Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”)
This discussion contains forward-looking statements that are based upon management’s current expectations and are subject to significant uncertainties and changes in circumstances. Please review “Part I—Item 1.Business—Forward-Looking Statements” for more information on the forward-looking statements in this Report. All statements that address operating performance, events or developments that we expect or anticipate will occur in the future are forward-looking statements. Our actual results may differ materially from those included in these forward-looking statements due to a variety of factors including, but not limited to, those described in “Part I—Item 1A. Risk Factors” in this Report. Unless otherwise specified, references to notes to our consolidated financial statements refer to the notes to our consolidated financial statements as of December 31, 2022 included in this Report.
Management monitors a variety of key indicators to evaluate our business results and financial condition. The following MD&A is intended to provide the reader with an understanding of our results of operations and financial condition, including capital and liquidity management, by focusing on changes from year to year in certain key measures used by management to evaluate performance, such as profitability, growth and credit quality metrics. MD&A is provided as a supplement to, and should be read in conjunction with, our audited consolidated financial statements as of and for the year ended December 31, 2022 and accompanying notes. MD&A is organized in the following sections:
• Executive Summary • Capital Management
• Consolidated Results of Operations • Risk Management
• Consolidated Balance Sheets Analysis • Credit Risk Profile
• Off-Balance Sheet Arrangements • Liquidity Risk Profile
• Business Segment Financial Performance • Market Risk Profile
• Critical Accounting Policies and Estimates • Supplemental Tables
• Accounting Changes and Developments • Glossary and Acronyms
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Selected Financial Data
The following table presents selected consolidated financial data and performance metrics for the three-year period ended December 31, 2022, 2021 and 2020. We also provide selected key metrics we use in evaluating our performance, including certain metrics that are computed using non-GAAP measures. We consider these metrics to be key financial measures that management uses in assessing our operating performance, capital adequacy and the level of returns generated. We believe these non-GAAP metrics provide useful insight to investors and users of our financial information as they provide an alternate measurement of our performance and assist in assessing our capital adequacy and the level of return generated. These non-GAAP measures should not be viewed as a substitute for reported results determined in accordance with GAAP, nor are they necessarily comparable to non-GAAP measures that may be presented by other companies.
Three-Year Summary of Selected Financial Data
Income statement
Non-interest expense:
Income from continuing operations before income taxes 9,240 15,809 3,203 (42) **
Income (loss) from discontinued operations, net of tax — (4) (3) ** 33
Issuance cost for redeemed preferred stock — (46) (39) ** 18
Net income available to common stockholders $ 7,044 $ 11,965 $ 2,375 (41) **
Common share statistics
Basic earnings per common share:
Net income from continuing operations $ 17.98 $ 27.05 $ 5.20 (34)% **
Income (loss) from discontinued operations — (0.01) (0.01) ** —
Diluted earnings per common share:
Net income from continuing operations $ 17.91 $ 26.95 $ 5.19 (34)% **
Income (loss) from discontinued operations — (0.01) (0.01) ** —
Net income per diluted common share $ 17.91 $ 26.94 $ 5.18 (34) **
Common shares outstanding (period-end, in millions) 381.3 413.9 459.0 (8) (10)%
Dividends declared and paid per common share $ 2.40 $ 2.60 $ 1.00 (8) 160
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Balance sheet (average balances)
Selected performance metrics
Effective income tax rate from continuing operations 20.3 21.6 15.2 (130) 6%
December 31, Change
Balance sheet (period-end)
Credit quality metrics
Capital ratios
Other
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December 31, Change
__________
(1)Tangible book value per common share is a non-GAAP measure calculated based on tangible common equity (“TCE”) divided by common shares outstanding. See “Supplemental Tables—Table B—Reconciliation of Non-GAAP Measures” for additional information on non-GAAP measures.
(2)Common dividend payout ratio is calculated based on dividends per common share for the period divided by basic earnings per common share for the period.
(3)Total net revenue margin is calculated based on total net revenue for the period divided by average interest-earning assets for the period.
(4)Return on average assets is calculated based on income from continuing operations, net of tax, for the period divided by average total assets for the period.
(5)Return on average tangible assets is a non-GAAP measure calculated based on income from continuing operations, net of tax, for the period divided by average tangible assets for the period. See “Supplemental Tables—Table B—Reconciliation of Non-GAAP Measures” for additional information on non-GAAP measures.
(6)Return on average common equity is calculated based on net income (loss) available to common stockholders less income (loss) from discontinued operations, net of tax, for the period, divided by average common equity. Our calculation of return on average common equity may not be comparable to similarly-titled measures reported by other companies.
(7)Return on average tangible common equity is a non-GAAP measure calculated based on net income (loss) available to common stockholders less income (loss) from discontinued operations, net of tax, for the period, divided by average TCE. Our calculation of return on average TCE may not be comparable to similarly-titled measures reported by other companies. See “Supplemental Tables—Table B—Reconciliation of Non-GAAP Measures” for additional information on non-GAAP measures.
(8)Equity-to-assets ratio is calculated based on average stockholders’ equity for the period divided by average total assets for the period.
(9)Efficiency ratio is calculated based on total non-interest expense for the period divided by total net revenue for the period.
(10)Operating efficiency ratio is calculated based on operating expense for the period divided by total net revenue for the period.
(11)Adjusted operating efficiency ratio is a non-GAAP measure. See “Supplemental Tables—Table B—Reconciliation of Non-GAAP Measures” for a reconciliation of our adjusted operating efficiency ratio (non-GAAP) to our operating efficiency ratio (GAAP).
(12)Capital ratios are calculated based on the Basel III standardized approach framework, see “Capital Management” for additional information.
(13)Tangible common equity ratio is a non-GAAP measure calculated based on TCE divided by tangible assets. See “Supplemental Tables—Table B—Reconciliation of Non-GAAP Measures” for the calculation of this measure and reconciliation to the comparative U.S. GAAP measure.
(14)The Company’s supplementary leverage ratio as of December 31, 2020 reflected the temporary exclusions of U.S Treasury securities and deposits with the Federal Reserve Banks from the denominator of the supplementary leverage ratio, pursuant to an interim final rule issued by the Federal Reserve in April 2020. These temporary exclusions remained in effect through March 31, 2021 and expired as scheduled thereafter. For the description of the regulatory capital rules to which we are subject, see “Capital Management—Capital Standards and Prompt Corrective Action.”
** Not meaningful.
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EXECUTIVE SUMMARY
Financial Highlights
We reported net income of $7.4 billion ($17.91 per diluted common share) on total net revenue of $34.3 billion for 2022. In comparison, we reported net income of $12.4 billion ($26.94 per diluted common share) on total net revenue of $30.4 billion for 2021 and net income of $2.7 billion ($5.18 per diluted common share) on total net revenue of $28.5 billion for 2020.
Our common equity Tier 1 capital ratio as calculated under the Basel III standardized approach was 12.5% and 13.1% as of December 31, 2022 and 2021, respectively. See “Capital Management” for additional information.
In January 2022, our Board of Directors authorized the repurchase of up to $5.0 billion of shares of our common stock. In April 2022, our Board of Directors authorized the repurchase of up to an additional $5.0 billion of shares of our common stock. For the year ended December 31, 2022, we repurchased $4.8 billion of shares of our common stock. See “MD&A—Capital Management—Dividend Policy and Stock Purchases” for additional information.
Below are additional highlights of our performance in 2022. These highlights are based on a comparison between the results of 2022 and 2021, except as otherwise noted. The changes in our financial condition and credit performance are generally based on our financial condition and credit performance as of December 31, 2022 compared to December 31, 2021. We provide a more detailed discussion of our financial performance in the sections following this “Executive Summary.”
Discussions of our performance for 2021 compared to 2020 can be found in “Part II—Item 7. MD&A” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2021.
Total Company Performance
•Earnings:
Our net income decreased by $5.0 billion to $7.4 billion in 2022 compared to 2021 primarily driven by:
◦Higher provision for credit losses primarily driven by a net allowance build across all of our segments due to credit normalization, a modestly worse economic outlook and loan growth, compared to a net allowance release across all of our segments in 2021.
◦Higher non-interest expense primarily driven by increased marketing spend, as well as continued investment in technology.
These drivers were partially offset by:
◦Higher net interest income and net interest margin primarily driven by higher average loan balances in our credit card loan portfolio relative to the movement of other interest-earning assets.
◦Higher non-interest income primarily driven by higher net interchange fees due to an increase in purchase volume.
•Loans Held for Investment:
◦Period-end loans held for investment increased by $35.0 billion to $312.3 billion as of December 31, 2022 from December 31, 2021 primarily driven by growth across all of our segments, including $23.0 billion in Credit Card.
◦Average loans held for investment increased by $39.5 billion to $292.2 billion in 2022 compared to 2021 primarily driven by growth across all of our segments, including $17.7 billion in Credit Card.
•Net Charge-Off and Delinquency Metrics:
◦Our net charge-off rate increased by 48 basis points (“bps”) to 1.36% in 2022 compared to 2021 primarily driven by continued credit normalization in our consumer businesses.
◦Our 30+ day delinquency rate increased by 80 bps to 3.21% as of December 31, 2022 from December 31, 2021 primarily driven by continued credit normalization.
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•Allowance for Credit Losses: Our allowance for credit losses increased by $1.8 billion to $13.2 billion and our allowance coverage ratio increased by 12 bps to 4.24% as of December 31, 2022 compared to December 31, 2021.
CONSOLIDATED RESULTS OF OPERATIONS
The section below provides a comparative discussion of our consolidated financial performance for 2022 and 2021. We provide a discussion of our business segment results in the following section, “Business Segment Financial Performance.” This section should be read together with our “Executive Summary,” where we discuss trends and other factors that we expect will affect our future results of operations.
Net Interest Income
Net interest income represents the difference between interest income, including certain fees, earned on our interest-earning assets and the interest expense incurred on our interest-bearing liabilities. Our interest-earning assets include loans, investment securities and other interest-earning assets, while our interest-bearing liabilities include interest-bearing deposits, securitized debt obligations, senior and subordinated notes, other borrowings and other interest-bearing liabilities. Generally, we include in interest income any past due fees, net of reversals, on loans that we deem collectible. Our net interest margin, based on our consolidated results, represents the difference between the yield on our interest-earning assets and the cost of our interest-bearing liabilities, including the notional impact of non-interest-bearing funding. We expect net interest income and our net interest margin to fluctuate based on changes in interest rates and changes in the amount and composition of our interest-earning assets and interest-bearing liabilities.
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Table 1 below presents the average outstanding balance, interest income earned, interest expense incurred and average yield for 2022, 2021 and 2020 for each major category of our interest-earning assets and interest-bearing liabilities. Nonperforming loans are included in the average loan balances below.
Table 1: Average Balances, Net Interest Income and Net Interest Margin
Year Ended December 31,
Assets:
Interest-earning assets:
Loans:(2)
Liabilities and stockholders’ equity:
Interest-bearing liabilities:
Impact of non-interest-bearing funding 0.24 0.10 0.18
__________
(1)Average yield is calculated based on interest income for the period divided by average loans during the period. Interest income does not include any allocations, such as funds transfer pricing. Average yield is calculated using whole dollar values for average balances and interest income/expense.
(2)Past due fees, net of reversals, included in interest income totaled approximately $1.9 billion in 2022, $1.4 billion in 2021 and $1.3 billion in 2020.
(3)Some of our commercial investments generate tax-exempt income, tax credits or other tax benefits. Accordingly, we present our Commercial Banking revenue and yields on a taxable-equivalent basis, calculated using the federal statutory tax rate of 21% and state taxes where applicable, with offsetting reductions to the Other category. Taxable-equivalent adjustments included in the interest income and yield computations for our commercial loans totaled approximately $74 million in both 2022 and 2021, and $81 million in 2020, with corresponding reductions to the Other category.
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(4)Interest income/expense in the Other category represents the impact of hedge accounting on our loan portfolios and the offsetting reduction of the taxable-equivalent adjustments of our commercial loans as described above.
** Not meaningful.
Net interest income increased by $2.9 billion to $27.1 billion in 2022 compared to 2021 primarily driven by higher average loan balances in our credit card loan portfolio.
Net interest margin increased by 46 basis points to 6.67% in 2022 compared to 2021 primarily driven by growth in our credit card loan portfolio relative to the movement in other interest-earning assets, partially offset by higher rates paid on interest-bearing liabilities.
Table 2 displays the change in our net interest income between periods and the extent to which the variance is attributable to:
•changes in the volume of our interest-earning assets and interest-bearing liabilities; or
•changes in the interest rates related to these assets and liabilities.
Table 2: Rate/Volume Analysis of Net Interest Income(1)
(Dollars in millions) Total Variance Volume Rate Total Variance Volume Rate
Interest income:
Loans:
Cash equivalents and other interest-earning assets 383 (20) 403 (22) (6) (16)
Interest expense:
Other borrowings and liabilities 95 92 3 (9) (9) —
__________
(1)We calculate the change in interest income and interest expense separately for each item. The portion of interest income or interest expense attributable to both volume and rate is allocated proportionately when the calculation results in a positive value. When the portion of interest income or interest expense attributable to both volume and rate results in a negative value, the total amount is allocated to volume or rate, depending on which amount is positive.
(2)Some of our commercial investments generate tax-exempt income, tax credits or other tax benefits. Accordingly, we present our Commercial Banking revenue and yields on a taxable-equivalent basis, calculated using the federal statutory tax rate of 21% and state taxes where applicable, with offsetting reductions to the Other category.
(3)Interest income/expense in the Other category represents the impact of hedge accounting on our loan portfolios and the offsetting reduction of the taxable-equivalent adjustments of our commercial loans as described above.
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Non-Interest Income
Table 3 displays the components of non-interest income for 2022, 2021 and 2020.
Table 3: Non-Interest Income
Year Ended December 31,
Service charges and other customer-related fees 1,625 1,578 1,243
Other non-interest income:(1)
Treasury and other investment income 51 151 701
________
(1)Includes a loss of $78 million and gains of $69 million and $45 million on deferred compensation plan investments for 2022, 2021 and 2020, respectively. These amounts have corresponding offsets in non-interest expense.
(2)Primarily consists of revenue from Capital One Shopping, our credit card partnership agreements and gains or losses on loan sales. In 2022, the gain on sale of card partnership loan portfolios was $192 million.
Non-interest income increased by $872 million to $7.1 billion in 2022 compared to 2021 primarily driven by higher net interchange fees due to an increase in purchase volume in our Credit Card business.
Provision for Credit Losses
Our provision for credit losses in each period is driven by net charge-offs, changes to the allowance for credit losses and changes to the reserve for unfunded lending commitments. We recorded a provision for credit losses of $5.8 billion in 2022, $(1.9) billion in 2021 and $10.3 billion in 2020.
Our provision for credit losses increased by $7.8 billion to $5.8 billion in 2022 compared to 2021 primarily driven by a net allowance build across all of our segments due to credit normalization, a modestly worse economic outlook and loan growth, compared to a net allowance release across all of our segments in 2021.
We provide additional information on the provision for credit losses and changes in the allowance for credit losses within “Credit Risk Profile” and “Part II—Item 8. Financial Statements and Supplementary Data—Note 4—Allowance for Credit Losses and Reserve for Unfunded Lending Commitments.” For information on the allowance methodology for each of our loan categories, see “Part II—Item 8. Financial Statements and Supplementary Data—Note 1—Summary of Significant Accounting Policies.”
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Non-Interest Expense
Table 4 displays the components of non-interest expense for 2022, 2021 and 2020.
Table 4: Non-Interest Expense
Year Ended December 31,
Operating Expense:
Amortization of intangibles 70 29 60
Other non-interest expense:
Bankcard, regulatory and other fee assessments 264 199 267
_________
(1)Includes a benefit of$78 million and expenses of $69 million and $45 million related to our deferred compensation plan investments for 2022, 2021 and 2020, respectively. These amounts have corresponding offsets from investments in other non-interest income.
Non-interest expense increased by $2.6 billion to $19.2 billion in the year ended 2022 compared to 2021, primarily driven by increased marketing spend and increased salaries and associate benefits due to increased employee headcount and continued investment in technology.
Income Taxes
We recorded an income tax provision of $1.9 billion (20.3% effective income tax rate), $3.4 billion (21.6% effective income tax rate), and $486 million (15.2% effective income tax rate) in 2022, 2021 and 2020, respectively. Our effective tax rate on income from continuing operations varies between periods due, in part, to the impact of changes in pre-tax income and changes in tax credits, tax-exempt income and non-deductible expenses relative to our pre-tax earnings.
Our effective income tax rate in 2022 decreased by 1.3% compared to 2021. We recorded discrete tax benefits of $71 million in 2022, $66 million in 2021 and $22 million in 2020.
We provide additional information on items affecting our income taxes and effective tax rate in “Part II—Item 8. Financial Statements and Supplementary Data—Note 15—Income Taxes.”
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CONSOLIDATED BALANCE SHEETS ANALYSIS
Total assets increased by $22.9 billion to $455.2 billion as of December 31, 2022 from December 31, 2021 primarily driven by growth in our loan portfolios, partially offset by a decrease in our investment securities portfolio.
Total liabilities increased by $31.3 billion to $402.7 billion as of December 31, 2022 from December 31, 2021 primarily driven by deposit growth.
Stockholders’ equity decreased by $8.4 billion to $52.6 billion as of December 31, 2022 from December 31, 2021 primarily driven by a decrease in AOCI due to a decline in the fair value of our investment securities portfolio and our common stock repurchases, partially offset by net income of $7.4 billion.
The following is a discussion of material changes in the major components of our assets and liabilities during 2022. Period-end balance sheet amounts may vary from average balance sheet amounts due to liquidity and balance sheet management activities that are intended to support the adequacy of capital while managing our liquidity requirements, our customers and our market risk exposure in accordance with our risk appetite.
Investment Securities
Our investment securities portfolio consists of the following: U.S. government-sponsored enterprise or agency (“Agency”) and non-agency residential mortgage-backed securities (“RMBS”), agency commercial mortgage-backed securities (“CMBS”), U.S. Treasury securities and other securities. Agency securities include Government National Mortgage Association (“Ginnie Mae”) guaranteed securities, Federal National Mortgage Association (“Fannie Mae”) and Federal Home Loan Mortgage Corporation (“Freddie Mac”) issued securities. The carrying value of our investments in Agency and U.S. Treasury securities represented 97% and 96% of our total investment securities portfolio as of December 31, 2022 and 2021, respectively.
The fair value of our available for sale securities portfolio decreased by $18.3 billion to $76.9 billion as of December 31, 2022 from December 31, 2021, driven by increases in interest rates and credit spreads, lower reinvestment rates of principal paydowns, and sales. See “Part II—Item 8. Financial Statements and Supplementary Data—Note 2—Investment Securities” for more information.
Loans Held for Investment
Total loans held for investment consists of both unsecuritized loans and loans held in our consolidated trusts. Table 5 summarizes, by portfolio segment, the carrying value of our loans held for investment, the allowance for credit losses and net loan balance as of December 31, 2022 and 2021.
Table 5: Loans Held for Investment
(Dollars in millions) Loans Allowance Net Loans Loans Allowance Net Loans
Loans held for investment increased by $35.0 billion to $312.3 billion as of December 31, 2022 from December 31, 2021 primarily driven by growth across all of our segments.
We provide additional information on the composition of our loan portfolio and credit quality in “Credit Risk Profile,” “Consolidated Results of Operations” and “Part II—Item 8. Financial Statements and Supplementary Data—Note 3—Loans.”
Funding Sources
Our primary source of funding comes from deposits, as they are a stable and relatively low cost source of funding. In addition to deposits, we raise funding through the issuance of senior and subordinated notes, securitized debt obligations, federal funds
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purchased, securities loaned or sold under agreements to repurchase, and FHLB advances secured by certain portions of our loan and securities portfolios.
Table 6 provides the composition of our primary sources of funding as of December 31, 2022 and 2021.
Table 6: Funding Sources Composition
(Dollars in millions) Amount % of Total Amount % of Total
Deposits:
__________
(1)Includes brokered deposits of $20.6 billion and $8.6 billion as of December 31, 2022 and 2021, respectively.
Total deposits increased by $22.0 billion to $333.0 billion as of December 31, 2022 from December 31, 2021 primarily driven by our national banking strategy and issuances of brokered deposits.
Securitized debt obligations increased by $2.0 billion to $17.0 billion as of December 31, 2022 from December 31, 2021 primarily driven by net issuances in our auto and credit card securitization programs.
Other debt increased by $3.7 billion to $31.7 billion as of December 31, 2022 from December 31, 2021 primarily driven by net issuances of senior debt.
We provide additional information on our funding sources in “Liquidity Risk Profile” and “Part II—Item 8. Financial Statements and Supplementary Data—Note 8—Deposits and Borrowings.”
Deferred Tax Assets and Liabilities
Deferred tax assets and liabilities represent decreases or increases in taxes expected to be paid in the future because of future reversals of temporary differences between the financial reporting and tax bases of assets and liabilities, as well as from net operating loss and tax credit carryforwards. Deferred tax assets are recognized subject to management’s judgment that these future deductions are more likely than not to be realized. We evaluate the recoverability of these future tax deductions by assessing the adequacy of expected taxable income from all sources, including taxable income in carryback years, reversal of taxable temporary differences, forecasted operating earnings and available tax planning strategies. These sources of income rely heavily on estimates. We use our historical experience and our short and long-range business forecasts to make these estimates.
Deferred tax assets, net of deferred tax liabilities and valuation allowances, were approximately $7.7 billion as of December 31, 2022, an increase of $4.0 billion from December 31, 2021. The increase in our net deferred tax assets was primarily driven by the decrease in fair value of our available for sale securities and derivatives, as well as the increase in allowance for credit losses in 2022.
We recorded valuation allowances of $446 million and $355 million as of December 31, 2022 and 2021, respectively. If changes in circumstances lead us to change our judgment about our ability to realize deferred tax assets in future years, we will adjust our valuation allowances in the period that our change in judgment occurs and record a corresponding increase or charge to income.
We provide additional information on income taxes in “Consolidated Results of Operations” and “Part II—Item 8. Financial Statements and Supplementary Data—Note 15—Income Taxes.”
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OFF-BALANCE SHEET ARRANGEMENTS
In the ordinary course of business, we engage in certain activities that are not reflected on our consolidated balance sheets, generally referred to as off-balance sheet arrangements. These activities typically involve transactions with unconsolidated variable interest entities (“VIEs”) as well as other arrangements, such as letters of credit, loan commitments and guarantees, to meet the financing needs of our customers and support their ongoing operations. We provide additional information regarding these types of activities in “Part II—Item 8. Financial Statements and Supplementary Data—Note 5—Variable Interest Entities and Securitizations” and “Part II—Item 8. Financial Statements and Supplementary Data—Note 18—Commitments, Contingencies, Guarantees and Others.”
BUSINESS SEGMENT FINANCIAL PERFORMANCE
Our principal operations are organized for management reporting purposes into three major business segments, which are defined primarily based on the products and services provided or the types of customer served: Credit Card, Consumer Banking and Commercial Banking. The operations of acquired businesses have been integrated into or managed as a part of our existing business segments. Certain activities that are not part of a segment, such as management of our corporate investment portfolio, asset/liability management and oversight of our funds transfer pricing process, are centralized in our Corporate Treasury group. Our residual tax expense or benefit to arrive at the consolidated effective tax rate that is not assessed to our primary business segments is included in the Other category.
The results of our individual businesses, which we report on a continuing operations basis, reflect the manner in which management evaluates performance and makes decisions about funding our operations and allocating resources. We may periodically change our business segments or reclassify business segment results based on modifications to our management reporting methodologies and changes in organizational alignment. Our business segment results are intended to reflect each segment as if it were a stand-alone business. We use an internal management and reporting process to derive our business segment results. Our internal management and reporting process employs various allocation methodologies, including funds transfer pricing, to assign certain balance sheet assets, deposits and other liabilities and their related revenue and expenses directly or indirectly attributable to each business segment. Total interest income and non-interest income are directly attributable to the segment in which they are reported. The net interest income of each segment reflects the results of our funds transfer pricing process, which is primarily based on a matched funding concept that takes into consideration market interest rates. Our funds transfer pricing process is managed by our centralized Corporate Treasury group and provides a funds credit for sources of funds, such as deposits generated by our Consumer Banking and Commercial Banking businesses, and a charge for the use of funds by each segment. The allocation is unique to each business segment and acquired business and is based on the composition of assets and liabilities. The funds transfer pricing process considers the interest rate and liquidity risk characteristics of assets and liabilities and off-balance sheet products. Periodically, the methodology and assumptions utilized in the funds transfer pricing process are adjusted to reflect economic conditions and other factors, which may impact the allocation of net interest income to the business segments. We regularly assess the assumptions, methodologies and reporting classifications used for segment reporting, which may result in the implementation of refinements or changes in future periods.
We refer to the business segment results derived from our internal management accounting and reporting process as our “managed” presentation, which differs in some cases from our reported results prepared based on U.S. GAAP. There is no comprehensive authoritative body of guidance for management accounting equivalent to U.S. GAAP; therefore, the managed presentation of our business segment results may not be comparable to similar information provided by other financial services companies. In addition, our individual business segment results should not be used as a substitute for comparable results determined in accordance with U.S. GAAP.
We summarize our business segment results for the years ended December 31, 2022, 2021 and 2020 and provide a comparative discussion of these results for 2022 and 2021, as well as changes in our financial condition and credit performance metrics as of December 31, 2022 compared to December 31, 2021. We provide a reconciliation of our total business segment results to our reported consolidated results in “Part II—Item 8. Financial Statements and Supplementary Data—Note 17—Business Segments and Revenue from Contracts with Customers.”
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Business Segment Financial Performance
Table 7 summarizes our business segment results, which we report based on revenue (loss) and income (loss) from continuing operations, for the years ended December 31, 2022, 2021 and 2020. We provide information on the allocation methodologies used to derive our business segment results in “Part II—Item 8. Financial Statements and Supplementary Data—Note 17—Business Segments and Revenue from Contracts with Customers.”
Table 7: Business Segment Results
Year Ended December 31,
__________
(1)Total net revenue (loss) consists of net interest income and non-interest income.
(2)Net income (loss) for our business segments and the Other category is based on income (loss) from continuing operations, net of tax.
(3)Some of our commercial investments generate tax-exempt income, tax credits or other tax benefits. Accordingly, we present our Commercial Banking revenue and yields on a taxable-equivalent basis, calculated using the federal statutory tax rate of 21% and state taxes where applicable, with offsetting reductions to the Other category.
Credit Card Business
The primary sources of revenue for our Credit Card business are net interest income, net interchange income and fees collected from customers. Expenses primarily consist of the provision for credit losses, operating costs and marketing expenses.
Our Credit Card business generated net income from continuing operations of $4.9 billion, $7.8 billion and $1.4 billion in 2022, 2021 and 2020, respectively.
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Table 8 summarizes the financial results of our Credit Card business and displays selected key metrics for the periods indicated.
Table 8: Credit Card Business Results
Year Ended December 31, Change
Selected income statement data:
Provision (benefit) for credit losses 4,265 (902) 7,327 ** **
Income from continuing operations before income taxes 6,463 10,161 1,781 (36) **
Income from continuing operations, net of tax $ 4,927 $ 7,758 $ 1,361 (36) **
Selected performance metrics:
Selected period-end data:
30+ day performing delinquency rate 3.46 % 2.28 % 118bps
Nonperforming loan rate(4) 0.01 0.01 —
Allowance coverage ratio 6.93 % 7.27 % (34)bps
__________
(1)We recognize finance charges and fee income on open-ended loans in accordance with the contractual provisions of the credit arrangements and charge off any uncollectible amounts. Total net revenue was reduced by $946 million, $629 million and $1.1 billion in 2022, 2021 and 2020, respectively, for finance charges and fees charged-off as uncollectible.
(2)Average yield is calculated based on interest income for the period divided by average loans during the period and does not include any allocations, such as funds transfer pricing.
(3)Total net revenue margin is calculated based on total net revenue for the period divided by average loans during the period.
(4)Within our credit card loan portfolio, only certain loans in our international card businesses are classified as nonperforming. See “Nonperforming Loans and Other Nonperforming Assets” for additional information.
** Not meaningful.
Key factors affecting the results of our Credit Card business for 2022 compared to 2021, and changes in financial condition and credit performance between December 31, 2022 and 2021 include the following:
•Net Interest Income: Net interest income increased by $2.5 billion to $16.6 billion in 2022 primarily driven by higher average loan balances.
•Non-Interest Income: Non-interest income increased by $965 million to $5.8 billion in 2022 primarily driven by higher net interchange fees due to an increase in purchase volume.
•Provision for Credit Losses: Provision for credit losses increased by $5.2 billion to $4.3 billion in 2022 primarily driven by a net allowance build due to credit normalization, a modestly worse economic outlook and loan growth, compared to a net allowance release in 2021.
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•Non-Interest Expense: Non-interest expense increased by $2.0 billion to $11.6 billion in 2022 primarily driven by increased marketing spend, as well as continued investment in technology.
Loans Held for Investment:
•Period-end loans held for investment increased by $23.0 billion to $137.7 billion as of December 31, 2022 from December 31, 2021 and average loans held for investment increased by $17.7 billion to $120.4 billion in 2022 compared to 2021 primarily driven by continued strength in purchase volume, which outpaced customer payments.
Net Charge-Off and Delinquency Metrics:
•The net charge-off rate increased by 63 basis points to 2.53% in 2022 compared to 2021 primarily driven by continued credit normalization.
•The 30+ day delinquency rate increased by 117 basis points to 3.46% as of December 31, 2022 from December 31, 2021 primarily driven by continued credit normalization.
Domestic Card Business
The Domestic Card business generated net income from continuing operations of $4.7 billion, $7.3 billion and $1.2 billion in 2022, 2021 and 2020, respectively. In 2022, 2021 and 2020, the Domestic Card business accounted for greater than 90% of total net revenue of our Credit Card business.
Table 8.1 summarizes the financial results for Domestic Card business and displays selected key metrics for the periods indicated.
Table 8.1: Domestic Card Business Results
Year Ended December 31, Change
Selected income statement data:
Provision (benefit) for credit losses 4,020 (868) 6,979 ** **
Income from continuing operations before income taxes 6,132 9,604 1,578 (36) **
Income from continuing operations, net of tax $ 4,679 $ 7,338 $ 1,204 (36) **
Selected performance metrics:
Selected period-end data:
30+ day performing delinquency rate 3.43 % 2.22 % 121bps
Allowance coverage ratio 6.97 % 7.33 % (36)bps
__________
(1)We recognize finance charges and fee income on open-ended loans in accordance with the contractual provisions of the credit arrangements and charge off any uncollectible amounts. Finance charges and fees charged off as uncollectible are reflected as a reduction in total net revenue.
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(2)Average yield is calculated based on interest income for the period divided by average loans during the period and does not include any allocations, such as funds transfer pricing.
(3)Total net revenue margin is calculated based on total net revenue for the period divided by average loans during the period.
** Not meaningful.
Because our Domestic Card business accounts for the substantial majority of our Credit Card business, the key factors driving the results are similar to the key factors affecting our total Credit Card business. Net income for our Domestic Card business decreased in 2022 compared to 2021 primarily driven by:
•Higher provision for credit losses primarily driven by a net allowance build due to credit normalization, a modestly worse economic outlook and loan growth, compared to a net allowance release in 2021.
•Higher non-interest expense primarily driven by increased marketing spend, as well as continued investment in technology.
These drivers were partially offset by:
•Higher net interest income primarily driven by higher average loan balances.
•Higher non-interest income primarily driven by higher net interchange fees due to an increase in purchase volume.
Consumer Banking Business
The primary sources of revenue for our Consumer Banking business are net interest income from loans and deposits. Expenses primarily consist of the provision for credit losses, operating costs and marketing expenses.
Our Consumer Banking business generated net income from continuing operations of $2.3 billion, $3.7 billion and $1.4 billion in 2022, 2021 and 2020, respectively.
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Table 9 summarizes the financial results of our Consumer Banking business and displays selected key metrics for the periods indicated.
Table 9: Consumer Banking Business Results
Year Ended December 31, Change
Selected income statement data:
Provision (benefit) for credit losses 1,173 (521) 1,753 ** **
Selected performance metrics:
Average loans held for investment:
Average deposits interest rate 0.72 % 0.32 % 0.76 % 40bps (44) bps
Selected period-end data:
Loans held for investment:
30+ day performing delinquency rate 5.53 % 4.26 % 127bps
Allowance coverage ratio 2.80 % 2.47 % 33bps
__________
(1)Average yield is calculated based on interest income for the period divided by average loans during the period and does not include any allocations, such as funds transfer pricing.
(2)Nonperforming assets primarily consist of nonperforming loans and repossessed assets. The total nonperforming asset rate is calculated based on total nonperforming assets divided by the combined period-end total loans held for investment and repossessed assets.
** Not meaningful.
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Key factors affecting the results of our Consumer Banking business for 2022 compared to 2021, and changes in financial condition and credit performance between December 31, 2022 and 2021 include the following:
•Net Interest Income: Net interest income increased by $517 million to $9.0 billion in 2022 primarily driven by higher margins in our retail banking business due to the increases in interest rates, partially offset by lower margins in our auto business.
•Non-Interest Income: Non-interest income decreased by $85 million to $469 million in 2022 primarily driven by changes to our customer overdraft and non-sufficient funds policies in our retail banking business.
•Provision for Credit Losses: Provision for credit losses increased by $1.7 billion to $1.2 billion in 2022 primarily driven by a net allowance build due to credit normalization, a modestly worse economic outlook and loan growth, compared to a net allowance release in 2021.
•Non-Interest Expense: Non-interest expense increased by $601 million to $5.3 billion in 2022 primarily driven by continued investment in technology and increased marketing spend in our retail banking business.
Loans Held for Investment:
•Period-end loans held for investment increased by $2.3 billion to $79.9 billion as of December 31, 2022 from December 31, 2021 and average loans held for investment increased by $6.6 billion to $80.4 billion in 2022 compared to 2021 primarily driven by growth in our auto loan portfolio.
Deposits:
•Period-end deposits increased by $14.2 billion at $270.6 billion as of December 31, 2022 from December 31, 2021 primarily driven by our national banking strategy.
Net Charge-Off and Delinquency Metrics:
•The net charge-off rate increased by 69 basis points to 1.06% in 2022 compared to 2021 primarily driven by continued credit normalization in our auto loan portfolio.
•The 30+ day delinquency rate increased by 152 basis points to 6.18% as of December 31, 2022 from December 31, 2021 primarily driven by continued credit normalization in our auto loan portfolio.
Commercial Banking Business
The primary sources of revenue for our Commercial Banking business are net interest income from loans and deposits and non-interest income earned from products and services provided to our clients such as advisory services, capital markets and treasury management. Because our Commercial Banking business has loans and investments that generate tax-exempt income, tax credits or other tax benefits, we present the revenues on a taxable-equivalent basis. Expenses primarily consist of the provision for credit losses and operating costs.
Our Commercial Banking business generated net income from continuing operations of $843 million, $1.5 billion and $65 million in 2022, 2021 and 2020, respectively.
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Table 10 summarizes the financial results of our Commercial Banking business and displays selected key metrics for the periods indicated.
Table 10: Commercial Banking Business Results
Year Ended December 31, Change
Selected income statement data:
Provision (benefit) for credit losses(2) 415 (519) 1,181 ** **
Income from continuing operations before income taxes 1,105 2,005 84 (45) **
Income from continuing operations, net of tax $ 843 $ 1,532 $ 65 (45) **
Selected performance metrics:
Average loans held for investment:
Average deposits interest rate 0.73 % 0.14 % 0.40 % 59bps (26) bps
Net charge-off (recovery) rate 0.08 % — 0.49 % 8bps (49) bps
Selected period-end data:
Loans held for investment:
Commercial and multifamily real estate $ 37,453 $ 35,262 6%
Nonperforming loan rate 0.74 % 0.82 % (8) bps
Nonperforming asset rate(4) 0.74 0.82 (8)
Allowance coverage ratio 1.54% 1.37% 17bps
__________
(1)Some of our commercial investments generate tax-exempt income, tax credits or other tax benefits. Accordingly, we present our Commercial Banking revenue and yields on a taxable-equivalent basis, calculated using the federal statutory tax rate of 21% and state taxes where applicable, with offsetting reductions to the Other category.
(2)The provision for losses on unfunded lending commitments is included in the provision for credit losses in our consolidated statements of income and the related reserve is included in other liabilities on our consolidated balance sheets. Our reserve for unfunded lending commitments totaled $218 million, $165 million and $195 million as of December 31, 2022, 2021 and 2020, respectively.
(3)Average yield is calculated based on interest income for the period divided by average loans during the period and does not include any allocations, such as funds transfer pricing.
(4)Nonperforming assets consist of nonperforming loans and other foreclosed assets. The total nonperforming asset rate is calculated based on total nonperforming assets divided by the combined period-end total loans held for investment and other foreclosed assets.
** Not meaningful.
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Key factors affecting the results of our Commercial Banking business for 2022 compared to 2021, and changes in financial condition and credit performance between December 31, 2022 and 2021 include the following:
•Net Interest Income: Net interest income increased by $308 million to $2.5 billion in 2022 primarily driven by higher average loan balances and yields, partially offset by higher funding costs driven by higher market interest rates and mix of deposits.
•Non-Interest Income: Non-interest income remained substantially flat at $1.1 billion in 2022.
•Provision for Credit Losses: Provision for credit losses increased by $934 million to $415 million in 2022 primarily driven by a net allowance build due to a modestly worse economic outlook and loan growth, compared to a net allowance release in 2021.
•Non-Interest Expense: Non-interest expense increased by $255 million to $2.1 billion in 2022 primarily driven by continued investment in growth and technology.
Loans Held for Investment:
•Period-end loans held for investment increased by $9.8 billion to $94.7 billion as of December 31, 2022 from December 31, 2021 and average loans held for investment increased by $15.3 billion to $91.4 billion in 2022 compared to 2021 primarily driven by growth across our loan portfolio.
Deposits:
•Period-end deposits decreased by $4.0 billion to $40.8 billion as of December 31, 2022 from December 31, 2021 primarily driven by the transfer of deposits to our retail banking portfolio in the second quarter of 2022.
Net Charge-Off and Nonperforming Metrics:
•The net charge-off rate increased by 8 basis points to 0.08% in 2022 primarily driven by isolated charge offs in our commercial and industrial loan portfolio.
•The nonperforming loan rate decreased by 8 basis points to 0.74% as of December 31, 2022 compared to December 31, 2021 primarily driven by higher ending loan balances.
Other Category
Other includes unallocated amounts related to our centralized Corporate Treasury group activities, such as management of our corporate investment securities portfolio, asset/liability management and oversight of our funds transfer pricing process. Other also includes:
•unallocated corporate revenue and expenses that do not directly support the operations of the business segments or for which the business segments are not considered financially accountable in evaluating their performance, such as certain restructuring charges;
•offsets related to certain line-item reclassifications;
•residual tax expense or benefit to arrive at the consolidated effective tax rate that is not assessed to our primary business segments; and
•foreign exchange-rate fluctuations on foreign currency-denominated balances.
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Table 11 summarizes the financial results of our Other category for the periods indicated.
Table 11: Other Category Results
Year Ended December 31, Change
Selected income statement data:
Provision (benefit) for credit losses (6) (2) 3 ** **
Loss from continuing operations before income taxes (1,277) (1,169) (454) 9 157
Loss from continuing operations, net of tax $ (660) $ (572) $ (76) 15 **
__________
(1)Some of our commercial investments generate tax-exempt income, tax credits or other tax benefits. Accordingly, we present our Commercial Banking revenue and yields on a taxable-equivalent basis, calculated using the federal statutory tax rate of 21% and state taxes where applicable, with offsetting reductions to the Other category.
** Not meaningful.
Loss from continuing operations increased by $88 million to a loss of $660 million in 2022 compared to 2021 primarily driven by higher net interest losses due to higher funding costs driven by higher market interest rates, partially offset by insurance recoveries on previously incurred expenses in non-interest expense.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements in accordance with U.S. GAAP requires management to make a number of judgments, estimates and assumptions that affect the amount of assets, liabilities, income and expenses on the consolidated financial statements. Understanding our accounting policies and the extent to which we use management judgment and estimates in applying these policies is integral to understanding our financial statements. We provide a summary of our significant accounting policies under “Part II—Item 8. Financial Statements and Supplementary Data—Note 1—Summary of Significant Accounting Policies.”
We have identified the following accounting estimates as critical because they require significant judgments and assumptions about highly complex and inherently uncertain matters and the use of reasonably different estimates and assumptions could have a material impact on our results of operations or financial condition. Our critical accounting policies and estimates are as follows:
•Loan loss reserves
•Goodwill
•Fair value
•Customer rewards reserve
We evaluate our critical accounting estimates and judgments on an ongoing basis and update them as necessary, based on changing conditions.
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Loan Loss Reserves
We maintain an allowance for credit losses that represents management’s current estimate of expected credit losses inherent in our credit card, consumer banking and commercial banking loans held for investment portfolios as of each balance sheet date. We also reserve for the uncollectible portion of finance charges and fees related to credit card loan receivables in the allowance for credit losses consistent with the methodology we use to estimate the allowance for credit losses on the principal portion of our credit card loan receivables. We also separately reserve for unfunded lending commitments that are not unconditionally cancellable. We build our allowance for credit losses and reserve for unfunded lending commitments through the provision for credit losses, which is driven by charge-offs, changes in the allowance for credit losses and changes in the reserve for unfunded lending commitments. The allowance for credit losses was $13.2 billion as of December 31, 2022, compared to $11.4 billion as of December 31, 2021.
Our allowance for credit losses and reserve for unfunded lending commitments utilize models to derive a quantitative estimate of credit losses that is supplemented with additional qualitative considerations to capture risks and uncertainties not included in the quantitative result. Our estimate of expected credit losses, for all loan and unfunded lending commitments, includes a reasonable and supportable forecast period of one year and then reverts over a one-year period to historical losses at each relevant loss component of the estimate. We use externally produced consensus estimates as inputs for our forward-looking macroeconomic forecast and consider other forecasts and sources of uncertainty to develop the quantitative component. This quantitative result is then supplemented qualitatively by management for economic uncertainty, including the consideration of alternative macroeconomic scenarios, changes and trends in loan portfolios that may not be captured in the quantitative component. These adjustments represent management’s judgment of the imprecision and risks inherent in the processes and assumptions used in establishing the allowance for credit losses.
We have an established process, using analytical tools and management judgment, to determine our allowance for credit losses. Significant management judgment is required to determine the relevant information and estimation methods used to arrive at our best estimate of lifetime credit losses. Establishing the allowance on a quarterly basis involves evaluating and forecasting both credit and macroeconomic variables. The macroeconomic forecast used to inform both quantitative and qualitative components of our allowance for credit losses estimate is sensitive to variables that may impact borrowers’ ability to pay, such as the U.S. Unemployment Rate, and the U.S. Real Gross Domestic Product (“U.S. Real GDP”) Rate assumptions. Our December 31, 2022 allowance assumes that the average unemployment rate gradually increases to approximately 5.0% by the fourth quarter of 2023 and annualized U.S. Real GDP decreases 0.3% in 2023.
In addition to macroeconomic factors, many credit factors inform our allowance for credit losses, including, but not limited to, historical loss and recovery experience, recent trends in delinquencies and charge-offs, risk ratings, the impact of bankruptcy filings, the value of collateral underlying secured loans, account seasoning, changes in our credit evaluation, underwriting and collection management policies, seasonality, credit bureau scores, current general economic conditions, changes in the legal and regulatory environment and uncertainties in forecasting and modeling techniques used in estimating our allowance for credit losses.
We have a governance framework supported by processes and controls intended to ensure that our estimate of the allowance for credit losses is appropriate. Our governance framework provides for oversight of methods, models, qualitative adjustments, process controls and results. At least quarterly, representatives from the Finance and Risk Management organizations review and assess our allowance methodologies, key assumptions and the appropriateness of the allowance for credit losses. Groups independent of our estimation functions participate in the review and validation process. Tasks performed by these groups include periodic review of the rationale for and quantification of inputs requiring judgment as well as adjustments to results.
We have a model policy, established by an independent Model Risk Office, which governs the validation of models and related supporting documentation to ensure the appropriate use of models for estimating credit losses. The Model Risk Office validates all models and requires ongoing monitoring of their performance.
In addition to the allowance for credit losses, on a quarterly basis, we review and assess our estimate of expected losses related to unfunded lending commitments that are not unconditionally cancellable which are generally in our Commercial Banking business. The factors impacting our assessment generally align with those considered in our evaluation of the allowance for credit losses for the Commercial Banking business. The reserve for losses on unfunded lending commitments is included in other liabilities on the consolidated balance sheets and changes to it are recorded through the provision for credit losses in the consolidated statements of income.
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Although we examine a variety of externally available data, as well as our internal loan performance data, to determine our allowance for credit losses and reserve for unfunded lending commitments, our estimation process is subject to risks and uncertainties, including a reliance on historical loss and trend information that may not be representative of current conditions and indicative of future performance as well as economic forecasts that may not align with actual future economic conditions. Accordingly, our actual credit loss experience may not be in line with our expectations. We provide additional information on the methodologies and key assumptions used in determining our allowance for credit losses for each of our loan portfolio segments in “Part II—Item 8. Financial Statements and Supplementary Data—Note 1—Summary of Significant Accounting Policies.” We provide information on the components of our allowance, disaggregated by operating segment, and changes in our allowance in “Part II—Item 8. Financial Statements and Supplementary Data—Note 4—Allowance for Credit Losses and Reserve for Unfunded Lending Commitments.”
Goodwill
Goodwill represents the excess of the fair value of the consideration transferred, plus the fair value of any non-controlling interests in the acquiree, over the fair value of the net assets acquired and liabilities assumed as of the acquisition date.
Goodwill totaled $14.8 billion as of both December 31, 2022 and 2021. We did not recognize any goodwill impairment in 2022 or 2021. See “Part II—Item 8. Financial Statements and Supplementary Data—Note 6—Goodwill and Other Intangible Assets” for additional information.
We perform our goodwill impairment test annually on October 1 at a reporting unit level. We are also required to test goodwill for impairment whenever events or circumstances indicate it is more-likely-than-not that an impairment may have occurred. An impairment of a reporting unit’s goodwill is determined based on the amount by which the reporting unit’s carrying value exceeds its fair value, limited to the amount of goodwill allocated to the reporting unit. We have four reporting units: Credit Card, Auto Finance, Other Consumer Banking and Commercial Banking.
For the purpose of our goodwill impairment testing, we calculate the carrying amount of a reporting unit using an allocated capital approach based on each reporting unit’s specific regulatory capital requirements, economic capital requirements and underlying risks. The carrying amount for a reporting unit is the sum of its respective capital requirements, goodwill and other intangibles balances. Known future capital needs, such as dividends, share buybacks or other strategic initiatives, are assumed distributed to equity holders in future periods and are not allocated to the reporting units or the Other category.
Determining the fair value of a reporting unit is a subjective process that requires the use of estimates and the exercise of significant judgment. We calculate the fair value of our reporting units using a discounted cash flow (“DCF”) calculation, a form of the income approach. This DCF calculation uses projected cash flows based on each reporting unit’s internal forecast and the perpetuity growth method to calculate terminal values. Our DCF calculation requires management to make estimates about future loan, deposit and revenue growth, as well as credit losses and capital rates. These cash flows and terminal values are then discounted using discount rates based on our external cost of capital with adjustments for the risk inherent in each reporting unit. Discount rates used for our reporting units ranged from 8.4% to 12.2%, and we applied a terminal year long-term growth rate of 3.7% to all reporting units. The reasonableness of our DCF calculation is assessed by reference to a market-based approach using comparable market multiples and recent market transactions where available. The results of the 2022 annual impairment test for the reporting units indicated that the estimated fair values of the Commercial Banking, Credit Card, Auto Finance, and Other Consumer Banking reporting units exceeded their carrying amounts by between 17% and 72%.
Assumptions used in estimating the fair value of a reporting unit are judgmental and inherently uncertain. A change in the economic conditions of a reporting unit, such as declines in business performance as a result of industry or macroeconomic trends or changes in our strategy, adverse impacts to loan or deposit growth trends, decreases in revenue, increases in expenses, increases in credit losses, increases in capital requirements, deterioration of market conditions, declines in long-term growth expectations, adverse impacts of regulatory or legislative changes or increases in the estimated cost of capital, including if these conditions are merely forecasted to occur in future periods, could cause the estimated fair values of our reporting units to decline in the future, and increase the risk of a goodwill impairment in a future period.
We have a governance framework supported by processes and controls intended to ensure that the accounting and disclosure for goodwill is appropriate. Our governance framework provides for oversight of assumptions, forecast inputs, methods, process controls and results.
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Fair Value
Fair value, also referred to as an exit price, is defined as the price that would be received for an asset or paid to transfer a liability in an orderly transaction between market participants on the measurement date. The fair value accounting guidance provides a three-level fair value hierarchy for classifying financial instruments. This hierarchy is based on the markets in which the assets or liabilities trade and whether the inputs to the valuation techniques used to measure fair value are observable or unobservable. The fair value measurement of a financial asset or liability is assigned a level based on the lowest level of any input that is significant to the fair value measurement in its entirety. The three levels of the fair value hierarchy are described below:
Level 1: Valuation is based on quoted prices (unadjusted) in active markets for identical assets or liabilities.
Level 2: Valuation is based on observable market-based inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3: Valuation is generated from techniques that use significant assumptions not observable in the market. Valuation techniques include pricing models, discounted cash flow methodologies or similar techniques.
The degree of management judgment involved in determining the fair value of a financial instrument is dependent upon the availability of quoted prices in active markets or observable market parameters. When quoted prices and observable data in active markets are not fully available, management judgment is necessary to estimate fair value. Changes in market conditions, such as reduced liquidity in the capital markets or changes in secondary market activities, may reduce the availability and reliability of quoted prices or observable data used to determine fair value.
We have developed policies and procedures to determine when markets for our financial assets and liabilities are inactive if the level and volume of activity has declined significantly relative to normal conditions. If markets are determined to be inactive, it may be appropriate to adjust price quotes received. When significant adjustments are required to price quotes or inputs, it may be appropriate to utilize an estimate based primarily on unobservable inputs.
Significant judgment may be required to determine whether certain financial instruments measured at fair value are classified as Level 2 or Level 3. In making this determination, we consider all available information that market participants use to measure the fair value of the financial instrument, including observable market data, indications of market liquidity and orderliness, and our understanding of the valuation techniques and significant inputs used. Based upon the specific facts and circumstances of each instrument or instrument category, judgments are made regarding the significance of the Level 3 inputs to the instruments’ fair value measurement in its entirety. If Level 3 inputs are considered significant, the instrument is classified as Level 3. The process for determining fair value using unobservable inputs is generally more subjective and involves a high degree of management judgment and assumptions. We discuss changes in the valuation inputs and assumptions used in determining the fair value of our financial instruments, including the extent to which we have relied on significant unobservable inputs to estimate fair value and our process for corroborating these inputs, in “Part II—Item 8. Financial Statements and Supplementary Data—Note 16—Fair Value Measurement.”
We have a governance framework and a number of key controls that are intended to ensure that our fair value measurements are appropriate and reliable. Our governance framework provides for independent oversight and segregation of duties. Our control processes include review and approval of new transaction types, price verification, and review of valuation judgments, methods, models, process controls and results.
Groups independent of our trading and investing functions participate in the review and validation process. Tasks performed by these groups include periodic verification of fair value measurements to determine if assigned fair values are reasonable, including comparing prices from vendor pricing services to other available market information.
Our Fair Value Committee (“FVC”), which includes representation from business areas, Risk Management and Finance, provides guidance and oversight to ensure an appropriate valuation control environment. The FVC regularly reviews and approves our fair valuations to ensure that our valuation practices are consistent with industry standards and adhere to regulatory and accounting guidance.
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We have a model policy, established by an independent Model Risk Office, which governs the validation of models and related supporting documentation to ensure the appropriate use of models for pricing and fair value measurements. The Model Risk Office validates all models and requires ongoing monitoring of their performance.
The fair value governance process is set up in a manner that allows the Chairperson of the FVC to escalate valuation disputes that cannot be resolved by the FVC to a more senior committee called the Valuations Advisory Committee (“VAC”) for resolution. The VAC is chaired by the Chief Financial Officer and includes other members of senior management. . There were no disputes escalated to the VAC for the years ended December 31, 2022 and 2021.
Customer Rewards Reserve
We offer products, primarily credit cards, which include programs that allow members to earn rewards based on account activity that can be redeemed for cash (primarily in the form of statement credits), gift cards, travel, or covering eligible charges. The amount of rewards that a customer earns varies based on the terms and conditions of the rewards program and product. The majority of our rewards do not expire and there is no limit on the amount of rewards an eligible card member can earn. Customer rewards costs, which we generally record as an offset to interchange income, are driven by various factors such as card member purchase volume, the terms and conditions of the rewards program and rewards redemption cost. 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 the weighted-average redemption cost during the previous twelve months, adjusted as appropriate for recent changes in redemption costs, including changes related to the mix of rewards redeemed, to estimate future redemption costs. We continually evaluate our reserve and assumptions based on developments in redemption patterns, changes to the terms and conditions of the rewards program and other factors. While the rewards liability is sensitive to changes in assumptions for redemption rates and costs and involves management judgment, we believe portfolio characteristics and historical performance are the best indication of future reward redemption behavior and are the primary basis for our estimate. We recognized customer rewards expense of $7.6 billion, $6.4 billion and $4.9 billion in 2022, 2021and 2020, respectively. Our customer rewards reserve, which is included in other liabilities on our consolidated balance sheets, totaled $6.8 billion and $6.2 billion as of December 31, 2022 and 2021, respectively.
We have a governance framework supported by processes and controls that are intended to ensure that our rewards liability estimate is appropriate and reliable. Our governance framework provides for oversight of assumptions, inputs, methods, process controls and results. Additional controls are performed to ensure all underlying data used to derive the rewards liability is complete and accurate.
ACCOUNTING CHANGES AND DEVELOPMENTS
Accounting Standards Issued but Not Adopted as of December 31, 2022
Standard Guidance Adoption Timing and Financial Statement Impacts
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CAPITAL MANAGEMENT
The level and composition of our capital are determined by multiple factors, including our consolidated regulatory capital requirements as described in more detail below and internal risk-based capital assessments such as internal stress testing. The level and composition of our capital may also be influenced by rating agency guidelines, subsidiary capital requirements, business environment, conditions in the financial markets and assessments of potential future losses due to adverse changes in our business and market environments.
Capital Standards and Prompt Corrective Action
The Company and the Bank are subject to the Basel III Capital Rules. The Basel III Capital Rules implement certain capital requirements published by the Basel Committee, along with certain provisions of the Dodd-Frank Act and other capital provisions.
As a BHC with total consolidated assets of at least $250 billion but less than $700 billion and not exceeding any of the applicable risk-based thresholds, the Company is a Category III institution under the Basel III Capital Rules.
The Bank, as a subsidiary of a Category III institution, is a Category III bank. Moreover, the Bank, as an insured depository institution, is subject to PCA capital regulations.
Basel III and United States Capital Rules
Under the Basel III Capital Rules, we must maintain a minimum CET1 capital ratio of 4.5%, a Tier 1 capital ratio of 6.0% and a total capital ratio of 8.0%, in each case in relation to risk-weighted assets. In addition, we must maintain a minimum leverage ratio of 4.0% and a minimum supplementary leverage ratio of 3.0%. We are also subject to the capital conservation buffer requirement and countercyclical capital buffer requirement as described below. Our capital and leverage ratios are calculated based on the Basel III standardized approach framework.
We have elected to exclude certain elements of AOCI from our regulatory capital as permitted for a Category III institution.
G-SIBs that are based in the U.S. are subject to an additional CET1 capital requirement known as the “G-SIB Surcharge.” We are not a G-SIB based on the most recent available data and thus we are not subject to a G-SIB Surcharge.
Stress Capital Buffer Rule
The Basel III Capital Rules require banking institutions to maintain a capital conservation buffer, composed of CET1 capital, above the regulatory minimum ratios. Under the Stress Capital Buffer Rule, the Company’s “standardized approach capital conservation buffer” includes its stress capital buffer requirement (as described below), any G-SIB Surcharge (which is not applicable to us) and the countercyclical capital buffer requirement (which is currently set at 0%). Any determination to increase the countercyclical capital buffer generally would be effective twelve months after the announcement of such an increase, unless the Federal Banking Agencies set an earlier effective date.
The Company’s stress capital buffer requirement is recalibrated every year based on the Company’s supervisory stress test results. In particular, the Company’s stress capital buffer requirement equals, subject to a floor of 2.5%, the sum of (i) the difference between the Company’s starting CET1 capital ratio and its lowest projected CET1 capital ratio under the severely adverse scenario of the Federal Reserve’s supervisory stress test plus (ii) the ratio of the Company’s projected four quarters of common stock dividends (for the fourth to seventh quarters of the planning horizon) to the projected risk-weighted assets for the quarter in which the Company’s projected CET1 capital ratio reaches its minimum under the supervisory stress test.
Based on the Company’s 2021 supervisory stress test results, the Company’s stress capital buffer requirement for the period beginning on October 1, 2021 through September 30, 2022 was 2.5%. Therefore, the Company’s minimum capital requirements plus the standardized approach capital conservation buffer for CET1 capital, Tier 1 capital and total capital ratios under the stress capital buffer framework were 7.0%, 8.5% and 10.5%, respectively, for the period from October 1, 2021 through September 30, 2022.
Based on the Company’s 2022 supervisory stress test results, the Company’s stress capital buffer requirement for the period beginning on October 1, 2022 through September 30, 2023 is 3.1%. Therefore, the Company’s minimum capital requirements plus the standardized approach capital conservation buffer for CET1 capital, Tier 1 capital and total capital ratios under the
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stress capital buffer framework are 7.6%, 9.1% and 11.1%, respectively, for the period from October 1, 2022 through September 30, 2023.
The Stress Capital Buffer Rule does not apply to the Bank. The capital conservation buffer for the Bank continues to be fixed at 2.5%. Accordingly, the Bank’s minimum capital requirements plus its capital conservation buffer for CET1 capital, Tier 1 capital and total capital ratios are 7.0%, 8.5% and 10.5% respectively.
If the Company or the Bank fails to maintain its capital ratios above the minimum capital requirements plus the applicable capital conservation buffer requirements, it will face increasingly strict automatic limitations on capital distributions and discretionary bonus payments to certain executive officers.
As of December 31, 2022 and 2021, respectively, the Company and the Bank each exceeded the minimum capital requirements and the capital conservation buffer requirements applicable to them, and the Company and the Bank were each “well-capitalized.” The “well-capitalized” standards applicable to the Company are established in the Federal Reserve’s regulations, and the “well-capitalized” standards applicable to the Bank are established in the OCC’s PCA capital requirements.
Market Risk Rule
The “Market Risk Rule” supplements the Basel III Capital Rules by requiring institutions subject to the rule to adjust their risk-based capital ratios to reflect the market risk in their trading book. The Market Risk Rule generally applies to institutions with aggregate trading assets and liabilities equal to 10% or more of total assets or $1 billion or more. As of December 31, 2022, the Company and CONA are subject to the Market Risk Rule. See “Market Risk Profile” below for additional information.
CECL Transition Rule
The Federal Banking Agencies adopted the CECL Transition Rule that provides banking institutions an optional five-year transition period to phase in the impact of the CECL standard on their regulatory capital, the CECL Transition Election. We adopted the CECL standard (for accounting purposes) as of January 1, 2020, and made the CECL Transition Election (for regulatory capital purposes) in the first quarter of 2020. Therefore, the applicable amounts presented in this Report reflect such election.
Pursuant to the CECL Transition Rule, a banking institution could elect to delay the estimated impact of adopting CECL on its regulatory capital through December 31, 2021 and then phase in the estimated cumulative impact from January 1, 2022 through December 31, 2024. For the “day 2” ongoing impact of CECL during the initial two years, the Federal Banking Agencies used a uniform “scaling factor” of 25% as an approximation of the increase in the allowance under the CECL standard compared to the prior incurred loss methodology. Accordingly, from January 1, 2020 through December 31, 2021, electing banking institutions were permitted to add back to their regulatory capital an amount equal to the sum of the after-tax “day 1” CECL adoption impact and 25% of the increase in the allowance since the adoption of the CECL standard. From January 1, 2022 through December 31, 2024, the after-tax “day 1” CECL adoption impact and the cumulative “day 2” ongoing impact are being phased in to regulatory capital at 25% per year. The following table summarizes the capital impact delay and phase in period on our regulatory capital from years 2020 to 2025.
Capital Impact Delayed Phase In Period
As of December 31, 2021, we added back an aggregate amount of $2.4 billion to our regulatory capital pursuant to the CECL Transition Rule. Consistent with the rule, we phased in 25% of this amount, or $599 million, on January 1, 2022, leaving $1.8 billion to be phased in over 2023-2025. As of December 31, 2022, the Company’s CET1 capital ratio, reflecting the CECL Transition Rule, was 12.5% and would have been 12.0% excluding the impact of the CECL Transition Rule (or “on a fully phased-in basis”).
For the description of the regulatory capital rules to which we are subject, see “Part I—Item 1. Business—Supervision and Regulation.”
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Table 12 provides a comparison of our regulatory capital ratios under the Basel III standardized approach, the regulatory minimum capital adequacy ratios and the applicable well-capitalized standards as of December 31, 2022 and 2021.
Table 12: Capital Ratios Under Basel III(1)
Capital One Financial Corp:
Common equity Tier 1 capital(2) 12.5 % 4.5 % N/A 13.1 % 4.5 % N/A
Supplementary leverage(6) 9.5 3.0 N/A 9.9 3.0 N/A
CONA:
Supplementary leverage(6) 9.0 3.0 N/A 6.6 3.0 N/A
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(1)Capital requirements that are not applicable are denoted by “N/A.”
(2)Common equity Tier 1 capital ratio is a regulatory capital measure calculated based on common equity Tier 1 capital divided by risk-weighted assets.
(3)Tier 1 capital ratio is a regulatory capital measure calculated based on Tier 1 capital divided by risk-weighted assets.
(4)Total capital ratio is a regulatory capital measure calculated based on total capital divided by risk-weighted assets.
(5)Tier 1 leverage ratio is a regulatory capital measure calculated based on Tier 1 capital divided by adjusted average assets.
(6)Supplementary leverage ratio is a regulatory capital measure calculated based on Tier 1 capital divided by total leverage exposure.
On October 1, 2022, COBNA merged with and into CONA, with CONA as the surviving entity. The capital ratios of COBNA immediately prior to the Bank Merger were higher than those of CONA, therefore increasing the capital ratios of CONA immediately after the Bank Merger and as of December 31, 2022. See “Part I—Item 1. Business—Overview” of this Report for additional information on the Bank Merger.
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Table 13 presents regulatory capital under the Basel III standardized approach and regulatory capital metrics as of December 31, 2022 and 2021.
Table 13: Regulatory Risk-Based Capital Components and Regulatory Capital Metrics
Regulatory capital under Basel III standardized approach
Adjustments and deductions:
AOCI, net of tax(1) (17) (23)
Goodwill, net of related deferred tax liabilities (14,540) (14,562)
Qualifying allowance for credit losses 4,553 4,211
Regulatory capital metrics
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(1)Excludes certain components of AOCI in accordance with rules applicable to Category III institutions. See “Part I—Item 1. Business—Supervision and Regulation” in this Report.
Capital Planning and Regulatory Stress Testing
In January 2022, our Board of Directors authorized the repurchase of up to $5.0 billion of shares of our common stock. In April 2022, our Board of Directors authorized the repurchase of up to an additional $5.0 billion of shares of our common stock. For the year ended December 31, 2022, we repurchased $4.8 billion of shares of our common stock.
On June 23, 2022, the Federal Reserve released the supervisory stress test results for the 2022 CCAR cycle. Based on the Company’s 2022 supervisory stress test results, the Company’s stress capital buffer requirement for the period beginning on October 1, 2022 through September 30, 2023 is 3.1%. Therefore, the Company’s minimum capital requirements plus the standardized approach capital conservation buffer for CET1 capital, Tier 1 capital and total capital ratios under the stress capital buffer framework are 7.6%, 9.1% and 11.1%, respectively, for the period from October 1, 2022 through September 30, 2023.
For the description of the regulatory capital planning rules and stress testing requirements to which we are subject, see “Part I—Item 1. Business—Supervision and Regulation.”
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Dividend Policy and Stock Purchases
For the year ended December 31, 2022, we declared and paid common stock dividends of $954 million, or $2.40 per share, and preferred stock dividends of $228 million. The following table summarizes the dividends paid per share on our various preferred stock series in each quarter of 2022.
Table 14: Preferred Stock Dividends Paid Per Share
Series Description Issuance Date Per Annum Dividend Rate Dividend Frequency 2022
The declaration and payment of dividends to our stockholders, as well as the amount thereof, are subject to the discretion of our Board of Directors and depend upon our results of operations, financial condition, capital levels, cash requirements, future prospects, regulatory requirements and other factors deemed relevant by the Board of Directors. As a BHC, our ability to pay dividends is largely dependent upon the receipt of dividends or other payments from our subsidiaries. The Bank is subject to regulatory restrictions that limit its ability to transfer funds to our BHC. As of December 31, 2022, funds available for dividend payments from the Bank were $3.2 billion. There can be no assurance that we will declare and pay any dividends to stockholders.
In January 2022, our Board of Directors authorized the repurchase of up to $5.0 billion of shares of our common stock. In April 2022, our Board of Directors authorized the repurchase of up to an additional $5.0 billion of shares of our common stock. For the year ended December 31, 2022, we repurchased $4.8 billion of shares of our common stock.
The timing and exact amount of any future common stock repurchases will depend on various factors, including regulatory approval, market conditions, opportunities for growth, our capital position and the amount of retained earnings. The Board authorized stock repurchase program does not include specific price targets, may be executed through open market purchases, tender offers, or privately negotiated transactions, including utilizing Rule 10b5-1 programs, and may be suspended at any time. For additional information on dividends and stock repurchases, see “Capital Management—Capital Planning and Regulatory Stress Testing” and “Part I—Item 1. Business—Supervision and Regulation—Dividends, Stock Repurchases and Transfers of Funds.”
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RISK MANAGEMENT
Risk Management Framework
Our Framework ( sets consistent expectations for risk management across the Company. It also sets expectations for our “Three Lines of Defense” model, which defines the roles, responsibilities and accountabilities for taking and managing risk across the Company. Accountability for overseeing an effective Framework resides with our Board of Directors either directly or through its committees.
The Framework also sets expectations for our “Three Lines of Defense” model, which defines the roles, responsibilities and accountabilities for taking and managing risk across the Company.
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Our Framework sets consistent expectations for risk management across the Company and consists of the following nine elements:
Governance and Accountability
Strategy and Risk Alignment
Capital and Liquidity Management (including Stress Testing)
Risk Data and Enabling Technology
Culture and Talent Management
Governance and Accountability
This element of the Framework sets the foundation for the methods for governing risk taking and the interactions within and among our three lines of defense.
We established a risk governance structure and accountabilities to effectively and consistently oversee the management of risks across the Company. Our Board of Directors, Chief Executive Officer and management establish the tone at the top regarding the culture of the Company, including management of risk. Management reinforces expectations at the various levels of the organization.
Strategy and Risk Alignment
Our strategy is informed by and aligned with risk appetite, from development to execution. The Chief Executive Officer develops the strategy with input from the first, second, and third lines of defense, as well as the Board of Directors. The strategic planning process considers relevant changes to the Company’s overall risk profile.
Our Board of Directors approves a Risk Appetite Statement for the Company to set forth the high-level principles that govern risk taking at the Company. The Risk Appetite Statement defines the Board of Directors’ tolerance for certain risk outcomes at an enterprise level and enables senior management to manage and report within these boundaries. This Risk Appetite Statement is also supported by risk category specific risk appetite statements as well as metrics and, where appropriate, Board Limits and Board Notification Thresholds.
Risk Identification
The first line of defense and certain Support Functions identify new and emerging risks, including concentration of risk, across the relevant risk categories associated with their business activities and objectives, in consultation with IRM. Risk identification also must be informed by major changes in infrastructure or organization, introduction of new products and services, acquisitions of businesses, or substantial changes in the internal or external environment.
IRM and certain Support Functions, where appropriate, provide effective challenge in the risk identification process. IRM is also responsible for identifying our material aggregate risks on an ongoing basis.
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Assessment, Measurement and Response
Management assesses risks associated with our activities. Risks identified are assessed to understand the severity of each risk and likelihood of occurrence under both normal and stressful conditions. Risk severity is measured through modeling and other quantitative estimation approaches, as well as qualitative approaches, based on management judgment. As part of the risk assessment process, the first and second lines of defense also evaluate the effectiveness of the existing control environment and mitigation strategies.
Management determines the appropriate risk response. Risks may be mitigated or accepted. Actions taken to respond to the risk include implementing new controls, enhancing existing controls, developing additional mitigation strategies to reduce the impact of the risk, and/or monitoring the risk.
Monitoring and Testing
Management periodically monitors risks to evaluate and measure how the risk is affecting our strategy and business objectives, in alignment with risk appetite, including established concentration risk limits. The scope and frequency of monitoring activities depends on the results of relevant risk assessments, as well as specific business risk operations and activities.
The first line of defense is required to evaluate the effectiveness of risk management practices and controls through testing and other activities. IRM and Support Functions, as appropriate, assess the first line of defense’s evaluation of risk management, which may include conducting effective challenge, performing independent monitoring, or conducting risk or control validations. The third line of defense provides independent assurance for first and second line risk management practices and controls.
Aggregation, Reporting and Escalation
Risk aggregation supports strategic decision making and risk management practices through collectively reporting risks across different levels of the Company and providing a comprehensive view of performance against risk appetite. Capital One’s risk aggregation processes are designed to aggregate risk information from lower levels of the business hierarchy to high levels and to aggregate risk information to determine material risk themes.
Material risks, new or emerging risks, aggregate risks, risk appetite metrics and other measures across all risk categories are reported to the appropriate governance forum no less than quarterly. Material risks are reported to the Board of Directors and senior management committees no less than quarterly.
Capital and Liquidity Management (including Stress Testing)
Our capital management processes are linked to its risk management practices, including the enterprise-wide identification, assessment and measurement of risks to ensure that all relevant risks are incorporated in the assessment of the Company's capital adequacy. We use identified risks to inform key aspects of the Company’s capital planning, including the development of stress scenarios, the assessment of the adequacy of post-stress capital levels, and the appropriateness of potential capital actions considering the Company’s capital objectives. We quantify capital needs through stress testing, regulatory capital, economic capital and assessments of market considerations. In assessing its capital adequacy, we identify how and where our material risks are accounted for within the capital planning process. Monitoring and escalation processes exist for key capital thresholds and metrics to continuously monitor capital adequacy.
We manage liquidity risk by applying our Liquidity Adequacy Framework (the “Liquidity Framework”). The Liquidity Framework uses internal and regulatory stress testing and the evaluation of other balance sheet metrics to confirm that we maintain a fortified balance sheet that is resilient to uncertainties that may arise as a consequence of systemic, idiosyncratic, or combined liquidity events.
Risk Data and Enabling Technology
Risk data and technology provides the basis for risk reporting and is used in decision making and to monitor and review changes to our risk profile. There is a core Governance, Risk Management and Compliance system which is used as the system of record for risks, controls, issues and events for our risk categories and supports the analysis, aggregation and reporting capabilities across the categories.
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Culture and Talent Management
The Framework must be supported with the right culture, talent and skills to enable effective risk management across the Company.
Every associate at the Company is responsible for risk management; however, associates with specific risk management skills and expertise within the first, second and third lines of defense are critical to execute appropriate risk management across the enterprise.
Risk Categories
We apply our Framework to protect the Company from the major categories of risk that we are exposed to through our business activities. Our seven major categories of risk are:
Major Categories of Risk
We provide an overview of how we manage our seven major categories of risk below.
Compliance Risk Management
We recognize that compliance requirements for financial institutions are increasingly complex and that there are heightened expectations from our regulators and our customers. In response, we continuously evaluate the regulatory environment and proactively adjust our compliance program to fully address these expectations.
Our Compliance Management Program establishes expectations for determining compliance requirements, assessing the risk of new product offerings, creating appropriate controls and training to address requirements, monitoring for control performance, and independently testing for adherence to compliance requirements. The program also establishes regular compliance reporting to senior business leaders, the executive committee and the Board of Directors.
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The Chief Compliance Officer is responsible for establishing and overseeing our Compliance Management Program. Business areas incorporate compliance requirements and controls into their business policies, standards, processes and procedures. They regularly monitor and report on the efficacy of their compliance controls and our Compliance team periodically independently tests to validate the effectiveness of business controls.
Credit Risk Management
We recognize that we are exposed to cyclical changes in credit quality. Consequently, we try to ensure our credit portfolio is resilient to economic downturns. Our most important tool in this endeavor is sound underwriting. In unsecured consumer loan underwriting, we generally assume that loans will be subject to an environment in which losses are higher than those prevailing at the time of underwriting. In commercial underwriting, we generally require strong cash flow, collateral, covenants, and guarantees. In addition to sound underwriting, we continually monitor our portfolio and take steps to collect or work out distressed loans.
The Chief Risk Officer, in conjunction with the Consumer and Commercial Chief Credit Officers, is responsible for establishing credit risk policies and procedures, including underwriting and hold guidelines and credit approval authority, and monitoring credit exposure and performance of our lending related transactions. Our Consumer and Commercial Chief Credit Officers are responsible for evaluating the risk implications of credit strategy and the oversight of credit for both the existing portfolio and any new credit investments. They also have formal approval authority for various types and levels of credit decisions, including individual commercial loan transactions. Division Presidents within each segment are responsible for managing the credit risk within their divisions and maintaining processes to control credit risk and comply with credit policies and guidelines. In addition, the Chief Risk Officer establishes policies, delegates approval authority and monitors performance for non-loan credit exposure entered into with financial counterparties or through the purchase of credit sensitive securities in our investment portfolio.
Our credit policies establish standards in five areas: customer selection, underwriting, monitoring, remediation and portfolio management. The standards in each area provide a framework comprising specific objectives and control processes. These standards are supported by detailed policies and procedures for each component of the credit process. Starting with customer selection, our goal is to generally provide credit on terms that generate above hurdle returns. We use a number of quantitative and qualitative factors to manage credit risk, including setting credit risk limits and guidelines for each of our lines of business. We monitor performance relative to these guidelines and report results and any required mitigating actions to appropriate senior management committees and our Board of Directors.
Liquidity Risk Management
We manage liquidity risk by applying our Liquidity Adequacy Framework (the “Liquidity Framework”). The Liquidity Framework uses internal and regulatory stress testing and the evaluation of other balance sheet metrics to confirm that we maintain a fortified balance sheet that is resilient to uncertainties that may arise as a consequence of systemic, idiosyncratic, or combined liquidity events. We continuously monitor market and economic conditions to evaluate emerging stress conditions and to develop appropriate action plans in accordance with our Contingency Funding Plan and our Recovery Plan, which include the Company’s policies, procedures and action plans for managing liquidity stress events. The Liquidity Framework enables us to manage our liquidity risk in accordance with regulatory requirements.
Additionally, the Liquidity Framework establishes governing principles that apply to the management of liquidity risk. We use these principles to monitor, measure and report liquidity risk; to develop funding and investment strategies that enable us to maintain an adequate level of liquidity to support our businesses and satisfy regulatory requirements; and to protect us from a broad range of liquidity events should they arise.
The Chief Risk Officer, in conjunction with the Chief Market and Liquidity Risk Officer, is responsible for the establishment of liquidity risk management policies and standards for governance and monitoring of liquidity risk at a corporate level. We assess liquidity strength by evaluating several different balance sheet metrics under severe stress scenarios to ensure we can withstand significant funding degradation through idiosyncratic, systemic and combined liquidity stress scenarios. Management reports liquidity metrics to appropriate senior management committees and to our Board of Directors no less than quarterly.
We seek to mitigate liquidity risk strategically and tactically. From a strategic perspective, we have acquired and built deposit gathering businesses and actively monitor our funding concentration. From a tactical perspective, we have accumulated a sizable liquidity reserve comprised of cash and cash equivalents, high-quality, unencumbered securities and committed
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collateralized credit lines. We also continue to maintain access to secured and unsecured debt markets through regular issuance. This combination of stable and diversified funding sources and our stockpile of liquidity reserves enable us to maintain confidence in our liquidity position.
Market Risk Management
The Chief Financial Officer and the Chief Risk Officer are responsible for the establishment of market risk management policies and standards for the governance and monitoring of market risk at a corporate level. Market risk is inherent from the financial instruments associated with our business operations and activities including loans, deposits, securities, short-term borrowings, long-term debt and derivatives. We manage market risk exposure, which is principally driven by balance sheet interest rate risk, centrally and establish quantitative risk limits to monitor and control our exposure.
We recognize that interest rate and foreign exchange risk is present in our business due to the nature of our assets and liabilities. In addition to using industry accepted techniques to analyze and measure interest rate and foreign exchange risk, we perform sensitivity analysis to identify our risk exposures under a broad range of scenarios. Investment securities and derivatives are the main levers for the management of interest rate risk. In addition, we also use derivatives to manage our foreign exchange risk.
The market risk positions for the Company and the Bank are calculated separately and in aggregate, and analyzed against pre-established limits. Results are reported to the Asset Liability Committee monthly and to the Risk Committee of the Board of Directors no less than quarterly. Management is authorized to utilize financial instruments as outlined in our policy to actively manage market risk exposure.
Operational Risk Management
We recognize the criticality of managing operational risk on both a strategic and day-to-day basis and that there are heightened expectations from our regulators and our customers. We have implemented appropriate operational risk management policies, standards, processes and controls to enable the delivery of high quality and consistent customer experiences and to achieve business objectives in a controlled manner.
The Chief Operational Risk Officer is responsible for establishing and overseeing our Operational Risk Management Program. The program establishes practices for assessing the operational risk profile and executing key control processes for operational risks. These risks include topics such as internal and external fraud, cyber and technology risk, data management, model risk, third party management, and business continuity. Operational Risk Management enforces these practices and delivers reporting of operational risk results to senior business leaders, the executive committee and the Board of Directors.
Reputation Risk Management
We recognize that reputation risk is of particular concern for financial institutions and, increasingly, technology companies, in the current environment. Areas of concern have expanded to include company policies, practices and values and, with the growing use of social and digital platforms, public corporations face a new level of scrutiny and channels for activism and advocacy. The heightened expectations of internal and external stakeholders have made corporate culture, values and conduct pressure points for individuals and advocates voicing concerns or seeking change. We manage both strategic and tactical reputation issues and build our relationships with government officials, media, community and consumer advocates, customers and other constituencies to help strengthen the reputations of both our Company and industry. Our actions include implementing pro-customer practices in our business and serving low to moderate income communities in our market area consistent with a quality bank and an innovative technology leader. The Executive Vice President of External Affairs is responsible for managing our overall reputation risk program. Day-to-day activities are controlled by the frameworks set forth in our Reputation Risk Management Policy and other risk management policies.
Strategic Risk Management
We monitor external market and industry developments to identify potential areas of strategic opportunity or risk. These inform the Company’s strategy, which is led by the Chief Executive Officer and other senior executives. The Chief Risk Officer identifies and assesses risks associated with the Company’s strategy across all risk categories and monitors these risks throughout the year.
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Our Strategic Risk Management Policy, processes and controls encompass an ongoing assessment of risks associated with corporate or line of business specific strategies. These risks are managed through periodic reviews, along with regular updates to senior management and the Board.
CREDIT RISK PROFILE
Our loan portfolio accounts for the substantial majority of our credit risk exposure. Our lending activities are governed under our credit policy and are subject to independent review and approval. Below we provide information about the composition of our loan portfolio, key concentrations and credit performance metrics.
We also engage in certain non-lending activities that may give rise to ongoing credit and counterparty settlement risk, including purchasing securities for our investment securities portfolio, entering into derivative transactions to manage our market risk exposure and to accommodate customers, extending short-term advances on syndication activity including bridge financing transactions we have underwritten, depositing certain operational cash balances in other financial institutions, executing certain foreign exchange transactions and extending customer overdrafts. We provide additional information related to our investment securities portfolio under “Consolidated Balance Sheets Analysis—Investment Securities” and “Part II—Item 8. Financial Statements and Supplementary Data—Note 2—Investment Securities” as well as credit risk related to derivative transactions in “Part II—Item 8. Financial Statements and Supplementary Data—Note 9—Derivative Instruments and Hedging Activities.”
Primary Loan Products
We provide a variety of lending products. Our primary loan products include credit cards, auto loans and commercial lending products.
•Credit cards: We originate both prime and subprime credit cards through a variety of channels. Our credit cards generally have variable interest rates. Credit card accounts are primarily underwritten using an automated underwriting system based on predictive models that we have developed. The underwriting criteria, which are customized for individual products and marketing programs, are established based on an analysis of the net present value of expected revenues, expenses and losses, subject to further analysis using a variety of stress conditions. Underwriting decisions are generally based on credit bureau information, including payment history, debt burden and credit scores, such as FICO scores, and on other factors, such as applicant income. We maintain a credit card securitization program and selectively sell charged-off credit card loans.
•Auto: We originate both prime and subprime auto loans through a network of auto dealers and direct marketing. Our auto loans generally have fixed interest rates and loan terms of 75 months or less, but can go up to 84 months. Loan size limits are customized by program and are generally less than $75,000. Similar to credit card accounts, the underwriting criteria are customized for individual products and marketing programs and based on analysis of net present value of expected revenues, expenses and losses, and are subject to maintaining resilience under a variety of stress conditions. Underwriting decisions are generally based on an applicant’s income, estimated net disposable income, and credit bureau information including FICO scores, along with collateral characteristics such as loan-to-value (“LTV”) ratio. We maintain an auto securitization program.
•Commercial: We offer a range of commercial lending products, including loans secured by commercial real estate and loans to middle market commercial and industrial companies. Our commercial loans may have a fixed or variable interest rate; however, the majority of our commercial loans have variable rates. Our underwriting standards require an analysis of the borrower’s financial condition and prospects, as well as an assessment of the industry in which the borrower operates. Where relevant, we evaluate and appraise underlying collateral and guarantees. We maintain underwriting guidelines and limits for major types of borrowers and loan products that specify, where applicable, guidelines for debt service coverage, leverage, LTV ratio and standard covenants and conditions. We assign a risk rating and establish a monitoring schedule for loans based on the risk profile of the borrower, industry segment, source of repayment, the underlying collateral and guarantees, if any, and current market conditions. Although we generally retain the commercial loans we underwrite, we may syndicate positions for risk mitigation purposes, including bridge financing transactions we have underwritten. In addition, we originate and service multifamily commercial real estate loans which are sold to government-sponsored enterprises.
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Portfolio and Geographic Composition of Loans Held for Investment
Our loan portfolio consists of loans held for investment, including loans held in our consolidated trusts, and loans held for sale. The information presented in this section excludes loans held for sale, which totaled $203 million and $5.9 billion as of December 31, 2022 and 2021, respectively.
Table 15 presents the composition of our portfolio of loans held for investment by portfolio segment as of December 31, 2022 and 2021.
Table 15: Portfolio Composition of Loans Held for Investment
(Dollars in millions) Loans % of Total Loans % of Total
Credit Card:
Consumer Banking:
Commercial Banking:
Table 16 presents the maturities of our loans held for investment portfolio as of December 31, 2022.
Table 16: Loan Maturity Schedule
Fixed rate:
Variable rate:
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