Capital One 2007 Annual Report Download - page 127

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Cash Flow Hedges
The Company has entered into interest rate swap agreements that effectively modify the Companys exposure to interest rate risk by
converting floating rate debt to a fixed rate over the next six years. The agreements involve the receipt of floating rate amounts in
exchange for fixed rate interest payments over the life of the agreement without an exchange of underlying principal amounts.
The Company has entered into forward exchange contracts to reduce the Companys sensitivity to foreign currency exchange rate
changes on its foreign currency denominated loans. The forward rate agreements allow the Company to lock-in functional currency
equivalent cash flows associated with the foreign currency denominated loans.
Any unrealized gains or losses related to cash flow hedging instruments are reclassified from other comprehensive income (loss) into
earnings in the same period or periods during which the hedged forecasted transaction affects earnings and are recorded in interest
income, interest expense or non-interest income depending on the hedged item.
During the years ended December 31, 2007 and 2006, the Company recognized no losses related to the ineffective portions of its cash
flow hedging instruments. The Company recognized no net gains or losses during the years ended December 31, 2006 and
December 31, 2005 for cash flow hedges that have been discontinued because the forecasted transaction was no longer probable of
occurring.
At December 31, 2007, the Company expects to reclassify $0.3 million of net losses, after tax, on derivative instruments from
cumulative other comprehensive income to earnings during the next 12 months as terminated swaps are amortized and as interest
payments and receipts on derivative instruments occur.
Hedge of Net Investment in Foreign Operations
The Company uses forward exchange contracts to protect the value of its investment in its foreign subsidiaries. Realized and
unrealized foreign currency gains and losses from these hedges are not included in the income statement, but are shown in the
translation adjustments in other comprehensive income. The purpose of these hedges is to protect against adverse movements in
exchange rates.
For the year ended December 31, 2007, net losses of $0.5 million, related to these derivatives were included in the cumulative
translation adjustment. For the year ended December 31, 2006, net gains of $1.5 million, related to these derivatives were included in
the cumulative translation adjustment.
Non-Trading Derivatives
The Company uses interest rate swaps to manage interest rate sensitivity related to loan securitizations. The Company enters into
interest rate swaps with its securitization trust and essentially offsets the derivative with separate interest rate swaps with third parties.
The Company uses interest rate swaps in conjunction with its auto securitizations. These swaps have zero balance notional amounts
unless the paydown of auto securitizations differs from its scheduled amortization.
The Company uses interest rate swaps in conjunction with its mortgage servicing rights portfolio. These derivatives are designed to
offset changes in the value of mortgage servicing rights attributable to interest rate fluctuations.
The Company enters into customer-oriented derivative financial instruments, including interest rate swaps, options, caps, floors, and
foreign exchange contracts. These customer-oriented positions are matched with offsetting positions to minimize risk to the Company.
These derivatives do not qualify as hedges and are recorded on the balance sheet at fair value with changes in value included in
current earnings in non-interest income.
In April 2006, the Company entered into derivative instruments to mitigate certain exposures it faced as a result of the expected
acquisition of North Fork. The position was designed to protect the Companys tangible capital ratios from falling below a desired
level in the event that subsequent increases in interest rates had reduced the mark-to-market value of North Forks balance sheet prior
to closing. The Companys maximum negative exposure was no more than approximately $50 million. The derivative instruments
were not treated as designated hedges and were marked to market through the income statement until expiration. During their
existence, $30.2 million was recognized as a reduction to Mortgage servicing and other as a mark to market adjustment. The
derivative instruments expired out of the money and unexercised on October 2, 2006 with a $19.9 million reduction to mortgage
servicing and other income.
Mortgage Banking Derivatives
In third quarter 2007, the Company shut down the mortgage origination operations of its wholesale mortgage banking unit, GreenPoint
Mortgage. The results of the mortgage origination operation of GreenPoint have been accounted for as a discontinued operation and