Capital One 2013 Annual Report Download - page 166

CAPITAL ONE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Allowance for Loan and Lease Losses
We maintain an allowance for loan and lease losses (“the allowance”) that represents management’s best
estimate of incurred loan and lease losses inherent in our held-for-investment portfolio as of each balance sheet
date. The provision for credit losses, which is charged to earnings, reflects credit losses we believe have been
incurred and will eventually be reflected over time in our charge-offs. Charge-offs of uncollectible amounts are
deducted from the allowance and subsequent recoveries are added back.
Management performs a quarterly analysis of our loan portfolio to determine if impairment has occurred and to
assess the adequacy of the allowance based on historical and current trends and other factors affecting credit
losses. We apply documented systematic methodologies to separately calculate the allowance for our consumer
loan and commercial loan portfolios and for loans within each of these portfolios that we identify as individually
impaired. Our allowance for loan and lease losses consists of three components that are allocated to cover the
estimated probable losses in each loan portfolio based on the results of our detailed review and loan impairment
assessment process: (1) a component for loans collectively evaluated for impairment; (2) an asset-specific
component for individually impaired loans; and (3) a component related to Acquired Loans that have experienced
significant decreases in expected cash flows subsequent to acquisition. Each of our allowance components is
supplemented by an amount that represents management’s qualitative judgment of the imprecision and risks
inherent in the processes and assumptions used in establishing the allowance. Management’s judgment involves
an assessment of subjective factors, such as process risk, modeling assumption and adjustment risks and probable
internal and external events that will likely impact losses.
Our consumer loan portfolio consists of smaller-balance, homogeneous loans, divided into four primary portfolio
segments: credit card loans, auto loans, residential home loans and retail banking loans. Each of these portfolios
is further divided by our business units into pools based on common risk characteristics, such as origination year,
contract type, interest rate and geography, which are collectively evaluated for impairment. The commercial loan
portfolio is primarily composed of larger-balance, non-homogeneous loans. These loans are subject to individual
reviews that result in internal risk ratings. In assessing the risk rating of a particular loan, among the factors we
consider are the financial condition of the borrower, geography, collateral performance, historical loss
experience, and industry-specific information that management believes is relevant in determining the occurrence
of a loss event and measuring impairment. These factors are based on an evaluation of historical and current
information, and involve subjective assessment and interpretation. Emphasizing one factor over another or
considering additional factors could impact the risk rating assigned to that loan.
The component of the allowance for credit card and other consumer loans that we collectively evaluate for
impairment is based on a statistical calculation, which is supplemented by management judgment as described
above. Because of the homogeneous nature of our consumer loan portfolios, the allowance is based on the
aggregated portfolio segment evaluations. The allowance is established through a process that begins with
estimates of incurred losses in each pool based upon various statistical analyses. Loss forecast models are utilized
to estimate incurred losses and consider several portfolio indicators including, but not limited to, historical loss
experience, account seasoning, the value of collateral underlying secured loans, estimated foreclosures or
defaults based on observable trends, delinquencies, bankruptcy filings, unemployment, credit bureau scores and
general economic and business trends. Management believes these factors are relevant in estimating incurred
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.
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