bps

Revenue margin(2)

    18.64        17.42        122        17.12        16.44        68   

Net charge-off rate(3)

    4.95        6.15        (120     5.32        6.31        (99

Purchase volume(4)

  $ 3,468      $ 3,232        7   $ 9,970      $ 9,161        9

(Dollars in millions)

  September 30,
2012
    December 31,
2011
    Change                    

Selected period-end data:

           

Loans held for investment

  $ 8,412      $ 8,466        (1 )%       

30+ day delinquency rate(5)

    4.92     5.18     (26 )bps       

Allowance for loan and lease losses

  $ 450      $ 472        (5 )%       

 

** Change is less than one percent or not meaningful.
(1) 

Calculated by dividing annualized interest income for the period by average loans held for investment during the period.

(2) 

Calculated by dividing annualized total revenue for the period by loans held for investment during the period for the specified loan category.

(3) 

Calculated by dividing annualized net charge-offs for the period by average loans held for investment during the period for the specified loan category.

(4) 

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

(5) 

Calculated by loan category by dividing 30+ day delinquent loans as of the end of the period by period-end loans held for investment for the specified loan category. The 30+ day performing delinquency rate is the same as the 30+ day delinquency rate for our Credit Card business, as credit card loans remain on accrual status until the loan is charged-off.

Consumer Banking Business

Our Consumer Banking business generated net income from continuing operations of $376 million and $1.0 billion in the third quarter and first nine months of 2012, respectively, compared with net income from

 

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continuing operations of $190 million and $692 million in the third quarter and first nine months of 2011, respectively. The primary sources of revenue for our Consumer Banking business are net interest income from loans and deposits and non-interest income from customer fees. Expenses primarily consist of ongoing operating costs, such as salaries and associate benefits, communications and other technology expenses, supplies and equipment and occupancy costs.

On February 17, 2012, we acquired ING Direct, and the substantial majority of the lending and retail deposit businesses acquired are reported in the Consumer Banking segment. The acquisition resulted in the addition of loans with a carrying value of $40.4 billion and deposits of $84.4 billion at acquisition.

Table 8 summarizes the financial results of our Consumer Banking business and displays selected key metrics for the periods indicated.

Table 8: Consumer Banking Business Results

 

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

(Dollars in millions)

       2012             2011             Change             2012             2011             Change      

Selected income statement data:

            

Net interest income

   $ 1,501      $ 1,097        37   $ 4,285      $ 3,131        37

Non-interest income

     260        188        38        621        568        9   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total net revenue

     1,761        1,285        37        4,906        3,699        33   

Provision for credit losses

     202        136        49        420        272        54   

Non-interest expense

     977        853        15        2,879        2,351        22   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations before income taxes

     582        296        97        1,607        1,076        49   

Income tax provision

     206        106        94        569        384        48   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations, net of tax

   $ 376      $ 190        98   $ 1,038      $ 692        50
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Selected performance metrics:

            

Average loans held for investment:(1)

            

Auto

   $ 25,923      $ 19,757        31   $ 24,336      $ 18,851        29

Home loan

     47,262        11,126        325        41,930        11,537        263   

Retail banking

     4,086        3,979        3        4,139        4,127        **   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total consumer banking

   $ 77,271      $ 34,862        122   $ 70,405      $ 34,515        104
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Average yield on loans held for investment

     6.05     9.83     (378 )bps      6.40     9.65     (325 )bps

Average deposits

   $ 173,334      $ 88,266        96   $ 159,273      $ 86,375        84

Average deposit interest rate

     0.71     0.95     (24 )bps      0.71     0.98     (27 )bps 

Core deposit intangible amortization

   $ 41      $ 32        28   $ 120      $ 100        20

Net charge-off rate(2)

     0.83     1.32     (49 )bps      0.69     1.30     (61 )bps 

Net charge-off rate (excluding acquired loans)(2)

     1.70        1.51        19        1.34        1.50        (16

Automobile loan originations

   $ 3,905      $ 3,409        15   $ 12,481      $ 8,890        40

 

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Table of Contents

(Dollars in millions)

   September 30,
2012
    December 31,
2011
    Change                

Selected period-end data:

              

Loans held for investment:(1)

              

Auto

   $ 26,434      $ 21,779        21        

Home loans

     46,275        10,433        344           

Retail banking

     4,029        4,103        (2        
  

 

 

   

 

 

   

 

 

         

Total consumer banking

   $ 76,738      $ 36,315        111        
  

 

 

   

 

 

   

 

 

         

30+ day performing delinquency rate(4)

     2.23     4.47     (224 )bps         

30+ day performing delinquency rate (excluding acquired loans)(3)

     4.50        5.06        (56        

30+ day delinquency rate(5)

     2.91        5.99        (308        

30+ day delinquency rate (excluding acquired loans)(3)

     5.85        6.78        (93        

Nonperforming loan rate(6)

     0.84        1.79        (95        

Nonperforming loan rate (excluding acquired loans)(3)

     1.69        2.03        (34        

Nonperforming asset rate(7)

     0.89        1.94        (105        

Nonperforming asset rate (excluding acquired loans)(3)

     1.78        2.20        (42        

Allowance for loan and lease losses

   $ 711      $ 652        9        

Deposits

     173,100        88,540        96           

Loans serviced for others

     15,659        17,998        (13        

 

** Change is less than one percent or not meaningful.
(1) 

Loans held for investment includes loans acquired in the ING Direct and Chevy Chase Bank acquisitions. The carrying value of consumer banking acquired loans accounted for subsequent to acquisition based on expected cash flows to be collected was $38.6 billion and $4.2 billion as of September 30, 2012, and December 31, 2011, respectively. The average balance of consumer banking loans held for investment, excluding the carrying value of acquired loans, was $38.0 billion and $30.4 billion for the three months ended September 30, 2012 and 2011, respectively and $36.0 billion and $29.9 billion for the nine months ended September 30, 2012 and 2011, respectively.

(2) 

Calculated by dividing annualized net charge-offs for the period by average loans held for investment during the period for the specified loan category.

(3) 

Calculation of ratio adjusted to exclude from the denominator acquired loans accounted for subsequent to acquisition based on expected cash flows to be collected. See “Summary of Selected Financial Data,” “Credit Risk Profile” and “Note 5—Loans—Credit Quality” for additional information on the impact of acquired loans on our credit quality metrics.

(4) 

Calculated by loan category by dividing 30+ day performing delinquent loans as of the end of the period by period-end loans held for investment for the specified loan category.

(5) 

Calculated by loan category by dividing 30+ day delinquent loans as of the end of the period by period-end loans held for investment for the specified loan category.

(6) 

Calculated by loan category by dividing nonperforming loans as of the end of the period by period-end loans held for investment for the specified loan category. Nonperforming loans generally include loans that have been placed on nonaccrual status and certain restructured loans whose contractual terms have been restructured in a manner that grants a concession to a borrower experiencing financial difficulty.

(7) 

The nonperforming asset rate is calculated by loan category by dividing nonperforming assets as of the end of the period by period-end nonperforming assets. Nonperforming assets consist of nonperforming loans, real estate owned (“REO”) and other foreclosed assets.

 

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Key factors contributing to the improvement in the results of our Consumer Banking business for the third quarter and first nine months of 2012, compared with the third quarter and first nine months of 2011 included the following:

 

   

Net Interest Income: Net interest income increased by $404 million, or 37%, in the third quarter of 2012 and by $1.2 billion, or 37%, in the first nine months of 2012. The increase was primarily attributable to an increase in average loans held for investment resulting from the acquisition of ING Direct home loans and deposits in the first quarter of 2012 and growth in auto loan balances due to increased auto loan originations over the past two years. This increase was partially offset by the expected continued run-off of acquired home loans, which has accelerated slightly as a result of the low mortgage interest rate environment. The favorable impact from the increase in average loans more than offset a decline in average loan yields resulting from the lower yielding acquired ING Direct home loan portfolio.

 

   

Non-Interest Income: Non-interest income increased by $72 million, or 38%, in the third quarter of 2012 and by $53 million, or 9%, in the first nine months of 2012. The increase was primarily attributable to mark-to-market gains on retained interests in interest-only strips and negative amortization mortgage securities recognized in the third quarter of 2012.

 

   

Provision for Credit Losses: The provision for credit losses increased by $66 million to $202 million in the third quarter of 2012 and by $148 million to $420 million in the first nine months of 2012. The increase in the provision was largely due to higher auto loan balances resulting from increased originations over the past two years, which more than offset the benefits from lower net charge-off rates and continued credit performance improvement. We recorded allowance builds of $42 million and $59 million in the third quarter and first nine months of 2012, respectively, compared with an allowance build of $22 million in the third quarter of 2011 and an allowance release of $55 million in the first nine months of 2011.

 

   

Non-Interest Expense: Non-interest expense increased by $124 million, or 15%, in the third quarter of 2012 and by $528 million, or 22% in the first nine months of 2012. The increase was largely attributable to operating expenses related to ING Direct, merger-related expenses associated with the acquisition and higher infrastructure expenditures resulting from continued investments in the home loan business and growth in auto loan balances as a result of increased auto loan originations over the past two years.

 

   

Total Loans: Period-end loans held for investment in our Consumer Banking business more than doubled, increasing by $40.4 billion to $76.7 billion as of September 30, 2012, from $36.3 billion as of December 31, 2011, primarily due to the acquisition of $40.4 billion of ING Direct home loans and growth in auto loan originations, which were partially offset by the expected continued run-off of our acquired home loan portfolios.

 

   

Deposits: Period-end deposits in the Consumer Banking business increased by $84.6 billion, or 96%, to $173.1 billion as of September 30, 2012, from $88.5 billion as of December 31, 2011, primarily due to the addition of ING Direct deposits of $84.4 billion and a modest increase in deposits in our retail branch franchise.

 

   

Charge-off and Delinquency Statistics: The net charge-off rate decreased to 0.83% and 0.69% in the third quarter and first nine months of 2012, respectively, from 1.32% and 1.30% in the third quarter and first nine months of 2011, respectively. The 30+ day delinquency rate decreased to 2.91% as of September 30, 2012, from 5.99% as of December 31, 2011. The improvement in our reported net charge-off and delinquency rates for our Consumer Banking business reflects the impact of the addition of the ING Direct home loan portfolio, the substantial majority of which is accounted for based on estimated cash flows expected to be collected over the life of the loans. As discussed above in “Summary of Selected Financial Data,” because the credit mark established at acquisition for these loans takes into consideration future credit losses expected to be incurred, there are no charge-offs or an allowance associated with these loans unless the estimated cash flows expected to be collected decrease subsequent to acquisition. In addition, these loans are not classified as delinquent or nonperforming even though the customer may be contractually past due because we expect that we will fully collect the carrying value of these loans. The overall improvement in credit quality metrics, excluding acquired loans, reflects improved credit performance in our legacy consumer loan portfolios.

 

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Commercial Banking Business

Our Commercial Banking business generated net income from continuing operations of $228 million and $666 million in the third quarter and first nine months of 2012, respectively, compared with net income from continuing operations of $157 million and $478 million in the third quarter and first nine months of 2011, respectively. The primary sources of revenue for our Commercial Banking business are net interest income from loans and deposits and non-interest income from customer fees. Expenses primarily consist of ongoing operating costs, such as salaries and associate benefits, communications and other technology expenses, supplies and equipment, occupancy costs and marketing expenditures. Because we have some affordable housing tax-related investments that generate tax-exempt income or tax credits, we make certain reclassifications to our Commercial Banking business results to present revenues on a taxable-equivalent basis.

Table 9 summarizes the financial results of our Commercial Banking business and displays selected key metrics for the periods indicated.

Table 9: Commercial Banking Business Results

 

(Dollars in millions)

   Three Months Ended September 30,     Nine Months Ended September 30,  
       2012             2011             Change             2012             2011             Change      

Selected income statement data:

            

Net interest income

   $ 432      $ 407        6   $ 1,290      $ 1,171        10

Non-interest income

     87        63        38        254        196        30   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total net revenue

     519        470        10        1,544        1,367        13   

Provision for credit losses

     (87 )     (10 )     770        (250 )     (45 )     456   

Non-interest expense

     253        237        7        765        671        14   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations before income taxes

     353        243        45        1,029        741        39   

Income tax provision

     125        86        45        363        263        38   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations, net of tax

   $ 228      $ 157        45   $ 666      $ 478        39
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Selected performance metrics:

            

Average loans held for investment:(1)

            

Commercial and multifamily real estate

   $ 16,654      $ 14,291        17   $ 16,004      $ 13,912        15

Commercial and industrial

     18,817        15,726        20        17,955        15,121        19   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial lending

     35,471        30,017        18        33,959        29,033        17   

Small-ticket commercial real estate

     1,296        1,598        (19     1,388        1,713        (19
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial banking

   $ 36,767      $ 31,615        16   $ 35,347      $ 30,746        15
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Average yield on loans held for investment

     4.14     4.71     (57 )bps      4.29     4.75     (46 )bps 

Average deposits

   $ 28,063      $ 25,321        11   $ 27,859      $ 24,645        13

Average deposit interest rate

     0.31     0.47     (16 )bps      0.34     0.51     (17 )bps 

Core deposit intangible amortization

   $ 8      $ 10        (20 )%    $ 26      $ 31        (16 )% 

Net charge-off rate(2)

         0.37     (37 )bps      0.13     0.55     (42 )bps 

Net charge-off rate (excluding acquired loans)(3)

            0.38        (38     0.13        0.56        (43

 

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(Dollars in millions)

   September 30,
2012
    December 31,
2011
    Change                

Selected period-end data:

              

Loans held for investment:(1)

              

Commercial and multifamily real estate

   $ 16,963      $ 15,736        8        

Commercial and industrial

     18,965        17,088        11           
  

 

 

   

 

 

   

 

 

         

Total commercial lending

     35,928        32,824        9           

Small-ticket commercial real estate

     1,281        1,503        (15        
  

 

 

   

 

 

   

 

 

         

Total commercial banking

   $ 37,209      $ 34,327        8        
  

 

 

   

 

 

   

 

 

         

Nonperforming loan rate(4)

     0.82     1.08     (26 )bps         

Nonperforming loan rate (excluding acquired loans)(3)

     0.83        1.10        (27        

Nonperforming asset rate(5)

     0.87        1.17        (30        

Nonperforming asset rate (excluding acquired loans)(3)

     0.88        1.18        (30        

Allowance for loan and lease losses

   $ 460      $ 715        (36 )%         

Deposits

     28,670        26,683        7           

 

(1) 

Loans held for investment includes loans acquired in the ING Direct and Chevy Chase Bank acquisitions. The carrying value of commercial banking acquired loans accounted for subsequent to acquisition based on expected cash flows to be collected was $398 million and $479 million as of September 30, 2012, and December 31, 2011, respectively. The average balance of commercial banking loans held for investment, excluding the carrying value of acquired loans, was $36.4 billion and $34.9 billion in the third quarter and first nine months of 2012, respectively and $31.1 billion and $30.3 billion in the third quarter and first nine months of 2011, respectively.

(2) 

Calculated by dividing annualized net charge-offs for the period by average loans held for investment during the period for the specified loan category.

(3) 

Calculation of ratio adjusted to exclude from the denominator acquired loans accounted for subsequent to acquisition based on expected cash flows to be collected. See “Summary of Selected Financial Data,” “Credit Risk Profile” and “Note 5—Loans—Credit Quality” for additional information on the impact of acquired loans on our credit quality metrics.

(4) 

Calculated by loan category by dividing nonperforming loans as of the end of the period by period-end loans held for investment for the specified loan category. Nonperforming loans generally include loans that have been placed on nonaccrual status and certain restructured loans whose contractual terms have been restructured in a manner that grants a concession to a borrower experiencing financial difficulty.

(5) 

The nonperforming asset rate is calculated by loan category by dividing nonperforming assets as of the end of the period by period-end loans held for investment, REO, and other foreclosed assets for the specified loan category.

Key factors affecting the results of our Commercial Banking business for the third quarter and first nine months of 2012, compared with the third quarter and first nine months of 2011 included the following:

 

   

Net Interest Income: Net interest income increased by $25 million, or 6%, in the third quarter of 2012 and by $119 million, or 10%, in the first nine months of 2012. The increase was primarily driven by higher deposit balances and growth in commercial real estate and commercial and industrial loans, partially offset by lower spreads between interest-earning assets and net deposits.

 

   

Non-Interest Income: Non-interest income increased by $24 million, or 38% in the third quarter of 2012 and by $58 million, or 30% in the first nine months of 2012, largely attributable to growth in fees from ancillary services provided to customers and a gain of $7 million recorded in the third quarter of 2012 on the sale of certain real-estate investment projects.

 

   

Provision for Credit Losses: The provision for credit losses was a net benefit of $87 million and $250 million in the third quarter and first nine months of 2012, compared with net benefit of $10 million and $45 million in the third quarter and first nine months 2011. The improvements were due to both a lower level of

 

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net loan charge-offs and an increase in allowance releases, attributable to an improvement in underlying credit performance trends. We recorded releases of the combined allowance and reserve for unfunding lending commitments of $87 million and $283 million in the third quarter and first nine months of 2012, respectively, compared with releases of $39 million and $172 million in the third quarter and first nine months of 2011, respectively.

 

   

Non-Interest Expense: Non-interest expense increased by $16 million, or 7% in the third quarter of 2012 and by $94 million, or 14% in the first nine months of 2012. The increase was due to costs associated with higher originations in our commercial real estate and commercial and industrial businesses, expansion into new markets and infrastructure investments.

 

   

Total Loans: Period-end loans in the Commercial Banking business increased by $2.9 billion, or 8%, to $37.2 billion as of September 30, 2012, from $34.3 billion as of December 31, 2011. The increase was driven by stronger loan originations in the commercial and industrial and commercial real estate businesses, which was partially offset by the continued run-off of the small-ticket commercial real estate loan portfolio.

 

   

Deposits: Period-end deposits in the Commercial Banking business increased by $2.0 billion, or 7%, to $28.7 billion as of September 30, 2012, from $26.7 billion as of December 31, 2011, driven by our strategy to strengthen existing relationships and increase liquidity from commercial customers.

 

   

Charge-off Statistics: Net charge-offs totaled $1 million and $34 million in the third quarter and first nine months of 2012, respectively, compared with $29 million and $127 million in the third quarter and first nine months of 2011, respectively. The net charge-off rate decreased to 0.00% and 0.13% in third quarter and first nine months of 2012, from 0.37% and 0.55% in the third quarter and first nine months of 2011, respectively. The significant improvement in the credit metrics in our Commercial Banking business reflects a continued improvement in credit trends and strengthening of underlying collateral values, resulting in lower loss severities and opportunities for recoveries on previously charged-off loans.

 

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CONSOLIDATED BALANCE SHEET ANALYSIS

 

Total assets of $302.0 billion as of September 30, 2012 increased by $96.0 billion, or 47%, from $206.0 billion as of December 31, 2011. Total liabilities of $262.3 billion as of September 30, 2012, increased by $85.9 billion, or 49%, from $176.4 billion as of December 31, 2011. The increase in total assets and total liabilities was largely attributable to the assets acquired and liabilities assumed in the ING Direct and HSBC U.S. card acquisitions. Stockholders’ equity increased by $10.0 billion during the first nine months of 2012, to $39.7 billion as of September 30, 2012 from $29.7 billion as of December 31, 2011. The increase in stockholders’ equity was attributable to our net income of $2.7 billion in the first nine months of 2012, and $6.8 billion of capital raised from equity issuances during the first nine months of 2012.

Following is a discussion of material changes in the major components of our assets and liabilities during the first nine months of 2012.

Investment Securities

Our portfolio of investment securities available for sale, which had a fair value of $61.5 billion and $38.8 billion, as of September 30, 2012 and December 31, 2011, respectively, consists of the following: U.S. Treasury and U.S. agency debt obligations; agency and non-agency mortgage-backed securities; asset-backed securities collateralized primarily by credit card loans, auto loans, student loans, auto dealer floor plan inventory loans, equipment loans, commercial paper, and home equity lines of credit; municipal securities; foreign government/agency bonds; covered bonds; and Community Reinvestment Act (“CRA”) e