Capital One 2005 Annual Report Download - page 36

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
I. Introduction
Capital One Financial Corporation (the “Corporation”) is a diversified financial services company whose banking and non-
banking subsidiaries market a variety of financial products and services. The Corporation’ s principal subsidiaries are Capital
One Bank (the “Bank”) which currently offers credit card products and takes retail deposits, Capital One, F.S.B. (the
“Savings Bank”), which offers consumer and commercial lending and consumer deposit products, Hibernia National Bank
(the “National Bank”) which offers a broad spectrum of financial products and services to consumers, small businesses and
commercial clients, 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, 2005, the Company had $47.9 billion in deposits and $105.5 billion in managed 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, overlimit and
other fee income, collectively “fees”), cross-sell, interchange 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
associate salaries and benefits), marketing expenses and income taxes. Marketing expenses (e.g., advertising, printing, credit
bureau costs and postage) to implement the Company’ s product strategies are expensed as incurred while the revenues
sulting from acquired accounts are recognized over their life. re
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. 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 66.
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 and historical loss trends.
The entire balance of an account is contractually delinquent if the minimum payment is not received by the payment due date.
In evaluating the sufficiency of the allowance for loan losses, management takes into consideration the following factors:
recent trends in delinquencies and charge-offs including bankrupt, deceased and recovered amounts; forecasting uncertainties
and size of credit risks; the degree of risk inherent in the composition of the loan portfolio; economic conditions; legal and
regulatory guidance; credit evaluations and underwriting policies; seasonality; and the value of collateral supporting the
loans. To the extent credit experience is not indicative of future performance or other assumptions used by management do
not prevail, loss experience could differ significantly, resulting in either higher or lower future provision for loan losses, as
pplicable. a
A
ccounting for Securitization Transactions
Loan securitization involves the transfer of a pool of loan receivables to a trust or other special purpose entity. The trust sells
an undivided interest in the pool of loan receivables to third-party investors through the issuance of asset backed securities
and distributes the proceeds to the Company as consideration for the loans transferred. The Company removes loan
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