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CAPITAL ONE FINANCIAL CORP - Quarter Report: 2018 June (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 June 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 and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted 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 and post 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
 
¨ (Do not check if a smaller reporting company)
 
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 June 30, 2018, there were 478,425,026 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.
Controls and Procedures
 
 
 

 
 
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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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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 June 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 June 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, including 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.
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.

 
 
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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 second quarter and first six months of 2018 and 2017 and selected comparative balance sheet data as of June 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 June 30,
 
Six Months Ended June 30,
(Dollars in millions, except per share data and as noted)
 
2018
 
2017
 
Change
 
2018
 
2017
 
Change
Income statement
 
 
 
 
 
 
 
 
 
 
 
 
Net interest income
 
$
5,551

 
$
5,473

 
1
 %
 
$
11,269

 
$
10,947

 
3
 %
Non-interest income
 
1,641

 
1,231

 
33

 
2,832

 
2,292

 
24

Total net revenue
 
7,192

 
6,704

 
7

 
14,101

 
13,239

 
7

Provision for credit losses
 
1,276

 
1,800

 
(29
)
 
2,950

 
3,792

 
(22
)
Non-interest expense:
 
 
 
 
 
 
 
 
 
 
 
 
Marketing
 
425

 
435

 
(2
)
 
839

 
831

 
1

Operating expenses
 
2,999

 
2,979

 
1

 
6,158

 
6,017

 
2

Total non-interest expense
 
3,424

 
3,414

 

 
6,997

 
6,848

 
2

Income from continuing operations before income taxes
 
2,492

 
1,490

 
67

 
4,154

 
2,599

 
60

Income tax provision
 
575

 
443

 
30

 
894

 
757

 
18

Income from continuing operations, net of tax
 
1,917

 
1,047

 
83

 
3,260

 
1,842

 
77

Income (loss) from discontinued operations, net of tax
 
(11
)
 
(11
)
 

 
(8
)
 
4

 
**

Net income
 
1,906

 
1,036

 
84

 
3,252

 
1,846

 
76

Dividends and undistributed earnings allocated to participating securities
 
(12
)
 
(8
)
 
50

 
(23
)
 
(13
)
 
77

Preferred stock dividends
 
(80
)
 
(80
)
 

 
(132
)
 
(133
)
 
(1
)
Net income available to common stockholders
 
$
1,814

 
$
948

 
91

 
$
3,097

 
$
1,700

 
82

Common share statistics
 
 
 
 
 
 
 
 
 
 
 
 

Basic earnings per common share:
 
 
 
 
 
 
 
 
 
 
 
 
Net income from continuing operations
 
$
3.76

 
$
1.98

 
90
 %
 
$
6.39

 
$
3.51

 
82
 %
Income (loss) from discontinued operations
 
(0.02
)
 
(0.02
)
 

 
(0.02
)
 
0.01

 
**

Net income per basic common share
 
$
3.74

 
$
1.96

 
91

 
$
6.37

 
$
3.52

 
81

Diluted earnings per common share:
 
 
 
 
 
 
 
 
 
 
 
 
Net income from continuing operations
 
$
3.73

 
$
1.96

 
90

 
$
6.35

 
$
3.48

 
82

Income (loss) from discontinued operations
 
(0.02
)
 
(0.02
)
 

 
(0.02
)
 
0.01

 
**

Net income per diluted common share
 
$
3.71

 
$
1.94

 
91

 
$
6.33

 
$
3.49

 
81

Weighted-average common shares outstanding (in millions):
 
 
 
 
 
 
 
 
 
 
 
 
Basic
 
485.1

 
484.0

 

 
485.9

 
483.1

 
1
 %
Diluted
 
488.3

 
488.1

 

 
489.6

 
487.7

 

Common shares outstanding (period-end, in millions)
 
478.4

 
483.7

 
(1
)%
 
478.4

 
483.7

 
(1
)
Dividends declared and paid per common share
 
$
0.40

 
$
0.40

 

 
$
0.80

 
$
0.80

 

Tangible book value per common share (period-end)(1)
 
63.86

 
60.94

 
5

 
63.86

 
60.94

 
5

Balance sheet (average balances)
 
 
 
 
 
 
 
 
 
 
 
 
Loans held for investment
 
$
240,758

 
$
242,241

 
(1
)%
 
$
245,218

 
$
241,875

 
1
 %
Interest-earning assets
 
333,495

 
318,078

 
5

 
331,850

 
318,215

 
4

Total assets
 
363,929

 
349,891

 
4

 
362,988

 
350,761

 
3

Interest-bearing deposits
 
223,079

 
214,412

 
4

 
221,384

 
213,696

 
4

Total deposits
 
248,790

 
240,550

 
3

 
247,040

 
239,555

 
3

Borrowings
 
52,333

 
48,838

 
7

 
53,454

 
51,085

 
5

Common equity
 
45,466

 
44,645

 
2

 
45,070

 
44,241

 
2

Total stockholders’ equity
 
49,827

 
49,005

 
2

 
49,431

 
48,602

 
2


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

Purchase volume(2)
 
$
97,392

 
$
83,079

 
17
 %
 
$
183,937

 
$
156,276

 
18
 %
Total net revenue margin(3)
 
8.63
%
 
8.43
%
 
20
bps
 
8.50
%
 
8.32
%
 
18
bps
Net interest margin(4)
 
6.66

 
6.88

 
(22
)
 
6.79

 
6.88

 
(9
)
Return on average assets
 
2.11

 
1.20

 
91

 
1.80

 
1.05

 
75

Return on average tangible assets(5)
 
2.20

 
1.25

 
95

 
1.87

 
1.10

 
77

Return on average common equity(6)
 
16.06

 
8.59

 
7
 %
 
13.78

 
7.67

 
6
 %
Return on average tangible common equity (“TCE”)(7)
 
23.99

 
13.09

 
11

 
20.70

 
11.75

 
9

Equity-to-assets ratio(8)
 
13.69

 
14.01

 
(32
)bps
 
13.62

 
13.86

 
(24
)bps
Non-interest expense as a percentage of average loans held for investment
 
5.69

 
5.64

 
5

 
5.71

 
5.66

 
5

Efficiency ratio(9)
 
47.61

 
50.92

 
(3
)%
 
49.62

 
51.73

 
(2
)%
Operating efficiency ratio(10)
 
41.70

 
44.44

 
(3
)
 
43.67

 
45.45

 
(2
)
Effective income tax rate from continuing operations
 
23.1

 
29.7

 
(7
)
 
21.5

 
29.1

 
(8
)
Net charge-offs
 
$
1,459

 
$
1,618

 
(10
)
 
$
3,077

 
$
3,128

 
(2
)
Net charge-off rate(11)
 
2.42
%
 
2.67
%
 
(25
)bps
 
2.51
%
 
2.59
%
 
(8
)bps
(Dollars in millions, except as noted)

June 30, 2018
 
December 31, 2017
 
Change
Balance sheet (period-end)
 
 
 
 
 
 
Loans held for investment
 
$
236,124

 
$
254,473

 
(7
)%
Interest-earning assets
 
332,167

 
334,124

 
(1
)
Total assets
 
363,989

 
365,693

 

Interest-bearing deposits
 
222,605

 
217,298

 
2

Total deposits
 
248,225

 
243,702

 
2

Borrowings
 
53,310

 
60,281

 
(12
)
Common equity
 
45,566

 
44,370

 
3

Total stockholders’ equity
 
49,926

 
48,730

 
2

Credit quality metrics
 
 
 
 
 


Allowance for loan and lease losses
 
$
7,368

 
$
7,502

 
(2
)%
Allowance as a percentage of loans held for investment (“allowance coverage ratio”)
 
3.12
%
 
2.95
%
 
17
bps
30+ day performing delinquency rate
 
2.88

 
3.23

 
(35
)
30+ day delinquency rate
 
3.05

 
3.48

 
(43
)
Capital ratios
 
 
 
 
 


Common equity Tier 1 capital(12)
 
11.1
%
 
10.3
%
 
80
bps
Tier 1 capital(12)
 
12.6

 
11.8

 
80

Total capital(12)
 
15.1

 
14.4

 
70

Tier 1 leverage(12)
 
10.3

 
9.9

 
40

Tangible common equity(13)
 
8.8

 
8.3

 
50

Supplementary leverage(12)
 
8.8

 
8.4

 
40

Other
 
 
 
 
 


Employees (period end, in thousands)
 
47.8

 
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 A —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 $1.9 billion ($3.71 per diluted common share) on total net revenue of $7.2 billion and net income of $3.3 billion ($6.33 per diluted common share) on total net revenue of $14.1 billion for the second quarter and first six months of 2018, respectively. In comparison, we reported net income of $1.0 billion ($1.94 per diluted common share) on total net revenue of $6.7 billion and net income of $1.8 billion ($3.49 per diluted common share) on total net revenue of $13.2 billion for the second quarter and first six months of 2017, respectively.
Our common equity Tier 1 capital ratio as calculated under the Basel III Standardized Approach, including transition provisions, was 11.1% and 10.3% as of June 30, 2018 and December 31, 2017, respectively. See “MD&A—Capital Management” below for additional information.
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 of $398 million to loans held for sale as of June 30, 2018. These actions resulted in a net gain of $400 million, including a benefit for credit losses of $46 million, which is reflected in the Other category.
On June 28, 2017, we announced that our Board of Directors authorized the repurchase of up to $1.85 billion of shares of our common stock from the third quarter of 2017 through the end of the second quarter of 2018. In December 2017, the Board of Directors reduced the authorized repurchases of our common stock to up to $1.0 billion for the remaining 2017 Comprehensive Capital Analysis and Review (“CCAR”) period, which ended June 30, 2018 (“2017 Stock Repurchase Program”). Through the end of the second quarter of 2018, we repurchased approximately $1.0 billion of shares of our common stock under the 2017 Stock Repurchase Program. Additionally, 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. See “MD&A—Capital Management—Dividend Policy and Stock Purchases” for additional information.
Below are additional highlights of our performance in the second quarter and first six months of 2018. These highlights are generally based on a comparison between the results of the second quarter and first six 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 June 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 $870 million to $1.9 billion in the second quarter of 2018 and increased by $1.4 billion to $3.3 billion in the first six months of 2018 primarily driven by:
lower provision for credit losses driven by the allowance releases in our domestic credit card and auto loan portfolios largely due to improvements in credit trends and lower charge-offs mainly due to elevated charge-offs in the second quarter of 2017 in our oil and gas and taxi medallion lending portfolios;
higher non-interest income largely driven by the net gain from the sale of the substantial majority of our consumer home loan portfolio; 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 due to the net effect of higher interest rates.
Loans Held for Investment:
Period-end loans held for investment decreased by $18.3 billion to $236.1 billion as of June 30, 2018 from December 31, 2017 primarily driven by the sale of the substantial majority of our consumer home loan portfolio and the transfer of the remaining portfolio to loans held for sale, as well as seasonal paydowns in our domestic credit card loan portfolio, partially offset by growth in our commercial and auto loan portfolios.
Average loans held for investment decreased by $1.5 billion to $240.8 billion in the second quarter of 2018 compared to the second quarter of 2017 primarily due to 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 being more than offset by the impact of the sale of the substantial majority of our consumer home loan portfolio and the transfer of the remaining portfolio to loans held for sale. These same factors drove average loans held for investment to increase by $3.3 billion to $245.2 billion in the first six months of 2018 compared to the first six months of 2017 as the growth in our domestic credit card and auto loan portfolios more than offset the impact of the sale of the substantial majority of our consumer home loan portfolio and the transfer of the remaining portfolio to loans held for sale.
Net Charge-Off and Delinquency Metrics: Our net charge-off rate decreased by 25 basis points to 2.42% in the second quarter of 2018 compared to the second quarter of 2017 and decreased by 8 basis points to 2.51% in the first six months of 2018 compared to the first six months of 2017 primarily driven by elevated charge-offs in the second quarter of 2017 in our oil and gas and taxi medallion lending portfolios.
Our 30+ day delinquency rate decreased by 43 basis points to 3.05% as of June 30, 2018 from December 31, 2017 primarily due to seasonally lower delinquency inventories in our domestic credit card and auto loan portfolios, partially offset by the sale of the substantial majority of our consumer home loan portfolio.
Allowance for Loan and Lease Losses: Our allowance for loan and lease losses decreased by $134 million to $7.4 billion as of June 30, 2018 from December 31, 2017 primarily driven by an allowance release in our auto loan portfolio largely due to improvements in credit trends and an allowance release due to the sale of the substantial majority of our consumer home loan portfolio.
The allowance coverage ratio increased by 17 basis points to 3.12% as of June 30, 2018 from December 31, 2017 primarily driven by lower loan balances largely due to the sale of the substantial majority of our consumer home loan portfolio and seasonal paydowns in our domestic credit card loan portfolio, partially offset by allowance releases in our auto and domestic credit card loan portfolios.

 
 
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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 continue to expect our 2018 corporate annual effective tax rate to be around 20% before discrete items.
After two years of significant improvement, we expect our annual 2018 operating efficiency ratio, net of adjusting items, 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 continue to expect marketing expense in 2018 will be higher than 2017, with essentially all of the increase coming in the second half of the year.
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 second quarter and first six 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.
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

 
 
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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 second quarter and first six 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 June 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
 
$
107,893

 
$
4,062

 
15.06
 %
 
$
100,043

 
$
3,787

 
15.14
%
Consumer banking
 
66,692

 
1,218

 
7.31

 
74,644

 
1,223

 
6.55

Commercial banking(2)
 
67,198

 
744

 
4.43

 
68,220

 
647

 
3.79

Other(2)
 
260

 
(35
)
 
(53.85
)
 
60

 
12

 
80.00

Total loans, including loans held for sale
 
242,043

 
5,989

 
9.90

 
242,967

 
5,669

 
9.33

Investment securities
 
79,829

 
539

 
2.70

 
68,857

 
433

 
2.52

Cash equivalents and other interest-earning assets
 
11,623

 
68

 
2.34

 
6,254

 
26

 
1.66

Total interest-earning assets
 
333,495

 
6,596

 
7.91

 
318,078

 
6,128

 
7.71

Cash and due from banks
 
3,596

 
 
 
 
 
3,314

 
 
 
 
Allowance for loan and lease losses
 
(7,536
)
 
 
 
 
 
(6,982
)
 
 
 
 
Premises and equipment, net
 
4,145

 
 
 
 
 
3,855

 
 
 
 
Other assets
 
30,229

 
 
 
 
 
31,626

 
 
 
 
Total assets
 
$
363,929

 
 
 
 
 
$
349,891

 
 
 
 
Liabilities and stockholders’ equity:
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
Deposits
 
$
223,079

 
$
622

 
1.12
 %
 
$
214,412

 
$
382

 
0.71
%
Securitized debt obligations
 
19,147

 
124

 
2.59

 
18,400

 
82

 
1.78

Senior and subordinated notes
 
32,250

 
289

 
3.58

 
27,821

 
179

 
2.57

Other borrowings and liabilities
 
4,132

 
10

 
0.97

 
3,656

 
12

 
1.31

Total interest-bearing liabilities
 
278,608

 
1,045

 
1.50

 
$
264,289

 
655

 
0.99

Non-interest-bearing deposits
 
25,711

 
 
 
 
 
26,138

 
 
 
 
Other liabilities
 
9,783

 
 
 
 
 
10,459

 
 
 
 
Total liabilities
 
314,102

 
 
 
 
 
300,886

 
 
 
 
Stockholders’ equity
 
49,827

 
 
 
 
 
49,005

 
 
 
 
Total liabilities and stockholders’ equity
 
$
363,929

 
 
 
 
 
$
349,891

 
 
 
 
Net interest income/spread
 
$
5,551

 
6.41

 
 
 
$
5,473

 
6.72

Impact of non-interest-bearing funding
 
0.25

 
 
 
 
 
0.16

Net interest margin
 
6.66
 %
 
 
 
 
 
6.88
%

 
 
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Six Months Ended June 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
 
$
108,693

 
$
8,235

 
15.15
 %
 
$
100,603

 
$
7,577

 
15.06
%
Consumer banking
 
70,875

 
2,504

 
7.07

 
74,081

 
2,413

 
6.51

Commercial banking(2)
 
66,590

 
1,427

 
4.29

 
67,863

 
1,262

 
3.72

Other(2)
 
293

 
(43
)
 
(29.35
)
 
63

 
43

 
136.51

Total loans, including loans held for sale
 
246,451

 
12,123

 
9.84

 
242,610

 
11,295

 
9.31

Investment securities
 
74,731

 
991

 
2.65

 
68,637

 
849

 
2.47

Cash equivalents and other interest-earning assets
 
10,668

 
119

 
2.23

 
6,968

 
54

 
1.55

Total interest-earning assets
 
331,850

 
13,233

 
7.98

 
318,215

 
12,198

 
7.67

Cash and due from banks
 
3,704

 
 
 
 
 
3,400

 
 
 
 
Allowance for loan and lease losses
 
(7,520
)
 
 
 
 
 
(6,749
)
 
 
 
 
Premises and equipment, net
 
4,142

 
 
 
 
 
3,826

 
 
 
 
Other assets
 
30,812

 
 
 
 
 
32,069

 
 
 
 
Total assets
 
$
362,988

 
 
 
 
 
$
350,761

 
 
 
 
Liabilities and stockholders’ equity:
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
Deposits
 
$
221,384

 
$
1,161

 
1.05
 %
 
$
213,696

 
$
735

 
0.69
%
Securitized debt obligations
 
19,421

 
231

 
2.38

 
17,791

 
151

 
1.70

Senior and subordinated notes
 
31,345

 
540

 
3.45

 
26,321

 
328

 
2.49

Other borrowings and liabilities
 
5,483

 
32

 
1.17

 
7,981

 
37

 
0.93

Total interest-bearing liabilities
 
277,633

 
1,964

 
1.41

 
265,789

 
1,251

 
0.94

Non-interest-bearing deposits
 
25,656

 
 
 
 
 
25,859

 
 
 
 
Other liabilities
 
10,268

 
 
 
 
 
10,511

 
 
 
 
Total liabilities
 
313,557

 
 
 
 
 
302,159

 
 
 
 
Stockholders’ equity
 
49,431

 
 
 
 
 
48,602

 
 
 
 
Total liabilities and stockholders’ equity
 
$
362,988

 
 
 
 
 
$
350,761

 
 
 
 
Net interest income/spread
 
$
11,269

 
6.57

 
 
 
$
10,947

 
6.73

Impact of non-interest-bearing funding
 
0.22

 
 
 
 
 
0.15

Net interest margin
 
6.79
 %
 
 
 
 
 
6.88
%
__________
(1) 
Past due fees included in interest income totaled approximately $387 million and $790 million in the second quarter and first six months of 2018, respectively, and $382 million and $766 million in the second quarter and first six 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 $21 million and $41 million in the second quarter and first six months of 2018, respectively, and $32 million and $64 million in the second quarter and first six 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 June 30, 2018 include $2 million and $16 million, respectively, and for the six months ended June 30, 2018 include $3 million and $46 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 $78 million to $5.6 billion in the second quarter of 2018 compared to the second quarter of 2017 and increased by $322 million to $11.3 billion in the first six months of 2018 compared to the first six 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 the net effect of higher interest rates.
Net interest margin decreased by 22 basis points to 6.66% in the second quarter of 2018 compared to the second quarter of 2017 and decreased by 9 basis points to 6.79% in the first six months of 2018 compared to the first six months of 2017 primarily driven by higher interest expense due to the net effect of 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 June 30,
 
Six Months Ended June 30,
 
 
2018 vs. 2017
 
2018 vs. 2017
(Dollars in millions)
 
Total Variance
 
Volume
 
Rate
 
Total Variance
 
Volume
 
Rate
Interest income:
 
 
 
 
 
 
 
 
 
 
 
 
Loans:(1)
 
 
 
 
 
 
 
 
 
 
 
 
Credit card
 
$
275

 
$
296

 
$
(21
)
 
$
658

 
$
613

 
$
45

Consumer banking
 
(5
)
 
(130
)
 
125

 
91

 
(104
)
 
195

Commercial banking(2)
 
97

 
(10
)
 
107

 
165

 
(24
)
 
189

Other(2)
 
(47
)
 
(27
)
 
(20
)
 
(86
)
 
(34
)
 
(52
)
Total loans, including loans held for sale
 
320

 
129

 
191

 
828

 
451

 
377

Investment securities
 
106

 
72

 
34

 
142

 
78

 
64

Cash equivalents and other interest-earning assets
 
42

 
27

 
15

 
65

 
34

 
31

Total interest income
 
468

 
228

 
240

 
1,035

 
563

 
472

Interest expense:
 
 
 
 
 
 
 
 
 
 
 
 
Deposits
 
240

 
16

 
224

 
426

 
27

 
399

Securitized debt obligations
 
42

 
3

 
39

 
80

 
15

 
65

Senior and subordinated notes
 
110

 
32

 
78

 
212

 
70

 
142

Other borrowings and liabilities
 
(2
)
 
1

 
(3
)
 
(5
)
 
(12
)
 
7

Total interest expense
 
390

 
52

 
338

 
713

 
100

 
613

Net interest income
 
$
78

 
$
176

 
$
(98
)
 
$
322

 
$
463

 
$
(141
)
__________
(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 second quarter and first six months of 2018 and 2017.
Table 4: Non-Interest Income
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(Dollars in millions)
 
2018
 
2017
 
2018
 
2017
Interchange fees, net
 
$
723

 
$
676

 
$
1,366

 
$
1,246

Service charges and other customer-related fees
 
391

 
418

 
823

 
789

Net securities gains (losses)
 
(1
)
 
(4
)
 
7

 
(4
)
Other non-interest income:
 
 
 
 
 
 
 
 
Mortgage banking revenue
 
440

 
41

 
478

 
110

Treasury and other investment income
 
38

 
36

 
46

 
50

Other
 
50

 
64

 
112

 
101

Total other non-interest income
 
528

 
141

 
636

 
261

Total non-interest income
 
$
1,641

 
$
1,231

 
$
2,832

 
$
2,292

Non-interest income increased by $410 million to $1.6 billion in the second quarter of 2018 compared to the second quarter of 2017 and increased by $540 million to $2.8 billion in the first six months of 2018 compared to the first six months of 2017 primarily driven by:
the net gain from the sale of the substantial majority of our consumer home loan portfolio; and
an increase in net interchange fees primarily due to higher purchase volume.
Provision for Credit Losses
Our provision for credit losses in each period is driven by net charge-offs and 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 $3.0 billion in the second quarter and first six months of 2018, respectively, compared to $1.8 billion and $3.8 billion in the second quarter and first six months of 2017, respectively. The provision for credit losses as a percentage of net interest income was 23.0% and 26.2% in the second quarter and first six months of 2018, respectively, compared to 32.9% and 34.6% in the second quarter and first six months of 2017, respectively.
Our provision for credit losses decreased by $524 million in the second quarter of 2018 compared to the second quarter of 2017 and decreased by $842 million in the first six months of 2018 compared to the first six months of 2017 primarily driven by:
allowance releases in our domestic credit card and auto loan portfolios largely due to improvements in credit trends; and
elevated charge-offs in the second quarter of 2017 in our oil and gas and taxi medallion lending portfolios.
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 second quarter and first six months of 2018 and 2017.
Table 5: Non-Interest Expense
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(Dollars in millions)
 
2018
 
2017
 
2018
 
2017
Salaries and associate benefits
 
$
1,430

 
$
1,383

 
$
2,950

 
$
2,854

Occupancy and equipment
 
503

 
474

 
993

 
945

Marketing
 
425

 
435

 
839

 
831

Professional services
 
234

 
279

 
444

 
526

Communications and data processing
 
317

 
289

 
623

 
577

Amortization of intangibles
 
43

 
61

 
87

 
123

Other non-interest expense:
 
 
 
 
 
 
 
 
Bankcard, regulatory and other fee assessments
 
65

 
146

 
234

 
282

Collections
 
104

 
88

 
212

 
173

Fraud losses
 
89

 
78

 
186

 
156

Other
 
214

 
181

 
429

 
381

Total other non-interest expense
 
472

 
493

 
1,061

 
992

Total non-interest expense
 
$
3,424

 
$
3,414

 
$
6,997

 
$
6,848

Non-interest expense remained flat at $3.4 billion in the second quarter of 2018.
Non-interest expense increased by $149 million to $7.0 billion in the first six months of 2018 compared to the first six months of 2017 primarily due to:
higher operating expenses associated with loan growth, as well as continued investments in technology and infrastructure; and
restructuring activities, which primarily consisted of severance and related benefits pursuant to our ongoing benefit programs, that are the result of exiting certain business activities and locations.
These increases were partially offset by lower bankcard, regulatory and other fee assessments.
Income Taxes
We recorded income tax provisions of $575 million (23.1% effective income tax rate) and $894 million (21.5% effective income tax rate) in the second quarter and first six months of 2018, respectively, compared to $443 million (29.7% effective income tax rate) and $757 million (29.1% effective income tax rate) in the second quarter and first six months of 2017, respectively.
The decrease in our effective income tax rate in the second quarter and first six months of 2018 compared to the second quarter and first six 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 discrete tax expense.
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 $1.7 billion to $364.0 billion as of June 30, 2018 from December 31, 2017 primarily attributable to a decrease in loans held for investment driven by the sale of the substantial majority 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 and auto loan portfolios.
Total liabilities decreased by $2.9 billion to $314.1 billion as of June 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. This decrease was partially offset by:
deposit growth in our Consumer Banking business; and
net issuances of senior and subordinated notes.
Stockholders’ equity increased by $1.2 billion to $49.9 billion as of June 30, 2018 from December 31, 2017 primarily due to our net income of $3.3 billion in the first six 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 six 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 June 30, 2018 and December 31, 2017, respectively.
The fair value of our available for sale securities portfolio increased by $13.0 billion to $50.7 billion as of June 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 $3.7 billion to $33.1 billion as of June 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 June 30, 2018 and December 31, 2017.
Table 6: Investment Securities
 
 
June 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
 
$
8,603

 
$
8,624

 
$
5,168

 
$
5,171

RMBS:
 
 
 
 
 
 
 
 
Agency
 
34,870

 
33,742

 
26,013

 
25,678

Non-agency
 
1,563

 
1,940

 
1,722

 
2,114

Total RMBS
 
36,433

 
35,682

 
27,735

 
27,792

Agency CMBS
 
4,858

 
4,763

 
3,209

 
3,175

Other ABS
 
296

 
294

 
513

 
512

Other securities(1)
 
1,331

 
1,328

 
1,003

 
1,005

Total investment securities available for sale
 
$
51,521

 
$
50,691

 
$
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
 
$
30,377

 
$
30,108

 
24,980

 
25,395

Agency CMBS
 
3,087

 
2,989

 
3,804

 
3,842

Total investment securities held to maturity
 
$
33,464

 
$
33,097

 
$
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 June 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 June 30, 2018 and December 31, 2017, respectively, while approximately 2% and 3% was below investment grade as of June 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 June 30, 2018 and December 31, 2017.
Table 7: Non-Agency Investment Securities Credit Ratings
 
 
June 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
 
$
1,940

 

 
6
%
 
94
%
 
$
2,114

 

 
3
%
 
97
%
Other ABS
 
294

 
59
%
 

 
41

 
512

 
100
%
 

 

Other securities
 
1,328

 
88

 
12

 

 
1,005

 
71

 
19

 
10

__________
(1) 
Includes investment securities that were not rated by S&P as of June 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 six 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 June 30, 2018 and December 31, 2017.
Table 8: Loans Held for Investment
 
 
June 30, 2018
 
December 31, 2017
(Dollars in millions)
 
Loans
 
Allowance
 
Net Loans
 
Loans
 
Allowance
 
Net Loans
Credit Card
 
$
109,777

 
$
5,624

 
$
104,153

 
$
114,762

 
$
5,648

 
$
109,114

Consumer Banking
 
58,727

 
1,120

 
57,607

 
75,078

 
1,242

 
73,836

Commercial Banking
 
67,609

 
624

 
66,985

 
64,575

 
611

 
63,964

Other
 
11

 

 
11

 
58

 
1

 
57

Total
 
$
236,124

 
$
7,368

 
$
228,756

 
$
254,473

 
$
7,502

 
$
246,971

Loans held for investment decreased by $18.3 billion to $236.1 billion as of June 30, 2018 from December 31, 2017 primarily driven by the sale of the substantial majority of our consumer home loan portfolio and the transfer of the remaining portfolio to loans held for sale and expected seasonal paydowns in our domestic credit card loan portfolio, partially offset by growth in our commercial and auto 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 June 30, 2018 and December 31, 2017.
Table 9: Funding Sources Composition
 
 
June 30, 2018
 
December 31, 2017
(Dollars in millions)
 
Amount
 
% of Total
 
Amount
 
% of Total
Deposits:(1)
 
 
 
 
 
 
 
 
Consumer Banking
 
$
194,962

 
65
%
 
$
185,842

 
61
%
Commercial Banking
 
31,078

 
10

 
33,938

 
11

Other
 
22,185

 
7

 
23,922

 
8

Total deposits
 
248,225

 
82

 
243,702

 
80

Securitized debt obligations
 
19,649

 
7

 
20,010

 
7

Other debt
 
33,661

 
11

 
40,271

 
13

Total funding sources
 
$
301,535

 
100
%
 
$
303,983

 
100
%
__________
(1) 
Includes brokered deposits of $23.3 billion and $25.1 billion as of June 30, 2018 and December 31, 2017, respectively.
Total deposits increased by $4.5 billion to $248.2 billion as of June 30, 2018 from December 31, 2017 primarily driven by growth in our deposit products that are sold to both existing and new customers in our Consumer Banking business.
Securitized debt obligations remained relatively flat at $19.6 billion as of June 30, 2018.
Other debt decreased by $6.6 billion to $33.7 billion as of June 30, 2018 from December 31, 2017 primarily driven by a decrease in our FHLB advances outstanding, partially offset by senior and subordinated notes issuances.
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.

 
 
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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 second quarter and first six 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 June 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 second quarter and first six months of 2018 and 2017.
Table 10: Business Segment Results
 
 
Three Months Ended June 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
 
$
4,280

 
59
%
 
$
923

 
48
%
 
$
4,169

 
63
%
 
$
553

 
53
%
Consumer Banking
 
1,784

 
25

 
539

 
28

 
1,761

 
26

 
276

 
26

Commercial Banking(3)(4)
 
758

 
11

 
242

 
13

 
752

 
11

 
146

 
14

Other(3)(4)
 
370

 
5

 
213

 
11

 
22

 

 
72

 
7

Total
 
$
7,192

 
100
%
 
$
1,917

 
100
%
 
$
6,704

 
100
%
 
$
1,047

 
100
%
 
 
Six Months Ended June 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
 
$
8,695

 
62
%
 
$
1,630

 
50
%
 
$
8,253

 
63
%
 
$
824

 
45
%
Consumer Banking
 
3,573

 
25

 
965

 
30

 
3,473

 
26

 
524

 
28

Commercial Banking(3)(4)
 
1,481

 
11

 
498

 
15

 
1,476

 
11

 
359

 
20

Other(3)(4)
 
352

 
2

 
167

 
5

 
37

 

 
135

 
7

Total
 
$
14,101

 
100
%
 
$
3,260

 
100
%
 
$
13,239

 
100
%
 
$
1,842

 
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 $28 million and $56 million in revenue in our Commercial Banking business in the second quarter and first six 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 $923 million and $1.6 billion in the second quarter and first six months of 2018, respectively, and $553 million and $824 million in the second quarter and first six 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 June 30,
 
Six Months Ended June 30,
(Dollars in millions, except as noted)
 
2018
 
2017
 
Change
 
2018
 
2017
 
Change
Selected income statement data:
 
 
 
 
 
 
 
 
 
 
 
 
Net interest income
 
$
3,396

 
$
3,294

 
3
 %
 
$
6,954

 
$
6,640

 
5
 %
Non-interest income
 
884

 
875

 
1

 
1,741

 
1,613

 
8

Total net revenue(1)
 
4,280

 
4,169

 
3

 
8,695

 
8,253

 
5

Provision for credit losses
 
1,171

 
1,397

 
(16
)
 
2,627

 
3,114

 
(16
)
Non-interest expense
 
1,904

 
1,918

 
(1
)
 
3,943

 
3,847

 
2

Income from continuing operations before income taxes
 
1,205

 
854

 
41

 
2,125

 
1,292

 
64

Income tax provision
 
282

 
301

 
(6
)
 
495

 
468

 
6

Income from continuing operations, net of tax
 
$
923

 
$
553

 
67

 
$
1,630

 
$
824

 
98

Selected performance metrics:
 
 
 
 
 
 
 
 
 
 
 
 
Average loans held for investment(2)
 
$
107,893

 
$
100,043

 
8

 
$
108,693

 
$
100,603

 
8

Average yield on loans held for investment(3)
 
15.06
%
 
15.14
%
 
(8
)bps
 
15.15
%
 
15.06
%
 
9
bps
Total net revenue margin(4)
 
15.87

 
16.67

 
(80
)
 
16.00

 
16.41

 
(41
)
Net charge-offs
 
$
1,260

 
$
1,256

 

 
$
2,637

 
$
2,527

 
4
 %
Net charge-off rate
 
4.67
%
 
5.02
%
 
(35
)bps
 
4.85
%
 
5.02
%
 
(17
)bps
Purchase volume(5)
 
$
97,392

 
$
83,079

 
17
 %
 
$
183,937

 
$
156,276

 
18
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
(Dollars in millions, except as noted)
 
June 30,
2018
 
December 31, 2017
 
Change
 
 
 
 
 
 
Selected period-end data:
 
 
 
 
 
 
 
 
 
 
 
 
Loans held for investment(2)
 
$
109,777

 
$
114,762

 
(4
)%
 
 
 
 
 

30+ day performing delinquency rate
 
3.32
%
 
3.98
%
 
(66
)bps
 
 
 
 
 


30+ day delinquency rate
 
3.33

 
3.99

 
(66
)
 
 
 
 
 

Nonperforming loan rate(6)
 
0.02

 
0.02

 

 
 
 
 
 


Allowance for loan and lease losses
 
$
5,624

 
$
5,648

 

 
 
 
 
 

Allowance coverage ratio
 
5.12
%
 
4.92
%
 
20
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 $309 million and $644 million in the second quarter and first six months of 2018, respectively, and by $313 million and $634 million in the second quarter and first six 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 $416 million and $491 million as of June 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 second quarter and first six months of 2018 compared to the second quarter and first six months of 2017, and changes in financial condition and credit performance between June 30, 2018 and December 31, 2017 include the following:
Net Interest Income: Net interest income increased by $102 million to $3.4 billion in the second quarter of 2018 and increased by $314 million to $7.0 billion in the first six 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 was substantially flat at $884 million in the second quarter of 2018 as an increase in net interchange fees primarily due to higher purchase volume was offset by lower service charges and other customer-related fees.
Non-interest income increased by $128 million to $1.7 billion in the first six months of 2018 primarily driven by an increase in net interchange fees due to higher purchase volume.
Provision for Credit Losses: The provision for credit losses decreased by $226 million to $1.2 billion in the second quarter of 2018 and decreased by $487 million to $2.6 billion in the first six months of 2018 primarily driven by an allowance release in our domestic credit card loan portfolio largely due to improvements in credit trends .
Non-Interest Expense: Non-interest expense was substantially flat at $1.9 billion in the second quarter of 2018.
Non-interest expense increased by $96 million to $3.9 billion in the first six months of 2018 primarily driven by higher operating expenses associated with loan growth and continued investments in technology and infrastructure, as well as costs associated with the acquired Cabela’s portfolio.
Loans Held for Investment: Period-end loans held for investment decreased by $5.0 billion to $109.8 billion as of June 30, 2018 from December 31, 2017 primarily due to expected seasonal paydowns in our domestic credit card loan portfolio.
Average loans held for investment increased by $7.9 billion to $107.9 billion in the second quarter of 2018 compared to the second quarter of 2017 and increased by $8.1 billion to $108.7 billion in the first six months of 2018 compared to the first six 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 35 basis points to 4.67% in the second quarter of 2018 compared to the second quarter of 2017 primarily driven by the loans obtained in the Cabela’s acquisition, which have a lower charge-off rate, and favorability realized from portfolio seasoning.
The net charge-off rate decreased by 17 basis points to 4.85% in the first six months of 2018 compared to the first six months of 2017 primarily driven by the loans obtained in the Cabela’s acquisition, which have a lower charge-off rate.
The 30+ day delinquency rate decreased by 66 basis points to 3.33% as of June 30, 2018 from December 31, 2017 primarily driven by seasonally lower delinquency inventories and improvements in credit trends in our domestic credit card loan portfolio.
Domestic Card Business
Domestic Card generated net income from continuing operations of $881 million and $1.5 billion in the second quarter and first six months of 2018, respectively, compared to net income from continuing operations of $482 million and $760 million in the second quarter and first six months of 2017, respectively. In the second quarter and first six 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 June 30,
 
Six Months Ended June 30,
(Dollars in millions, except as noted)
 
2018
 
2017
 
Change
 
2018
 
2017
 
Change
Selected income statement data:
 
 
 
 
 
 
 
 
 
 
 
 
Net interest income
 
$
3,108

 
$
3,011

 
3
 %
 
$
6,337

 
$
6,104

 
4
 %
Non-interest income
 
818

 
802

 
2

 
1,592

 
1,501

 
6

Total net revenue(1)
 
3,926

 
3,813

 
3

 
7,929

 
7,605

 
4

Provision for credit losses
 
1,094

 
1,327

 
(18
)
 
2,474

 
2,964

 
(17
)
Non-interest expense
 
1,683

 
1,727

 
(3
)
 
3,515

 
3,444

 
2

Income from continuing operations before income taxes
 
1,149

 
759

 
51

 
1,940

 
1,197

 
62

Income tax provision
 
268

 
277

 
(3
)
 
452

 
437

 
3

Income from continuing operations, net of tax
 
$
881

 
$
482

 
83

 
$
1,488

 
$
760

 
96

Selected performance metrics:
 
 
 
 
 
 
 
 
 
 
 
 
Average loans held for investment(2)
 
$
98,895

 
$
91,769

 
8

 
$
99,668

 
$
92,398

 
8

Average yield on loans held for investment(3)
 
15.05
%
 
15.07
%
 
(2
)bps
 
15.07
%
 
15.04
%
 
3
bps
Total net revenue margin(4)
 
15.88

 
16.62

 
(74
)
 
15.91

 
16.46

 
(55
)
Net charge-offs
 
$
1,166

 
$
1,172

 
(1
)%
 
$
2,487

 
$
2,368

 
5
 %
Net charge-off rate
 
4.72
%
 
5.11
%
 
(39
)bps
 
4.99
%
 
5.12
%
 
(13
)bps
Purchase volume(5)
 
$
88,941

 
$
75,781

 
17
 %
 
$
168,135

 
$
142,731

 
18
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
(Dollars in millions, except as noted)
 
June 30,
2018
 
December 31, 2017
 
Change
 
 
 
 
 
 
Selected period-end data:
 
 
 
 
 
 
 
 
 
 
 
 
Loans held for investment(2)
 
$
100,714

 
$
105,293

 
(4
)%
 
 
 
 
 
 
30+ day delinquency rate
 
3.32
%
 
4.01
%
 
(69
)bps
 
 
 
 
 
 
Allowance for loan and lease losses
 
$
5,260

 
$
5,273

 

 
 
 
 
 
 
Allowance coverage ratio
 
5.22
%
 
5.01
%
 
21
bps