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

Moshe, you and I have talked a lot about the top of the market, the heavy spender marketplace and how competitive that environment is. I think it would take quite a downturn for the industry to actually dial back its rewards, just the customer disappointment and the inertial aspects of players doing that. I think more likely in downturns, people would spend less, maybe early spend bonuses go down, that kind of thing as opposed to the actual points that are offered. But in this downturn, we have certainly seen a steady increase in competitive activity. And I think from a rewards offerings point of view, at the heart of it, I think a lot of the players with travel businesses, and entertainment-based rewards business saw obviously that there wasn't a lot of spending and the appetite for new cards in this space has been more limited. And so there has been a comping up of rewards and expanding of rewards that it will be interesting to see how sustainable that is. One thing I know is it's a lot easier to add rewards than it is to take them away from consumers. So we'll have to keep an eye on that. But what we have seen and it continues to this day during this time period, higher rewards, rising early spend bonuses and increased marketing. So all 3 of those -- those are kind of the sort of 3 big levers by which companies try to shore up a position or gain share. And on the outside kind of looking at this segment, I know a lot of people have said, "How on earth can anybody make money with the intense competition and all the marketing that's there. I think this marketplace has increasingly been a marketplace of a small number of -- more of a small number of banks and card issuers who are really committed to doing what it takes to be successful in the -- at the top of the market because it's more than just product. I mean product is really important, but also the customer experience. Now increasingly, the digital experience, the marketing levels, the brand and the sustained investment over a period of time, the -- that all costs money. The flip side I have found is one of those small number -- the handful of players that have really gone all in on this space that we've seen continued opportunities and the ability to be financially successful in this space even with the intense competition. So this is a very intensive -- a very competitive space, but I still like our chances.

Got you. Last thing related directly to the card business for me would be the recent trends from merchants and, therefore, consumers to kind of the Buy Now Pay Later space. Just wanted to get your thoughts on it as to how is this a competitive alternative to the credit card business? Is it going to provide a source for you to refinance some of those customers down the road? How do you think about Buy Now Pay Later kind of as a product standing along side the credit card business?

Well the Buy Now Pay Later business has been a very impressive one to watch. And I think there are several breakthroughs that have happened there. It's a very nice tech experience, most importantly is the placement that they have gotten as kind of another payment button on the Internet. I think also the ability to use data is -- there's an opportunity there as well. So we've been very impressed with that space. Moshe, you've heard me talk cautiously over the years about the installment lending business and some of the resilience issues there. I would say the short-term pay and for type business, I think, has a lot of positives to it. It's impressive. The big strategic issue that overhangs that business in my mind is what happens to the merchant subsidy for that business. Right now, it's high and for most merchants quite a bit higher than interchange itself, which is, as merchants would say, it's a pretty high number. And so -- but that has allowed the business to be -- to have no charge for consumers because the merchant is really paying for it. And that then tends to lead to a virtuous cycle of better selection than you would otherwise get so if the consumer had to pay for it. Now the question to me is what happens over time when more and more competitors come in the space, what is -- what happens to that merchant subsidy, if you will. And could it get to a point where, in fact, there's an inflection point where people are charging consumers, which would really change the selection dynamics. So we're impressed with the business. We -- I think it's a sustainable business model, and we'll all have to really keep an eye on what happens to the merchant margin.

Got you. Shift a little towards the auto business, your growth rate has been above the industry, which is kind of the norm actually for periods of industry stress, and it's been a very successful business for you. And you sound a little more cautious on growth as competition started to return during the fourth quarter call. Can you talk just a little bit about how you see the competitive environment right now?

Yes. Let me talk first a little bit about the -- we've had a lot of growth in the auto business really during this downturn. And that I think that this business particularly stands on the shoulders of our technology transformation and the digital infrastructure and capabilities we've built from the bottom-up put us in a strong position with dealers who want to provide a low-touch car buying experience during the pandemic. And technology also powers our ability to win dealer business on speed and service rather than just on sort of price and the underwriting choice. So -- and then as social distancing became so much the norm, it also increased direct auto sales, which direct auto sales and direct digital originations through auto navigator for Capital One. So a lot of planets have aligned to make a particularly good situation for us in the auto space. The -- competitively, many lenders pulled back, especially in subprime in the second quarter. During Q3, we saw many lenders recapturing market share. Some of the smaller subprime lenders have regained shares -- regain share as the -- for them, a key thing is what are the spreads and availability in the subprime auto ABS market. Captives have scaled back competitive offers as new vehicle supply remains constrained. And this especially sort of in the middle to later part of last year. And then we started seeing prime lenders with such an influx of deposits, lowering prices and leveraging dealer relationships to regain share in the market. And since then, sort of throughout Q4 and to where we are right now, we've seen competitive pressures continue to increase, and particularly in the subprime marketplace. So we -- some of the structural benefits and competitive benefits we have, we think, are very much still there in terms of technology and some of the underwriting capabilities that we have. But I've always said that this business is hypersensitive to the competitive environment and the underwriting choices, because let's remember, that the dealer is still sitting there holding an auction. And so when another player comes in and has a looser credit box or a different choice, the dealers can drive a bunch of business in that direction in a more amplified way than would happen in a one-to-one credit card kind of business. So what we're saying is we really like our positioning. We like our opportunity, but the competitive environment is getting more intense. And so that could impact how big the growth opportunity is. We'll have to see.

Got it. And how do you think about managing the -- when people in the industry call it channel conflict between a direct-to-consumer model versus the dealer model? And how big do you think your direct-to-consumer could be over time?

The fintechs and attacker companies that have come out in the auto space, I think, for the most part, are going right after the dealers basically saying, that's yesterday's model. Buy this thing direct and they're going on national TV with advertising that's very critical of dealers. And there's kind of a fork in the road choice. If you are working to try to reinvent this business with technology, are people going against the dealers or with the dealers, Capital One with deep embedded dealer relationships and a lot of history in this business is very much -- our innovation is designed to work with the dealers. So for example, our Auto Navigator product, which allows people to arrange their financing for any car that they want in advance before going into -- before buying the car, it is still a dealer fulfillment experience. So between the technology we're providing to consumers, the technology we're providing to dealers. It is all designed to help make the dealer experience much more efficient and allow consumers to still get the benefits. The substantial benefits that a car dealer offers, which is, of course, lots of selection, lots of ability to test drive cars, advice and what it's all designed to do is minimize the red tape, the time spent and some of the wear and tear that can come from that model.

Got you. Okay. Can you talk a little bit about how you see -- what you see as the benefits to consumers and Capital One for -- on the bank side, the digital banking side, I mean, clearly, I think the benefits of the tech transformation are felt on the lending businesses, but could you talk about it on the bank offerings? Are there things that you are either able to do now or will be able to do that will enhance that offering relative to others that are out there in the marketplace?

Yes. We have -- if you think about our journey, Moshe, we really were an original fintech. And you were there from the very beginning and one of the most striking things about our journey is we transformed our capital market dependent fintech into a traditional bank balance sheet and bought some banks along the way. But while we had a traditional bank balance sheet, we have very much wanted to be on the forefront of how retail banking is evolving. And that is the bank in your hand, increasingly, the bank in your hand. And not so much the brands you're visiting all the time. But that is -- and there are a lot of players out there who believe in the branchless approach. And I believe in -- we have a huge amount of experience to back this up. A lot of people while they're using their branches less, they still appreciate the physical proximity, the opportunities and the comfort and things that, that physical presence allows. And there is a credibility associated with physical presence that, especially when you get beyond savings really into checking accounts, that a lot of the capabilities of traditional banking actually do matter. So what we have done is to build a national bank strategy that tries to get -- bring the best of the sort of pure digital model and combine it with some of the best of physical distribution. But not being a player with 5,000 branches across the country and no opportunity or no path to doing that. We said, while others are going out to buy more banks, what we want to do is build a -- try to build the bank of the future in a sense, which is -- leads with a digital first, mobile-first banking experience, but has some physical distribution in the form of -- in our existing footprint, physical branches, but on a thinner basis and cafes, which are more like banking showrooms in key metropolitan areas all across the nation. And that has been our strategy for a number of years. I think the pandemic helped accelerate. I don't think it really changed anything, but it helped accelerate changes that were in the works for consumer behavior, and that's been beneficial for us. But our strategy to kind of emphasize this is a physical distribution light model and a tech-heavy mobile banking experiential model of the bank of the future. And we think we're in a perfect position to do that because we're one of the -- we have the nation's largest direct bank and one of the big physical banks in the country. So that's our strategy, and we have a lot of momentum.

Got it. Capital One had -- of your peers in the credit card space, the largest buyback authorization to talk about the thought process? Any kind of thought as to how it will be used relative to what metrics? Is it going to be relative to a percentage of the earnings? Or does it relate to growth in assets? Like how should we think about the time period over which that is used?

So the $7.5 billion authorized by our Board, I think, demonstrates our commitment to returning excess capital to our shareholders. As we think about capital deployment, we look to first deploy capital to growth opportunities then share buybacks and dividends. As evidenced by our past practice, we manage our share buybacks dynamically, taking into account market conditions, relative value and our holistic view on our capital position. So the pacing of our share repurchases will be guided by these factors. When planning our share buybacks, we are mindful of expected changes in our allowance and also consider our current capital levels, our long-term capital need, our expectations for growth and sort of our view of the risk environment. So we will clearly take changes into our allowance into account as we manage our repurchase program. The size of the program we announced is not dependent on a specific allowance forecast and it is also not precisely time-bound to a calendar year.

Okay. Perhaps last question from me would be, clearly, from your answer on the branch banking system, that's not an area of incremental capital deployment. But are there any kind of external capital uses that you could be thinking about acquisition, whether they're portfolios or companies? Any areas that interest you for Capital One?

I think while most banks are focused on what other banks they can buy, we -- any thinking we're doing about acquisitions is more focused on tech companies where we can leverage what that tech company has built in our company where we, ourselves, have built a modern tech stack. And we have had a really -- some striking success with some of the small companies that we bought. And I think that's where the opportunity lies for us. Now it's also not lost on us that a lot of the tech companies have breathtaking valuations. So that's why our acquisitions have been more in the -- of smaller tech companies. But as we continue to have success in this area and as innovation continues, we will continue to look at those opportunities. And our track record is one that is encouraging. The other thing that we are doing is increasingly taking investment stakes in companies that we're partnering with as we together pioneer new capabilities out there. And a good example of that is our investment in Snowflake. Now it's a relatively small investment, but even our small investment became worth hundreds of millions of dollars with Snowflake's extraordinary IPO and performance. But that, I think, gives a little window to the marketplace of the kind of people that we're partnering with and the philosophy that we take of either partially participating in some of that innovation or from time to time doing acquisitions?

Got it. With that, unfortunately, we're out of time. I could certainly continue this for lots and lots more, but Rich and Danielle, thank you so much for participating. And to the audience, thank you. And that's all the time we have, unfortunately.

Thank you so much. And Moshe, I just wanted to say you've spent a lot of years in this business. I think you have a lot of wisdom and insight to -- and you often push my thinking as well. So thank you, and thanks for hosting the conference. And thanks, everyone, for being with us today.

Thanks, Rich.