Capital One Financial Corporation (COF) Earnings Call Transcript & Summary

Okay. Thanks, everybody, for joining us this afternoon. I am pleased to have with me today, Richard Fairbank, Chairman and CEO of Capital One; and Scott Blackley, CFO of Capital One. Gentlemen, thanks for joining me this afternoon.

Thank you, Betsy, and good afternoon to everyone.

So I do have to read the disclosure statement. For important disclosures, please see Morgan Stanley Research disclosure website at morganstanley.com/researchdisclosures. And if you have any questions, please reach out to your Morgan Stanley sales rep. So Rich, wanted to, again, say thank you very much for joining us this afternoon here at the Morgan Stanley Virtual Financials Conference.

A couple of key topics we want to dig into. How are clients behaving? What does it mean for your credit outlook? How are you running the firm? And discuss a little bit about capital. So in the half hour that we have here today, let's just kick off on how clients are behaving. What do their deferral requests and payments tell you about the outlook for the economy?

So Betsy, I've always been struck by how rational consumers are. And I often joke that there's truth in this joke because I think consumers are a lot more rational than the institutions that serve them. Heading into the pandemic, the consumer was in a solid and really balanced position. There's obviously a huge radiant in behaviors across customers. But so far, consumers are behaving, like they have in prior downturns, being more conservative, battening down the hatches, pulling back on spending, increasing their savings if they have the ability to do so, and paying their debts and sometimes paying down the debts. And I think the general consumer behaviors we've seen in downturns are magnified here because of, I think, when you go into sort of a vertical descent, like we have, rather than the -- think about the Great Recession, what a gradual entry into that it was, I think the behaviors are magnified. So one recent trend that we've seen is a rebound though in purchase volume in our Domestic Card business. So purchase volume is still down year-over-year, very consistent with cautious consumer behavior. But in March -- in late March and early April, as people were really into that free fall, purchase volume was down about 30% year-over-year. Over the last couple of weeks, the decline was about 10% year-over-year. But I do want to point out one thing, that given that our purchase volume was up 13% year-over-year before March, the decline is greater than the numbers indicate. And I think all companies are going out giving year-over-year numbers. But I think that if you want to see the real impact, you kind of have to start with where they were right before that. So I think that the decline is greater than our year-over-year numbers indicate. On the credit side -- yes, go ahead, Betsy.

So it's just that consumer is being pretty conservative here. I guess the next question is just around how are you seeing differences between your corporate portfolio and your commercial real estate portfolio versus what your consumers are doing.

Yes. Well, can I just seize the moment for a second, Betsy, and just get to the other part of your first question, which was the deferral request? Let me just do that if I can. In Domestic Card, we currently offer forbearance to customers who are current or less than 60 days delinquent. And for card customers who enroll, we're allowing them to skip a payment with no late fee on a month-to-month basis, and the interest continues to accrue. For auto, we're offering short-term payment deferrals to both current and delinquent customers, as we've historically seen a reasonable portion of later-stage delinquent customers in that business end up making sufficient payments to become current again. Interest continues to accrue and payments are added through the end of the loan. So here's what we're seeing through the end of May. The volume of forbearance requests is slowing. So in our Domestic Card business, we had about 70,000 requests in the last week of May. That's down from about 175,000 requests in the final week in March. In auto, forbearance requests were trending at around 35,000 weekly requests at the end of May, down from the peak of 125,000 requests in the final week of March. The requests include accounts asking for forbearance for the first time as well as accounts renewing for another month. And over half of the requests for card and auto are renewals because we have this month-to-month program. As I mentioned on our earnings call, as of April 17, Domestic Card forbearance cumulative enrollments were about 1% of active accounts and 2% of loan balances. And in our auto business, about 9% of accounts and 11% of balances. At the end of May, the cumulative totals were about 2% of active accounts and 3% of loan balances in Domestic Card. And in auto, 13% of accounts and 15% of loans in -- yes. And roughly half of the cumulative enrollments in both Domestic Card and auto have made a payment. So would you like me to go on to your next question, Betsy, about the differences between the consumer portfolio and sort of the corporate and CRE portfolio? Would you like me to go into that?

Yes. That would be great. Thanks.

Yes. Okay. So let me start with consumer. I think the U.S. consumer is in a better shape than at the outset of the Great Recession. I mean consumer debt levels are lower than on a per capita basis. Payment obligations are lower still, supported by low interest rates. The savings rate over the past few years is double what it was before the Great Recession. And we're not dealing with a structural problem in the economy like the housing sector pre Great Recession. That had to work itself out over multiple years before we could really see a sustained recovery. And our card and auto businesses have both evolved since the Great Recession and are, I think, really well positioned sort of entering this downturn. We've talked about on the consumer side the very rational things that we're seeing in terms of their behavior. In corporate markets, as we flagged for a couple of years going into this downturn, there have been some increasing challenges in these markets: higher debt levels, lower interest coverage, weaker covenants and more aggressive add-backs that inflate borrowers' earnings. All of which feel substantially weaker than before the Great Recession. Although on the other hand, the banks have been a smaller part of this trend in increasing leverage, with capital markets and nonbanks taking an increasing share of the growth. In our commercial business, the primary direct exposure to COVID credit risk that we have is in the oil and gas portfolio due to the COVID-driven pressures on commodity prices. But sort of -- and we've provided some enhanced disclosures on energy exposure. Overall though, we're not seeing any sort of fires in our commercial business in the early stages of the downturn. Commercial line draws and deferral requests have both subsided from peaks in late March and early April. And outside of oil and gas, we have relatively little exposure to the direct COVID-impacted industry verticals.

Okay. So a little -- so maybe the customers are in not as good shape as they were precrisis in the '09 crisis, but you also don't have that much exposure to them. And also, I suppose on the oil and gas side, you've already made some nice reserves against that book of business. I wonder if we could take the next question just on how you're seeing your customers behave in the opened versus the locked-down economies. Is there any difference there, geographically speaking, that you're noticing?

Yes. I think it's going to be a very interesting thing to watch. I think it's still too early to see.

Okay. All right. Let's turn to just credit quality. With all of this as a backdrop, how do you think about your reserving given the experience that you're witnessing in the consumer book and in your corporate and C&I book? Do you feel like you...

Betsy, could you repeat that one?

Oh, yes, sure. Just from a credit quality perspective, wondering, taking all of this in, how the consumers and the corporates are behaving versus the 15%, well, it's really like 13.5% unemployment rate that we have, how do you think about reserving for what you're anticipating over the next year or so? Do you feel like you're reserved enough for the credit outlook that you've got today?

Yes. Sure. Betsy, I'm sure as you can imagine, this is a particularly tough time to try and estimate what will happen with losses and reserves from here. And I would just say that there's a few factors that we know or that we can estimate with confidence. And then there are some factors which are far less certain. I'll start off with what we know. So we know that the unemployment rate has reached levels that are well above the assumptions of peak unemployment that we had in Q1, which was in the mid-9% range. That was in the primary scenario we used there. So we're at a starting point with our Q2 allowance where that allowance is going to be based off of a higher unassumed level of employment. We also know that the credit results at Capital One, and really across the industry, have yet to really show adverse effects from COVID-related shutdown of economic activity. And we can pretty confidently conclude that the continued strength of the credit results is in part driven by the positive impact of the significant government stimulus and the broad-based forbearance, which has really been across the financial industry. So the thing that I would just point out here is that we really don't know how long the favorable impacts of stimulus and forbearance will sustain. And I expect that in our second quarter allowance, our assumptions will include less estimated benefit from stimulus to account for that uncertainty, which I think will be an important factor in the total size of our allowance. So when I kind of look at all of those factors together and bring it together, if I were doing our Q2 reserves today, I would expect a healthy allowance build. We're going to continue to look at economic information and indicators through the end of the quarter. We haven't run our full process, but that's where I see things if we were doing the allowance today.

And would you say your 1Q reserve build was healthy? I mean basically, I'm trying to ask the question as to how you think about it on a Q-on-Q basis.

Yes. I'm not going to dimension the size any further. I think that we will just have to wait and see exactly where that turns out.

Okay. Yes. Because your -- one of the questions is, does fiscal continue to occur? Do they extend the $600 a week? Those are the uncertainties that you're talking about.

That's correct. And I just think that's a really important -- there's a very important relationship. And I talked a little bit about this in our Q1 call, that you can't just really latch on to what is the unemployment scenario that you're using because the stimulus factor is going to be so important. And if we were to see some significant extension of stimulus, that would certainly drive down what allowances would be required. But given that we don't have clarity on that point at this juncture, I'm just not at a point where I can give you a specific number.

Got it. Okay. No. That's really helpful. The other part of this question has to do with how you are availing your capital to your clients. I mean are you at the stage where you're ready to lean in with new lending or increased lines? Are you making loans to new customers? Or are you on the flip side maybe pulling back on utilization rates? It would be helpful to understand how you're thinking about that.

So given the wide range of economic uncertainty and the significant downside risks and the concerns about adverse selection, we're taking a cautious approach to new lending for the time being. We have structured our business and our playbooks to always be testing and looking for inflection points to see where the opportunities for growth can come. And what we found in prior downturns, and I think it will be very much the case this time as well, it's not like the inflection point comes at one point across our business. There isn't such a thing as a single inflection point. When and how the opportunities will emerge will vary by product, customer segment and competitor behaviors. And in past recessions, we found that, that inflection point can vary by many months or even well beyond a year across different parts of our company. So pulling up, we're very closely monitoring and when and where these opportunities will present themselves. But right now, we're taking a pretty cautious approach.

And on your existing book, do you -- I mean I'm sure you're always looking at lines and line availability. But is there any tweaking going on there that's more than normal course?

No. I mean we're always managing at the individual customer level. But generally, in terms of line increases, we are being very cautious on those. They represent sort of potential energy that can be turned into kinetic energy at some point. But now we feel it's generally not the time. So we're being pretty careful on the management of credit lines.

Got it. Okay. So let's bring it up a level. Just trying to understand how you are running the firm, not just the exposures, but how you are running Capital One, both near term and longer term. So let's start with near term. What type of blocking and tackling can you do here on expenses or on some of your investments that you're making to flex for this credit and growth environment that we're in today?

So the first thing we're doing is very much focusing on the COVID response itself and managing the credit and resilience side of the business. That's been the #1 focus and where a lot of our energy has been put. We're also working very hard on how to, at a very granular level, be able to ascertain the risks in -- the credit risk and the credit risk of extending more credit for all the subsegments. And that's -- those are critical pieces of work because it drives how quickly we can resume the revenue growth of the company. In conjunction with that work, we're also pulling back. We pulled back on near-term marketing. And the marketing will be tied into where the growth opportunities are, of course. And so a big expense item that will vary here over time is the marketing. And we're also, on the expense side, tightening up on hiring. We're tightly managing operating expenses. And we're still very much going forward with our exit of our data centers on schedule here at the end of this year.

Okay. Great. All right. Just thinking a little bit longer term. As we get through this current environment, where do you want to be investing most for growth as we get through the current environment here, either in card, auto or maybe in the C&I and the CRE books? If you could speak to what your strategy is for that.

So I think all of the books -- all of those books will represent growth opportunities over time, but it will probably be in segments within each of those. And that's very consistent with what we did last year. And that -- because it's not only going to depend on how the economy is doing and how customers are doing. But it's really going to depend also on the competitive environment. So that will have to -- that's going to be line of scrimmage calls and will probably vary quite a bit across our portfolio. We are also though -- I very much want to stress in terms of the growth opportunities of our company. The foundation for that is we continue to go all-in on our tech transformation. And I think the importance of the tech transformation is underscored by and accelerated by the pandemic. So we are building technology from the ground up, which is a longer and harder process, but it creates shoulders to stand on for all the other growth opportunities that we have, for all the customer-facing technology that we're building. So we're in the eighth year of our all-in tech transformation. And as we emerge from the pandemic, we're confident that the benefits will increase across many dimensions. And the set of benefits, we've always talked about and we continue to see those benefits being faster to market, being able to offer better products and a better customer experience, being able to be -- have dramatically better risk management. And risk management really matters in terms of capitalizing on opportunities to grow on the other side of this because it is -- your opportunity is only as good as the -- some of the data and the risk management and the tech capabilities one has. But -- and over time, the tech transformation enabling us to do even more growth and get better efficiency as well. We are also continuing to invest in building and leveraging our brand to secure lasting and deeper relationships with our customers. So that's something we are continuing to invest in, and we're investing in it right as we speak. And as we've done from our founding days, we're hardwiring resilience into every choice that we make on credit, capital and liquidity, because we know from 2.5 decades of doing this, that it's the choices you make during the good times that have the most impact on how you weather the bad times. That's a core tenet of how we manage Capital One today. I think it's a reason that Capital One, I think, is in a good position as we enter this downturn and can put us in a -- collectively, the things I'm talking about, I think, give us a platform to really accelerate at the right time as this extraordinary marketplace and pandemic evolves.

Yes. On the tech side, you've been highlighting how over the next couple of years you'll be completing at least this phase, decade-long phase, of the investment spend you've been making. And I know that one of your recent partners, Walmart, did select you in part because of your tech skills. I guess the question I'm having with Walmart that I get from investors is, how do you leverage your new relationship with them? And given the fact that we're just at the beginning of this -- well, we're in this pandemic right now, at the beginning of your relationship with Walmart. Is that something that can give us a little bit more legs to growth as we reopen and come out of it? Basically, the question is, was there a little bit of holding back on growth with the partnership because of the environment that we found ourselves in at the beginning of all this?

Well, we are using the same credit policy basically for Walmart and with Walmart that we're using in the business. So a lot of the things that I've said more generally about credit also apply to our view there. Walmart shares in credit losses. We have found Walmart is completely aligned with us with respect to our credit choices. But we have a lot of momentum with Walmart in terms of putting all the pieces in place to make the card a more central part of the Walmart experience than it's been in the past. All other things being equal, the pandemic and the tightening of credit does slow things down a bit on some of the growth opportunities, but that's just an issue of timing. And the great thing is Walmart, and we see absolutely eye to eye on the choices that we're making on credit, the collective choices we're making on technology and the business objectives that we are both trying to achieve.

Got it. Okay. Two other questions here, one from the web and then we'll go on to capital. But one of the questions we're getting in from the web is around how you're expecting your portfolio to perform as your clients exit forbearance. I mean you've seen some clients exit forbearance here. Are they returning to performing? Are there -- when should the investors begin to expect the delinquency trends to start to come through as forborne loans begin to roll off over the next several quarters?

So I think that the thing that will -- first of all, we'll have to see. There's no way that we're going to be able to exactly predict this. But the first thing I would say is that we have quite a bit of experience with crisis-driven forbearance in prior hurricanes and most notably, in Hurricane Katrina, and so we -- where a lot of forbearance was granted, and we got a chance to see the before and after. Now a hurricane or even Katrina is not the same thing as this pandemic, but there were some similar things. And even in the Katrina case, there was also government stimulus and some things like that. Our experience has been a positive one to us. I guess we've been struck by when -- if you have a selection process that is -- where you can tell that the customers who are seeking the relief are doing it for the right reason, which I think they are today and they were back then, that we have been relative to maybe initial expectations pretty struck by how customers were -- how good the performance was with those that got the forbearance. The second thing I would say is you also see some key indicators already in what we and other companies are reporting that a fairly sizable number of folks who are on forbearance are already voluntarily paying anyway even though they're on it, which I think is a good sign. Where we've had particularly positive results on the forbearance is in the auto business where -- because as you get in the later stages of delinquency, it's not just the charge-off that's at stake. We're talking about a car and being able to have the car, all of this. So not only in terms of the importance to the consumer of this forbearance, but the ability to work with the consumer and come up with a soft landing and keep customers in their car is something that I think we have a very good experience with. The other thing I would say is though, that the bigger the forbearance numbers -- I acknowledge it's harder for investors to sort of interpret the credit results. I think you're going to have the blessing in card that for companies like Capital One, the forbearance numbers are so low, that mostly what you see is going to be a good indicator of what's coming. But we and others will try to help you in terms of disclosures to help you be able to interpret how these customers are performing.

Okay. No. That's really helpful. And then just lastly, Rich, on capital. Could you give us a sense as to how you're thinking about the dividend payout sustainability? And what kind of triggers for turning back on the buyback are that maybe not -- when that timing is appropriate?

Betsy, I'll take that. So just before I jump into capital and dividends, I will just remind you, as we talked about on our call last quarter, we started the -- going into this pandemic with 12% CET1. So we really feel like we're going into this downturn with a very healthy amount of capital. And then on the liquidity side, we had 145% LCR, which is well above the 100% requirement. And in fact, as I mentioned on the call, we had $25 billion of cash at the end of the first quarter. We've actually got significantly more cash at this point. We've been taking in a strong level of deposits, and so it's great to have high liquidity. Of course, that always can create some pressures for NIM. But going into the situation, we find ourselves really well capitalized and having terrific liquidity. So when you think about what does that mean to dividend and to repurchase. On the dividend side, there's just -- it's really not that large of an obligation for us. So there's really not a lot of leverage in cutting it. At this point, we are so far away from a discussion where we would think that we would need to turn off the dividend that I'm not sure that it's worthwhile to speculate about when that might be. There's always going to be levels where as we see capital starting to -- should it go to lower levels and start to approach minimums, we would certainly look at the dividend. But at this point, feel very comfortable with where it is. And with respect to buybacks, we're going to see CCAR coming from the Fed here on the 25th of June. We'll look at that and what those outcomes are. The only comment I would make is we're not in doing buybacks now. We [ don't ] think that's prudent given the economy. We will have, I think, additional flexibility under the stress capital buffer framework to be able to turn share repurchases back on. Should we see a significant improvement in the economy, we're talking about getting back to kind of pre-COVID types of economic performance. But there's more flexibility there, but I still think that's a ways off.

Okay. Great. Well, that wraps us up with the 0.5 hour. Rich, Scott, thank you very much for joining us and sharing your thoughts as we go through these tough times. Appreciate it.

Thank you so much, Betsy. Always a pleasure. Thanks, everyone, for tuning in today.

All right. Take care. Have a good day.

All right. Bye-bye.

Bye-bye.

Bye.