Capital One 2005 Annual Report Download - page 77

identification method. The Company evaluates its unrealized loss positions for impairment in accordance with FASB Staff
osition No. 115-1, “The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments”. P
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evenue Recognition
The Company recognizes earned finance charges and fee income on loans according to the contractual provisions of the
credit arrangements. When the Company does not expect full payment of finance charges and fees, it does not accrue the
estimated uncollectible portion as income (hereafter the “suppression amount”). To calculate the suppression amount, the
Company first estimates the uncollectible portion of finance charge and fee receivables using a formula based on historical
account migration patterns and current delinquency status. This formula is consistent with that used to estimate the allowance
related to expected principal losses on reported loans. The suppression amount is calculated by adding any current period
change in the estimate of the uncollectible portion of finance charge and fee receivables to the amount of finance charges and
fees charged-off (net of recoveries) during the period. The Company subtracts the suppression amount from the total finance
charges and fees billed during the period to arrive at total reported revenue. The amount of finance charge and fees
suppressed were $1.0 billion, $1.1 billion and $2.0 billion for the years ended December 31, 2005, 2004 and 2003,
spectively. re
Interchange income is a fee paid by a merchant bank to the card-issuing bank through the interchange network. Interchange
fees are set by MasterCard International Inc. (“MasterCard”) and Visa U.S.A. Inc. (“Visa”) and are based on cardholder
purchase volumes. The Company recognizes interchange income as earned.
Annual membership fees and direct loan origination costs are deferred and amortized over one year on a straight-line basis.
Dealer fees and premiums are deferred and amortized over the average life of the related loans using the interest method for
auto loan originations. Direct loan origination costs consist of both internal and external costs associated with the origination
of a loan. Deferred fees (net of deferred costs) were $217.8 million and $302.5 million as of December 31, 2005 and 2004,
respectively.
Rewards
The Company offers credit cards that provide reward program members with various rewards such as airline tickets, free or
deeply discounted products or cash rebates, based on purchase volume. The Company establishes a rewards liability based
upon points earned which are ultimately expected to be redeemed and the average cost per point redemption. As points are
redeemed, the rewards liability is relieved. The estimated cost of reward programs is reflected as a reduction to interchange
income. The cost of reward programs related to securitized loans is deducted from servicing and securitizations income.
Loan Securitizations
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
receivables from the Consolidated Balance Sheets for securitizations that qualify as sales in accordance with SFAS No. 140,
Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities—a Replacement of SFAS
No. 125 (“SFAS 140”). The trusts are qualified special purpose entities as defined by SFAS 140 and are not subsidiaries of
the Company and are not included in the Company’ s consolidated financial statements. Gains on securitization transactions,
fair value adjustments related to residual interests and earnings on the Company’ s securitizations are included in servicing
and securitizations income in the Consolidated Statements of Income and amounts due from the trusts are included in
accounts receivable from securitizations on the Consolidated Balance Sheets.
The gain on sale recorded from off-balance sheet securitizations is based on the estimated fair value of the assets sold and
retained and liabilities incurred, and is recorded at the time of sale, net of transaction costs, in servicing and securitizations
income on the Consolidated Statements of Income. The related receivable is the interest-only strip, which is based on the
present value of the estimated future cash flows from excess finance charges and past-due fees over the sum of the return paid
to security holders, estimated contractual servicing fees and credit losses. To the extent assumptions used by management do
not prevail, fair value estimates of the interest-only strip could differ significantly, resulting in either higher or lower future
servicing and securitization income, as applicable.
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, on forward loss curves and historical loss trends.
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