Capital One 2004 Annual Report Download - page 51

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Introduction
Capital One Financial Corporation (the “Corporation”) is a holding company whose subsidiaries market a variety
of consumer financial products and services. In 2004, the Corporation became a bank holding company. The
Corporation’s principal subsidiaries are Capital One Bank (the “Bank”) which currently offers credit card
products and takes retail deposits, Capital One, F.S.B. (the “Savings Bank”), which offers consumer and
commercial lending and consumer deposit products, and Capital One Auto Finance, Inc. (“COAF”) which offers
automobile and other motor vehicle financing products. The Corporation and its subsidiaries are hereafter
collectively referred to as the “Company”. As of December 31, 2004, the Company had 48.6 million accounts
and $79.9 billion in managed consumer loans outstanding and was one of the largest providers of MasterCard
and Visa credit cards in the world.
The Company’s profitability is affected by the net interest income and non-interest income generated on earning
assets, consumer usage and payment patterns, credit quality, levels of marketing expense and operating
efficiency. The Company’s revenues consist primarily of interest income on consumer loans (including past-due
fees) and securities and non-interest income consisting of servicing income on securitized loans, fees (such as
annual membership, cash advance, cross-sell, interchange, overlimit and other fee income, collectively “fees”)
and gains on the securitizations of loans. Loan securitization transactions qualifying as sales under accounting
principles generally accepted in the United States (“GAAP”) remove the loan receivables from the consolidated
balance sheet; however, the Company continues to both own and service the related accounts. The Company
generates earnings from its managed loan portfolio that includes both on-balance sheet and off-balance sheet
loans. Interest income, fees, and recoveries in excess of the interest paid to investors and charge-offs generated
from off-balance sheet loans are recognized as servicing and securitizations income.
The Company’s primary expenses are the costs of funding assets, provision for loan losses, operating expenses
(including salaries and associate benefits), marketing expenses and income taxes. Marketing expenses (e.g.,
advertising, printing, credit bureau costs and postage) to implement the Company’s new product strategies are
incurred and expensed prior to the acquisition of new accounts while the resulting revenues are recognized over
the life of the acquired accounts. Revenues recognized are a function of the response rate of the initial marketing
program, usage and attrition patterns, credit quality of accounts, product pricing and effectiveness of account
management programs.
Significant Accounting Policies
The Notes to the Consolidated Financial Statements contain a summary of the Company’s significant accounting
policies, including a discussion of recently issued accounting pronouncements. Several of these policies are
considered to be important to the portrayal of the Company’s financial condition, since they require management
to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently
uncertain. These policies include determination of the level of allowance for loan losses, accounting for
securitization transactions, recognition of customer reward costs and finance charge and fee revenue recognition.
Additional information about accounting policies can be found in Item 8 “Financial Statements and
Supplementary Data—Notes to the Consolidated Financial Statements—Note 1” on page 62.
Allowance for Loan Losses
The allowance for loan losses is maintained at the amount estimated to be sufficient to absorb probable principal
losses, net of principal recoveries (including recovery of collateral), inherent in the existing reported loan
portfolio. The provision for loan losses is the periodic cost of maintaining an adequate allowance. The amount of
allowance necessary is determined primarily based on a migration analysis of delinquent and current accounts
and forward loss curves. The entire balance of an account is contractually delinquent if the minimum payment is
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