Capital One 2004 Annual Report Download - page 56

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Adoption of Accounting Pronouncements and Accounting Changes
In December 2003, the Company adopted the expense recognition provisions of Statement of Financial
Accounting Standard No. 123 Accounting for Stock Based Compensation (“SFAS 123”), prospectively to all
awards granted, modified or settled after January 1, 2003. The adoption of SFAS 123 resulted in the recognition
of compensation expense of $5.0 million for the year ended December 31, 2003. Compensation expense resulted
from the discounts provided under the Associate Stock Purchase Plan and the amortization of the estimated fair
value of stock options granted during 2003.
In July 2003, the Company adopted the provisions of FASB interpretation No. 46(R), Consolidation of Variable
Interest Entities, an Interpretation of ARB No. 51, Revised (“FIN 46(R)”). The Company has consolidated all
material variable interest entities (“VIEs”) for which the Company is the primary beneficiary, as defined by FIN
46(R). The consolidation of the VIEs resulted in a $15.0 million ($23.9 pre-tax) charge for the cumulative effect
of a change in accounting principle.
In 2002, the Company changed its financial presentation of recoveries which resulted in a one-time increase in
the Company’s allowance for loan losses of $133.4 million, and a corresponding increase in the recognition of
interest income of $38.4 million (pre-tax) and non-interest income of $44.4 million (pre-tax). Therefore, net
income for the year ended December 31, 2002 was negatively impacted by $31.4 million after-tax.
Consolidated Earnings Summary
The following discussion provides a summary of 2004 results compared to 2003 results and 2003 results
compared to 2002 results. Each component is discussed in further detail in subsequent sections of this analysis.
Year Ended December 31, 2004 Compared to Year Ended December 31, 2003
Net income increased to $1.5 billion, or $6.21 per share (diluted), for the year ended December 31, 2004,
compared to net income of $1.1 billion, or $4.85 per share (diluted), in 2003. This represents 36% net income
growth and 28% earnings per share growth in 2004. The growth in earnings for 2004 was primarily driven by an
increase in the managed consumer loan portfolio, a reduction in the provision for loan losses, and an increase in
servicing and securitization income and other non-interest income, offset in part by an increase in marketing and
operating expenses.
Managed loans consist of the Company’s reported loan portfolio combined with the off-balance sheet securitized
loan portfolio. The Company has retained servicing rights for its securitized loans and receives servicing fees in
addition to the excess spread generated from the off-balance sheet loan portfolio. Average managed loans
increased $10.8 billion, or 17%, to $73.7 billion for the year ended December 31, 2004 from $62.9 billion for the
prior year.
The managed net interest margin for the year ended December 31, 2004, decreased to 7.88% from 8.64% for the
year ended December 31, 2003. This decrease was due to a reduction in managed earning asset yields, slightly
offset by a reduction in the cost of funds. Managed loan yields decreased by 83 basis points to 13.05% for the
year ended December 31, 2004, from 13.88% in the prior year. The decrease in managed loan yields resulted
from the Company’s continued asset diversification beyond U.S. consumer credit cards and a bias toward
originating higher credit quality, lower yielding loans. In addition, the Company built the average size of its
liquidity portfolio by $3.5 billion to $10.5 billion in 2004, from $7.0 billion in 2003, placing additional
downward pressure on managed earning asset yields as the yield on the liquidity portfolio is lower than the yield
on consumer loans.
For the year ended December 31, 2004, the provision for loan losses decreased to $1.2 billion from $1.5 billion
for the year ended December 31, 2003. The decrease in the provision for loan losses reflects a reduction in net
charge-offs, improving delinquency rates and lower forecasted charge-offs for the reported loan portfolio at
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