--Agency also fined two bank executives
--Bank says settlement will not affect current or future business activities
(Updated with details from order in paragraphs eight and 11 and analyst comment in paragraphs 17 and 18.)
By Andrew R. JohnsonThe Securities and Exchange Commission Wednesday fined Capital One Financial Corp. (COF) $3.5 million for alleged lapses in how the lender reserved for potential losses on auto loans prior to the financial crisis.
In an enforcement action, the regulator said Capital One failed to set aside an appropriate amount of money when auto-loan losses turned higher than the company originally estimated. It also said two Capital One executives agreed to settle charges against them.
"Capital One failed in this responsibility by underreporting expenses relating to its loan losses even as its own internal forecasting tool had signaled an increase in incurred losses due to the impending financial crisis," said George Canellos, co-director of the division of enforcement for the SEC.
A spokeswoman for the McLean, Va., company said Wednesday no consumers were affected by the actions and the settlement doesn't require it to restate its financial results.
"The settlement will not affect any current or future business activities by Capital One," the spokeswoman said.
According to the SEC, Capital One's auto-finance business experienced "significantly higher" loan charge-offs and delinquencies on its loans than it originally forecasted.
In its order, the agency said the bank had determined the elevated losses were due to external economic factors, which would have resulted in Capital One adding $72 million to its reserve for loan losses in the second quarter of 2007 by year end. Because it failed to do so, Capital One should have added $85 million to its allowance for third-quarter 2007 loan losses by year end.
As a result, the bank's consolidated provision for loan and lease losses was understated by about 18% in the second quarter and by about 9% in the third quarter, the order said.
Lenders set money aside in reserves to account for future losses on loans that could go bad. Since the financial crisis, banks have boosted their profits in part by releasing such funds from their reserves as loan losses have declined.
The Financial Accounting Standards Board last year proposed changes that would require U.S. banks to record expected losses more quickly and increase the size of their reserves.
Capital One's total loan-loss expense in the second quarter of 2007 would have been $473 million, or 18% higher than it reported for that period, had it factored in the external factors. The bank's total net income would have been 7% lower, at $699 million, than it reported for the period.
The SEC also said Peter Schnall, the former chief risk officer of Capital One, failed to communicate such issues to the senior management and David LaGassa, the former credit officer for the auto-finance business, failed to ensure the external factors were included in the loss forecast for the auto business.
Mr. Schnall agreed to pay an $85,000 fine and Mr. LaGassa agreed to pay a $50,000 fine to settle the allegations. The bank and the executives neither admitted nor denied the findings.
The Capital One spokeswoman said the bank "continues to have confidence in Mr. Schnall and Mr. LaGassa and we believe that they can perform in their current roles with the company," she said.
Mr. LaGassa is currently a managing vice president in Capital One's financial-services division.
In October, Capital One announced Mr. Schnall planned to step down as chief risk officer but would remain with the company in a senior advisory role through this year. "His change of position and planned departure are not related to the SEC action," the spokeswoman said.
Sanjay Sakhrani, an analyst with KBW, said the impact of the settlement on Capital One was minimal.
"While not a positive headline, we don't view the settlement as material," Mr. Sakhrani wrote in a research note on Wednesday.
Capital One's shares were up 1% at $56.88 in recent trading. The shares are down 1.8% this year.
The SEC settlement is the latest regulatory action against the bank, which generates the bulk of its money through credit-card lending.
Last July, Capital One agreed to pay $210 million to settle allegations by the Consumer Financial Protection Bureau and Office of the Comptroller of the Currency that it failed to monitor third-party sales of add-on products, such as payment protection and identity-theft monitoring, to credit-card customers.
That same month it agreed to pay about $12 million in a settlement with the U.S. Justice Department and OCC stemming from payment collection and other activities involving active-duty military borrowers.
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