Capital One 2012 Annual Report Download - page 75

non-litigation liabilities. The reserve-setting process relies heavily on estimates, which are inherently uncertain,
and requires the application of judgment. In establishing the representation and warranty reserves, we consider a
variety of factors, depending on the category of purchaser and rely on historical data. These factors include, but
are not limited to, the historical relationship between loan losses and repurchase outcomes; the percentage of
current and future loan defaults that we anticipate will result in repurchase requests over the lifetime of the loans;
the percentage of those repurchase requests that we anticipate will result in actual repurchases; and estimated
collateral valuations. We evaluate these factors and update our loss forecast models on a quarterly basis to
estimate our lifetime liability.
Our aggregate representation and warranty mortgage repurchase reserves, which we report as a component of
other liabilities in our consolidated balance sheets, totaled $899 million as of December 31, 2012, compared with
$943 million as of December 31, 2011. The adequacy of the reserves and the ultimate amount of losses incurred
by us or one of our subsidiaries will depend on, among other things, actual future mortgage loan performance, the
actual level of future repurchase and indemnification requests, the actual success rates of claimants,
developments in litigation, actual recoveries on the collateral and macroeconomic conditions (including
unemployment levels and housing prices).
As part of our business planning processes, we have considered various outcomes relating to the potential future
representation and warranty liabilities of our subsidiaries that are reasonably possible but do not rise to the level
of being both probable and reasonably estimable outcomes justifying an incremental accrual under applicable
accounting standards. As of December 31, 2012, our best estimate of reasonably possible future losses from
representation and warranty claims beyond what is in our reserve was approximately $2.7 billion, an increase
from our previous estimates of $1.7 billion as of September 30, 2012, and $1.5 billion as of December 31, 2011.
Notwithstanding our ongoing attempts to estimate a reasonably possible amount of future losses beyond our
current accrual levels based on current information, it is possible that actual future losses will exceed both the
current accrual level and our current estimate of the amount of reasonably possible losses. This estimate involves
considerable judgment, and reflects that there is still significant uncertainty regarding the numerous factors that
may impact the ultimate loss levels, including, but not limited to, anticipated litigation outcomes, future
repurchase and indemnification claim levels, ultimate repurchase and indemnification rates, future mortgage loan
performance levels, actual recoveries on the collateral and macroeconomic conditions (including unemployment
levels and housing prices). In light of the significant uncertainty as to the ultimate liability our subsidiaries may
incur from these matters, an adverse outcome in one or more of these matters could be material to our results of
operations or cash flows for any particular reporting period. See “Note 21—Commitments, Contingencies and
Guarantees” for additional information.
Customer Rewards Reserve
We offer products, primarily credit cards, which offer reward program members with various rewards, such as
cash, airline tickets or merchandise. The majority of our rewards do not expire and there is no limit on the
number of reward points an eligible card member may earn. Customer rewards costs, which we generally record
as an offset to interchange income, are driven by various factors, such as card member charge volume, customer
participation in the rewards program and contractual arrangements with redemption partners. We establish a
customer rewards reserve that reflects management’s judgment regarding rewards earned that are expected to be
redeemed and the estimated redemption cost.
We use financial models to estimate ultimate redemption rates of rewards earned to date by current card
members based on historical redemption trends, current enrollee redemption behavior, card product type, year of
program enrollment, enrollment tenure and card spend levels. Our current assumption is that the vast majority of
all rewards earned will eventually be redeemed. We use a weighted-average cost per reward redeemed during the
previous twelve months, adjusted as appropriate for recent changes in redemption costs, including mix of
rewards redeemed, to estimate future redemption costs.
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