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

Moving right along, very pleased to have Capital One Financial with us to kick off this afternoon session, as I usually do on Day 2 of this event. [Operator Instructions] From Capital One, very pleased to have Rich Fairbank, Chairman, Founder and CEO with us; Scott Blackley, I think, is on the line, Chief Financial Officer as well.

Rich, let's jump right into it. Of all the companies I cover, Capital one probably has the strongest land since the U.S. consumer. And obviously, a big card portfolio, big auto portfolio, a big deposit gathering network of local branches in select markets, digital banking. Can you maybe just start off and kind of give us an overview on kind of what you're seeing from your customers?

So thank you, Jason. It's always a pleasure doing this event with you, and welcome, everyone, listening in today. I think the U.S. consumer, first of all, just going into this crisis was in better shape than at the outset of The Great Recession. And we should always keep this in mind. Consumer debt levels are lower on a per capita basis. Payment obligations are lower, still supported by low interest rates. The savings rate, over the past few years, was 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 see a sustained recovery. So the consumer entered in, in strikingly strong shape. Now obviously, the speed and intensity of this downturn have been unprecedented. But like we've seen so many times, and I think people underestimate sometimes this factor, consumers, yet again, acted rationally, adopting more conservative behaviors pretty much immediately. Consumers are spending less, they're saving more, and they're paying down debt. In our own numbers, we see these behaviors show up in lower purchase volume, higher payment rates and increased deposit flows. And of course, cautious consumer behavior has been greatly aided by the swift and unprecedented government stimulus and widespread forbearance across the broad banking industry. And so all of this has kind of added up to a somewhat of a striking disconnect between the performance we see in things like credit versus what we see in the economic metrics right now.

Yes. I mean, the credit metrics have been, I think, it's certainly much better than we anticipated. We started off this morning, kind of looking at your August metrics, but car debt charge-offs, the lowest level in almost 4 years, 11 straight months of improvement year-over-year. Delinquencies, 7 straight months of improvement. Charge-offs, lowest level in our data set, and our data set goes back to at least 2007, but you did see an uptick in auto delinquencies. I guess, clearly, you've seen a foot part clearance programs have had an impact. The stimulus programs have had an impact. You obviously talked about some of this. But you've been doing this longer than anyone. Looking out, how do we kind of -- when would we expect kind of the delinquencies to tick up? Or more helpful kind of -- what does that kind of long loss picture look like over the ensuing months? Because I think, clearly, we all expect losses to tick up. It just doesn't appear to be happening. So maybe just kind of flush it out by thoughts around that.

Yes. So it certainly is striking the numbers. And as you mentioned, Jason, just this morning, we put out our August credit numbers. And they were particularly striking because some important elements of the CARES Act expired in July, specifically the bulk of PPE funding and the additional $600 a week unemployment insurance benefit. So I think to get a picture for any of us to sort of view where things may go from here, I think we should kind of look at the key factors that are driving the strong performance, and I think I'd highlight 4 of them. First of all, at Capital One point. The underlying resilience of our portfolio, which has been supported by our cautious credit lines, which we've talked to investors about and increasingly so in the last couple of years, and a thing that we've been driving for 4 years, ever since The Great Recession, the lower and lower mix of high balance revolvers or essentially more highly indebted revolvers. The other 3 factors I would point out are industry factors. So the cautious U.S. consumer, as we mentioned, spending less, saving more and entering the downturn in really strikingly good shape without structural challenges. Then we also have the unprecedented level of direct consumer support through the CARES Act. And even there, some aspects of that will continue through year-end. For example, while the amount of payout has been by not getting renewed, some of the amounts of the payouts have gone way down. The eligibility, which was expanded relative to the last downturn, the eligibility for unemployment benefits, that expanded eligibility still holds through the end of the year. The fourth factor is just widespread forbearance across the banking industry, which is helping consumers manage through the temporary stress. And we think the benefits of some of these effects, like higher savings, are cumulative to some extent, improving consumer balance sheet in ways that could lead to some sustained credit benefits. In our Auto business, we've seen mostly similar credit trends to what I mentioned in card for some similar reasons, but these are even more pronounced. And Auto has also benefited from very strong used car auction prices, which have been at all-time highs and well above pre-COVID levels since July, all right? And we've also seen somewhat higher Auto recoveries from the catch-up from our temporary suspension of repossessions earlier in the downturn. This is a temporary effect. A lot of people ask about what's the impact of our own forbearance programs, let me talk about that for a minute here. We think our own COVID-related hardship programs are relatively modest factor in our credit performance, especially in card. The penetration in our card Skip-Pay program is quite low, and it's only available to customers who are current or in early stages of delinquency. So even if we make conservative assumptions about how these customers would have otherwise behaved, it would not materially change our credit metrics. Enrollment rates in our Auto COVID loans extension program have been higher than in card, and we've extended relief to impacted customers in later stages of delinquency. So these programs are having a more meaningful impact on our Auto credit metrics, both our delinquencies and our charge-offs. But as we discussed in our call in July, a significant majority of customers, who have enrolled in these programs since they began in March, in both card and auto, are no longer enrolled and have resumed normal payment patterns. And the numbers of new enrollees have declined dramatically since their peak early in the pandemic. So the number of customers presently enrolled in both card and auto has plateaued at a relatively low level. Of course, with all the uncertainty that remains about how this downturn will ultimately play out, we're making conservative assumptions in our loss allowance, setting reserves based on the old relationship between economic metrics and credit and assuming we'll see renewed declines in vehicle values. But in some sense, every month that the consumer remains healthy, we are burrowing a longer tunnel underneath the mountain of how unemployment and reducing the cumulative losses through the downturn rather than just delaying the impacts. So Jason, if you think about those 4 factors that I talked about, the big one that is changing is the stimulus and the potential for not having that. And we certainly do think that will have an effect. When the stimulus came in the first place within moments of when the payments came early in the downturn, we could see impacts on a number of our metrics. But some of the other factors that I pointed out here are a little bit more structural, and probably have a sustaining component to them. So with great interest, along with all of you, watch how this thing unfolds from here.

That's fair. I mean, that being said, you put up a significant allowance for loan loss build in both the first and second quarters of this year. I think when you kind of gave your forecast, you had an unemployment rate ending the year at 11.5%, which was, I think, one of the highest in our coverage of banks that disclosed that figure. I kind of look at the print we got earlier this month, and it was 8.4% unemployment. So how does that inform kind of the allowance in the back half of the year? And just how do we think about -- I get losses are going up, but how do we think about the whole reserve build process?

Jason, why don't I take that one? Couple of thoughts. So first of all, our future allowance moves are going to depend really on what's going on with the balance sheet. And then broadly, how the economy plays out. With respect to the economy, if we see the economy worsening compared to our past forecast, that's going to be a factor that would drive further allowance builds. As you mentioned though, the actual unemployment rate that we've seen has been favorable to the front-end of the economic scenario that we used in our Q2 allowance forecast. I'd also just point out that in our Q2 build, we also assume no further government stimulus beyond what was in place at the end of the second quarter. And so further government stimulus, that could be an upside to our allowance at this point. Importantly, I think that the magnitude of the upside would be dependent on the nature of that stimulus and how it impacts the consumer. So I think we'd have to wait and see exactly on how stimulus would impact our allowance. But at this point, I'm pretty pleased with the conservative lean that we had on stimulus in our Q2 allowance, given that it seems like there's a pretty healthy amount of uncertainty about where the government might land on its on stimulus at this point. So if I just pull up, I'm not going to give you a point estimate on our Q3 allowances because we haven't yet finalized that, but I would say, at a high-level, in the first half of the year, it felt like at the end of each quarter, we were catching up to a worsening economic outlook, and that was driving large allowance builds. And since then, credit has continued to be strong. As you talked about, unemployment has improved some. And so from an allowance perspective, it feels like to me that we're in a better place in Q3 than where we were in the first half of the year. And then I'd just balance that out to say that, of course, there's still a very fragile economy. We've got a high level of uncertainty, given that you're really still in the middle of a 100-year pandemic. And so given that, I think that, that just suggests continued caution on the allowance.

No. That's fair. Maybe shifting gears to growth, one of the takeaways from this morning's monthly numbers is, after 7 straight months of contraction, card balances did increase from July to August, granted 0.1%. But I guess, it's a step in the right direction, perhaps. Can you just maybe talk to what you're seeing in terms of balanced growth? And also just maybe kind of quarter-to-date spending trends, how is that tracking?

Yes. So Jason, there are 3 primary drivers of our loan trends in card. One is spend volumes. And while they have recovered from lows early in Q2, they're still roughly flat year-over-year in recent weeks. And notably, this is still down from the double-digit growth we were seeing earlier in the year. And that decrease is mostly a result of reductions in spend by transactors. We're seeing consistent payment to spend dynamics on transactors, but this leads to lower outstandings growth due to lower spend each month. A second driver of the loan growth trends we are seeing in card is that revolving customers are behaving cautiously. They're spending a little less. You're increasing their savings and more actively paying down debt. We're seeing stronger payment rates and very strong credit with revolvers. This is a function of several things, including the cumulative effect of stimulus and industry-wide forbearance across several asset classes. But it's also a credit to consumers behaving cautiously and our underwriting choices over many years. But I really want to highlight a thing that I think is sort of not always at the top of the investor conversations, is the role that payment rates play in the growth equation. Now in most years, payment rates are pretty stable and so it's not very newsworthy. But right now, and during this downturn, the payment rates are notably higher. In other words, payment rates, consumers, the rate at which they're paying on their credit cards, what percentage of all the balances they're paying, et cetera. Now we like higher payment rates. We encourage and do everything we can to get higher payment rates, and it's the absolute flip side of the great credit quality we're seeing. But what I would point out, though, is that higher payment rates, on a very large portfolio, do impact the growth rate. A third factor is our own choices, to be more cautious in our underwriting right now, given all of the uncertainties. So we tightened our underwriting, both in originations and on line increases. Now it's selective tightening. It started when the pandemic happened and the world was going into vertical, we really tightened. But if we sort of look net at where we are, we're still net in a tighter position than we were before the pandemic, particularly more cautious around people with a bunch of debt, people that are seeking credit a little too actively. And then we also initially pulled back in some of our marketing. And that, on a rolling basis, has impact on our growth as well. So the trajectory of card loans from here will predominantly depend on the broader impacts from the pandemic, what happens to businesses and employment. To your earlier questions, Jason, with a magnifying glass, we're going to be watching consumer credit and consumer behavior, possibly in the context of not having a stimulus. And then we -- I've always talked about how we work hard to originate accounts. The credit line, so much of growth depends on the credit line that they are given. And so we build the potential energy by originating accounts, and it turns into kinetic energy as the lines get higher. We're being pretty conservative on lines. But over time, as things unfold, we'll open those out, and that represents quite a bit of delayed kinetic energy when we make those choices.

Helpful. Maybe just sticking on cards for a moment, there are a couple of questions from the audience. If you could just talk about an update on the Walmart portfolio, how that's performed relative to your expectations, what size that could be. Obviously, Walmart has put up some good numbers of itself. What kind of role of Capital One play within that?

Walmart stores have largely remained open. So its sales weren't as impacted as many other retailers. We're seeing strong engagement on our portfolio as customers benefit from our product. And we -- Walmart has got a million things to do right now, and I think they're magnificently managing through the pandemic. But we continue to look forward to working to have our product and this very attractive product in the context of their digital transformation be more and more salient in the way that their business operates.

And I guess, maybe more broadly, has COVID-19 kind of impacted the way you're approaching either partnerships or rewards programs? And just maybe how you've kind of pivoted in the current landscape?

Sorry, Jason. Could you ask that question again?