Capital One 2015 Annual Report Download - page 146

CAPITAL ONE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
127 Capital One Financial Corporation (COF)
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 related to 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 probable losses incurred 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 probable losses incurred 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, the effect of other external factors such as competition and legal and regulatory requirements, 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 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, which is
supplemented by management judgment as described above. 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). 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 homogeneous consumer loans whose terms have been
modified in a TDR and larger balance nonperforming, non-homogeneous commercial loans. As discussed above under “Impaired
Loans,” we generally 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 of expected
future cash flows is lower than the carrying value of the loan, impairment is recognized through the provision for credit losses. If
the loan is collateral dependent, we measure impairment based on the current fair value of the collateral less estimated selling
costs, instead of discounted cash flows. 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.
We record all purchased loans at fair value at acquisition. 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 Acquired Loans would trigger the recognition of impairment through our provision for credit
losses. Subsequent increases in expected cash flows would first result in a recovery of any previously recorded allowance, to the
extent applicable, and then increase the accretable yield. 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 loan portfolios
associated with acquisitions.
In addition to the allowance, we also estimate probable losses related to contractually binding unfunded lending commitments,
such as letters of credit and financial guarantees, and binding unfunded loan commitments. The provision for unfunded lending
commitments is included in the provision for credit losses in 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, which we use