Form 10Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

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

For the quarterly period ended June 30, 2011

OR

 

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

For the transition period from                      to                     

Commission File No. 1-13300

 

 

CAPITAL ONE FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   54-1719854

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

1680 Capital One Drive,

McLean, Virginia

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

Registrant’s telephone number, including area code:

(703) 720-1000

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

(Not applicable)

 

 

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

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

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

 

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

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

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

 

 

 


Table of Contents

TABLE OF CONTENTS

 

          Page  

PART I—FINANCIAL INFORMATION

     1   
Item 1.   

Financial Statements

     66   
  

Condensed Consolidated Statements of Income

     66   
  

Condensed Consolidated Balance Sheets

     67   
  

Condensed Consolidated Statements of Changes in Stockholders’ Equity

     68   
  

Condensed Consolidated Statements of Cash Flows

     69   
  

Notes to Condensed Consolidated Financial Statements

     70   
  

Note   1—Summary of Significant Accounting Policies

     70   
  

Note   2—Acquisitions

     72   
  

Note   3—Discontinued Operations

     74   
  

Note   4—Investment Securities

     74   
  

Note   5—Loans

     82   
  

Note   6—Allowance for Loan and Lease Losses

     100   
  

Note   7—Variable Interest Entities and Securitizations

     102   
  

Note   8—Goodwill and Other Intangible Assets

     110   
  

Note   9—Deposits and Borrowings

     113   
  

Note 10—Derivative Instruments and Hedging Activities

     116   
  

Note 11—Stockholders’ Equity

     122   
  

Note 12—Earnings Per Common Share

     122   
  

Note 13—Fair Value of Financial Instruments

     123   
  

Note 14—Business Segments

     134   
  

Note 15—Commitments, Contingencies and Guarantees

     138   
  

Note 16—Subsequent Events

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

Summary of Selected Financial Data

     1   
  

Introduction

     4   
  

Executive Summary and Business Outlook

     6   
  

Critical Accounting Policies and Estimates

     11   
  

Consolidated Results of Operations

     13   
  

Business Segment Financial Performance

     20   
  

Consolidated Balance Sheet Analysis and Credit Performance

     32   
  

Off-Balance Sheet Arrangements and Variable Interest Entities

     50   
  

Risk Management

     51   
  

Liquidity and Capital Management

     51   
  

Market Risk Management

     58   
  

Supervision and Regulatory Developments

     60   
  

Accounting Changes and Developments

     62   
  

Forward-Looking Statements

     62   
  

Supplemental Tables

     64   
Item 3.   

Quantitative and Qualitative Disclosures about Market Risk

     149   
Item 4.   

Controls and Procedures

     149   

PART II—OTHER INFORMATION

     150   
Item 1.   

Legal Proceedings

     150   
Item 1A.   

Risk Factors

     150   
Item 2.   

Unregistered Sales of Equity Securities and Use of Proceeds

     150   
Item 3.   

Defaults upon Senior Securities

     150   
Item 5.   

Other Information

     150   
Item 6.   

Exhibits

     150   

SIGNATURES

     151   

INDEX TO EXHIBITS

     152   

 

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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)

     1   
2   

Business Segments Results

     5   
3   

Average Balances, Net Interest Income and Net Interest Yield

     14   
4   

Rate/Volume Analysis of Net Interest Income

     16   
5   

Non-Interest Income

     17   
6   

Non-Interest Expense

     19   
7   

Credit Card Business Results

     22   
7.1   

Domestic Credit Card Business Results

     24   
7.2   

International Credit Card Business Results

     25   
8   

Consumer Banking Business Results

     27   
9   

Commercial Banking Business Results

     30   
10   

Investment Securities

     32   
11   

Loan Portfolio Composition

     34   
12   

30+ Day Delinquencies

     36   
13   

Aging of 30+ Day Delinquent Loans

     37   
14   

90+ Day Delinquent Loans Accruing Interest

     37   
15   

Nonperforming Loans and Other Nonperforming Assets

     38   
16   

Net Charge-Offs

     39   
17   

Loan Modifications and Restructurings

     40   
18   

Allowance for Loan and Lease Losses Activity

     43   
19   

Allocation of the Allowance for Loan and Lease Losses

     44   
20   

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

     46   
21   

Open Pipeline All Vintages (all entities)

     47   
22   

Changes in Representation and Warranty Reserve

     49   
23   

Allocation of Representation and Warranty Reserve

     50   
24   

Liquidity Reserves

     51   
25   

Deposits

     52   
26   

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

     53   
27   

Borrowing Capacity

     54   
28   

Senior Unsecured Debt Credit Ratings

     55   
29   

Capital Ratios Under Basel I

     56   
30   

Risk-Based Capital Components Under Basel I

     57   
31   

Interest Rate Sensitivity Analysis

     60   
  

Supplemental Tables:

  
A   

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

     64   

 

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Table of Contents

PART I—FINANCIAL INFORMATION

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

This Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) should be read in conjunction with our unaudited condensed consolidated financial statements and related notes in this Report and the more detailed information contained in our 2010 Annual Report on Form 10-K (“2010 Form 10-K”). This discussion contains forward-looking statements that are based upon management’s current expectations and are subject to significant uncertainties and changes in circumstances. Please review “Forward-Looking Statements” for more information on the forward-looking statements in this Report. Our actual results may differ materially from those included in these forward-looking statements due to a variety of factors including, but not limited to, those described in this Report in “Part II—Item 1A. Risk Factors,” in our 2010 Form 10-K in “Part I—Item 1A. Risk Factors” and in Exhibit 99.5 to our Current Report on Form 8-K filed on July 13, 2011.

 

 

SUMMARY OF SELECTED FINANCIAL DATA

 

Below we provide selected consolidated financial data from our results of operations for the three and six months ended June 30, 2011 and 2010, and selected comparative consolidated balance sheet data as of June 30, 2011, and December 31, 2010. We also provide selected key metrics we use in evaluating our performance.

Table 1: Consolidated Financial Highlights (Unaudited)

 

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

Income statement

            

Net interest income(17)

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

Non-interest income

     857        807        6        1,799        1,868        (4
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

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

Provision for loan and lease losses(17)

     343        723        (53     877        2,201        (60

Non-interest expense

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

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations before income taxes

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

Income tax provision

     450        369        22        804        613        31   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations, net of taxes

     945        812        16        1,977        1,532        29   

Loss from discontinued operations, net of taxes(1)

     (34     (204     83        (50     (288     83   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

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

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Common share statistics

            

Earnings per common share:

            

Basic earnings per common share

   $ 2.00      $ 1.34        49   $ 4.24      $ 2.75        54

Diluted earnings per common share

     1.97        1.33        48        4.18        2.73        53   

Weighted average common shares outstanding:

            

Basic earnings per common share

     455.6        452.1        1        454.9        451.6        1   

Diluted earnings per common share

     462.2        456.4        1        461.3        455.9        1   

Dividends per common share

     0.05        0.05               0.10        0.10          

Stock price per common share at period end

     51.67        40.30        28        51.67        40.30        28   

Total market capitalization at period end

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

 

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

Average balances

            

Loans held for investment

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

Interest-earning assets

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

Total assets

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

Interest-bearing deposits

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

Total deposits

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

Borrowings

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

Stockholders’ equity

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

Performance metrics

            

Purchase volume(2)

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

Revenue margin(3)(17)

     9.17     8.94     23 bps      9.29     9.19     10 bps 

Net interest margin(4)(17)

     7.20        7.09        11        7.22        7.09        13   

Net charge-off rate(5)(17)

     2.91        5.36        (245     3.28        5.69        (241

Risk-adjusted margin(6)

     7.03        5.01        202        6.90        5.00        190   

Return on average assets(7)

     1.90        1.63        27        1.99        1.51        48   

Return on average equity(8)

     13.38        13.24        14        14.31        12.71        160   

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

     7.05        6.24        81        6.98        5.86        112   

Efficiency ratio(10)

     56.47        51.23        524        54.70        46.95        775   

Effective income tax rate

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

Balance sheet (period end)

            

Loans held for investment

   $ 128,965      $ 125,947        2      

Interest-earning assets

     174,302        172,024        1         

Total assets

     199,753        197,503        1         

Interest-bearing deposits

     109,278        107,162        2         

Total deposits

     126,117        122,210        3         

Borrowings

     37,735        41,796        (10      

Total liabilities

     171,072        170,962        **         

Stockholders’ equity

     28,681        26,541        8         

Tangible common equity (“TCE”)(11)

     14,675        12,558        17         

Credit quality metrics (period end)

            

Allowance for loan and lease losses(17)

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

Allowance as a % of loans held of investment

     3.48     4.47     (99 )bps       

30+ day performing delinquency rate(12)

     2.90        3.52        (62      

30+ day delinquency rate

     3.57        4.23        (66      

Capital ratios

            

Tier 1 common equity ratio(13)

     9.4     8.8     40 bps       

Tier 1 risk-based capital ratio(14)

     11.8        11.6                

Total risk-based capital ratio(15)

     15.0        16.8        (200      

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

     7.9        6.9        100         

 

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

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

 

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(2) 

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

(3) 

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

(4) 

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

(5) 

Calculated based on annualized net charge-offs for the period divided by average loans held for investment for the period. Average loans held for investment include purchased credit-impaired loans acquired as part of the Chevy Chase Bank acquisition.

(6) 

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

(7) 

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

(8) 

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

(9) 

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

(10) 

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

(11) 

Tangible common equity is a non-GAAP measure consisting of total assets less assets from discontinued operations and intangible assets. See “Supplemental Tables—Table A: Reconciliation of Non-GAAP Measures and Calculation of Regulatory Capital Measures” for the calculation of this measure and reconciliation to the comparative GAAP measure.

(12) 

See “Consolidated Balance Sheet Analysis and Credit Performance—Credit Performance—Nonperforming Assets” for our policies for classifying loans as nonperforming by loan category.

(13) 

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

(14) 

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

(15) 

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

(16) 

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

(17) 

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

 

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INTRODUCTION

 

Capital One Financial Corporation (the “Company”) is a diversified financial services holding company with banking and non-banking subsidiaries that offer a broad array of financial products and services to consumers, small businesses and commercial clients through branches, the internet and other distribution channels. Our principal subsidiaries include:

 

   

Capital One Bank (USA), National Association (“COBNA”), which currently offers credit and debit card products, other lending products and deposit products; and

 

   

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

The Company and its subsidiaries are collectively referred to as “we,” “us” or “our” in this Report. CONA and COBNA are collectively referred to as the “Banks” in this Report.

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

Our principal operations are currently organized, for management reporting purposes, into three major business segments, which are defined based on the products and services provided or the type of customer served: Credit Card, Consumer Banking and Commercial Banking. The operations of acquired businesses have been integrated into our existing business segments.

 

   

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

 

   

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

 

   

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

Certain activities that are not part of a segment are included in our “Other” category.

Table 2 summarizes our business segment results, which we report based on income from continuing operations, net of tax, for the three and six months ended June 30, 2011 and 2010. We provide a reconciliation of our total business segment results to our consolidated U.S. GAAP results in “Note 14—Business Segments” of this Report.

 

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Table 2: Business Segment Results

 

     Three Months Ended June 30,  
     2011     2010  
     Total  Revenue(1)     Net Income  (Loss)(2)     Total  Revenue(1)     Net Income  (Loss)(2)  

(Dollars in millions)

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

Credit Card

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

Consumer Banking

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

Commercial Banking

     395        10        142        15        379        10        77        9   

Other(3)

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

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total from continuing operations

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

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

     Six Months Ended June 30,  
     2011     2010  
     Total  Revenue(1)     Net Income  (Loss)(2)     Total  Revenue(1)     Net Income  (Loss)(2)  

(Dollars in millions)

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

Credit Card

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

Consumer Banking

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

Commercial Banking

     787        10        290        15        733        9        28        2   

Other(3)

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

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total from continuing operations

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

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1)

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

(2)

Net income (loss) for our business segments reflects income from continuing operations, net of tax.

(3) 

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

 

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EXECUTIVE SUMMARY AND BUSINESS OUTLOOK

 

Financial Highlights

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

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

We grew loans and deposits in the second quarter of 2011. Our strategies and actions are designed to deliver profitable long-term growth through the acquisition and retention of franchise-enhancing customer relationships across our businesses. We believe that franchise-enhancing customer relationships produce strong long-term economics through low credit costs, low customer attrition and a gradual build in loan balances and revenues over time. Examples of franchise-enhancing customer relationships include transactor customers and new partnerships in our Credit Card business, long-term retail deposit customers in our Consumer Banking business and primary banking relationships with commercial customers in our Commercial Banking business. We intend to grow these customer relationships by continuing to invest in our bank infrastructure to allow us to provide more convenient and flexible customer banking options, including a broader range of fee-based and credit products and services, by leveraging our direct bank customer franchise with national reach and by continued marketing investments to further strengthen our brand. We believe our actions have created a well-positioned balance sheet and strong capital and liquidity levels which have provided us with investment flexibility to take advantage of attractive opportunities and adjust, where we believe appropriate, to changing market conditions.

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

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

Our financial strength and flexibility and our experience in the credit card and direct banking businesses are key factors that we believe have enabled us to take advantage of our recent investment opportunities. We believe these factors will help us deliver attractive financial results as well as compelling value creation over time.

 

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Below are additional highlights of our performance for the second quarter and first six months of 2011. These highlights generally are based on a comparison to the same prior year periods. The changes in our financial condition and credit performance are generally based on our financial condition and credit performance as of June 30, 2011, compared with our financial condition and credit performance as of December 31, 2010. We provide a more detailed discussion of our financial performance in the sections following this “Executive Summary and Business Outlook.”

Total Company

 

   

Earnings: We reported earnings of $911 million in the second quarter of 2011 and $1.9 billion in the first six months of 2011. Our earnings increased by $303 million, or 50%, in the second quarter of 2011, and by $683 million, or 55%, in the first six months of 2011, compared with the same prior year periods. The increase in net income was attributable to lower credit costs and strong underlying credit improvement trends, including lower provision for loan and lease losses compared to the prior year periods, as well as a substantial reduction in the provision for mortgage repurchase losses for legacy mortgage related representation and warranty claims in the second quarter and first six months of 2011 as compared to the prior year periods. The impact of these factors was partially offset by higher operating expenses related to our recent acquisitions and increased marketing expenditures.

 

   

Total Loans: Period-end loans held for investment increased by $3.0 billion, or 2%, during the first six months of 2011, to $129.0 billion as of June 30, 2011, from $125.9 billion as of December 31, 2010. The increase was primarily attributable to the additions of the Kohl’s portfolio of $3.7 billion and the HBC portfolio of $1.4 billion. Excluding the impact of the addition of the Kohl’s and HBC portfolios, total loans decreased by $2.1 billion, or 2%, in the first six months of 2011, due to the continued expected run-off of installment loans in our Credit Card business and home loans in our Consumer Banking business, other loan paydowns and charge-offs. The impact from these factors more than offset the strong growth in purchase volume across the Domestic Card business.

 

   

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

 

   

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

 

   

Representation and Warranty Reserve: Our representation and warranty reserve totaled $869 million as of June 30, 2011, compared with $816 million as of December 31, 2010. This reserve relates to our mortgage loan repurchase exposure for legacy mortgage loans sold by our subsidiaries to various parties under contractual provisions that include various representations and warranties. The reserve reflects losses as of each balance sheet date that we consider to be both probable and reasonably estimable. We recorded a provision for this exposure of $37 million and $81 million in the second quarter and first six months of 2011, respectively, compared with a provision of $404 million and $628 million in the second quarter and first six months of 2010, respectively.

Business Segments

 

   

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

 

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Consumer Banking Business: Our Consumer Banking business generated net income from continuing operations of $287 million and $502 million in the second quarter and first six months of 2011, respectively, compared with net income from continuing operations of $305 million and $610 million in the second quarter and first six months of 2010, respectively. The decrease in net income reflected the impact of a one-time pre-tax gain of $128 million recorded in the first quarter of 2010 from the deconsolidation of certain option-adjustable rate mortgage trusts and an increase in the provision for loan and lease losses due to growth in auto loans. These factors were partially offset by an increase in total revenue due to higher pricing for new auto loan originations and deposit growth resulting from our continued strategy to leverage our bank outlets to attract lower cost funding sources.

 

   

Commercial Banking: Our Commercial Banking business generated net income from continuing operations of $142 million and $290 million in the second quarter and first six months of 2011, respectively, compared with net income from continuing operations of $77 million and $28 million in the second quarter and first six months of 2010, respectively. The improvement in results for our Commercial Banking business reflected an increase in revenues, a decrease in non-interest expense and a decrease in the provision for loan and lease losses due to the continued improvement in our Commercial Banking credit performance metrics. As a result of this improvement, we reduced our allowance for loan and lease losses and recorded a negative provision for loan and lease losses of $18 million and $33 million in the second quarter and first six months of 2011, respectively. In comparison, we recorded a provision for loan and lease losses of $62 million and $300 million in the second quarter and first six months of 2010, respectively, related to our Commercial Banking business.

Business Environment and Recent Developments

Recent Business and Regulatory Developments

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

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

Recent Acquisitions and Related Developments

During the past several years, we have explored opportunities to acquire financial services companies and financial assets and enter into strategic partnerships as part of our growth strategy. In the first six months of 2011, we acquired the existing credit card loan portfolios of HBC and Kohl’s and announced our planned acquisition of ING Direct. We continue to evaluate and anticipate engaging in additional strategic partnerships and selected acquisitions of financial institutions and other financial assets, including credit card and other loan portfolios. We may issue common stock or debt in connection with future acquisitions, including in public offerings, to fund such acquisitions.

Hudson’s Bay Company

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

 

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Kohl’s

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

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

ING Direct

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

Equity and Debt Offerings

On July 19, 2011, we closed a public offering of shares of our common stock, subject to forward sale agreements that we entered into with certain counterparties acting as forward purchasers. The forward purchasers agreed to borrow and sell to the public, through the underwriters, 40 million shares of our common stock at a price per share of $50.00. After underwriter’s discounts and commissions, the net proceeds to the company will be at an initial forward sale price per share of $48.50. We did not receive any proceeds from this public offering of our shares of common stock. Under the terms of the forward sale agreements, we must settle the forward sale agreements on or before February 15, 2012. We expect to settle the forward sale agreements entirely by physical delivery of shares of common stock in exchange for cash proceeds from the forward purchasers of $1.9 billion based on the initial forward price. The forward sale price is subject to adjustment under the forward sale agreements. However, we may, subject to certain conditions, elect cash or net share settlement of all or a portion of our obligation to deliver shares of common stock. In addition, we granted the underwriters a 30-day option to purchase an additional 6 million shares of our common stock to cover any over-allotments, which shares are not subject to the forward sale agreements.

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

 

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

Business Outlook

We discuss below our current expectations regarding our total company performance and the performance of each of our business segments over the near-term based on market conditions, the regulatory environment and our business strategies as of the time we filed this Report. The statements contained in this section are based on our current expectations regarding our outlook for our financial results and business strategies. Our expectations take into account, and should be read in conjunction with, our expectations regarding economic trends and analysis of our business as discussed in “Part I—Item 1. Business” and “Part I—Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our 2010 Form 10-K. Certain statements are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual results could differ materially from those in our forward-looking statements. Forward-looking statements do not reflect (i) any change in current dividend or repurchase strategies, (ii) the effect of any acquisitions, divestitures or similar transactions or (iii) any changes in laws, regulations or regulatory interpretations, in each case after the date as of which such statements are made. See “Forward-Looking Statements” in this Report “Item 1A. Risk Factors” in our 2010 Form 10-K and Exhibit 99.5 to our Current Report on Form 8-K filed on July 13, 2011, for factors that could materially influence our results.

Total Company Expectations

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

Business Segments Expectations

Credit Card Business

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

Consumer Banking Business

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

 

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

Commercial Banking Business

In our Commercial Banking business, we believe that the worst of the commercial credit downturn is behind us and there is positive trajectory. However, we continue to expect some quarterly uncertainty and volatility in commercial charge-offs and nonperforming loans. We have been growing commercial loans with lower credit risk and expect further modest growth to continue in 2011. Growth in treasury management and capital market services is driving higher fee revenues and deepening relationships with our commercial customers.

 

 

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

 

The preparation of financial statements in accordance with U.S. GAAP requires management to make a number of judgments, estimates and assumptions that affect the reported amount of assets, liabilities, income and expenses in the consolidated financial statements. Understanding our accounting policies and the extent to which we use management judgment and estimates in applying these policies is integral to understanding our financial statements. We provide a summary of our significant accounting policies in “Note 1—Summary of Significant Accounting Policies” of our 2010 Form 10-K.

We have identified the following accounting policies as critical because they require significant judgments and assumptions about highly complex and inherently uncertain matters and the use of reasonably different estimates and assumptions could have a material impact on our reported results of operations or financial condition. These critical accounting policies govern:

 

   

Fair value

   

Allowance for loan and lease losses

   

Asset impairment

   

Representation and warranty reserve

   

Revenue recognition

   

Derivative and hedge accounting

   

Income taxes

We evaluate our critical accounting estimates and judgments on an ongoing basis and update them as necessary based on changing conditions. The use of fair value to measure our financial instruments is fundamental to the preparation of our consolidated financial statements because we account for and record a significant portion of our assets and liabilities at fair value. Accordingly, we provide information below on financial instruments recorded at fair value in our consolidated balance sheets. Management has discussed our critical accounting policies and estimates with the Audit and Risk Committee of the Board of Directors.

 

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Fair Value

Fair value is defined as the price that would be received for an asset or paid to transfer a liability in an orderly transaction between market participants on the measurement date (also referred to as an exit price). The fair value accounting guidance provides a three-level fair value hierarchy for classifying financial instruments. This hierarchy is based on whether the inputs to the valuation techniques used to measure fair value are observable or unobservable. Fair value measurement of a financial asset or liability is assigned to a level based on the lowest level of any input that is significant to the fair value measurement in its entirety. The three levels of the fair value hierarchy are described below:

 

Level 1:

   Quoted prices (unadjusted) in active markets for identical assets or liabilities.

Level 2:

   Observable market-based inputs, other than quoted prices in active markets for identical assets or liabilities.

Level 3:

   Unobservable inputs.

The degree of management judgment involved in determining the fair value of a financial instrument is dependent upon the availability of quoted prices in active markets or observable market parameters. When quoted prices and observable data in active markets are not fully available, management judgment is necessary to estimate fair value. Changes in market conditions, such as reduced liquidity in the capital markets or changes in secondary market activities, may reduce the availability and reliability of quoted prices or observable data used to determine fair value.

We have developed policies and procedures to determine when markets for our financial assets and liabilities are inactive if the level and volume of activity has declined significantly relative to normal conditions. If markets are determined to be inactive, it may be appropriate to adjust price quotes received. When significant adjustments are required to price quotes or inputs, it may be appropriate to utilize an estimate based primarily on unobservable inputs.

Significant judgment may be required to determine whether certain financial instruments measured at fair value are included in Level 2 or Level 3. In making this determination, we consider all available information that market participants use to measure the fair value of the financial instrument, including observable market data, indications of market liquidity and orderliness, and our understanding of the valuation techniques and significant inputs used. Based upon the specific facts and circumstances of each instrument or instrument category, judgments are made regarding the significance of the Level 3 inputs to the instruments’ fair value measurement in its entirety. If Level 3 inputs are considered significant, the instrument is classified as Level 3. The process for determining fair value using unobservable inputs is generally more subjective and involves a high degree of management judgment and assumptions.

Our financial instruments recorded at fair value on a recurring basis represented approximately 21% of our total assets of $199.8 billion as of June 30, 2011, compared with 22% of our total assets of $197.5 billion as of December 31, 2010. Financial assets for which the fair value was determined using significant Level 3 inputs represented approximately 2% of these financial instruments (less than 1% of total assets) as of June 30, 2011, and approximately 2% of these financial instruments (1% of total assets) as of December 31, 2010.

We discuss changes in the valuation inputs and assumptions used in determining the fair value of our financial instruments, including the extent to which we have relied on significant unobservable inputs to estimate fair value and our process for corroborating these inputs, in “Note 13—Fair Value of Financial Instruments.”

 

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Key Controls Over Fair Value Measurement

We have a governance framework and a number of key controls that are intended to ensure that our fair value measurements are appropriate and reliable. Our governance framework provides for independent oversight and segregation of duties. Our control processes include review and approval of new transaction types, price verification and review of valuation judgments, methods, models, process controls and results. Groups independent from our trading and investing function, including our Valuations Group and Valuations Advisory Committee, participate in the review and validation process. The Valuation Advisory Committee includes senior representation from business areas, our Enterprise Risk Oversight division and our Finance division.

Our Valuations Group performs monthly independent verification of fair value measurements by comparing the methodology driven price to other market source data (to the extent available), and uses independent analytics to determine if assigned fair values are reasonable. The Valuations Advisory Committee regularly reviews and approves our valuation methodologies to ensure that our methodologies and practices are consistent with industry standards and adhere to regulatory and accounting guidance.

For additional information on our critical accounting policies and estimates, see “Part II—Item 7. MD&A—Critical Accounting Policies and Estimates” of our 2010 Form 10-K.

 

 

CONSOLIDATED RESULTS OF OPERATIONS

 

The section below provides a comparative discussion of our consolidated financial performance for the three and six months ended June 30, 2011 and 2010. Following this section, we provide a discussion of our business segment results. You should read this section together with our “Executive Summary and Business Outlook” where we discuss trends and other factors that we expect will affect our future results of operations.

Net Interest Income

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

Table 3 below presents, for each major category of our interest-earning assets and interest-bearing liabilities, the average outstanding balances, interest income earned or interest expense incurred, and the average yield or cost for the three and six months ended June 30, 2011 and 2010.

 

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

 

     Three Months Ended June 30,  
     2011     2010  

(Dollars in millions)

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

Assets:

              

Interest-earning assets:

              

Consumer loans:(2)

              

Domestic(3)

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

International

     8,823        349         15.82        7,427        296         15.94   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total consumer loans(3)

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

Commercial loans(3)

     30,316        360         4.75        29,533        365         4.94   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total loans held for investment

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

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Investment securities

     40,381        313         3.10        39,022        342         3.51   

Other interest-earning assets:

              

Domestic

     5,148        16         1.24        6,933        17         0.98   

International

     698        3         1.72        514        —           0.00   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total other interest-earning assets

     5,846        19         1.30        7,447        17         0.91   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total interest-earning assets

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

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Cash and due from banks

     1,870             2,413        

Allowance for loan and lease losses

     (5,069          (7,735     

Premises and equipment, net

     2,715             2,723        

Other assets

     25,570             27,284        
  

 

 

        

 

 

      

Total assets

   $ 199,229           $ 199,357        
  

 

 

        

 

 

      

Liabilities and equity:

              

Interest-bearing liabilities:

              

Deposits

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

Securitized debt obligations:

              

Domestic

     18,384        91         1.98        30,333        182         2.40   

International

     3,807        22         2.31        4,915        30         2.44   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total securitized debt obligations

     22,191        113         2.04        35,248        212         2.41   

Senior and subordinated notes

     8,093        63         3.11        8,760        72         3.29   

Other borrowings

     9,167        80         3.49        6,396        86         5.38   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total interest-bearing liabilities

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

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Non-interest bearing deposits

     16,583             14,321        

Other liabilities

     5,689             5,943        
  

 

 

        

 

 

      

Total liabilities

     170,974             174,831        

Stockholders’ equity

     28,255             24,526        
  

 

 

        

 

 

      

Total liabilities and stockholders’ equity

   $ 199,229           $ 199,357        
  

 

 

        

 

 

      

Net interest income/spread

     $ 3,136         6.99     $ 3,097         6.87
    

 

 

    

 

 

     

 

 

    

 

 

 

Interest income to average interest-earning assets

          8.50          8.78

Interest expense to average interest-earning assets

          1.30             1.69   
       

 

 

        

 

 

 

Net interest margin

          7.20          7.09
       

 

 

        

 

 

 

 

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Table of Contents
     Six Months Ended June 30,  
     2011     2010  

(Dollars in millions)

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

Assets:

              

Interest-earning assets:

              

Consumer loans:(2)

              

Domestic(3)

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

International

     8,761        703         16.05        7,619        601         15.78   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total consumer loans(3)

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

Commercial loans(3)

     30,056        717         4.77        29,627        738         4.98   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total loans held for investment

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

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Investment securities

     40,953        629         3.07        38,525        691         3.59   

Other interest-earning assets:

              

Domestic

     5,698        32         1.12        7,942        39         0.98   

International

     689        6         1.74        608        1         0.33   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total other interest-earning assets

     6,387        38         1.19        8,550        40         0.94   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total interest-earning assets

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

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Cash and due from banks

     1,912             2,338        

Allowance for loan and lease losses

     (5,348          (8,040     

Premises and equipment, net

     2,717             2,724        

Other assets

     25,487             27,841        
  

 

 

        

 

 

      

Total assets

   $ 198,612           $ 203,159        
  

 

 

        

 

 

      

Liabilities and equity:

              

Interest-bearing liabilities:

              

Deposits

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

Securitized debt obligations:

              

Domestic

     19,983        208         2.08        34,253        390         2.28   

International

     3,869        45         2.33        5,230        64         2.45   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total securitized debt obligations

     23,852        253         2.12        39,483        454         2.30   

Senior and subordinated notes

     8,091        127         3.14        8,758        140         3.20   

Other borrowings

     8,048        166         4.13        6,921        179         5.17   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total interest-bearing liabilities

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

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Non-interest bearing deposits

     16,057             13,928        

Other liabilities

     5,984             5,895        
  

 

 

        

 

 

      

Total liabilities

     170,976             179,068        

Stockholders’ equity

     27,636             24,091        
  

 

 

        

 

 

      

Total liabilities and stockholders’ equity

   $ 198,612           $ 203,159        
  

 

 

        

 

 

      

Net interest income/spread

     $ 6,276         6.99     $ 6,325         6.89
    

 

 

    

 

 

     

 

 

    

 

 

 

Interest income to average interest-earning assets

          8.57          8.82

Interest expense to average interest-earning assets

          1.35             1.73   
       

 

 

        

 

 

 

Net interest margin

          7.22          7.09
       

 

 

        

 

 

 

 

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(1) 

Past due fees included in interest income totaled approximately $245 million and $312 million for the three months ended June 30, 2011 and 2010, respectively, and approximately $490 million and $644 million for the six months ended June 30, 2011 and 2010, respectively.

(2) 

Interest income on credit card, auto, home and retail banking loans is reflected in consumer loans. Interest income generated from small business credit cards also is included in consumer loans.

(3)

In the first quarter of 2011, we revised our previously reported interest income on interest-earning assets and average yield on loans held for investment for 2010 to conform to the internal management accounting methodology used in our segment reporting. The interest income and average loan yields presented reflect this revision. The previously reported interest income and average yields for the second quarter of 2010 were as follows: domestic consumer loans ($2,882 million and 12.63%); total consumer loans ($3,178 million and 12.88%); and commercial loans ($298 million and 4.04%). The previously reported interest income and average yields for the first six months were as follows: domestic consumer loans ($5,844 million and 12.44%); total consumer loans ($6,445 million and 12.69%); and commercial loans ($689 million and 4.65%).

Table 4 presents the variance between our net interest income for the three months ended June 30, 2011 and 2010, and for the six months ended June 30, 2011 and 2010, and the extent to which the variance was attributable to: (i) changes in the volume of our interest-earning assets and interest-bearing liabilities or (ii) changes in the interest rates of these assets and liabilities.

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

 

    Three Months Ended June 30,
2011 vs. 2010
    Six Months Ended June 30,
2011 vs. 2010
 

(Dollars in millions)

  Total
Variance
    Variance Due to     Total
Variance
    Variance Due to  
      Volume         Rate           Volume         Rate    

Interest income:

           

Loans held for investment:

           

Consumer loans

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

Commercial loans

    (5     10        (15     (21     11        (32
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans held for investment, including past-due fees

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

Investment securities

    (29     12        (41     (62     42        (104

Other

    2        (4     6        (2     (11     9   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest income

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

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest expense:

           

Deposits

    (61     17        (78     (138     34        (172

Securitized debt obligations

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

Senior and subordinated notes

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

Other borrowings

    (6     30        (36     (13     27        (40
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest expense

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

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

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

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) 

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

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

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

 

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The decrease in average interest-earning assets in the second quarter and first six months of 2011 reflected the continued run-off of businesses that we exited or repositioned, including our installment, home loan and small-ticket commercial real estate loan portfolios, which more than offset the impact of modest revolving credit card loan growth and the addition of the existing HBC credit card loan portfolio of $1.4 billion in the first quarter of 2011 and the addition of the existing Kohl’s private-label credit card loan portfolio of $3.7 billion in the second quarter of 2011.

The increase in our net interest margin in the second quarter of 2011 and first six months of 2011 was primarily attributable to an improvement in our cost of funds, which was partially offset by a decline in the yield on our interest-earning assets. Our cost of funds continued to benefit from the shift in the mix of our funding to lower cost consumer and commercial banking deposits from higher cost wholesale sources. In addition, the overall interest rate environment, combined with our disciplined pricing, contributed to the decrease in our average deposit interest rates.

The decrease in yield on interest-earning assets was attributable to a reduction in late payment fees resulting from the Federal Reserve guidelines regarding reasonable fees that went info effect in the third quarter of 2010 and the addition of the Kohl’s portfolio. Under our partnership agreement with Kohl’s, we share a fixed percentage of revenues, consisting of finance charges and late fees. We report revenues related to Kohl’s credit card loans on a net basis in our consolidated financial statements, which has the effect of reducing the yield on our average interest-earning assets. The impact of these factors was partially offset by the run-off of lower margin installment loans, a reduced level of new accounts with low introductory promotional rates and an increase in the recognition of billed finance charges and fees due to the improvement in credit performance.

Non-Interest Income

Non-interest income consists of servicing and securitizations income, service charges and other customer-related fees, interchange income and other non-interest income. We also record the provision for mortgage repurchase losses related to continuing operations in non-interest income. The servicing fees, finance charges, other fees, net of charge-offs and interest paid to third party investors related to our consolidated securitization trusts are reported as a component of net interest income.

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

Table 5: Non-Interest Income

 

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

(Dollars in millions)

           2011                     2010                     2011                     2010          

Servicing and securitizations

   $ 12      $ 21      $ 23      $ (15

Service charges and other customer-related fees

     460        496        985        1,081   

Interchange

     331        333        651        644   

Net other-than-temporary impairment

     (6 )     (26     (9     (57

Provision for mortgage repurchase losses(1)

     (4     (95     (9     (195

Other

     64        78        158        410   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total non-interest income

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

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) 

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

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

 

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

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

Provision for Loan and Lease Losses

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

Our provision for loan and lease losses fell by $380 million to $343 million in the second quarter of 2011 and by $1.3 billion in the first six months of 2011 to $877 million, compared with the same prior year periods. The decrease in the provision was largely driven by a substantial decline in net charge-offs across all of our business segments, as underlying credit trends and credit performance continued to improve. The net charge-off rate was 2.91% and 3.28% for the second quarter and first six months of 2011, respectively, compared with 5.36% and 5.69% for the second quarter and first six months of 2010, respectively. As charge-offs declined, we recorded an allowance release of $579 million and $1.1 billion in the second quarter and first six months of 2011, respectively.

See “Consolidated Balance Sheet Analysis and Credit Performance—Allowance for Loan and Lease Losses” for a discussion of changes in our allowance for loan and lease losses and details of our provision for loan and lease losses and charge-offs by loan category for the three and six months ended June 30, 2011 and 2010.

Non-Interest Expense

Non-interest expense consists of ongoing operating costs, such as salaries and associated employee benefits, communications and other technology expenses, supplies and equipment, occupancy costs and miscellaneous expenses. Marketing expenses also are included in non-interest expense. Table 6 displays the components of non-interest expense for the three and six months ended June 30, 2011 and 2010.

 

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Table 6: Non-Interest Expense

 

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

(Dollars in millions)

         2011                2010                2011                2010      

Salaries and associated benefits

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

Marketing

       329           219           605           399   

Communications and data processing

       162           164           326           333   

Supplies and equipment

       124           129           259           253   

Occupancy

       118           117           237           237   

Other(1)

       807           721           1,534           1,329   
    

 

 

      

 

 

      

 

 

      

 

 

 

Total non-interest expense

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

 

 

      

 

 

      

 

 

      

 

 

 

 

(1) 

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

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

Income Taxes

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

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

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

We provide additional information on items affecting our income taxes and effective tax rate in our 2010 Form 10-K under “Note 18—Income Taxes.”

Loss from Discontinued Operations, Net of Tax

Loss from discontinued operations reflects ongoing costs, which primarily consist of mortgage loan repurchase representation and warranty charges, related to the mortgage origination operations of GreenPoint’s wholesale mortgage banking unit, which we closed in 2007. We recorded a loss from discontinued operations, net of tax, of $34 million and $50 million in the second quarter and first six months of 2011, respectively. In comparison, we recorded a loss from discontinued operations, net of tax, of $204 million and $288 million in the second quarter and first six months of 2010, respectively.

 

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Table of Contents

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

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

 

 

BUSINESS SEGMENT FINANCIAL PERFORMANCE

 

Our principal operations are currently organized into three major business segments, which are defined based on the products and services provided or the type of customer served: Credit Card, Consumer Banking and Commercial Banking. The operations of acquired businesses have been integrated into our existing business segments.

The results of our individual businesses, which we report on a continuing operations basis, reflect the manner in which management evaluates performance and makes decisions about funding our operations and allocating resources. Our business segment results are intended to reflect each segment as if it were a stand-alone business. We use an internal management and reporting process to derive our business segment results. Our internal management and reporting process employs various allocation methodologies, including funds transfer pricing, to assign certain balance sheet assets, deposits and other liabilities and their related revenue and expenses directly or indirectly attributable to each business segment. We may periodically change our business segments or reclassify business segment results based on modifications to our management reporting methodologies and changes in organizational alignment. See “Note 20—Business Segments” of our 2010 Form 10-K for information on the allocation methodologies used to derive our business segment results.

We summarize our business segment results for the three and six months ended June 30, 2011 and 2010 in the tables below and provide a comparative discussion of these results. We also discuss changes in our financial condition and credit performance statistics as of June 30, 2011, compared with December 31, 2010. See “Note 14—Business Segments” of this Report for a reconciliation of our business segment results to our consolidated U.S. GAAP results. Information on the outlook for each of our business segments is presented above under “Executive Summary and Business Outlook.”

 

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Credit Card Business

Our Credit Card business generated net income from continuing operations of $618 million and $1.3 billion in the second quarter and first six months of 2011, respectively, compared with net income from continuing operations of $568 million and $1.1 billion in the second quarter and first six months of 2010, respectively. The primary sources of revenue for our Credit Card business are net interest income and non-interest income from customer and interchange fees. Expenses primarily consist of ongoing operating costs, such as salaries and associated benefits, communications and other technology expenses, supplies and equipment, occupancy costs and marketing expenses.

Table 7 summarizes the financial results of our Credit Card business, which is comprised of the Domestic Card and International Card operations, and displays selected key metrics for the periods indicated. Our Credit Card business results for 2011 reflect the impact of the acquisitions of the existing portfolio credit card loan portfolios of Kohl’s and HBC. The results related to the Kohl’s loan portfolio, which totaled approximately $3.7 billion at acquisition on April 1, 2011, are included in our Domestic Card business. The results related to the HBC loan portfolio, which totaled approximately $1.4 billion at acquisition on January 7, 2011, are included in our International Card business.

Under the terms of the partnership agreement with Kohl’s, we share a fixed percentage of revenues, consisting of finance charges and late fees, with Kohl’s, and Kohl’s is required to reimburse us for fixed percentage of credit losses incurred. Revenues and losses related to the Kohl’s credit card program are reported on a net basis in our consolidated financial statements. The revenue sharing amounts earned by Kohl’s are reflected as an offset against our revenues in our consolidated statements of income, which has the effect of reducing our net interest income and revenue margins. The loss sharing amounts from Kohl’s are reflected as a reduction in our provision for loan and lease losses in our consolidated statements of income. We also report the related allowance for loan and lease losses attributable to the Kohl’s portfolio in our consolidated balance sheets net of the loss sharing amount due from Kohl’s.

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

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

 

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Table 7: Credit Card Business Results

 

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

(Dollars in millions)

   2011    

    2010    

    Change     2011     2010     Change  

Selected income statement data:

            

Net interest income

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

Non-interest income

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

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

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

Provision for loan and lease losses

     309        765        (60     759        1,940        (61

Non-interest expense

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

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations before income taxes

     962        869        11        1,949        1,611        21   

Income tax provision

     344        301        14        688        554        24   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations, net of tax

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

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Selected performance metrics:

            

Average loans held for investment

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

Average yield on loans held for investment(1)

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

Revenue margin(2)

     16.01        16.82        (81 )     16.62        17.01        (39 )

Net charge-off rate(3)

     5.06        9.36        (430     5.59        9.84        (425 )

Purchase volume(4)

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

(Dollars in millions)

   June 30,
2011
    December 31,
2010
    Change                    

Selected period-end data:

            

Loans held for investment

   $ 62,705      $ 61,371        2      

30+ day delinquency rate(5)

     3.60     4.29     (69 )bps       

Allowance for loan and lease losses

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

 

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

Average yield on loans held for investment is calculated by dividing annualized interest income for the period by average loans held for investment during the period. In preparing our Report on Form 10-Q for the first quarter of 2011 we determined that beginning in the second quarter of 2010, our management accounting processes excluded certain accounts that should have been included in the calculation of the average yield on loans held for investment. The mapping error was limited to the average yields on loans held for investment for our Credit Card business and had no impact on income statement amounts or the yields reported for any of our other business segments or for the total company. The revised average loan yields for our Credit Card business were 14.67%, 14.65%, 14.28% for the second quarter, third quarter and fourth quarter of 2010, respectively, and 14.78% for the six months ended June 30, 2010, 14.74% for the nine months ended September 30, 2010 and 14.63% for full year 2010. The previously reported average loan yields for our Credit Card business were 14.25%, 14.27%, 13.97% for the second quarter, third quarter and fourth quarter of 2010, respectively, and 14.57% for the six months ended June 30, 2010, 14.48% for the nine months ended September 30, 2010 and 14.36% for full year 2010.

(2) 

Revenue margin is calculated by dividing annualized revenues for the period by average loans held for investment during the period for the specified loan category.

(3) 

The net charge-off rate is calculated by loan category by dividing annualized net charge-offs for the period by average loans held for investment during the period for the specified loan category.

(4) 

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

(5)

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

 

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

 

   

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

 

   

Non-Interest Income: Non-interest income decreased by $40 million, or 6%, in the second quarter of 2011 and $84 million, or 6%, in the first six months of 2011. The decrease reflects the impact of contra-revenue amounts recorded in the second quarter of 2011, including a provision of $52 million for anticipated refunds to U.K. customers related to retrospective regulatory requirements pertaining to payment protection insurance (“PPI”) in our U.K. business and a provision of $21 million related to the periodic adjustment of our customer rewards points liability to reflect the estimated cost of points earned to date that are ultimately expected to be redeemed. These decreases were partially offset by higher interchange fees in the second quarter of 2011 resulting from increased purchase volume attributable to growth in our higher spend customer segments.

 

   

Provision for Loan and Lease Losses: The provision for loan and lease losses related to our Credit Card business decreased by $456 million in the second quarter of 2011, to $309 million and by $1.2 billion in the first six months of 2011, to $759 million. The significant reduction in the provision was primarily attributable to the continued improvement in underlying credit trends, including reduced delinquency rates, lower bankruptcy losses and higher recoveries. As estimated net charge-offs declined, we recorded an allowance release of $483 million and $948 million in the second quarter and first six months of 2011, respectively.

 

   

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

 

   

Total Loans: Period-end loans in the Credit Card business increased by $1.3 billion, or 2%, in the first six months of 2011, to $62.7 billion as of June 30, 2011, from $61.4 billion as of December 31, 2010. The increase was primarily attributable to the acquisitions of the Kohl’s credit card portfolio of $3.7 billion and the HBC credit card portfolio of $1.4 billion, which were partially offset by the continued run-off of the installment loan portfolio and seasonal credit card balance paydowns.

 

   

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

 

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Domestic Credit Card Business

Table 7.1 summarizes the financial results for Domestic Card and displays selected key metrics for the periods indicated. Domestic Card accounted for 87% of total revenues for our Credit Card business in the second quarter of 2011 and 86% in the first six months of 2011, compared with 87% in both the second quarter and first six months of 2010. Because our Domestic Card business currently accounts for the substantial majority of our Credit Card business, the key factors driving the results for this division are similar to the key factors affecting our total Credit Card business.

Table 7.1: Domestic Card Business Results

 

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

(Dollars in millions)

   2011    

    2010    

    Change     2011     2010     Change  

Selected income statement data:

            

Net interest income

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

Non-interest income

     584        560        4        1,167        1,178        (1
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

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

Provision for loan and lease losses

     187        675        (72     417        1,771        (76

Non-interest expense

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

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations before income taxes

     996        751        33        2,010        1,329        51   

Income tax provision

     354        268        32        714        474        51   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations, net of tax

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

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Selected performance metrics:

            

Average loans held for investment

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

Average yield on loans held for investment(1)

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

Revenue margin(2)

     16.27        16.61        (34 )     16.73        16.86        (13 )

Net charge-off rate(3)

     4.74        9.49        (475     5.45        10.00        (455 )

Purchase volume(4)

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

(Dollars in millions)

   June 30,
2011
    December 31,
2010
    Change                    

Selected period-end data:

            

Loans held for investment

   $ 53,994      $ 53,849          **%       

30+ day delinquency rate(5)

     3.33     4.09     (76 )bps       

Allowance for loan and lease losses

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

 

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

Average yield on loans held for investment is calculated by dividing annualized interest income for the period by average loans held for investment during the period. As indicated above, in preparing our Report on Form 10-Q for the first quarter of 2011, we determined that beginning in the second quarter of 2010, our management accounting processes excluded certain accounts that affected the calculation of the average yield on loans held for investment for our Credit Card business. The revised average loan yields for our Domestic Credit Card business were 14.49%, 14.40%, 13.96% for the second quarter, third quarter and fourth quarter of 2010, respectively, and 14.64% for the six months ended June 30, 2010, 14.57% for the nine months ended September 30, 2010 and 14.42% for full year 2010. The previously reported average loan yields for our Domestic Credit Card business were 13.98%, 13.95%, 13.57% for the second quarter, third quarter and fourth quarter of 2010, respectively, and 14.39% for the six months ended June 30, 2010, 14.25% for the nine months ended September 30, 2010 and 14.09% for full year 2010.

(2) 

Revenue margin is calculated by dividing annualized revenues for the period by average loans held for investment during the period for the specified loan category.

 

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(3) 

The net charge-off rate is calculated by loan category by dividing annualized net charge-offs for the period by average loans held for investment during the period for the specified loan category.

(4) 

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

(5)

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

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

The primary factors affecting Domestic Card results for the second quarter and the first six months of 2011, compared with the second quarter and the first six months of 2010 include: (1) a decline in total revenue attributable to a decrease in average loan yields as a result of reduced fees and the impact of the addition of the Kohl’s loan portfolio and lower average loan balances; (2) a significant reduction in the provision for loan and lease losses due to the continued improvement in credit performance metrics, including decreases in delinquency and charge-off rates; and (3) an increase in non-interest expense attributable to increased operating costs associated with higher purchase volumes and with the acquisitions of the Sony and Kohl’s loan portfolios, higher legal expenses and increased marketing expenditures.

International Credit Card Business

Table 7.2 summarizes the financial results for International Card and displays selected key metrics for the periods indicated. International Card accounted for 13% of total revenues for our Credit Card business in the second quarter of 2011 and 14% in the first six months of 2011, compared with 13% in both the second quarter and first six months of 2010.

Table 7.2: International Card Business Results

 

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

(Dollars in millions)

   2011     2010     Change     2011     2010     Change  

Selected income statement data:

            

Net interest income

   $ 283      $ 242        17   $ 573      $ 490        17

Non-interest income

     35        99        (65     126        199        (37
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

     318        341        (7     699        689        1   

Provision for loan and lease losses

     122        90        36        342        169        102   

Non-interest expense

     230        133        73        418        238        76   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations before income taxes

     (34     118        (129     (61 )     282        (122 )

Income tax provision

     (10     33        (130     (26 )     80        (133 )
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations, net of tax

   $ (24   $ 85        (128 )%    $ (35   $ 202        (117 )% 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Selected performance metrics:

            

Average loans held for investment

   $ 8,823      $ 7,427        19   $ 8,760      $ 7,620        15

Average yield on loans held for investment(1)

     15.77     16.00     (23 )bps      16.02     15.83     19 bps

Revenue margin(2)

     14.42        18.37        (395 )     15.96        18.09        (213 )

Net charge-off rate(3)

     7.02        8.38        (136     6.39        8.61        (222

Purchase volume(4)

   $ 3,156      $ 2,057        53   $ 5,929      $ 3,993        48

 

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(Dollars in millions)

   June 30,
2011
    December 31,
2010
    Change                

Selected period-end data:

              

Loans held for investment

   $ 8,711      $ 7,522        16        

30+ day delinquency rate(5)

     5.30     5.75     (45 )bps         

Allowance for loan and lease losses

   $ 538      $ 460        17        

 

(1) 

Average yield on loans held for investment is calculated by dividing annualized interest income for the period by average loans held for investment during the period. As indicated above, in preparing our Report on Form 10-Q for the first quarter of 2011, we determined that beginning in the second quarter of 2010, our management accounting processes excluded certain accounts that affected the calculation of the average yield on loans held for investment for our Credit Card business. The revised average loan yields for our International Credit Card business were 16.00%, 16.40%, 16.61% for the second quarter, third quarter and fourth quarter of 2010, respectively, and 15.83% for the six months ended June 30, 2010, 16.02% for the nine months ended September 30, 2010 and 16.16% for full year 2010. The previously reported average loan yields for our International Credit Card business were 16.21%, 16.62%, 16.82% for the second quarter, third quarter and fourth quarter of 2010, respectively, and 15.93% for the six months ended June 30, 2010, 16.16% for the nine months ended September 30, 2010 and 16.33% for full year 2010.

(2) 

Revenue margin is calculated by dividing annualized revenues for the period by average loans held for investment during the period for the specified loan category.

(3) 

The net charge-off rate is calculated by loan category by dividing annualized net charge-offs for the period by average loans held for investment during the period for the specified loan category.

(4) 

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

(5)

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

Our International Card division generated a net loss from continuing operations of $24 million and $35 million in the second quarter and first six months of 2011, respectively, compared with net income from continuing operations of $85 million and $202 million in the second quarter and first six months of 2010, respectively.

The primary factors contributing to the International Card net losses in the second quarter and the first six months of 2011, compared with net income in the second quarter and the first six months of 2010 include: (1) a decrease in non-interest income due to the contra-revenue provision of $52 million recorded in the second quarter of 2011 for the anticipated refunds to U.K. customers related to retrospective regulatory requirements pertaining to PPI insurance in our U.K. business; (2) an increase in the provision for loan losses due to the addition of the HBC loan portfolio and lower allowance releases relative to the same prior year periods; and (3) an increase in non-interest expense attributable to increased operating costs associated with HBC associates who joined us as a result of the acquisition. These factors were partially offset by an increase in non-interest income attributable to higher loan balances.

Consumer Banking Business

Our Consumer Banking business generated net income from continuing operations of $287 million and $502 million in the second quarter and first six months of 2011, respectively, compared with $305 million and $610 million in the second quarter and first six months of 2010, respectively. The primary sources of revenue for our Consumer Banking business are net interest income from loans and deposits and non-interest income from customer fees. Expenses primarily consist of ongoing operating costs, such as salaries and associated benefits, communications and other technology expenses, supplies and equipment and occupancy costs.

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

 

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Table 8: Consumer Banking Business Results

 

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

(Dollars in millions)

   2011     2010     Change     2011     2010     Change  

Selected income statement data:

            

Net interest income

   $ 1,051      $ 935        12   $ 2,034      $ 1,831        11

Non-interest income

     194        162        20        380        478        (21
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

     1,245        1,097        13        2,414        2,309        5   

Provision for loan and lease losses

     41        (112 )     137        136        (62 )     319   

Non-interest expense

     758        735        3        1,498        1,423        5   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations before income taxes

     446        474        (6     780        948        (18 )

Income tax provision

     159        169        (6     278        338        (18 )
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations, net of tax

   $ 287      $ 305        (6 )%    $ 502      $ 610        (18 )% 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Selected performance metrics:

            

Average loans held for investment:

            

Auto

   $ 18,753      $ 17,276        9   $ 18,391      $ 17,521        5

Home loan

     11,534        13,573        (15     11,746        14,531        (19

Retail banking

     4,154        4,811        (14     4,202        4,926        (15
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total consumer banking

   $ 34,441      $ 35,660        (3 )%    $ 34,339      $ 36,978        (7 )% 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Average yield on loans held for investment

     9.51     8.99     52 bps      9.55     8.97     58 bps

Average deposits

   $ 86,926      $ 77,082        13   $ 85,413      $ 76,104        12

Average deposit interest rate

     1.00     1.18     (18 )bps      1.03     1.23     (20 )bps 

Core deposit intangible amortization

   $ 34      $ 36        (6 )%    $ 68      $ 74        (8 )% 

Net charge-off rate(1)(2)

     1.01     1.47     (46 )bps      1.29     1.76     (47 )bps 

Automobile loan originations

   $ 2,910      $ 1,765        65   $ 5,481      $ 3,108        76

(Dollars in millions)

   June 30,
2011
    December 31,
2010
    Change                    

Selected period-end data:

        

Loans held for investment:

            

Auto

   $ 19,223      $ 17,867        8      

Home loans

     11,323        12,103        (6      

Retail banking

     4,046        4,413        (8      
  

 

 

   

 

 

   

 

 

       

Total consumer banking

   $ 34,592      $ 34,383        1      
  

 

 

   

 

 

   

 

 

       

30+ day performing delinquency rate(1)(3)

     3.70     4.28     (58 )bps       

30+ day delinquency rate(1)(3)

     5.26        5.96        (70      

Nonperforming loan rate(1)(4)

     1.83        1.97        (14      

Nonperforming asset rate(1)(5)

     2.00        2.17        (17      

Allowance for loan and lease losses

   $ 598      $ 675        (11 )%       

Deposits

     87,282        82,959        5         

Loans serviced for others

     19,226        20,689        (7      

 

(1)

Average loans held for investment used in the denominator in calculating net charge-off, delinquency and nonperforming loan and nonperforming asset rates includes the impact of loans acquired as part of the Chevy Chase Bank acquisition, which were considered purchased credit impaired (“PCI”) loans. However, we separately track and report PCI loans and exclude these loans from our net charge-off, delinquency, nonperforming loan and nonperforming asset rates.

 

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(2)

The net charge-off rate is calculated by loan category by dividing annualized net charge-offs for the period by average loans held for investment during the period for the specified loan category. The net charge-off rate, excluding loans acquired from Chevy Chase Bank from the denominator, was 1.17% and 1.76% for the three months ended June 30, 2011 and 2010, respectively, and 1.50% and 2.10% for the six months ended June 30, 2011 and 2010, respectively.

(3)

The delinquency rate is calculated by loan category by dividing delinquent loans as of the end of the period by period-end loans held for investment for the specified loan category. The 30+ day performing delinquency rate, excluding loans acquired from Chevy Chase Bank from the denominator, was 4.29% as of June 30, 2011 and 5.01% as of December 31, 2010. The 30+ day delinquency rate, excluding loans acquired from Chevy Chase Bank from the denominator, was 6.09% as of June 30, 2011 and 6.98% as of December 31, 2010.

(4) 

Nonperforming loans generally include loans that have been placed on nonaccrual status and certain restructured loans whose contractual terms have been restructured in a manner that grants a concession to a borrower experiencing financial difficulty. The nonperforming loan rate is calculated by loan category by dividing nonperforming loans as of the end of the period by period-end loans held for investment for the specified loan category. The nonperforming loan rate, excluding the impact of loans acquired from Chevy Chase Bank from the denominator, was 2.12% and 2.30% as of June 30, 2011 and December 31, 2010, respectively.

(5)

Nonperforming assets consist of nonperforming loans and real estate owned (“REO”). The nonperforming asset rate is calculated by loan category by dividing nonperforming assets as of the end of the period by period-end loans held for investment and REO for the specified loan category. The nonperforming asset rate, excluding loans acquired from Chevy Chase Bank from the denominator, was 2.32% and 2.54% as of June 30, 2011 and December 31, 2010, respectively.

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

 

   

Net Interest Income: Net interest income increased by $116 million, or 12%, in the second quarter of 2011, and $203 million, or 11%, in the first six months of 2011. The primary drivers of the increase in net interest income were improved loan margins, primarily resulting from higher pricing for new auto loan originations and lower interest expense associated with deposit growth resulting from our continued strategy to leverage our banking branches to attract lower cost funding sources. In addition, better than expected performance of PCI loans related to our Chevy Chase Bank acquisition resulted in an increase in the accretion of amounts into income. The favorable impact from these factors more than offset the decline in average loans held for investment resulting from the continued run-off of home loans.

 

   

Non-Interest Income: Non-interest income increased by $32 million, or 20%, in the second quarter of 2011 and decreased by $98 million, or 21%, in the first six months of 2011. The increase in non-interest income in the second quarter of 2011 from the same prior year period was primarily due to the absence of an impairment charge on mortgage servicing rights recorded in the second quarter of 2010. The decrease in non-interest income in the first six months of 2011 from the same prior year period was primarily attributable to the combined impact of the absence of a net gain of $128 million recorded in the first quarter of 2010 related to the deconsolidation of certain option-adjustable rate mortgage trusts that were consolidated on January 1, 2010 as a result of our adoption of the new consolidation accounting standards and the absence of the impairment charge on mortgage servicing rights recorded in the second quarter of 2010.

 

   

Provision for Loan and Lease Losses: The provision for loan and lease losses increased by $153 million in the second quarter of 2011, to $41 million and by $198 million in the first six months of 2011, to $136 million. Although we experienced continued improvement in credit performance in our Consumer Banking business, including reduced delinquency and net charge-off rates, we recorded a higher provision for loan and lease losses in the second quarter and first six months of 2011 relative to the same prior year periods due to a reduction in allowance releases and growth in our auto loan portfolio.

 

   

Non-Interest Expense: Non-interest expense increased by $23 million, or 3%, in the second quarter and by $75 million, or 5%, in the first six months of 2011. The increases over the same prior year periods were largely attributable to higher infrastructure expenditures due to increased headcount and increased marketing expenditures, primarily related to our retail banking operations.

 

   

Total Loans: Period-end loans in the Consumer Banking business increased by $209 million, or less than 1%, in the first six months of 2011, to $34.6 billion as of June 30, 2011, from $34.4 billion as of December 31, 2010, primarily due to growth in auto loans that was partially offset by continued run-off of home loans.

 

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Deposits: Period-end deposits in the Consumer Banking business increased by $4.3 billion, or 5%, in the first six months of 2011, to $87.3 billion as of June 30, 2011, reflecting the impact of our strategy to replace maturing higher cost wholesale funding sources with lower cost funding sources and our increased retail marketing efforts to attract new business to meet this objective.

 

   

Charge-off and Delinquency Statistics: The net charge-off rate decreased to 1.01% and 1.29% in the second quarter and first six months of 2011, respectively, from 1.47% and 1.76% in the second quarter and first six months of 2010, respectively. The 30+ day delinquency rate was 5.26% as of June 30, 2011, compared to 4.96% as of March 31, 2011 and 5.96% as of December 31, 2010. The improvement in the net charge-off and delinquency rates reflects the impact from strong underlying credit performance trends and the higher credit quality of our more recent auto loan vintages, as well as current favorable benefits from elevated auction prices.

Commercial Banking Business

Our Commercial Banking business generated net income from continuing operations of $142 million and $290 million for the second quarter and first six months of 2011, respectively, compared with a net income from continuing operations of $77 million and $28 million in the second quarter and first six months of 2010, respectively. The primary sources of revenue for our Commercial Banking business are net interest income from loans and deposits and non-interest income from customer fees. Expenses primarily consist of ongoing operating costs, such as salaries and associated benefits, communications and other technology expenses, supplies and equipment and occupancy costs.

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

 

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Table 9: Commercial Banking Business Results

 

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

(Dollars in millions)

   2011     2010     Change     2011     2010     Change  

Selected income statement data:

            

Net interest income

   $ 333      $ 319        4   $ 654      $ 631        4

Non-interest income

     62        60        3        133        102        30   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

     395        379        4        787        733        7   

Provision for loan and lease losses

     (18 )     62        (129     (33 )     300        (89

Non-interest expense

     192        198        (3 )     369        390        (5 )
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations before income taxes

     221        119        86        451        43        949   

Income tax provision

     79        42        88        161        15        973   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations, net of tax

   $ 142      $ 77        84   $ 290      $ 28        936
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Selected performance metrics:

            

Average loans held for investment:

            

Commercial and multifamily real estate

   $ 13,597      $ 13,543          **%    $ 13,472      $ 13,629        (1 )% 

Middle market

     10,979        10,276        7        10,823        10,300        5   

Specialty lending

     4,014        3,654        10        3,989        3,632        10   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial lending

     28,590        27,473        4        28,284        27,561        3   

Small-ticket commercial real estate

     1,726        2,060        (16     1,772        2,067        (14
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial banking

   $ 30,316      $ 29,533        3   $ 30,056      $ 29,628        1
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Average yield on loans held for investment

     4.74     4.94     (20 )bps      4.77     4.99     (22 )bps 

Average deposits

   $ 24,282      $ 22,171        10   $ 24,210      $ 22,016        10

Average deposit interest rate

     0.52     0.67     (15 )bps      0.53     0.71     (18 )bps 

Core deposit intangible amortization

   $ 10      $ 14        (29 )%    $ 21      $ 28        (25 )% 

Net charge-off rate(1)(2)

     0.50     1.21     (71 )bps      0.64     1.29     (65 )bps 

(Dollars in millions)

   June 30,
2011
    December 31,
2010
    Change                    

Selected period-end data:

            

Loans held for investment:

            

Commercial and multifamily real estate

   $ 14,035      $ 13,396        5      

Middle market

     11,404        10,484        9         

Specialty lending

     4,122        4,020        3         
  

 

 

   

 

 

   

 

 

       

Total commercial lending

     29,561        27,900        6         

Small-ticket commercial real estate

     1,642        1,842        (11      
  

 

 

   

 

 

   

 

 

       

Total commercial banking

   $ 31,203      $ 29,742        5      
  

 

 

   

 

 

   

 

 

       

Nonperforming loan rate(1)(3)

     1.54     1.66     (12 )bps       

Nonperforming asset rate(1)(4)

     1.66        1.80        (14      

Allowance for loan and lease losses

   $ 730      $ 826        (12 )%       

Deposits

     24,304        22,630        7         

 

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

Average loans held for investment used in the denominator in calculating net charge-off, delinquency and nonperforming loan and nonperforming asset rates includes the impact of loans acquired as part of the Chevy Chase Bank acquisition, which were considered purchased credit impaired (“PCI”) loans. However, we separately track and report PCI loans and exclude these loans from our net charge-off, delinquency, nonperforming loan and nonperforming asset rates.

(2)

The net charge-off rate is calculated by loan category by dividing annualized net charge-offs for the period by average loans held for investment during the period for the specified loan category. The net charge-off rate, excluding loans

 

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  acquired from Chevy Chase Bank from the denominator, was 0.51% and 1.24% for the three months ended June 30, 2011 and 2010, respectively, and 0.65% and 1.33% for the six months ended June 30, 2011 and 2010, respectively.
(3) 

The nonperforming loan rate is calculated by loan category by dividing nonperforming loans as of the end of the period by period-end loans held for investment for the specified loan category. The nonperforming loan rate, excluding the impact of loans acquired from Chevy Chase Bank from the denominator, was 1.56% and 1.69% as of June 30, 2011 and December 31, 2010, respectively.

(4)

The nonperforming asset rate is calculated by loan category by dividing nonperforming assets as of the end of the period by period-end loans held for investment and REO for the specified loan category. The nonperforming asset rate, excluding loans acquired from Chevy Chase Bank from the denominator, was 1.68% and 1.83% as of June 30, 2011 and December 31, 2010, respectively.

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

 

   

Net Interest Income: Net interest income increased by $14 million, or 4%, in the second quarter of 2011, and by $23 million, or 4%, in the first six months of 2011. The primary drivers of the increase in net interest income from the same prior year periods were lower interest expense associated with strong deposit growth resulting from our continued strategy to shift our funding mix to lower cost commercial banking deposits from higher cost wholesale sources, more favorable deposit pricing resulting from the repricing of higher rate deposits to lower rates in response to the overall lower interest rate environment and commercial loan growth.

 

   

Non-Interest Income: Non-interest income increased by $2 million, or 3%, in the second quarter of 2011 and $31 million, or 30%, in the first six months of 2011. The increase in non-interest income from the same prior year periods was largely attributable to growth in fees in the middle market segment, as well as increased customer fees related to treasury management and public financing activities.

 

   

Provision for Loan and Lease Losses: The Commercial Banking business recorded a negative provision for loan and lease losses of $18 million and $33 million in the second quarter and first six months of 2011, respectively, compared with provision expense of $62 million and $300 million in the second quarter and first six months of 2010, respectively. The negative provision in the second quarter and first six months of 2011 was attributable to lower loss severities resulting from an improvement in underlying credit performance trends. As a result, we reduced the allowance related to the Commercial Banking business by $52 million and $96 million in the second quarter and first six months of 2011, respectively. In comparison, we reduced the allowance by $36 million in the second quarter of 2010 and increased the allowance by $97 million in the first six months of 2010.

 

   

Non-Interest Expense: Non-interest expense decreased by $6 million, or 3%, in the second quarter of 2011 to $192 million and by $21 million, or 5%, in the first six months of 2011 to $369 million. The decreases from the same prior year periods were attributable to a reduction in the integration costs related to the Chevy Chase Bank acquisition incurred in the first six months of 2010.

 

   

Total Loans: Period-end loans increased by $1.5 billion, or 5%, in the first six months of 2011 to $31.2 billion as of June 30, 2011, from $29.7 billion as of December 31, 2010. The increase was driven by stronger loan demand in the middle market and commercial real estate businesses, which was partially offset by attrition in our multifamily real estate portfolio and the run-off and sale of a portion of the small-ticket commercial real estate loan portfolio.

 

   

Deposits: Period-end deposits in the Commercial Banking business increased by $1.7 billion, or 7%, in the first six months of 2011, to $24.3 billion as of June 30, 2011, driven by our increased effort to build and expand commercial relationships and attract lower cost funding sources.

 

   

Charge-off and Nonperforming Loan Statistics: The net charge-off rate decreased to 0.50% and 0.64% in the second quarter and first six months of 2011, respectively, from 1.21% and 1.29% in the second quarter and first six months of 2010, respectively. The nonperforming loan rate decreased to 1.54% as of June 30, 2011, from 1.66% as of December 31, 2010. The improvement in the net charge-off and nonperforming loan rates was attributable to strong underlying credit improvement trends.

 

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CONSOLIDATED BALANCE SHEET ANALYSIS AND CREDIT PERFORMANCE

 

Total assets of $199.8 billion as of June 30, 2011 increased by $2.3 billion, or 1%, from $197.5 billion as of December 31, 2010. Total liabilities of $171.1 billion as of June 30, 2011, increased by $110 million, or less than 1%, from $171.0 billion as of December 31, 2010. Stockholders’ equity increased by $2.1 billion during the first six months of 2011, to $28.7 billion as of June 30, 2011 from $26.5 billion as of December 31, 2010. The increase in stockholders’ equity was primarily attributable to our net income of $1.9 billion in the first six months of 2011.

Following is a discussion of material changes in the major components of our assets and liabilities during the first six months of 2011.

Investment Securities

Our investment securities portfolio, which had a fair value of $39.5 billion and $41.5 billion, as of June 30, 2011 and December 31, 2010, respectively, consists of the following: U.S. Treasury and U.S. agency debt obligations; agency and non-agency mortgage-backed securities; other asset-backed securities collateralized primarily by credit card loans, auto loans, student loans, auto dealer floor plan inventory loans and leases, equipment loans and home equity lines of credit; municipal securities; and limited Community Reinvestment Act (“CRA”) equity securities. Our investment securities portfolio continues to be heavily concentrated in securities that generally have lower credit risk and high credit ratings, such as securities issued and guaranteed by the U.S. Treasury and government sponsored enterprises or agencies. Our investments in U.S. Treasury and agency securities, based on fair value, represented approximately 71% and 70% of our total investment securities portfolio as of June 30, 2011, and December 31, 2010, respectively.

All of our investment securities were classified as available for sale as of June 30, 2011 and December 31, 2010, and reported in our consolidated balance sheet at fair value. Table 10 presents the amortized cost and fair value of our investment securities, by investment type, as of June 30, 2011 and December  31, 2010.

Table 10: Investment Securities

 

     June 30, 2011      December 31, 2010  

(Dollars in millions)

   Amortized
Cost
     Fair
Value
     Amortized
Cost
     Fair
Value
 

U.S. Treasury debt obligations

   $ 301       $ 311       $ 373       $ 386   

U.S. Agency debt obligations(1)

     166         176         301         314   

Collateralized mortgage obligations (“CMO”):

           

Agency(2)

     12,104         12,412         12,303         12,566   

Non-agency

     953         889         1,091         1,019   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total CMOs

     13,057         13,301         13,394         13,585   

Mortgage-backed securities (“MBS”):

           

Agency(2)

     14,344         14,733         15,721         15,983   

Non-agency

     630         573         735         681   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total MBS

     14,974         15,306         16,456         16,664   

Asset-backed securities (“ABS”)(3)

     9,769         9,832         9,901         9,966   

Other securities(4)

     489         548         563         622   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total securities available for sale

   $ 38,756       $ 39,474       $ 40,988       $ 41,537   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) 

Consists of debt securities issued by Fannie Mae and Freddie Mac with an amortized cost of $165 million and $200 million, as of June 30, 2011 and December 31, 2010, respectively, and fair value of $175 million and $213 million, as of June 30, 2011 and December 31, 2010, respectively.

 

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(2) 

Consists of mortgage-backed securities issued by Fannie Mae, Freddie Mac and Ginnie Mae with an amortized cost of $15.5 billion, $7.7 billion and $3.2 billion, respectively, and fair value of $15.9 billion, $7.9 billion and $3.3 billion, respectively, as of June 30, 2011. The book value of Fannie Mae, Freddie Mac and Ginnie Mae investments each exceeded 10% of our stockholders’ equity as of June 30, 2011.

(3) 

Consists of securities collateralized by credit card loans, auto dealer floor plan inventory loans and leases, student loans, auto loans, equipment loans and other. The distribution among these asset types was approximately 71.0% credit card loans, 9.3% auto dealer floor plan inventory loans and leases, 6.9% student loans, 6.6% auto loans, 1.9% equipment loans, and 4.3% of other loans as of June 30, 2011. In comparison, the distribution was approximately 77.8% credit card loans, 5.6% auto dealer floor plan inventory loans and leases, 7.2% student loans, 6.7% auto loans, 2.5% equipment loans and 0.2% home equity lines of credit as of December 31, 2010. Approximately 91.7% of the securities in our asset-backed security portfolio were rated AAA or its equivalent as of June 30, 2011, compared with 90.1% as of December 31, 2010. Our asset-backed security portfolio also includes commercial mortgage-backed securities issued by Fannie Mae, Freddie Mac, and Ginnie Mae with an amortized cost of $8 million, $158 million and $55 million, respectively, and fair values of $9 million, $161 million and $56 million, respectively, as of June 30, 2011.

(4) 

Consists of municipal securities and equity investments, primarily related to CRA activities.

Unrealized gains and losses on our available-for-sale securities are recorded net of tax as a component of accumulated other comprehensive income (“AOCI”). We had gross unrealized gains of $914 million and gross unrealized losses of $196 million on available-for-sale securities as of June 30, 2011, compared with gross unrealized gains of $830 million and gross unrealized losses of $281 million as of December 31, 2010. Of the $196 million in gross unrealized losses as of June 30, 2011, $124 million related to securities that had been in a loss position for more than 12 months.

We evaluate available-for-sale securities in an unrealized loss position as of the end of each quarter for other-than-temporary impairment (“OTTI”) based on a number of criteria, including the extent and duration of the decline in value, the severity and duration of the impairment, recent events specific to the issuer and/or industry to which the issuer belongs, the payment structure of the security, external credit ratings, the failure of the issuer to make scheduled interest or principal payments, the value of underlying collateral, our intent and ability to hold the security and current market conditions. We recognized net OTTI on investment securities of $6 million and $9 million in the second quarter and first six months of 2011, respectively. In comparison, we recognized net OTTI on investment securities of $26 million and $57 million in the second quarter and first six months of 2010, respectively, which was due in part to our decision to sell certain other securities before recovery of the impairment amount as well as the deterioration in the credit performance of certain non-agency mortgage-related securities resulting from weaknesses in the housing market and high unemployment.

We provide additional information on our available-for-sale securities and OTTI assessment in “Note 4—Investment Securities.”

 

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Total Loans

Table 11 presents the composition of our total loan portfolio, by business segments, as of June 30, 2011 and December 31, 2010:

Table 11: Loan Portfolio Composition

 

     June 30, 2011     December 31, 2010  

(Dollars in millions)

   Amount      % of
Total Loans
    Amount      % of
Total Loans
 

Credit Card business:

          

Credit card loans:

          

Domestic credit card loans

   $ 51,236         39.7   $ 49,979         39.7

International credit card loans

     8,709         6.8        7,513         6.0   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total credit card loans

     59,945         46.5        57,492         45.7   
  

 

 

    

 

 

   

 

 

    

 

 

 

Installment loans:

          

Domestic installment loans

     2,758         2.1        3,870         3.0   

International installment loans

     2         —          9         —     
  

 

 

    

 

 

   

 

 

    

 

 

 

Total installment loans

     2,760         2.1        3,879         3.0   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total credit card

     62,705         48.6        61,371         48.7   
  

 

 

    

 

 

   

 

 

    

 

 

 

Consumer Banking business:

          

Automobile

     19,223         14.9        17,867         14.2   

Home loan

     11,323         8.8        12,103         9.6   

Retail banking

     4,046         3.1        4,413         3.5   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total consumer banking

     34,592         26.8        34,383         27.3   
  

 

 

    

 

 

   

 

 

    

 

 

 

Commercial Banking business:

          

Commercial and multifamily real estate(1)

     14,035         10.9        13,396         10.6   

Middle market

     11,404         8.8        10,484         8.3   

Specialty lending

     4,122         3.2        4,020         3.2   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total commercial lending

     29,561         22.9        27,900         22.1   

Small-ticket commercial real estate

     1,642         1.3        1,842         1.5   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total commercial banking

     31,203         24.2        29,742         23.6   
  

 

 

    

 

 

   

 

 

    

 

 

 

Other:

          

Other loans

     465         0.4        451         0.4   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total loans

   $ 128,965         100.0   $ 125,947         100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

 

(1) 

Includes construction and land development loans totaling $2.1 billion and $2.4 billion as of June 30, 2011 and December 31, 2010, respectively.

Total loans increased by $3.0 billion, or 2%, to $129.0 billion as of June 30, 2011, from $125.9 billion as of December 31, 2010. The increase was primarily attributable to the acquisitions of the Kohl’s portfolio of $3.7 billion and the HBC portfolio of $1.4 billion, strong growth in purchase volume across our Domestic Card business and growth in both Auto Finance and Commercial Banking loans. Excluding the impact of the Kohl’s and HBC acquisitions, total loans decreased by $2.1 billion, or 2%, in the first six months of 2011. The decrease was attributable to the continued expected run-off of loans in businesses we exited or repositioned early in the economic recession, other loan paydowns and charge-offs, which more than offset the strong growth in purchase volume across the Domestic Card business. The run-off portfolios include installment loans in our Credit Card business, home loans in our Consumer Banking business and small-ticket commercial real estate loans in our Commercial Banking business.

 

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Credit Performance

We closely monitor economic conditions and loan performance trends to manage and evaluate our exposure to credit risk. Trends in delinquency ratios are an indicator, among other considerations, of credit risk within our loan portfolios. The level of nonperforming assets represents another indicator of the potential for future credit losses. Accordingly, key metrics we track and use in evaluating the credit quality of our loan portfolio include delinquency and nonperforming asset rates, as well as charge-off rates and our internal risk ratings of commercial loans. We experienced an improvement in credit performance across all of our businesses during the second quarter and first six months of 2011, including reduced delinquency rates, average loss severities and charge-off rates. We present information in the section below on the credit performance of our loan portfolio, including the key metrics we use in tracking changes in the credit quality of our loan portfolio. See “Note 5—Loans” for additional information.

Delinquency Rates

We consider the entire balance of an account to be delinquent if the minimum required payment is not received by the first statement cycle date equal to or following the due date specified on the customer’s billing statement. Table 12 below compares 30+ day performing loan delinquency rates, by loan category, as of June 30, 2011 and December 31, 2010. We also present total 30+ day delinquent loans.

Our 30+ day delinquency metrics include all held for investment loans that are 30 or more days past due, whereas our 30+ day performing delinquency metrics include loans that are 30 or more days past due and that are also currently classified as performing and accruing interest. The 30+ day delinquency and 30+ day performing delinquency metrics are the same for credit card loans, as we continue to classify credit card loans as performing until they are charged-off, generally when the loan is 180 days past due. However, the 30+ day delinquency and 30+ day performing delinquency metrics differ for other loan categories based on our policies for classifying loans as nonperforming. See “Note 5—Loans” for additional information on our policies for classifying loans as nonperforming and for charging-off loans.

The delinquency rates presented are calculated, by loan category, based on our total loan portfolio. Our total loan portfolio consists of loans recorded on our balance sheet, which includes purchased credit impaired (“PCI”) loans acquired from Chevy Chase Bank, and loans held in our securitization trusts. Loans acquired from Chevy Chase Bank were recorded at fair value at acquisition. We separately track and report the performance of PCI loans and exclude these loans from the numerator in calculating our net charge-off, delinquency, nonperforming loan and nonperforming asset rates.

 

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Table 12: 30+ Day Delinquencies

 

     June 30, 2011     December 31, 2010  
     30+ Day Performing     30+ Day Total     30+ Day Performing     30+ Day Total  

(Dollars in millions)

     Amount          Rate(1)        Amount      Rate(1)       Amount          Rate(1)        Amount      Rate(1)  

Credit Card business:

                    

Domestic credit card and installment loans

   $ 1,798         3.33   $ 1,798         3.33   $ 2,200         4.09   $ 2,200         4.09

International credit card and installment loans

     462         5.30        462         5.30        432         5.75        432         5.75   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total credit card

     2,260         3.60        2,260         3.60        2,632         4.29        2,632         4.29   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Consumer Banking business:

                    

Automobile

     1,170         6.09        1,252         6.51        1,355         7.58        1,453         8.13   

Home loan(2)

     80         0.70        487         4.30        77         0.64        504         4.16   

Retail banking(2)

     31         0.76        80         1.99        41         0.93        93         2.11   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total consumer banking(2)

     1,281         3.70        1,819         5.26        1,473         4.28        2,050         5.96   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Commercial Banking business:

                    

Commercial and multifamily real estate(2)

     65         0.47        269         1.92        147         1.10        302         2.25   

Middle market(2)

     32         0.28        100         0.88        28         0.27        89         0.85   

Specialty lending

     31         0.74        41         1.00        33         0.81        58         1.44   

Small-ticket commercial real estate

     44         2.71        52         3.16        95         5.16        131         7.11   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total commercial banking(2)

     172         0.55        462         1.48        303         1.02        580         1.95   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Other:

                    

Other loans

     24         5.32        68         14.59        22         4.88        69         15.30   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 3,737         2.90   $ 4,609         3.57   $ 4,430         3.52   $ 5,331         4.23
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

(1) 

Delinquency rates are 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.

(2) 

The 30+ day performing delinquency rate, excluding the impact of loans acquired from Chevy Chase Bank from the denominator, for home loans, retail banking, total consumer banking, commercial and multifamily real estate, middle market, and total commercial banking was 1.18%, 0.77%, 4.29%, 0.47%, 0.28% and 0.56%, respectively, as of June 30, 2011, compared with 1.06%, 0.97%, 5.01%, 1.12%, 0.28% and 1.04%, respectively, as of December 31, 2010.

Table 13 presents an aging of total 30+ day delinquent loans included in the above table.

 

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Table 13: Aging of 30+ Day Delinquent Loans

 

     June 30, 2011     December 31, 2010  

(Dollars in millions)

   Amount      % of
Total Loans(1)
    Amount      % of
Total Loans(1)
 

Total loan portfolio

   $ 128,965         100.00   $ 125,947         100.00
  

 

 

    

 

 

   

 

 

    

 

 

 

Delinquency status:

          

30 – 59 days

   $ 1,748         1.36   $ 2,008         1.59

60 – 89 days

     948         0.73        1,103         0.88   

90 + days

     1,913         1.48        2,220         1.76   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 4,609         3.57   $ 5,331         4.23
  

 

 

    

 

 

   

 

 

    

 

 

 

Geographic region:

          

Domestic

   $ 4,147         3.22   $ 4,899         3.89

International

     462         0.35        432         0.34   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 4,609         3.57   $ 5,331         4.23
  

 

 

    

 

 

   

 

 

    

 

 

 

 

(1) 

Calculated by dividing loans in each delinquency status category and geographic region as of the end of the period by the total loan portfolio.

Table 14 summarizes loans that were 90 days or more past due as to interest or principal payments and still accruing interest as of June 30, 2011 and December 31, 2010. These loans consist primarily of credit card accounts between 90 days and 179 days past due. As permitted by regulatory guidance issued by The Federal Financial Institutions Examination Council (“FFIEC”), we continue to accrue interest on credit card loans through the date of charge-off, typically in the period the account becomes 180 days past due. While credit card loans remain on accrual status until the loan is charged-off, we establish a reserve for finance charges and fees billed but not expected to be collected and exclude this amount from revenue.

Table 14: 90+ Day Delinquent Loans Accruing Interest

 

     June 30, 2011     December 31, 2010  

(Dollars in millions)

   Amount      % of
Total Loans(1)
    Amount      % of
Total Loans(1)
 

Loan category:

          

Credit card(2)

   $ 1,078         1.72   $ 1,379         2.25

Consumer

     3         0.01        5         0.01   

Commercial

     11         0.04        14         0.05   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 1,092         0.85   $ 1,398         1.11
  

 

 

    

 

 

   

 

 

    

 

 

 

Geographic region(3):

          

Domestic

   $ 880         0.68   $ 1,195         0.95

International

     212         0.17        203         0.16   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 1,092         0.85   $ 1,398         1.11
  

 

 

    

 

 

   

 

 

    

 

 

 

 

(1) 

Delinquency rates are calculated by loan category by dividing 90+ day delinquent loans accruing interest as of the end of the period by period-end loans held for investment for the specified loan category.

(2) 

Includes credit card loans that continue to accrue finance charges and fees until charged-off at 180 days. The amounts reported for credit card loans are net of billed finance charges and fees that we do not expect to collect. The estimated uncollectible portion of billed finance charges and fees excluded from revenue totaled $112 million and $261 million in the second quarter of 2011 and 2010, respectively, and $217 million and $615 million in the first six months of 2011 and 2010, respectively. The reserve for uncollectible billed finance charges and fees decreased to $153 million as of June 30, 2011, from $211 million as of December 31, 2010.

(3) 

Calculated by dividing loans in each geographic region as of the end of the period by the total loan portfolio.

 

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Nonperforming Assets

Nonperforming assets consist of nonperforming loans and foreclosed property and repossessed assets. 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. We continue to classify credit loans as performing until they are charged-off. As a result, delinquent credit cards loans are excluded from the numerator in calculating our nonperforming loan and nonperforming asset rates. We provide an aging of delinquent loans by loan category and describe our policies for classifying loans as nonperforming and for charging-off loans in “Note 5—Loans.”

Table 15 presents comparative information on nonperforming loans, by loan category, as of June 30, 2011 and December 31, 2010, and the ratio of nonperforming loans to total loans. We do not report loans classified as held for sale as nonperforming, as they are recorded at lower of cost or fair value. We also do not report PCI loans as nonperforming, as these loans were written down to fair value at acquisition and accrete interest income over the remaining life of the loan. We separately track and report the performance of PCI loans. See “Purchased Credit-Impaired Loans” below for additional information on PCI loans.

Table 15: Nonperforming Loans and Other Nonperforming Assets(1)(2)

 

     June 30, 2011(3)     December 31, 2010  

(Dollars in millions)

   Amount      % of Total
HFI Loans
    Amount      % of Total
HFI Loans
 

Nonperforming loans held for investment:

          

Consumer Banking business:

          

Automobile

   $ 81         0.42   $ 99         0.55

Home loans

     474         4.19        486         4.01   

Retail banking

     77         1.90        91         2.07   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total consumer banking

     632         1.83        676         1.97   
  

 

 

    

 

 

   

 

 

    

 

 

 

Commercial Banking business:

          

Commercial and multifamily real estate

     307         2.18        276         2.06   

Middle market

     129         1.13        133         1.27   

Specialty lending

     37         0.90        48         1.20   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total commercial lending

     473         1.60        457         1.64   

Small-ticket commercial real estate

     8         0.46        38         2.04   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total commercial banking

     481         1.54        495         1.66   
  

 

 

    

 

 

   

 

 

    

 

 

 

Other:

          

Other loans

     51         11.02        54         12.12   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total nonperforming loans held for investment(4)

   $ 1,164         0.90   $ 1,225         0.97
  

 

 

    

 

 

   

 

 

    

 

 

 

Other nonperforming assets:

          

Foreclosed property(5)

   $ 207         0.16   $ 306         0.24

Repossessed assets

     15         0.01        20         0.02   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total other nonperforming assets

     222         0.17        326         0.26   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total nonperforming assets

   $ 1,386         1.07   $ 1,551         1.23
  

 

 

    

 

 

   

 

 

    

 

 

 

 

(1) 

The ratio of nonperforming loans as a percentage of total loans held for investment is calculated based on the nonperforming loans in each loan category divided by the total outstanding unpaid principal balance of loans held for investment in each loan category. The denominator used in calculating the nonperforming asset ratios consists of total loans held for investment and other nonperforming assets.

 

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(2) 

The nonperforming loan ratios, excluding the impact of loans acquired from Chevy Chase Bank from the denominator, for home loans, retail banking, total consumer banking, commercial and multifamily real estate, middle market, total commercial banking, and total nonperforming loans held for investment were 7.03%, 1.93%, 2.12%, 2.22%, 1.16%, 1.56% and 0.94%, respectively, as of June 30, 2011, compared with 6.67%, 2.16%, 2.30%, 2.11%, 1.30%, 1.69% and 1.02%, respectively, as of December 31, 2010. The nonperforming asset ratio, excluding loans acquired from Chevy Chase Bank, was 1.12% and 1.29% as of June 30, 2011 and December 31, 2010, respectively.

(3) 

For the six months ended June 30, 2011, we recognized interest income for loans classified as nonperforming of $11 million. Forgone interest income represents the amount of interest income that would have been recorded during the period for nonperforming loans as of the end of the period had the loans performed according to their contractual terms. For the six months ended June 30, 2011, the interest income forgone related to nonperforming loans as of the end of the period was $30 million.

(4) 

Nonperforming loans as a percentage of loans held for investment, excluding credit card loans from the denominator, was 1.76% and 1.90% as of June 30, 2011 and December 31, 2010, respectively.

(5) 

Includes $106 million and $201 million of foreclosed properties related to loans acquired from Chevy Chase Bank, as of June 30, 2011 and December 31, 2010, respectively.

Net Charge-Offs

Net charge-offs consist of the unpaid principal balance of loans held for investment that we determine are uncollectible, net of recovered amounts. We exclude accrued and unpaid finance charges and fees and fraud losses from charge-offs. Charge-offs are recorded as a reduction to the allowance for loan and lease losses and subsequent recoveries of previously charged-off amounts are credited to the allowance for loan and lease losses. Costs incurred to recover charged-off loans are recorded as collection expense and included in our consolidated statements of income as a component of other non-interest expense. We discuss our charge-off time frame for loans, which varies based on the loan type, in “Note 5—Loans.”

Table 16 presents our net charge-off amounts and rates, by business segment, for the three and six months ended June 30, 2011 and 2010. We provide additional information on the amount of charge-offs by loan category below in Table 18.

Table 16: Net Charge-Offs

 

     Three Months Ended June 30,     Six Months Ended June 30,  
     2011     2010     2011     2010  

(Dollars in millions)

   Amount      Rate(1)     Amount      Rate(1)     Amount      Rate(1)     Amount      Rate(1)  

Credit card(2)

   $ 793         5.06   $ 1,463         9.36   $ 1,722         5.59   $ 3,156         9.84

Consumer banking(3)(4)

     88         1.01        131         1.47        221         1.29        326         1.76   

Commercial banking(3)(4)

     38         0.50        90         1.21        97         0.64        191         1.29   

Other

     12         10.59        33         28.51        36         15.23        62         26.11   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total company(4)

   $ 931         2.91   $ 1,717         5.36   $ 2,076         3.28   $ 3,735         5.69
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Average loans held for investment(5)

   $ 127,916         $ 128,203         $ 126,504         $ 131,222      

 

(1) 

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

(2) 

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

(3) 

Excludes losses on the purchased credit-impaired loans acquired from Chevy Chase Bank. We separately track and report these loans. We provide additional information on the loans acquired from Chevy Chase Bank in “Note 5—Loans.”

 

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(4) 

The average loans held for investment used in calculating net charge-off rates includes the impact of loans acquired as part of the Chevy Chase Bank acquisition. Our total net charge-off rate, excluding the impact of acquired Chevy Chase Bank loans, was 3.03% and 5.64% for the three months ended June 30, 2011 and 2010, respectively and 3.42% and 6.00% for the six months ended June 30, 2011 and 2010, respectively.

(5) 

The average balances of the acquired Chevy Chase Bank loan portfolio, which are included in the total average loans held for investment used in calculating the net charge-off rates, were $5.1 billion and $6.5 billion for the three months ended June 30, 2011 and 2010, respectively, and $5.2 billion and $6.8 billion for the six months ended June 30, 2011 and 2010, respectively.

The overall decrease in net charge-offs in the second quarter and first six months of 2011 from the second quarter and first six months of 2010 reflects the ongoing improvement in credit performance.

Loan Modifications and Restructurings

As part of our customer retention efforts, we may modify loans for certain borrowers who have demonstrated performance under the previous terms. As part of our loss mitigation efforts, we may make loan modifications to a borrower experiencing financial difficulty that are intended to minimize our economic loss and avoid the need for foreclosure or repossession of collateral. We may provide short-term (three to twelve months) or long-term (greater than twelve months) modifications to improve the long-term collectability of the loan. Our most common types of modifications include a reduction in the borrower’s initial periodic principal and interest payment through an extension of the loan term, a reduction in the interest rate or a combination of both. These modifications may result in our receiving the full amount due, or certain installments due, under the loan over a period of time that is longer than the period of time originally provided for under the terms of the loan. In some cases, we may curtail the amount of principal owed by the borrower. Loan modifications in which an economic concession has been granted to a borrower experiencing financial difficulty are accounted for and reported as troubled debt restructurings (“TDRs”).

Table 17 presents the loan balance as of June 30, 2011 and December 31, 2010 of loan modifications made as part of our loss mitigation efforts, all of which are considered to be TDRs. Table 17 excludes loan modifications that do not meet the definition of a TDR and acquired loans from Chevy Chase Bank, which we track and report separately. We provide additional detail on acquired loans from Chevy Chase Bank below under “Purchased Credit-Impaired Loan.”

Table 17: Loan Modifications and Restructurings(1)

 

(Dollars in millions)

   June 30,
2011
     December  31,
2010(2)
 

Modified and restructured loans:

     

Credit card(3)

   $ 929       $ 913   

Auto(4)

     20         —     

Home loans

     71         57   

Retail banking

     23         13   

Commercial

     265         162   
  

 

 

    

 

 

 

Total

   $ 1,308       $ 1,145   
  

 

 

    

 

 

 

Status of modified and restructured loans:

     

Performing

   $ 1,207       $ 1,049   

Nonperforming

     101         96   
  

 

 

    

 

 

 

Total

   $ 1,308       $ 1,145   
  

 

 

    

 

 

 

 

(1) 

Reflects modifications and restructuring of loans in our total loan portfolio. The total loan portfolio includes loans recorded on our balance sheet and loans held in securitization trusts.

(2) 

Certain prior period amounts have been reclassified to conform to the current period presentation.

 

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(3) 

Amount reported reflects the total outstanding customer balance, which consists of unpaid principal balance, accrued interest and fees.

(4) 

Prior to the first quarter of 2011, modified Auto loans were charged-off at the net collateral value and the remaining asset balance was reclassified to Other Assets on our consolidated balance sheet.

The outstanding balance of TDR loan modifications increased to $1.3 billion as of June 30, 2011 from $1.1 billion as of December 31, 2010. Of these modifications, $101 million, or 8%, were classified as nonperforming as of June 30, 2011, compared with $96 million, or 8%, as of December 31, 2010.

Credit card loan modifications have accounted for the substantial majority of our TDR loan modifications, representing $929 million, or 71%, of the outstanding balance of total TDR loans as of June 30, 2011, and $913 million, or 80%, of the outstanding balance of total TDR as of December 31, 2010. The vast majority of our credit card TDR loan modifications involve a reduction in the interest rate on the account and placing the customer on a fixed payment plan not exceeding 60 months. In some cases, the interest rate on a credit card account is automatically increased due to non-payment, late payment or similar events. We determine the effective interest rate for purposes of measuring impairment on modified loans that involve an increase and are considered to be a TDRs based on the interest rate in effect immediately prior to the loan entering the modification program. In all cases, we cancel the customer’s available line of credit on the credit card. If the cardholder does not comply with the modified payment terms, then the credit card loan agreement will revert back to its original payment terms, with the amount of any loan outstanding reflected in the appropriate delinquency category. The loan amount may then be charged-off in accordance with our standard charge-off policy.

We typically measure the re-performance rate of modified credit card loans over a 5-year period. Five years after starting a credit card modification, approximately 83% of the balances of modified loans are paid off in full and approximately 17% are charged-off. Based on our experience to date, we believe that credit losses are lower for credit card loans that have been modified than those of similar accounts that were not modified. We therefore plan to expand our short-term credit card loan modification programs and continue our long-term programs.

Home loan modifications represented $71 million, or 5%, of the outstanding balance of total modified loans as of June 30, 2011, compared with $57 million, or 5%, of the outstanding balance of total modified loans as of December 31, 2010. Approximately 78% of our modified mortgage loans include reduction in the contractual interest rate, approximately 23% include a term extension and approximately 22% include a principal reduction. The majority of our modified mortgage loans involve a combination of an interest rate reduction, term extension or principal reduction. Because many of the mortgage loan modification programs have been recently launched and we have had a limited number of modifications under these programs, we do not have sufficient history to fully assess the long-term performance of modified mortgage loans. Of the modified mortgage loans outstanding as of June 30, 2011, approximately 26% were 90 days or more delinquent.

Commercial loan modifications represented $265 million, or 20%, of the outstanding balance of total modified loans as of June 30, 2011, compared with $162 million, or 14%, of the outstanding balance of total modified loans as of December 31, 2010. The vast majority of modified commercial loans include a reduction in interest rate or a term extension. Because we have had only a limited number of commercial loan modifications and the structure of each loan varies, the ultimate success of our commercial loan modifications is uncertain. Of the modified commercial loans outstanding as of June 30, 2011, approximately 10% were 90 days or more delinquent.

Impaired Loans

A loan is considered impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due from the borrower in accordance with the original contractual terms of the loan. Loans defined as individually impaired, based on applicable accounting guidance, include larger balance

 

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commercial nonperforming loans and TDR loans. We do not report nonperforming consumer loans that have not been modified in a TDR as individually impaired, as we collectively evaluate these smaller-balance homogenous loans for impairment in accordance with applicable accounting guidance. Loans held for sale are also not reported as impaired, as these loans are recorded at lower of cost or fair value. Impaired loans also exclude loans acquired from Chevy Chase Bank because these loans were recorded at fair value upon acquisition.

Impaired loans, including TDRs, totaled $1.6 billion as of June 30, 2011, compared with $1.5 billion as of December 31, 2010. TDRs accounted for $1.3 billion and $1.1 billion of impaired loans as of June 30, 2011 and December 31, 2010, respectively. We provide additional information on our impaired loans, including the allowance established for these loans, in “Note 5—Loans” and “Note 6—Allowance for Loan and Lease Losses.”

Purchased Credit-Impaired Loans

Purchased credit-impaired loans decreased to $5.1 billion as of June 30, 2011, from $5.6 billion as of December 31, 2010. Our portfolio of purchased credit-impaired loans consists of loans acquired in the Chevy Chase Bank transaction, which were recorded at fair value at the date of acquisition. The fair value of these loans included an estimate of credit losses expected to be realized over the remaining lives of the loans. Therefore, no allowance for loan and lease losses was recorded for these loans as of the acquisition date. However, we regularly update the amount of expected principal and interest to be collected from these loans and evaluate the results on an aggregated pool basis for loans with common risk characteristics. Probable decreases in expected loan principal cash flows would trigger the recognition of impairment through our provision for loan and lease losses. Probable and significant increases in expected cash flows would first reverse any previously recorded allowance for loan and losses, with any remaining increase in expected cash flows recognized prospectively in interest income over the remaining estimated life of the underlying loans. In the first quarter of 2011, we recorded impairment of $8 million related to certain loan pools. In the second quarter of 2011, we reduced the allowance related to these loans by $28 million as a result of an increase in expected loan principal cash flows. Cumulative impairment recognized on PCI loans totaled $13 million as of June 30, 2011. The credit performance of the remaining pools has generally been in line with our expectations, and, in some cases, more favorable than expected, which has resulted in the reclassification of amounts from the nonaccretable difference to the accretable yield. We provide additional information on the PCI loans acquired from Chevy Chase Bank in “Note 5—Loans.”

Allowance for Loan and Lease Losses

Our allowance for loan and lease losses represents management’s best estimate of incurred loan and lease credit losses inherent in our held-for-investment portfolio as of each balance sheet date. We do not maintain an allowance for held-for-sale loans or purchased credit-impaired loans that are performing in accordance with or better than our expectations as of the date of acquisition, as the fair values of these loans already reflect a credit component. The allowance for loan and lease losses is increased through the provision for loan and lease losses and reduced by net charge-offs. The provision for loan and lease losses, which is charged to earnings, reflects credit losses we believe have been incurred and will eventually be reflected over time in our charge-offs. Charge-offs of uncollectible amounts are deducted from the allowance and subsequent recoveries are added.

Table 18, which displays changes in our allowance for loan and lease losses for the three and six months ended June 30, 2011 and 2010, details, by loan type, the provision for credit losses recognized in our consolidated statements of income each period and the charge-offs recorded against our allowance for loan and lease losses.

 

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Table 18: Allowance for Loan and Lease Losses Activity

 

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

(Dollars in millions)

       2011             2010         2011     2010  

Balance at beginning of period, as reported

   $ 5,067      $ 7,752      $ 5,628      $ 4,127   

Impact from January 1, 2010 adoption of new consolidation accounting

     0        53        0        4,316   
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance at beginning of period, as adjusted

   $ 5,067      $ 7,805      $ 5,628      $ 8,443   

Provision for loan and lease losses(1)(2)

     350        723        920        2,201   

Charge-offs:

        

Credit Card business:(2)

        

Domestic credit card and installment loans

     (905     (1,607     (1,997     (3,414

International credit card and installment loans

     (205     (195     (398     (408
  

 

 

   

 

 

   

 

 

   

 

 

 

Total credit card

     (1,110     (1,802     (2,395     (3,822
  

 

 

   

 

 

   

 

 

   

 

 

 

Consumer Banking business:

        

Auto

     (102     (150     (243     (343

Home loan

     (22     (16     (54     (53

Retail banking

     (25     (32     (55     (65
  

 

 

   

 

 

   

 

 

   

 

 

 

Total consumer banking

     (149     (198     (352     (461
  

 

 

   

 

 

   

 

 

   

 

 

 

Commercial Banking business:

        

Commercial and multifamily real estate

     (15     (52     (39     (102

Middle market

     (9     (22     (14     (45

Specialty lending

     (6     (9     (11     (18
  

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial lending

     (30     (83     (64     (165

Small-ticket commercial real estate

     (20     (23     (53     (47
  

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial banking

     (50     (106     (117     (212
  

 

 

   

 

 

   

 

 

   

 

 

 

Other loans

     (13     (36     (38     (66
  

 

 

   

 

 

   

 

 

   

 

 

 

Total charge-offs

     (1,322     (2,142     (2,902     (4,561
  

 

 

   

 

 

   

 

 

   

 

 

 

Recoveries:

        

Credit Card business:

        

Domestic credit card and installment loans

     267        299        555        586   

International credit card and installment loans

     50        40        118        80   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total credit card

     317        339        673        666   
  

 

 

   

 

 

   

 

 

   

 

 

 

Consumer Banking business:

        

Automobile

     50        60        102        120   

Home loans

     5        1        16        2   

Retail banking

     6        6        13        13   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total consumer banking

     61        67        131        135   
  

 

 

   

 

 

   

 

 

   

 

 

 

Commercial Banking business:

        

Commercial and multifamily real estate

     2        13        7        13   

Middle market

     5        1        6        4   

Specialty lending

     1        1        3        2   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial lending

     8        15        16        19   

Small-ticket commercial real estate

     4        1        4        2   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial banking

     12        16        20        21   

Other loans

     1        3        2        4   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total recoveries

     391        425        826        826   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net charge-offs

     (931     (1,717     (2,076     (3,735

Impact from loan sales and other changes

     2 (3)      (12 )(4)      16 (3)      (110 )(4) 
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance at end of period(2)

   $ 4,488      $ 6,799      $ 4,488      $ 6,799   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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(1)

Excludes negative provision for unfunded lending commitments of $7 million and $4 million for the three months ended June 30, 2011 and 2010, respectively, and $43 million for the six months ended June 30, 2011, and a provision of $17 million for the six months ended June 30, 2010.

(2) 

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

(3) 

Includes foreign translation adjustment of $2 million and $16 million for the second quarter and first six months of 2011, respectively.

(4) 

Includes a reduction in our allowance for loan and lease losses of $73 million first quarter of 2010 attributable to the sale of certain interest-only option-ARM bonds and the deconsolidation of the related securitization trusts related to Chevy Chase Bank in the first quarter of 2010.

Table 19 presents an allocation of our allowance for loan and lease losses by loan category as of June 30, 2011 and December 31, 2010:

Table 19: Allocation of the Allowance for Loan and Lease Losses

 

     June 30, 2011     December 31, 2010  

(Dollars in millions)

   Amount      % of  Total
Loans(1)
    Amount      % of  Total
Loans(1)
 

Credit Card:

          

Domestic credit card and installment loans(2)

   $ 2,555         4.73   $ 3,581         6.65

International credit card and installment loans

     538         6.18        460         6.12   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total credit card(2)

     3,093         4.93        4,041         6.58   
  

 

 

    

 

 

   

 

 

    

 

 

 

Consumer Banking:

          

Auto

     322         1.68        353         1.98   

Home loan

     90         0.79        112         0.93   

Retail banking

     186         4.60        210         4.76   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total consumer banking

     598         1.73        675         1.96   
  

 

 

    

 

 

   

 

 

    

 

 

 

Commercial Banking:

          

Commercial and multifamily real estate

     422         3.00        495         3.70   

Middle market

     124         1.09        162         1.55   

Specialty lending

     75         1.82        91         2.26   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total commercial lending

     621         2.10        748         2.68   

Small-ticket commercial real estate

     109         6.64        78         4.23   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total commercial banking

     730         2.34        826         2.78   
  

 

 

    

 

 

   

 

 

    

 

 

 

Other loans

     67         14.41        86         19.07   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total(2)

   $ 4,488         3.48   $ 5,628         4.47
  

 

 

    

 

 

   

 

 

    

 

 

 

Total allowance coverage ratios:

          

Period-end loans

   $ 128,965         3.48   $ 125,947         4.47

Nonperforming loans(3)

     1,164         385.57        1,225         459.43   

Allowance coverage ratios by loan category:

          

Credit card (30 + day delinquent loans)

   $ 2,260         136.86   $ 2,632         153.53

Consumer banking (30 + day delinquent loans)

     1,819         32.88        2,050         32.93   

Commercial banking (nonperforming loans)

     481         151.77        495         166.87   

 

(1) 

Calculated based on the allowance for loan and lease losses attributable to each loan category divided by the outstanding balance of loans within the specified loan category.

(2)

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

 

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(3) 

As permitted by regulatory guidance issued by the FFIEC, our policy is generally not to classify credit card loans as nonperforming. We accrue interest on credit card loans through the date of charge-off, typically in the period that the loan becomes 180 days past due. The allowance for loan and lease losses as a percentage of nonperforming loans, excluding the allowance related to our credit card loans, was 119.85% as of June 30, 2011 and 129.55% as of December 31, 2010.

Our allowance for loan and lease losses decreased by $1.1 billion during the first six months of 2011 to $4.5 billion. The decrease in our allowance reflected the continued improvement in credit performance trends across our portfolios as a result of the slowly improving economy coupled with actions we have taken over the past several years to tighten our underwriting standards and exit certain portfolios. Our allowance as a percentage of our total loan portfolio also decreased to 3.48% as of June 30, 2011, from 4.47% as of December 31, 2010.

Deposits

Our deposits have become our largest source of funding for our operations and asset growth. Total deposits increased by $3.9 billion, or 3%, in the first six months of 2011, to $126.1 billion as of June 30, 2011. The increase in deposits was primarily driven by increases of $4.1 billion, $1.8 billion, and $1.3 billion in savings accounts, non-interest bearing deposits, and money market deposits, respectively, which was partially offset by a decrease of $1.9 billion in other consumer time deposits, a $692 million decrease in NOW accounts and a $586 million decrease in certificates of deposit of $100,000 or more, reflecting our shift to more relationship driven, lower cost liquid savings and transaction accounts. We provide additional information on deposits, including the composition of our deposits, average outstanding balances, interest expense and yield, below in “Liquidity and Funding.”

Senior and Subordinated Notes and Other Borrowings

Senior and subordinated notes and other borrowings increased to $17.9 billion as of June 30, 2011, from $14.9 billion as of December 31, 2010. The increase was primarily attributable to an increase in FHLB advances of $1.9 billion and an increase in federal funds purchased and securities loaned or sold under agreements to repurchase of $1.1 billion. We provide additional information on our borrowings in “Note 9—Deposits and Borrowings.”

Securitized Debt Obligations

Borrowings owed to securitization investors decreased by $7.1 billion to $19.9 billion as of June 30, 2011, from $26.9 billion as of December 31, 2010. This decrease was attributable to pay downs and charge-offs of the loans underlying the consolidated securitization trusts.

Potential Mortgage Representation & Warranty Liabilities

In recent years, we acquired three subsidiaries that originated residential mortgage loans and sold them to various purchasers, including purchasers who created securitization trusts. These subsidiaries are Capital One Home Loans, which was acquired in February 2005; GreenPoint Mortgage Funding, Inc. (“GreenPoint”), which was acquired in December 2006 as part of the North Fork acquisition; and Chevy Chase Bank, which was acquired in February 2009 and subsequently merged into CONA.

In connection with their sales of mortgage loans, the subsidiaries entered into agreements containing varying representations and warranties about, among other things, the ownership of the loan, the validity of the lien securing the loan, the loan’s compliance with any applicable loan criteria established by the purchaser, including underwriting guidelines and the ongoing existence of mortgage insurance, and the loan’s compliance with applicable federal, state and local laws. The representations and warranties do not address the credit performance of the mortgage loans, but mortgage loan performance often influences whether a claim for breach of representation and warranty will be asserted and has an effect on the amount of any loss in the event of a breach of a representation or warranty.

 

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Each of these subsidiaries may be required to repurchase mortgage loans in the event of certain breaches of these representations and warranties. In the event of a repurchase, the subsidiary is typically required to pay the then unpaid principal balance of the loan together with interest and certain expenses (including, in certain cases, legal costs incurred by the purchaser and/or others). The subsidiary then recovers the loan or, if the loan has been foreclosed, the underlying collateral. The subsidiary is exposed to any losses on the repurchased loans after giving effect to any recoveries on the collateral. In some instances, rather than repurchase the loans, a subsidiary may agree to make a cash payment to make an investor whole on losses or to settle repurchase claims. In addition, our subsidiaries may be required to indemnify certain purchasers and others against losses they incur as a result of certain breaches of representations and warranties. In some cases, the amount of such losses could exceed the repurchase amount of the related loans.

These subsidiaries, in total, originated and sold to non-affiliates approximately $111 billion original principal balance of mortgage loans between 2005 and 2008, which are the years (or “vintages”) with respect to which our subsidiaries have received the vast majority of the repurchase requests and other related claims.

Table 20 presents the original principal balance of mortgage loan originations, by vintage, for the three general categories of purchasers of mortgage loans and the outstanding principal balance as of June 30, 2011 and December 31, 2010:

Table 20: Unpaid Principal Balance of Mortgage Loans Originated and Sold to Third Parties Based on Category of Purchaser

 

     Unpaid Principal Balance                                     
      June 30,
2011
     December 31,
2010
     Original Unpaid Principal Balance  

(Dollars in billions)

         Total      2008      2007      2006      2005  

Government sponsored enterprises (“GSEs”)(1)

   $ 5       $ 5       $ 11       $ 1       $ 4       $ 3       $ 3   

Insured Securitizations

     7         7         18         —           1         8         9   

Uninsured Securitizations and Other

     29         33         82         3         16         30         33   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 41       $ 45       $ 111       $ 4       $ 21       $ 41       $ 45   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) 

GSEs include Fannie Mae and Freddie Mac.

Between 2005 and 2008, our subsidiaries sold an aggregate amount of $11 billion in original principal balance mortgage loans to the GSEs.

Of the $18 billion in original principal balance of mortgage loans sold directly by our subsidiaries to private-label purchasers who placed the loans into securitizations supported by bond insurance (“Insured Securitizations”), approximately $13 billion original principal balance was placed in securitizations as to which the monoline bond insurers have made repurchase requests or loan file requests to one of our subsidiaries (“Active Insured Securitizations”), and the remaining approximately $5 billion original principal balance was placed in securitizations as to which the monoline bond insurers have not made repurchase requests or loan file requests to one of our subsidiaries (“Inactive Insured Securitizations”). Insured Securitizations often allow the monoline bond insurer to act independently of the investors. Bond insurers typically have indemnity agreements directly with both the mortgage originators and the securitizers, and they often have super-majority rights within the trust documentation that allow them to direct trustees to pursue mortgage repurchase requests without coordination with other investors.

Because we do not service most of the loans our subsidiaries sold to others, we do not have complete information about the current ownership of the $82 billion in original principal balance of mortgage loans not sold directly to GSEs or placed in Insured Securitizations. We have determined from third-party databases that about $39 billion original principal balance of these mortgage loans are currently held by private-label publicly issued

 

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securitizations not supported by bond insurance (“Uninsured Securitizations”). In contrast with the bond insurers in Insured Securitizations, investors in Uninsured Securitizations often face a number of legal and logistical hurdles before they can direct a securitization trustee to pursue mortgage repurchases, including the need to coordinate with a certain percentage of investors holding the securities and to indemnify the trustee for any litigation it undertakes. An additional approximately $30 billion original principal balance of mortgage loans were initially sold to private investors as whole loans. Of this amount, we believe approximately $10 billion original principal balance of mortgage loans were ultimately purchased by GSEs. For purposes of our reserves-setting process, we consider these loans to be private-label loans rather than GSE loans. We do not have information about the current holders or disposition of the remaining $13 billion original principal balance of mortgage loans in this category.

With respect to the $111 billion in original principal balance of mortgage loans originated and sold to others between 2005 and 2008, we estimate that approximately $41 billion in unpaid principal balance remains outstanding as of June 30, 2011, approximately $14 billion in losses have been realized and approximately $13 billion in unpaid principal balance is at least 90 days delinquent. Because we do not service most of the loans we sold to others, we do not have complete information about the underlying credit performance levels for some of these mortgage loans. These amounts reflect our best estimates, including extrapolations where necessary. These extrapolations occur on the approximately $13 billion original principal balance of mortgage loans for which we do not have information about the current holders or any underlying credit performance. These estimates could change as we get additional data or refine our analysis.

The subsidiaries had open repurchase requests relating to approximately $1.7 billion original principal balance of mortgage loans as of June 30, 2011, compared with $1.6 billion as of December 31, 2010. As of June 30, 2011, the vast majority of new repurchase demands received over the last year and, as discussed below, almost all of our $869 million reserve relates to the $24 billion of original principal balance of mortgage loans originally sold to the GSEs or to Active Insured Securitizations. Currently, repurchase demands predominantly relate to the 2006 and 2007 vintages. We have received relatively few repurchase demands from the 2008 and 2009 vintages, mostly because GreenPoint ceased originating mortgages in August 2007.

Table 21 presents information on pending repurchase requests by counterparty category and timing of initial repurchase request. The amounts presented are based on original loan principal balances.

Table 21: Open Pipeline All Vintages (all entities)(1)

 

(Dollars in millions)

   GSEs     Insured
Securitizations
    Uninsured
Securitizations
and Other
    Total  

Open claims as of December 31, 2009

   $ 61      $ 366      $ 588      $ 1,015   

Gross new demands received

     204        645        104        953   

Loans repurchased/made whole(2)

     (52     (179     (5     (236

Demands rescinded(2)

     (87     —          (22     (109
  

 

 

   

 

 

   

 

 

   

 

 

 

Open claims as of December 31, 2010

   $ 126      $ 832      $ 665      $ 1,623   

Gross new demands received

     88        96        43        227   

Loans repurchased/made whole

     (40     0        (8     (48

Demands rescinded

     (47     0        (9     (56

Reclassifications(3)

     (5     64        (59     —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Open claims as of June 30, 2011

   $ 122      $ 992      $ 632      $ 1,746   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) 

The open pipeline includes all repurchase requests ever received by our subsidiaries where the requesting party has not formally rescinded the repurchase request and where our subsidiary has not agreed to either repurchase the loan at issue or make the requesting party whole with respect to its losses. Accordingly, repurchase requests denied by our subsidiaries and not pursued by the counterparty remain in the open pipeline. Moreover, repurchase requests submitted

 

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  by parties without contractual standing to pursue repurchase requests are included within the open pipeline unless the requesting party has formally rescinded its repurchase request. Finally, the amounts reflected in this chart are original principal balance amounts and do not correspond to the losses our subsidiary would incur upon the repurchase of these loans.
(2) 

Activity in 2010 relates to repurchase demands from all years prior.

(3) 

Represents adjustments to correct the counterparty category as of December 31, 2010 for amounts that were misclassified. The reclassification had no impact on the total pending repurchase requests; however, it resulted in an increase in open claims attributable to insured securitizations and a decrease in open claims attributable to GSEs and Uninsured Securitizations & Other.

We have established representation and warranty reserves for losses associated with the mortgage loans sold by each subsidiary that we consider to be both probable and reasonably estimable, including both litigation and non-litigation liabilities. These reserves are reported in our consolidated balance sheets as a component of other liabilities. The reserve setting process relies heavily on estimates, which are inherently uncertain, and requires the application of judgment. We evaluate these estimates on a quarterly basis. We build our representation and warranty reserves through the provision for repurchase losses, which we report in our consolidated statements of income as a component of non-interest income for loans originated and sold by Chevy Chase Bank and Capital One Home Loans and as a component of discontinued operations for loans originated and sold by GreenPoint. In establishing the representation and warranty reserves, we consider a variety of factors depending on the category of purchaser.

In establishing reserves for the $11 billion original principal balance of GSE loans, we rely on the historical relationship between GSE loan losses and repurchase outcomes to estimate: (1) the percentage of current and future GSE loan defaults that we anticipate will result in repurchase requests from the GSEs over the lifetime of the GSE loans; and (2) the percentage of those repurchase requests that we anticipate will result in actual repurchases. We also rely on estimated collateral valuations and loss forecast models to estimate our lifetime liability on GSE loans. This reserving approach to the GSE loans reflects the historical interaction with the GSEs around repurchase requests, and also includes anticipated repurchases resulting from mortgage insurance rescissions. The GSEs typically have stronger contractual rights than non-GSE counterparties because GSE contracts typically do not contain prompt notice requirements for repurchase requests or materiality qualifications to the representations and warranties. Moreover, although we often disagree with the GSEs about the validity of their repurchase requests, we have established a negotiation pattern whereby the GSEs and our subsidiaries continually negotiate around individual repurchase requests, leading to the GSEs rescinding some repurchase requests and our subsidiaries agreeing in some cases to repurchase some loans or make the GSEs whole with respect to losses. Our lifetime representation and warranty reserves with respect to GSE loans are grounded in this history.

For the $13 billion original principal balance in Active Insured Securitizations, our reserving approach also reflects our historical interaction with monoline bond insurers around repurchase requests. Typically, monoline bond insurers allege a very high repurchase rate with respect to the mortgage loans in the Active Insured Securitization category. In response to these repurchase requests, our subsidiaries typically request information from the monoline bond insurers demonstrating that the contractual requirements around a valid repurchase request have been satisfied, such as, for example, the typical requirements that the counterparty promptly notify us upon discovery of any breach and that any breach materially and adversely affect the value of the mortgage loan at issue. In response to these requests for supporting documentation, monoline bond insurers typically initiate litigation. Accordingly, our reserves within the Active Insured Securitization are not based upon the historical repurchase rate with monoline bond insurers, but rather upon the expected resolution of litigation with the monoline bond insurers. Every bond insurer within this category is pursuing a substantially similar litigation strategy either through active or probable litigation. Accordingly, our representation and warranty reserves for this category are litigation reserves. In establishing litigation reserves for this category, we consider current and

 

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future losses inherent within the securitization and apply legal judgment to the anticipated factual and legal record to estimate the lifetime legal liability for each securitization. Our estimated legal liability for each securitization within this category assumes that we will be responsible for only a portion of the losses inherent in each securitization. Our litigation reserves with respect to both the U.S. Bank Lawsuit and the DBSP Lawsuit, in each case as referenced below, are contained within the Active Insured Securitization reserve category. Further, our litigation reserves with respect to indemnification risks from certain representation and warranty lawsuits brought by monoline bond insurers against third-party securitizations sponsors, where GreenPoint provided some or all of the mortgage collateral within the securitization but is not a defendant in the litigation, are also contained within this category. Our estimated legal liability for each securitization within this category assumes we will pay only a portion of the liabilities ultimately incurred by the party defendants to the litigation.

For the $5 billion original principal balance of mortgage loans in the Inactive Insured Securitizations category and the $82 billion original principal balance of mortgage loans in the Uninsured Securitizations and other whole loan sales categories, we establish reserves by relying on our historical repurchase rates and current negotiation patterns to estimate repurchase liabilities over the next twelve (12) months. We do not believe we can estimate repurchase liability for these categories for a period longer than twelve (12) months because of the relatively irregular nature of repurchase activity within these categories. Some Uninsured Securitization investors from this category who have not made repurchase requests or filed representation and warranty lawsuits have filed actions under federal and/or state securities laws against investment banks and securitization sponsors. Although we face some direct and indirect indemnity risks from these litigations, we have not established reserves with respect to these indemnity risks because we do not consider them to be both probable and reasonably estimable liabilities.

The aggregate reserve for all three subsidiaries was $869 million as of June 30, 2011, compared with $846 million as of March 31, 2011, and with $816 million as of December 31, 2010. Almost all of the increase in the reserve from March 31, 2011 is allocated to the Uninsured Securitizations and Other category, as reflected in Table 23, resulting from an increase in repurchase activity with respect to certain whole loan investors. We recorded a total provision for repurchase losses for our representation and warranty repurchase exposure of $37 million and $81 million for the three and six months ended June 30, 2011, respectively, and we had settlements of repurchase requests of $14 million and $28 million for the three and six months ended June 30, 2011, respectively, that were charged against the reserve.

Table 22 summarizes changes in our representation and warranty reserve for the three and six months ended June 30, 2011 and 2010, and for full year 2010.

Table 22: Changes in Representation and Warranty Reserve

 

     Three Months Ended
June  30,
    Six Months Ended
June  30,
    Full Year  

(Dollars in millions)

       2011             2010             2011             2010         2010  

Representation and warranty repurchase reserve, beginning of period(1)

   $ 846      $ 454      $ 816      $ 238      $ 238   

Provision for repurchase losses(2)

     37        404        81        628        636   

Net realized losses

     (14     (5     (28     (13     (58
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Representation and warranty repurchase reserve, end of period(1)

   $ 869      $ 853      $ 869      $ 853      $ 816   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) 

Reported in our consolidated balance sheets as a component of other liabilities.

(2) 

The portion of the provision for mortgage repurchase claims recognized in our consolidated statements of income as a component of non-interest income totaled $4 million and $9 million for the three and six months ended June 30, 2011, respectively, and $95 million and $195 million for the three and six months ended June 30, 2010, respectively. The pre-tax portion of the provision for mortgage repurchase claims recognized in our consolidated statements of income as a component of discontinued operations totaled $33 million and $72 million, for the three and six months ended June 30, 2011, respectively, and $309 million and $433 million for the three and six months ended June 30, 2010, respectively.

 

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As indicated in Table 23 below, substantially all of the representation and warranty reserve relates to the $11 billion in original principal balance of mortgage loans sold directly to the GSEs and to the $13 billion in mortgage loans sold to purchasers who placed them into Active Insured Securitizations.

Table 23: Allocation of Representation and Warranty Reserve

 

     Reserve Liability         

(Dollars in millions, except for loans sold)

   June 30,
2011
     December 31,
2010
     Loans Sold
2005 to 2008(1)
 

GSEs and Active Insured Securitizations

   $ 794       $ 796       $ 24   

Inactive Insured Securitizations, Uninsured Securitizations and Other

     75         20         87   
  

 

 

    

 

 

    

 

 

 

Total

   $ 869       $ 816       $ 111   
  

 

 

    

 

 

    

 

 

 

 

(1) 

Reflects, in billions, the total original principal balance of mortgage loans originated by our subsidiaries and sold to third party investors between 2005 and 2008.

The adequacy of the reserves and the ultimate amount of losses incurred by our subsidiaries will depend on, among other things, actual future mortgage loan performance, the actual level of future repurchase and indemnification requests (including the extent, if any, to which Inactive Insured Securitizations and other currently inactive investors ultimately assert claims), the actual success rates of claimants, developments in litigation, actual recoveries on the collateral and macroeconomic conditions (including unemployment levels and housing prices).

As part of our business planning processes, we have considered various outcomes relating to the potential future representation and warranty liabilities of our subsidiaries that are possible but do not rise to the level of being both probable and reasonably estimable outcomes that would justify an incremental accrual under applicable accounting standards. We believe that the upper end of the reasonably possible future losses from representation and warranty claims beyond the current accrual levels, including reasonably possible future losses relating to the US Bank Litigation and DBSP Litigation, could be as high as $1.1 billion. Notwithstanding our attempt to estimate a reasonably possible amount of loss beyond our current accrual levels based on current information, it is possible that actual future losses will exceed both the current accrual level and the amount of reasonably possible losses estimated here. There is still significant uncertainty as to numerous factors that contribute to ultimate liability levels, including, but not limited to, litigation outcomes, future repurchase claims levels, ultimate repurchase success rates and mortgage loan performance levels.

Also see representation and warranty liabilities and litigation claims in “Note 15—Commitments, Contingencies and Guarantees.”

 

 

OFF-BALANCE SHEET ARRANGEMENTS AND VARIABLE INTEREST ENTITIES

 

In the ordinary course of business, we are involved in various types of arrangements with limited liability companies, partnerships or trusts that often involve special purpose entities and variable interest entities (“VIEs”). Some of these arrangements are not recorded on our consolidated balance sheets or may be recorded in amounts different from the full contract or notional amount of the arrangements, depending on the nature or structure of, and accounting required to be applied to, the arrangement. These arrangements may expose us to potential losses in excess of the amounts recorded in the consolidated balance sheets. Our involvement in these arrangements can take many forms, including securitization and servicing activities, the purchase or sale of mortgage-backed or other asset-backed securities in connection with our home loan portfolio and loans to VIEs that hold debt, equity, real estate or other assets. Under previous accounting guidance, we were not required to consolidate the majority of our securitization trusts because they were qualified special purpose entities. Accordingly, we considered these trusts to be off-balance sheet arrangements.

 

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Our continuing involvement in unconsolidated VIEs primarily consists of certain mortgage loan trusts and community reinvestment and development entities. The carrying amount of assets and liabilities of these unconsolidated VIEs was $2.0 billion and $236 million, respectively, as of June 30, 2011, and our maximum exposure to loss was $2.0 billion. We provide a discussion of our activities related to these VIEs in “Note 7—Variable Interest Entities and Securitizations.”

 

 

RISK MANAGEMENT

 

Our business activities expose us to eight major categories of risks: liquidity risk, credit risk, reputational risk, market risk, strategic risk, operational risk, compliance risk and legal risk. Our risk management framework is intended to identify, assess and mitigate risks that affect or have the potential to affect our business in order to target financial returns commensurate with our risk appetite and to avoid excessive risk-taking. We follow four key risk management principles:

 

   

Individual businesses take and manage risk in pursuit of strategic, financial and other business objectives.

 

   

Independent risk management organizations support individual businesses by providing risk management tools and policies and by aggregating risks; in some cases, risks are managed centrally.

 

   

The Board of Directors and senior management review our aggregate risk position, establish the risk appetite and work with management to ensure conformance to policy and adherence to our adopted mitigation strategy.

 

   

We employ a top risk identification system to maintain the appropriate focus on the risks and issues that may have the most impact and to identify emerging risks of consequence.

 

 

LIQUIDITY AND CAPITAL MANAGEMENT

 

Liquidity

We have established liquidity guidelines that are intended to ensure that we have sufficient asset-based liquidity to withstand the potential impact of deposit attrition or diminished liquidity in the funding markets. Our guidelines include maintaining an adequate liquidity reserve to cover our potential funding requirements and diversified funding sources to avoid over-dependence on volatile, less reliable funding markets. Our liquidity reserves consist of cash and cash equivalents, unencumbered available-for-sale securities and undrawn committed securitization borrowing facilities. Table 24 below presents the composition of our liquidity reserves as of June 30, 2011 and December 31, 2010.

Table 24: Liquidity Reserves

 

(Dollars in millions)

   June 30,
2011
    December 31,
2010
 

Cash and cash equivalents

   $ 6,643      $ 5,249   

Securities available-for-sale(1)

     39,474        41,537   

Less: Pledged available-for-sale securities

     (10,717     (9,963
  

 

 

   

 

 

 

Unencumbered available-for-sale securities

     28,757        31,574   

Undrawn committed securitization borrowing facilities

     —          207   
  

 

 

   

 

 

 

Total liquidity reserves

   $ 35,400      $ 37,030   
  

 

 

   

 

 

 

 

(1) 

The weighted average life of our available-for-sale securities was approximately 3.7 years and 3.8 years as of June 30, 2011, and December 31, 2010, respectively.

 

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Funding

Our funding objective is to establish an appropriate maturity profile using a cost-effective mix of both short-term and long-term funds. We use a variety of funding sources, including deposits, loan securitizations, debt and equity securities, securitization borrowing facilities and FHLB advances.

Deposits

Our deposits provide a stable and relatively low cost of funds and have become our largest source of funding. We have expanded our opportunities for deposit growth through direct and indirect marketing channels, our existing branch network and branch expansion. These channels offer a broad set of deposit products that include demand deposits, money market deposits, negotiable order of withdrawal (“NOW”) accounts, savings accounts and certificates of deposit. Table 25 presents the composition of our deposits by type as of June 30, 2011 and December 31, 2010. Total deposits increased by $3.9 billion, or 3.2%, in the first six months of 2011, to $126.1 billion as of June 30, 2011, from $122.2 billion as of December 31, 2010.

Table 25: Deposits

 

(Dollars in millions)

   June 30,
2011
     December 31,
2010
 

Non-interest bearing

   $ 16,839       $ 15,048   

NOW accounts

     12,844         13,536   

Money market deposit accounts

     45,822         44,485   

Savings accounts

     30,218         26,077   

Other consumer time deposits

     13,807         15,753   
  

 

 

    

 

 

 

Total core deposits

     119,530         114,899   

Public fund certificates of deposit $100,000 or more

     104         177   

Certificates of deposit $100,000 or more

     5,714         6,300   

Foreign time deposits

     769         834   
  

 

 

    

 

 

 

Total deposits

   $ 126,117       $ 122,210   
  

 

 

    

 

 

 

Of our total deposits, $769 million and $834 million were held in foreign banking offices as of June 30, 2011 and December 31, 2010, respectively. Large domestic denomination certificates of deposits of $100,000 or more represented $5.8 billion and $6.5 billion of our total deposits as of June 30, 2011 and December 31, 2010, respectively. Our funding and liquidity strategy takes into consideration the scheduled maturities of large denomination time deposits. Of the $5.8 billion in large domestic denomination certificates of deposit as of June 30, 2011, $1.0 billion is scheduled to mature within the next three months, $1.7 billion is scheduled to mature between three and 12 months and $3.1 billion is scheduled to mature over 12 months. Based on past activity, we expect to retain a portion of these deposits as they mature.

We have brokered deposits, which we obtained through the use of third-party intermediaries. Brokered deposits are included in money market deposit accounts and other consumer time deposits in Table 25 above. The Federal Deposit Insurance Corporation Improvement Act of 1991 limits the use of brokered deposits to “well capitalized” insured depository institutions and, with a waiver from the Federal Deposit Insurance Corporation, to “adequately capitalized” institutions. COBNA and CONA were “well capitalized,” as defined under the federal banking regulatory guidelines, as of June 30, 2011, and therefore permitted to maintain brokered deposits. Our brokered deposits totaled $14.3 billion, or 11%, of total deposits as of June 30, 2011. Brokered deposits totaled $16.5 billion, or 14%, of total deposits as of December 31, 2010. Based on our historical access to the brokered deposit market, we expect to replace maturing brokered deposits with new brokered deposits or direct deposits and branch deposits.

 

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Other Funding Sources

We also access the capital markets to meet our funding needs through loan securitization transactions and the issuance of senior and subordinated debt. In addition, we utilize advances from the FHLB that are secured by our investment securities, residential home loan portfolio, multifamily loans, commercial real estate loans and home equity lines of credit for our funding needs.

Our debt, including federal funds purchased and securities loaned or sold under agreements to repurchase, senior and subordinated notes and other borrowings, such as FHLB advances, but excluding securitized debt obligations, totaled $17.9 billion as of June 30, 2011, up from $14.9 billion as of December 31, 2010. We had no open committed loan securitization conduit lines as of June 30, 2011.

The $3.0 billion increase in our debt, excluding securitized debt obligations, was primarily attributable to a $1.1 billion increase in federal funds purchased and securities loaned or sold under agreements to repurchase and a $1.9 billion increase in FHLB advances. We participate in the federal funds market daily to take advantage of attractive offers and to keep a visible presence in the market, which is designed to ensure that we are able to access it in a time of need. Monthly fluctuations will be regular, as the amount we can borrow is highly dependent on our counterparties’ cash positions. There was more liquidity available in the market as of June 30, 2011, as compared to December 31, 2010, and we were able to borrow more using our typical borrowing strategies. We did not issue any senior or subordinated debt during the first six months of 2011. Our FHLB membership is secured by our investment in FHLB stock, which totaled $230 million as of June 30, 2011.

Table 26 presents our short-term borrowings and long-term debt and the maturity profile based on expected maturities as of June 30, 2011. We provide additional information on our short-term borrowings and long-term debt in “Note 9—Deposits and Borrowings.”

Table 26: Expected Maturity Profile of Short-term Borrowings and Long-term Debt

 

(Dollars in millions)

   Up to 1
Year
    > 1 Year
to 2 Years
    > 2 Years
to 3 Years
    > 3 Years
to 4 Years
    > 4 Years
To 5 Years
    > 5 Years     Total  

Short-term borrowings:

              

Federal funds purchased and securities loaned or sold under agreements to repurchase

   $ 2,575      $ —        $ —        $ —        $ —        $ —        $ 2,575   

FHLB advances

     1,865        —          —          —          —          —          1,865   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total short-term borrowings

     4,440        —          —          —          —          —          4,440   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Long-term debt:(1)

              

Securitized debt obligations

     6,055        4,205        3,554        390        892        4,764        19,860   

Senior and subordinated notes:

              

Unsecured senior debt

     1,150        —          1,623        405        —          1,705        4,883   

Unsecured subordinated debt

     —          887        106        —          —          2,788        3,781   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total senior and subordinated notes

     1,150        887        1,729        405        —          4,493        8,664   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other long-term borrowings:

              

Junior subordinated debt

     —          —          —          —          —          3,642        3,642   

FHLB advances

     78        14        30        941        9        57        1,129   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other long-term borrowings

     78        14        30        941        9        3,699        4,771   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total long-term debt(2)

     7,283        5,106        5,313        1,736        901        12,956        33,295   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total short-term borrowings and long-term debt

   $ 11,723      $ 5,106      $ 5,313      $ 1,736      $ 901      $ 12,956      $ 37,735   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Percentage of total short

     31     14     14     5     2     34     100
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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(1) 

Includes fair value adjustments of $591 million as of June 30, 2011.

(2) 

Includes unamortized net discount of $20 million as of June 30, 2011.

ING Direct Acquisition

In June 2011, we entered into a definitive agreement under which we will acquire ING Direct. On July 19, 2011, we closed a public underwritten offering of 40,000,000 shares of our common stock, subject to forward sale agreements, and we closed a public offering of our senior notes for total proceeds of approximately $3.0 billion. Each of these offerings is described in more detail under “Executive Summary and Business Outlook—Recent Acquisitions and Related Developments—Equity and Debt Offerings” in this Report. We expect to use the net proceeds of these offerings, along with cash sourced from current liquidity, to fund the $6.2 billion in cash consideration payable in connection with the ING Direct acquisition. We expect the ING Direct acquisition to close in late 2011 or early 2012, subject to customary closing conditions, including certain governmental clearances and approvals.

Borrowing Capacity

As of June 30, 2011, we had an effective shelf registration statement filed with the U.S. Securities & Exchange Commission (“SEC”) under which, from time to time, we may offer and sell an indeterminate aggregate amount of senior or subordinated debt securities, preferred stock, depository shares representing preferred stock, common stock, purchase contracts, warrants, units, trust preferred securities, junior subordinated debt securities, guarantees of trust preferred securities and certain back-up obligations. There is no limit under this shelf registration statement to the amount or number of such securities that we may offer and sell. Under SEC rules, the shelf registration statement, which we filed in May 2009, expires three years after filing. We did not issue any senior or subordinated debt during the first six months of 2011.

In addition to issuance capacity under the shelf registration statement, we have access to other borrowing programs. Table 27 summarizes our borrowing capacity as of June 30, 2011. The committed securitization conduits terminated in April 2011, and as a result, we had no conduit capacity as of June 30, 2011. We do not expect to renew the securitization conduits.

Table 27: Borrowing Capacity

 

(Dollars or dollar equivalents in millions)

   Capacity(1)      Outstanding      Availability(1)      Termination  Date(2)  

FHLB advances and letters of credit(3)

   $ 8,881       $ 3,231       $ 5,650           

Committed securitization conduits

             448                 4/2011   

 

(1) 

All funding sources are non-revolving. Funding availability under all other sources is subject to market conditions. Capacity is the maximum amount that can be borrowed. Availability is the amount that can still be borrowed against the facility.

(2) 

Refers to the date the facility terminates, where applicable.

(3) 

The ability to draw down funding is based on membership status, and the amount is dependent upon the Banks’ ability to post collateral.

Credit Ratings

Rating agencies base their ratings on numerous factors, including liquidity, capital adequacy, asset quality and quality of earnings. Significant changes in these factors could result in different ratings. Such ratings help to support our cost effective unsecured funding as part of our overall financing programs. Table 28 provides a summary of the credit ratings for the senior unsecured debt of Capital One Financial Corporation, COBNA and CONA as of June 30, 2011.

 

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Table 28: Senior Unsecured Debt Credit Ratings

 

     As of June 30, 2011  

(Dollars or dollar equivalents in millions)

   Capital One
Financial Corporation
    Capital One Bank
(USA), N.A.
    Capital One, N.A.  

Moody’s Investor Services (“Moody’s”)

     Baa1        A3        A3   

Standard & Poor’s (“S&P”)

     BBB        BBB+        BBB+   

Fitch Ratings (“Fitch”)

     A-        A-        A-   

Dominion Bond Rating Services (“DBRS”)

     BBB **      A     A

 

* low
** high

As of July 31, 2011, Fitch and DBRS had us on a stable outlook. As of July 31, 2011, Moody’s has Capital One under review of a possible downgrade while S&P has Capital One on negative outlook.

Capital

The level and composition of our equity capital are determined by multiple factors, including our consolidated regulatory capital requirements and an internal risk-based capital assessment, and may also be influenced by rating agency guidelines, subsidiary capital requirements, the business environment, conditions in the financial markets and assessments of potential future losses due to adverse changes in our business and market environments.

Capital Standards and Prompt Corrective Action

Bank holding companies and national banks are subject to capital adequacy standards adopted by the Federal Reserve and the Office of the Comptroller of the Currency (“OCC”), respectively. The capital adequacy standards set forth minimum risk-based and leverage capital requirements that are based on quantitative and qualitative measures of their assets and off-balance sheet items. Under the capital adequacy standards, bank holding companies and banks currently are required to maintain a Tier 1 risk-based capital ratio of at least 4%, a total risk-based capital ratio of at least 8%, and a Tier 1 leverage capital ratio of at least 4% (3% for banks that meet certain specified criteria, including excellent asset quality, high liquidity, low interest rate exposure and the highest regulatory rating). Table 29 provides the details of the calculation of our capital ratios as of June 30, 2011 and December 31, 2010.

National banks also are subject to prompt corrective action capital regulations. Under prompt corrective action regulations, a bank is considered to be well capitalized if it maintains a Tier 1 risk-based capital ratio of at least 6% (200 basis points higher than the above minimum capital standard), a total risk-based capital ratio of at least 10% (200 basis points higher than the above minimum capital standard), a Tier 1 leverage capital ratio of at least 5% and is not subject to any supervisory agreement, order or directive to meet and maintain a specific capital level for any capital reserve. A bank is considered to be adequately capitalized if it meets the above minimum capital ratios and does not otherwise meet the well capitalized definition. Currently, prompt corrective action capital requirements do not apply to bank holding companies.

In addition to disclosing our regulatory capital ratios, we also disclose Tier 1 common equity and TCE ratios, which are non-GAAP measures widely used by investors, analysts, rating agencies and bank regulatory agencies to assess the capital position of financial services companies. There is currently no mandated minimum or “well capitalized” standard for Tier 1 common equity; instead the risk-based capital rules state voting common stockholders’ equity should be the dominant element within Tier 1 common equity. While these non-GAAP capital measures are widely used by investors, analysts and bank regulatory agencies to assess the capital

 

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position of financial services companies, they may not be comparable to similarly titled measures reported by other companies. We provide information on the calculation of these ratios and non-GAAP reconciliation in “Supplemental Tables” below.

Capital Ratios

Table 29 provides a comparison of our capital ratios under the Federal Reserve’s capital adequacy standards and the capital ratios of the Banks under the OCC’s capital adequacy standards as of June 30, 2011 and December 31, 2010. Table 30 provides the details of the calculation of our capital ratios.

Table 29: Capital Ratios Under Basel I(1)

 

     June 30, 2011     December 31, 2010  

(Dollars in millions)

   Capital
Ratio
    Minimum
Capital
Adequacy
    Well
Capitalized
    Capital
Ratio
    Minimum
Capital
Adequacy
    Well
Capitalized
 

Capital One Financial Corp:(2)

            

Tier 1 common equity(3)

     9.4     N/A        N/A        8.8     N/A        N/A   

Tier 1 risk-based capital(4)

     11.8        4.0     6.0     11.6        4.0     6.0

Total risk-based capital(5)

     15.0        8.0        10.0        16.8        8.0        10.0   

Tier 1 leverage(6)

     9.4        4.0        N/A        8.1        4.0        N/A   

Capital One Bank (USA) N.A.

            

Tier 1 risk-based capital

     11.8     4.0     6.0     13.5     4.0     6.0

Total risk-based capital

     15.8        8.0        10.0        23.6        8.0        10.0   

Tier 1 leverage

     10.2        4.0        5.0        8.3        4.0        5.0   

Capital One, N.A.

            

Tier 1 risk-based capital

     12.0     4.0     6.0     11.1     4.0     6.0

Total risk-based capital

     13.2        8.0        10.0        12.4        8.0        10.0   

Tier 1 leverage

     9.1        4.0        5.0        8.1        4.0        5.0   

 

(1) 

Calculated under capital standards and regulations based on the international capital framework commonly known as Basel I.

(2) 

The regulatory framework for prompt corrective action does not apply to Capital One Financial Corp. because it is a bank holding company.

(3) 

Tier 1 common equity ratio is a non-GAAP measure calculated based on Tier 1 common equity divided by risk-weighted assets.

(4) 

Calculated based on Tier 1 capital divided by risk-weighted assets.

(5) 

Calculated based on Total risk-based capital divided by risk-weighted assets.

(6) 

Calculated based on Tier 1 capital divided by quarterly average total assets, after certain adjustments.

We exceeded minimum capital requirements and met the “well capitalized” ratio levels for total risk-based capital and Tier 1 risk-based capital under Federal Reserve rules for bank holding companies as of June 30, 2011. The Banks also exceeded minimum regulatory requirements under the OCC’s applicable capital adequacy guidelines and were “well capitalized” under prompt corrective action requirements as of June 30, 2011.

 

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Table 30: Risk-Based Capital Components Under Basel I(1)

 

(Dollars in millions)

   June 30,
2011
    December 31,
2010
 

Total stockholders’ equity

   $ 28,681      $ 26,541   

Less: Net unrealized gains recorded in AOCI(2)

     (482     (368

Net losses on cash flow hedges recorded in AOCI(2)

     71        86   

Disallowed goodwill and other intangible assets(3)

     (13,954     (13,953

Disallowed deferred tax assets

     (647     (1,150

Other

     (2     (2
  

 

 

   

 

 

 

Tier 1 common equity

     13,667        11,154   

Plus: Tier 1 restricted core capital items(4)

     3,636        3,636   
  

 

 

   

 

 

 

Tier 1 risk-based capital

     17,303        14,790   
  

 

 

   

 

 

 

Plus: Long-term debt qualifying as Tier 2 capital

     2,727        2,827   

Qualifying allowance for loan and lease losses

     1,864        3,748   

Other Tier 2 components

     28        29   
  

 

 

   

 

 

 

Tier 2 risk-based capital

     4,619        6,604   
  

 

 

   

 

 

 

Total risk-based capital

   $ 21,922      $ 21,394   
  

 

 

   

 

 

 

Risk-weighted assets(5)

   $ 146,201      $ 127,043   
  

 

 

   

 

 

 

 

(1) 

Calculated under capital standards and regulations based on the international capital framework commonly known as Basel I.

(2) 

Amounts presented are net of tax.

(3) 

Disallowed goodwill and other intangible assets are net of related deferred tax liability.

(4) 

Consists primarily of trust preferred securities.

(5) 

Under regulatory guidelines for risk-based capital, on-balance sheet assets and credit equivalent amounts of derivatives and off-balance sheet items are assigned to one of several broad risk categories according to the obligor or, if relevant, the guarantor or the nature of any collateral. The aggregate dollar amount in each risk category is then multiplied by the risk weight associated with that category. The resulting weighted values from each of the risk categories are aggregated for determining total risk-weighted assets.

The January 1, 2010 adoption of the new consolidation accounting standards resulted in our consolidating a substantial portion of our securitization trusts and establishing an allowance for loan and lease losses for the assets underlying these trusts, which reduced retained earnings and our Tier 1 capital ratios. In January 2010, banking regulators issued regulatory capital rules related to the impact of the new consolidation accounting standards. Under these rules, we were required to hold additional capital for the assets we consolidated. The capital rules also provided for an optional phase-in of the impact from the adoption of the new consolidation accounting standards, including a two-quarter implementation delay followed by a two-quarter partial implementation of the effect on regulatory capital ratios.

We elected the phase-in option, which required us to phase-in 50% of consolidated assets beginning with the third quarter of 2010 for purposes of determining risk-weighted assets. The phase-in provisions expired after December 31, 2010, and we completed the final phase-in during the first quarter of 2011, which resulted in the addition of approximately $15.5 billion of assets to the denominator used in calculating our regulatory ratios. The addition of these assets contributed to a decrease in our risk-based regulatory capital ratios as of June 30, 2011 from December 31, 2010.

 

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Under the Dodd-Frank Act, many trust preferred securities will cease to qualify for Tier 1 capital, subject to a three year phase-out period expected to begin in 2013.

Dividend Policy

The declaration and payment of dividends to our stockholders, as well as the amount thereof, are subject to the discretion of our Board of Directors, in consultation with the Federal Reserve, and will depend upon our results of operations, financial condition, capital levels, cash requirements, future prospects, assessments of potential future losses due to adverse changes in our business and market environments and other factors deemed relevant by the Board of Directors. As a bank holding company, our ability to pay dividends is largely dependent upon the receipt of dividends or other payments from our subsidiaries. We provide additional information on factors affecting our dividend policy in “Supervision and Regulatory Developments—Capital Plans and Capital Distributions” of this Report and in our 2010 Form 10-K under “Part I—Item 1. Business—Supervision and Regulation—Dividends, Stock Purchases and Transfer of Funds.”

Restrictions exist that limit the ability of the Banks to transfer funds to us. Funds available for dividend payments from COBNA and CONA based on the Earnings Limitation Test were $2.4 billion and $781 million, respectively, as of June 30, 2011. Applicable provisions that may be contained in our borrowing agreements or the borrowing agreements of our subsidiaries may limit our subsidiaries’ ability to pay dividends to us or our ability to pay dividends to our stockholders. There can be no assurance that we will declare and pay any dividends.

 

 

MARKET RISK MANAGEMENT

 

Market Risk Exposure

Market risk represents the risk that our earnings and/or economic value of equity may be adversely affected by changes in market conditions, including changes in interest rates and foreign currency exchange rates, changes in credit spreads and price fluctuations and changes in value due to changes in market perception or the actual credit quality of issuers. Market risk is inherent in the financial instruments associated with our operations and activities, including loans, deposits, securities, short-term borrowings, long-term debt and derivatives. Below we discuss our primary sources of market risk: interest rate risk and foreign exchange risk.

Interest Rate Risk

Interest rate risk, which represents exposure to instruments whose yield or price varies with the level or volatility of interest rates, is our most significant source of market risk exposure. Banks are inevitably exposed to interest rate risk due to differences in the timing between the maturity or repricing of assets and liabilities. For example, if more assets are repricing than deposits and other borrowings when interest rates are declining, our earnings will decrease initially. Similarly, if more deposits and other borrowings than assets are repricing when interest rates are rising, our earnings will decrease initially.

Interest rate risk also results from changes in customer behavior and competitors’ responses to changes in interest rates or other market conditions. For example, decreases in mortgage rates generally result in faster than expected prepayments, which may adversely affect earnings. Increases in interest rates, coupled with strong demand from competitors for deposits, may influence industry pricing. Such competition may affect customer decisions to maintain balances in the deposit accounts, which may require replacing lower cost deposits with higher cost alternative sources of funding.

 

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Foreign Exchange Risk

Foreign exchange risk represents exposure to changes in the values of current holdings and future cash flows denominated in other currencies. The types of instruments exposed to this risk include investments in foreign subsidiaries, foreign currency-denominated loans and securities, future cash flows in foreign currencies arising from foreign exchange transactions, foreign currency-denominated debt and various foreign exchange derivative instruments whose values fluctuate with changes in the level or volatility of currency exchange rates or foreign interest rates.

Market Risk Measurement

We have prescribed risk management policies and limits established by our Asset/Liability Management Committee. Our objective is to manage our asset/liability risk position and exposure to market risk in accordance with these policies and prescribed limits based on prevailing market conditions and long-term expectations. Because no single measure can reflect all aspects of market risk, we use various industry standard market risk measurement techniques and analyses to measure, assess and manage the impact of changes in interest rates and foreign exchange rates on our earnings and the economic value of equity.

We consider the impact on both earnings and economic value of equity in measuring and managing our interest rate risk. Our earnings sensitivity measure estimates the impact on net interest income and the valuation of our mortgage servicing rights, including derivative hedging activity, resulting from movements in interest rates. Our economic value of equity sensitivity measure estimates the impact on the net present value of our assets and liabilities, including derivative hedging activity, resulting from movements in interest rates. Our earnings sensitivity and economic value of equity measurements are based on our existing assets and liabilities, including derivatives, and do not incorporate business growth assumptions or projected plans for funding mix changes. We do, however, assess and factor into our interest rate risk management decisions the potential impact of growth assumptions, changing business activities, alternative interest rate scenarios, such as a steepening or flattening of the yield curve, and changing market environments.

Under our current asset/liability management policy, our objective is to: (i) limit the potential decrease in our projected net interest income resulting from a gradual plus or minus 200 basis point change in forward rates to less than 5% over the next 12 months and (ii) limit the adverse change in the economic value of our equity due to an instantaneous parallel interest rate shock to spot rates of plus or minus 200 basis points to less than 12%. The federal funds rate remained at a target range of zero to 0.25% during the first six months of 2011. Given the level of short-term rates as of June 30, 2011 and December 31, 2010, a scenario where interest rates would decline by 200 basis points is not plausible. Therefore, in 2008, we temporarily revised our customary declining interest rate scenario of 200 basis points to a 50 basis point decrease. Our current asset/liability management policy also includes the use of derivatives to hedge material foreign currency denominated transactions to limit our earnings exposure to foreign exchange risk.

Table 31 shows the estimated percentage change impact to our projected net interest income and economic value of equity, calculated under our base case interest rate scenario, as of June 30, 2011 and December 31, 2010, resulting from selected hypothetical interest rate scenarios. We assume a hypothetical gradual increase in interest rates of 200 basis points and a hypothetical gradual decrease of 50 basis points to forward rates over the next six months in measuring the sensitivity of our forecasted net interest income over the next 12 months. We assume a hypothetical instantaneous parallel shift in the level of interest rates of plus 200 basis points and minus 50 basis points to spot rates in measuring the sensitivity of the valuation of our mortgage servicing rights and the economic value of equity.

 

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Table 31: Interest Rate Sensitivity Analysis

 

     June 30,
2011
    December 31,
2010
 

Impact to projected base-line net interest income:

    

+ 200 basis points

     0.1     (0.7 )% 

- 50 basis points

     (0.4     (0.2

Impact to economic value of equity:

    

+ 200 basis points

     (2.5 )%      (3.8 )% 

- 50 basis points

     0.0        0.1   

Our net interest income and economic value of equity sensitivity measures were within our prescribed asset/liability policy limits as of June 30, 2011 and December 31, 2010.

The interest rate risk models that we use in deriving these measures incorporate contractual information, internally-developed assumptions and proprietary modeling methodologies, which project borrower and deposit behavior patterns in certain interest rate environments. Other market inputs, such as interest rates, market prices and interest rate volatility, are also critical components of our interest rate risk measures. We regularly evaluate, update and enhance these assumptions, models and analytical tools as we believe appropriate to reflect our best assessment of the market environment and the expected behavior patterns of our existing assets and liabilities.

Limitations of Market Risk Measures

There are inherent limitations in any methodology used to estimate the exposure to changes in market interest rates. The above sensitivity analyses contemplate only certain movements in interest rates and are performed at a particular point in time based on the existing balance sheet, and do not incorporate other factors that may have a significant effect, most notably future business activities and strategic actions that management may take to manage interest rate risk. Actual earnings and economic value of equity could differ from the above sensitivity analyses.

Market Risk Management

We employ several techniques to manage our interest rate and foreign currency risk, which include, but are not limited to, changing the maturity and re-pricing characteristics of our various assets and liabilities. Derivatives are one of the primary tools we use in managing interest rate and foreign exchange risk.

We execute our derivative contracts in both over-the-counter and exchange-traded derivative markets. Although the majority of our derivatives are interest rate swaps, we also use a variety of other derivative instruments, including caps, floors, options, futures and forward contracts, to manage our interest rate and foreign currency risk. The outstanding notional amount of our derivative contracts totaled $50.3 billion as of June 30, 2011, compared with $50.7 billion as of December 31, 2010. See “Note 10—Derivative Instruments and Hedging Activities” for additional information on our derivatives activity.

We provide additional information on our market risk exposure and interest rate risk management process in our 2010 Form 10-K under “Part II—Item 7. MD&A—Market Risk Management.”

 

 

SUPERVISION AND REGULATORY DEVELOPMENTS

 

State Consumer Financial Laws

The Dodd-Frank Act created a new independent supervisory body, the Consumer Financial Protection Bureau (the “CFPB”) that became the primary regulator for federal consumer financial statutes on July 21, 2011. Rule writing authority for specified consumer financial statutes transferred to CFPB from other federal regulators. Similarly,

 

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supervisory authority over various institutions, including us, was transferred to the CFPB. State attorneys general will be authorized to enforce new regulations issued by the CFPB. State consumer financial laws will continue to be preempted under the National Bank Act under the existing standard set forth in the Supreme Court decision in Barnett Bank of Marion County, N.A. v. Nelson, which preempts any state law that significantly interferes with or impairs banking powers. Beginning July 21, 2011, OCC determinations of such preemption, however, must be on a case-by-case basis, and courts reviewing the OCC's preemption determinations will now consider the appropriateness of those determinations under a different standard of judicial review. As a result, state consumer financial laws enacted in the future that might previously have been preempted may be held to apply to our business activities.

Debit Interchange Fees

On June 29, 2011, the Board of Governors of the Federal Reserve System adopted a final rule and an interim final rule implementing the portion of the Dodd-Frank Act that limits interchange fees received by a debit card issuer. The final rule limits interchange fees per debit card transaction to $.21 plus five (5) basis points of the transaction amount and provides, through the interim final rule, for an additional $.01 fraud prevention adjustment to the interchange fee for issuers that meet certain fraud prevention requirements. If interchange fees are set at the maximum amount allowed by the rule and we receive the fraud prevention adjustment, we estimate that our debit interchange revenue will decline by approximately $88 million in 2012, without taking into account any actions we may take to offset this decline.

FDIC Assessments

The Dodd-Frank Act required the FDIC to change the deposit insurance assessment base from deposits to average consolidated total assets minus average tangible equity. The FDIC recently finalized rules to implement this change and to modify significantly how deposit insurance assessment rates are calculated for those banks with assets of $10 billion or greater, which rules went into effect on April 1, 2011. After taking into account planned actions by management intended to minimize the financial impact of the FDIC assessment changes, we do not anticipate that the Banks' assessments for 2011 will increase by a significant amount.

Capital Plans and Capital Distributions

In June, the Federal Reserve issued a proposed rule requiring bank holding companies over $50 billion in assets to submit annual capital plans. The proposal is similar to the Comprehensive Capital Analysis and Review (SR Letter 09-4: Dividend Increases and Other Capital Distributions for the 19 SCAP Bank Holding Companies (“CCAR”)). Like CCAR, the proposed rule seeks to ensure that bank holding companies have forward-looking capital planning processes that consider their unique risks and that permit continued operations during times of economic and financial stress. Among other requirements, the proposed rule would require a bank holding company to provide prior notice of capital distributions, including dividend payments and share repurchases, if the Federal Reserve objected to a capital plan. As proposed, prior notice would also be required – even if the Federal Reserve had not objected to a capital plan—if, for example, a distribution would result in material adverse changes to capital or liquidity or earnings were materially underperforming projections.

Payment Protection Insurance Matter

New rules on Payment Protection Insurance (“PPI”) complaints handling and redress were published by the United Kingdom Financial Services Authority (“FSA”) in August 2010 and came into force in December 2010. These rules are applicable to our UK consumer businesses and are intended to address concerns among consumers and regulators regarding the handling of PPI complaints across the industry. In October 2010, the British Bankers’ Association (“BBA”) issued judicial review proceedings to challenge the validity of the new rules on the basis that the rules have a retrospective effect. On April 20, 2011, the High Court issued a judgment upholding the FSA’s PPI rules as promulgated and dismissing the BBA’s challenge. The BBA is not appealing

 

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the decision. As a result of this judgment, we were required to conduct a review of our past PPI sales and, where any systemic issues are identified, take appropriate remedial action, which may involve proactively contacting non-complainants.

In anticipation of refunds to UK customers, we recorded a reserve in the second quarter of 2011 of $75 million, of which approximately $52 million was recorded as an offset against our revenues in the second quarter of 2011, and the reminder was recorded as non-interest expense.

We provide additional information on our supervision and regulation in our 2010 Form 10-K under “Part I—Item 1. Business—Supervision and Regulation.”

 

 

ACCOUNTING CHANGES AND DEVELOPMENTS

 

See “Note 1—Summary of Significant Accounting Policies” for information concerning recently issued accounting pronouncements, including those that we have not yet adopted and that will likely affect our consolidated financial statements.

 

 

FORWARD-LOOKING STATEMENTS

 

From time to time, we have made and will make forward-looking statements, including those that discuss, among other things, strategies, goals, outlook or other non-historical matters; projections, revenues, income, returns, accruals for claims in litigation and for other claims against us; earnings per share or other financial measures for us; future financial and operating results; our plans, objectives, expectations and intentions; and the assumptions that underlie these matters.

To the extent that any such information is forward-looking, it is intended to fit within the safe harbor for forward-looking information provided by the Private Securities Litigation Reform Act of 1995. Numerous factors could cause our actual results to differ materially from those described in such forward-looking statements, including, among other things:

 

   

general economic and business conditions in the U.S., the U.K., Canada or our local markets, including conditions affecting employment levels, interest rates, consumer income and confidence, spending and savings that may affect consumer bankruptcies, defaults, charge-offs and deposit activity;

 

   

an increase or decrease in credit losses (including increases due to a worsening of general economic conditions in the credit environment);

 

   

financial, legal, regulatory, tax or accounting changes or actions, including the impact of the Dodd-Frank Act and the regulations promulgated thereunder;

 

   

the possibility that regulatory and other approvals and conditions to our acquisition of ING Direct are not received or satisfied on a timely basis or at all;

 

   

the possibility that modifications to the terms of our acquisition of ING Direct may be required in order to obtain or satisfy such approvals or conditions;

 

   

changes in the anticipated timing for closing our acquisition of ING Direct;

 

   

difficulties and delays in integrating the Company’s and ING Direct’s businesses or fully realizing projected cost savings and other projected benefits of our acquisition of ING Direct;

 

   

business disruption during the pendency of or following our acquisition of ING Direct;

 

   

the inability to sustain revenue and earnings growth;

 

   

diversion of management time on any acquisition-related issues;

 

   

reputational risks and the reaction of customers and counterparties to the Company’s acquisitions;

 

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changes in asset quality and credit risk as a result of our acquisition of ING Direct;

 

   

developments, changes or actions relating to any litigation matter involving us;

 

   

increases or decreases in interest rates;

 

   

our ability to access the capital markets at attractive rates and terms to capitalize and fund our operations and future growth;

 

   

the success of our marketing efforts in attracting and retaining customers;

 

   

increases or decreases in our aggregate loan balances or the number of customers and the growth rate and composition thereof, including increases or decreases resulting from factors such as shifting product mix, amount of actual marketing expenses we incur and attrition of loan balances;

 

   

the level of future repurchase or indemnification requests we may receive, the actual future performance of mortgage loans relating to such requests, the success rates of claimants against us, any developments in litigation and the actual recoveries we may make on any collateral relating to claims against us;

 

   

the amount and rate of deposit growth;

 

   

changes in the reputation of or expectations regarding the financial services industry or us with respect to practices, products or financial condition;

 

   

any significant disruption in our operations or technology platform;

 

   

our ability to maintain a compliance infrastructure suitable for our size and complexity;

 

   

our ability to control costs;

 

   

the amount of, and rate of growth in, our expenses as our business develops or changes or as it expands into new market areas;

 

   

our ability to execute on our strategic and operational plans;

 

   

any significant disruption of, or loss of public confidence in, the United States Mail service affecting our response rates and consumer payments;

 

   

our ability to recruit and retain experienced personnel to assist in the management and operations of new products and services;

 

   

changes in the labor and employment markets;

 

   

the risk that cost savings and any other synergies from our acquisitions may not be fully realized or may take longer to realize than expected;

 

   

disruptions from our acquisitions negatively impacting our ability to maintain relationships with customers, employees or suppliers;

 

   

fraud or misconduct by our customers, employees or business partners;

 

   

competition from providers of products and services that compete with our businesses; and

 

   

other risk factors listed from time to time in reports that we file with the SEC.

Any forward-looking statements made by us or on our behalf speak only as of the date they are made or as of the date indicated, and we do not undertake any obligation to update forward-looking statements as a result of new information, future events or otherwise. You should carefully consider the factors discussed above in evaluating these forward-looking statements. For additional information on factors that could materially influence forward-looking statements included in this Report, see the risk factors set forth under “Part I—Item 1A. Risk Factors” in our 2010 Form 10-K and the risk factors set forth in Exhibit 99.5 to our Current Report on Form 8-K filed on July 13, 2011.

 

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SUPPLEMENTAL TABLES

 

Table A: Reconciliation of Non-GAAP Measures and Calculation of Regulatory Capital Measures

 

(Dollars in millions) (unaudited)

   June 30,
2011
    December 31,
2010
 

Stockholders’ Equity to Non-GAAP Tangible Common Equity

    

Total stockholders’ equity

   $ 28,681      $ 26,541   

Less: Intangible assets(1)

     (14,006     (13,983
  

 

 

   

 

 

 

Tangible common equity

   $ 14,675      $ 12,558   
  

 

 

   

 

 

 

Total Assets to Tangible Assets

    

Total assets

   $ 199,753      $ 197,503   

Less: Assets from discontinued operations

     (32     (362
  

 

 

   

 

 

 

Total assets from continuing operations

     199,721        197,141   

Less: Intangible assets(1)

     (14,006     (13,983
  

 

 

   

 

 

 

Tangible assets

   $ 185,715      $ 183,158   
  

 

 

   

 

 

 

Non-GAAP TCE Ratio

    

Tangible common equity

   $ 14,675      $ 12,558   

Tangible assets

     185,715        183,158   
  

 

 

   

 

 

 

TCE ratio(2)

     7.9     6.9
  

 

 

   

 

 

 

Regulatory Capital and Non-GAAP Tier 1 Common Equity Ratios

    

Total stockholders’ equity

   $ 28,681      $ 26,541   

Less: Net unrealized gains recorded in AOCI(3)

     (482     (368

           Net losses on cash flow hedges recorded in AOCI(3)

     71        86   

           Disallowed goodwill and other intangible assets(4)

     (13,954     (13,953

           Disallowed deferred tax assets

     (647     (1,150

           Other

     (2     (2
  

 

 

   

 

 

 

Tier 1 common equity

   $ 13,667      $ 11,154   

Plus: Tier 1 restricted core capital items(5)

     3,636        3,636   
  

 

 

   

 

 

 

Tier 1 capital

   $ 17,303      $ 14,790   
  

 

 

   

 

 

 

Plus: Long-term debt qualifying as Tier 2 capital

     2,727        2,827   

           Qualifying allowance for loan and lease losses

     1,864        3,748   

           Other Tier 2 components

     28        29   
  

 

 

   

 

 

 

Tier 2 capital

   $ 4,619      $ 6,604   
  

 

 

   

 

 

 

Total risk-based capital(6)

   $ 21,922      $ 21,394   
  

 

 

   

 

 

 

Risk-weighted assets(7)

   $ 146,201      $ 127,043   
  

 

 

   

 

 

 

Tier 1 common equity ratio(8)

     9.4     8.8

Tier 1 risk-based capital ratio(9)

     11.8     11.6

Total risk-based capital ratio(10)

     15.0     16.8

 

(1) 

Includes impact from related deferred taxes.

(2) 

Calculated based on tangible common equity divided by tangible assets.

(3) 

Amounts presented are net of tax.

(4) 

Disallowed goodwill and other intangible assets are net of related deferred tax liability.

(5) 

Consists primarily of trust preferred securities.

(6) 

Total risk-based capital equals the sum of Tier 1 capital and Tier 2 capital.

(7) 

Calculated based on prescribed regulatory guidelines.

 

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(8) 

Tier 1 common equity ratio is a non-GAAP measure calculated based on Tier 1 common equity divided by risk-weighted assets.

(9) 

Tier 1 risk-based capital ratio is a regulatory capital measure calculated based on Tier 1 capital divided by risk-weighted assets.

(10) 

Total risk-based capital ratio is a regulatory capital measure calculated based on total risk-based capital divided by risk-weighted assets.

 

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Item 1. Financial Statements

CAPITAL ONE FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

 

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

(Dollars in millions, except per share-related data)

       2011             2010             2011             2010      

Interest income:

        

Loans held for investment, including past-due fees

   $ 3,367      $ 3,476      $ 6,784      $ 7,134   

Investment securities

     313        342        629        691   

Other

     19        17        38        40   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total interest income

     3,699        3,835        7,451        7,865   
  

 

 

   

 

 

   

 

 

   

 

 

 

Interest expense:

        

Deposits

     307        368        629        767   

Securitized debt obligations

     113        212        253        454   

Senior and subordinated notes

     63        72        127        140   

Other borrowings

     80        86        166        179   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total interest expense

     563        738        1,175        1,540   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

     3,136        3,097        6,276        6,325   

Provision for loan and lease losses

     343        723        877        2,201   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income after provision for loan and lease losses

     2,793        2,374        5,399        4,124  
  

 

 

   

 

 

   

 

 

   

 

 

 

Non-interest income:

        

Servicing and securitizations

     12        21        23        (15

Service charges and other customer-related fees

     460        496        985        1,081   

Interchange fees

     331        333        651        644   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other-than-temporary losses

     (27     (27     (50     (77

Less: Non-credit component of other-than-temporary impairment losses recorded in AOCI

     21        1        41        20   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net other-than-temporary losses recognized in earnings

     (6     (26     (9     (57

Other

     60        (17     149        215   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total non-interest income

     857        807       1,799        1,868  
  

 

 

   

 

 

   

 

 

   

 

 

 

Non-interest expense:

        

Salaries and associate benefits

     715        650        1,456        1,296   

Marketing

     329        219        605        399   

Communications and data processing

     162        164        326        333   

Supplies and equipment

     124        129        259        253   

Occupancy

     118        117        237        237   

Other

     807        721        1,534        1,329   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total non-interest expense

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

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations before income taxes

     1,395        1,181        2,781        2,145   

Income tax provision

     450        369        804        613   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations, net of tax

     945        812        1,977        1,532   

Loss from discontinued operations, net of tax

     (34     (204     (50     (288
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 911      $ 608     $ 1,927      $ 1,244  
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic earnings per common share:

        

Income from continuing operations

   $ 2.07      $ 1.79      $ 4.35      $ 3.38   

Loss from discontinued operations

     (0.07     (0.45     (0.11     (0.63
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income per basic common share

   $ 2.00      $ 1.34     $ 4.24      $ 2.75  
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted earnings per common share:

        

Income from continuing operations

   $ 2.04      $ 1.78      $ 4.29      $ 3.36   

Loss from discontinued operations

     (0.07     (0.45     (0.11     (0.63
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income per diluted common share

   $ 1.97      $ 1.33      $ 4.18      $ 2.73   
  

 

 

   

 

 

   

 

 

   

 

 

 

Dividends paid per common share

   $ 0.05      $ 0.05      $ 0.10      $ 0.10   
  

 

 

   

 

 

   

 

 

   

 

 

 

See Notes to Consolidated Financial Statements.

 

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CAPITAL ONE FINANCIAL CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)

 

(Dollars in millions, except per share data)

   June 30,
2011
    December 31,
2010
 

Assets:

    

Cash and due from banks

   $ 1,954      $ 2,067   

Interest-bearing deposits with banks

     4,037        2,776   

Federal funds sold and securities purchased under agreements to resell

     652        406   
  

 

 

   

 

 

 

Cash and cash equivalents

     6,643        5,249   

Restricted cash for securitization investors

     1,328        1,602   

Securities available for sale, at fair value

     39,474        41,537   

Loans held for investment:

    

Unsecuritized loans held for investment, at amortized cost

     81,585        71,921   

Restricted loans for securitization investors

     47,380        54,026   
  

 

 

   

 

 

 

Total loans held for investment

     128,965        125,947   

Less: Allowance for loan and lease losses

     (4,488     (5,628
  

 

 

   

 

 

 

Net loans held for investment

     124,477        120,319   

Loans held for sale, at lower-of-cost-or-fair value

     80        228   

Accounts receivable from securitizations

     106        118   

Premises and equipment, net

     2,754        2,749   

Interest receivable

     1,027        1,070   

Goodwill

     13,596        13,591   

Other

     10,268        11,040   
  

 

 

   

 

 

 

Total assets

   $ 199,753      $ 197,503   
  

 

 

   

 

 

 

Liabilities:

    

Interest payable

   $ 469      $ 488   

Customer deposits:

    

Non-interest bearing deposits

     16,839        15,048   

Interest bearing deposits

     109,278        107,162   
  

 

 

   

 

 

 

Total customer deposits

     126,117        122,210   

Securitized debt obligations

     19,860        26,915   

Other debt:

    

Federal funds purchased and securities loaned or sold under agreements to repurchase

     2,575        1,517   

Senior and subordinated notes

     8,664        8,650   

Other borrowings

     6,636        4,714   
  

 

 

   

 

 

 

Total other debt

     17,875        14,881   

Other liabilities

     6,751        6,468   
  

 

 

   

 

 

 

Total liabilities

     171,072        170,962   
  

 

 

   

 

 

 

Stockholders’ equity:

    

Preferred stock, par value $.01 per share; authorized 50,000,000 shares; zero shares issued or outstanding as of June 30, 2011 and December 31, 2010

     0        0   

Common stock, par value $.01 per share; authorized 1,000,000,000 shares; 507,886,987 and 504,801,064 issued as of June 30, 2011 and December 31, 2010, respectively

     5        5   

Paid-in capital, net

     19,188        19,084   

Retained earnings

     12,287        10,406   

Accumulated other comprehensive income

     442        248   

Less: Treasury stock, at cost; 48,582,348 and 47,787,697 shares as of June 30, 2011 and December 31, 2010, respectively

     (3,241     (3,202
  

 

 

   

 

 

 

Total stockholders’ equity

     28,681        26,541   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 199,753      $ 197,503   
  

 

 

   

 

 

 

See Notes to Consolidated Financial Statements.

 

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CAPITAL ONE FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (UNAUDITED)

 

(Dollars in millions, except per share data)

  Common Stock     Additional
Paid-In
Capital
    Retained
Earnings
    Accumulated
Other
Comprehensive
Income
(Loss)
    Treasury
Stock
    Total
Stockholders’
Equity
 
           
           
  Shares     Amount            

Balance as of December 31, 2010

    504,801,064      $ 5      $ 19,084      $ 10,406      $ 248      $ (3,202   $ 26,541   

Net income

          1,927            1,927   

Other comprehensive income (loss), net of tax:

             

Change in unrealized gains on securities, net of income taxes of $67 million

            122          122   

Other-than-temporary impairment on available-for-sale securities not recognized in earnings, net of taxes of $4 million

            (7       (7

Foreign currency translation adjustments

            63          63   

Unrealized gains on cash flow hedges, net of taxes of $10 million

            19          19   

Other

            (3       (3
         

 

 

     

 

 

 

Other comprehensive income

            194          194   
         

 

 

     

 

 

 

Total comprehensive income

                2,121   

Cash dividends—common stock $0.10 per share

          (46         (46

Purchases of treasury stock

              (39     (39

Issuances of common stock and restricted stock, net of forfeitures

    1,935,616          18              18   

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

    1,150,307          42              42   

Restricted stock awards and stock options

        44              44   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance as of June 30, 2011

    507,886,987      $ 5      $ 19,188      $ 12,287      $ 442      $ (3,241   $ 28,681   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance as of December 31, 2009

    502,394,396      $ 5      $ 18,955      $ 10,727      $ 83      $ (3,180   $ 26,590   

Cumulative effect from adoption of new consolidation accounting standards

          (2,956     (16       (2,972

Comprehensive income:

             

Net income

          1,244            1,244   

Other comprehensive income (loss), net of tax:

             

Change in net unrealized gain on available-for-sale securities, net of taxes of $226 million

            447          447   

Other-than-temporary impairment on available-for-sale securities not recognized in earnings, net of taxes of $17 million

            30          30   

Defined benefit pension plans

            (1       (1

Foreign currency translation adjustments

            (98       (98

Unrealized gains on cash flow hedges, net of taxes of $14 million

            22          22   
         

 

 

     

 

 

 

Other comprehensive income

            400          400   
         

 

 

     

 

 

 

Total comprehensive income

                1,644   

Cash dividends—common stock $0.10 per share

          (46         (46

Purchases of treasury stock

              (20     (20

Issuances of common stock and restricted stock, net of forfeitures

    1,600,902          15              15   

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

    478,212          4              4   

Restricted stock awards and stock options

        55              55   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance as of June 30, 2010

    504,473,510      $ 5      $ 19,029      $ 8,969      $ 467      $ (3,200   $ 25,270   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See Notes to Consolidated Financial Statements.

 

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CAPITAL ONE FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

 

     Six Months Ended June 30,  

(Dollars in millions)

         2011                 2010        

Operating activities:

    

Income from continuing operations, net of tax

   $ 1,977      $ 1,532   

Loss from discontinued operations, net of tax

     (50     (288
  

 

 

   

 

 

 

Net income

     1,927        1,244   
  

 

 

   

 

 

 

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

    

Provision for loan and lease losses

     877        2,201   

Depreciation and amortization, net

     299        316   

Net gains on sales of securities available for sale

     (11     (108

Net gains on deconsolidation

     0        (177

Loans held for sale:

    

Transfers in

     (209     (450

Losses on sales

     23        1   

Proceeds from sales

     334        488   

Stock plan compensation expense

     117        87   

Changes in assets and liabilities, net of effects from purchase of companies acquired and the effect of new accounting standards:

    

(Increase) decrease in interest receivable

     43        (144

(Increase) decrease in accounts receivable from securitizations(1)

     12        (61

(Increase) decrease in other assets(1)

     792        1,647   

Increase (decrease) in interest payable

     (19     34   

Increase (decrease) in other liabilities(1)

     127        (286

Net cash provided by operating activities attributable to discontinued operations

     49        19   
  

 

 

   

 

 

 

Net cash provided by operating activities

     4,361        4,811   
  

 

 

   

 

 

 

Investing activities:

    

Increase in restricted cash for securitization investors(1)

     274        552   

Purchases of securities available for sale

     (5,085     (14,982

Proceeds from paydowns and maturities of securities available for sale

     4,715        6,085   

Proceeds from sales of securities available for sale

     2,570        9,061   

Proceeds from sale of interest-only bonds

     0        57   

Net (increase) decrease in loans held for investment(1)

     (4,474     5,023   

Principal recoveries of loans previously charged off

     826        826   

Additions of premises and equipment

     (159     (150

Net payments for acquisitions

     (1,444     0   
  

 

 

   

 

 

 

Net cash provided by (used in) investing activities

     (2,777     6,472   
  

 

 

   

 

 

 

Financing activities:

    

Net increase in deposits

     3,907        1,522   

Net decrease in securitized debt obligations

     (7,055     0   

Net (increase) decrease in other borrowings(1)

     2,983        (16,225

Purchases of treasury stock

     (39     (20

Dividends paid on common stock

     (46     (46

Net proceeds from issuances of common stock

     18        15   

Proceeds from share-based payment activities

     42        4   

Net cash used in financing activities attributable to discontinued operations

     0        (19
  

 

 

   

 

 

 

Net cash used in financing activities

     (190     (14,769
  

 

 

   

 

 

 

Increase (decrease) in cash and cash equivalents

     1,394        (3,486

Cash and cash equivalents at beginning of the period

     5,249        8,685   
  

 

 

   

 

 

 

Cash and cash equivalents at end of the period

   $ 6,643      $ 5,199   
  

 

 

   

 

 

 

Supplemental cash flow information:

    

Non-cash items:

    

Impact of the net fair value of assets acquired and liabilities assumed for acquisitions

   $ 3      $ 0   

Cumulative effect from adoption of new consolidation accounting standards

     0        2,972   

 

(1) 

Excludes the initial impact from the January 1, 2010 adoption of the new consolidation standards.

See Notes to Consolidated Financial Statements.

 

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NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

The Company

Capital One Financial Corporation, which was established in 1995, is a diversified financial services holding company headquartered in McLean, Virginia. Capital One Financial Corporation and its subsidiaries (the “Company”) offer a broad array of financial products and services to consumers, small businesses and commercial clients through branches, the internet and other distribution channels. Our principal subsidiaries include Capital One Bank (USA), National Association (“COBNA”) and Capital One, National Association (“CONA”). 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.” As one of the 10 largest banks in the United States based on deposits, we serve banking customers through branch locations primarily in New York, New Jersey, Texas, Louisiana, Maryland, Virginia and the District of Columbia. In addition to bank lending and depository services, we offer credit and debit card products, mortgage banking and treasury management services. We offer our products outside of the United States principally through operations in the United Kingdom and Canada.

Our principal operations are organized into three primary 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.

Basis of Presentation and Use of Estimates

The accompanying unaudited consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States (“U.S. GAAP”) for interim financial information and should be read in conjunction with the audited consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2010 (“2010 Form 10-K”). Certain financial information that is normally included in annual financial statements prepared in conformity with U.S. GAAP, but is not required for interim reporting purposes, has been condensed or omitted. In the opinion of management, all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of our interim unaudited financial statements have been reflected.

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and related disclosures. These estimates are based on information available as of the date of the consolidated financial statements. While management makes its best judgment, actual amounts or results could differ from these estimates. Interim period results may not be indicative of results for the full year.

Principles of Consolidation

The consolidated financial statements include the accounts of Capital One Financial Corporation and all other entities in which we have a controlling financial interest. All significant intercompany accounts and transactions have been eliminated. Certain prior period amounts have been reclassified to conform to the current period presentation.

Significant Accounting Policies

We provide a summary of our significant accounting policies in our 2010 Form 10-K under “Notes to Consolidated Financial Statements—Note 1—Summary of Significant Accounting Policies.” Below we describe accounting standards that we adopted in 2011 and recently issued accounting standards that we have not yet adopted.

 

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Accounting Standards Adopted in 2011

Fair Value Measurements and Disclosures—Improving Disclosures about Fair Value Measurements

In January 2010, the Financial Accounting Standards Board (“FASB”) issued guidance to improve disclosures about fair value measurements. The guidance, which amended previous disclosure requirements for fair value measurements, requires new disclosures for significant transfers of financial assets and liabilities into and out of Level 1 and Level 2 of the fair value hierarchy, and requires that information on purchases, sales, issuances and settlements in the rollforward of Level 3 activity be presented on a gross basis rather than on a net basis The amended guidance also provides several clarifications with respect to disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring instruments classified as either Level 2 or Level 3. We adopted the requirement for gross presentation in the Level 3 rollforward on January 1, 2011. The remaining provisions of the guidance were effective for us on January 1, 2010. Our adoption of the updated guidance did not affect our financial condition, results of operations or liquidity since it amends only the disclosure requirements for fair value measurements.

Recently Issued but Not Yet Adopted Accounting Standards

Presentation of Comprehensive Income

In June 2011, the FASB issued new accounting guidance that revises the manner in which comprehensive income is required to be presented in financial statements. The new guidance will require companies to present the components of net income and other comprehensive income either as one continuous statement or as two consecutive statements. The guidance eliminates the option to present components of other comprehensive income in the statement of changes in stockholders’ equity. It does not change the items which must be reported in other comprehensive income, how such items are measured or when they must be reclassified from other comprehensive income to net income. The guidance requires retrospective application and is effective for interim and annual periods beginning on or after December 15, 2011. We intend to adopt the guidance in the first quarter of 2012. Our adoption of the guidance will have no effect on our financial condition, results of operations or liquidity since it impacts presentation only.

Fair Value Measurement: Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards (“IFRS”)

In May 2011, the FASB issued amended guidance on fair value that is intended to provide a converged fair value framework for U.S. GAAP and IFRS. The amended guidance results in a consistent definition of fair value and common requirements for measurement of and disclosure about fair value between U.S. GAAP and IFRS. While the amended guidance continues to define fair value as an exit price, it changes some fair value measurement principles and expands the existing disclosure requirements for fair value measurements. The amended guidance is effective for public entities for interim and annual periods beginning on or after December 15, 2011, with early adoption prohibited. The new guidance requires prospective application and disclosure in the period of adoption of the change, if any, in valuation techniques and related inputs resulting from application of the amendments and quantification of the total effect, if practicable. We intend to adopt the amended guidance in the first quarter of 2012, and are currently assessing the impact that the adoption will have on our consolidated financial statements.

Receivables: A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring

In April 2011, the FASB issued an amendment to the accounting guidance for receivables to clarify when a restructuring, such as a loan modification, is considered a troubled debt restructuring (“TDR”). This amendment provides clarification on determining whether a debtor is experiencing financial difficulties and whether a concession has been granted to the debtor for purposes of determining if a loan modification constitutes a TDR. The amended guidance is effective for interim and annual periods beginning on or after June 15, 2011 and

 

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applies retrospectively to restructurings occurring on or after the beginning of the fiscal year of adoption, with early adoption permitted. We intend to adopt this guidance in the third quarter of 2011. We are currently assessing the impact that the adoption of this guidance will have on our consolidated financial statements.

Transfers and Servicing: Reconsideration of Effective Control for Repurchase Agreements

In April 2011, the FASB issued an amendment to the guidance for transfers and servicing with regard to repurchase agreements and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before their maturity. This amendment removes the criterion related to collateral maintenance from the transferor’s assessment of effective control. It focuses the assessment of effective control on the transferor’s rights and obligations with respect to the transferred financial assets and not whether the transferor has the practical ability to perform in accordance with those rights or obligations. As a result of this amendment, we do not expect that repurchase agreements will qualify for derecognition from the transferor’s financial statements and will be treated as secured borrowings. The amendment is effective prospectively for transactions or modification of existing transactions that occur on or after the first interim or annual period beginning on or after December 15, 2011. We intend to adopt the amended guidance on January 1, 2012. We do not expect that the adoption will have a material impact on our consolidated financial statements.

 

 

NOTE 2—ACQUISITIONS

 

We regularly explore opportunities to enter into strategic partnership agreements or acquire financial services companies and businesses to expand our distribution channels and grow our customer base. We may structure these transactions with both an initial payment and later contingent payments tied to future financial performance. In some partnership agreements, we may enter into collaborative risk-sharing arrangements that provide for revenue and loss sharing.

Accounting for Acquisitions

We account for acquisitions in accordance with the accounting guidance for business combinations. Under the guidance for business combinations, the accounting differs depending on whether the acquired set of activities and assets meets the definition of a business. A business is considered to be an integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing economic benefits directly to investors or other owners, members, or participants. If the acquired set of activities and assets meets the definition of a business, the transaction is accounted for as a business combination. Otherwise, it is accounted for as an asset acquisition.

In a business combination, identifiable assets acquired, liabilities assumed and any noncontrolling interest in the acquiree are recorded at fair value as of the acquisition date, with limited exceptions. Transaction costs and costs to restructure the acquired company are generally expensed as incurred. Goodwill is recognized as the excess of the acquisition price over the estimated fair value of the net assets acquired. The operating results of the acquired business are reflected in our consolidated financial statements subsequent to the date of the merger or acquisition. In an asset acquisition, the assets acquired are recorded at the purchase price plus any transaction costs incurred. Goodwill is not recognized in an asset acquisition.

Accounting for Partnership Agreements

Our partnership agreements primarily relate to alliances with third parties to provide lending and other services to private label credit card customers. We evaluate the specific terms of each agreement to determine whether it meets the definition of a collaborative arrangement and how revenue generated from third parties, costs incurred and transactions between participants in the partnership agreement should be accounted for and reported in our consolidated financial statements. A collaborative arrangement is a contractual arrangement that involves a joint operating activity involving two or more parties that are both active participants in the activity and exposed to significant risks and rewards dependent on the economic success of the activity.

 

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If the agreement involves payments between participants under a revenue or loss sharing arrangement, we must determine whether to report revenue or loss amounts on a gross basis or on a net basis after taking into consideration payments due to or due from participants. We evaluate the contractual provisions of each transaction and applicable accounting guidance in determining the manner in which to report the impact of revenue and loss sharing amounts in our consolidated balance sheet and the related impact on our allowance for loan and lease losses. Our consolidated net income is the same regardless of whether we record revenue or expense amounts on a gross or net basis.

2011 Acquisitions

Hudson’s Bay Company Credit Card Portfolio

On January 7, 2011, in a cash transaction, we acquired the credit card portfolio of Hudson’s Bay Company (“HBC”), a Canadian operation, from GE Capital Retail Finance. The acquisition and partnership with HBC significantly expands our credit card customer base in Canada, tripling the number of customer accounts, and provide an additional distribution channel. The acquisition included outstanding credit card loan receivables with a fair value of approximately $1.4 billion, and a transfer of approximately 400 employees directly involved in managing the HBC portfolio.

We accounted for the acquisition as a business combination. Accordingly, we recorded the assets acquired, including identifiable intangible assets, and liabilities assumed at their respective fair values as of the acquisition date and consolidated with our results. In connection with the acquisition, we recorded goodwill of $3 million representing the amount by which the purchase price exceeded the fair value of the net assets acquired. We also recognized a purchased credit card relationship intangible asset of $11 million at acquisition and a contract-based intangible asset of $70 million. Because the acquisition was considered to be a taxable transaction, the goodwill is deductible for tax purposes. The goodwill was assigned to the International Card reporting unit of our Credit Card segment, and the acquired loan portfolio is reflected in the operations of our International Card business.

Kohl’s Credit Card Portfolio

In August 2010, we entered into a private-label credit card partnership agreement with Kohl’s Department Stores (“Kohl’s”). In connection with the partnership agreement, effective April 1, 2011, we acquired Kohl’s existing private-label credit card loan portfolio from JPMorgan Chase & Co. The existing portfolio, which consists of more than 20 million Kohl’s customer accounts, had an outstanding principal and interest balance of approximately $3.7 billion at acquisition. The partnership agreement has an initial seven-year term and an automatic one-year renewal thereafter. We accounted for the purchase as an asset acquisition.

Under the terms of the partnership agreement and in conjunction with the acquisition, we began issuing Kohl’s branded private-label credit cards to new and existing Kohl’s customers on April 1, 2011. Risk management decisions are jointly managed by Kohl’s and us, but we retain final authority over risk management decisions. Kohl’s has primary responsibility for handling customer service functions and advertising and marketing related to credit card customers.

We share a fixed percentage of revenues, consisting of finance charges and late fees, with Kohl’s, and Kohl’s is required to reimburse us for a fixed percentage of credit losses incurred. Revenues and losses related to the Kohl’s credit card program are reported on a net basis in our consolidated financial statements. The revenue sharing amounts earned by Kohl’s are reflected as an offset against our revenues in our consolidated statements of income. The loss sharing amounts from Kohl’s are reflected as a reduction in our provision for loan and lease losses in our consolidated statements of income. We also report the related allowance for loan and lease losses attributable to the Kohl’s portfolio in our consolidated balance sheets net of the loss sharing amount due from Kohl’s.

 

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

 

 

NOTE 3—DISCONTINUED OPERATIONS

 

Shutdown of Mortgage Origination Operations of Wholesale Mortgage Banking Unit

In the third quarter of 2007, we closed the mortgage origination operations of our wholesale mortgage banking unit, acquired by us in December 2006 as part of the North Fork acquisition. The results of the mortgage origination operations and wholesale banking unit have been accounted for as a discontinued operation and therefore not included in our results from continuing operations for the three and six months ended June 30, 2011 and 2010. We have no significant continuing involvement in these operations.

The loss from discontinued operations includes an expense of $33 million ($22 million, net of tax) and $72 million ($51 million, net of tax), in the second quarter and first six months of 2011, respectively, and an expense of $309 million ($212 million, net of tax) and $433 million ($309 million, net of tax), in the second quarter and first six months of 2010, respectively, recorded in non-interest expense, primarily attributable to provisions for mortgage loan repurchase losses related to representations and warranties provided on loans previously sold to third parties by the wholesale banking unit.

The following table summarizes the results from discontinued operations related to the closure of our wholesale mortgage banking unit:

 

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

(Dollars in millions)

       2011             2010             2011             2010      

Net interest expense

   $ 0      $ 0      $ 0      $ (1

Non-interest expense

     (53     (316     (78     (445
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss from discontinued operations before taxes

     (53     (316     (78     (446

Income tax benefit

     19        112        28        158   
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss from discontinued operations, net of taxes

   $ (34   $ (204   $ (50   $ (288
  

 

 

   

 

 

   

 

 

   

 

 

 

The discontinued mortgage origination operations of our wholesale home loan banking unit had remaining assets of $32 million and $362 million as of June 30, 2011 and December 31, 2010, respectively, which consisted primarily of cash. Liabilities totaled $633 million and $585 million as of June 30, 2011 and December 31, 2010, respectively, consisting primarily of reserves for representations and warranties on loans previously sold to third parties.

 

 

NOTE 4—INVESTMENT SECURITIES

 

Our investment securities portfolio, which had a fair value of $39.5 billion and $41.5 billion, as of June 30, 2011 and December 31, 2010, respectively, consists of U.S. Treasury and U.S. agency debt obligations; agency and non-agency mortgage-backed securities; other asset-backed securities collateralized primarily by credit card loans, auto loans, student loans, auto dealer floor plan inventory loans and leases, equipment loans, and other; municipal securities and limited Community Reinvestment Act (“CRA”) equity securities. Our investment securities portfolio continues to be heavily concentrated in securities that generally have lower credit risk and

 

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high credit ratings, such as securities issued and guaranteed by the U.S. Treasury and government sponsored enterprises or agencies. Our investments in U.S. Treasury and agency securities, based on fair value, represented approximately 71% of our total investment securities portfolio as of June 30, 2011, compared with 70% as of December 31, 2010.

Securities Amortized Cost and Fair Value

All of our investment securities were classified as available-for-sale as of June 30, 2011, and are reported in our consolidated balance sheet at fair value. The following tables present the amortized cost, fair values and corresponding gross unrealized gains (losses), by major security type, for our investment securities as of June 30, 2011 and December 31, 2010. The gross unrealized gains (losses) related to our available-for-sale securities are recorded, net of tax, as a component of accumulated other comprehensive income (“AOCI”):

 

     June 30, 2011  

(Dollars in millions)

   Amortized
Cost
     Total
Gross
Unrealized
Gains
     Gross
Unrealized
Losses-
OTTI(1)
    Gross
Unrealized
Losses-
Other(2)
    Total
Gross
Unrealized
Losses
    Fair
Value
 

Securities available-for-sale:

              

U.S. Treasury debt obligations

   $ 301       $ 10       $ 0      $ 0      $ 0      $ 311   

U.S. Agency debt obligations(3)

     166         10         0        0        0        176   

Collateralized mortgage obligations (“CMOs”):

              

Agency(4)

     12,104         310         0        (2     (2     12,412   

Non-agency

     953         1         (59     (6     (65     889   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Total CMOs

     13,057         311         (59     (8     (67     13,301   

Mortgage-backed securities (“MBS”):

              

Agency(4)

     14,344         452         0        (63     (63     14,733   

Non-agency

     630         1         (57     (1     (58     573   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Total MBS

     14,974         453         (57     (64     (121     15,306   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Asset-backed securities (“ABS”)(5)

     9,769         67         0        (4     (4     9,832   

Other(6)

     489         63         0        (4     (4     548   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Total securities available-for-sale

   $ 38,756       $ 914       $ (116   $ (80   $ (196   $ 39,474   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

 

     December 31, 2010  

(Dollars in millions)

   Amortized
Cost
     Total
Gross
Unrealized
Gains
     Gross
Unrealized
Losses-
OTTI(1)
    Gross
Unrealized
Losses-
Other(2)
    Total
Gross
Unrealized
Losses
    Fair
Value
 

Securities available-for-sale:

              

U.S. Treasury debt obligations

   $ 373       $ 13       $ 0      $ 0      $ 0      $ 386   

U.S. Agency debt obligations(3)

     301         13         0        0        0        314   

Collateralized mortgage obligations (“CMOs”):

              

Agency(4)

     12,303         271         0        (8     (8     12,566   

Non-agency

     1,091         0         (59     (13     (72     1,019   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Total CMOs

     13,394         271         (59     (21     (80     13,585   

Mortgage-backed securities (“MBS”):

              

Agency(4)

     15,721         397         0        (135     (135     15,983   

Non-agency

     735         1         (46     (9     (55     681   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Total MBS

     16,456         398         (46     (144     (190     16,664   

Asset-backed securities (“ABS”)(5)

     9,901         69         0        (4     (4     9,966   

Other(6)

     563         66         0        (7     (7     622   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Total securities available-for-sale

   $ 40,988       $ 830       $ (105   $ (176   $ (281   $ 41,537   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

 

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(1) 

Represents the amount of cumulative non-credit other-than-temporary impairment (“OTTI”) losses recorded in AOCI. These losses are included in total gross unrealized losses.

(2) 

Represents the amount of cumulative gross unrealized losses on securities for which we have not recognized OTTI.

(3) 

Consists of debt securities issued by Fannie Mae and Freddie Mac, which had amortized cost of $165 million and $200 million as of June 30, 2011 and December 31, 2010, respectively, and fair value of $175 million and $213 million as of June 30, 2011 and December 31, 2010, respectively.

(4) 

Consists of mortgage-backed securities issued by Fannie Mae, Freddie Mac and Ginnie Mae, which had amortized cost of $15.5 billion, $7.7 billion and $3.2 billion, respectively, and fair value of $15.9 billion, $7.9 billion and $3.3 billion, respectively, as of June 30, 2011. The book value of Fannie Mae, Freddie Mac and Ginnie Mae investments exceeded 10% of our stockholders’ equity as of June 30, 2011.

(5) 

Consists of securities collateralized by credit card loans, auto dealer and floor plan inventory loans and leases, student loans, auto loans, equipment loans and other. The distribution among these asset types was approximately 71.0% credit card loans, 9.3% auto dealer floor plan inventory loans and leases, 6.9% student loans, 6.6% auto loans, 1.9% equipment loans, and 4.3% of other loans as of June 30, 2011. In comparison, the distribution was approximately 77.8% credit card loans, 5.6% auto dealer floor plan inventory loans and leases, 7.2% student loans, 6.7% auto loans, 2.5% equipment loans and 0.2% home equity lines of credit as of December 31, 2010. Approximately 91.7% of the securities in our asset-backed security portfolio were rated AAA or its equivalent as of June 30, 2011, compared with 90.1% as of December 31, 2010. Our asset-backed security portfolio also includes commercial mortgage-backed securities issued by Fannie Mae, Freddie Mac and Ginnie Mae which had an amortized cost of $8 million, $158 million and $55 million, respectively, and fair values of $9 million, $161 million and $56 million, respectively, as of June 30, 2011.

(6) 

Consists of municipal securities and equity investments related primarily to CRA activities.

Securities Available for Sale in a Gross Unrealized Loss Position

The table below provides, by major security type, information about our available-for-sale securities in a gross unrealized loss position and the length of time that individual securities have been in a continuous unrealized loss position as of June 30, 2011 and December 31, 2010:

 

     June 30, 2011  
      Less than 12 Months     12 Months or Longer     Total  

(Dollars in millions)

   Fair Value      Gross
Unrealized
Losses
    Fair Value      Gross
Unrealized
Losses
    Fair Value      Gross
Unrealized
Losses
 

Securities available-for-sale:

               

U.S. Treasury debt obligations

   $ 0       $ 0      $ 0       $ 0      $ 0       $ 0   

U.S. Agency debt obligations(1)

     0         0        0         0        0         0   

CMOs:

               

Agency(2)

     255         (1     240         (1     495         (2

Non-agency

     149         (6     643         (59     792         (65
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total CMOs

     404         (7     883         (60     1,287         (67

MBS:

               

Agency(2)

     4,036         (62     149         (1     4,185         (63

Non-agency

     36         0        515         (58     551         (58
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total MBS

     4,072         (62     664         (59     4,736         (121
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total ABS(3)

     868         (2     98         (2     966         (4

Other

     247         (1     64         (3     311         (4
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total securities available-for-sale in a gross unrealized loss position

   $ 5,591       $ (72   $ 1,709       $ (124   $ 7,300       $ (196
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

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     December 31, 2010  
      Less than 12 Months     12 Months or Longer     Total  

(Dollars in millions)

   Fair Value      Gross
Unrealized
Losses
    Fair Value      Gross
Unrealized
Losses
    Fair Value      Gross
Unrealized
Losses
 

Securities available-for-sale:

               

U.S. Treasury debt obligations

   $ 0       $ 0      $ 0       $ 0      $ 0       $ 0   

U.S. Agency debt obligations(1)

     0         0        0         0        0         0   

CMOs:

               

Agency(2)

     1,253         (7     279         (1     1,532         (8

Non-agency

     17         0        976         (72     993         (72
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total CMOs

     1,270         (7     1,255         (73     2,525         (80

MBS:

               

Agency(2)

     5,318         (134     177         (1     5,495         (135

Non-agency

     28         0        590         (55     618         (55
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total MBS

     5,346         (134     767         (56     6,113         (190

Total ABS

     1,411         (2     33         (2     1,444         (4

Other

     300         (1     80         (6     380         (7
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total securities available-for-sale in a gross unrealized loss position

   $ 8,327       $ (144   $ 2,135       $ (137   $ 10,462       $ (281
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

(1) 

Consists of debt securities issued by Fannie Mae and Freddie Mac.

(2) 

Consists of mortgage-backed securities issued by Fannie Mae, Freddie Mac and Ginnie Mae.

(3) 

Consists of commercial mortgage-backed securities issued by Freddie Mac and Ginnie Mae.

The gross unrealized losses on our available-for-sale securities of $196 million as of June 30, 2011 relate to approximately 262 individual securities. Our investments in non-agency CMOs, non-agency residential MBS and non-agency asset-backed securities accounted for $127 million, or 65%, of total gross unrealized losses as of June 30, 2011. Of the $196 million gross unrealized losses as of June 30, 2011, $124 million related to securities that had been in a loss position for more than 12 months. As discussed in more detail below, we conduct periodic reviews of all securities with unrealized losses to assess whether the impairment is other-than-temporary. Based on our assessments, we have recorded OTTI for a portion of our non-agency CMO and non-agency residential MBS, which is discussed in more detail later in this footnote.

Maturities and Yields of Securities Available-for-Sale

The following table summarizes the remaining scheduled contractual maturities, assuming no prepayments, of our investment securities as of June 30, 2011:

 

     June 30, 2011  

(Dollars in millions)

   Amortized
Cost
     Fair Value  

Due in 1 year or less

   $ 2,388       $ 2,397   

Due after 1 year through 5 years

     6,899         6,964   

Due after 5 years through 10 years

     1,304         1,337   

Due after 10 years(1)

     28,165         28,776   
  

 

 

    

 

 

 

Total

   $ 38,756       $ 39,474   
  

 

 

    

 

 

 

 

(1) 

Investments with no stated maturities, which consist of equity securities, are included with contractual maturities due after 10 years.

 

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Because borrowers may have the right to call or prepay certain obligations, the expected maturities of our securities are likely to differ from the scheduled contractual maturities presented above. The table below summarizes, by major security type, the expected maturities and the weighted average yields of our investment securities as of June 30, 2011. Actual calls or prepayment rates may differ from our estimates, which may cause the actual maturities of our investment securities to differ from the expected maturities presented below.

 

    June 30, 2011  
    Due in 1 Year
or Less
    Due > 1 Year
through
5 Years
    Due > 5 Years
through
10 Years
    Due > 10 Years     Total  

(Dollars in millions)

  Amount     Average
Yield(1)
    Amount     Average
Yield(1)
    Amount     Average
Yield(1)
    Amount     Average
Yield(1)
    Amount     Average
Yield(1)
 

Fair value of securities available- for-sale:

                   

U.S. Treasury debt obligations

  $ 186        1.83   $ 125        4.27   $ 0        0   $ 0        0   $ 311        2.76

U.S. Agency debt obligations(2)

    36        4.38        140        4.56        0        0        0        0        176        4.52   

CMOs:

                   

Agency(3)

    751        5.51        6,392        4.39        5,247        4.25        22        4.64        12,412        4.40   

Non-agency

    214        5.90        373        5.42        264        5.50        38        9.03        889        5.70   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total CMOs

    965        5.60        6,765        4.45        5,511        4.32        60        7.49        13,301        4.49   

MBS:

                   

Agency(3)

    86        5.18        4,532        4.87        9,739        4.37        376        4.19        14,733        4.52   

Non-agency

    0        0        316        6.03        257        5.88        0        0        573        5.96   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total MBS

    86        5.18        4,848        4.95        9,996        4.42        376        4.19        15,306        4.58   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total ABS(4)

    1,859        2.11        7,422        2.24        511        4.08        40        2.08        9,832        2.31   

Other(5)

    294        1.78        70        4.17        4        4.62        180        1.41        548        2.06   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total securities available for sale

  $ 3,426        3.14   $ 19,370        3.71   $ 16,022        4.37   $ 656        3.81   $ 39,474        3.93
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Amortized cost of securities available-for-sale

  $ 3,400        $ 18,989        $ 15,767        $ 600        $ 38,756     
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

 

(1) 

Yields are calculated based on the amortized cost of the securities.

(2) 

Consists of debt securities issued by Fannie Mae and Freddie Mac.

(3) 

Consists of mortgage-backed securities issued by Fannie Mae, Freddie Mac and Ginnie Mae.

(4) 

Consists of commercial mortgage-backed securities issued by Fannie Mae, Freddie Mac and Ginnie Mae.

(5) 

Yields of tax-exempt securities are calculated on a fully taxable-equivalent (FTE) basis.

 

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Credit Ratings

Approximately 93% and 92% of our total investment securities portfolio was rated AAA or its equivalent as of June 30, 2011 and December 31, 2010, respectively, while approximately 4% were below investment grade as of June 30, 2011 and December 31, 2010. All of our agency securities were rated AAA as of June 30, 2011 and December 31, 2010. The table below presents information on the credit ratings of our non-agency CMOs and non-agency MBS, which account for the substantial majority of the unrealized losses related to our investment securities portfolio as of June 30, 2011 and December 31, 2010:

 

     June 30, 2011     December 31, 2010  
     % of
Investment
Securities
Portfolio(1)
    AAA     Other
Investment
Grade
    Below
Investment
Grade or Not
Rated
    % of
Investment
Securities
Portfolio(1)
    AAA     Other
Investment
Grade
    Below
Investment
Grade or Not
Rated
 

Non-agency CMOs

     2     0     12     88     3     1     11     88

Non-agency MBS

     2        0        5        95        2        0        6        94   

 

(1) 

Calculated based on the amortized cost of the major security type presented divided by the amortized cost of our total investment securities portfolio as of the end of each period.

Other-Than-Temporary Impairment

We evaluate all securities in an unrealized loss position at least quarterly, and more often as market conditions require, to assess whether the impairment is other-than-temporary. Our OTTI assessment is a subjective process requiring the use of judgments and assumptions. Accordingly, we consider a number of qualitative and quantitative criteria in our assessment, including the extent and duration of the impairment; recent events specific to the issuer and/or industry to which the issuer belongs; the payment structure of the security; external credit ratings and the failure of the issuer to make scheduled interest or principal payments; the value of underlying collateral; our intent and ability to hold the security; and current market conditions.

We assess, measure and recognize OTTI in accordance with the accounting guidance for recognition and presentation of OTTI. Under this guidance, if we determine that impairment on our debt securities is other-than-temporary and we have made the decision to sell the security or it is more likely than not that we will be required to sell the security prior to recovery of its amortized cost basis, we recognize the entire portion of the impairment in earnings. If we have not made a decision to sell the security and we do not expect that we will be required to sell the security prior to recovery of the amortized cost basis, we recognize only the credit component of OTTI in earnings. The remaining unrealized loss due to factors other than credit, or the non-credit component, is recorded in AOCI. We determine the credit component based on the difference between the security’s amortized cost basis and the present value of its expected future cash flows, discounted based on the purchase yield. The non-credit component represents the difference between the security’s fair value and the present value of expected future cash flows.

The following table summarizes other-than-temporary impairment losses on debt securities recognized in earnings for the three and six months ended June 30, 2011 and 2010:

 

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

(Dollars in millions)

     2011         2010         2011         2010    

Total OTTI losses

   $ 27      $ 27      $ 50      $ 77   

Less: Non-credit component of OTTI losses recorded in OCI

     (21     (1     (41     (20
  

 

 

   

 

 

   

 

 

   

 

 

 

Net OTTI losses recognized in earnings

   $ 6      $ 26      $ 9      $ 57   
  

 

 

   

 

 

   

 

 

   

 

 

 

As indicated in the table above, we recorded credit related losses in earnings totaling $6 million and $26 million for the three months ended June 30, 2011 and 2010, respectively, and $9 million and $57 million for the six

 

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months ended June 30, 2011 and 2010, respectively. The cumulative non-credit related portion of OTTI on these securities recorded in AOCI totaled $116 million and $105 million as of June 30, 2011 and December 31, 2010, respectively. We estimate the portion of loss attributable to credit using a discounted cash flow model, and we estimate the expected cash flows from the underlying collateral using industry-standard third party modeling tools. These tools take into consideration security specific delinquencies, product specific delinquency roll rates and expected severities. Key assumptions used in estimating the expected cash flows include default rates, loss severity and prepayment rates. Assumptions used can vary widely based on the collateral underlying the securities and are influenced by factors such as collateral type, loan interest rate, geographical location of the borrower, and other borrower characteristics.

We believe the gross unrealized losses related to all other securities of $80 million as of June 30, 2011 are attributable to changes in market interest rates and asset spreads. We therefore do not expect to incur any credit losses related to these securities. In addition, we have no intent to sell these securities with unrealized losses and it is not more likely than not that we will be required to sell these securities prior to recovery of the amortized cost. Accordingly, we have concluded that the impairment on these securities as of June 30, 2011 is not other-than-temporary.

The table below presents activity for the three and six months ended June 30, 2011 and 2010, respectively, related to the credit component recognized in earnings on investment debt securities for which a portion of the OTTI loss, the non-credit component, was recorded in AOCI:

 

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

(Dollars in millions)

   2011      2010     2011     2010  

Beginning balance

   $ 50       $ 34      $ 49      $ 32   

Additions for the credit component of OTTI on debt securities for which OTTI losses were not previously recognized(2)

     2         2        3        7   

Additions for the credit component of OTTI on debt securities for which OTTI losses were previously recognized

     4         7        6        14   

Reductions related to debt securities for which the non-credit component previously recorded in AOCI was recognized in earnings because of our intent to sell the securities and for securities sold during the period(1)

     0         (2     (2     (12
  

 

 

    

 

 

   

 

 

   

 

 

 

Ending balance

   $ 56       $ 41      $ 56      $ 41   
  

 

 

    

 

 

   

 

 

   

 

 

 

 

(1) 

For the three and six months ended June 30, 2011, no OTTI losses were recognized in earnings on securities for which no portion of the OTTI losses remained in AOCI. For the three and six months ended June 30, 2010, we recognized $17 million and $36 million, respectively, on securities for which no portion of the OTTI losses remained in AOCI. OTTI losses related to these debt securities are excluded from these amounts.

(2)

Includes $4 million of OTTI recorded in the first quarter of 2010 on negative amortization bonds classified as held to maturity.

 

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AOCI, Net of Taxes, Related to Securities Available for Sale

The table below presents the changes in AOCI, net of taxes, related to our available-for-sale securities. The net unrealized gains (losses) represent the fair value adjustments recorded on available-for-sale securities, net of tax, during the period. The net reclassification adjustment for net realized losses (gains) represents the amount of those fair value adjustments, net of tax, that were recognized in earnings due to the sale of an available-for-sale security or the recognition of an impairment loss.

 

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

(Dollars in millions)

       2011              2010            2011          2010    

Beginning balance AOCI related to securities available for sale, net of tax(1)

   $ 311       $ 333       $ 369       $ 186   

Net unrealized gains (losses), net of tax(2)

     164         337         109         509   

Net realized losses (gains) reclassified from AOCI into earnings, net of tax(3)

     3         4         0         (21
  

 

 

    

 

 

    

 

 

    

 

 

 

Ending balance AOCI related to securities available for sale, net of tax

   $ 478       $ 674       $ 478       $ 674   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) 

Net of tax benefit (expense) of $(171) million and $(183) million for the three months ended June 30, 2011 and 2010, respectively, and $(203) million and $(102) million for the six months ended June 30, 2011 and 2010, respectively.

(2) 

Net of tax benefit (expense) of $(90) million and $(185) million for the three months ended June 30, 2011 and 2010, respectively, and $(60) million and $(280) million for the six months ended June 30, 2011 and 2010, respectively.

(3) 

Net of tax (benefit) expense of $2 million and $2 million for the three months ended June 30, 2011 and 2010, respectively, and $0 and $(11) million for the six months ended June 30, 2011 and 2010, respectively.

Realized Gains and Losses on Securities Available for Sale

The following table presents the gross realized gains and losses on the sale and redemption of available-for-sale securities recognized in earnings for the three and six months ended June 30, 2011 and 2010. The gross realized investment losses presented below exclude credit losses recognized in earnings attributable to OTTI. We also present the proceeds from the sale of available-for-sale investment securities for the periods presented.

 

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

(Dollars in millions)

       2011             2010          2011     2010  

Gross realized investment gains

   $ 9      $ 14       $ 14      $ 108   

Gross realized investment losses

     (1     0         (3     0   
  

 

 

   

 

 

    

 

 

   

 

 

 

Net realized gains

   $ 8      $ 14       $ 11      $ 108   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total proceeds from sales

   $ 1,724      $ 1,632       $ 2,570      $ 9,061   
  

 

 

   

 

 

    

 

 

   

 

 

 

Securities Pledged

As part of our liquidity management strategy, we pledge securities to secure borrowings from the Federal Home Loan Bank (“FHLB”) and the Federal Reserve Bank. We also pledge securities to secure trust and public deposits and for other purposes as required or permitted by law. We had securities pledged with a fair value of $10.7 billion and $10.0 billion as of June 30, 2011 and December 31, 2010, respectively. As of June 30, 2011, we pledged securities with the ability of the secured party to repledge of $1.4 billion and $20 million of cash collateral has been posted.

 

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Table of Contents

 

NOTE 5—LOANS

 

Loan Portfolio Composition

Our total loan portfolio consists of loans we own and loans underlying our securitization trusts. The table below presents the composition of our held-for-investment loan portfolio, including restricted loans for securitization investors, as of June 30, 2011 and December 31, 2010. Our loan portfolio consists of credit card, consumer banking and commercial banking loans. Credit card loans consist of domestic and international loans as well as installment loans. Consumer banking loans consist of automobile, home, and retail banking loans. Commercial banking loans consist of commercial and multifamily real estate, middle market, specialty lending and small-ticket commercial real estate loans.

 

(Dollars in millions)

   June 30,
2011
     December 31,
2010
 

Credit Card business:

     

Domestic credit card loans

   $ 51,236       $ 49,979   

International credit card loans

     8,709         7,513   
  

 

 

    

 

 

 

Total credit card loans

     59,945         57,492   
  

 

 

    

 

 

 

Domestic installment loans

     2,758         3,870   

International installment loans

     2         9   
  

 

 

    

 

 

 

Total installment loans

     2,760         3,879   
  

 

 

    

 

 

 

Total credit card

     62,705         61,371   
  

 

 

    

 

 

 

Consumer Banking business:

     

Automobile

     19,223         17,867   

Home loans

     11,323         12,103   

Other retail

     4,046         4,413   
  

 

 

    

 

 

 

Total consumer banking

     34,592         34,383   
  

 

 

    

 

 

 

Commercial Banking business:

     

Commercial and multifamily real estate(1)

     14,035         13,396   

Middle market

     11,404         10,484   

Specialty lending

     4,122         4,020   
  

 

 

    

 

 

 

Total commercial lending

     29,561         27,900   

Small-ticket commercial real estate

     1,642         1,842   
  

 

 

    

 

 

 

Total commercial banking

     31,203         29,742   

Other:

     

Other loans

     465         451   
  

 

 

    

 

 

 

Total loans

   $ 128,965       $ 125,947   
  

 

 

    

 

 

 

 

(1) 

Includes construction loans and land development loans totaling $2.1 billion as of June 30, 2011 and $2.4 billion as of December 31, 2010.

Credit Quality

We closely monitor economic conditions and loan performance trends to manage and evaluate our exposure to credit risk. Trends in delinquency ratios are an indicator, among other considerations, of credit risk within our loan portfolios. The level of nonperforming assets represents another indicator of the potential for future credit losses. Accordingly, key metrics we track and use in evaluating the credit quality of our loan portfolio include delinquency and nonperforming asset rates, as well as charge-off rates and our internal risk ratings of commercial loans.

 

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Delinquent and Nonperforming Loans

The entire balance of a loan is considered contractually delinquent if the minimum required payment is not received by the first statement cycle date equal to or following the due date specified on the customer’s billing statement. Delinquency is reported on loans that are 30 or more days past due. Interest and fees continue to accrue on past due loans until the date the loan is placed on nonaccrual status, if applicable. We generally place loans on nonaccrual status when we believe the collectability of interest and principal is not reasonably assured.

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. We do not report loans accounted for under the fair value option and loans held for sale as nonperforming. Our policies for classifying loans as nonperforming, by loan category, are as follows:

 

   

Credit card loans: As permitted by regulatory guidance issued by the Federal Financial Institutions Examination Council (“FFIEC”), our policy is generally to exempt credit card loans from being classified as nonperforming as these loans are generally charged-off in the period the account becomes 180 days past due. Consistent with industry conventions, we generally continue to accrue interest and fees on delinquent credit card loans until the loans are charged-off. When we do not expect full payment of billed finance charges and fees, we reduce the balance of the credit card loan by the estimated uncollectible portion of any billed finance charges and fees and exclude this amount from revenue. Installment loans are included in our credit card segment and classified as nonperforming when the loan is 120 days past due.

 

   

Consumer banking loans: We classify other non-credit card consumer loans as nonperforming at the earlier of the date when we determine that the collectability of interest or principal on the loan is not reasonably assured or in the period in which the loan becomes 90 days past due for automobile, home loans and unsecured small business revolving lines of credit and 120 days past due for all other non-credit card consumer loans.

 

   

Commercial banking loans: We classify commercial loans as nonperforming at the earlier of the date we determine that the collectability of interest or principal on the loan is not reasonably assured or in the period that the loan becomes 90 days past due.

 

   

Modified loans and troubled debt restructurings: Modified loans, including TDRs, that are current at the time of the restructuring remain on accrual status if there is demonstrated performance prior to the restructuring and continued performance under the modified terms is expected. Otherwise, the modified loan is classified as nonperforming and placed on nonaccrual status until the borrower demonstrates a sustained period of performance over several payment cycles, generally six months of consecutive payments, under the modified terms of the loan.

 

   

Purchased credit-impaired (“PCI”) loans: PCI loans primarily include loans acquired from Chevy Chase Bank, which we recorded at fair value at acquisition. Because the initial fair value of these loans included an estimate of credit losses expected to be realized over the remaining lives of the loans, our subsequent accounting for PCI loans differs from the accounting for non-PCI loans. We, therefore, separately track and report PCI loans and exclude these loans from our delinquency and nonperforming loan statistics.

Interest and fees accrued but not collected at the date a loan is placed on nonaccrual status are reversed against earnings. In addition, the amortization of net deferred loan fees is suspended. Interest and fee income is subsequently recognized only upon the receipt of cash payments. However, if there is doubt regarding the ultimate collectability of loan principal, all cash received is applied against the principal balance of the loan. Nonaccrual loans are generally returned to accrual status when all principal and interest is current and repayment of the remaining contractual principal and interest is reasonably assured or when the loan is both well-secured and in the process of collection and collectability is no longer doubtful.

The following table summarizes the payment status of loans in our total loan portfolio, including an aging of delinquent loans, loans 90 days or more past due continuing to accrue interest and loans classified as

 

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nonperforming. We present information below on the credit performance of our loan portfolio, by major loan category, including key metrics that we use in tracking changes in the credit quality of each of our loan portfolios. The delinquency aging includes all past due loans, both performing and nonperforming, as of June 30, 2011 and December 31, 2010.

Loans 90 days or more past due totaled approximately $1.9 billion and $2.2 billion as of June 30, 2011 and December 31, 2010, respectively. Loans classified as nonperforming totaled $1.2 billion as of both June 30, 2011 and December 31, 2010, respectively.

 

    June 30, 2011  

(Dollars in millions)

  Current     30-59
Days
    60-89
Days
    > 90
Days
    Total
Delinquent
Loans
    PCI
Loans
    Total
Loans
    > 90 Days
and
Accruing(1)
    Nonperforming
Loans(1)
 

Credit card:

                 

Domestic credit card and installment loans

  $ 52,196      $ 558      $ 374      $ 866      $ 1,798      $ 0      $ 53,994      $ 866      $ 0   

International credit card and installment loans

    8,249        149        101        212        462        0        8,711        212        0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total credit card

    60,445        707        475        1,078        2,260        0        62,705        1,078        0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Consumer Banking:

                 

Auto

    17,904        823        347        82        1,252        67        19,223        0        81   

Home loans

    6,259        68        41        378        487        4,577        11,323        0        474   

Retail banking

    3,963        22        12        46        80        3        4,046        3        77   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total consumer banking

    28,126        913        400        506        1,819        4,647        34,592        3        632   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Commercial Banking:

                 

Commercial and multifamily real estate

    13,555        20        45        204        269        211        14,035        9        307   

Middle market

    11,017        26        7        67        100        287        11,404        0        129   

Specialty lending

    4,081        24        7        10        41        0        4,122        2        37   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial lending

    28,653        70        59        281        410        498        29,561        11        473   

Small-ticket commercial real estate

    1,590        38        7        7        52        0        1,642        0        8   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial banking

    30,243        108        66        288        462        498        31,203        11        481   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other:

                 

Other loans

    397        20        7        41        68        0        465        0        51   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 119,211      $ 1,748      $ 948      $ 1,913      $ 4,609      $ 5,145      $ 128,965      $ 1,092      $ 1,164   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

% of Total loans

    92.4     1.4     0.7     1.5     3.6     4.0     100.0     0.9     0.9
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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    December 31, 2010  

(Dollars in millions)

  Current     30-59
Days
    60-89
Days
    > 90
Days
    Total
Delinquent
Loans
    PCI
Loans
    Total
Loans
    > 90 Days
and
Accruing(1)
    Nonperforming
Loans(1)
 

Credit card:

                 

Domestic credit card and installment loans

  $ 51,649      $ 558      $ 466      $ 1,176      $ 2,200      $ 0      $ 53,849      $ 1,176      $ 0   

International credit card and installment loans

    7,090        132        97        203        432        0        7,522        203        0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total credit card

    58,739        690        563        1,379        2,632        0        61,371        1,379        0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Consumer Banking:

                 

Auto

    16,414        952        402        99        1,453        0        17,867        0        99   

Home loans

    6,707        65        44        395        504        4,892        12,103        0        486   

Retail banking

    4,218        31        22        40        93        102        4,413        5        91   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total consumer banking

    27,339        1,048        468        534        2,050        4,994        34,383        5        676   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Commercial Banking:

                 

Commercial and multifamily real estate

    12,816        118        31        153        302        278        13,396        14        276   

Middle market

    10,113        34        5        50        89        282        10,484        0        133   

Specialty lending

    3,962        25        7        26        58        0        4,020        0        48   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial lending

    26,891        177        43        229        449        560        27,900        14        457   

Small-ticket commercial real estate

    1,711        74        24        33        131        0        1,842        0        38   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial banking

    28,602        251        67        262        580        560        29,742        14        495   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other:

                 

Other loans

    382        19        5        45        69        0        451        0        54   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 115,062      $ 2,008      $ 1,103      $ 2,220      $ 5,331      $ 5,554      $ 125,947      $ 1,398      $ 1,225   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

% of Total loans

    91.4     1.6     0.9     1.7     4.2     4.4     100.0     1.1     1.0
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) 

Purchased credit-impaired loans are excluded from loans reported as 90 days or more past due and still accruing interest and nonperforming loans.

Charge-Offs

Net charge-offs consist of the unpaid principal balance of loans held for investment that we determine are uncollectible, net of recovered amounts. We exclude accrued and unpaid finance charges and fees and fraud losses from charge-offs. Charge-offs are recorded as a reduction to the allowance for loan and lease losses and subsequent recoveries of previously charged-off amounts are credited to the allowance for loan and lease losses. Costs incurred to recover charged-off loans are recorded as collection expense and included in our consolidated statements of income as a component of other non-interest expense. Our charge-off time frame for loans, which varies based on the loan type, is presented below.

 

   

Credit card loans: We generally charge-off credit card loans when the account is 180 days past due from the statement cycle date. Credit card loans in bankruptcy are charged-off within 30 days of receipt of a complete bankruptcy notification from the bankruptcy court, except for U.K. credit card loans, which are charged-off within 60 days. Credit card loans of deceased account holders are charged-off within 60 days of receipt of notification.

 

   

Consumer banking loans: We generally charge-off consumer loans at the earlier of the date when the account is a specified number of days past due or upon repossession of the underlying collateral. Our charge-off time frame is 180 days for mortgage loans and unsecured small business lines of credit and 120 days for auto and other non-credit card consumer loans. We calculate the charge-off amount for mortgage loans based on the difference between our recorded investment in the loan and the fair value of the underlying property and estimated selling costs as of the date of the charge-off. We update our home value estimates on a regular basis and recognize additional charge-offs for declines in home values below our initial fair value and selling cost estimate at the date mortgage loans are charged-off. Consumer loans in

 

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bankruptcy, except for auto and mortgage loans, generally are charged-off within 40 days of receipt of notification from the bankruptcy court. Auto and home loans in bankruptcy are charged-off in the period that the loan is both 60 days or more past due and 60 days or more past the bankruptcy notification date or in the period the loan becomes 120 days past due for auto loans and 180 days past due for mortgage loans regardless of the bankruptcy notification date. Consumer loans of deceased account holders are charged-off within 60 days of receipt of notification.

 

   

Commercial banking loans: We charge-off commercial loans in the period we determine that the unpaid principal loan amounts are uncollectible.

 

   

Purchased credit-impaired loans: We do not record charge-offs on PCI loans that are performing in accordance with or better than our expectations as of the date of acquisition, as the fair values of these loans already reflect a credit component. We record charge-offs on purchased credit-impaired loans only if actual losses exceed estimated losses incorporated into the fair value recorded at acquisition.

Credit Card

Our credit card loan portfolio is generally highly diversified across millions of accounts and multiple geographies without significant individual exposures. We, therefore, generally manage credit risk on a portfolio basis. The risk in our credit card portfolio is correlated with broad economic trends, such as unemployment rates, gross domestic product (“GDP”) growth, and home values, as well as customer liquidity, which can have a material effect on credit performance. The primary factors we assess in monitoring the credit quality and risk of our credit card portfolio are delinquency and charge-off trends, including an analysis of the migration of loans between delinquency categories over time. The table below displays the geographic profile of our credit card loan portfolio and delinquency statistics as of June 30, 2011 and December 31, 2010. We also present comparative net charge-offs for the three and six months ended June 30, 2011 and 2010.

Credit Card: Risk Profile by Geographic Region and Delinquency Status

 

     June 30, 2011     December 31, 2010  

(Dollars in millions)

   Amount      % of
Total(1)
    Amount      % of
Total(1)
 

Domestic card and installment loans:

          

California

   $ 6,233         9.9   $ 6,242         10.2

Texas

     3,532         5.6        3,633         5.9   

New York

     3,669         5.9        3,599         5.8   

Florida

     3,224         5.1        3,298         5.4   

Illinois

     2,546         4.1        2,403         3.9   

Pennsylvania

     2,432         3.9        2,389         3.9   

Ohio

     2,170         3.5        2,109         3.4   

New Jersey

     2,070         3.3        1,971         3.2   

Michigan

     1,747         2.8        1,716         2.8   

Other

     26,371         42.0        26,489         43.2   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total domestic card and installment loans

     53,994         86.1     53,849         87.7
  

 

 

    

 

 

   

 

 

    

 

 

 

International card and installment loans:

          

United Kingdom

     4,689         7.5        4,102         6.7   

Canada

     4,022         6.4        3,420         5.6   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total international card and installment loans

     8,711         13.9     7,522         12.3
  

 

 

    

 

 

   

 

 

    

 

 

 

Total credit card

   $ 62,705         100.0   $ 61,371         100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

Selected credit metrics:

          

30+ day delinquencies(2)

   $ 2,260         3.60   $ 2,632         4.29

90+ day delinquencies(2)

     1,078         1.72        1,379         2.25   

 

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Table of Contents
     Three Months Ended June 30,  
     2011     2010  

(Dollars in millions)

   Amount      Rate     Amount      Rate  

Net charge-offs:

          

Domestic

   $ 638         4.74   $ 1,308         9.49

International

     155         7.02        155         8.38   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total(3)

   $ 793         5.06   $ 1,463         9.36
  

 

 

    

 

 

   

 

 

    

 

 

 

 

     Six Months Ended June 30,  
     2011     2010  

(Dollars in millions)

   Amount      Rate     Amount      Rate  

Net charge-offs:

          

Domestic

   $ 1,442         5.45   $ 2,828         10.00

International

     280         6.39        328         8.61   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total(3)

   $ 1,722         5.59   $ 3,156         9.84
  

 

 

    

 

 

   

 

 

    

 

 

 

 

(1) 

Percentages by geographic region within the domestic and international credit card portfolios are calculated based on the total held for investment credit card and installment loans as of the end of the reported period.

(2) 

Delinquency rates calculated by dividing delinquent credit card and installment loans by the total balance of credit card and installment loans held for investment as of the end of the reported period.

(3) 

Calculated by dividing annualized net charge-offs by average credit card loans held for investment during the three and six months ended June 30, 2011 and 2010.

The 30+ day delinquency rate for our credit card loan portfolio decreased to 3.60% as of June 30, 2011, from 4.29% as of December 31, 2010, reflecting strong underlying credit improvement trends.

Consumer Banking

Our consumer banking loan portfolio consists of auto, home loan and retail banking loans. Similar to our credit card loan portfolio, the risk in our consumer banking loan portfolio is correlated with broad economic trends, such as unemployment rates, GDP growth, and home values, as well as customer liquidity, which can have a material effect on credit performance. Delinquency, nonperforming loans and charge-off trends are key factors we assess in monitoring the credit quality and risk of our consumer banking loan portfolio. The table below displays the geographic profile of our consumer banking loan portfolio, including PCI loans acquired from Chevy Chase Bank. We also present the delinquency and nonperforming loan rates of our consumer banking loan portfolio, excluding PCI loans as of June 30, 2011 and December 31, 2010, and net charge-offs for the three and six months ended June 30, 2011 and 2010.

 

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Consumer Banking: Risk Profile by Geographic Region, Delinquency Status and Performing Status

 

     June 30, 2011  
      Non-PCI Loans     PCI Loans     Total  

(Dollars in millions)

   Loans      % of
Total(1)
    Loans      % of
Total(1)
    Loans      % of
Total(1)
 

Auto:

               

Texas

   $ 3,496         10.1   $ 0         0.0   $ 3,496         10.1

California

     1,487         4.3        0         0.0        1,487         4.3   

Louisiana

     1,367         4.0        0         0.0        1,367         4.0   

Florida

     1,037         3.0        0         0.0        1,037         3.0   

Georgia

     1,007         2.9        0         0.0        1,007         2.9   

New York

     916         2.6        0         0.0        916         2.6   

Illinois

     893         2.6        0         0.0        893         2.6   

Other

     8,953         25.9        67         0.2        9,020         26.1   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total auto

   $ 19,156         55.4   $ 67         0.2   $ 19,223         55.6
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Home loans:

               

New York

   $ 1,908         5.5   $ 274         0.8   $ 2,182         6.3

California

     880         2.5        1,287         3.7        2,167         6.2   

Louisiana

     1,781         5.2        2         0.0        1,783         5.2   

Maryland

     301         0.9        581         1.7        882         2.6   

Virginia

     212         0.6        555         1.6        767         2.2   

New Jersey

     377         1.1        254         0.7        631         1.8   

Other

     1,287         3.7        1,624         4.7        2,911         8.4   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total home loans

   $ 6,746         19.5   $ 4,577         13.2   $ 11,323         32.7
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Retail banking:

               

Louisiana

   $ 1,610         4.7   $ 0         0.0   $ 1,610         4.7

Texas

     996         2.9        0         0.0        996         2.9   

New York

     868         2.5        0         0.0        868         2.5   

New Jersey

     330         1.0        0         0.0        330         1.0   

Maryland

     73         0.2        2         0.0        75         0.2   

Virginia

     45         0.1        1         0.0        46         0.1   

Other

     121         0.3        0         0.0        121         0.3   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total retail banking

   $ 4,043         11.7   $ 3         0.0   $ 4,046         11.7
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total consumer banking

   $ 29,945         86.6   $ 4,647         13.4   $ 34,592         100.0
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

     June 30, 2011  
     Auto     Home Loans     Retail Banking     Total Consumer
Banking
 

(Dollars in millions)

   Amount      Rate     Amount      Rate     Amount      Rate     Amount      Rate  

Credit performance:(2)

                    

30+ day delinquencies

   $ 1,252         6.51   $ 487         4.30   $ 80         1.99   $ 1,819         5.26

90+ day delinquencies

     82         0.43        378         3.34        46         1.14        506         1.46   

Nonperforming loans

     81         0.42        474         4.19        77         1.90        632         1.83   

 

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Table of Contents
     December 31, 2010  
     Non-PCI Loans     PCI Loans     Total  

(Dollars in millions)

   Loans      % of
Total(1)
    Loans      % of
Total(1)
    Loans      % of
Total(1)
 

Auto:

               

Texas

   $ 3,161         9.2   $ 0         0.0   $ 3,161         9.2

California

     1,412         4.1        0         0.0        1,412         4.1   

Louisiana

     1,334         3.9        0         0.0        1,334         3.9   

Florida

     954         2.8        0         0.0        954         2.8   

Georgia

     908         2.6        0         0.0        908         2.6   

New York

     894         2.6        0         0.0        894         2.6   

Illinois

     843         2.5        0         0.0        843         2.5   

Other

     8,361         24.3        0         0.0        8,361         24.3   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total auto

   $ 17,867         52.0   $ 0         0.0   $ 17,867         52.0
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Home loans:

               

New York

   $ 2,069         6.0   $ 311         0.9   $ 2,380         6.9

California

     959         2.8        1,380         4.0        2,339         6.8   

Louisiana

     1,776         5.2        2         0.0        1,778         5.2   

Maryland

     281         0.8        605         1.8        886         2.6   

Virginia

     200         0.6        591         1.7        791         2.3   

New Jersey

     423         1.2        278         0.8        701         2.0   

Other

     1,503         4.4        1,725         5.0        3,228         9.4   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total home loans

   $ 7,211         21.0   $ 4,892         14.2   $ 12,103         35.2
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Retail banking:

               

Louisiana

   $ 1,754         5.1   $ 0         0.0   $ 1,754         5.1

Texas

     1,125         3.3        0         0.0        1,125         3.3   

New York

     909         2.6        0         0.0        909         2.6   

New Jersey

     357         1.0        0         0.0        357         1.0   

Maryland

     58         0.2        31         0.1        89         0.3   

Virginia

     35         0.1        17         0.1        52         0.2   

Other

     73         0.2        54         0.1        127         0.3   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total retail banking

   $ 4,311         12.5   $ 102         0.3   $ 4,413         12.8
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total consumer banking

   $ 29,389         85.5   $ 4,994         14.5   $ 34,383         100.0
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

     December 31, 2010  
     Auto     Home Loans     Retail Banking     Total Consumer
Banking
 

(Dollars in millions)

   Amount      Rate     Amount      Rate     Amount      Rate     Amount      Rate  

Credit performance:(2)

                    

30+ day delinquencies

   $ 1,453         8.13   $ 504         4.16   $ 93         2.11   $ 2,050         5.96

90+ day delinquencies

     99         0.55        395         3.27        40         0.91        534         1.54   

Nonperforming loans

     99         0.55        486         4.01        91         2.07        676         1.97   
     Three Months Ended June 30, 2011  
     Auto     Home Loans     Retail Banking     Total Consumer
Banking
 

(Dollars in millions)

   Amount      Rate     Amount      Rate     Amount      Rate     Amount      Rate  

Net charge-offs(3)

   $ 52         1.11   $ 17         0.60   $ 19         1.73   $ 88         1.01

 

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Table of Contents
     Three Months Ended June 30, 2010  
      Auto     Home Loans     Retail Banking     Total Consumer
Banking
 

(Dollars in millions)

   Amount      Rate     Amount      Rate     Amount      Rate     Amount      Rate  

Net charge-offs(3)

   $ 90         2.09   $ 16         0.46   $ 25         2.11   $ 131         1.47
     Six Months Ended June 30, 2011  
     Auto     Home Loans     Retail Banking     Total Consumer
Banking
 

(Dollars in millions)

   Amount      Rate     Amount      Rate     Amount      Rate     Amount      Rate  

Net charge-offs(3)

   $ 141         1.53   $ 38         0.65   $ 42         2.00   $ 221         1.29
     Six Months Ended June 30, 2010  
     Auto     Home Loans     Retail Banking     Total Consumer
Banking
 

(Dollars in millions)

   Amount      Rate     Amount      Rate     Amount      Rate     Amount      Rate  

Net charge-offs(3)

   $ 223         2.55   $ 51         0.70   $ 52         2.11   $ 326         1.76

 

(1) 

Percentages by geographic region are calculated based on the total held-for-investment consumer banking loans as of the end of the reported period.

(2) 

Credit performance statistics exclude PCI loans, which were recorded at fair value at acquisition. Although PCI loans may be contractually delinquent, we separately track these loans and do not include them in our delinquency and nonperforming loan statistics as the fair value recorded at acquisition included an estimate of credit losses expected to be realized over the remaining lives of the loans.

(3) 

Calculated by dividing annualized net charge-offs by average loans held for investment for the three and six months ended June 30, 2011 and 2010.

Home Loans

Our home loans portfolio consists of both first-lien and second-lien residential mortgage loans. In evaluating the credit quality and risk of our home loans portfolio, we continually monitor a variety of mortgage loan characteristics that may affect the default experience on our overall home loans portfolio, such as vintage, geographic concentrations, lien priority and product type. Certain loan concentrations have experienced higher delinquency rates as a result of the significant decline in home prices since the home price peak in 2006 and rise in unemployment. These loan concentrations include loans originated during 2008, 2007 and 2006 in an environment of decreasing home sales, broadly declining home prices and more relaxed underwriting standards and loans on properties in Arizona, California, Florida and Nevada, which have experienced the most severe decline in home prices. The following table presents the distribution of our home loans portfolio as of June 30, 2011 and December 31, 2010 based on selected key risk characteristics.

 

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Table of Contents

Home Loans: Risk Profile by Vintage, Geography, Lien Priority and Interest Rate Type

 

     June 30, 2011  
     Non-PCI Loans     PCI Loans     Total Home Loans  

(Dollars in millions)

   Amount      % of
Total(1)
    Amount      % of
Total(1)
    Amount      % of
Total(1)
 

Origination year:

               

< = 2005

   $ 4,390         38.7   $ 1,752         15.5   $ 6,142         54.2

2006

     766         6.8        1,061         9.3        1,827         16.1   

2007

     563         5.0        1,421         12.5        1,984         17.5   

2008

     278         2.5        336         3.0        614         5.5   

2009

     262         2.3        7         0.1        269         2.4   

2010

     361         3.2        0         0.0        361         3.2   

2011

     126         1.1        0         0.0        126         1.1   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 6,746         59.6   $ 4,577         40.4   $ 11,323         100.0
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Geographic concentration:(2)

               

New York

   $ 1,908         16.9   $ 274         2.4   $ 2,182         19.3

California

     880         7.8        1,287         11.4        2,167         19.2   

Louisiana

     1,781         15.7        2         0.0        1,783         15.7   

Maryland

     301         2.7        581         5.1        882         7.8   

Virginia

     212         1.9        555         4.9        767         6.8   

New Jersey

     377         3.3        254         2.2        631         5.5   

Texas

     495         4.4        30         0.3        525         4.7   

Florida

     128         1.1        263         2.3        391         3.4   

District of Columbia

     79         0.6        136         1.2        215         1.8   

Washington

     69         0.6        99         0.9        168         1.5   

Connecticut

     88         0.8        70         0.6        158         1.4   

Other

     428         3.8        1,026         9.1        1,454         12.9   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 6,746         59.6   $ 4,577         40.4   $ 11,323         100.0
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Lien type:

               

1st lien

   $ 5,604         49.5   $ 4,012         35.4   $ 9,602         84.9

2nd lien

     1,142         10.1        565         5.0        1,721         15.1   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 6,746         59.6   $ 4,577         40.4   $ 11,323         100.0
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Interest rate type:

               

Fixed rate

   $ 2,892         25.6   $ 110         0.9   $ 3,002         26.5

Adjustable rate

     3,854         34.0        4,467         39.5        8,321         73.5   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 6,746         59.6   $ 4,577         40.4   $ 11,323         100.0
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

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Table of Contents
     December 31, 2010  
     Non-PCI Loans     PCI Loans     Total Home Loans  

(Dollars in millions)

   Amount      % of
Total(1)
    Amount      % of
Total(1)
    Amount      % of
Total(1)
 

Origination year:

               

< = 2005

   $ 4,801         39.7   $ 1,852         15.3   $ 6,653         55.0

2006

     848         7.0        1,133         9.3        1,981         16.3   

2007

     609         5.0        1,527         12.6        2,136         17.6   

2008

     305         2.5        371         3.1        676         5.6   

2009

     288         2.4        9         0.1        297         2.5   

2010

     360         3.0        0         0.0        360         3.0   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 7,211         59.6   $ 4,892         40.4   $ 12,103         100.0
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Geographic concentration:(2)

               

New York

   $ 2,069         17.1   $ 311         2.6   $ 2,380         19.7

California

     959         7.9        1,380         11.4        2,339         19.3   

Louisiana

     1,776         14.7        2         0.0        1,778         14.7   

Maryland

     281         2.3        605         5.0        886         7.3   

Virginia

     200         1.7        591         4.9        791         6.6   

New Jersey

     423         3.5        278         2.3        701         5.8   

Texas

     491         4.1        32         0.3        523         4.4   

Florida

     139         1.1        290         2.4        429         3.5   

District of Columbia

     77         0.6        149         1.2        226         1.8   

Connecticut

     110         0.9        85         0.7        195         1.6   

Other

     686         5.7        1,169         9.6        1,855         15.3   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 7,211         59.6   $ 4,892         40.4   $ 12,103         100.0
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Lien type:

               

1st lien

   $ 6,015         49.7   $ 4,303         35.5   $ 10,318         85.2

2nd lien

     1,196         9.9        589         4.9        1,785         14.8   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 7,211         59.6   $ 4,892         40.4   $ 12,103         100.0
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Interest rate type:

               

Fixed rate

   $ 3,548         29.3   $ 182         1.5   $ 3,730         30.8

Adjustable rate

     3,663         30.3        4,710         38.9        8,373         69.2   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 7,211         59.6   $ 4,892         40.4   $ 12,103         100.0
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

(1) 

Percentages within each risk category calculated based on total held for investment home loans.

(2) 

Represents the top ten states in which we have the highest concentration of home loans.

Commercial Banking

We evaluate the credit risk of commercial loans individually and use a risk-rating system to determine the credit quality of our commercial loans. We assign internal risk grades to loans based on relevant information about the ability of borrowers to service their debt. In determining the risk rating of a particular loan, among the factors considered are the borrower’s current financial condition, historical credit performance, projected future credit performance, prospects for support from financially responsible guarantors, the estimated realizable value of any collateral and current economic trends. The ratings scale based on our internal risk-rating system is as follows:

 

   

Noncriticized: Loans that have not been designated as criticized, frequently referred to as “pass” loans.

 

   

Criticized performing: Loans in which the financial condition of the obligor is stressed, affecting earnings, cash flows or collateral values. The borrower currently has adequate capacity to meet near-term obligations; however, the stress, left unabated, may result in deterioration of the repayment prospects at some future date.

 

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Table of Contents
   

Criticized nonperforming: Loans that are not adequately protected by the current sound worth and paying capacity of the obligor or the collateral pledged, if any. Loans classified as criticized nonperforming have a well-defined weakness, or weaknesses, which jeopardize the repayment of the debt. These loans are characterized by the distinct possibility that we will sustain a credit loss if the deficiencies are not corrected.

We use our internal risk-rating system for regulatory reporting, determining the frequency of review of the credit exposures and evaluation and determination of the allowance for commercial loans. Loans of $1 million or more designated as criticized performing and criticized nonperforming are reviewed quarterly by management for further deterioration or improvement to determine if they are appropriately classified/graded and whether impairment exists. All other loans greater than $1 million are specifically reviewed at least annually to determine the appropriate loan grading. In addition, during the renewal process of any loan, as well if a loan becomes past due, we evaluate the risk rating.

The following table presents the geographic distribution and internal risk ratings of our commercial loan portfolio as of June 30, 2011 and December 31, 2010.

Commercial Banking: Risk Profile by Geographic Region and Internal Risk Rating(1)

 

    June 30, 2011  

(Dollars in millions)

  Commercial
&
Multifamily
Real Estate
    % of
Total(2)
    Middle
Market
    % of
Total(2)
    Specialty
Lending
    % of
Total(2)
    Small-ticket
Commercial
Real Estate
    % of
Total(2)
    Total
Commercial
    % of
Total(2)
 

Geographic concentration:(3)

                   

Non-PCI loans:

                   

Northeast

  $ 11,228        80.0   $ 3,339        29.3   $ 1,550        37.6   $ 1,019        62.1   $ 17,136        54.9

Mid-Atlantic

    1,137        8.1        823        7.2        188        4.6        64        3.9        2,212        7.1   

South

    1,254        8.9        6,389        56.0        748        18.1        99        6.0        8,490        27.2   

Other

    205        1.5        566        5.0        1,636        39.7        460        28.0        2,867        9.2   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total non-PCI loans

    13,824        98.5        11,117        97.5        4,122        100.0        1,642        100.0        30,705        98.4   

PCI loans

    211        1.5        287        2.5        0        0.0        0        0.0        498        1.6   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 14,035        100.0   $ 11,404        100.0   $ 4,122        100.0   $ 1,642        100.0   $ 31,203        100.0
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Internal risk rating:(4)

                   

Non-PCI loans:

                   

Noncriticized

  $ 12,462        88.8   $ 10,387        91.1   $ 4,020        97.5   $ 1,590        96.8   $ 28,459        91.2

Criticized performing

    1,056        7.5        600        5.3        65        1.6        44        2.7        1,765        5.7   

Criticized nonperforming

    306        2.2        130        1.1        37        0.9        8        0.5        481        1.5   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total non-PCI loans

    13,824        98.5        11,117        97.5        4,122        100.0        1,642        100.0        30,705        98.4   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

PCI loans:

                   

Noncriticized

  $ 127        0.9   $ 250        2.2   $ 0        0.0   $ 0        0.0   $ 377        1.2

Criticized performing

    84        0.6        37        0.3        0        0.0        0        0.0        121        0.4   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total PCI loans

    211        1.5        287        2.5        0        0.0        0        0.0        498        1.6   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 14,035        100.0   $ 11,404        100.0   $ 4,122        100.0   $ 1,642        100.0   $ 31,203        100.0
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents
    December 31, 2010  

(Dollars in millions)

  Commercial
&
Multifamily
Real Estate
    % of
Total(2)
    Middle
Market
    % of
Total(2)
    Specialty
Lending
    % of
Total(2)
    Small-ticket
Commercial
Real Estate
    % of
Total(2)
    Total
Commercial
    % of
Total(2)
 

Geographic concentration:(3)

                   

Non-PCI loans:

                   

Northeast

  $ 10,849        81.0   $ 3,240        30.9   $ 1,548        38.5   $ 1,137        61.7   $ 16,774        56.4

Mid-Atlantic

    720        5.4        960        9.2        185        4.6        71        3.9        1,936        6.5   

South

    1,315        9.8        5,191        49.5        733        18.2        119        6.5        7,358        24.7   

Other

    234        1.8        811        7.7        1,554        38.7        515        27.9        3,114        10.5   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total non-PCI loans

    13,118        98.0        10,202        97.3        4,020        100.0        1,842        100.0        29,182        98.1   

PCI loans

    278        2.0        282        2.7        0        0.0        0        0.0        560        1.9   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 13,396        100.0   $ 10,484        100.0   $ 4,020        100.0   $ 1,842        100.0   $ 29,742        100.0
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Internal risk rating:(4)

                   

Non-PCI loans:

                   

Noncriticized

  $ 11,611        86.7   $ 9,445        90.1   $ 3,897        96.9   $ 1,710        92.8   $ 26,663        89.6

Criticized performing

    1,231        9.2        624        6.0        75        1.9        95        5.2        2,025        6.8   

Criticized nonperforming

    276        2.1        133        1.2        48        1.2        37        2.0        494        1.7   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total non-PCI loans

    13,118        98.0        10,202        97.3        4,020        100.0        1,842        100.0        29,182        98.1   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

PCI loans:

                   

Noncriticized

  $ 186        1.3   $ 235        2.3   $ 0        0.0   $ 0        0.0   $ 421        1.4

Criticized performing

    92        0.7        47        0.4        0        0.0        0        0.0        139        0.5   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total PCI loans

    278        2.0        282        2.7        0        0.0        0        0.0        560        1.9   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 13,396        100.0   $ 10,484        100.0   $ 4,020        100.0   $ 1,842        100.0   $ 29,742        100.0
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) 

Amounts based on total loans as of June 30, 2011 and December 31, 2010.

(2) 

Percentages calculated based on total held for investment commercial loans in each respective loan category as of the end of the reported period.

(3) 

Northeast consists of CT, ME, MA, NH, NJ, NY, PA and VT. Mid-Atlantic consists of DE, DC, MD, VA and WV. South consists of AL, AR, FL, GA, KY, LA, MS, MO, NC, SC, TN and TX.

(4) 

Criticized exposures correspond to the “Special Mention”, “Substandard” and “Doubtful” asset categories defined by banking regulatory authorities.

Impaired Loans and Troubled Debt Restructurings

A loan is considered impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due from the borrower in accordance with the original contractual terms of the loan. Loans with insignificant delays or insignificant shortfalls in the amount of payments expected to be collected are not considered to be impaired. Income recognition on impaired loans is consistent with that of nonaccrual loans discussed above under “Delinquent and Nonperforming Loans.”

Loans defined as individually impaired, based on applicable accounting guidance, include larger balance nonperforming loans and TDR loans. Our policies for reporting loans as individually impaired, by loan category, are as follows:

 

   

Credit card loans: Credit card loans, including installment loans, that have been modified in a troubled debt restructuring are accounted for and reported as individually impaired.

 

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Consumer banking loans: Consumer banking loans that have been modified in a troubled debt restructuring are accounted for and reported as individually impaired.

 

   

Commercial banking loans: Commercial banking loans classified as nonperforming or that have been modified in a troubled debt restructuring are reported as impaired.

 

   

Purchased credit-impaired loans: We track and report PCI loans separately from other impaired loans.

We do not report nonperforming consumer loans that have not been modified in a TDR as individually impaired, as we collectively evaluate these smaller-balance homogenous loans for impairment in accordance with applicable accounting guidance. Held for sale loans are also not reported as impaired, as these loans are recorded at lower of cost or fair value.

All individually impaired loans are evaluated for an asset-specific allowance. Once a loan is modified in a TDR, the loan is generally considered impaired until maturity regardless of whether the borrower performs under the modified terms. Although the loan may be returned to accrual status if the criteria above under “Delinquent and Nonperforming Loans” are met, the loan would continue to be evaluated for an asset-specific allowance for loan losses and we would continue to report the loan as impaired.

We generally measure impairment and the related asset-specific allowance for individually impaired loans based on the difference between the recorded investment of the loan and present value of the loans’ expected future cash flows, discounted at the effective original interest rate of the loan at the time of modification or the loan’s observable market price. If the loan is collateral dependent, we measure impairment based upon the fair value of the underlying collateral, which we determine based on the current fair value of the collateral less estimated selling costs, instead of discounted cash flows. Loans are identified as collateral dependent if we believe that collateral is the sole source of repayment.

If the fair value of the loan is less than the recorded investment, we recognize impairment by establishing an allowance for the loan or by adjusting an allowance for the impaired loan.

 

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The following table presents information about our impaired loans, excluding purchased credit-impaired loans, which are reported separately and discussed below:

 

    June 30, 2011  

(Dollars in millions)

  With an
Allowance
    Without
an
Allowance
    Total
Recorded
Investment
    Related
Allowance
    Net
Recorded
Investment
    Unpaid
Principal
Balance
    Average
Recorded
Investment
    Interest
Income
Recognized
 

Credit card and Installment loans:

               

Domestic card and installment loans

  $ 746      $ 0      $ 746      $ 264      $ 482      $ 726      $ 748      $ 37   

International card and installment loans

    183        0        183        118        65        174        134        2   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total credit card and installment loans

    929        0        929        382        547        900        882        39   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Consumer banking:

               

Auto

    20        0        20        2        18        19        8        1   

Home loans

    71        0        71        9        62        71        63        2   

Retail banking

    17        21        38        1        37        43        40        0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total consumer banking

    108        21        129        12        117        133        111        3   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Commercial banking:

               

Commercial and multifamily real estate

    220        220        440        32        408        531        384        3   

Middle market

    33        90        123        9        114        145        119        1   

Specialty lending

    3        15        18        1        17        18        20        0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial lending

    256        325        581        42        539        694        523        4   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Small-ticket commercial real estate

    9        0        9        1        8        9        37        0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial banking

    265        325        590        43        547        703        560        4   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other:

               

Other loans

    0        1        1        0        1        1        1        0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 1,302      $ 347      $ 1,649      $ 437      $ 1,212      $ 1,737      $ 1,554      $ 46   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents
    December 31, 2010  

(Dollars in millions)

  With an
Allowance
    Without an
Allowance
    Total
Recorded
Investment
    Related
Allowance
    Net
Recorded
Investment
    Unpaid
Principal
Balance
    Average
Recorded
Investment
    Interest
Income
Recognized
 

Credit card and installment loans:

               

Domestic card and installment loans

  $ 753      $ 0      $ 753      $ 253      $ 500      $ 739      $ 644      $ 76   

International card and installment loans

    160        0        160        133        27        154        128        0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total credit card and installment loans

    913        0        913        386        527        893        772        76   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Consumer banking:

               

Auto

    0        0        0        0        0        0        0        0   

Home loans

    57        0        57        1        56        57        28        1   

Retail banking

    23        17        40        1        39        51        46        1   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total consumer banking

    80        17        97        2        95        108        74        2   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Commercial banking:

               

Commercial and multifamily real estate

    40        283        323        6        317        436        385        4   

Middle market

    25        95        120        7        113        156        109        1   

Specialty lending

    1        20        21        0        21        22        35        0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial lending

    66        398        464        13        451        614        529        5   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Small-ticket commercial real estate

    16        20        36        2        34        73        41        1   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial banking

    82        418        500        15        485        687        570        6   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other:

               

Other loans

    0        0        0        0        0        0        0        0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 1,075      $ 435      $ 1,510      $ 403      $ 1,107      $ 1,688      $ 1,416      $ 84   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

TDR loans accounted for $1.3 billion and $1.1 billion of impaired loans as of June 30, 2011 and December 31, 2010, respectively. Consumer and commercial TDR loans classified as performing totaled $1.0 billion and $171 million, respectively, as of June 30, 2011, and $970 million and $79 million, respectively, as of December 31, 2010.

Purchased Credit-Impaired Loans

In connection with the acquisition of Chevy Chase Bank on February 27, 2009, we acquired loans with a contractual outstanding unpaid principal and interest balance at acquisition of $15.4 billion. We recorded these loans on our consolidated balance sheet at estimated fair value at the date of acquisition of $9.0 billion. We concluded that the substantial majority of the loans we acquired from Chevy Chase Bank were PCI loans. PCI loans are acquired loans with evidence of credit quality deterioration since origination for which it is probable at the date of purchase that we will be unable to collect all contractually required payments. The Chevy Chase Bank loans that we concluded were credit impaired had a contractual outstanding unpaid principal and interest balance at acquisition of $12.0 billion and an estimated fair value of $6.3 billion. These loans consisted of Chevy Chase Bank’s entire portfolio of option-adjustable rate mortgage loans, hybrid adjustable-rate mortgage loans and construction-to-permanent mortgage loans. We also concluded that Chevy Chase Bank’s portfolio of commercial loans, auto loans, fixed-mortgage loans, home equity loans and other consumer loans included segments of PCI loans.

 

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Initial Fair Value and Accretable Yield of Acquired Loans

At acquisition, we estimated the cash flows we expected to collect on these loans. Under the accounting guidance for PCI loans, the difference between the contractually required payments and the cash flows expected to be collected at acquisition is referred to as the nonaccretable difference. This difference is neither accreted into income nor recorded on our consolidated balance sheet. The excess of cash flows expected to be collected over the estimated fair value is referred to as the accretable yield and is recognized in interest income over the remaining life of the loan, or pool of loans, using the effective yield method. The table below displays the contractually required principal and interest, cash flows expected to be collected and fair value at acquisition related to the Chevy Chase Bank loans we acquired. The table also displays the nonaccretable difference and the accretable yield at acquisition.

 

     At Acquisition on February 27, 2009  

(Dollars in millions)

   Total
Acquired Loans
    Purchased Credit-
Impaired Loans
    Non-Impaired Loans  

Contractually outstanding principal and interest at acquisition

   $ 15,387      $ 12,039      $ 3,348   

Less: Nonaccretable difference (expected principal losses of $2,207 and foregone interest of $1,820)(1)

     (4,027     (3,851     (176
  

 

 

   

 

 

   

 

 

 

Cash flows expected to be collected at acquisition(2)

     11,360        8,188        3,172   

Less: Accretable yield

     (2,360     (1,861     (499
  

 

 

   

 

 

   

 

 

 

Fair value of loans acquired(3)

   $ 9,000      $ 6,327      $ 2,673   
  

 

 

   

 

 

   

 

 

 

 

(1) 

Expected principal losses and foregone interest on purchased credit-impaired loans at acquisition totaled $2.1 billion and $1.8 billion, respectively. Expected principal losses and foregone interest on non-impaired loans at acquisition totaled $154 million and $23 million, respectively.

(2) 

Represents undiscounted expected principal and interest cash flows at acquisition.

(3) 

A portion of the loans acquired in connection with the Chevy Chase Bank acquisition was classified as held for sale. These loans, which had an estimated fair value at acquisition of $235 million, are not included in the above tables.

Outstanding Balance and Carrying Value of Acquired Loans

The table below presents the outstanding contractual principal balance and the carrying value of the Chevy Chase Bank acquired loans as of June 30, 2011 and December 31, 2010:

 

    June 30, 2011     December 31, 2010  

(Dollars in millions)

  Total
Acquired Loans
    Purchased Credit-
Impaired Loans
    Non-Impaired
Loans
    Total
Acquired Loans
    Purchased Credit-
Impaired Loans
    Non-Impaired
Loans
 

Contractual balance

  $ 6,383      $ 5,061      $ 1,322      $ 7,054      $ 5,546      $ 1,508   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Carrying value(1)

    5,132        3,922        1,210        5,554        4,165        1,389   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) 

Includes $13 million and $33 million of cumulative impairment recognized as of June 30, 2011 and December 31, 2010, respectively.

Changes in Accretable Yield of Acquired Loans

Subsequent to acquisition, we are required to periodically evaluate our estimate of cash flows expected to be collected. These evaluations, performed quarterly, require the continued use of key assumptions and estimates, similar to the initial estimate of fair value. Subsequent changes in the estimated cash flows expected to be collected may result in changes in the accretable yield and nonaccretable difference or reclassifications from nonaccretable yield to accretable. Increases in the cash flows expected to be collected will generally result in an increase in interest income over the remaining life of the loan or pool of loans. Decreases in expected cash flows due to further credit deterioration will generally result in an impairment charge recognized in our provision for

 

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loan and lease losses, resulting in an increase to the allowance for loan losses. We recognized impairment in our provision for loan lease losses related to PCI loans of $0 million and $5 million for the three months ended June 30, 2011 and 2010, respectively, and $8 million and $5 million for the six months ended June 30, 2011 and 2010, respectively. The cumulative impairment recognized on PCI loans totaled $13 million as of June 30, 2011 and $33 million as of December 31, 2010.

The following table presents changes in the accretable yield related to the acquired Chevy Chase Bank loans:

 

(Dollars in millions)

   Total Acquired Loans     Purchased Credit-
Impaired Loans
    Non-Impaired Loans  

Accretable yield as of December 31, 2009

   $ 2,067      $ 1,742      $ 325   

Accretion recognized in earnings

     (405     (299     (106

Reclassifications from nonaccretable difference for loans with improvement in expected cash flows

     350        311        39   
  

 

 

   

 

 

   

 

 

 

Accretable yield as of December 31, 2010

   $ 2,012      $ 1,754      $ 258   
  

 

 

   

 

 

   

 

 

 

Accretion recognized in earnings

     (230     (197     (33

Reclassifications from nonaccretable difference for loans with improving cash flows(1)

     218        218        0   

Reductions in accretable yield for non-credit related changes in expected cash flows(2)

     (98     (12     (86
  

 

 

   

 

 

   

 

 

 

Accretable yield as of June 30, 2011

   $ 1,902        1,763        139   
  

 

 

   

 

 

   

 

 

 

 

(1)

Represents increases in accretable yields for those pools with increases primarily the result of improved credit performance.

(2)

Represents changes in accretable yields for those pools with reductions driven primarily by changes in prepayment levels.

Unfunded Lending Commitments

We manage the potential risk in credit commitments by limiting the total amount of arrangements, both by individual customer and in total, by monitoring the size and maturity structure of these portfolios and by applying the same credit standards for all of our credit activities. Unused credit card lines available to our customers totaled $206.9 billion and $161.5 billion as of June 30, 2011 and December 31, 2010, respectively. While these amounts represented the total available unused credit card lines, we have not experienced, and do not anticipate, that all of our customers will access their entire available line at any given point in time.

In addition to available unused credit card lines, we enter into commitments to extend credit that are legally binding conditional agreements having fixed expirations or termination dates and specified interest rates and purposes. Outstanding unfunded commitments to extend credit other than credit card lines totaled approximately $14.2 billion and $13.2 billion as of June 30, 2011 and December 31, 2010, respectively. Commitments may expire without being drawn upon. Therefore, the total commitment amount does not necessarily represent future funding requirements.

We maintain a reserve for unfunded loan commitments and letters of credit to absorb estimated probable losses related to these unfunded credit facilities, which is included in other liabilities on our consolidated balance sheets. Our reserve for unfunded loan commitments and letters of credit was $64 million and $107 million as of June 30, 2011 and December 31, 2010, respectively. See “Note 6—Allowance for Loan and Lease Losses” below for additional information.

 

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NOTE 6—ALLOWANCE FOR LOAN AND LEASE LOSSES

 

We maintain an allowance for loan and lease losses (“the allowance”) that represents management’s best estimate of incurred loan and lease credit losses inherent in our held for investment portfolio as of each balance sheet date. We do not maintain an allowance for held for sale loans or purchased credit-impaired loans that are performing in accordance with or better than our expectations as of the date of acquisition, as the fair values of these loans already reflect a credit component. The allowance for loan and lease losses is increased through the provision for loan and lease losses and reduced by net charge-offs. The provision for loan and lease losses, which is charged to earnings, reflects credit losses we believe have been incurred and will eventually be reflected over time in our charge-offs. Charge-offs of uncollectible amounts are deducted from the allowance and subsequent recoveries are added.

In determining the allowance for loan and lease losses, we disaggregate loans in our portfolio with similar credit risk characteristics into portfolio segments. Management performs quarterly analysis of these portfolios to determine if impairment has occurred and to assess the adequacy of the allowance based on historical and current trends and other factors affecting credit losses. We apply documented systematic methodologies to separately calculate the allowance for our consumer loan and commercial loan portfolio and for loans within each of these portfolios that we identify as individually impaired. Our allowance for loan and lease losses consists of three components that are allocated to cover the estimated probable losses in each loan portfolio based on the results of our detailed review and loan impairment assessment process: (1) a formula-based component for loans collectively evaluated for impairment; (2) an asset-specific component for individually impaired loans; and (3) a component related to purchased credit-impaired loans that have experienced significant decreases in expected cash flows subsequent to acquisition. See “Note 1—Summary of Significant Accounting Policies” of our 2010 Form 10-K for a description of the methodologies and policies for determining our allowance for loan and lease losses for each of our loan portfolio segments.

Allowance for Loan and Lease Losses Activity

The allowance for loan and lease losses is increased through the provision for loan and lease losses and reduced by net charge-offs. The provision for loan and lease losses, which is charged to earnings, reflects credit losses we believe have been incurred and will eventually be reflected over time in our charge-offs. Charge-offs of uncollectible amounts are deducted from the allowance and subsequent recoveries are included. The table below summarizes changes in the allowance for loan and lease losses, by portfolio segment, and our unfunded lending commitment reserve during the three and six months ended June 30, 2011:

 

    Three Months Ended June 30, 2011  
          Consumer                       Unfunded
Lending
Reserve
    Combined
Allowance

&
Unfunded
Reserve
 

(Dollars in millions)

  Credit
Card
    Auto     Home
Loan
    Retail
Banking
    Total
Consumer
    Commercial     Other(1)     Total
Allowance
     

Balance as of March 31, 2011

  $ 3,576      $ 318      $ 119      $ 204      $ 641      $ 782      $ 68      $ 5,067      $ 71      $ 5,138   

Provision for loan and lease losses(2)

    309        56        (12     1        45        (14     10        350        (7     343   

Charge-offs(2)

    (1,110     (102     (22     (25     (149     (50     (13     (1,322     0        (1,322

Recoveries

    317        50        5        6        61        12        1        391        0        391   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net charge-offs

    (793     (52     (17     (19     (88     (38     (12     (931     0        (931

Other changes(3)

    1        0        0        0        0        0        1        2        0        2   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance as of June 30, 2011(2)

  $ 3,093      $ 322      $ 90      $ 186      $ 598      $ 730      $ 67      $ 4,488      $ 64      $ 4,552   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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    Six Months Ended June 30, 2011  
          Consumer                       Unfunded
Lending
Reserve
    Combined
Allowance
&
Unfunded
Reserve
 

(Dollars in millions)

  Credit
Card
    Auto     Home
Loan
    Retail
Banking
    Total
Consumer
    Commercial     Other(1)     Total
Allowance
     

Balance as of December 31, 2010

  $ 4,041      $ 353      $ 112      $ 210      $ 675      $ 826      $ 86      $ 5,628      $ 107      $ 5,735   

Provision for loan and lease losses(2)

    759        110        16        18        144        1        16        920        (43     877   

Charge-offs(2)

    (2,395     (243     (54     (55     (352     (117     (38     (2,902     0        (2,902

Recoveries

    673        102        16        13        131        20        2        826        0        826   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net charge-offs

    (1,722     (141     (38     (42     (221     (97     (36     (2,076     0        (2,076

Other changes(3)

    15        0        0        0        0        0        1        16        0        16   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance as of June 30, 2011(2)

  $ 3,093      $ 322      $ 90      $ 186      $ 598      $ 730      $ 67      $ 4,488      $ 64      $ 4,552   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) 

Other consists of our discontinued GreenPoint mortgage operations loan portfolio and our community redevelopment loan portfolio.

(2)

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

(3) 

Includes foreign exchange translation adjustments of $2 million and $16 million for the three and six months ended June 30, 2011, respectively.

Components of Allowance for Loan and Lease Losses by Impairment Methodology

The table below presents the components of our allowance for loan and lease losses, by loan category and impairment methodology, and the recorded investment of the related loans as of June 30, 2011 and December 31, 2010:

 

    June 30, 2011  
          Consumer                          

(Dollars in millions)

  Credit
Card
    Auto     Home
Loan
    Retail
Banking
    Total
Consumer
    Commercial     Other     Total  

Allowance for loan and lease losses by impairment methodology:

               

Collectively evaluated for impairment

  $ 2,711      $ 320      $ 72      $ 184      $ 576      $ 684      $ 67      $ 4,038   

Individually evaluated for impairment

    382        2        9        1        12        43        0        437   

Purchased credit-impaired loans

    0        0        9        1        10        3        0        13   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total allowance for loan and lease losses

  $ 3,093      $ 322      $ 90      $ 186      $ 598      $ 730      $ 67      $ 4,488   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Held for investment loans by impairment methodology:

               

Collectively evaluated for impairment

  $ 61,776      $ 19,136      $ 6,675      $ 4,005      $ 29,816      $ 30,115      $ 465      $ 122,172   

Individually evaluated for impairment

    929        20        71        38        129        590        0        1,648   

Purchased credit-impaired loans

    0        67        4,577        3        4,647        498        0        5,145   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total held for investment loans

  $ 62,705      $ 19,223      $ 11,323      $ 4,046      $ 34,592      $ 31,203      $ 465      $ 128,965   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Allowance as a percentage of period end held for investment loans

    4.93     1.68     0.79     4.60     1.73     2.34     14.41     3.48

 

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    December 31, 2010  
          Consumer                          

(Dollars in millions)

  Credit
Card
    Auto     Home
Loan
    Retail
Banking
    Total
Consumer
    Commercial     Other     Total  

Allowance for loan and lease losses by impairment methodology:

               

Collectively evaluated for impairment

  $ 3,655      $ 353      $ 81      $ 209      $ 643      $ 808      $ 86      $ 5,192   

Individually evaluated for impairment

    386        0        1        1        2        15        0        403   

Purchased credit-impaired loans

    0        0        30        0        30        3        0        33   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total allowance for loan and lease losses

  $ 4,041      $ 353      $ 112      $ 210      $ 675      $ 826      $ 86      $ 5,628   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Held for investment loans by impairment methodology:

               

Collectively evaluated for impairment

  $ 60,458      $ 17,867      $ 7,154      $ 4,271      $ 29,292      $ 28,682      $ 451      $ 118,883   

Individually evaluated for impairment

    913        0        57        40        97        500        0        1,510   

Purchased credit impaired loans

    0        0        4,892        102        4,994        560        0        5,554   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total held for investment loans

  $ 61,371      $ 17,867      $ 12,103      $ 4,413      $ 34,383      $ 29,742      $ 451      $ 125,947   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Allowance as a percentage of period end held for investment loans

    6.58     1.98     0.93     4.76     1.96     2.78     19.07     4.47

 

 

NOTE 7—VARIABLE INTEREST ENTITIES AND SECURITIZATIONS

 

In the normal course of business, we enter into various types of transactions with entities that are considered to be variable interest entities (“VIEs”). Historically, our primary involvement with VIEs related to our securitization transactions in which we transferred assets from our balance sheet to securitization trusts. These securitization trusts typically meet the definition of a VIE. We generally securitized credit card loans, auto loans, home loans and installment loans, which provided a source of funding for us and as a means of transferring a certain portion of the economic risk of the loans or debt securities to third parties.

Under revised consolidation accounting guidance that became effective on January 1, 2010, the entity that has a controlling financial interest in a VIE is referred to as the primary beneficiary and is required to consolidate the VIE. As a result of this guidance, the vast majority of the VIEs in which we are involved have been consolidated in our financial statements.

Summary of Consolidated and Unconsolidated VIEs

The table below presents a summary of VIEs, aggregated based on VIEs with similar characteristics, in which we had continuing involvement or held a variable interest as of June 30, 2011 and December 31, 2010. We separately present information for consolidated and unconsolidated VIEs.

For consolidated VIEs, we present the carrying amount of assets and liabilities reflected on our consolidated balance sheets. The assets of consolidated VIEs primarily consist of cash and loans, which we report on our consolidated balance sheets under restricted cash for securitization investors and restricted loans for

 

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securitization investors, respectively. The assets of a particular VIE are the primary source of funds to settle its obligations. The creditors of the VIEs typically do not have recourse to the general credit of our company. The liabilities primarily consist of debt securities issued by the VIEs, which we report under securitized debt obligations. For unconsolidated VIEs, we present the carrying amount of assets and liabilities reflected on our consolidated balance sheets and our maximum exposure to loss. Our maximum exposure to loss is estimated based on the unlikely event that all of the assets in the VIEs became worthless and we were required to meet our maximum remaining funding obligations.

 

     June 30, 2011  
      Consolidated      Unconsolidated  

(Dollars in millions)

   Carrying
Amount
of Assets
     Carrying
Amount of
Liabilities
     Carrying
Amount
of Assets
    Carrying
Amount of
Liabilities
    Maximum
Exposure  to
Loss(3)
 

Securitization-related VIEs:

            

Credit card loan securitizations

   $ 47,977       $ 20,386       $ 0      $ 0      $ 0   

Auto loan securitizations

     693         578         0        0        0   

Mortgage loan securitizations

     0         0         160 (1)      34 (2)      277   

Other asset securitizations

     37         37         0        0        0   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total securitization related VIEs

     48,707         21,001         160        34        277   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Other VIEs:

            

Affordable housing entities

     0         0         1,804        233        1,804   

Entities that provide capital to low-income and rural communities

     251         0         6        3        6   

Other

     0         0         153        0        153   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total Other VIEs

     251         0         1,963        236        1,963   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total VIEs

   $ 48,958       $ 21,001       $ 2,123      $ 270      $ 2,240   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 
     December 31, 2010  
     Consolidated      Unconsolidated  

(Dollars in millions)

   Carrying
Amount
of Assets
     Carrying
Amount of
Liabilities
     Carrying
Amount
of Assets(1)
    Carrying
Amount of
Liabilities(2)
    Maximum
Exposure  to
Loss(3)
 

Securitization-related VIEs:

            

Credit card loan securitizations

   $ 53,694       $ 25,622       $ 0      $ 0      $ 0   

Auto loan securitizations

     1,784         1,518         0        0        0   

Mortgage loan securitizations

     0         0         174        37        297   

Other asset securitizations

     198         64         0        0        0   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total securitization related VIEs

     55,676         27,204         174        37        297   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Other VIEs:

            

Affordable housing entities

     0         0         1,681        304        1,681   

Entities that provide capital to low-income and rural communities

     230         0         6        3        6   

Other

     0         0         174        0        174   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total Other VIEs

     230         0         1,861        307        1,861   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total VIEs

   $ 55,906       $ 27,204       $ 2,035      $ 344      $ 2,158   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

 

(1) 

The carrying amount of assets of unconsolidated securitization-related VIEs consists of retained interests and letters of credit related to manufactured housing securitizations. Mortgage servicing rights related to unconsolidated VIEs are reported on our consolidated balance sheets under goodwill and other intangible

 

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  assets. See “Note 8—Goodwill and Other Intangible Assets” for additional information on our mortgage servicing rights. Other retained interests are reported on our consolidated balance sheets under accounts receivable from securitizations.
(2) 

The carrying amount of liabilities of unconsolidated securitization-related VIEs consists of obligations to fund negative amortization bonds associated with the securitization of option-adjustable rate mortgage loans (“option-ARMs”) and obligations on certain swap agreements associated with the securitization of manufactured housing loans.

(3) 

The maximum exposure to loss represents the amount of loss we would incur in the unlikely event that all our assets in the VIE become worthless and we were required to meet our maximum remaining funding obligations.

Securitization-Related VIEs

We historically have securitized credit card loans, auto loans, home loans and installment loans. In a securitization transaction, assets from our balance sheet are transferred to a trust, which typically meets the definition of a VIE. The trust then issues various forms of interests in those assets to investors. We typically receive cash proceeds and/or other interests in the securitization trust for the assets we transfer. If the transfer of the assets to an unconsolidated securitization trust qualifies as a sale, we remove the assets from our consolidated balance sheet and recognize a gain or loss on the transfer. Alternatively, if the transfer does not qualify as a sale but instead is considered a secured borrowing or the transfer of assets is to a consolidated VIE, the assets remain on our consolidated financial statements and we record an offsetting liability for the proceeds received. We did not execute any new securitizations during the second quarter of 2011; however, we have continuing involvement in the securitization trusts.

Our continuing involvement in the majority of our securitization transactions consists primarily of holding certain retained interests and acting as the primary servicer. We also may be required to repurchase receivables from the trust if the outstanding balance of the receivables falls to a level where the cost exceeds the benefits of servicing such receivables. We also may have exposure associated with contractual obligations to repurchase previously transferred loans due to breaches of representations and warranties. See “Note 15—Commitments, Contingencies and Guarantees” for information related to reserves we have established for our potential mortgage representation and warranty exposure.

The table below presents the securitization-related VIEs in which we had continuing involvement as of June 30, 2011 and December 31, 2010:

 

     June 30, 2011  
     Non-Mortgage      Mortgage  

(Dollars in millions)

   Credit
Card
     Auto
Loan
     Other
Loan
     Option
ARM
    GreenPoint
HELOCs
    GreenPoint
Manufactured
Housing
 

Securities held by third-party investors

   $ 19,348       $ 533       $ 25       $ 3,380      $ 242      $ 1,313   

Receivables in the trust

     46,768         574         38         3,494        242        1,320   

Cash balance of spread or reserve accounts

     64         72         0         8        0        175   

Retained interests

     Yes         Yes         Yes         Yes        Yes        Yes   

Servicing retained

     Yes         Yes         Yes         Yes (1)      Yes (1)      No (3) 

Amortization event(4)

     No         No         No         No        Yes (2)      No   

 

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     December 31, 2010  
     Non-Mortgage      Mortgage  

(Dollars in millions)

   Credit
Card
     Auto
Loan
     Other
Loan
     Option
ARM
    GreenPoint
HELOCs
    GreenPoint
Manufactured
Housing
 

Securities held by third-party investors

   $ 25,415       $ 1,453       $ 48       $ 3,690      $ 284      $ 1,386   

Receivables in the trust

     52,355         1,528         191         3,813        284        1,393   

Cash balance of spread or reserve accounts

     77         147         0         8        0        183   

Retained interests

     Yes         Yes         Yes         Yes        Yes        Yes   

Servicing retained

     Yes         Yes         Yes         Yes (1)      Yes (1)      No (3) 

Amortization event(4)

     No         No         No         No        Yes (2)      No   

 

(1) 

We continue to service some of the outstanding balance of securitized mortgage receivables.

(2) 

See information below regarding on-going involvement in the GreenPoint Home Equity Line of Credit (“HELOC”) securitizations.

(3) 

The manufactured housing securitizations are serviced by a third party. For two of the deals, that third party works in the capacity of subservicer with Capital One being the Master Servicer.

(4) 

Amortization events vary according to each specific trust agreement but generally are triggered by declines in performance or credit metrics such as charge-off rates or delinquency rates below certain predetermined thresholds. Generally, the occurrence of an amortization event changes the sequencing and amount of trust related cash flows to the benefit of senior noteholders.

Non-Mortgage Securitizations

As of June 30, 2011 and December 31, 2010, we were deemed to be the primary beneficiary of all of our non-mortgage securitization trusts. Accordingly, all of these trusts have been consolidated in our financial statements. For additional information on our principal involvement with non-mortgage securitization trusts and the impact of the consolidation of these trusts on our financial statements, see “Note 1—Summary of Significant Accounting Policies” and “Note 7—Variable Interest Entities and Securitizations” of our 2010 Form 10-K.

Mortgage Securitizations

Option-ARM Loans

We had previously securitized option-ARM loans by transferring the mortgage loans to securitization trusts that issued mortgage-backed securities to investors. The outstanding balance of debt securities held by third-party investors related to our mortgage securitization trusts was $3.4 billion as of June 30, 2011 and $3.7 billion as of December 31, 2010.

We continue to service some of the outstanding balance of securitized mortgage receivables. We also retain rights to future cash flows arising from the receivables, the most significant being certificated interest-only bonds issued by the trusts, certain of which we sold during the first quarter of 2010. We generally estimate the fair value of these retained interests based on the estimated present value of expected future cash flows from securitized and sold receivables, using our best estimates of the key assumptions – credit losses, prepayment speeds and discount rates commensurate with the risks involved. We do not consolidate these trusts because we do not have the right to receive benefits that could potentially be significant nor the obligation absorb losses that could potentially be significant to the trusts.

In connection with the securitization of certain option-ARM loans, a third party is obligated to advance a portion of any “negative amortization” resulting from monthly payments that are less than the interest accrued for that payment period. We have an agreement in place with the third party that mirrors this advance requirement. The amount advanced is tracked through mortgage-backed securities retained as part of the securitization transaction. As the borrowers make principal payments, these securities receive their net pro rata portion of those payments in cash, and advances of negative amortization are refunded accordingly. As advances occur, we record an asset in the form

 

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of negative amortization bonds, which are classified as available-for-sale securities. We have also entered into certain derivative contracts related to the securitization activities. These are classified as free standing derivatives, with fair value adjustments recorded in non-interest income. See “Note 10—Derivative Instruments and Hedging Activities” for further details on these derivatives.

GreenPoint Mortgage HELOCs

Our discontinued wholesale mortgage banking unit, GreenPoint, previously sold home equity lines of credit in whole loan sales and subsequently acquired a residual interest in certain trusts which securitized some of those loans. As the residual interest holder, GreenPoint is required to fund advances on the home equity lines of credit when certain performance triggers are met due to deterioration in asset performance. We had funded $27 million in advances as of June 30, 2011, all of which was expensed as funded. Our unfunded commitment related to these residual interests was $11 million as of June 30, 2011. We have not consolidated these trusts because the residual certificates did not provide the obligation to absorb losses or the right to receive benefits that could potentially be significant to the trusts.

GreenPoint Mortgage Manufactured Housing

We retain the primary obligation for certain provisions of corporate guarantees, recourse sales and clean-up calls related to the discontinued manufactured housing operations of GreenPoint Credit LLC (“GPC”) which was sold to a third party in 2004. Although we are the primary obligor, recourse obligations related to former GPC whole loan sales, commitments to exercise mandatory clean-up calls on certain GPC securitization transactions and servicing were transferred to a third party in the sale transaction. We do not consolidate the trusts used for the securitization of manufactured housing loans because we do not have the power to direct the activities that most significantly impact the economic performance of the trusts since we no longer service the loans.

We were required to fund letters of credit in 2004 to cover losses, and are obligated to fund future amounts under swap agreements for certain transactions. We have the right to receive any funds remaining in the letters of credit after the securities are released. The amount available under the letters of credit was $175 million and $183 million as of June 30, 2011 and December 31, 2010, respectively. The fair value of the expected residual balances on the funded letters of credit was $36 million and $35 million as of June 30, 2011 and December 31, 2010, respectively, and is included in other assets on the consolidated balance sheet. Our maximum exposure under the swap agreements was $25 million and $27 million as of June 30, 2011 and December 31, 2010, respectively. The value of our obligations under these swaps, which is included in other liabilities on our consolidated balance sheets, was $17 million as of June 30, 2011 and $18 million as of December 31, 2010.

The unpaid principal balance of manufactured housing securitization transactions where we are the residual interest holder was $1.3 billion and $1.4 billion as of June 30, 2011 and December 31, 2010, respectively. In the event the third party does not fulfill on its obligations to exercise the clean-up calls on certain transactions, the obligation reverts to us and we would assume approximately $420 million of loans receivable upon our execution of the clean-up call with the requirement to absorb any losses on the loans receivable. There have been no instances of non-performance to date by the third party.

We monitor the underlying assets for trends in delinquencies and related losses and reviews the purchaser’s financial strength as well as servicing performance. These factors are considered in assessing the adequacy of the liabilities established for these obligations and the valuations of the assets.

Retained Interests in Unconsolidated Securitizations

Accounts Receivable from Securitizations

Retained interests in unconsolidated securitizations are included in accounts receivable from securitizations on our consolidated balance sheets. These retained interests consist of interest-only strips, retained tranches, cash collateral accounts, cash reserve accounts and unpaid interest and fees on the third-party investors’ portion of the transferred principal receivables.

 

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The following table provides details of accounts receivable from securitizations as of June 30, 2011 and December 31, 2010:

 

(Dollars in millions)

   June 30,
2011
     December 31,
2010
 

Interest-only strip classified as trading

   $ 67       $ 75   

Retained interests classified as trading:

     

Retained notes

     31         34   

Cash collateral

     8         8   

Investor accrued interest receivable

     0         0   
  

 

 

    

 

 

 

Total retained interests classified as trading

     39         42   

Retained notes classified as available for sale

     0         0   

Other retained interests

     0         3   
  

 

 

    

 

 

 

Total accounts receivable from securitizations

   $ 106       $ 120   
  

 

 

    

 

 

 

We may retain tranches in certain of the securitization transactions which are considered to be higher investment grade securities and subject to lower risk of loss. Those retained tranches are classified as available-for-sale securities, and changes in the estimated fair value are recorded in other comprehensive income.

The components of the net gains (losses) recognized as a result of changes in the fair value of retained interests are presented below:

 

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

(Dollars in millions)

   2011     2010(1)      2011     2010(1)  

Interest only strip valuation changes

   $ (4   $ 6       $ (7   $ 10   

Fair value adjustments related to spread accounts

     12        0         25        0   

Fair value adjustments related to investors’ accrued interest receivable

     0        0         0        0   

Fair value adjustments related to retained subordinated notes

     (17     0         1        0   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total income statement impact

   $ (9   $ 6       $ 19      $ 10   
  

 

 

   

 

 

    

 

 

   

 

 

 

 

(1) 

2010 includes both mortgage related amounts representing valuation changes of mortgage interest only strips, spread accounts, and retained interests held at December 31, 2010 and non-mortgage related amounts representing the one installment loan securitization that remained off-balance sheet through September 15, 2010.

The changes in the fair value of retained interests are primarily driven by rate assumption changes and volume fluctuations. All of these retained residual interests are subject to loss in the event assumptions used to determine the estimated fair value do not prevail, or if borrowers default on the related securitized receivables and our retained subordinated tranches are used to repay investors. See the table below for key assumptions and sensitivities for retained interest valuations.

Key Assumptions and Sensitivities for Retained Interest Valuations

The key assumptions used in determining the fair value of the interest-only strip and other retained residual interests include the weighted average ranges for principal payment rates, lives of receivables and discount rates, all of which are included in the following table. The principal repayment rate assumptions were determined using actual and forecast trust principal payment rates based on the collateral. The lives of receivables were determined as the number of months necessary to repay the investors given the principal payment rate assumptions. The

 

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discount rates were determined using primarily trust specific statistics and forward rate curves, and were reflective of what market participants would use in a similar valuation. Additionally, accrued interest receivable, cash reserve and spread accounts were discounted over the estimated life of the assets.

If these assumptions are not met, or if they change, the interest-only strip, retained interests and related servicing and securitizations income would be affected. The following adverse changes to the key assumptions and estimates are hypothetical and should be used with caution. As the figures indicate, any change in fair value based on a 10% or 20% variation in assumptions cannot be extrapolated because the relationship of a change in assumption to the change in fair value may not be linear. Also, the effect of a variation in a particular assumption on the fair value of the interest-only strip is calculated independently from any change in another assumption. However, changes in one factor may result in changes in other factors, which might magnify or counteract the sensitivities.

For the periods ending June 30, 2011 and December 31, 2010, the assumptions and sensitivities shown below included all credit card and installment loan securitizations:

 

(Dollars in millions)

   June 30,
2011
    December 31,
2010
 

Interest-only strip and retained interests

   $ 124 (1)    $ 136 (1) 
  

 

 

   

 

 

 

Weighted average life for receivables (months)

     65        60   
  

 

 

   

 

 

 

Principal repayment rate (weighted average rate)

     14.9 – 17.1     16.3 – 18.1

Impact on fair value of 10% adverse change

   $ (3   $ 2   

Impact on fair value of 20% adverse change

     (5     (6
  

 

 

   

 

 

 

Discount rate (weighted average rate)

     25.1 – 42.2     25.2 – 42.2

Impact on fair value of 10% adverse change

   $ (7   $ (7

Impact on fair value of 20% adverse change

     (13     (14

 

(1) 

Does not include liquidity swap related to the negative amortization bonds of $18 million as of June 30, 2011 and $19 million at December 31, 2010.

Static pool credit losses were calculated by summing the actual and projected future credit losses and dividing them by the original balance of each pool of assets. Due to the short-term revolving nature of the loan receivables, the weighted average percentage of static pool credit losses was not considered materially different from the assumed charge-off rates used to determine the fair value of the retained interests.

We act as a servicing agent and receive contractual servicing fees of between 0.5% and 4% of the investor principal outstanding, based upon the type of assets serviced. For off-balance sheet securitizations, we generally did not record material servicing assets or liabilities for these rights since the contractual servicing fee approximates market rates.

Cash Flows Related to the Unconsolidated Securitizations

The following provides the details of the cash flows related to securitization transactions that qualified as off-balance sheet for the three and six months ended June 30, 2011 and 2010:

 

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

(Dollars in millions)

   2011      2010      2011      2010  

Servicing fees received

   $ 7       $ 4       $ 15       $ 9   

Cash flows received on retained interests(1)

     12         17         25         94   

 

(1) 

Includes all cash receipts of excess spread and other payments (excluding servicing fees) from the program.

 

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Supplemental Loan Information

The table below displays the unpaid principal balance of off-balance sheet single-family residential loans we serviced as of June 30, 2011 and December 31, 2010. We also display the unpaid principal balance of loans past due 90 days or more as of June 30, 2011 and December 31, 2010. Net credit losses associated with these loans totaled $22 million and $28 million for the six months ended June 30, 2011 and 2010, respectively, and $136 million for the year ended December 31, 2010.

 

(Dollars in millions)

   June 30,
2011
     December 31,
2010
 

Total principal amount of loans

   $ 1,305       $ 1,396   

Principal amount of loans past due 90 days or more

   $ 240       $ 257   

Other VIEs

Affordable Housing Entities

As part of our community reinvestment initiatives, we invest in private investment funds that make equity investments in multi-family affordable housing properties. We receive affordable housing tax credits for these investments. The activities of these entities are financed with a combination of invested equity capital and debt. For those investment funds considered to be VIEs, we are not required to consolidate if we do not have the power to direct the activities that most significantly impact the economic performance of those entities. We record our interests in these unconsolidated VIEs in loans held for investment, other assets and other liabilities. Our interests consisted of assets of approximately $1.8 billion and $1.7 billion as of June 30, 2011 and December 31, 2010, respectively. Our maximum exposure to these entities is limited to our variable interests in the entities and is $1.8 billion as of June 30, 2011. The creditors of the VIEs have no recourse to our general credit and we do not provide additional financial or other support during the period that we were not previously contractually required to provide. The total assets of the unconsolidated VIE investment funds were approximately $8.7 billion and $7.5 billion as of June 30, 2011 and December 31, 2010, respectively.

Entities that Provide Capital to Low-Income and Rural Communities

We hold variable interests in entities (“Investor Entities”) that invest in community development entities (“CDEs”) that provide debt financing to businesses and non-profit entities in low-income and rural communities. Investments of the consolidated Investor Entities are also our variable interests. The activities of the Investor Entities are financed with a combination of invested equity capital and debt. The activities of the CDEs are financed solely with invested equity capital. We receive federal and state tax credits for these investments. We consolidate the VIEs in which we have the power to direct the activities that most significantly impact the VIE’s economic performance and the obligation to absorb losses or the right to receive benefits that could be potentially significant to the VIE. The assets of the VIEs that we consolidated totaled approximately $251 million and $230 million as of June 30, 2011 and December 31, 2010, respectively. The assets of the consolidated VIEs are reflected on our consolidated balance sheets in cash, loans held for investment, interest receivable and other assets. The liabilities are reflected in other liabilities.

The total assets of the VIEs that we held an interest in but were not required to consolidate totaled approximately $6 million as of June 30, 2011 and December 31, 2010. Our interests in these unconsolidated VIEs are reflected on our consolidated balance sheets in loans held for investment and other assets. Our maximum exposure to these entities is limited to our variable interest of $6 million as of June 30, 2011. The creditors of the VIEs have no recourse to our general credit. We have not provided additional financial or other support during the period that we were not previously contractually required to provide.

Other

We also have a variable interest in a trust that has a royalty interest in certain oil and gas properties. The activities of the trust are financed solely with debt. The total assets of the trust were $332 million and $395 million as of

 

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June 30, 2011 and December 31, 2010, respectively. We were not required to consolidate the trust because we do not have the power to direct the activities of the trust that most significantly impact the trust’s economic performance. Our retained interest in the trust, which totaled approximately $153 million and $174 million as of June 30, 2011 and December 31, 2010, respectively, is reflected on our consolidated balance sheets under loans held for investment. Our maximum exposure is limited to our variable interest of $153 million as of June 30, 2011. The creditors of the trust have no recourse to our general credit. We have not provided additional financial or other support during the period that we were not previously contractually required to provide.

 

 

NOTE 8—GOODWILL AND OTHER INTANGIBLE ASSETS

 

The following table presents the components of goodwill and other intangible assets, including mortgage servicing rights, as of June 30, 2011 and December 31, 2010:

 

(Dollars in millions)

   June 30,
2011
     December 31,
2010
 

Goodwill

   $ 13,596       $ 13,591   

Other intangible assets:

     

Core deposit intangibles

     562         650   

Contract intangible(1)

     63         0   

Purchased credit card relationship intangibles(2)

     62         42   

Lease intangibles

     23         26   

Trust intangibles

     5         6   

Other intangibles

     6         9   
  

 

 

    

 

 

 

Total other intangible assets

     721         733   
  

 

 

    

 

 

 

Total goodwill and other intangible assets

   $ 14,317       $ 14,324   
  

 

 

    

 

 

 

Mortgage servicing rights

   $ 130       $ 141   

 

(1) 

Relates to the acquisition of the HBC portfolio in the first quarter of 2011.

(2)

Relates to the acquisitions of the Kohl’s private-label credit card portfolio in the second quarter of 2011, the existing HBC credit card portfolio in the first quarter of 2011 and the Sony Card portfolio in the third quarter of 2010.

Goodwill

In accordance with accounting guidance, goodwill is not amortized but is tested for impairment at the reporting unit level, which is at the operating segment level or one level below an operating segment. Impairment is the condition that exists when the carrying amount of goodwill exceeds its implied fair value. Goodwill is required to be tested for impairment annually and between annual tests if events or circumstances change, such as adverse changes in the business climate, that would more likely than not reduce the fair value of the reporting unit below its carrying value. Goodwill is assigned to one or more reporting units at the date of acquisition. Our reporting units are Domestic Card, International Card, Auto Finance, other Consumer Banking and Commercial Banking. As of June 30, 2011 and December 31, 2010, goodwill of $13.6 billion was included in the accompanying consolidated balance sheets. There were no events requiring an interim impairment test and there has been no goodwill impairment recorded for the three and six months ended June 30, 2011.

During the first quarter of 2011, we acquired the credit card portfolio of HBC. In connection with the acquisition, we recorded goodwill of $3 million representing the amount by which the purchase price exceeded the fair value of the net assets acquired. Because the acquisition was considered to be a taxable transaction, the goodwill is deductible for tax purposes. The goodwill was assigned to the International Card reporting unit of our Credit Card segment and the acquired loan portfolio is reflected in the operations of our International Card business. See “Note 2—Acquisitions” for information regarding the credit card portfolio acquisition.

 

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The following table presents a summary of changes in goodwill, by reporting unit, for the six months ended June 30, 2011:

 

(Dollars in millions)

   Credit Card      Consumer      Commercial      Total  

Balance as of December 31, 2010

   $ 4,690       $ 4,583       $ 4,318       $ 13,591   

Acquisitions

     3         0         0         3   

Other adjustments

     2         0         0         2   
  

 

 

    

 

 

    

 

 

    

 

 

 

Balance as of June 30, 2011

   $ 4,695       $ 4,583       $ 4,318       $ 13,596   
  

 

 

    

 

 

    

 

 

    

 

 

 

Other Intangible Assets

In connection with prior acquisitions, we recorded intangible assets which consisted of core deposit intangibles, trust intangibles, lease intangibles, and other intangibles, which are subject to amortization. The core deposit and trust intangibles reflect the estimated value of deposit and trust relationships. The lease intangibles reflect the difference between the contractual obligation under current lease contracts and the fair market value of the lease contracts at the acquisition date. The other intangible items relate to customer lists and brokerage relationships.

In connection with the acquisition of the credit card loan portfolios of Sony, HBC and Kohl’s, we recognized purchased credit card relationship intangibles, representing the difference between the purchase price and the fair value of the credit card loans acquired. In connection with the January 7, 2010 acquisition of the HBC credit card portfolio, we also recognized a contract-based intangible asset of $70 million. The contract intangible represents the value attributable to future draws on future accounts.

The following table summarizes our intangible assets subject to amortization as of June 30, 2011 and December 31, 2010:

 

     June 30, 2011  

(Dollars in millions)

   Gross
Carrying
Amount
     Accumulated
Amortization
    Currency
Valuation
Adjustments
     Net
Carrying
Amount
     Remaining
Amortization

Period
 

Core deposit intangibles

   $ 1,562       $ (1,000   $ 0       $ 562         6.5 years   

Purchased credit card relationship intangibles(1)

     77         (15     0         62         5.7 years   

Contract intangible(2)

     70         (9     2         63         6.5 years   

Lease intangibles

     54         (31     0         23         21.2 years   

Trust intangibles

     11         (6     0         5         12.4 years   

Other intangibles

     25         (19     0         6         2.8 years   
  

 

 

    

 

 

   

 

 

    

 

 

    

Total

   $ 1,799       $ (1,080   $ 2       $ 721      
  

 

 

    

 

 

   

 

 

    

 

 

    

 

     December 31, 2010  

(Dollars in millions)

   Gross
Carrying
Amount
     Accumulated
Amortization
    Currency
Valuation
Adjustments
     Net
Carrying
Amount
     Remaining
Amortization

Period
 

Core deposit intangibles

   $ 1,562       $ (912   $ 0       $ 650         7.0 years   

Purchased credit card relationship intangibles(1)

     47         (5     0         42         6.1 years   

Lease intangibles

     54         (28     0         26         21.7 years   

Trust intangibles

     11         (5     0         6         12.9 years   

Other intangibles

     35         (26     0         9         3.3 years   
  

 

 

    

 

 

   

 

 

    

 

 

    

Total

   $ 1,709       $ (976   $ 0       $ 733      
  

 

 

    

 

 

   

 

 

    

 

 

    

 

(1) 

Relates to the acquisitions of the existing Kohl’s private-label credit card portfolio in the second quarter of 2011, the existing HBC credit card portfolio in the first quarter of 2011 and the existing Sony Card portfolio in the third quarter of 2010.

 

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(2)

Relates to the acquisition of the existing HBC credit card portfolio in the first quarter of 2011.

Intangible assets, which are reported in other assets on our consolidated balance sheets, are amortized over their respective estimated useful lives on an accelerated basis using the sum of the year’s digits methodology. Intangible amortization expense, which is included in non-interest expense on our consolidated statements of income, totaled $57 million and $55 million for the three months ended June 30, 2011 and 2010, respectively, and $115 million and $112 million for the six months ended June 30, 2011 and 2010, respectively. The weighted average amortization period for purchase accounting intangibles is 6.9 years as of June 30, 2011.

The following table summarizes the estimated future amortization expense for intangible assets as of June 30, 2011:

 

(Dollars in millions)

   Estimated
Future
Amortization

Amounts
 

2011 (remaining six months)

   $ 108   

2012

     185   

2013

     149   

2014

     114   

2015

     81   

2016

     49   

Thereafter

     35   
  

 

 

 

Total

   $ 721   
  

 

 

 

Mortgage Servicing Rights

MSRs are recognized at fair value when mortgage loans are sold or securitized in the secondary market and the right to service these loans is retained for a fee. MSRs are recorded at fair value and changes in fair value are recorded as a component of mortgage servicing and other income. We may enter into derivatives to economically hedge changes in fair value of MSRs. We have no other loss exposure on MSRs in excess of the recorded fair value.

We continue to operate the mortgage servicing business and to report the changes in the fair value of MSRs in continuing operations. To evaluate and measure fair value, the underlying loans are stratified based on certain risk characteristics, including loan type, note rate and investor servicing requirements.

The following table sets forth the changes in the fair value of MSRs during the three and six months ended June 30, 2011 and 2010:

 

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

(Dollars in millions)

       2011             2010             2011             2010      

Balance at beginning of period

   $ 144      $ 230      $ 141      $ 240   

Originations

     2        3        6        6   

Sales

     0        (42     0        (42

Change in fair value, net

     (16     (54     (17     (67
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance at end of period

   $ 130      $ 137      $ 130      $ 137   
  

 

 

   

 

 

   

 

 

   

 

 

 

Ratio of mortgage servicing rights to related loans serviced for others

     0.69     0.65     0.71     0.65

Weighted average service fee

     0.28        0.28        0.28        0.28   

 

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MSR fair value adjustments for the three and six months ended June 30, 2011 included decreases of $3 million and $7 million, respectively, due to run-off, and decreases of $13 million and $10 million, respectively, due to changes in the valuation inputs and assumptions.

MSR fair value adjustments for the three and six months ended June 30, 2010 included decreases of $7 million and $17 million, respectively, due to run-off and cash collections, and decrease of $47 million and $50 million, respectively, due to changes in the valuation inputs and assumptions.

The significant assumptions used in estimating the fair value of the MSRs as of June 30, 2011 and 2010 were as follows:

 

     June 30,  
      2011     2010  

Weighted average prepayment rate (includes default rate)

     14.51     18.26

Weighted average life (in years)

     5.99        4.97   

Discount rate

     11.74     11.83

The decrease in the weighted average prepayment rate and the corresponding increase in weighted average life, were both driven by a reduction in voluntary attrition due to market conditions.

At June 30, 2011, the sensitivities to immediate 10% and 20% increases in the weighted average prepayment rates would decrease the fair value of mortgage servicing rights by $6 million and $11 million, respectively.

At June 30, 2011, the sensitivities to immediate 10% and 20% adverse changes in servicing costs would decrease the fair value of mortgage servicing rights by $10 million and $22 million, respectively.

As of June 30, 2011, our mortgage loan servicing portfolio consisted of mortgage loans with an aggregate unpaid principal balance of $29 billion, of which $19 billion was serviced for other investors. As of June 30, 2010, our mortgage loan servicing portfolio consisted of mortgage loans with an aggregate unpaid principal balance of $33 billion, of which $21 billion was serviced for other investors.

 

 

NOTE 9—DEPOSITS AND BORROWINGS

 

Customer Deposits

Our customer deposits, which have become our largest source of funding for our operations and asset growth, consist of non-interest bearing and interest-bearing deposits, including demand deposits, money market deposits, negotiable order of withdrawal (“NOW”) accounts, savings accounts and certificates of deposit.

As of June 30, 2011, we had $109.3 billion in interest-bearing deposits, of which $5.8 billion represented large denomination certificates of $100,000 or more. As of December 31, 2010, we had $107.2 billion in interest-bearing deposits, of which $6.5 billion represented large denomination certificates of $100,000 or more.

Borrowings

We also access the capital markets to meet our funding needs through loan securitization transactions and the issuance of senior and subordinated debt. As of June 30, 2011, we had an effective shelf registration statement filed with the U.S. Securities & Exchange Commission (“SEC”) under which, from time to time, we may offer and sell an indeterminate aggregate amount of senior or subordinated debt securities, preferred stock, depository shares representing preferred stock, common stock, purchase contracts, warrants, units, trust preferred securities, junior subordinated debentures, guarantees of trust preferred securities and certain back-up obligations. There is no limit under this shelf registration statement to the amount or number of such securities that we may offer and

 

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sell. Under SEC rules, the shelf registration statement, which we filed in May 2009, expires three years after filing. We did not issue any senior, subordinated or other debt securities under the shelf registration statement during the first six months of 2011.

In addition to issuance capacity under the shelf registration statement, we have access to other borrowing programs, including advances from the Federal Home Loan Bank (“FHLB”). Our FHLB membership is secured by our investment in FHLB stock, which totaled $230 million as of June 30, 2011 and $269 million as of December 31, 2010.

Securitized Debt Obligations

Effective January 1, 2010, we added to our consolidated balance sheet $41.9 billion of assets, consisting primarily of credit card loan receivables underlying our consolidated securitization trusts, along with $44.3 billion of related debt issued by these trusts to third-party investors.

Senior and Subordinated Debt

As of June 30, 2011, we had $8.7 billion of senior and subordinated notes outstanding, which included $591 million in fair value hedging losses. As of December 31, 2010, we had $8.7 billion of senior and subordinated notes outstanding, which included $578 million in fair value hedging losses. There were no senior or subordinated notes that matured during the six months ended June 30, 2011. Two senior notes totaling $671 million matured during the year ended December 31, 2010. See “Note 10—Derivative Instruments and Hedging Activities” for information about our fair value hedging activities.

Under a Senior and Subordinated Global Bank Note Program, COBNA has the ability to issue debt securities to both U.S. and non-U.S. lenders and to raise funds in U.S. and foreign currencies. The Senior and Subordinated Global Bank Note Program had $817 million and $820 million outstanding at June 30, 2011 and December 31, 2010, respectively.

Junior Subordinated Debentures

We had $3.6 billion of outstanding junior subordinated debentures as of both June 30, 2011 and December 31, 2010. There were no junior subordinated borrowings that were called or matured during the six months ended June 30, 2011.

FHLB Advances

We had outstanding FHLB advances, which are secured by our investment securities, residential mortgage loan portfolio, multifamily loans, commercial real estate loans and home equity lines of credit, totaling $3.0 billion as of June 30, 2011, and $1.1 billion as of December 31, 2010. During the second quarter of 2011, we withdrew an additional $1.9 billion in short-term FHLB advances for general operating purposes.

 

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Composition of Customer Deposits, Short-term Borrowings and Long-term Debt

The table below summarizes the components of our deposits, short-term borrowings and long-term debt as of June 30, 2011 and December 31, 2010. Our total short-term borrowings consist of federal funds purchased and securities loaned under agreements to repurchase and other short-term borrowings with an original contractual maturity of one year or less. Our long-term debt consists of borrowings with an original contractual maturity of greater than one year. The amounts presented for outstanding borrowings include unamortized debt premiums and discounts, net of fair value hedge accounting adjustments.

 

(Dollars in millions)

   June 30,
2011
     December 31,
2010
 

Deposits:

     

Non-interest bearing deposits

   $ 16,839       $ 15,048   

Interest-bearing deposits

     109,278         107,162   
  

 

 

    

 

 

 

Total deposits

   $ 126,117       $ 122,210   
  

 

 

    

 

 

 

Short-term borrowings:

     

Federal funds purchased and securities loaned or sold under agreements to repurchase

   $ 2,575       $ 1,517   

FHLB advances

     1,865         0   

Other short-term borrowings

     0         7   
  

 

 

    

 

 

 

Total short-term borrowings

     4,440         1,524   
  

 

 

    

 

 

 

Long-term debt:

     

Securitized debt obligations

     19,860         26,836 (1) 

Senior and subordinated notes:

     

Unsecured senior debt

     4,883         4,883   

Unsecured subordinated debt

     3,781         3,767   
  

 

 

    

 

 

 

Total senior and subordinated notes

     8,664         8,650   
  

 

 

    

 

 

 

Other long-term borrowings:

     

Junior subordinated debt

     3,642         3,642   

FHLB advances

     1,129         1,144   
  

 

 

    

 

 

 

Other long-term borrowings

     4,771         4,786   
  

 

 

    

 

 

 

Total long-term debt

     33,295         40,272   
  

 

 

    

 

 

 

Total short-term borrowings and long-term debt

   $ 37,735       $ 41,796   
  

 

 

    

 

 

 

 

(1) 

Includes fair value hedges related to securitized debt of $79 million as of December 31, 2010, which was disclosed on the consolidated balance sheet in Other borrowings.

 

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Components of Interest Expense

The following table displays interest expense attributable to short-term borrowings and long-term debt for the three and six months ended June 30, 2011 and 2010:

 

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

(Dollars in millions)

       2011              2010              2011              2010      

Short-term borrowings:

           

Federal funds purchased and securities loaned or sold under agreements to repurchase

   $ 2       $ 1       $ 3       $ 2   

FHLB advances

     1         0         1         0   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total short-term borrowings

     3         1         4         2   
  

 

 

    

 

 

    

 

 

    

 

 

 

Long-term debt:

           

Securitized debt obligations

     113         212         253         454   

Senior and subordinated notes:

           

Unsecured senior debt

     34         41         69         79   

Unsecured subordinated debt

     29         31         58         61   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total senior and subordinated notes

     63         72         127         140   
  

 

 

    

 

 

    

 

 

    

 

 

 

Other long-term borrowings:

           

Junior subordinated debt

     72         80         152         163   

FHLB advances

     3         4         6         13   

Other

     2         1         4         1   
  

 

 

    

 

 

    

 

 

    

 

 

 

Other long-term borrowings

     77         85         162         177   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total long-term debt

     253         369         542         771   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total short-term borrowings and long-term debt

   $ 256       $ 370       $ 546       $ 773   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

 

NOTE 10— DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

 

Use of Derivatives

We manage our asset/liability risk position and exposure to market risk in accordance with prescribed risk management policies and limits established by our Asset Liability Management Committee and approved by our Board of Directors. Our primary market risk stems from the impact on our earnings and our economic value of equity from changes in interest rates, and to a lesser extent, changes in foreign exchange rates. We manage our interest rate sensitivity through several techniques, which include, but are not limited to, changing the maturity and re-pricing characteristics of various balance sheet categories and by entering into interest rate derivatives. Derivatives are also utilized to manage our exposure to changes in foreign exchange rates. Derivative instruments may be privately negotiated contracts, which are often referred to as over-the-counter (“OTC”) derivatives, or they may be listed and traded on an exchange. We execute our derivative contracts in both the OTC and exchange-traded derivative markets. In addition to interest rate swaps, we use a variety of other derivative instruments, including caps, floors, options, futures and forward contracts, to manage our interest rate and foreign currency risk. From time to time, we enter into customer-accommodation derivative transactions. We engage in these transactions as a service to our commercial banking customers to facilitate their risk management objectives. We typically offset the market risk exposure to our customer-accommodation derivatives through derivative transactions with other counterparties.

Accounting for Derivatives

We account for derivatives pursuant to the accounting standards for derivatives and hedging. The outstanding notional amount of our derivative contracts totaled $50.3 billion as of June 30, 2011, compared with $50.7 billion

 

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as of December 31, 2010. The notional amount provides an indication of the volume of our derivatives activity and is used as the basis on which interest and other payments are determined; however, it is generally not the amount exchanged. Derivatives are recorded at fair value in our consolidated balance sheets. The fair value of a derivative represents our estimate of the amount at which a derivative could be exchanged in an orderly transaction between market participants. We report derivatives in a gain position, or derivative assets, in our consolidated balance sheets as a component of other assets. We report derivatives in a loss position, or derivative liabilities, in our consolidated balance sheets as a component of other liabilities. We report derivative asset and liability amounts on a gross basis based on individual contracts, which does not take into consideration the effects of master counterparty netting agreements or collateral netting. The fair value of derivative assets and derivative liabilities reported in our consolidated balance sheets was $1.4 billion and $549 million, respectively, as of June 30, 2011, compared with $1.3 billion and $636 million, respectively, as of December 31, 2010.

Our derivatives are designated as either qualifying accounting hedges or free-standing derivatives. Free-standing derivatives consist of customer-accommodation derivatives and economic hedges that we enter into for risk management purposes that are not linked to specific assets or liabilities or to forecasted transactions and, therefore, do not qualify for hedge accounting. Qualifying accounting hedges are designated as fair value hedges, cash flow hedges or net investment hedges.

 

   

Fair Value Hedges: We designate derivatives as fair value hedges to manage our exposure to changes in the fair value of certain financial assets and liabilities, which fluctuate in value as a result of movements in interest rates. Changes in the fair value of derivatives designated as fair value hedges are recorded in earnings together with offsetting changes in the fair value of the hedged item and any resulting ineffectiveness. Our fair value hedges consist of interest rate swaps that are intended to modify our exposure to interest rate risk on various fixed rate senior notes, subordinated notes, brokered certificates of deposits and U.S. agency investments. These hedges have maturities through 2019 and have the effect of converting some of our fixed rate debt, deposits and investments to variable rate.

 

   

Cash Flow Hedges: We designate derivatives as cash flow hedges to manage our exposure to variability in cash flows related to forecasted transactions. Changes in the fair value of derivatives designated as cash flow hedges are recorded as a component of AOCI, to the extent that the hedge relationships are effective, and amounts are reclassified from AOCI to earnings as the forecasted transactions occur. To the extent that any ineffectiveness exists in the hedge relationships, the amounts are recorded in current period earnings. Our cash flow hedges consist of interest rate swaps that are intended to hedge the variability in interest payments on some of our variable rate debt issuances and assets through 2017. These hedges have the effect of converting some of our variable rate debt and assets to a fixed rate. We also have entered into forward foreign currency derivative contracts to hedge our exposure to variability in cash flows related to foreign currency denominated debt.

 

   

Net Investment Hedges: We use net investment hedges, primarily forward foreign exchange contracts, to manage the exposure related to our net investments in consolidated foreign operations that have functional currencies other than the U.S. dollar. Changes in the fair value of net investment hedges are recorded in the translation adjustment component of AOCI.

 

   

Free-Standing Derivatives: We use free-standing derivatives, or economic hedges, to hedge the risk of changes in the fair value of residential MSRs, mortgage loan origination and purchase commitments and other interests held. We also categorize our customer-accommodation derivatives and the related offsetting contracts as free-standing derivatives. Changes in the fair value of free-standing derivatives are recorded in earnings as a component of servicing and securitizations income or as a component of other non-interest income.

 

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Balance Sheet Presentation

The following table summarizes the fair value and related outstanding notional amounts of derivative instruments reported in our consolidated balance sheets as of June 30, 2011 and December 31, 2010. The fair value amounts are segregated by derivatives that are designated as accounting hedges and those that are not, and are further segregated by type of contract within those two categories.

 

     June 30, 2011      December 31, 2010  
     Notional or
Contractual
Amount
     Derivatives at  Fair
Value
     Notional or
Contractual
Amount
     Derivatives at  Fair
Value
 

(Dollars in millions)

      Assets(1)      Liabilities(1)         Assets(1)      Liabilities(1)  

Derivatives designated as accounting hedges:

                 

Interest rate contracts:

                 

Fair value interest rate contracts

   $ 16,236       $ 753       $ 43       $ 17,001       $ 747       $ 77   

Cash flow interest rate contracts

     6,325         28         110         8,585         14         151   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total interest rate contracts

     22,561         781         153         25,586         761         228   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Foreign exchange contracts:

                 

Cash flow foreign exchange contracts

     4,732         12         44         2,266         5         26   

Net investment foreign exchange contracts

     53         0         2         52         0         1   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total foreign exchange contracts

     4,785         12         46         2,318         5         27   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total derivatives designated as accounting hedges

     27,346         793         199         27,904         766         255   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Derivatives not designated as accounting hedges:(1)

                 

Interest rate contracts covering:

                 

MSRs

     483         5         10         625         3         18   

Customer accommodation(2)

     13,851         302         254         12,255         282         244   

Other interest rate exposures

     5,694         26         28         7,579         46         35   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total interest rate contracts

     20,028         333         292         20,459         331         297   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Foreign exchange contracts

     1,483         279         56         1,384         214         67   

Other contracts

     1,480         5         2         980         8         17   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total derivatives not designated as accounting hedges

     22,991         617         350         22,823         553         381   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total derivatives

   $ 50,337       $ 1,410       $ 549       $ 50,727       $ 1,319       $ 636   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

 

(1) 

Derivative asset and liability amounts are presented on a gross basis based on individual contracts and do not reflect the impact of legally enforceable master counterparty netting agreements, collateral received/posted or net credit risk valuation adjustments. We recorded a net cumulative credit risk valuation adjustment related to our derivative positions of $21 million and $20 million as of June 30, 2011 and December 31, 2010, respectively. See “Derivative Counterparty Credit Risk” below for additional information.

(2) 

Customer accommodation derivatives include those entered into with our commercial banking customers and those entered into with other counterparties to offset the market risk.

 

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Income Statement Presentation and AOCI

The following tables summarize the impact of derivatives and related hedged items on our consolidated statements of income and AOCI.

Fair Value Hedges and Free-Standing Derivatives

The net gains (losses) recognized in earnings related to derivatives in fair value hedging relationships and free-standing derivatives are presented below for the three and six months ended June 30, 2011 and 2010:

 

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

(Dollars in millions)

       2011             2010           2011         2010    

Derivatives designated as accounting hedges:

        

Fair value interest rate contracts:

        

Gain (loss) recognized in earnings on derivatives(1)

   $ 190      $ 374      $ 41      $ 525   

Gain (loss) recognized in earnings on hedged items(1)

     (192     (353     (37     (487 )
  

 

 

   

 

 

   

 

 

   

 

 

 

Net fair value hedge ineffectiveness gain (loss)

     (2     21        4        38   
  

 

 

   

 

 

   

 

 

   

 

 

 

Derivatives not designated as accounting hedges:

        

Interest rate contracts covering:

        

MSRs(1)

     (3     (7     (4     (13

Customer accommodation(1)

     3        6        10        8   

Other interest rate exposures(1)

     0        2        6        6   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total interest rate contracts

     0        1        12        1   
  

 

 

   

 

 

   

 

 

   

 

 

 

Foreign exchange contracts(1)

     1        (3 )     (2     9   

Other contracts(2)

     12        23        9        32   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total gain (loss) on derivatives not designated as accounting hedges

     13        21        19        42   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net derivatives gain (loss) recognized in earnings

   $ 11      $ 42      $ 23      $ 80   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) 

Amounts are recorded in our consolidated statements of income in other non-interest income.

(2) 

Other contracts include items such as To Be Announced (“TBA”) forward contracts and futures contracts. Of the $12 million and $9 million of income recognized in the three and six months ended June 30, 2011, respectively, $16 million and $14 million, respectively, of income was included in our consolidated statements of income in servicing and securitizations income and $4 million and $5 million, respectively, of expense was included in non-interest income. Of the $23 million and $32 million of income recognized in the three and six months ended June 30, 2010, respectively, $31 million and $42 million, respectively, was included in servicing and securitizations income and $8 million and $10 million, respectively, of expense was included in non-interest income.

 

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Cash Flow and Net Investment Hedges

The table below shows the net gains (losses) related to derivatives designated as cash flow hedges and net investment hedges for the three and six months ended June 30, 2011 and 2010:

 

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

(Dollars in millions)

       2011             2010           2011         2010    

Gain (loss) recorded in AOCI:(1)

        

Cash flow hedges:

        

Interest rate contracts

   $ 15      $ (5   $ 22      $ (15

Foreign exchange contracts

     (10     0        (10     2   
  

 

 

   

 

 

   

 

 

   

 

 

 

Subtotal

     5        (5     12        (13
  

 

 

   

 

 

   

 

 

   

 

 

 

Net investment hedges:

        

Foreign exchange contracts

     0        0        (1     3   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net derivatives gain recognized in AOCI

   $ 5      $ (5   $ 11      $ (10
  

 

 

   

 

 

   

 

 

   

 

 

 

Gain (loss) recorded in earnings:

        

Cash flow hedges:

        

Gain (loss) reclassified from AOCI into earnings:

        

Interest rate contracts(2)

   $ 14      $ (13   $ 2      $ (38

Foreign exchange contracts(3)

     (7     0        (9     3   
  

 

 

   

 

 

   

 

 

   

 

 

 

Subtotal

     7        (13     (7     (35

Gain (loss) recognized in earnings due to ineffectiveness:

        

Interest rate contracts(3)

     0        0        0        1   

Foreign exchange contracts(3)

     0        0        0        0   
  

 

 

   

 

 

   

 

 

   

 

 

 

Subtotal

     0        0        0        1   

Net investment hedges:

        

Gain (loss) reclassified from AOCI into earnings:

        

Foreign exchange contracts(3)

     0        0        0        0   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net derivatives gain (loss) recognized in earnings

   $ 7      $ (13 )   $ (7   $ (34
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) 

Amounts represent the effective portion.

(2) 

Amounts reclassified are recorded in our consolidated statements of income in interest income or interest expense.

(3) 

Amounts reclassified are recorded in our consolidated statements of income in other non-interest income.

We expect to reclassify net after-tax gains of $2 million recorded in AOCI as of June 30, 2011, related to derivatives designated as cash flow hedges to earnings over the next 12 months, which we expect to offset against the cash flows associated with the hedged forecasted transactions. The maximum length of time over which forecasted transactions were hedged was six years as of June 30, 2011. The amount we expect to reclassify into earnings may change as a result of changes in market conditions and ongoing actions taken as part of our overall risk management strategy.

Credit Default Swaps

We have credit exposure on credit default swap agreements that we entered into to manage our risk of loss on certain manufactured housing securitizations issued by GreenPoint Credit LLC in 2000. Our maximum credit exposure related to these swap agreements totaled $25 million and $27 million as of June 30, 2011 and December 31, 2010, respectively. These agreements are recorded in our consolidated balance sheets as a component of other liabilities. The value of our obligations under these swaps was $17 million as of June 30, 2011 and $18 million as of December 31, 2010. See “Note 7—Variable Interest Entities and Securitizations” for additional information about our manufactured housing securitization transactions.

 

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Credit Risk-Related Contingency Features

Certain of our derivative contracts include provisions requiring that our debt maintain a credit rating of investment grade or above by each of the major credit rating agencies. In the event of a downgrade of our debt credit rating below investment grade, some of our derivative counterparties would have the right to terminate the derivative contract and close-out the existing positions. Other derivative contracts include provisions that would, in the event of a downgrade of our debt credit rating below investment grade, allow our derivative counterparties to demand immediate and ongoing full overnight collateralization on derivative instruments in a net liability position. Certain of our derivative contracts may allow, in the event of a downgrade of our debt credit rating of any kind, our derivative counterparties to demand additional collateralization on such derivative instruments in a net liability position. The fair value of derivative instruments with credit-risk-related contingent features in a net liability position was $62 million and $66 million as of June 30, 2011 and December 31, 2010, respectively. We were required to post collateral, consisting of a combination of cash and securities, totaling $204 million and $229 million as of June 30, 2011 and December 31, 2010, respectively. If our debt credit rating had fallen below investment grade, we would have been required to post additional collateral of $20 million and $39 million as of June 30, 2011 and December 31, 2010, respectively.

Derivative Counterparty Credit Risk

Derivative instruments contain an element of credit risk that arises from the potential failure of a counterparty to perform according to the contractual terms of the contract. Our exposure to derivative counterparty credit risk at any point in time is represented by the fair value of derivatives in a gain position, or derivative assets, assuming no recoveries of underlying collateral. To mitigate the risk of counterparty default, we maintain collateral agreements with certain derivative counterparties. These agreements typically require both parties to maintain collateral in the event the fair values of derivative financial instruments exceed established thresholds. We received cash collateral from derivatives counterparties totaling $750 million and $668 million as of June 30, 2011 and December 31, 2010, respectively. We posted cash collateral in accounts maintained by derivatives counterparties totaling $204 million and $229 million as of June 30, 2011 and December 31, 2010, respectively.

We record counterparty credit risk valuation adjustments on our derivative assets to properly reflect the credit quality of the counterparty. We consider collateral and legally enforceable master netting agreements that mitigate our credit exposure to each counterparty in determining the counterparty credit risk valuation adjustment, which may be adjusted in future periods due to changes in the fair value of the derivative contract, collateral and creditworthiness of the counterparty. The cumulative counterparty credit risk valuation adjustment recorded on our consolidated balance sheets as a reduction in the derivative asset balance was $22 million as of June 30, 2011 and December 31, 2010. We also adjust the fair value of our derivative liabilities to reflect the impact of our credit quality. We calculate this adjustment by comparing the spreads on our credit default swaps to the discount benchmark curve. The cumulative credit risk valuation adjustment related to our credit quality recorded on our consolidated balance sheets as a reduction in the derivative liability balance was $1 million and $2 million as of June 30, 2011 and December 31, 2010, respectively.

We provide additional information on our management of derivative counterparty credit risk in our 2010 Form 10-K “Note 11—Derivative Instruments and Hedging Activities.”

 

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NOTE 11—STOCKHOLDERS’ EQUITY

 

Accumulated Other Comprehensive Income (AOCI)

The following table presents the cumulative balances of accumulated other comprehensive income, net of deferred tax of $215 million and $143 million as of June 30, 2011 and December 31, 2010, respectively:

 

(Dollars in millions)

   June 30,
2011
    December 31,
2010
 

Net unrealized gains on securities(1)

   $ 455      $ 333   

Net unrecognized elements of defined benefit plans

     (29     (29

Foreign currency translation adjustments

     27        (36

Unrealized losses on cash flow hedging instruments and Other

     (36     (52

Other-than-temporary impairment not recognized in earnings on securities

     42        49   

Initial application of measurement date provisions for postretirement benefits other than pensions

     (1     (1

Initial application from adoption of consolidation standards

     (16     (16
  

 

 

   

 

 

 

Total accumulated other comprehensive income

   $ 442      $ 248   
  

 

 

   

 

 

 

 

(1) 

Includes net unrealized gains (losses) on securities available for sale and retained subordinated notes. Unrealized losses not related to credit on other-than-temporarily impaired securities of $116 million (net of income tax of $75 million) and $105 million (net of income tax of $68 million) was reported in other comprehensive income as of June 30, 2011 and December 31, 2010, respectively.

 

 

NOTE 12—EARNINGS PER COMMON SHARE

 

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

 

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

(Dollars and shares in millions, except per share-related data)

       2011             2010             2011             2010      

Numerator:

        

Income from continuing operations, net of tax

   $ 945      $ 812      $ 1,977      $ 1,532   

Loss from discontinued operations, net of tax

     (34     (204     (50     (288
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 911      $ 608      $ 1,927      $ 1,244   
  

 

 

   

 

 

   

 

 

   

 

 

 

Denominator:

        

Denominator for basic earnings per share-Weighted-average shares

     456        452        455        452   

Effect of dilutive securities(1):

        

Stock options

     2        1        2        1   

Contingently issuable shares

     2        0        2        0   

Restricted stock and units

     2        3        2        3   
  

 

 

   

 

 

   

 

 

   

 

 

 

Dilutive potential common shares

     6        4        6        4   
  

 

 

   

 

 

   

 

 

   

 

 

 

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

     462        456        461        456   
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic earnings per share

        

Income from continuing operations

   $ 2.07      $ 1.79      $ 4.35      $ 3.38   

Loss from discontinued operations

     (0.07     (0.45     (0.11     (0.63
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 2.00      $ 1.34      $ 4.24      $ 2.75   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted earnings per share

        

Income from continuing operations

   $ 2.04      $ 1.78      $ 4.29      $ 3.36   

Loss from discontinued operations

     (0.07     (0.45     (0.11     (0.63
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 1.97      $ 1.33      $ 4.18      $ 2.73   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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(1) 

Excluded from the computation of diluted earnings per share was 8 million and 17 million of awards, options or warrants, for the three months ended June 30, 2011 and 2010, respectively, and 9 million and 24 million of awards, options or warrants, for the six months ended June 30, 2011 and 2010, respectively, because their inclusion would be anti-dilutive.

On July 19, 2011, we closed a public offering of shares of our common stock, subject to forward sale agreements that we entered into with certain counterparties acting as forward purchasers. The forward purchasers agreed to borrow and sell to the public, through the underwriters, 40 million shares of our common stock at a price per share of $50.00. After underwriter’s discounts and commissions, the net proceeds to the company will be at an initial forward sale price per share of $48.50.

 

 

NOTE 13—FAIR VALUE OF FINANCIAL INSTRUMENTS

 

Fair Value

Fair value is defined as the price that would be received for an asset or paid to transfer a liability in an orderly transaction between market participants on the measurement date (also referred to as an exit price). The fair value accounting guidance provides a three-level fair value hierarchy for classifying financial instruments. This hierarchy is based on whether the inputs to the valuation techniques used to measure fair value are observable or unobservable. Fair value measurement of a financial asset or liability is assigned to a level based on the lowest level of any input that is significant to the fair value measurement in its entirety. The three levels of the fair value hierarchy are described below:

 

Level 1:

   Quoted prices (unadjusted) in active markets for identical assets or liabilities.

Level 2:

   Observable market-based inputs, other than quoted prices in active markets for identical assets or liabilities.

Level 3:

   Unobservable inputs.

The accounting guidance for fair value requires that we maximize the use of observable inputs and minimize the use of unobservable inputs in determining fair value. The accounting guidance for derivatives also provides for the irrevocable option to elect, on a contract-by-contract basis, to measure certain financial assets and liabilities at fair value at inception of the contract and record any subsequent changes in fair value into earnings. We had not made any material fair value option elections as of June 30, 2011 and December 31, 2010.

Level 1, 2 and 3 Valuation Techniques

Financial instruments are considered Level 1 when the valuation can be based on quoted prices in active markets for identical assets or liabilities. Level 2 financial instruments are valued using quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or models using inputs that are observable or can be corroborated by observable market data of substantially the full term of the assets or liabilities. Financial instruments are considered Level 3 when their values are determined using pricing models, discounted cash flow methodologies or similar techniques, and at least one significant model assumption or input is unobservable and when determination of the fair value requires significant management judgment or estimation.

 

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The following table displays our assets and liabilities measured on our consolidated balance sheets at fair value on a recurring basis as of June 30, 2011 and December 31, 2010:

Assets and Liabilities Measured at Fair Value on a Recurring Basis

 

     June 30, 2011  
     Fair Value Measurements Using      Assets/
Liabilities
at Fair Value
 

(Dollars in millions)

   Level 1      Level 2      Level 3     

Assets

           

Securities available for sale:

           

U.S. Treasury and other U.S. Agency

   $ 311       $ 176       $ 0       $ 487   

Collateralized mortgage obligations

     0         13,143         158         13,301   

Mortgage-backed securities

     0         15,107         199         15,306   

Asset-backed securities

     0         9,823         9         9,832   

Other

     297         239         12         548   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total securities available for sale

     608         38,488         378         39,474   

Other assets:

           

Mortgage servicing rights

     0         0         130         130   

Derivative receivables(1)(2)

     5         1,361         44         1,410   

Retained interests in securitization

     0         0         106         106   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Assets

   $ 613       $ 39,849       $ 658       $ 41,120   
  

 

 

    

 

 

    

 

 

    

 

 

 

Liabilities

           

Other liabilities:

           

Derivative payables(1)(2)

   $ 2       $ 505       $ 42       $ 549   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Liabilities

   $ 2       $ 505       $ 42       $ 549   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     December 31, 2010  
     Fair Value Measurements Using      Assets/
Liabilities
at Fair Value
 

(Dollars in millions)

   Level 1      Level 2      Level 3     

Assets

           

Securities available for sale:

           

U.S. Treasury and other U.S. Agency

   $ 386       $ 314       $ 0       $ 700   

Collateralized mortgage obligations

     0         13,277         308         13,585   

Mortgage-backed securities

     0         16,394         270         16,664   

Asset-backed securities

     0         9,953         13         9,966   

Other

     293         322         7         622   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total securities available for sale

     679         40,260         598         41,537   

Other assets:

           

Mortgage servicing rights

     0         0         141         141   

Derivative receivables(1)(2)

     8         1,265         46         1,319   

Retained interests in securitizations

     0         0         117         117   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Assets

   $ 687       $ 41,525       $ 903       $ 43,114   
  

 

 

    

 

 

    

 

 

    

 

 

 

Liabilities

           

Other liabilities:

           

Derivative payables(1)(2)

   $ 18       $ 575       $ 43       $ 636   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Liabilities

   $ 18       $ 575       $ 43       $ 636   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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(1) 

We do not offset the fair value of derivative contracts in a loss position against the fair value of contracts in a gain position. We also do not offset fair value amounts recognized for derivative instruments and fair value amounts recognized for the right to reclaim cash collateral or the obligation to return cash collateral arising from derivative instruments executed with the same counterparty under a master netting arrangement.

(2) 

Does not reflect $21 million and $20 million recognized as a net valuation allowance on derivative assets and liabilities for non-performance risk as of June 30, 2011 and December 31, 2010, respectively. Non-performance risk is reflected in other assets/liabilities on the balance sheet and offset through the income statement in other income.

The determination of the classification of financial instruments in Level 2 or Level 3 of the fair value hierarchy is performed at the end of each reporting period. We consider all available information, including observable market data, indications of market liquidity and orderliness, and our understanding of the valuation techniques and significant inputs. Based upon the specific facts and circumstances of each instrument or instrument category, judgments are made regarding the significance of the Level 3 inputs to the instruments’ fair value measurement in its entirety. If Level 3 inputs are considered significant, the instrument is classified as Level 3. The process for determining fair value using unobservable inputs is generally more subjective and involves a high degree of management judgment and assumptions.

During the second quarter of 2011, we did not have material movements between Levels 1 and 2. In connection with the adoption of the new consolidation accounting standards on January 1, 2010, retained interests in securitizations, which were considered a Level 3 security, were reclassified to loans held for investment when the underlying trusts were consolidated.

Level 3 Instruments Only

Financial instruments are considered Level 3 when their values are determined using pricing models, which include comparison of prices from multiple sources, discounted cash flow methodologies or similar techniques and at least one significant model assumption or input is unobservable or there is significant variability among pricing sources. Level 3 financial instruments also include those for which the determination of fair value requires significant management judgment or estimation. The table below presents reconciliation for all assets and liabilities measured and recognized at fair value on a recurring basis using significant unobservable inputs (Level 3).

 

(Dollars in millions)

   Three Months Ended June 30, 2011  
   Securities
Available  for
Sale
    Mortgage
Servicing
Rights
    Derivative
Receivables (2)
    Retained
Interests in
Securitizations(3)
    Derivative
Payables(2)
 
          
          

Balance, March 31, 2011

   $ 539      $ 144      $ 41      $ 112      $ 39   

Total realized and unrealized gains (losses):

          

Included in net income

     0        (13 )(1)      9        (6     5   

Included in other comprehensive income

     2        0        0        0        0   

Purchases

     34        0        0        0        0   

Sales

     0        0        0        0        0   

Issuances

     0        2        2        0        2   

Settlements

     (22     (3     (7     0        (4

Transfers in to Level 3(4)

     31        0        0        0        0   

Transfers out of Level 3(4)

     (206     0        (1     0        0   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, June 30, 2011

   $ 378      $ 130      $ 44      $ 106      $ 42   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total unrealized gains (losses) included in net income related to assets and liabilities still held as of June 30, 2011(5)

   $ 0      $ (13   $ 9      $ (6   $ 5   

 

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Table of Contents
     Three Months Ended June 30, 2011  

(Dollars in millions)

   U.S. Treasury
&
Agency
     Collateralized
Mortgage
Obligations
    Mortgage-
backed
Securities
    Asset-
backed
Securities
    Other      Total  

Securities Available for Sale

              

Balance, March 31, 2011

   $ 0       $ 272      $ 247      $ 13      $ 7       $ 539   

Total realized and unrealized gains (losses):

              

Included in net income

     0         0        0        0        0         0   

Included in other comprehensive income

     0         (1     4        (1     0         2   

Purchases

     0         34        0        0        0         34   

Sales

     0         0        0        0        0         0   

Issuances

     0         0        0        0        0         0   

Settlements

     0         (9     (13     0        0         (22

Transfers in to Level 3(4)

     0         24        2        0        5         31   

Transfers out of Level 3(4)

     0         (162     (41     (3     0         (206
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Balance, June 30, 2011

   $ 0       $ 158      $ 199      $ 9      $ 12       $ 378   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Total unrealized gains (losses) included in net income related to assets and liabilities still held as of June 30, 2011(5)

   $ 0       $ 0      $ 0      $ 0      $ 0       $ 0   

 

     Three Months Ended June 30, 2010  

(Dollars in millions)

   Securities
Available  for
Sale
    Mortgage
Servicing
Rights
    Derivative
Receivables(2)
     Retained
Interests in
Securitizations(3)
    Derivative
Payables(2)
 

Balance, March 31, 2010

   $ 1,253      $ 230      $ 38       $ 196      $ 35   

Total realized and unrealized gains (losses):

           

Included in net income

     0        (47 )(1)      12         6        11   

Included in other comprehensive income

     (28     0        0         0        0   

Purchases, sales, issuances and settlements, net

     0        (46     1         (6     1   

Impact of adoption of consolidation standards

     0        0        0         0        0   

Transfers in to Level 3(4)

     437        0        0         0        0   

Transfers out of Level 3(4)

     (450     0        0         0        0   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Balance, June 30, 2010

   $ 1,212      $ 137      $ 51       $ 196      $ 47   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total unrealized gains (losses) included in net income related to assets and liabilities still held as of June 30, 2010(5)

   $ 0      $ (47   $ 12       $ 5      $ 11   

 

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Table of Contents
     Three Months Ended June 30, 2010  

(Dollars in millions)

   U.S.  Treasury
&

Agency
     Collateralized
Mortgage
Obligations
    Mortgage-
backed
Securities
    Asset-
backed
Securities
    Other     Total  

Securities Available for Sale

             

Balance, March 31, 2010

   $ 0       $ 774      $ 371      $ 83      $ 25      $ 1,253   

Total realized and unrealized gains (losses):

             

Included in net income

     0         0        0        0        0        0   

Included in other comprehensive income

     0         (13     (14     (1     0        (28

Purchases, sales, issuances and settlements, net

     0         0        0        0        0        0   

Transfers in to Level 3(4)

     0         172        215        50        0        437   

Transfers out of Level 3(4)

     0         (300     (144     0        (6     (450
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, June 30, 2010

   $ 0       $ 633      $ 428      $ 132      $ 19      $ 1,212   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total unrealized gains (losses) included in net income related to assets and liabilities still held as of June 30, 2010(5)

   $ 0       $ 0      $ 0      $ 0      $ 0      $ 0   

 

     Six Months Ended June 30, 2011  

(Dollars in millions)

   Securities
Available for
Sale
    Mortgage
Servicing
Rights
    Derivative
Receivables(2)
    Retained
Interests in
Securitizations(3)
    Derivative
Payables(2)
 

Balance, January 1, 2011

   $ 598      $ 141      $ 46      $ 117      $ 43   

Total realized and unrealized gains (losses):

          

Included in net income

     0        (10 )(1)      11        (11     4   

Included in other comprehensive income

     (5     0        0        0        0   

Purchases

     34        0        0        0        0   

Sales

     0        0        0        0        0   

Issuances

     (15     6        3        0        2   

Settlements

     (59     (7     (15     0        (7

Transfers in to Level 3(4)

     31        0        0        0        0   

Transfers out of Level 3(4)

     (206     0        (1     0        0   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, June 30, 2011

   $ 378      $ 130      $ 44      $ 106      $ 42   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total unrealized gains (losses) included in net income related to assets and liabilities still held as of June 30, 2011(5)

   $ 0      $ (10   $ 11      $ (11   $ 4   

 

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Table of Contents
     Six Months Ended June 30, 2011  

(Dollars in millions)

   U.S.  Treasury
&

Agency
     Collateralized
Mortgage
Obligations
    Mortgage-
backed
Securities
    Asset-
backed
Securities
    Other      Total  

Securities Available for Sale

              

Balance, January 1, 2011

   $ 0       $ 308      $ 270      $ 13      $ 7       $ 598   

Total realized and unrealized gains (losses):

              

Included in net income

     0         0        0        0        0         0   

Included in other comprehensive income

     0         (1     (3     (1     0         (5

Purchases

     0         34        0        0        0         34   

Sales

     0         (15     0        0        0         (15

Issuances

     0         0        0        0        0         0   

Settlements

     0         (30     (29     0        0         (59

Transfers in to Level 3(4)

     0         24        2        0        5         31   

Transfers out of Level 3(4)

     0         (162     (41     (3     0         (206
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Balance, June 30, 2011

   $ 0       $ 158      $ 199      $ 9      $ 12       $ 378   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Total unrealized gains (losses) included in net income related to assets and liabilities still held as of June 30, 2011(5)

   $ 0       $ 0      $ 0      $ 0      $ 0       $ 0   

 

     Six Months Ended June 30, 2010  

(Dollars in millions)

   Securities
Available for
Sale
    Mortgage
Servicing
Rights
    Derivative
Receivables(2)
    Retained
Interests in
Securitizations(3)
    Derivative
Payables(2)
 

Balance, January 1, 2010

   $ 1,506      $ 240      $ 441      $ 3,945      $ 33   

Total realized and unrealized gains (losses):

          

Included in net income

     0        (53 )(1)      10        9        13   

Included in other comprehensive income

     (49     0        0        0        0   

Purchases, sales, issuances and settlements, net

     61        (50     1        (7     1   

Impact of adoption of consolidation standards

     0        0        (401     (3,751     0   

Transfers in to Level 3(4)

     752        0        0        0        0   

Transfers out of Level 3(4)

     (1,058     0        0        0        0   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, June 30, 2010

   $ 1,212      $ 137      $ 51      $ 196      $ 47   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total unrealized gains (losses) included in net income related to assets and liabilities still held as of June 30, 2010(5)

   $ 0      $ (53   $ 10      $ 8      $ 13   

 

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Table of Contents
     Six Months Ended June 30, 2010  

(Dollars in millions)

   U.S.  Treasury
&

Agency
     Collateralized
Mortgage
Obligations
    Mortgage-
backed
Securities
    Asset-
backed
Securities
    Other     Total  

Securities Available for Sale

             

Balance January 1, 2010

   $ 0       $ 982      $ 486      $ 13      $ 25      $ 1,506   

Total realized and unrealized gains (losses):

             

Included in net income

     0         0        0        0        0        0   

Included in other comprehensive income

     0         (36     (12     (1     0        (49

Purchases, sales, issuances and settlements, net

     0         (9     0        70        0        61   

Transfers in to Level 3(4)

     0         285        417        50        0        752   

Transfers out of Level 3(4)

     0         (589     (463     0        (6     (1,058
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, June 30, 2010

   $ 0       $ 633      $ 428      $ 132      $ 19      $ 1,212   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total unrealized gains (losses) included in net income related to assets and liabilities still held as of June 30, 2010(5)

   $ 0       $ 0      $ 0      $ 0      $ 0      $ 0   

 

(1) 

Gains (losses) related to Level 3 mortgage servicing rights are reported in mortgage servicing and other income, which is a component of non-interest income.

(2) 

An end of quarter convention is used to measure derivative activity, resulting in end of quarter values being reflected as purchases, issuances and settlements for derivatives having a zero fair value at inception. Gains (losses) related to Level 3 derivative receivables and derivative payables are reported in other non-interest income, which is a component of non-interest income.

(3) 

An end of quarter convention is used to reflect activity in retained interests in securitizations, resulting in all transactions and assumption changes being reflected as if they occurred on the last day of the quarter. Gains (losses) related to Level 3 retained interests in securitizations are reported in servicing and securitizations income, which is a component of non-interest income.

(4) 

The transfer out of Level 3 for the second quarter and first six months of 2011 and 2010 was primarily driven by greater consistency amongst multiple pricing sources. The transfer into Level 3 was primarily driven by less consistency amongst vendor pricing on individual securities for non-agency MBS.

(5) 

The amount presented for unrealized gains (loss) for assets still held as of the reporting date primarily represents impairments for available-for-sale securities and accretion on certain fixed maturity securities, and are reported in total other-than-temporary losses as a component of non-interest income.

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

We are required to measure and recognize certain other financial assets at fair value on a nonrecurring basis in the consolidated balance sheet. These financial assets are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when we evaluate impairment). Fair value adjustments for loans held for sale, foreclosed assets, and other assets are recorded in other non-interest expense, and fair value adjustments for loans held for investment are recorded in provision for loan and lease losses in the consolidated statement of income.

 

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Table of Contents

For assets measured at fair value on a nonrecurring basis and still held on the consolidated balance sheet, the following table provides the fair value measures by level of valuation assumptions used as of June 30, 2011 and 2010 and the gains or losses recognized for these assets as a result of fair value measurements for the three and six months ended June 30, 2011 and 2010:

 

     June 30, 2011      Three Months
Ended

June 30, 2011
    Six Months
Ended
June  30, 2011
 
     Fair Value Measurements Using      Assets at
Fair Value
     Total
Gains/(Losses)(2)
    Total
Gains/(Losses)(2)
 

(Dollars in millions)

   Level 1      Level 2      Level 3          

Assets

                

Loans held for sale

   $ 0       $ 82       $ 0       $ 82       $ 0      $ 0   

Loans held for investment

     0         76         86         162         (28     (50

Foreclosed assets(1)

     0         154         0         154         (13     (24

Other

     0         18         0         18         (12     (13
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 0       $ 330       $ 86       $ 416       $ (53   $ (87
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

 

     June 30, 2010      Three Months
Ended

June 30, 2010
    Six Months
Ended
June 30, 2010
 
     Fair Value Measurements Using      Assets at
Fair Value
     Total
Gains/(Losses)(2)
    Total
Gains/(Losses)(2)
 

(Dollars in millions)

     Level 1          Level 2          Level 3            

Assets

                

Loans held for sale

   $ 0       $ 245       $ 0       $ 245       $ 1      $ (4

Loans held for investment

     0         19         181         200         17        (107

Foreclosed assets(1)

     0         238         0         238         (9     (20

Other

     0         8         0         8         (4     (2
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 0       $ 510       $ 181       $ 691       $ 5      $ (133
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

 

(1) 

Represents the fair value and related losses of foreclosed properties that were written down subsequent to their initial classification as foreclosed properties.

(2) 

Represents the gains/losses recognized for the periods presented.

 

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Table of Contents

Fair Value of Financial Instruments

The table below presents the fair value of financial instruments, whether or not recognized on the consolidated balance sheet, at fair value as of June 30, 2011 and December 31, 2010:

 

     June 30, 2011      December 31, 2010  

(Dollars in millions)

   Carrying
Amount
     Estimated
Fair Value
     Carrying
Amount
     Estimated
Fair Value
 

Financial Assets

           

Cash and cash equivalents

   $ 6,643       $ 6,643       $ 5,249       $ 5,249   

Restricted cash for securitization investors

     1,328         1,328         1,602         1,602   

Securities available for sale

     39,474         39,474         41,537         41,537   

Loans held for sale

     80         80         228         228   

Net loans held for investment

     124,477         127,520         120,319         124,117   

Interest receivable

     1,027         1,027         1,070         1,070   

Accounts receivable from securitization

     106         106         118         118   

Derivatives

     1,410         1,410         1,319         1,319   

Mortgage servicing rights

     130         130         141         141   

Financial Liabilities

           

Non-interest bearing deposits

   $ 16,839       $ 16,839       $ 15,048       $ 15,048   

Interest-bearing deposits

     109,278         109,752         107,162         107,587   

Senior and subordinated notes

     8,664         9,068         8,650         9,236   

Securitized debt obligations

     19,860         19,626         26,915         26,943   

Federal funds purchased and securities loaned or sold under agreements to repurchase

     2,575         2,575         1,517         1,517   

Other borrowings

     6,636         6774         4,714         4,901   

Interest payable

     469         469         488         488   

Derivatives

     549         549         636         636   

The following describes the valuation techniques used in estimating the fair value of our financial instruments as of June 30, 2011 and December 31, 2010. We applied the fair value provisions, to the financial instruments not recognized on the consolidated balance sheet at fair value, which include loans held for investment, interest receivable, non-interest bearing and interest bearing deposits, other borrowings, senior and subordinated notes, and interest payable. The provisions requiring us to maximize the use of observable inputs and to measure fair value using a notion of exit price were factored into our selection of inputs of our established valuation techniques.

Financial Assets

Cash and Cash Equivalents

The carrying amounts of cash and due from banks, federal funds sold and securities purchases under agreements to resell and interest-bearing deposits with other banks approximate fair value.

Restricted Cash for Securitization Investors

The carrying amounts of restricted cash for securitization investors approximate their fair value due to their relatively short-term nature.

Securities Held To Maturity

The carrying amounts of securities held to maturity, which consists of negative amortization bonds, approximate fair value. We recorded these securities at fair value on the date of acquisition. Fair value is determined using a discounted cash flow method, a form of the income approach. Discount rates were determined considering market rates at which similar instruments would be sold to third parties.

 

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Table of Contents

Securities Available For Sale

Quoted prices in active markets are used to measure the fair value of U.S. Treasury securities. For other investment categories, we utilize multiple third party pricing services to obtain fair value measures for the large majority of our securities. A pricing service may be considered as the primary pricing provider for certain types of securities, and the designation of the primary pricing provider may vary depending on the type of securities. The determination of the primary pricing provider is based on our experience and validation benchmark of the pricing service’s performance in terms of providing fair value measurement for the various types of securities.

Certain securities available for sale are classified as Level 2 and 3, the majority of which are collateralized mortgage obligations and mortgage-backed securities. Classification indicates that significant valuation assumptions are not consistently observable in the market. When significant assumptions are not consistently observable, fair values are derived using the best available data. Such data may include quotes provided by a dealer, the use of external pricing services, independent pricing models, or other model-based valuation techniques such as calculation of the present values of future cash flows incorporating assumptions such as benchmark yields, spreads, prepayment speeds, credit ratings, and losses. The techniques used by the pricing services utilize observable market data to the extent available. Pricing models may be used, which can vary by asset class and may incorporate available trade, bid and other market information. Across asset classes, information such as trader/dealer input, credit spreads, forward curves, and prepayment speeds are used to help determine appropriate valuations. Because many fixed income securities do not trade on a daily basis, the evaluated pricing applications may apply available information through processes such as benchmarking curves, like securities, sector groupings, and matrix pricing to prepare valuations. In addition, model processes are used by the pricing services to develop prepayment and interest rate scenarios.

We validate the pricing obtained from the primary pricing providers through comparison of pricing to additional sources, including other pricing services, dealer pricing indications in transaction results, and other internal sources. Pricing variances among different pricing sources are analyzed and validated.

The decrease in the amount of Level 3 securities reflected run-off of non-agency mortgage securities and tighter pricing of these securities between third party vendors.

Loans Held For Sale

Loans held for sale are carried at the lower of aggregate cost, net of deferred fees, deferred origination costs and effects of hedge accounting, or fair value. The fair value of loans held for sale is determined using current secondary market prices for portfolios with similar characteristics. The carrying amounts as of June 30, 2011 and December 31, 2010 approximate fair value.

Loans Held For Investment, Net

The fair values of credit card loans, installment loans, auto loans, home loans and commercial loans were estimated using a discounted cash flow method, a form of the income approach. Discount rates were determined considering rates at which similar portfolios of loans would be made under current conditions and considering liquidity spreads applicable to each loan portfolio based on the secondary market. The fair value of credit card loans excluded any value related to customer account relationships.

Interest Receivable

The carrying amount of interest receivable approximates the fair value of this asset due to its relatively short-term nature.

 

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Accounts Receivable from Securitizations

Accounts receivable from securitizations include the interest-only strip, retained notes accrued interest receivable, cash reserve accounts and cash spread accounts for those securitization structures achieving off-balance sheet treatment. We use a valuation model that calculates the present value of estimated future cash flows. The model incorporates our estimate of assumptions market participants use in determining fair value, including estimates of payment rates, defaults, and discount rates including adjustments for liquidity, and contractual interest and fees. Other retained interests related to securitizations are carried at cost, which approximates fair value. The valuation technique for these securities is discussed in more detail in “Note 7—Variable Interest Entities and Securitizations.”

Derivative Assets

Most of our derivatives are not exchange traded, but instead traded in over the counter markets where quoted market prices are not readily available. The fair value derived for those derivatives using models that use primarily market observable inputs, such as interest rate yield curves, credit curves, option volatility and currency rates are classified as Level 2. Any derivative fair value measurements using significant assumptions that are unobservable are classified as Level 3, which include interest rate swaps whose remaining terms do not correlate with market observable interest rate yield curves. The impact of counterparty non-performance risk is considered when measuring the fair value of derivative assets. These derivatives are included in other assets on the balance sheet.

We validate the pricing obtained from the internal models through comparison of pricing to additional sources, including external valuation agents and other internal sources. Pricing variances among different pricing sources are analyzed and validated.

Mortgage Servicing Rights

MSRs do not trade in an active market with readily observable prices. Accordingly, we determine the fair value of MSRs using a valuation model that calculates the present value of estimated future net servicing income. The model incorporates assumptions that market participants use in estimating future net servicing income, including estimates of prepayment spreads, discount rate, cost to service, contractual servicing fee income, ancillary income and late fees. We record MSRs at fair value on a recurring basis. Fair value measurements of MSRs use significant unobservable inputs and, accordingly, are classified as Level 3. The valuation technique for these securities is discussed in more detail in “Note 8—Goodwill and Other Intangible Assets.”

Financial Liabilities

Interest Bearing Deposits

The fair value of other interest-bearing deposits was determined based on discounted expected cash flows using discount rates consistent with current market rates for similar products with similar remaining terms.

Non-Interest Bearing Deposits

The carrying amount of non-interest bearing deposits approximates fair value.

Senior and Subordinated Notes

We engage multiple third party pricing services in order to estimate the fair value of senior and subordinated notes. The pricing service utilizes a pricing model that incorporates available trade, bid and other market information. It also incorporates spread assumptions, volatility assumptions and relevant credit information into the pricing models.

 

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Securitized Debt Obligations

We utilized multiple third party pricing services to obtain fair value measures for the large majority of our securitized debt obligations. The techniques used by the pricing services utilize observable market data to the extent available; and pricing models may be used which incorporate available trade, bid and other market information as described in the above section. We used internal pricing models, discounted cash flow models or similar techniques to estimate the fair value of certain securitization trusts where third party pricing was not available.

Other Borrowings

The carrying amount of federal funds purchased and repurchase agreements, and other short-term borrowings approximates fair value. The fair value of junior subordinated borrowings was estimated using the same methodology as described for senior and subordinated notes. The fair value of other borrowings was determined based on trade information for bonds with similar duration and credit quality, adjusted to incorporate any relevant credit information of the issuer.

Interest Payable

The carrying amount of interest payable approximates the fair value of this liability due to its relatively short-term nature.

Derivative Liabilities

Most of our derivatives are not exchange traded, but instead traded in over the counter markets where quoted market prices are not readily available. The fair value of those derivatives, derived using models that use primarily market observable inputs, such as interest rate yield curves, credit curves, option volatility and currency rates, are classified as Level 2. Any derivative fair value measurements using significant assumptions that are unobservable are classified as Level 3, which include interest rate swaps whose remaining terms do not correlate with market observable interest rate yield curves. The impact of counterparty non-performance risk is considered when measuring the fair value of derivative assets. These derivatives are included in other liabilities on the consolidated balance sheets.

We validate the pricing obtained from the internal models through comparison of pricing to additional sources, including external valuation agents and other internal sources. Pricing variances among different pricing sources are analyzed and validated.

Commitments to Extend Credit and Letters of Credit

These financial instruments are generally not sold or traded. The fair value of the guarantees outstanding which we include on our consolidated balance sheets in other liabilities was $4 million and $3 million as of June 30, 2011 and December 31, 2010, respectively. The estimated fair values of extensions of credit and letters of credit are not readily available. However, the fair value of commitments to extend credit and letters of credit is based on fees currently charged to enter into similar agreements with comparable credit risks and the current creditworthiness of the counterparties. Commitments to extend credit issued by us are generally short-term in nature and, if drawn upon, are issued under current market terms and conditions for credits with comparable risks. At June 30, 2011 and December 31, 2010, there was no material unrealized appreciation or depreciation on these financial instruments.

 

 

NOTE 14—BUSINESS SEGMENTS

 

Segment Description

Our principal operations are currently organized into three primary business segments, which are defined based on the products and services provided, or the type of customer served: Credit Card, Consumer Banking and

 

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Commercial Banking. The operations of acquired businesses have been integrated into our existing business segments. Certain activities that are not part of a segment are included in the “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 consumer and small businesses, national deposit gathering, national automobile lending and consumer home loan lending and servicing activities.

 

   

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

 

   

Other Category: 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. Accordingly, net gains and losses on our investment securities portfolio and certain trading activities are included in the Other category. The Other category also includes foreign exchange-rate fluctuations related to the revaluation of foreign currency-denominated investments; certain gains (losses) on the sale and securitization of loans; unallocated corporate expenses that do not directly support the operations of the business segments or for which the business segments are not considered financially accountable in evaluating their performance, such as acquisition and restructuring charges; provisions for representation and warranty reserves related to continuing operations; certain material items that are non-recurring in nature; and offsets related to certain line-item reclassifications.

Basis of Presentation

We report the financial results of our business segments on a continuing operations basis. See “Note 3—Discontinued Operations” for a discussion of discontinued operations. The results of our individual businesses, which are prepared on an internal management accounting and reporting basis, reflect the manner in which management evaluates performance and makes decisions about funding our operations and allocating resources. See “Note 20—Business Segments” of our 2010 Form 10-K for more information on our business segment reporting methodology.

 

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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.

 

     Three Months Ended June 30, 2011  

(Dollars in millions)

   Credit
Card
     Consumer
Banking
     Commercial
Banking
    Other(1)     Total
Managed
     Reconciliation(2)      Total
Reported
 

Net interest income (expense)

   $ 1,890       $ 1,051       $ 333      $ (138   $ 3,136       $ 0       $ 3,136   

Non-interest income

     619         194         62        (18     857         0         857   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Total revenue

     2,509         1,245         395        (156     3,993         0         3,993   

Provision for loan and lease losses

     309         41         (18     11        343         0         343   

Non-interest expense:

                  

Core deposit intangible amortization

     0         34         10        0        44         0         44   

Other non-interest expense

     1,238         724         182        67        2,211         0         2,211   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Total non-interest expense

     1,238         758         192        67        2,255         0         2,255   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Income (loss) from continuing operations before income taxes

     962         446         221        (234     1,395         0         1,395   

Income tax provision (benefit)

     344         159         79        (132     450         0         450   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Income from continuing operations, net of tax

   $ 618       $ 287       $ 142      $ (102   $ 945       $ 0       $ 945   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

 

     Three Months Ended June 30, 2010  

(Dollars in millions)

   Credit
Card
     Consumer
Banking
    Commercial
Banking
     Other(1)     Total
Managed
     Reconciliation(2)     Total
Reported
 

Net interest income (expense)

   $ 1,977       $ 935      $ 319       $ (132   $ 3,099       $ (2   $ 3,097   

Non-interest income

     659         162        60         (74     807         0        807   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Total revenue

     2,636         1,097        379         (206     3,906         (2     3,904   

Provision for loan and lease losses

     765         (112     62         10        725         (2     723   

Non-interest expense:

                 

Core deposit intangible amortization

     0         36        14         0        50         0        50   

Other non-interest expense

     1,002         699        184         65        1,950         0        1,950   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Total non-interest expense

     1,002         735        198         65        2,000         0        2,000   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Income (loss) from continuing operations before income taxes

     869         474        119         (281     1,181         0        1,181   

Income tax provision (benefit)

     301         169        42         (143     369         0        369   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Income from continuing operations, net of tax

   $ 568       $ 305      $ 77       $ (138   $ 812       $ 0      $ 812   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

 

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     Six Months Ended June 30, 2011  

(Dollars in millions)

   Credit
Card
     Consumer
Banking
     Commercial
Banking
    Other(1)     Total
Managed
     Reconciliation(2)      Total
Reported
 

Net interest income (expense)

   $ 3,831       $ 2,034       $ 654      $ (243   $ 6,276       $ 0       $ 6,276   

Non-interest income

     1,293         380         133        (7     1,799         0         1,799   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Total revenue

     5,124         2,414         787        (250     8,075         0         8,075   

Provision for loan and lease losses

     759         136         (33     15        877         0         877   

Non-interest expense:

                  

Core deposit intangible amortization

     0         68         21        0        89         0         89   

Other non-interest expense

     2,416         1,430         348        134        4,328         0         4,328   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Total non-interest expense

     2,416         1,498         369        134        4,417         0         4,417   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Income (loss) from continuing operations before income taxes

     1,949         780         451        (399     2,781         0         2,781   

Income tax provision (benefit)

     688         278         161        (323     804         0         804   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Income from continuing operations, net of tax

   $ 1,261       $ 502       $ 290      $ (76   $ 1,977       $ 0       $ 1,977   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

 

     Six Months Ended June 30, 2010  

(Dollars in millions)

   Credit
Card
     Consumer
Banking
    Commercial
Banking
     Other(1)     Total
Managed
     Reconciliation(2)     Total
Reported
 

Net interest income (expense)

   $ 4,090       $ 1,831      $ 631       $ (223   $ 6,329       $ (4   $ 6,325   

Non-interest income

     1,377         478        102         (88     1,869         (1     1,868   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Total revenue

     5,467         2,309        733         (311     8,198         (5     8,193   

Provision for loan and lease losses

     1,940         (62     300         28        2,206         (5     2,201   

Non-interest expense:

                 

Core deposit intangible amortization

     0         74        28         0        102         0        102   

Other non-interest expense

     1,916         1,349        362         118        3,745         0        3,745   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Total non-interest expense

     1,916         1,423        390         118        3,847         0        3,847   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Income (loss) from continuing operations before income taxes

     1,611         948        43         (457     2,145         0        2,145   

Income tax provision (benefit)

     554         338        15         (294     613         0        613   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Income from continuing operations, net of tax

   $ 1,057       $ 610      $ 28       $ (163   $ 1,532       $ 0      $ 1,532   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

 

(1) 

The improvement in income from continuing operations reported in the “Other” category for the three and six months ended June 30, 2011 compared with the three and six months ended June 30, 2010, was primarily attributable to a negative provision for mortgage loan repurchase losses recorded in the second quarter and first six months of 2011 of $4 million and $12 million, respectively, compared to a mortgage repurchase provision of $94 million and $193 million, respectively, in the second quarter and first six months of 2010.

 

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(2) 

Reflects the impact of adjustments to reconcile our total business segment results, which are presented on a managed basis, to our reported GAAP results. These adjustments primarily consist of: (i) the reclassification of finance charges, past due fees, other interest income and interest expense amounts included in non-interest income for management reporting purposes to net interest income for GAAP reporting purposes and (ii) the reclassification of net charge-offs included in non-interest income for management reporting purposes to the provision for loan and lease losses for GAAP reporting purposes.

 

     June 30, 2011  

(Dollars in millions)

   Credit
Card
     Consumer
Banking
     Commercial
Banking
     Other      Total  

Loans held for investment

   $ 62,705       $ 34,592       $ 31,203       $ 465       $ 128,965   

Total deposits

     0         87,282         24,304         14,531         126,117   
     December 31, 2010  

(Dollars in millions)

   Credit
Card
     Consumer
Banking
     Commercial
Banking
     Other      Total  

Loans held for investment

   $ 61,371       $ 34,383       $ 29,742       $ 451       $ 125,947   

Total deposits

     0         82,959         22,630         16,621         122,210   

 

 

NOTE 15—COMMITMENTS, CONTINGENCIES AND GUARANTEES

 

Letters of Credit

We issue letters of credit (financial standby, performance standby and commercial) to meet the financing needs of our customers. Standby letters of credit are conditional commitments issued by us to guarantee the performance of a customer to a third party in a borrowing arrangement. Commercial letters of credit are short-term commitments issued primarily to facilitate trade finance activities for customers and are generally collateralized by the goods being shipped to the client. Collateral requirements are similar to those for funded transactions and are established based on management’s credit assessment of the customer. Management conducts regular reviews of all outstanding letters of credit and customer acceptances, and the results of these reviews are considered in assessing the adequacy of our allowance for loan and lease losses.

We had contractual amounts of standby letters of credit and commercial letters of credit of $880 million as of June 30, 2011 and $922 million as of December 31, 2010. These financial guarantees had expiration dates ranging from 2011 to 2025 as of June 30, 2011. The fair value of the guarantees outstanding which we include on our consolidated balance sheets in other liabilities was $4 million as of June 30, 2011.

Contingent Payments Related to Chevy Chase Bank Acquisition

In connection with our February 27, 2009 acquisition of Chevy Chase Bank, we entered into a loss-sharing arrangement. To the extent that losses on certain of Chevy Chase Bank’s mortgage loans are less than the level reflected in the net expected principal losses estimated at the time the deal was signed, we will share a portion of the benefit with the former Chevy Chase Bank common stockholders (the “earn-out”). The maximum payment under the earn-out is $300 million and would occur after December 31, 2013. Any such amounts payable would be recognized in our consolidated statement of income. Based on estimated credit losses related to this portfolio as of June 30, 2011 and December 31, 2010, we did not recognize a liability related to the earn-out.

Contingent Payments Related to Sony Credit Card Portfolio Acquisition

In connection with our September 1, 2010 acquisition of the legacy Sony credit card portfolio, we entered into a loss-sharing arrangement with Chase Card Services. To the extent that principal losses on the acquired portfolio are less than a specified amount, we will share a portion of the benefit with Chase Card Services. The maximum payment under the loss-sharing arrangement, which would occur after September 30, 2013, is $30 million. Based

 

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on the estimated principal losses of this portfolio as of June 30, 2011, we recognized the maximum loss-sharing payment amount of $30 million as an expense in the second quarter of 2011 and recorded a related liability.

Potential Mortgage Representation & Warranty Liabilities

In recent years, we acquired three subsidiaries that originated residential mortgage loans and sold them to various purchasers, including purchasers who created securitization trusts. These subsidiaries are Capital One Home Loans, which was acquired in February 2005; GreenPoint Mortgage Funding, Inc. (“GreenPoint”), which was acquired in December 2006 as part of the North Fork acquisition; and Chevy Chase Bank, which was acquired in February 2009 and subsequently merged into CONA.

In connection with their sales of mortgage loans, the subsidiaries entered into agreements containing varying representations and warranties about, among other things, the ownership of the loan, the validity of the lien securing the loan, the loan’s compliance with any applicable loan criteria established by the purchaser, including underwriting guidelines and the ongoing existence of mortgage insurance, and the loan’s compliance with applicable federal, state and local laws. The representations and warranties do not address the credit performance of the mortgage loans, but mortgage loan performance often influences whether a claim for breach of representation and warranty will be asserted and has an effect on the amount of any loss in the event of a breach of a representation or warranty.

Each of these subsidiaries may be required to repurchase mortgage loans in the event of certain breaches of these representations and warranties. In the event of a repurchase, the subsidiary is typically required to pay the then unpaid principal balance of the loan together with interest and certain expenses (including, in certain cases, legal costs incurred by the purchaser and/or others). The subsidiary then recovers the loan or, if the loan has been foreclosed, the underlying collateral. The subsidiary is exposed to any losses on the repurchased loans after giving effect to any recoveries on the collateral. In some instances, rather than repurchase the loans, a subsidiary may agree to make a cash payment to make an investor whole on losses or to settle repurchase claims. In addition, our subsidiaries may be required to indemnify certain purchasers and others against losses they incur as a result of certain breaches of representations and warranties. In some cases, the amount of such losses could exceed the repurchase amount of the related loans.

These subsidiaries, in total, originated and sold to non-affiliates approximately $111 billion original principal balance of mortgage loans between 2005 and 2008, which are the years (or “vintages”) with respect to which our subsidiaries have received the vast majority of the repurchase requests and other related claims.

The following table presents the original principal balance of mortgage loan originations, by vintage, for the three general categories of purchasers of mortgage loans and the outstanding principal balance as of June 30, 2011 and December 31, 2010:

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

 

     Unpaid Principal Balance                                     
     June  30,
2011
     December  31,
2010
     Original Unpaid Principal Balance  

(Dollars in billions)

         Total      2008      2007      2006      2005  

Government sponsored enterprises (“GSEs”)(1)

   $ 5       $ 5       $ 11       $ 1       $ 4       $ 3       $ 3   

Insured Securitizations

     7         7         18         0         1         8         9   

Uninsured Securitizations and Other

     29         33         82         3         16         30         33   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 41       $ 45       $ 111       $ 4       $ 21       $ 41       $ 45   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) 

GSEs include Fannie Mae and Freddie Mac.

 

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Between 2005 and 2008, our subsidiaries sold an aggregate amount of $11 billion in original principal balance mortgage loans to the GSEs.

Of the $18 billion in original principal balance of mortgage loans sold directly by our subsidiaries to private-label purchasers who placed the loans into securitizations supported by bond insurance (“Insured Securitizations”), approximately $13 billion original principal balance was placed in securitizations as to which the monoline bond insurers have made repurchase requests or loan file requests to one of our subsidiaries (“Active Insured Securitizations”), and the remaining approximately $5 billion original principal balance was placed in securitizations as to which the monoline bond insurers have not made repurchase requests or loan file requests to one of our subsidiaries (“Inactive Insured Securitizations”). Insured Securitizations often allow the monoline bond insurer to act independently of the investors. Bond insurers typically have indemnity agreements directly with both the mortgage originators and the securitizers, and they often have super-majority rights within the trust documentation that allow them to direct trustees to pursue mortgage repurchase requests without coordination with other investors.

Because we do not service most of the loans our subsidiaries sold to others, we do not have complete information about the current ownership of the $82 billion in original principal balance of mortgage loans not sold directly to GSEs or placed in Insured Securitizations. We have determined from third-party databases that about $39 billion original principal balance of these mortgage loans are currently held by private-label publicly issued securitizations not supported by bond insurance (“Uninsured Securitizations”). In contrast with the bond insurers in Insured Securitizations, investors in Uninsured Securitizations often face a number of legal and logistical hurdles before they can direct a securitization trustee to pursue mortgage repurchases, including the need to coordinate with a certain percentage of investors holding the securities and to indemnify the trustee for any litigation it undertakes. An additional approximately $30 billion original principal balance of mortgage loans were initially sold to private investors as whole loans. Of this amount, we believe approximately $10 billion original principal balance of mortgage loans were ultimately purchased by GSEs. For purposes of our reserves-setting process, we consider these loans to be private-label loans rather than GSE loans. We do not have information about the current holders or disposition of the remaining $13 billion original principal balance of mortgage loans in this category.

With respect to the $111 billion in original principal balance of mortgage loans originated and sold to others between 2005 and 2008, we estimate that approximately $41 billion in unpaid principal balance remains outstanding as of June 30, 2011, approximately $14 billion in losses have been realized and approximately $13 billion in unpaid principal balance is at least 90 days delinquent. Because we do not service most of the loans we sold to others, we do not have complete information about the underlying credit performance levels for some of these mortgage loans. These amounts reflect our best estimates, including extrapolations where necessary. These extrapolations occur on the approximately $13 billion original principal balance of mortgage loans for which we do not have information about the current holders or any underlying credit performance. These estimates could change as we get additional data or refine our analysis.

The subsidiaries had open repurchase requests relating to approximately $1.7 billion original principal balance of mortgage loans as of June 30, 2011, compared with $1.6 billion as of December 31, 2010. As of June 30, 2011, the vast majority of new repurchase demands received over the last year and, as discussed below, almost all of our $869 million reserve relates to the $24 billion of original principal balance of mortgage loans originally sold to the GSEs or to Active Insured Securitizations. Currently, repurchase demands predominantly relate to the 2006 and 2007 vintages. We have received relatively few repurchase demands from the 2008 and 2009 vintages, mostly because GreenPoint ceased originating mortgages in August 2007.

 

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The following table presents information on pending repurchase requests by counterparty category and timing of initial repurchase request. The amounts presented are based on original loan principal balances.

Open Pipeline All Vintages (all entities)(1)

 

(Dollars in millions)

   GSEs     Insured
Securitizations
    Uninsured
Securitizations
and Other
    Total  

Open claims as of December 31, 2009

   $ 61      $ 366      $ 588      $ 1,015   

Gross new demands received

     204        645        104        953   

Loans repurchased/made whole(2)

     (52     (179     (5     (236

Demands rescinded(2)

     (87     0        (22     (109
  

 

 

   

 

 

   

 

 

   

 

 

 

Open claims as of December 31, 2010

   $ 126      $ 832      $ 665      $ 1,623   

Gross new demands received

     88        96        43        227   

Loans repurchased/made whole

     (40     0        (8     (48

Demands rescinded

     (47     0        (9     (56

Reclassifications(3)

     (5     64        (59     0   
  

 

 

   

 

 

   

 

 

   

 

 

 

Open claims as of June 30, 2011

   $ 122      $ 992      $ 632      $ 1,746   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) 

The open pipeline includes all repurchase requests ever received by our subsidiaries where the requesting party has not formally rescinded the repurchase request and where our subsidiary has not agreed to either repurchase the loan at issue or make the requesting party whole with respect to its losses. Accordingly, repurchase requests denied by our subsidiaries and not pursued by the counterparty remain in the open pipeline. Moreover, repurchase requests submitted by parties without contractual standing to pursue repurchase requests are included within the open pipeline unless the requesting party has formally rescinded its repurchase request. Finally, the amounts reflected in this chart are original principal balance amounts and do not correspond to the losses our subsidiary would incur upon the repurchase of these loans.

(2) 

Activity in 2010 relates to repurchase demands from all years prior.

(3)

Represents adjustments to correct the counterparty category as of December 31, 2010 for amounts that were misclassified. The reclassification had no impact on the total pending repurchase requests; however, it resulted in an increase in open claims attributable to insured securitizations and a decrease in open claims attributable to GSEs and Uninsured Securitizations & Other.

We have established representation and warranty reserves for losses associated with the mortgage loans sold by each subsidiary that we consider to be both probable and reasonably estimable, including both litigation and non-litigation liabilities. These reserves are reported in our consolidated balance sheets as a component of other liabilities. The reserve setting process relies heavily on estimates, which are inherently uncertain, and requires the application of judgment. We evaluate these estimates on a quarterly basis. We build our representation and warranty reserves through the provision for repurchase losses, which we report in our consolidated statements of income as a component of non-interest income for loans originated and sold by Chevy Chase Bank and Capital One Home Loans and as a component of discontinued operations for loans originated and sold by GreenPoint. In establishing the representation and warranty reserves, we consider a variety of factors depending on the category of purchaser.

In establishing reserves for the $11 billion original principal balance of GSE loans, we rely on the historical relationship between GSE loan losses and repurchase outcomes to estimate: (1) the percentage of current and future GSE loan defaults that we anticipate will result in repurchase requests from the GSEs over the lifetime of the GSE loans; and (2) the percentage of those repurchase requests that we anticipate will result in actual repurchases. We also rely on estimated collateral valuations and loss forecast models to estimate our lifetime liability on GSE loans. This reserving approach to the GSE loans reflects the historical interaction with the GSEs around repurchase requests, and also includes anticipated repurchases resulting from mortgage insurance rescissions. The GSEs typically have stronger contractual rights than non-GSE counterparties because GSE contracts typically do not contain prompt notice requirements for repurchase requests or materiality

 

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qualifications to the representations and warranties. Moreover, although we often disagree with the GSEs about the validity of their repurchase requests, we have established a negotiation pattern whereby the GSEs and our subsidiaries continually negotiate around individual repurchase requests, leading to the GSEs rescinding some repurchase requests and our subsidiaries agreeing in some cases to repurchase some loans or make the GSEs whole with respect to losses. Our lifetime representation and warranty reserves with respect to GSE loans are grounded in this history.

For the $13 billion original principal balance in Active Insured Securitizations, our reserving approach also reflects our historical interaction with monoline bond insurers around repurchase requests. Typically, monoline bond insurers allege a very high repurchase rate with respect to the mortgage loans in the Active Insured Securitization category. In response to these repurchase requests, our subsidiaries typically request information from the monoline bond insurers demonstrating that the contractual requirements around a valid repurchase request have been satisfied, such as, for example, the typical requirements that the counterparty promptly notify us upon discovery of any breach and that any breach materially and adversely affect the value of the mortgage loan at issue. In response to these requests for supporting documentation, monoline bond insurers typically initiate litigation. Accordingly, our reserves within the Active Insured Securitization are not based upon the historical repurchase rate with monoline bond insurers, but rather upon the expected resolution of litigation with the monoline bond insurers. Every bond insurer within this category is pursuing a substantially similar litigation strategy either through active or probable litigation. Accordingly, our representation and warranty reserves for this category are litigation reserves. In establishing litigation reserves for this category, we consider current and future losses inherent within the securitization and apply legal judgment to the anticipated factual and legal record to estimate the lifetime legal liability for each securitization. Our estimated legal liability for each securitization within this category assumes that we will be responsible for only a portion of the losses inherent in each securitization. Our litigation reserves with respect to both the U.S. Bank Lawsuit and the DBSP Lawsuit, in each case as referenced below, are contained within the Active Insured Securitization reserve category. Further, our litigation reserves with respect to indemnification risks from certain representation and warranty lawsuits brought by monoline bond insurers against third-party securitizations sponsors, where GreenPoint provided some or all of the mortgage collateral within the securitization but is not a defendant in the litigation, are also contained within this category. Our estimated legal liability for each securitization within this category assumes we will pay only a portion of the liabilities ultimately incurred by the party defendants to the litigation.

For the $5 billion original principal balance of mortgage loans in the Inactive Insured Securitizations category and the $82 billion original principal balance of mortgage loans in the Uninsured Securitizations and other whole loan sales categories, we establish reserves by relying on our historical repurchase rates and current negotiation patterns to estimate repurchase liabilities over the next twelve (12) months. We do not believe we can estimate repurchase liability for these categories for a period longer than twelve (12) months because of the relatively irregular nature of repurchase activity within these categories. Some Uninsured Securitization investors from this category who have not made repurchase requests or filed representation and warranty lawsuits have filed actions under federal and/or state securities laws against investment banks and securitization sponsors. Although we face some direct and indirect indemnity risks from these litigations, we have not established reserves with respect to these indemnity risks because we do not consider them to be both probable and reasonably estimable liabilities.

The aggregate reserve for all three subsidiaries was $869 million as of June 30, 2011, compared with $846 million as of March 31, 2011, and with $816 million as of December 31, 2010. Almost all of the increase in the reserve from March 31, 2011 is allocated to the Uninsured Securitizations and Other category resulting from an increase in repurchase activity with respect to certain whole loan investors. We recorded a total provision for repurchase losses for our representation and warranty repurchase exposure of $37 million and $81 million for the three and six months ended June 30, 2011, respectively, and we had settlements of repurchase requests of $14 million and $28 million for the three and six months ended June 30, 2011, respectively, that were charged against the reserve.

 

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The following table summarizes changes in our representation and warranty reserve for the three and six months ended June 30, 2011 and 2010, and for full year 2010:

Changes in Representation and Warranty Reserve

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
    Full Year  

(Dollars in millions)

       2011             2010             2011             2010         2010  

Representation and warranty repurchase reserve, beginning of period(1)

   $ 846      $ 454      $ 816      $ 238      $ 238   

Provision for repurchase losses(2)

     37        404        81        628        636   

Net realized losses

     (14     (5     (28     (13     (58
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Representation and warranty repurchase reserve, end of period(1)

   $ 869      $ 853      $ 869      $ 853      $ 816   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) 

Reported in our consolidated balance sheets as a component of other liabilities.

(2) 

The portion of the provision for mortgage repurchase claims recognized in our consolidated statements of income as a component of non-interest income totaled $4 million and $9 million for the three and six months ended June 30, 2011, respectively, and $95 million and $195 million for the three and six months ended June 30, 2010, respectively. The pre-tax portion of the provision for mortgage repurchase claims recognized in our consolidated statements of income as a component of discontinued operations totaled $33 million and $72 million, for the three and six months ended June 30, 2011, respectively, and $309 million and $433 million for the three and six months ended June 30, 2010, respectively.

As indicated in the table below, substantially all of the representation and warranty reserve relates to the $11 billion in original principal balance of mortgage loans sold directly to the GSEs and to the $13 billion in mortgage loans sold to purchasers who placed them into Active Insured Securitizations.

Allocation of Representation and Warranty Reserve

 

     Reserve Liability         

(Dollars in millions, except for loans sold)

   June 30,
2011
     December 31,
2010
     Loans Sold
2005 to 2008(1)
 

GSEs and Active Insured Securitizations

   $ 794       $ 796       $ 24   

Inactive Insured Securitizations, Uninsured Securitizations and Other

     75         20         87   
  

 

 

    

 

 

    

 

 

 

Total

   $ 869       $ 816       $ 111   
  

 

 

    

 

 

    

 

 

 

 

(1) 

Reflects, in billions, the total original principal balance of mortgage loans originated by our subsidiaries and sold to third party investors between 2005 and 2008.

The adequacy of the reserves and the ultimate amount of losses incurred by our subsidiaries will depend on, among other things, actual future mortgage loan performance, the actual level of future repurchase and indemnification requests (including the extent, if any, to which Inactive Insured Securitizations and other currently inactive investors ultimately assert claims), the actual success rates of claimants, developments in litigation, actual recoveries on the collateral and macroeconomic conditions (including unemployment levels and housing prices).

As part of our business planning processes, we have considered various outcomes relating to the potential future representation and warranty liabilities of our subsidiaries that are possible but do not rise to the level of being both probable and reasonably estimable outcomes that would justify an incremental accrual under applicable accounting standards. We believe that the upper end of the reasonably possible future losses from representation and warranty claims beyond the current accrual levels, including reasonably possible future losses relating to the US Bank Litigation and DBSP Litigation, could be as high as $1.1 billion. Notwithstanding our attempt to

 

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estimate a reasonably possible amount of loss beyond our current accrual levels based on current information, it is possible that actual future losses will exceed both the current accrual level and the amount of reasonably possible losses estimated here. There is still significant uncertainty as to numerous factors that contribute to ultimate liability levels, including, but not limited to, litigation outcomes, future repurchase claims levels, ultimate repurchase success rates and mortgage loan performance levels.

Litigation

In accordance with the current accounting standards for loss contingencies, we establish reserves for litigation related matters when it is probable that a loss associated with a claim or proceeding has been incurred and the amount of the loss can be reasonably estimated. Litigation claims and proceedings of all types are subject to many uncertain factors that generally cannot be predicted with assurance. Below we provide a description of material legal proceedings and claims.

For some of the matters disclosed below, we are able to determine estimates of potential future outcomes that are not probable and reasonably estimable outcomes justifying either the establishment of a reserve or an incremental reserve build, but which are reasonably possible outcomes. For other disclosed matters, such an estimate is not possible at this time. For those matters where an estimate is possible, excluding the reasonably possible future losses relating to the U.S. Bank Litigation and the DBSP Litigation because reasonably possible losses with respect to those litigations are included within the range of reasonably possible representation and warranty liabilities discussed above, management currently estimates the aggregate high end of the range of possible loss is $75 million to $225 million. Notwithstanding our attempt to estimate a reasonably possible range of loss beyond our current accrual levels for some litigation matters based on current information, it is possible that actual future losses will exceed both the current accrual level and the range of reasonably possible losses disclosed here. Given the inherent uncertainties involved in these matters, and the very large or indeterminate damages sought in some of these matters, there is significant uncertainty as to the ultimate liability we may incur from these litigation matters and an adverse outcome in one or more of these matters could be material to our results of operations or cash flows for any particular reporting period.

Interchange Litigation

In 2005, a number of entities, each purporting to represent a class of retail merchants, filed antitrust lawsuits (the “Interchange Lawsuits”) against MasterCard and Visa and several member banks, including our subsidiaries and us, alleging among other things, that the defendants conspired to fix the level of interchange fees. The complaints seek injunctive relief and civil monetary damages, which could be trebled. Separately, a number of large merchants have asserted similar claims against Visa and MasterCard only. In October 2005, the class and merchant Interchange Lawsuits were consolidated before the U.S. District Court for the Eastern District of New York for certain purposes, including discovery. Fact and expert discovery have closed. The parties have briefed and presented oral argument on motions to dismiss and class certification and are awaiting decisions from the court.

The defendant banks are members of Visa U.S.A., Inc. (“Visa”). As members, our subsidiary banks have indemnification obligations to Visa with respect to final judgments and settlements of certain litigation against Visa. In the first quarter of 2008, Visa completed an IPO of its stock. With IPO proceeds, Visa established an escrow account for the benefit of member banks to fund certain litigation settlements and claims, including the Interchange Lawsuits. As a result, in the first quarter of 2008, we reduced our Visa-related indemnification liabilities of $91 million recorded in other liabilities with a corresponding reduction of other non-interest expense. We made an election in accordance with the accounting guidance for fair value option for financial assets and liabilities on the indemnification guarantee to Visa, and the fair value of the guarantee at December 31, 2010 and June 30, 2011 was zero. In January 2011, we entered into a MasterCard Settlement and Judgment Sharing Agreement, along with other defendant banks, which apportions between MasterCard and its member banks any costs and liabilities of any judgment or settlement arising from the Interchange Lawsuits.

 

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In March 2011, a furniture store owner, on behalf of himself and other merchants who accept Visa and MasterCard branded credit cards, filed a class action in the Supreme Court of British Columbia (Vancouver Registry) against the Visa and MasterCard membership associations related to credit card interchange fees. In May 2011, another merchant, on behalf of himself and other merchants who accept Visa and MasterCard branded credit cards, filed a class action in the Ontario Superior Court of Justice (Toronto Region) asserting the same alleged violations of law related to credit card interchange fees and network rules. Both class actions name Visa and MasterCard and a number of member banks, including Capital One Financial Corporation, which only issues MasterCard branded credit cards in Canada. The class action complaints allege that the associations and member banks are liable for civil conspiracy, unjust enrichment, constructive trust and unlawful interference with economic interests and violated Canadian anti-competition laws by (a) conspiring to fix supra-competitive interchange fees and merchant discounts, and (b) requiring participation in the respective networks and adherence to Visa and MasterCard Rules to acceptance of payment guarantee services.

Late Fees Litigation

In 2007, a number of individual plaintiffs, each purporting to represent a class of cardholders, filed antitrust lawsuits in the U.S. District Court for the Northern District of California against several issuing banks, including us. These lawsuits allege, among other things, that the defendants conspired to fix the level of late fees and over-limit fees charged to cardholders, and that these fees are excessive. In May 2007, the cases were consolidated for all purposes, and a consolidated amended complaint was filed alleging violations of federal statutes and state law. The amended complaint requests civil monetary damages, which could be trebled, and injunctive relief. In November 2007, the court dismissed the amended complaint. Plaintiffs appealed that order to the Ninth Circuit Court of Appeals. The plaintiffs’ appeal challenges the dismissal of their claims under the National Bank Act, the Depository Institutions Deregulation Act of 1980 and the California Unfair Competition Law (the “UCL”), but not their antitrust conspiracy claims. In June 2009, the Ninth Circuit Court of Appeals stayed the matter pending the bankruptcy proceedings of one of the defendant financial institutions. In December 2010, the Ninth Circuit Court of Appeals entered an additional order continuing the stay of the matter pending the bankruptcy proceedings.

Credit Card Interest Rate Litigation

In July 2010, the U.S. Court of Appeals for the Ninth Circuit reversed a dismissal entered in favor of COBNA in Rubio v. Capital One Bank, which was filed in the U.S. District Court for the Central District of California in 2007. The plaintiff in Rubio alleged in a putative class action that COBNA breached its contractual obligations and violated the Truth In Lending Act (the “TILA”) and the UCL when it raised interest rates on certain credit card accounts. The plaintiff seeks damages, restitution, attorney’s fees and an injunction against future rate increases. The District Court granted COBNA’s motion to dismiss all claims as a matter of law prior to any discovery. On appeal, the Ninth Circuit reversed the District Court’s dismissal with respect to the TILA and UCL claims, remanding the case back to the District Court for further proceedings. The Ninth Circuit upheld the dismissal of the plaintiff’s breach of contract claim, finding that COBNA was contractually allowed to increase interest rates. In September 2010, the Ninth Circuit denied COBNA’s Petition for Panel Rehearing and Rehearing En Banc. In January 2011, COBNA filed a writ of certiorari with the United States Supreme Court, seeking leave to appeal the Ninth Circuit’s ruling. On April 4, 2011, the United States Supreme Court denied Capital One’s writ of certiorari, and as a result, the Ninth Circuit remanded the case back to the District Court to begin discovery.

The Capital One Bank Credit Card Interest Rate Multi-district Litigation matter involves similar issues as Rubio. This multi-district litigation matter was created as a result of a June 2010 transfer order issued by the United States Judicial Panel on Multi-district Litigation (“MDL”), which consolidated for pretrial proceedings in the U.S. District Court for the Northern District of Georgia two pending putative class actions against COBNA — Nancy Mancuso, et al. v. Capital One Bank (USA), N.A., et al., (E.D. Virginia); and Kevin S. Barker, et al. v. Capital One Bank (USA), N.A., (N.D. Georgia), A third action, Jennifer L. Kolkowski v. Capital One Bank (USA), N.A., (C.D. California) was subsequently transferred into the MDL. On August 2, 2010, the plaintiffs in the MDL filed a Consolidated Amended Complaint. The Consolidated Amended Complaint alleges in a putative class

 

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action that COBNA breached its contractual obligations, and violated the TILA, the California Consumers Legal Remedies Act, the UCL, the California False Advertising Act, the New Jersey Consumer Fraud Act, and the Kansas Consumer Protection Act when it raised interest rates on certain credit card accounts. The MDL plaintiffs seek statutory damages, restitution, attorney’s fees and an injunction against future rate increases. Fact discovery is now closed and the parties are preparing for summary judgment filings.

West Virginia Attorney General Litigation

In January 2010, the West Virginia Attorney General filed suit against COBNA and various affiliates in Mason County, West Virginia, challenging numerous credit card practices under the West Virginia Consumer Credit and Protection Act. The West Virginia Attorney General seeks injunctive relief, consumer refunds, statutory damages, disgorgement, and attorneys’ fees. COBNA removed the case to the U.S. District Court for the Southern District of West Virginia and filed a motion to dismiss the complaint. In July 2010, the U.S. District Court for the Southern District of West Virginia remanded the case back to Mason County Circuit Court and denied the motion to dismiss as moot. In August 2010, we filed a motion to dismiss and a motion to stay discovery pending resolution of the motion to dismiss. In April 2011, the Court denied our motion to dismiss and scheduled a bench trial to begin on December 6, 2011. On July 20, 2011, COBNA removed the case again to the U.S. District Court for the Southern District of West Virginia, and plaintiff subsequently filed a motion to remand the matter to state court.

Mortgage Repurchase Litigation

On February 5, 2009, GreenPoint was named as a defendant in a lawsuit commenced in the Supreme Court of the State of New York, New York County, by U.S. Bank National Association, Syncora Guarantee Inc. (formerly known as XL Capital Assurance Inc.) and CIFG Assurance North America, Inc. (the “U.S. Bank Litigation”). Plaintiffs allege, among other things, that GreenPoint breached certain representations and warranties in two contracts pursuant to which GreenPoint sold approximately 30,000 mortgage loans having an aggregate original principal balance of approximately $1.8 billion to a purchaser that ultimately transferred most of these mortgage loans to a securitization trust. Some of the securities issued by the trust were insured by two of the plaintiffs. Plaintiffs have alleged breaches of representations and warranties with respect to certain specific mortgage loans. Plaintiffs seek unspecified damages and an order compelling GreenPoint to repurchase the entire portfolio of 30,000 mortgage loans based on alleged breaches of representations and warranties relating to a limited sampling of loans in the portfolio, or, alternatively, the repurchase of specific mortgage loans to which the alleged breaches of representations and warranties relate. On March 3, 2010, the Court granted GreenPoint’s motion to dismiss with respect to plaintiffs Syncora and CIFG and denied the motion with respect to U.S. Bank. In March 2010, GreenPoint answered the complaint with respect to U.S. Bank, denying the allegations, and filed a counterclaim against U.S. Bank alleging breach of covenant of good faith and fair dealing. In April 2010, plaintiffs U.S. Bank, Syncora, and CIFG filed an amended complaint seeking, among other things, the repurchase remedies described above and indemnification for losses suffered by Syncora and CIFG. GreenPoint filed a motion to dismiss the amended complaint. On January 6, 2011, the Court instructed plaintiffs to seek leave of court to file an amended complaint supported by an evidentiary showing of merit. Plaintiffs filed their motion for leave in June 2011, which is currently expected to be argued in the fourth quarter of 2011. As noted above, GreenPoint has established reserves with respect to its probable and reasonably estimable legal liability from the U.S. Bank Lawsuit, which reserves are included within the overall representation and warranty reserve. Also as noted above, GreenPoint has exposure to loss in excess of the amount established within the overall representation and warranty reserve because GreenPoint has not established reserves with respect to the portfolio-wide repurchase claim on the basis that the claim is not considered probable and reasonably estimable. In the event GreenPoint is obligated to repurchase all 30,000 mortgage loans under the portfolio-wide repurchase claim, GreenPoint would incur the current and future economic losses inherent in the portfolio. With respect to the mortgage loan portfolio at issue in the U.S. Bank Litigation, we believe approximately $808 million of losses have been realized and approximately $355 million in mortgage loans are still outstanding, of which approximately $29 million are more than 90 days delinquent, including foreclosures and REO.

 

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In September 2010, DB Structured Products, Inc. (“DBSP”) named GreenPoint in a third-party complaint, filed in the New York County Supreme Court, alleging breach of contract and seeking indemnification (the “DBSP Litigation”). In the underlying suit, Assured Guaranty Municipal Corp. (“AGM”) sued DBSP for alleged breaches of representations and warranties made by DBSP with respect to certain residential mortgage loans that collateralize a securitization insured by AGM and sponsored by DBSP (the “Underlying Lawsuit”). DBSP purchased the HELOC loans from GreenPoint in 2006. The entire securitization is comprised of about 6,200 mortgage loans with an aggregate original principal balance of approximately $353 million. DBSP asserts that any liability it faces lies with GreenPoint, alleging that DBSP’s representations and warranties to AGM are substantially similar to the representations and warranties made by GreenPoint to DBSP. GreenPoint filed a motion to dismiss the complaint in October 2010, which the court denied on July 25, 2011. The parties are currently engaged in discovery. As noted above, GreenPoint has established reserves with respect to its estimated probable and reasonable estimable legal liability from the DBSP Litigation, which reserves are included within the overall representation and warranty reserve. Also as noted above, GreenPoint has not established a reserve with respect to any portfolio-wide repurchase claim, but in the event GreenPoint is obligated to indemnify DBSP for the repurchase of all 6,200 mortgage loans, GreenPoint would incur the current and future economic losses inherent in the securitization. With respect to these loans, we believe approximately $136 million of losses have been realized and approximately $62 million in mortgage loans are still outstanding, of which approximately $9 million are more than 90 days delinquent, including foreclosures and REO.

SEC Investigation

Since July 2009, we have been providing documents and information in response to an inquiry by the Staff of the SEC. In the first quarter of 2010, the SEC issued a formal order of investigation with respect to this inquiry. Although the order, as is generally customary, authorizes a broader inquiry by the Staff, we believe that the investigation is focused largely on our method of determining the loan loss reserves for our auto finance business for certain quarterly periods in 2007. We are cooperating fully with the Staff’s investigation.

Checking Account Overdraft Litigation

In May 2010, Capital One Financial Corporation and COBNA were named as defendants in a putative class action named Steen v. Capital One Financial Corporation, et al., filed in the U.S. District Court for the Eastern District of Louisiana. Plaintiff challenges our practices relating to fees for overdraft and non-sufficient funds fees on consumer checking accounts. Plaintiff alleges that our methodology for posting transactions to customer accounts is designed to maximize the generation of overdraft fees, supporting claims for breach of contract, breach of the covenant of good faith and fair dealing, unconscionability, conversion, unjust enrichment and violations of state unfair trade practices laws. Plaintiff seeks a range of remedies, including restitution, disgorgement, injunctive relief, punitive damages and attorneys’ fees. In May 2010, the case was transferred to the Southern District of Florida for coordinated pre-trial proceedings as part of a multi-district litigation (MDL) involving numerous defendant banks, In re Checking Account Overdraft Litigation. In January 2011, plaintiffs filed a second amended complaint against CONA in the MDL court. In February 2011, CONA filed a motion to dismiss the second amended complaint. On March 21, 2011, the MDL court granted the motion to dismiss claims of breach of the covenant of good faith and fair dealing under Texas law, but denied the motion to dismiss in all other respects. On April 18, 2011, CONA moved for reconsideration of those portions of the court’s ruling denying its motion to dismiss, and on June 7, 2011, CONA moved for certification of an interlocutory appeal. The MDL court denied the motion to reconsider on June 23, 2011. The parties are now engaged in discovery.

Patent Litigation

On February 23, 2011, Capital One Financial Corporation, Capital One, N.A., and Capital One Bank (USA), N.A. (collectively, “Capital One”), were named as defendants, along with several other banks, in a patent infringement lawsuit filed by DataTreasury Corporation (“DataTreasury”) in the United States District Court for

 

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the Eastern District of Texas. DataTreasury alleges that Capital One and the other banks willfully infringed certain patents relating to remote image capture with centralized processing and storage. Capital One was served with the complaint on April 5, 2011, and filed an answer on May 26, 2011.

FHLB Securities Litigation

On April 20, 2011, the Federal Home Loan Bank of Boston (the “FHLB of Boston”) filed suit against dozens of mortgage industry participants in Massachusetts Superior Court, alleging, among other things, violations of Massachusetts state securities laws in the sale and marketing of certain residential mortgage-backed securities. Capital One Financial Corporation and Capital One, National Association are named in the complaint as alleged successors in interest to Chevy Chase Bank, which allegedly marketed some of the mortgage-backed securities at issue in the litigation. The FHLB of Boston seeks rescission, unspecified damages, attorneys’ fees, and other unspecified relief. The case was removed to the United States District Court for the District of Massachusetts in May 2011, and plaintiff subsequently filed a motion to remand the matter to state court.

Tax Matters

On September 21, 2009, the Tax Court issued a decision in the case Capital One Financial Corporation and Subsidiaries v. Commissioner covering tax years 1995-1999, with both parties prevailing on certain issues. On July 6, 2010, we filed a motion to appeal certain issues upon which the IRS prevailed. The IRS chose not to appeal the issues upon which we prevailed resulting in a final resolution of those issues favorable to us. Although the final resolution of the remaining issues in the case is uncertain and involves unsettled areas of law, we accounted for this matter applying the recognition and measurement criteria required for accounting for uncertainty in income taxes.

Other Pending and Threatened Litigation

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

 

 

NOTE 16—SUBSEQUENT EVENTS

 

On June 16, 2011, we entered into a purchase and sale agreement with ING Groep N.V., ING Bank N.V., ING Direct N.V., ING Direct Bancorp, collectively, the Sellers, under which we will acquire substantially all of the Sellers' ING Direct business in the United States in exchange for $6.2 billion in cash and approximately 55.9 million shares of our common stock, subject to certain adjustments described in the purchase and sale agreement. We expect the ING transaction to close in late 2011 or early 2012, subject to customary closing conditions, including certain governmental clearances and approvals.

On July 19, 2011, we closed a public offering of shares of our common stock, subject to forward sale agreements that we entered into with certain counterparties acting as forward purchasers. The forward purchasers agreed to borrow and sell to the public, through the underwriters, 40 million shares of our common stock at a price per share of $50.00. After underwriter’s discounts and commissions, the net proceeds to the company will be at an initial forward sale price per share of $48.50. We did not receive any proceeds from this public offering of our shares of common stock. Under the terms of the forward sale agreements, we must settle the forward sale agreements on or before February 15, 2012. We expect to settle the forward sale agreements entirely by physical delivery of shares of common stock in exchange for cash proceeds from the forward purchasers of $1.9 billion based on the initial forward price. The forward sale price is subject to adjustment under the forward sale agreements. However, we may, subject to certain conditions, elect cash or net share settlement of all or a portion of our obligation to deliver shares of common stock. In addition, we granted the underwriters a 30-day option to purchase an additional 6 million shares of our common stock to cover any over-allotments, which shares are not subject to the forward sale agreements.

 

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

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

Item 3. Quantitative and Qualitative Disclosures about Market Risk

For a discussion of the quantitative and qualitative disclosures about market risk, see “Part I—Item 2. MD&A—Market Risk Management.”

Item 4. Controls and Procedures

Overview

We are required under applicable laws and regulations to maintain controls and procedures, which include disclosure controls and procedures as well as internal control over financial reporting, as further described below.

(a) Disclosure Controls and Procedures

Disclosure Controls and Procedures

Disclosure controls and procedures refer to controls and other procedures designed to provide reasonable assurance that information required to be disclosed in our financial reports is recorded, processed, summarized and reported within the time periods specified by SEC rules and forms and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding our required disclosure. In designing and evaluating our disclosure controls and procedures, we recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and we must apply judgment in evaluating and implementing possible controls and procedures.

Evaluation of Disclosure Controls and Procedures

As required by Rule 13a-15 of the Securities Exchange Act of 1934 (the “Exchange Act”), our management, including the Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures (as that term is defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) as of June 30, 2011, the end of the period covered by this Report. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of June 30, 2011, at a reasonable level of assurance, in recording, processing, summarizing and reporting information required to be disclosed within the time periods specified by the SEC rules and forms.

(b) Changes in Internal Control Over Financial Reporting

We regularly review our disclosure controls and procedures and make changes intended to ensure the quality of our financial reporting. There were no changes in internal control over financial reporting that occurred in the second quarter of 2011 that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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PART II—OTHER INFORMATION

Item 1. Legal Proceedings

The information required by Item 1 is included in “Notes to the Consolidated Financial Statements—Note 15— Commitments, Contingencies and Guarantees.”

Item 1A. Risk Factors

We are not aware of any material changes from the risk factors set forth under “Part I—Item 1A. Risk Factors” in our 2010 Form 10-K and the risk factors set forth in Exhibit 99.5 to our Current Report on Form 8-K filed on July 13, 2011.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

The following table shows shares of our common stock we repurchased during the second quarter of 2011:

 

(Dollars in millions, except per share information)

   Total
Number of
Shares
Purchased(1)
     Average Price
Paid per Share
     Total Number
of Shares
Purchased as
Part of
Publicly
Announced
Plans
     Maximum
Amount That
May Yet be
Purchased
Under the Plan
or Program
 

April 1-30, 2011

     14,746       $ 49.92         —         $ —     

May 1-31, 2011

     —           —           —           —     

June 1-30, 2011

     —           —           —           —     
  

 

 

       

 

 

    

Total

     14,746            —        
  

 

 

       

 

 

    

 

(1) 

Shares purchased represent shares purchased and share swaps made in connection with stock option exercises and the withholding of shares to cover taxes on restricted stock lapses.

Item 3. Defaults upon Senior Securities

None.

Item 5. Other Information

On May 11, 2011, our stockholders voted, on an advisory basis, on the frequency of conducting an advisory vote on our named executive officer compensation. Based on the results of the advisory vote and the recommendation of our Governance and Nominating Committee, the Board of Directors has resolved to hold an advisory vote on the compensation of our named executive officers every year until the next advisory vote on the frequency of stockholder advisory votes on named executive officer compensation, which will occur no later than our annual meeting of stockholders in 2017.

Item 6. Exhibits

An index to exhibits has been filed as part of this report beginning on page E-1 and is incorporated herein by reference.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

   

CAPITAL ONE FINANCIAL CORPORATION

(Registrant)

Date: August 5, 2011     By:   /S/ GARY L. PERLIN
     

Gary L. Perlin

Chief Financial Officer

 

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INDEX TO EXHIBITS

The following exhibits are incorporated by reference or filed herewith. References to (i) the “2003 Form 10-K” are to the Company’s Annual Report on Form 10-K for the year ended December 31, 2003, filed on March 5, 2004; (ii) the “2004 Form 10-K” are to the Company’s Annual Report on Form 10-K for the year ended December 31, 2004, filed on March 9, 2005; (iii) the “2008 Form 10-K” are to the Company’s Annual Report on Form 10-K for the year Ended December 31, 2008, filed on February 26, 2009; and (iv) the “2009 Form 10-K” are to the Company’s Annual Report on Form 10-K for the year Ended December 31, 2009, filed on February 26, 2010.

 

Exhibit No.

  

Description

    2.1         Stock Purchase Agreement, dated as of December 3, 2008, by and among Capital One Financial Corporation, B.F. Saul Real Estate Investment Trust, Derwood Investment Corporation, and B.F. Saul Company Employees’ Profit Sharing and Retirement Trust (incorporated by reference to Exhibit 2.4 of the 2008 Form 10-K).
    2.2         Purchase and Sale Agreement, dated as of June 16, 2011, by and among Capital One Financial Corporation, ING Groep N.V., ING Bank N.V., ING Direct N.V. and ING Direct Bancorp (incorporated by reference to Exhibit 2.1 of the Company’s Report on Form-8-K, filed on June 22, 2011).
    3.1         Restated Certificate of Incorporation of Capital One Financial Corporation, (as amended and restated May 16, 2011 (incorporated by reference to Exhibit 3.4 of the Company’s Report on Form 8-K, filed on May 17, 2011).
    3.2         Amended and Restated Bylaws of Capital One Financial Corporation (incorporated by reference to Exhibit 3.3 of the Company’s Report on Form 8-K, filed on May 17, 2011).
    4.1.1      Specimen certificate representing the Common Stock (incorporated by reference to Exhibit 4.1 of the 2003 Form 10-K).
    4.1.2      Warrant Agreement, dated December 3, 2009, between Capital One Financial Corporation and Computershare Trust Company, N.A. (incorporated herein by reference to the Exhibit 4.1 of the Company’s Form 8-A filed on December 4, 2009).
    4.2.1      Senior Indenture dated as of November 1, 1996 between Capital One Financial Corporation and The Bank of New York Mellon Trust Company, N.A., formerly known as The Bank of New York Trust Company, N.A. (as successor to Harris Trust and Savings Bank), as trustee (incorporated by reference to Exhibit 4.1 of the Company’s Report on Form 8-K, filed on November 13, 1996).
    4.2.2      Copy of 6.25% Senior Notes, due 2013, of Capital One Financial Corporation (incorporated by reference to Exhibit 4.5.5 of the 2003 Form 10-K).
    4.2.3      Copy of 5.25% Senior Notes, due 2017, of Capital One Financial Corporation (incorporated by reference to Exhibit 4.5.6 of the 2004 Form 10-K).
    4.2.4      Copy of 4.80% Senior Notes, due 2012, of Capital One Financial Corporation (incorporated by reference to Exhibit 4.5.7 of the 2004 Form 10-K).
    4.2.5      Copy of 5.50% Senior Notes, due 2015, of Capital One Financial Corporation (incorporated by reference to Exhibit 4.1 of the Company’s Quarterly Report on Form 10-Q for the period ending June 30, 2005).
    4.2.6      Specimen of 5.70% Senior Note, due 2011, of Capital One Financial Corporation (incorporated by reference to Exhibit 4.2 of the Company’s Report on Form 8-K, filed on September 18, 2006).
    4.2.7      Specimen of 6.750% Senior Note, due 2017, of Capital One Financial Corporation (incorporated by reference to Exhibit 4.1 of the Company’s Report on Form 8-K, filed on September 5, 2007).

 

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Exhibit No.

  

Description

    4.2.8      Specimen of 7.375% Senior Note, due 2014, of Capital One Financial Corporation (incorporated by reference to Exhibit 4.1 of the Company’s Report on Form 8-K, filed on May 22, 2009).
    4.2.8      Specimen of Floating Rate Senior Note due 2014, of Capital One Financial Corporation (incorporated by reference to Exhibit 4.3 of the Company’s Report on Form 8-K, filed on July 19, 2011).
    4.2.9      Specimen of 2.125% Senior Note due 2014, of Capital One Financial Corporation (incorporated by reference to Exhibit 4.4 of the Company’s Report on Form 8-K, filed on July 19, 2011).
    4.2.10    Specimen of 3.150% Senior Note due 2016, of Capital One Financial Corporation (incorporated by reference to Exhibit 4.5 of the Company’s Report on Form 8-K, filed on July 19, 2011).
    4.2.11    Specimen of 4.750% Senior Note due 2021, of Capital One Financial Corporation (incorporated by reference to Exhibit 4.6 of the Company’s Report on Form 8-K, filed on July 19, 2011).
    4.3        Indenture (providing for the issuance of Junior Subordinated Debt Securities), dated as of June 6, 2006, between Capital One Financial Corporation and The Bank of New York Mellon Trust Company, N.A., as indenture trustee (incorporated by reference to Exhibit 4.1 of the Company’s Current Report on Form 8-K, filed on June 12, 2006).
    4.4.1      First Supplemental Indenture, dated as of June 6, 2006, between Capital One Financial Corporation and The Bank of New York Mellon Trust Company, N.A., as indenture trustee (incorporated by reference to Exhibit 4.2 of the Company’s Current Report on Form 8-K, filed on June 12, 2006).
    4.4.2      Amended and Restated Declaration of Trust of Capital One Capital II, dated as of June 6, 2006, between Capital One Financial Corporation, as Sponsor, The Bank of New York Mellon, as institutional trustee, BNY Mellon Trust of Delaware, as Delaware Trustee and the Administrative Trustees named therein (incorporated by reference to Exhibit 4.3 of the Company’s Current Report on Form 8-K, filed on June 12, 2006).
    4.4.3      Guarantee Agreement, dated as of June 6, 2006, between Capital One Financial Corporation and The Bank of New York Mellon Trust Company, N.A., as guarantee trustee (incorporated by reference to Exhibit 4.4 of the Company’s Current Report on Form 8-K, filed on June 12, 2006).
    4.4.4      Specimen certificate representing the Enhanced TRUPS (incorporated by reference to Exhibit 4.5 of the Company’s Current Report on Form 8-K, filed on June 12, 2006).
    4.4.5      Specimen certificate representing the Junior Subordinated Debt Security (incorporated by reference to Exhibit 4.6 of the Company’s Current Report on Form 8-K, filed on June 12, 2006).
    4.5.1      Second Supplemental Indenture, dated as of August 1, 2006, between Capital One Financial Corporation and The Bank of New York Mellon Trust Company, N.A., as indenture trustee (incorporated by reference to Exhibit 4.2 of the Company’s Current Report on Form 8-K, filed on August 4, 2006).
    4.5.2      Specimen certificate representing the Junior Subordinated Debt Security (incorporated by reference to Exhibit 4.6 of the Company’s Current Report on Form 8-K, filed on August 4, 2006).
    4.5.3      Amended and Restated Declaration of Trust of Capital One Capital III, dated as of August 1, 2006, between Capital One Financial Corporation, as Sponsor, The Bank of New York Mellon, as institutional trustee, BNY Mellon Trust of Delaware, as Delaware trustee and the Administrative Trustees named therein (incorporated by reference to Exhibit 4.3 of the Company’s Current Report on Form 8-K, filed on August 4, 2006).
    4.5.4      Guarantee Agreement, dated as of August 1, 2006, between Capital One Financial Corporation and The Bank of New York Mellon Trust Company, N.A., as guarantee trustee (incorporated by reference to Exhibit 4.4 of the Company’s Current Report on Form 8-K, filed on August 4, 2006).

 

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Exhibit No.

  

Description

    4.5.5      Specimen certificate representing the Capital Security (incorporated by reference to Exhibit 4.5 of the Company’s Current Report on Form 8-K, filed on August 4, 2006).
    4.6.1      Third Supplemental Indenture, dated as of February 5, 2007, between Capital One Financial Corporation and The Bank of New York Mellon Trust Company, N.A., as indenture trustee (incorporated by reference to Exhibit 4.2 of the Company’s Current Report on Form 8-K, filed on February 8, 2007).
    4.6.2      Amended and Restated Declaration of Trust of Capital One Capital IV, dated as of February 5, 2007, between Capital One Financial Corporation, as Sponsor, The Bank of New York Mellon, as institutional trustee, BNY Mellon Trust of Delaware, as Delaware trustee and the Administrative Trustees named therein (incorporated by reference to Exhibit 4.3 of the Company’s Current Report on Form 8-K, filed on February 8, 2007).
    4.6.3      Guarantee Agreement, dated as of February 5, 2007, between Capital One Financial Corporation and The Bank of New York Mellon Trust Company, N.A., as guarantee trustee (incorporated by reference to Exhibit 4.4 of the Company’s Current Report on Form 8-K, filed on February 8, 2007).
    4.6.4      Specimen certificate representing the Capital Security (incorporated by reference to Exhibit 4.5 of the Company’s Current Report on Form 8-K, filed on February 8, 2007).
    4.6.5      Specimen certificate representing the Capital Efficient Note (incorporated by reference to Exhibit 4.6 of the Company’s Current Report on Form 8-K, filed on February 8, 2007).
    4.7.1      Fourth Supplemental Indenture, dated as of August 5, 2009, between Capital One Financial Corporation and The Bank of New York Mellon Trust Company, N.A., as indenture trustee (incorporated by reference to Exhibit 4.2 of the Company’s Current Report on Form 8-K, filed on August 6, 2009).
    4.7.2      Amended and Restated Declaration of Trust of Capital One Capital V, dated as of August 5, 2009, between Capital One Financial Corporation, as Sponsor, The Bank of New York Mellon Trust Company, N.A., as institutional trustee, BNY Mellon Trust of Delaware, as Delaware trustee and the Administrative Trustees named therein (incorporated by reference to Exhibit 4.3 of the Company’s Current Report on Form 8-K, filed on August 6, 2009).
    4.7.3      Guarantee Agreement, dated as of August 5, 2009, between Capital One Financial Corporation and The Bank of New York Mellon Trust Company, N.A., as guarantee trustee (incorporated by reference to Exhibit 4.4 of the Company’s Current Report on Form 8-K, filed on August 6, 2009).
    4.7.4      Specimen certificate representing the Trust Preferred Security (incorporated by reference to Exhibit 4.5 of the Company’s Current Report on Form 8-K, filed on August 6, 2009).
    4.7.5      Specimen certificate representing the Junior Subordinated Debt Security (incorporated by reference to Exhibit 4.6 of the Company’s Current Report on Form 8-K, filed on August 6, 2009).
    4.8.1      Fifth Supplemental Indenture, dated as of November 13, 2009, between Capital One Financial Corporation and The Bank of New York Mellon Trust Company, N.A., as indenture trustee (incorporated by reference to Exhibit 4.2 of the Company’s Current Report on Form 8-K, filed on November 13, 2009).
    4.8.2      Amended and Restated Declaration of Trust of Capital One Capital VI, dated as of November 13, 2009, between Capital One Financial Corporation, as Sponsor, The Bank of New York Mellon Trust Company, N.A., as institutional trustee, BNY Mellon Trust of Delaware, as Delaware Trustee and the Administrative Trustees named therein (incorporated by reference to Exhibit 4.3 of the Company’s Current Report on Form 8-K, filed on November 13, 2009).

 

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Exhibit No.

  

Description

    4.8.3    Guarantee Agreement, dated as of November 13, 2009, between Capital One Financial Corporation and The Bank of New York Mellon Trust Company, N.A., as guarantee trustee (incorporated by reference to Exhibit 4.4 of the Company’s Current Report on Form 8-K, filed on November 13, 2009).
    4.8.4    Specimen certificate representing the Trust Preferred Security (incorporated by reference to Exhibit 4.5 of the Company’s Current Report on Form 8-K, filed on November 13, 2009).
    4.8.5    Specimen certificate representing the Junior Subordinated Debt Security (incorporated by reference to Exhibit 4.6 of the Company’s Current Report on Form 8-K, filed on November 13, 2009).
    4.9.1    Indenture, dated as of August 29, 2006, between Capital One Financial Corporation and The Bank of New York Mellon Trust Company, N.A., as indenture trustee (incorporated by reference to Exhibit 4.1 of the Company’s Current Report on Form 8-K, filed on August 31, 2006).
    4.9.2    Specimen certificate representing the Subordinated Note Certificate (incorporated by reference to Exhibit 4.2 of the Company’s Current Report on Form 8-K, filed on August 31, 2006).
10.1      Forward Sale Agreement between Capital One Financial Corporation and Barclays Capital Inc., dated July 14, 2011 (incorporated by reference to Exhibit 10.1 of the Company’s Report on Form 8-K, filed on July 19, 2011).
10.2      Forward Sale Agreement between Capital One Financial Corporation and Morgan Stanley & Co. LLP, dated July 14, 2011 (incorporated by reference to Exhibit 10.2 of the Company’s Report on Form 8-K, filed on July 19, 2011).
12.1      Computation of Ratio of Earnings to Combined Fixed Charges (incorporated by reference to Exhibit 12.1 of the Company’s Report on Form 8-K, filed on July 19, 2011).
12.2*      Computation of Ratio of Earnings to Combined Fixed Charges and Preferred Stock Dividends
31.1*      Certification of Richard D. Fairbank
31.2*      Certification of Gary L. Perlin
32.1*      Certification** of Richard D. Fairbank
32.2*      Certification** of Gary L. Perlin
101.INS*    XBRL Instance Document
101.SCH*    XBRL Taxonomy Extension Schema Document
101.CAL*    XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF*    XBRL Taxonomy Extension Definition Linkbase Document
101.LAB*    XBRL Taxonomy Extension Label Linkbase Document
101.PRE*    XBRL Taxonomy Presentation Linkbase Document

 

* Indicates a document being filed with this Form 10-Q.
** Information in this Form 10-Q furnished herewith shall not be deemed to be “filed” for the purposes of Section 18 of the 1934 Act or otherwise subject to the liabilities of that section.

 

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