Capital One 2013 Annual Report Download - page 162

CAPITAL ONE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
In accounting for purchased loans based on expected cash flows, we first determine the contractually required
payments due, which represent the total undiscounted amount of all uncollected principal and interest payments,
adjusted for the effect of estimated prepayments. We then estimate the undiscounted cash flows we expect to
collect by incorporating several key assumptions including default rates, loss severities and the amount and
timing of prepayments. We estimate the fair value by discounting the estimated cash flows we expect to collect
using an observable market rate of interest, when available, adjusted for factors that a market participant would
consider in determining fair value. We are permitted to aggregate loans acquired in the same fiscal quarter into
one or more pools if the loans have common risk characteristics. A pool is then accounted for as a single asset,
with a single composite interest rate and an aggregate fair value and expected cash flows.
The difference between total contractual payments on the loans and all expected cash flows represents the
nonaccretable difference or the amount of principal and interest not considered collectible, which incorporates
future expected credit losses over the life of the loans. Decreases in expected cash flows resulting from further
credit deterioration will generally result in a loan loss recognized in our provision for credit losses and an
increase in the allowance for loan and lease losses. Charge-offs are not recorded until the expected credit losses
within the nonaccretable difference is depleted. In addition, Acquired Loans are not classified as delinquent or
nonperforming as we expect to collect our net investment in these loans and the nonaccretable difference will
absorb the majority of the losses associated with these loans. The excess of cash flows expected to be collected
over the estimated fair value of purchased loans is referred to as the accretable yield. This amount is not recorded
on our consolidated balance sheets, but is accreted into interest income over the life of the loan, or pool of loans,
using the effective interest method.
Subsequent to acquisition, we are required to periodically evaluate our estimate of cash flows expected to be
collected. These evaluations, which we perform quarterly, require the use of key assumptions and estimates
similar to those used in estimating the initial fair value at acquisition. Subsequent changes in the estimated cash
flows expected to be collected may result in changes in the accretable yield and nonaccretable difference or
reclassifications from the nonaccretable difference to the accretable yield. Decreases in expected cash flows
resulting from credit deterioration will generally result in an impairment charge recognized in our provision for
credit losses and an increase in the allowance for loan and lease losses. Increases in the cash flows expected to be
collected would first reduce any previously recorded allowance for loan and lease losses established subsequent
to acquisition. The excess over the recorded allowance for loan and lease losses would result in a reclassification
to the accretable yield from the nonaccretable difference and an increase in interest income recognized over the
remaining life of the loan or pool of loans. Disposals of loans, which may include sales to third parties, receipt of
payments in full or in part by the borrower, and foreclosure of the collateral, result in removal of the loan from
the acquired loan portfolio. See “Note 4—Loans” for additional information.
Loans Acquired and Accounted for Based on Contractual Cash Flows
The substantial majority of the loans purchased in the 2012 U. S. card acquisition had existing revolving
privileges at acquisition, therefore were excluded from the accounting guidance applied to the Acquired Loans
described above, and accounted for based on contractual cash flows. To determine the fair value of these loans at
acquisition, we discounted the contractual cash flows due using an observable market rate of interest, when
available, adjusted for factors that a market participant would consider in determining fair value. In determining
fair value, contractual cash flows are adjusted to include prepayment estimates based upon trends in default rates
and loss severities. The difference between the fair value and the contractual cash flows is recorded as a loan
discount or premium at acquisition. The premium or discount is amortized into interest income using the
effective interest method over the remaining life of the loans. We are permitted to aggregate loans acquired in the
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