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CAPITAL ONE FINANCIAL CORP - Quarter Report: 2018 September (Form 10-Q)

 
 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
____________________________________
FORM 10-Q
____________________________________
ý QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2018
OR
¨    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______ to _______
Commission File No. 1-13300
____________________________________
CAPITAL ONE FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter) 
____________________________________
Delaware
 
54-1719854
(State or Other Jurisdiction of Incorporation or Organization)
 
(I.R.S. Employer Identification No.)
1680 Capital One Drive,
McLean, Virginia
 
22102
(Address of Principal Executive Offices)
 
(Zip Code)
Registrant’s telephone number, including area code: (703) 720-1000
(Former name, former address and former fiscal year, if changed since last report)
(Not applicable)
____________________________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes ý  No ¨
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes  ý No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 
ý
 
Accelerated filer
 
¨
Non-accelerated filer
 
¨ 
 
Smaller reporting company
 
¨
 
 
 
 
Emerging growth company
 
¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a Shell Company (as defined in Rule 12b-2 of the Exchange Act) Yes ¨ No ý
As of September 30, 2018, there were 473,656,501 shares of the registrant’s Common Stock outstanding.
 
 



TABLE OF CONTENTS
 
 
Page
Item 1.
 
 
 
 
 
 
 
Note 1—Summary of Significant Accounting Policies
 
Note 2—Business Developments and Discontinued Operations
 
Note 3—Investment Securities
 
Note 4—Loans
 
Note 5—Allowance for Loan and Lease Losses and Reserve for Unfunded Lending Commitments
 
Note 6—Variable Interest Entities and Securitizations
 
Note 7—Goodwill and Intangible Assets
 
Note 8—Deposits and Borrowings
 
Note 9—Derivative Instruments and Hedging Activities
 
Note 10—Stockholders’ Equity
 
Note 11—Earnings Per Common Share
 
Note 12—Fair Value Measurement
 
Note 13—Business Segments and Revenue from Contracts with Customers
 
Note 14—Commitments, Contingencies, Guarantees and Others
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”)
 
 
Summary of Selected Financial Data
 
Executive Summary and Business Outlook
 
Consolidated Results of Operations
 
Consolidated Balance Sheets Analysis
 
 
Business Segment Financial Performance
 
 
Accounting Changes and Developments
 
Capital Management
 
Risk Management
 
Credit Risk Profile
 
Liquidity Risk Profile
 
Market Risk Profile
 
Supervision and Regulation
 
 
Supplemental Table
 
Glossary and Acronyms
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
Item 4.
 
 
 

 
 
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Capital One Financial Corporation (COF)


PART II—OTHER INFORMATION
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.
 
 
 
EXHIBIT INDEX
SIGNATURES

 
 
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Capital One Financial Corporation (COF)


INDEX OF MD&A AND SUPPLEMENTAL TABLES
MD&A Tables:
Page
1
Consolidated Financial Highlights
2
Average Balances, Net Interest Income and Net Interest Margin
3
Rate/Volume Analysis of Net Interest Income
4
Non-Interest Income
5
Non-Interest Expense
6
Investment Securities
7
Non-Agency Investment Securities Credit Ratings
8
Loans Held for Investment
9
Funding Sources Composition
10
Business Segment Results
11
Credit Card Business Results
11.1
Domestic Card Business Results
12
Consumer Banking Business Results
13
Commercial Banking Business Results
14
Other Category Results
15
Capital Ratios under Basel III
16
Preferred Stock Dividends Paid Per Share
17
Loans Held for Investment Portfolio Composition
18
Commercial Loans by Industry
19
Credit Score Distribution
20
30+ Day Delinquencies
21
Aging and Geography of 30+ Day Delinquent Loans
22
90+ Day Delinquent Loans Accruing Interest
23
Nonperforming Loans and Other Nonperforming Assets
24
Net Charge-Offs (Recoveries)
25
Troubled Debt Restructurings
26
Allowance for Loan and Lease Losses and Reserve for Unfunded Lending Commitments Activity
27
Allowance Coverage Ratios
28
Liquidity Reserves
29
Deposits Composition and Average Deposits Interest Rates
30
Long-Term Funding
31
Senior Unsecured Long-Term Debt Credit Ratings
32
Interest Rate Sensitivity Analysis
 
 
 
 
A
Reconciliation of Non-GAAP Measures and Calculation of Regulatory Capital Measures

 
 
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PART I—FINANCIAL INFORMATION
Item 2. 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 “MD&A—Forward-Looking Statements” for more information on the forward-looking statements in this Quarterly Report on Form 10-Q (“this Report”). 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 II—Item 1A. Risk Factors” in this Report and in “Part I—Item 1A. Risk Factors” in our 2017 Annual Report on Form 10-K (“2017 Form 10-K”). Unless otherwise specified, references to notes to our consolidated financial statements refer to the notes to our unaudited consolidated financial statements as of September 30, 2018 included in this Report.
 
Management monitors a variety of key indicators to evaluate our business results and financial condition. The following MD&A is provided as a supplement to, and should be read in conjunction with, our audited consolidated financial statements and related notes in this Report and the more detailed information contained in our 2017 Form 10-K.
INTRODUCTION
We are a diversified financial services holding company with banking and non-banking subsidiaries. Capital One Financial Corporation and its subsidiaries (the “Company”) offer a broad array of financial products and services to consumers, small businesses and commercial clients through branches, the internet and other distribution channels. As of September 30, 2018, our principal subsidiaries included:
Capital One Bank (USA), National Association (“COBNA”), which offers credit and debit card products, other lending products and deposit products; and
Capital One, National Association (“CONA”), which offers a broad spectrum of banking products and financial services to consumers, small businesses and commercial clients.
The Company is hereafter collectively referred to as “we,” “us” or “our.” COBNA and CONA are collectively referred to as the “Banks.” Certain business terms used in this document are defined in the “MD&A—Glossary and Acronyms” and should be read in conjunction with the consolidated financial statements included in this Report.
Our consolidated total net revenues are derived primarily from lending to consumer and commercial customers net of funding costs associated with interest on deposits, short-term borrowings and long-term debt. We also earn non-interest income which primarily consists of interchange income net of reward expenses, and service charges and other customer-related fees. Our expenses primarily consist of the provision for credit losses, operating expenses, marketing expenses and income taxes.
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 type of customer served: Credit Card, Consumer Banking and Commercial Banking. The operations of acquired businesses have been integrated into our existing business segments. Certain activities that are not part of a segment, such as management of our corporate investment portfolio, asset/liability management by our centralized Corporate Treasury group and residual tax expense or benefit to arrive at the consolidated effective tax rate that is not assessed to our primary business segments, are included in the Other category.
Credit Card: Consists of our domestic consumer and small business card lending, and international card businesses in Canada and the United Kingdom (“U.K.”).
Consumer Banking: Consists of our branch-based lending and deposit gathering activities for consumers and small businesses, national deposit gathering and national auto lending.

 
 
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Commercial Banking: Consists of our lending, deposit gathering, capital markets and treasury management services to commercial real estate and commercial and industrial customers. Our commercial and industrial customers typically include companies with annual revenues between $20 million and $2 billion.
Business Developments
We regularly explore and evaluate opportunities to acquire financial services and financial assets, including credit card and other loan portfolios, and enter into strategic partnerships as part of our growth strategy. We also explore opportunities to acquire digital companies and related assets to improve our information technology infrastructure and to deliver on our digital strategy. In addition, we regularly consider the potential disposition of certain of our assets, branches, partnership agreements or lines of business. We may issue equity or debt, through one or more public offerings, to fund our acquisitions.
On July 26, 2018, we announced that we entered into a new, long-term credit card program agreement with Walmart Inc. (“Walmart”). Under the terms of the agreement, we will become the exclusive issuer of Walmart’s private label and co-branded credit card program in the U.S. beginning August 1, 2019.
In the fourth quarter of 2017, we announced our decision to cease new originations of residential mortgage and home equity loan products within our Consumer Banking business. In the first quarter of 2018, we sold the substantial majority of the mortgage servicing rights related to loans serviced for others. In the second quarter of 2018, we sold the substantial majority of our consumer home loan portfolio and the related servicing. We also transferred the remaining portfolio to loans held for sale as of June 30, 2018. In the third quarter of 2018, we sold substantially all of the remaining consumer home loan portfolio.
On September 25, 2017, we completed the acquisition from Synovus Bank of credit card assets and related liabilities of World’s Foremost Bank, a wholly-owned subsidiary of Cabela’s Incorporated (“Cabela’s acquisition”). The Cabela’s acquisition added approximately $5.7 billion to our domestic credit card loans held for investment portfolio as of the acquisition date. On October 5, 2018, we completed the acquisition of the Bass Pro co-brand credit card portfolio (“Bass Pro acquisition”) which added approximately $534 million to our domestic credit card loans held for investment as of the acquisition date.

 
 
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SUMMARY OF SELECTED FINANCIAL DATA
The following table presents selected consolidated financial data and performance from our results of operations for the third quarter and first nine months of 2018 and 2017 and selected comparative balance sheet data as of September 30, 2018 and December 31, 2017. We also provide selected key metrics we use in evaluating our performance, including certain metrics that are computed using non-GAAP measures. We believe these non-GAAP metrics provide useful insight to investors and users of our financial information in assessing the results of the Company.
Table 1: Consolidated Financial Highlights
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(Dollars in millions, except per share data and as noted)
 
2018
 
2017
 
Change
 
2018
 
2017
 
Change
Income statement
 
 
 
 
 
 
 
 
 
 
 
 
Net interest income
 
$
5,786

 
$
5,700

 
2
 %
 
$
17,055

 
$
16,647

 
2
 %
Non-interest income
 
1,176

 
1,285

 
(8
)
 
4,008

 
3,577

 
12

Total net revenue
 
6,962

 
6,985

 

 
21,063

 
20,224

 
4

Provision for credit losses
 
1,268

 
1,833

 
(31
)
 
4,218

 
5,625

 
(25
)
Non-interest expense:
 
 
 
 
 
 
 
 
 
 
 
 
Marketing
 
504

 
379

 
33

 
1,343

 
1,210

 
11

Operating expenses
 
3,269

 
3,188

 
3

 
9,427

 
9,205

 
2

Total non-interest expense
 
3,773

 
3,567

 
6

 
10,770

 
10,415

 
3

Income from continuing operations before income taxes
 
1,921

 
1,585

 
21

 
6,075

 
4,184

 
45

Income tax provision
 
420

 
448

 
(6
)
 
1,314

 
1,205

 
9

Income from continuing operations, net of tax
 
1,501

 
1,137

 
32

 
4,761

 
2,979

 
60

Income (loss) from discontinued operations, net of tax
 
1

 
(30
)
 
**

 
(7
)
 
(26
)
 
(73
)
Net income
 
1,502

 
1,107

 
36

 
4,754

 
2,953

 
61

Dividends and undistributed earnings allocated to participating securities
 
(9
)
 
(8
)
 
13

 
(32
)
 
(21
)
 
52

Preferred stock dividends
 
(53
)
 
(52
)
 
2

 
(185
)
 
(185
)
 

Net income available to common stockholders
 
$
1,440

 
$
1,047

 
38

 
$
4,537

 
$
2,747

 
65

Common share statistics
 
 
 
 

 
 
 
 
 
 
 
 

Basic earnings per common share:
 
 
 
 
 
 
 
 
 
 
 
 
Net income from continuing operations
 
$
3.01

 
$
2.22

 
36
 %
 
$
9.40

 
$
5.73

 
64
 %
Loss from discontinued operations
 

 
(0.06
)
 
**

 
(0.01
)
 
(0.05
)
 
(80
)
Net income per basic common share
 
$
3.01

 
$
2.16

 
39

 
$
9.39

 
$
5.68

 
65

Diluted earnings per common share:
 
 
 
 
 
 
 
 
 
 
 
 
Net income from continuing operations
 
$
2.99

 
$
2.20

 
36

 
$
9.33

 
$
5.68

 
64

Loss from discontinued operations
 

 
(0.06
)
 
**

 
(0.01
)
 
(0.05
)
 
(80
)
Net income per diluted common share
 
$
2.99

 
$
2.14

 
40

 
$
9.32

 
$
5.63

 
66

Weighted-average common shares outstanding (in millions):
 
 
 
 
 
 
 
 
 
 
 
 
Basic
 
477.8

 
484.9

 
(1
)%
 
483.2

 
483.7

 

Diluted
 
480.9

 
489.0

 
(2
)
 
486.7

 
488.1

 

Common shares outstanding (period-end, in millions)
 
473.7

 
484.4

 
(2
)
 
473.7

 
484.4

 
(2
)%
Dividends declared and paid per common share
 
$
0.40

 
$
0.40

 

 
$
1.20

 
$
1.20

 

Tangible book value per common share (period-end)(1)
 
66.15

 
63.06

 
5

 
66.15

 
63.06

 
5

Balance sheet (average balances)
 
 
 
 
 
 
 
 
 
 
 
 
Loans held for investment
 
$
236,766

 
$
245,822

 
(4
)%
 
$
242,369

 
$
243,205

 

Interest-earning assets
 
330,272

 
322,015

 
3

 
331,318

 
319,497

 
4
 %
Total assets
 
360,937

 
355,191

 
2

 
362,293

 
352,216

 
3

Interest-bearing deposits
 
221,431

 
213,137

 
4

 
221,400

 
213,508

 
4

Total deposits
 
246,720

 
238,843

 
3

 
246,932

 
239,316

 
3

Borrowings
 
51,684

 
54,271

 
(5
)
 
52,858

 
52,159

 
1

Common equity
 
46,407

 
45,816

 
1

 
45,521

 
44,772

 
2

Total stockholders’ equity
 
50,768

 
50,176

 
1

 
49,882

 
49,132

 
2


 
 
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Three Months Ended September 30,
 
Nine Months Ended September 30,
(Dollars in millions, except per share data and as noted)
 
2018
 
2017
 
Change
 
2018
 
2017
 
Change
Selected performance metrics
 
 
 
 
 
 
 
 
 
 
 
 

Purchase volume(2)
 
$
97,469

 
$
84,505

 
15
 %
 
$
281,406

 
$
240,781

 
17
 %
Total net revenue margin(3)
 
8.43
%
 
8.68
%
 
(25
)bps
 
8.48
%
 
8.44
%
 
4
bps
Net interest margin(4)
 
7.01

 
7.08

 
(7
)
 
6.86

 
6.95

 
(9
)
Return on average assets
 
1.66

 
1.28

 
38

 
1.75

 
1.13

 
62

Return on average tangible assets(5)
 
1.74

 
1.34

 
40

 
1.83

 
1.18

 
65

Return on average common equity(6)
 
12.40

 
9.40

 
3
 %
 
13.31

 
8.26

 
5
 %
Return on average tangible common equity (“TCE”)(7)
 
18.32

 
14.11

 
4

 
19.88

 
12.56

 
7

Equity-to-assets ratio(8)
 
14.07

 
14.13

 
(6
)bps
 
13.77

 
13.95

 
(18
)bps
Non-interest expense as a percentage of average loans held for investment
 
6.37

 
5.80

 
57

 
5.92

 
5.71

 
21

Efficiency ratio(9)
 
54.19

 
51.07

 
3
 %
 
51.13

 
51.50

 

Operating efficiency ratio(10)
 
46.95

 
45.64

 
1

 
44.76

 
45.52

 
(1
)%
Effective income tax rate from continuing operations
 
21.9

 
28.3

 
(6
)
 
21.6

 
28.8

 
(7
)
Net charge-offs
 
$
1,425

 
$
1,606

 
(11
)
 
$
4,502

 
$
4,734

 
(5
)
Net charge-off rate(11)
 
2.41
%
 
2.61
%
 
(20
)bps
 
2.48
%
 
2.60
%
 
(12
)bps
(Dollars in millions, except as noted)

September 30, 2018
 
December 31, 2017
 
Change
Balance sheet (period-end)
 
 
 
 
 
 
Loans held for investment
 
$
238,761

 
$
254,473

 
(6
)%
Interest-earning assets
 
331,293

 
334,124

 
(1
)
Total assets
 
362,909

 
365,693

 
(1
)
Interest-bearing deposits
 
222,356

 
217,298

 
2

Total deposits
 
247,195

 
243,702

 
1

Borrowings
 
52,205

 
60,281

 
(13
)
Common equity
 
46,277

 
44,370

 
4

Total stockholders’ equity
 
50,638

 
48,730

 
4

Credit quality metrics
 
 
 
 
 


Allowance for loan and lease losses
 
$
7,219

 
$
7,502

 
(4
)%
Allowance as a percentage of loans held for investment (“allowance coverage ratio”)
 
3.02
%
 
2.95
%
 
7
bps
30+ day performing delinquency rate
 
3.28

 
3.23

 
5

30+ day delinquency rate
 
3.48

 
3.48

 

Capital ratios
 
 
 
 
 


Common equity Tier 1 capital(12)
 
11.2
%
 
10.3
%
 
90
bps
Tier 1 capital(12)
 
12.8

 
11.8

 
100

Total capital(12)
 
15.2

 
14.4

 
80

Tier 1 leverage(12)
 
10.6

 
9.9

 
70

Tangible common equity(13)
 
9.0

 
8.3

 
70

Supplementary leverage(12)
 
9.0

 
8.4

 
60

Other
 
 
 
 
 


Employees (period end, in thousands)
 
47.6

 
49.3

 
(3
)%
__________
(1) 
Tangible book value per common share is a non-GAAP measure calculated based on tangible common equity divided by common shares outstanding. See “MD&A—Table —Reconciliation of Non-GAAP Measures and Calculation of Regulatory Capital Measures” for additional information on non-GAAP measures.
(2) 
Purchase volume consists of purchase transactions, net of returns, for the period in our Credit Card business, and excludes cash advance and balance transfer transactions.
(3) 
Total net revenue margin is calculated based on annualized total net revenue for the period divided by average interest-earning assets for the period.
(4) 
Net interest margin is calculated based on annualized net interest income for the period divided by average interest-earning assets for the period.
(5) 
Return on average tangible assets is a non-GAAP measure calculated based on annualized income from continuing operations, net of tax, for the period divided by average tangible assets for the period. See “MD&A—Table A—Reconciliation of Non-GAAP Measures and Calculation of Regulatory Capital Measures” for additional information on non-GAAP measures.

 
 
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(6) 
Return on average common equity is calculated based on annualized (i) income from continuing operations, net of tax; (ii) less dividends and undistributed earnings allocated to participating securities; (iii) less preferred stock dividends, 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 annualized (i) income from continuing operations, net of tax; (ii) less dividends and undistributed earnings allocated to participating securities; (iii) less preferred stock dividends, 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 “MD&A—Table A—Reconciliation of Non-GAAP Measures and Calculation of Regulatory Capital 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 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) 
Net charge-off rate is calculated by dividing annualized net charge-offs by average loans held for investment for the period for each loan category.
(12) 
Capital ratios are calculated based on the Basel III Standardized Approach framework, subject to applicable transition provision. See “MD&A—Capital Management” for additional information.
(13) 
Tangible common equity ratio is a non-GAAP measure calculated based on TCE divided by tangible assets. See “MD&A—Table A—Reconciliation of Non-GAAP Measures and Calculation of Regulatory Capital Measures” for the calculation of this measure and reconciliation to the comparative U.S. GAAP measure.
** Not meaningful.
EXECUTIVE SUMMARY AND BUSINESS OUTLOOK
Financial Highlights
We reported net income of $1.5 billion ($2.99 per diluted common share) on total net revenue of $7.0 billion and net income of $4.8 billion ($9.32 per diluted common share) on total net revenue of $21.1 billion for the third quarter and first nine months of 2018, respectively. In comparison, we reported net income of $1.1 billion ($2.14 per diluted common share) on total net revenue of $7.0 billion and net income of $3.0 billion ($5.63 per diluted common share) on total net revenue of $20.2 billion for the third quarter and first nine months of 2017, respectively.
Our common equity Tier 1 capital ratio as calculated under the Basel III Standardized Approach, including transition provisions, was 11.2% and 10.3% as of September 30, 2018 and December 31, 2017, respectively. See “MD&A—Capital Management” below for additional information.
We sold the substantial majority of our consumer home loan portfolio and the related servicing in the second quarter of 2018, and transferred the remaining consumer home loan portfolio of $398 million to loans held for sale as of June 30, 2018. These actions resulted in a net gain of approximately $400 million in the second quarter of 2018, including a benefit for credit losses of $46 million, which was reflected in the Other category. In the third quarter of 2018, we sold substantially all of the remaining consumer home loan portfolio and recognized a gain of $99 million in the Other category.
On June 28, 2018, we announced that our Board of Directors authorized the repurchase of up to $1.2 billion of shares of our common stock (“2018 Stock Repurchase Program”) beginning the third quarter of 2018 through the end of the second quarter of 2019. During the third quarter of 2018, we repurchased approximately $569 million of shares of our common stock under the 2018 Stock Repurchase Program. See “MD&A—Capital Management—Dividend Policy and Stock Purchases” for additional information.
Below are additional highlights of our performance in the third quarter and first nine months of 2018. These highlights are generally based on a comparison between the results of the third quarter and first nine months of 2018 and 2017, 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 September 30, 2018 compared to our financial condition and credit performance as of December 31, 2017. We provide a more detailed discussion of our financial performance in the sections following this “Executive Summary and Business Outlook.”

 
 
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Total Company Performance
Earnings: Our net income increased by $395 million to $1.5 billion in the third quarter of 2018 primarily driven by:
lower provision for credit losses driven by allowance releases in our domestic credit card and auto loan portfolios largely due to improvements in credit trends; and
higher net interest income due to growth in our domestic credit card and auto loan portfolios and higher yields on interest earning assets as a result of higher interest rates, partially offset by higher interest expense attributable to higher interest rates.
These drivers are partially offset by:
higher non-interest expense driven by a legal reserve build and increased marketing expense; and
lower non-interest income due to an impairment charge as a result of repositioning our investment securities portfolio, partially offset by the net gains from the sales of exited businesses.
Net income increased by $1.8 billion to $4.8 billion in the first nine months of 2018 primarily driven by:
lower provision for credit losses driven by allowance releases in our domestic credit card and auto loan portfolios largely due to improvements in credit trends;
higher net interest income due to growth in our domestic credit card and auto loan portfolios and higher yields on interest earning assets as a result of higher interest rates, partially offset by higher interest expense attributable to higher interest rates; and
higher non-interest income largely due to the net gains from the sales of exited businesses including sale of substantially all of our consumer home loan portfolio and an increase in net interchange fees primarily due to higher purchase volume, partially offset by an impairment charge as a result of repositioning our investment securities portfolio.
These drivers are partially offset by higher non-interest expense largely driven by a legal reserve build and increased marketing expense.
Loans Held for Investment:
Period-end loans held for investment decreased by $15.7 billion to $238.8 billion as of September 30, 2018 from December 31, 2017 primarily driven by the sale of substantially all of our consumer home loan portfolio and expected seasonal paydowns in our domestic credit card loan portfolio, partially offset by growth in our commercial, auto and domestic credit card loan portfolios.
Average loans held for investment decreased by $9.1 billion to $236.8 billion in the third quarter of 2018 compared to the third quarter of 2017 primarily driven by the impact of the sale of substantially all of our consumer home loan portfolio, partially offset by growth in our domestic credit card loan portfolio, mainly due to loans obtained in the Cabela’s acquisition, and growth in our auto loan portfolio. These same factors drove average loans held for investment to decrease by $836 million to $242.4 billion in the first nine months of 2018 compared to the first nine months of 2017 as the impact of the sale of substantially all of our consumer home loan portfolio was largely offset by the growth in our domestic credit card and auto loan portfolios.
Net Charge-Off and Delinquency Metrics: Our net charge-off rate decreased by 20 basis points to 2.41% in the third quarter of 2018 compared to the third quarter of 2017, and decreased by 12 basis points to 2.48% in the first nine months of 2018 compared to the first nine months of 2017, primarily driven by elevated charge-offs in the third quarter and first nine months of 2017 in our taxi medallion and oil and gas lending portfolios within our Commercial Banking business.
Our 30+ day delinquency rate was flat at 3.48% as of September 30, 2018 from December 31, 2017 as the impact of lower loan balances from the sale of substantially all of our consumer home loan portfolio was largely offset by improvements in credit trends in our domestic credit card loan portfolio.

 
 
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Allowance for Loan and Lease Losses: Our allowance for loan and lease losses decreased by $283 million to $7.2 billion as of September 30, 2018 from December 31, 2017 primarily driven by allowance releases in our domestic credit card and auto loan portfolios largely due to improvements in credit trends.
The allowance coverage ratio increased by 7 basis points to 3.02% as of September 30, 2018 from December 31, 2017 primarily driven by lower loan balances largely due to the sale of substantially all of our consumer home loan portfolio, partially offset by allowance releases in our domestic credit card and auto loan portfolios.
Business Outlook
We discuss below our current expectations regarding our total company performance and the performance of our business segments over the near-term based on market conditions, the regulatory environment and our business strategies as of the time we filed this Report. The statements contained in this section are based on our current expectations regarding our outlook for our financial results and business strategies. Our expectations take into account, and should be read in conjunction with, our expectations regarding economic trends and analysis of our business as discussed in “Part I—Item 1. Business” and “Part II—Item 7. MD&A” in our 2017 Form 10-K. Certain statements are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual results could differ materially from those in our forward-looking statements. Except as otherwise disclosed, forward-looking statements do not reflect:
any change in current dividend or repurchase strategies;
the effect of any acquisitions, divestitures or similar transactions that have not been previously disclosed; or
any changes in laws, regulations or regulatory interpretations, in each case after the date as of which such statements are made.
See “MD&A—Forward-Looking Statements” in this Report for more information on the forward-looking statements and “Part I—Item 1A. Risk Factors” in our 2017 Form 10-K for factors that could materially influence our results.
Total Company Expectations
We expect our 2018 corporate annual effective tax rate to be around 22% before discrete items.
We continue to expect that our full-year 2018 operating efficiency ratio will be roughly flat compared to our 2017 operating efficiency ratio, net of adjusting items. While efficiency ratio can vary in any given year, over the long term, we continue to believe that we will be able to achieve gradual efficiency improvement driven by growth and digital productivity gains. We expect our long-term improvements in total efficiency ratio will mostly come from an improving operating efficiency ratio.
We expect our fourth quarter 2018 marketing expense to be elevated well above the historical seasonal patterns we typically see between the third quarter and fourth quarter.
We believe the increases in deposit costs will continue, which will be a headwind to net interest margin going forward.
Business Segment Expectations
Consumer Banking: In our Consumer Banking business, we expect further increases in average deposit costs driven by higher market rates and increasing competition for deposits, as well as changing product mix as our national banking growth strategy continues to gain traction.
Over the longer term, we continue to expect that the charge-off rate in our auto finance business will increase gradually.
CONSOLIDATED RESULTS OF OPERATIONS
The section below provides a comparative discussion of our consolidated financial performance for the third quarter and first nine months of 2018 and 2017. We provide a discussion of our business segment results in the following section, “MD&A—Business Segment Financial Performance.” You should read this section together with our “MD&A—Executive Summary and Business Outlook,” where we discuss trends and other factors that we expect will affect our future results of operations.

 
 
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Net Interest Income
Net interest income represents the difference between the interest income, including certain fees, earned on our interest-earning assets and the interest expense on our interest-bearing liabilities. 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 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 2 below presents, for each major category of our interest-earning assets and interest-bearing liabilities, the average outstanding balance, interest income earned, interest expense incurred and average yield for the third quarter and first nine months of 2018 and 2017. Nonperforming loans are included in the average loan balances below.
Table 2: Average Balances, Net Interest Income and Net Interest Margin
 
 
Three Months Ended September 30,
 
 
2018
 
2017
(Dollars in millions)
 
Average
Balance
 
Interest
Income/
Expense(3)
 
Average Yield/
Rate
(3)
 
Average
Balance
 
Interest
Income/
Expense(3)
 
Average Yield/
Rate
(3)
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
Interest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
 
Loans:(1)
 
 
 
 
 
 
 
 
 
 
 
 
Credit card
 
$
109,510

 
$
4,324

 
15.79
 %
 
$
102,545

 
$
3,995

 
15.58
%
Consumer banking
 
59,633

 
1,191

 
7.99

 
75,645

 
1,280

 
6.77

Commercial banking(2)
 
68,913

 
782

 
4.54

 
68,777

 
684

 
3.98

Other
 
94

 
(50
)
 
(211.75
)
 
55

 
1

 
7.27

Total loans, including loans held for sale
 
238,150

 
6,247

 
10.49

 
247,022

 
5,960

 
9.65

Investment securities
 
83,894

 
593

 
2.83

 
69,302

 
431

 
2.49

Cash equivalents and other interest-earning assets
 
8,228

 
55

 
2.66

 
5,691

 
29

 
2.04

Total interest-earning assets
 
330,272

 
6,895

 
8.35

 
322,015

 
6,420

 
7.97

Cash and due from banks
 
3,898

 
 
 
 
 
3,336

 
 
 
 
Allowance for loan and lease losses
 
(7,366
)
 
 
 
 
 
(7,180
)
 
 
 
 
Premises and equipment, net
 
4,157

 
 
 
 
 
3,983

 
 
 
 
Other assets
 
29,976

 
 
 
 
 
33,037

 
 
 
 
Total assets
 
$
360,937

 
 
 
 
 
$
355,191

 
 
 
 
Liabilities and stockholders’ equity:
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits
 
$
221,431

 
$
681

 
1.23
 %
 
$
213,137

 
$
410

 
0.77
%
Securitized debt obligations
 
18,917

 
127

 
2.68

 
17,598

 
85

 
1.93

Senior and subordinated notes
 
31,660

 
288

 
3.63

 
28,753

 
194

 
2.70

Other borrowings and liabilities
 
3,084

 
13

 
1.67

 
9,320

 
31

 
1.33

Total interest-bearing liabilities
 
275,092

 
1,109

 
1.62

 
268,808

 
720

 
1.07

Non-interest-bearing deposits
 
25,289

 
 
 
 
 
25,706

 
 
 
 
Other liabilities
 
9,788

 
 
 
 
 
10,501

 
 
 
 
Total liabilities
 
310,169

 
 
 
 
 
305,015

 
 
 
 
Stockholders’ equity
 
50,768

 
 
 
 
 
50,176

 
 
 
 
Total liabilities and stockholders’ equity
 
$
360,937

 
 
 
 
 
$
355,191

 
 
 
 
Net interest income/spread
 
$
5,786

 
6.73

 
 
 
$
5,700

 
6.90

Impact of non-interest-bearing funding
 
0.28

 
 
 
 
 
0.18

Net interest margin
 
7.01
 %
 
 
 
 
 
7.08
%

 
 
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Nine Months Ended September 30,
 
 
2018
 
2017
(Dollars in millions)
 
Average
Balance
 
Interest
Income/
Expense(3)
 
Average Yield/
Rate
(3)
 
Average
Balance
 
Interest
Income/
Expense(3)
 
Average Yield/
Rate
(3)
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
Interest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
 
Loans:(1)
 
 
 
 
 
 
 
 
 
 
 
 
Credit card
 
$
108,968

 
$
12,559

 
15.37
 %
 
$
101,258

 
$
11,572

 
15.24
%
Consumer banking
 
67,086

 
3,695

 
7.34

 
74,607

 
3,693

 
6.60

Commercial banking(2)
 
67,373

 
2,209

 
4.37

 
68,171

 
1,946

 
3.81

Other
 
226

 
(93
)
 
(54.77
)
 
61

 
44

 
96.17

Total loans, including loans held for sale
 
243,653

 
18,370

 
10.05

 
244,097

 
17,255

 
9.43

Investment securities
 
77,819

 
1,584

 
2.71

 
68,862

 
1,280

 
2.48

Cash equivalents and other interest-earning assets
 
9,846

 
174

 
2.36

 
6,538

 
83

 
1.69

Total interest-earning assets
 
331,318

 
20,128

 
8.10

 
319,497

 
18,618

 
7.77

Cash and due from banks
 
3,768

 
 
 
 
 
3,378

 
 
 
 
Allowance for loan and lease losses
 
(7,468
)
 
 
 
 
 
(6,894
)
 
 
 
 
Premises and equipment, net
 
4,147

 
 
 
 
 
3,879

 
 
 
 
Other assets
 
30,528

 
 
 
 
 
32,356

 
 
 
 
Total assets
 
$
362,293

 
 
 
 
 
$
352,216

 
 
 
 
Liabilities and stockholders’ equity:
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits
 
$
221,400

 
$
1,842

 
1.11
 %
 
$
213,508

 
$
1,145

 
0.72
%
Securitized debt obligations
 
19,251

 
358

 
2.46

 
17,726

 
236

 
1.78

Senior and subordinated notes
 
31,452

 
828

 
3.51

 
27,140

 
522

 
2.56

Other borrowings and liabilities
 
4,674

 
45

 
1.28

 
8,434

 
68

 
1.08

Total interest-bearing liabilities
 
276,777

 
3,073

 
1.49

 
266,808

 
1,971

 
0.98

Non-interest-bearing deposits
 
25,532

 
 
 
 
 
25,808

 
 
 
 
Other liabilities
 
10,102

 
 
 
 
 
10,468

 
 
 
 
Total liabilities
 
312,411

 
 
 
 
 
303,084

 
 
 
 
Stockholders’ equity
 
49,882

 
 
 
 
 
49,132

 
 
 
 
Total liabilities and stockholders’ equity
 
$
362,293

 
 
 
 
 
$
352,216

 
 
 
 
Net interest income/spread
 
$
17,055

 
6.61

 
 
 
$
16,647

 
6.79

Impact of non-interest-bearing funding
 
0.25

 
 
 
 
 
0.16

Net interest margin
 
6.86
 %
 
 
 
 
 
6.95
%
__________
(1) 
Past due fees included in interest income totaled approximately $433 million and $1.2 billion in the third quarter and first nine months of 2018, respectively, and $413 million and $1.2 billion in the third quarter and first nine months of 2017, respectively.
(2) 
Some of our commercial loans generate tax-exempt income. Accordingly, we present our Commercial Banking interest income and yields on a taxable-equivalent basis, calculated using the federal statutory rate (21% and 35% for all periods presented in 2018 and 2017, respectively) 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 banking loans totaled approximately $20 million and $61 million in the third quarter and first nine months of 2018, respectively, and $32 million and $96 million in the third quarter and first nine months of 2017, respectively, with corresponding reductions to Other category.
(3) 
Interest income and interest expense and the calculation of average yields on interest-earning assets and average rates on interest-bearing liabilities include the impact of hedge accounting. In the first quarter of 2018, we adopted Accounting Standards Update (“ASU”) No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. As a result, interest income and interest expense amounts shown above for the three months ended September 30, 2018 include $2 million and $10 million, respectively, and for the nine months ended September 30, 2018 include $1 million and $36 million, respectively, related to hedge ineffectiveness that would previously have been included in other non-interest income.


 
 
 
 
 
 
 
 
 
 
 
 
 

 
 
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Net interest income increased by $86 million to $5.8 billion in the third quarter of 2018 compared to the third quarter of 2017, and increased by $408 million to $17.1 billion in the first nine months of 2018 compared to the first nine months of 2017, primarily driven by higher interest income due to growth in our domestic credit card and auto loan portfolios, and higher yields as a result of higher interest rates, partially offset by higher interest expense due to higher interest rates.
Net interest margin decreased by 7 basis points to 7.01% in the third quarter of 2018 compared to the third quarter of 2017, and decreased by 9 basis points to 6.86% in the first nine months of 2018 compared to the first nine months of 2017, primarily driven by higher interest expense due to higher interest rates, partially offset by product mix changes and higher yields in our interest-earning assets.
Table 3 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 3: Rate/Volume Analysis of Net Interest Income(1)
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2018 vs. 2017
 
2018 vs. 2017
(Dollars in millions)
 
Total Variance
 
Volume
 
Rate
 
Total Variance
 
Volume
 
Rate
Interest income:
 
 
 
 
 
 
 
 
 
 
 
 
Loans:(1)
 
 
 
 
 
 
 
 
 
 
 
 
Credit card
 
$
329

 
$
274

 
$
55

 
$
987

 
$
888

 
$
99

Consumer banking
 
(89
)
 
(270
)
 
181

 
2

 
(372
)
 
374

Commercial banking(2)
 
98

 
1

 
97

 
263

 
(23
)
 
286

Other(2)
 
(51
)
 
(21
)
 
(30
)
 
(137
)
 
(68
)
 
(69
)
Total loans, including loans held for sale
 
287

 
(16
)
 
303

 
1,115

 
425

 
690

Investment securities
 
162

 
98

 
64

 
304

 
175

 
129

Cash equivalents and other interest-earning assets
 
26

 
15

 
11

 
91

 
50

 
41

Total interest income
 
475

 
97

 
378

 
1,510

 
650

 
860

Interest expense:
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits
 
271

 
17

 
254

 
697

 
44

 
653

Securitized debt obligations
 
42

 
7

 
35

 
122

 
22

 
100

Senior and subordinated notes
 
94

 
21

 
73

 
306

 
91

 
215

Other borrowings and liabilities
 
(18
)
 
(21
)
 
3

 
(23
)
 
(30
)
 
7

Total interest expense
 
389

 
24

 
365

 
1,102

 
127

 
975

Net interest income
 
$
86

 
$
73

 
$
13

 
$
408

 
$
523

 
$
(115
)
__________
(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 loans generate tax-exempt income. Accordingly, we present our Commercial Banking interest income and yields on a taxable-equivalent basis, calculated using the federal statutory rate (21% and 35% for all periods presented in 2018 and 2017, respectively) and state taxes where applicable, with offsetting reductions to the Other category.

 
 
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Non-Interest Income
Table 4 displays the components of non-interest income for the third quarter and first nine months of 2018 and 2017.
Table 4: Non-Interest Income
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(Dollars in millions)
 
2018
 
2017
 
2018
 
2017
Interchange fees, net
 
$
714

 
$
662

 
$
2,080

 
$
1,908

Service charges and other customer-related fees
 
410

 
414

 
1,233

 
1,203

Net securities gains (losses)
 
(196
)
 
68

 
(189
)
 
64

Other non-interest income:
 
 
 
 
 
 
 
 
Mortgage banking revenue
 
151

 
50

 
629

 
160

Treasury and other investment income
 
16

 
35

 
62

 
85

Other
 
81

 
56

 
193

 
157

Total other non-interest income
 
248

 
141

 
884

 
402

Total non-interest income
 
$
1,176

 
$
1,285

 
$
4,008

 
$
3,577

Non-interest income decreased by $109 million to $1.2 billion in the third quarter of 2018 compared to the third quarter of 2017 primarily driven by an impairment charge as a result of repositioning our investment securities portfolio, partially offset by the net gains from the sales of exited businesses.
Non-interest income increased by $431 million to $4.0 billion in the first nine months of 2018 compared to the first nine months of 2017 primarily driven by:
the net gains from the sales of exited businesses including sale of substantially all of our consumer home loan portfolio; and
an increase in net interchange fees primarily due to higher purchase volume.
These drivers are partially offset by an impairment charge as a result of repositioning our investment securities portfolio.
Provision for Credit Losses
Our provision for credit losses in each period is driven by net charge-offs, changes to the allowance for loan and lease losses, and the reserve for unfunded lending commitments. We recorded a provision for credit losses of $1.3 billion and $4.2 billion in the third quarter and first nine months of 2018, respectively, compared to $1.8 billion and $5.6 billion in the third quarter and first nine months of 2017, respectively. The provision for credit losses as a percentage of net interest income was 21.9% and 24.7% in the third quarter and first nine months of 2018, respectively, compared to 32.2% and 33.8% in the third quarter and first nine months of 2017, respectively.
Our provision for credit losses decreased by $565 million in the third quarter of 2018 compared to the third quarter of 2017, and decreased by $1.4 billion in the first nine months of 2018 compared to the first nine months of 2017, primarily driven by allowance releases in our domestic credit card and auto loan portfolios largely due to improvements in credit trends.
We provide additional information on the provision for credit losses and changes in the allowance for loan and lease losses within “MD&A—Credit Risk Profile,” “Note 4—Loans” and “Note 5—Allowance for Loan and Lease Losses and Reserve for Unfunded Lending Commitments.” For information on the allowance methodology for each of our loan categories, see “Note 1—Summary of Significant Accounting Policies” in our 2017 Form 10-K.

 
 
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Non-Interest Expense
Table 5 displays the components of non-interest expense for the third quarter and first nine months of 2018 and 2017.
Table 5: Non-Interest Expense
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(Dollars in millions)
 
2018
 
2017
 
2018
 
2017
Salaries and associate benefits
 
$
1,432

 
$
1,524

 
$
4,382

 
$
4,378

Occupancy and equipment
 
515

 
471

 
1,508

 
1,416

Marketing
 
504

 
379

 
1,343

 
1,210

Professional services
 
275

 
297

 
719

 
823

Communications and data processing
 
311

 
294

 
934

 
871

Amortization of intangibles
 
44

 
61

 
131

 
184

Other non-interest expense:
 
 
 
 
 
 
 
 
Bankcard, regulatory and other fee assessments
 
147

 
156

 
381

 
438

Collections
 
105

 
93

 
317

 
266

Fraud losses
 
88

 
89

 
274

 
245

Other
 
352

 
203

 
781

 
584

Total other non-interest expense
 
692

 
541

 
1,753

 
1,533

Total non-interest expense
 
$
3,773

 
$
3,567

 
$
10,770

 
$
10,415

Non-interest expense increased by $206 million to $3.8 billion in the third quarter of 2018 compared to the third quarter of 2017, and increased by $355 million to $10.8 billion in the first nine months of 2018 compared to the first nine months of 2017, primarily due to a legal reserve build and increased marketing expense.
Income Taxes
We recorded income tax provisions of $420 million (21.9% effective income tax rate) and $1.3 billion (21.6% effective income tax rate) in the third quarter and first nine months of 2018, respectively, compared to $448 million (28.3% effective income tax rate) and $1.2 billion (28.8% effective income tax rate) in the third quarter and first nine months of 2017, respectively.
The decrease in our effective income tax rate in the third quarter and first nine months of 2018 compared to the third quarter and first nine months of 2017 was primarily due to the federal statutory tax rate decrease from 35% to 21% as a result of the Tax Act, partially offset by higher income relative to our tax credits and higher non-deductible expenses.
We provide additional information on items affecting our income taxes and effective tax rate in “Note 16—Income Taxes” in our 2017 Form 10-K.

 
 
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CONSOLIDATED BALANCE SHEETS ANALYSIS
Total assets decreased by $2.8 billion to $362.9 billion as of September 30, 2018 from December 31, 2017 primarily attributable to a decrease in loans held for investment driven by the sale of substantially all of our consumer home loan portfolio and expected seasonal paydowns in our domestic credit card loan portfolio, partially offset by an increase in investment securities and growth in our commercial, auto and domestic credit card loan portfolios.
Total liabilities decreased by $4.7 billion to $312.3 billion as of September 30, 2018 from December 31, 2017 primarily driven by a decrease in our Federal Home Loan Banks (“FHLB”) advances outstanding, which are included in other debt, partially offset by deposit growth in our Consumer Banking business.
Stockholders’ equity increased by $1.9 billion to $50.6 billion as of September 30, 2018 from December 31, 2017 primarily due to our net income of $4.8 billion in the first nine months of 2018. This driver was partially offset by:
treasury stock purchases and dividend payments to our stockholders; and
unrealized losses on our available for sale securities and cash flow hedges included in accumulated other comprehensive loss primarily driven by higher interest rates.
The following is a discussion of material changes in the major components of our assets and liabilities during the first nine months of 2018. Period-end balance sheet amounts may vary from average balance sheet amounts due to liquidity and balance sheet management activities that are intended to ensure the adequacy of capital while managing the liquidity requirements of the Company, our customers and our market risk exposure in accordance with our risk appetite.
Investment Securities
Our investment securities portfolio consists primarily of the following: U.S. Treasury securities; U.S. government-sponsored enterprise or agency (“Agency”) and non-agency residential mortgage-backed securities (“RMBS”); Agency commercial mortgage-backed securities (“CMBS”); other asset-backed securities (“ABS”); 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 U.S. Treasury and Agency securities represented 96% and 95% of our total investment securities as of September 30, 2018 and December 31, 2017, respectively.
The fair value of our available for sale securities portfolio increased by $9.7 billion to $47.4 billion as of September 30, 2018 from December 31, 2017 primarily due to a one-time transfer of held to maturity securities to available for sale as a result of our adoption of ASU No. 2017-12. The fair value of our held to maturity securities portfolio increased by $4.5 billion to $33.9 billion as of September 30, 2018 from December 31, 2017 primarily driven by purchases in the second quarter of 2018 as we invested a portion of the proceeds from the sale of the substantial majority of our consumer home loan portfolio into securities, partially offset by the one-time transfer to available for sale.

 
 
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Table 6 presents the amortized cost, carrying value and fair value for the major categories of our investment securities portfolio as of September 30, 2018 and December 31, 2017.
Table 6: Investment Securities
 
 
September 30, 2018
 
December 31, 2017
(Dollars in millions)
 
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
Investment securities available for sale:
 
 
 
 
 
 
 
 
U.S. Treasury securities
 
$
6,012

 
$
6,008

 
$
5,168

 
$
5,171

RMBS:
 
 
 
 
 
 
 
 
Agency
 
34,134

 
32,996

 
26,013

 
25,678

Non-agency
 
1,495

 
1,869

 
1,722

 
2,114

Total RMBS
 
35,629

 
34,865

 
27,735

 
27,792

Agency CMBS
 
5,008

 
4,923

 
3,209

 
3,175

Other ABS
 
277

 
275

 
513

 
512

Other securities(1)
 
1,319

 
1,313

 
1,003

 
1,005

Total investment securities available for sale
 
$
48,245

 
$
47,384

 
$
37,628

 
$
37,655

 
 
 
 
 
 
 
 
 
(Dollars in millions)
 
Carrying Value
 
Fair
Value
 
Carrying Value
 
Fair
Value
Investment securities held to maturity:
 
 
 
 
 
 
 
 
U.S. Treasury securities
 

 

 
$
200

 
$
200

Agency RMBS
 
$
31,265

 
$
30,663

 
24,980

 
25,395

Agency CMBS
 
3,366

 
3,237

 
3,804

 
3,842

Total investment securities held to maturity
 
$
34,631

 
$
33,900

 
$
28,984

 
$
29,437

__________
(1) 
Includes primarily supranational bonds and foreign government bonds.
Credit Ratings
Our portfolio of investment securities continues to be concentrated in securities that generally have high credit ratings and low credit risk, such as securities issued and guaranteed by the U.S. Treasury and Agencies. We categorize the credit ratings of our investment securities based on the credit ratings issued by Standard & Poor’s Ratings Services (“S&P”) as of September 30, 2018 and the lower of the credit ratings issued by S&P and Moody’s Investors Service (“Moody’s”) as of December 31, 2017.
Approximately 97% and 96% of our total investment securities portfolio was rated AA+ or its equivalent, or better, as of September 30, 2018 and December 31, 2017, respectively, while approximately 2% and 3% was below investment grade as of September 30, 2018 and December 31, 2017, respectively.

 
 
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Table 7 provides information on the credit ratings of our non-agency RMBS, other ABS and other securities in our portfolio as of September 30, 2018 and December 31, 2017.
Table 7: Non-Agency Investment Securities Credit Ratings
 
 
September 30, 2018
 
December 31, 2017
(Dollars in millions)
 
Fair Value
 
AAA
 
Other
Investment
Grade
 
Below
Investment
Grade/Not Rated(1)
 
Fair Value
 
AAA
 
Other
Investment
Grade
 
Below
Investment
Grade/Not Rated(1)
Non-agency RMBS
 
$
1,869

 

 
5
%
 
95
%
 
$
2,114

 

 
3
%
 
97
%
Other ABS
 
275

 
57
%
 

 
43

 
512

 
100
%
 

 

Other securities
 
1,313

 
88

 
12

 

 
1,005

 
71

 
19

 
10

__________
(1) 
Includes investment securities that were not rated by S&P as of September 30, 2018 and investment securities not rated by S&P or Moody’s as of December 31, 2017. There were no new additions nor downgrades to other ABS in the first nine months of 2018.
For additional information on our investment securities, see “Note 3—Investment Securities.”
Loans Held for Investment
Total loans held for investment consist of both unsecuritized loans and loans held in our consolidated trusts. Table 8 summarizes the carrying value of our portfolio of loans held for investment by portfolio segment, the allowance for loan and lease losses, and net loan balances as of September 30, 2018 and December 31, 2017.
Table 8: Loans Held for Investment
 
 
September 30, 2018
 
December 31, 2017
(Dollars in millions)
 
Loans
 
Allowance
 
Net Loans
 
Loans
 
Allowance
 
Net Loans
Credit Card
 
$
110,685

 
$
5,520

 
$
105,165

 
$
114,762

 
$
5,648

 
$
109,114

Consumer Banking
 
59,329

 
1,043

 
58,286

 
75,078

 
1,242

 
73,836

Commercial Banking
 
68,747

 
656

 
68,091

 
64,575

 
611

 
63,964

Other
 

 

 

 
58

 
1

 
57

Total
 
$
238,761

 
$
7,219

 
$
231,542

 
$
254,473

 
$
7,502

 
$
246,971

Loans held for investment decreased by $15.7 billion to $238.8 billion as of September 30, 2018 from December 31, 2017 primarily driven by the sale of substantially all of our consumer home loan portfolio and expected seasonal paydowns in our domestic credit card loan portfolio, partially offset by growth in our commercial, auto and domestic credit card loan portfolios.
We provide additional information on the composition of our loan portfolio and credit quality below in “MD&A—Credit Risk Profile,” “MD&A—Consolidated Results of Operations” and “Note 4—Loans.”
Funding Sources
Our primary source of funding comes from deposits, which provide a stable and relatively low cost of funds. In addition to deposits, we also raise funding through the issuance of securitized debt obligations and other debt. Other debt primarily consists of senior and subordinated notes, FHLB advances secured by certain portions of our loan and securities portfolios, and federal funds purchased and securities loaned or sold under agreements to repurchase.

 
 
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Table 9 provides the composition of our primary sources of funding as of September 30, 2018 and December 31, 2017.
Table 9: Funding Sources Composition
 
 
September 30, 2018
 
December 31, 2017
(Dollars in millions)
 
Amount
 
% of Total
 
Amount
 
% of Total
Deposits:(1)
 
 
 
 
 
 
 
 
Consumer Banking
 
$
196,635

 
66
%
 
$
185,842

 
61
%
Commercial Banking
 
30,474

 
10

 
33,938

 
11

Other
 
20,086

 
7

 
23,922

 
8

Total deposits
 
247,195

 
83

 
243,702

 
80

Securitized debt obligations
 
18,649

 
6

 
20,010

 
7

Other debt
 
33,556

 
11

 
40,271

 
13

Total funding sources
 
$
299,400

 
100
%
 
$
303,983

 
100
%
__________
(1) 
Includes brokered deposits of $21.1 billion and $25.1 billion as of September 30, 2018 and December 31, 2017, respectively.
Total deposits increased by $3.5 billion to $247.2 billion as of September 30, 2018 from December 31, 2017 primarily driven by growth in our deposit products that are offered to both existing and new customers in our Consumer Banking business.
Securitized debt obligations decreased by $1.4 billion to $18.6 billion as of September 30, 2018 from December 31, 2017, as debt maturities exceeded issuances during the first nine months of 2018.
Other debt decreased by $6.7 billion to $33.6 billion as of September 30, 2018 from December 31, 2017 primarily driven by a decrease in our FHLB advances outstanding.
We provide additional information on our funding sources in “MD&A—Liquidity Risk Profile” and in “Note 8—Deposits and Borrowings.”
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 “Note 6—Variable Interest Entities and Securitizations” and “Note 14—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 type of customer served: Credit Card, Consumer Banking and Commercial Banking. The operations of acquired businesses have been integrated into our existing business segments. Certain activities that are not part of a segment, such as management of our corporate investment portfolio, asset/liability management by our centralized Corporate Treasury group and residual tax expense or benefit to arrive at the consolidated effective tax rate that is not assessed to our primary business segments, are 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 provide additional information on the allocation methodologies used to derive our business segment results in “Note 18—Business Segments” in our 2017 Form 10-K.
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

 
 
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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 third quarter and first nine months of 2018 and 2017 and provide a comparative discussion of these results, as well as changes in our financial condition and credit performance metrics as of September 30, 2018 compared to December 31, 2017. We provide a reconciliation of our total business segment results to our reported consolidated results in “Note 13—Business Segments and Revenue from Contracts with Customers.”
Business Segment Financial Performance
Table 10 summarizes our business segment results, which we report based on revenue and net income from continuing operations, for the third quarter and first nine months of 2018 and 2017.
Table 10: Business Segment Results
 
 
Three Months Ended September 30,
 
 
2018
 
2017
 
 
Total Net
Revenue
(1)
 
Net Income(2)
 
Total Net
Revenue
(1)
 
Net Income(2)
(Dollars in millions)
 
Amount
 
% of
Total
 
Amount
 
% of
Total
 
Amount
 
% of
Total
 
Amount
 
% of
Total
Credit Card
 
$
4,489

 
65
 %
 
$
1,040

 
69
 %
 
$
4,305

 
62
%
 
$
572

 
50
%
Consumer Banking
 
1,791

 
26

 
482

 
32

 
1,841

 
26

 
316

 
28

Commercial Banking(3)(4)
 
728

 
10

 
204

 
14

 
739

 
11

 
179

 
16

Other(3)(4)
 
(46
)
 
(1
)
 
(225
)
 
(15
)
 
100

 
1

 
70

 
6

Total
 
$
6,962

 
100
 %
 
$
1,501

 
100
 %
 
$
6,985

 
100
%
 
$
1,137

 
100
%
 
 
Nine Months Ended September 30,
 
 
2018
 
2017
 
 
Total Net
Revenue
(1)
 
Net Income(2)
 
Total Net
Revenue
(1)
 
Net Income(2)
(Dollars in millions)
 
Amount
 
% of
Total
 
Amount
 
% of
Total
 
Amount
 
% of
Total
 
Amount
 
% of
Total
Credit Card
 
$
13,184

 
63
%
 
$
2,670

 
56
 %
 
$
12,558

 
62
%
 
$
1,396

 
47
%
Consumer Banking
 
5,364

 
26

 
1,447

 
30

 
5,314

 
26

 
840

 
28

Commercial Banking(3)(4)
 
2,209

 
10

 
702

 
15

 
2,215

 
11

 
538

 
18

Other(3)(4)
 
306

 
1

 
(58
)
 
(1
)
 
137

 
1

 
205

 
7

Total
 
$
21,063

 
100
%
 
$
4,761

 
100
 %
 
$
20,224

 
100
%
 
$
2,979

 
100
%
________
(1) 
Total net revenue consists of net interest income and non-interest income.
(2) 
Net income for our business segments and the Other category is based on income 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 (21% and 35% for all periods presented in 2018 and 2017, respectively) and state taxes where applicable, with offsetting reductions to the Other category.
(4) 
In the first quarter of 2018, we made a change in how revenue is measured in our Commercial Banking business to include the tax benefits of losses on certain tax-advantaged investments. These tax benefits are included in revenue on a taxable-equivalent basis within our Commercial Banking business, with an offsetting reduction to the Other category. In addition, all revenue presented on a taxable-equivalent basis in our Commercial Banking business was impacted by the reduction of the federal tax rate set forth in the Tax Act. The net impact of the measurement change and the reduction of the federal tax rate was a decrease of $30 million and $86 million in revenue in our Commercial Banking business in the third quarter and first nine months of 2018, respectively, with an offsetting impact to the Other category.

 
 
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Credit Card Business
The primary sources of revenue for our Credit Card business are 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 $1.0 billion and $2.7 billion in the third quarter and first nine months of 2018, respectively, and $572 million and $1.4 billion in the third quarter and first nine months of 2017, respectively.
Table 11 summarizes the financial results of our Credit Card business and displays selected key metrics for the periods indicated.
Table 11: Credit Card Business Results
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(Dollars in millions, except as noted)
 
2018
 
2017
 
Change
 
2018
 
2017
 
Change
Selected income statement data:
 
 
 
 
 
 
 
 
 
 
 
 
Net interest income
 
$
3,596

 
$
3,440

 
5
 %
 
$
10,550

 
$
10,080

 
5
 %
Non-interest income
 
893

 
865

 
3

 
2,634

 
2,478

 
6

Total net revenue(1)
 
4,489

 
4,305

 
4

 
13,184

 
12,558

 
5

Provision for credit losses
 
1,031

 
1,466

 
(30
)
 
3,658

 
4,580

 
(20
)
Non-interest expense
 
2,103

 
1,961

 
7

 
6,046

 
5,808

 
4

Income from continuing operations before income taxes
 
1,355

 
878

 
54

 
3,480

 
2,170

 
60

Income tax provision
 
315

 
306

 
3

 
810

 
774

 
5

Income from continuing operations, net of tax
 
$
1,040

 
$
572

 
82

 
$
2,670

 
$
1,396

 
91

Selected performance metrics:
 
 
 
 
 
 
 
 
 
 
 
 
Average loans held for investment(2)
 
$
109,510

 
$
102,545

 
7

 
$
108,968

 
$
101,258

 
8

Average yield on loans held for investment(3)
 
15.79
%
 
15.58
%
 
21
bps
 
15.37
%
 
15.24
%
 
13
bps
Total net revenue margin(4)
 
16.40

 
16.79

 
(39
)
 
16.13

 
16.54

 
(41
)
Net charge-offs
 
$
1,137

 
$
1,155

 
(2
)%
 
$
3,774

 
$
3,682

 
2
 %
Net charge-off rate
 
4.15
%
 
4.51
%
 
(36
)bps
 
4.62
%
 
4.85
%
 
(23
)bps
Purchase volume(5)
 
$
97,469

 
$
84,505

 
15
 %
 
$
281,406

 
$
240,781

 
17
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
(Dollars in millions, except as noted)
 
September 30, 2018
 
December 31, 2017
 
Change
 
 
 
 
 
 
Selected period-end data:
 
 
 
 
 
 
 
 
 
 
 
 
Loans held for investment(2)
 
$
110,685

 
$
114,762

 
(4
)%
 
 
 
 
 

30+ day performing delinquency rate
 
3.78
%
 
3.98
%
 
(20
)bps
 
 
 
 
 


30+ day delinquency rate
 
3.80

 
3.99

 
(19
)
 
 
 
 
 

Nonperforming loan rate(6)
 
0.02

 
0.02

 

 
 
 
 
 


Allowance for loan and lease losses
 
$
5,520

 
$
5,648

 
(2
)%
 
 
 
 
 

Allowance coverage ratio
 
4.99
%
 
4.92
%
 
7
bps
 
 
 
 
 

__________
(1) 
We recognize billed finance charges and fee income on open-ended loans in accordance with the contractual provisions of the credit arrangements and estimate the uncollectible amount on a quarterly basis. The estimated uncollectible amount of billed finance charges and fees is reflected as a reduction in revenue and is not included in our net charge-offs. Total net revenue was reduced by $305 million and $949 million in the third quarter and first nine months of 2018, respectively, and by $356 million and $990 million in the third quarter and first nine months of 2017, respectively, for the estimated uncollectible amount of billed finance charges and fees and related losses. The finance charge and fee reserve totaled $425 million and $491 million as of September 30, 2018 and December 31, 2017, respectively.
(2) 
Period-end loans held for investment and average loans held for investment include billed finance charges and fees, net of the estimated uncollectible amount.
(3) 
Average yield on loans held for investment is calculated by dividing annualized interest income for the period by average loans held for investment during the period. Interest income excludes various allocations including funds transfer pricing that assigns certain balance sheet assets, deposits and other liabilities and their related revenue and expenses attributable to each business segment.
(4) 
Total net revenue margin is calculated by dividing annualized total net revenue for the period by average loans held for investment during the period. Interest income also includes interest income on loans held for sale.

 
 
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(5) 
Purchase volume consists of purchase transactions, net of returns, for the period, and excludes cash advance and balance transfer transactions.
(6) 
Within our credit card loan portfolio, only certain loans in our international card businesses are classified as nonperforming. See “MD&A—Nonperforming Loans and Other Nonperforming Assets” for additional information.
Key factors affecting the results of our Credit Card business for the third quarter and first nine months of 2018 compared to the third quarter and first nine months of 2017, and changes in financial condition and credit performance between September 30, 2018 and December 31, 2017 include the following:
Net Interest Income: Net interest income increased by $156 million to $3.6 billion in the third quarter of 2018 and increased by $470 million to $10.6 billion in the first nine months of 2018 primarily driven by loan growth in our Domestic Card business, including loans obtained in the Cabela’s acquisition.
Non-Interest Income: Non-interest income increased by $28 million to $893 million in the third quarter of 2018 and increased by $156 million to $2.6 billion in the first nine months of 2018 primarily driven by an increase in net interchange fees primarily due to higher purchase volume.
Provision for Credit Losses: The provision for credit losses decreased by $435 million to $1.0 billion in the third quarter of 2018 and decreased by $922 million to $3.7 billion in the first nine months of 2018 primarily driven by allowance releases in our domestic credit card loan portfolio due to improvements in credit trends.
Non-Interest Expense: Non-interest expense increased by $142 million to $2.1 billion in the third quarter of 2018 and increased by $238 million to $6.0 billion in the first nine months of 2018 primarily driven by higher marketing and operating expenses associated with loan growth and continued investments in technology and infrastructure.
Loans Held for Investment: Period-end loans held for investment decreased by $4.1 billion to $110.7 billion as of September 30, 2018 from December 31, 2017 as expected seasonal paydowns more than offset growth in our domestic credit card loan portfolio.
Average loans held for investment increased by $7.0 billion to $109.5 billion in the third quarter of 2018 compared to the third quarter of 2017 and increased by $7.7 billion to $109.0 billion in the first nine months of 2018 compared to the first nine months of 2017 primarily due to growth in our domestic credit card loan portfolio largely driven by loans obtained in the Cabela’s acquisition.
Net Charge-Off and Delinquency Metrics: The net charge-off rate decreased by 36 basis points to 4.15% in the third quarter of 2018 compared to the third quarter of 2017 and decreased by 23 basis points to 4.62% in the first nine months of 2018 compared to the first nine months of 2017 primarily driven by favorability realized from portfolio seasoning.
The 30+ day delinquency rate decreased by 19 basis points to 3.80% as of September 30, 2018 from December 31, 2017 primarily driven by improvements in credit trends in our domestic credit card loan portfolio.
Domestic Card Business
Domestic Card generated net income from continuing operations of $966 million and $2.5 billion in the third quarter and first nine months of 2018, respectively, compared to net income from continuing operations of $475 million and $1.2 billion in the third quarter and first nine months of 2017, respectively. In the third quarter and first nine months of 2018 and 2017, Domestic Card accounted for greater than 90% of total net revenue of our Credit Card business.

 
 
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Table 11.1 summarizes the financial results for Domestic Card and displays selected key metrics for the periods indicated.
Table 11.1: Domestic Card Business Results
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(Dollars in millions, except as noted)
 
2018
 
2017
 
Change
 
2018
 
2017
 
Change
Selected income statement data:
 
 
 
 
 
 
 
 
 
 
 
 
Net interest income
 
$
3,280

 
$
3,132

 
5
 %
 
$
9,617

 
$
9,236

 
4
 %
Non-interest income
 
819

 
787

 
4

 
2,411

 
2,288

 
5

Total net revenue(1)
 
4,099

 
3,919

 
5

 
12,028

 
11,524

 
4

Provision for credit losses
 
950

 
1,417

 
(33
)
 
3,424

 
4,381

 
(22
)
Non-interest expense
 
1,890

 
1,754

 
8

 
5,405

 
5,198

 
4

Income from continuing operations before income taxes
 
1,259

 
748

 
68

 
3,199

 
1,945

 
64

Income tax provision
 
293

 
273

 
7

 
745

 
710

 
5

Income from continuing operations, net of tax
 
$
966

 
$
475

 
103

 
$
2,454

 
$
1,235

 
99

Selected performance metrics:
 
 
 
 
 
 
 
 
 
 
 
 
Average loans held for investment(2)
 
$
100,566

 
$
93,729

 
7

 
$
99,970

 
$
92,847

 
8

Average yield on loans held for investment(3)
 
15.73
%
 
15.51
%
 
22
bps
 
15.29
%
 
15.20
%
 
9
bps
Total net revenue margin(4)
 
16.30

 
16.72

 
(42
)
 
16.04

 
16.55

 
(51
)
Net charge-offs
 
$
1,094

 
$
1,087

 
1
 %
 
$
3,581

 
$
3,455

 
4
 %
Net charge-off rate
 
4.35
%
 
4.64
%
 
(29
)bps
 
4.78
%
 
4.96
%
 
(18
)bps
Purchase volume(5)
 
$
89,205

 
$
76,806

 
16
 %
 
$
257,340

 
$
219,537

 
17
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
(Dollars in millions, except as noted)
 
September 30, 2018
 
December 31, 2017
 
Change
 
 
 
 
 
 
Selected period-end data:
 
 
 
 
 
 
 
 
 
 
 
 
Loans held for investment(2)
 
$
101,564

 
$
105,293

 
(4
)%
 
 
 
 
 
 
30+ day delinquency rate
 
3.80
%
 
4.01
%
 
(21
)bps
 
 
 
 
 
 
Allowance for loan and lease losses
 
$
5,116

 
$
5,273

 
(3
)%
 
 
 
 
 
 
Allowance coverage ratio
 
5.04
%
 
5.01
%
 
3