Capital One 2010 Annual Report Download - page 123

CAPITAL ONE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED STATEMENTS
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losses and also considers an evaluation of overall portfolio credit quality based on indicators such as changes in our credit evaluation,
underwriting and collection management policies, changes in the legal and regulatory environment, general economic conditions and
business trends and uncertainties in forecasting and modeling techniques used in estimating our allowance. We update our consumer
loss forecast models and portfolio indicators on a quarterly basis to incorporate information reflective of the current economic
environment.
The formula-based component of the allowance for commercial loans that we collectively evaluate for impairment is based on our
historical loss experience for loans with similar risk characteristics and consideration of the current credit quality of the portfolio,
supplemented by management judgment and interpretation. We apply internal risk ratings to commercial loans, which we use to assess
credit quality and derive a total loss estimate based on an estimated probability of default (default rate) and loss given default (loss
severity). We generally use the prior four-year actual portfolio credit loss experience to develop our estimate of credit losses inherent
in the portfolio as of each balance sheet date. Management may also apply judgment to adjust the loss factors derived, taking into
consideration both quantitative and qualitative factors, including general economic conditions, specific industry and geographic
trends, portfolio concentrations, trends in internal credit quality indicators and current and past underwriting standards that have
occurred but are not yet reflected in the historical data underlying our loss estimates.
The asset-specific component of the allowance covers smaller-balance homogenous credit card and consumer loans whose terms have
been modified in a TDR and larger balance nonperforming, non-homogenous commercial loans. As discussed above under “Impaired
Loans,” we measure the asset-specific component of the allowance based on the difference between the recorded investment of
individually impaired loans and the present value of expected future cash flows. When the present value is lower than the carrying
value of the loan, impairment is recognized through the provision for loan and lease losses. The asset specific component of the
allowance for smaller-balance impaired loans is calculated on a pool basis using historical loss experience for the respective class of
assets. The asset-specific component of the allowance for larger-balance, commercial loans is individually calculated for each loan.
Key considerations in determining the allowance include the borrower’s overall financial condition, resources and payment history,
prospects for support from financially responsible guarantors, and when applicable, the estimated realizable value of any collateral.
Purchased credit-impaired loans are recorded at fair value at acquisition and applicable accounting guidance prohibits the carry over or
creation of valuation allowances in the initial accounting for impaired loans acquired in a transfer. Subsequent to acquisition,
decreases in expected principal cash flows of purchased impaired loans are recorded as a valuation allowance included in the
allowance for loan and lease losses. Subsequent increases in expected principal cash flows result in a recovery of any previously
recorded allowance for loan and lease losses, to the extent applicable. Write-downs on purchased impaired loans in excess of the
nonaccretable difference are charged against the allowance for loan and lease losses. See “Note 5—Loans” for information on
purchased credit-impaired portfolios associated with acquisitions.
In addition to the allowance for loan and lease losses, we also estimate probable losses related to unfunded lending commitments, such
as letters of credit and financial guarantees, and binding unfunded loan commitments. The reserve for unfunded lending commitments
excludes commitments accounted for under the fair value option. The provision for unfunded lending commitments is included in the
provision for loan and lease losses on our consolidated statements of income and the related reserve for unfunded lending
commitments is included in other liabilities on our consolidated balance sheets. Unfunded lending commitments are subject to
individual reviews and are analyzed and segregated by risk according to our internal risk rating scale. We assess these risk
classifications, in conjunction with historical loss experience, utilization assumptions, current economic conditions, performance
trends within specific portfolio segments and other pertinent information to estimate the reserve for unfunded lending commitments.
While we attribute portions of the allowance to components across our lending portfolios, the entire allowance is available to absorb
probable credit losses inherent in our total lending portfolio. Determining the appropriateness of the allowance is complex and
requires judgment by management about the effect of matters that are inherently uncertain. Subsequent evaluations of the loan
portfolio, in light of the factors then prevailing, may result in significant changes in the allowances for loan and lease losses and
reserve for unfunded lending commitments in future periods.
Special Purpose Entities and Variable Interest Entities
In June 2009, the Financial Accounting Standards Board (“FASB”) issued two new accounting standards that amended guidance
applicable to the accounting for transfers of financial assets and the consolidation of VIEs. The guidance in these new consolidation
accounting standards was effective for fiscal years beginning after November 15, 2009. We adopted the new consolidation accounting
standards on January 1, 2010. Prior to January 1, 2010, our securitization trusts generally met the definition of a QSPE and were
therefore not subject to consolidation. The new consolidation accounting standards eliminated the concept of a QSPE, requiring that
entities previously considered as QSPEs be evaluated for consolidation. Based on our evaluation, we determined that we were the
primary beneficiary of all of our credit card and auto securitization trusts, one installment loan securitization trust and certain