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.

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:

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.

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.

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

** Not meaningful.

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 .”

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.

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 .

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:

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.

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

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.

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	%