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

Sure. So you referenced Rich's comments. And we're very much students of marketplaces, as he likes to say. And in fact, Jeff and I were just talking about this before that 30 years ago, there was a marketplace called Capital One, and I think it was maybe ignored a little bit too much by people. And so I think we have learned to really have the humility to watch marketplaces very closely and try to learn and understand what's happening. And while point-of-sale lending is not new, as Rich was saying, credit cards is the original kind of buy now pay later. But there's probably a few things, Sanjay, that are creating the rapid adoption that we've seen over recent months and quarters. One being, we have people at home and the acceleration of just e-commerce due to the pandemic. Two, you have advancements in technology that are making that offering far more frictionless than it ever was. Three, I'd say that there's nonbanks, private equity, others who are willing to fund these effectively short-term loans. And then lastly, you have the willingness of merchants who, in essence, are willing to pay for these loans. So as we're trying to learn in this space, there's a lot of learning to do. And getting our arms on data and knowing really what's happening underneath the surface is a bit of a challenge. But one of the things that I've at least seen in some articles quoting merchants paying anything from 3% to 6%. So if you're a merchant in this marketplace, you clearly, I would imagine, want competition to drive that subsidy down. But if you're on the backside of that as a financial institution or private equity funding a loan, you also need to make sure that you're keeping a close eye on credit over time. And that margin is helpful to you to sort of protect the economics. And so the real question, I think, for us at this point is what happens to margin over time. And we're keeping a close eye on it. At the end of the day, we will always work back from the needs of our customers, the wants of our customers. And if we believe that this is a product that has sustainable economics, sustainable elements that our customers are looking for, we have the ability to integrate it into our offerings, either we can create the capabilities, we can partner with somebody, we could do. I think it's Chase who has essentially created a card product that you turn in effectively to buy now pay later. So there's a bunch of ways that we can be in this space. But at this point, we're still really in learning mode to see where the marketplace goes. Jeff, you had anything you wanted to add there?

Yes. The only other thing I'd add is from a sustainability standpoint, kind of making sure the product in the marketplace stays on the right side of the customer issue. When the merchants are subsidizing the product, it's essentially free to consumers and it's a really good customer experience. The more that, that margin gets competed away or the cost of it gets shifted to consumers themselves over time, the more risk there is of unfriendly customer practices creeping in. And we would seek to avoid that.

That's fair. So maybe we shift to other aspects of the competitive landscape. You guys have a history of zigging while others zag across different parts of your segments. Maybe you could just speak to the competitive landscape across the different segments, card, auto, commercial, and which segment are you most optimistic about near term and which one the least?

So why don't I start, Sanjay, by just kind of pulling up and talking about overall marketplace dynamics that will serve perhaps as a useful background and then I can touch on a few points on each of the businesses. But the first thing I'd say is just bank balance sheets are incredibly strong at this point, flush with deposits, holding lots of capital, high levels of reserves, credits strong, recently passed second round of stimulus, the prospects of an additional round of stimulus. So I think that there's a strength and a desire of banks to grow into the strength of that balance sheet. Number two, perhaps relatedly, there's also appetite in the capital markets as well. And then the last bit of backdrop is consumer balance sheets are remarkably strong, too, notwithstanding the elevated levels of unemployment. We just see savings rates and lower spending that is powering their balance sheet. And I think those dynamics, if I pull up, are sprinkled throughout what we're seeing in the competition across the business lines. And so I'll start with card and say, card, as you look back on 2020, it's the one area that shrank quite a bit. And that's the elephant in the room as we're talking about growth from here. But credit cards are a discretionary product. And so therefore, we saw fairly modest demand. We saw the strength of consumer balance sheets driving payment rates. And so with that competitive backdrop, while it's driving incredibly strong credit, having those strong balance sheet, it's the one thing that I think is ultimately going to drive competitive behavior as others out there in the marketplace are looking for growth in card. And so cards are consolidated and mature. So what we see typically is competitive intensity that's always pretty high but pretty rational. And so over the course of last year, you saw everyone really pulling back on marketing growth coming down quite a bit. But since that low point, we started to see a steady increase in competitive activity. And it's playing out in multiple ways. We see enhanced rewards at the top of the market. Many of our peers have talked about increasing marketing across the marketplace. And so I think the intensity from here, ultimately, is going to be influenced, at least, at the margin by consumer demand. But I also think that competitive intensity is going to rise given the strength of balance sheets. But so far, seems to be pretty rational. If I just move on to auto, a slightly different story that we observed there over the course of 2020, which the supply in the auto market really had a really sizable decline in the early days of the pandemic with supply chains not at full capacity. The industry at this point seems to be much closer to what I would call normal levels. But partially as a result of the pullback in supply, we saw used car prices initially drop very low, but then hit all-time highs in Q3. And so we were tightening our credit box at the time, but saw that our technology, our offerings as consumers were looking for a much more low-touch car buying experience and the deep relationships we've built with dealers, in spite of some of the challenging marketplace dynamics in the middle of the year, we had our 2 highest quarters of originations ever. And now what we've seen over the last couple of quarters, again, kind of going back to the bank balance sheet point I made earlier, you see competitors really starting to step in at this point. The subprime ABS markets kind of opening back up and providing funding sources for some players. The prime players looking for alternatives to parking deposits in their investment portfolios. So we're starting to see things pick back up in the auto space, something that, we like the underwriting choices that we're making and the capabilities that we have, but we're just keeping a close eye on what others are doing. And then lastly, on commercial, another competitive landscape that's particularly strong. The example or the most obvious tangible example to me is the spread difference between B and BBB loans at this point is tighter than what it was pre-COVID. And again, you see banks looking for places for yields with a backdrop at least right now of really strong credit. And so from our standpoint, we're really looking to just create differentiated products and services, forging strong relationships and not just chase pricing. And I think we do that by really focusing on kind of national scale specialties that we've talked about quite a bit. So I know that was a lot, Sanjay, but putting it all together.

It was good. It was good context. No. It's very good, very good context. Jeff, you have anything to add to that?

Well, your question was which one would be our favorite. I'm not sure we want to declare a favorite. I think in card, more than usual growth opportunity is going to be dependent upon consumer behaviors, and those are uncertain. But we see opportunities and we're leaning in and keeping our fingers crossed there. In auto, our growth has decelerated lately given the rising competition, but we still feel like we've got some technology-driven competitive advantages that we're going to be in there pitching in that marketplace as well. And in commercial, we're seeing the current pipeline starting to fill up a little bit. So all 3 of our, I won't declare a favorite, but while there's still a fair amount of uncertainty, we're pursuing growth where we can find it.

Okay. Great. So I think you guys have talked about growth through line increases and adding new originations on your earnings call. I think Rich mentioned it yesterday. Maybe you could sort of elaborate on what you're seeing through those 2 areas and what gives you comfort to do that at this point, where we're still in the relatively high unemployment rate, uncertain backdrop.

Sure. So when I think about growth, maybe I'll take the liberty to reframe your question a little bit more broadly, Sanjay. When I think about growth there's 2 things that we largely control and 2 things that we largely don't. And the things that we don't are how much consumers are spending and their payment rates. And those are things we've talked quite a bit about. And so I won't go into great depth there. But the things that we do control are booking new accounts and line increases, as you say, to our existing customers. And the reason it's important to highlight the things that we don't control is, those are things that are going to have a substantial impact on net growth even if there's a lot of growth. As we're paddling underneath the surface of the water, there may be a lot happening there that is kind of offset by consumer behavior that we can't fully predict. Going back to the middle of last year, we pulled back quite a bit on new originations and credit line increases. And we've always had a strategy of low lines at origination, which I think enables us to be a bit more aggressive in the timing of pushing on the origination side as we see opportunities emerge. And so with sustained strong credit and just our capabilities of seeing things at a very micro level, that's been a place where we've been leaning in. And then kind of by extension, as we get more comfortable on a customer-by-customer basis, we then have the option to expand line. And powered by our tech transformation and our analytical capabilities, we're seeing opportunities to expand lines as well. And where we go from here, we're going to be closely watching the marketplace, watching consumer behavior, watching stimulus. There's a number of factors that will drive the degree to which we're leaning in on both of those fronts, but that's where it really comes down to each customer is resilient and the underwriting choices that we can make to feel good about what we're booking in terms of new accounts, but also extending lines to existing customers.

Jeff, anything you want to add to it?

No, sir.

All right. Cool. So you probably thought you were going to get away from this question, get away without me asking this question, but I'm going to ask this question. So credit quality, really solid, right? You wouldn't imagine we're in a recession if you looked at your charge-off rate or your delinquency rate. At what point do you guys make a decision that we're probably going to get through this better than what's being assumed inside the reserves? Had to ask the question.

Yes. No. It's a great question. And it's one, Sanjay, we've been asking ourselves every quarter since the pandemic started. And there's multiple factors that will go into the allowance from here, right? So the more mechanical internal factors of changes in loan volumes and what we're actually seeing in the moment in credit performance and delinquencies and roll rates. And those are things that the outside world can see. But the bigger focus or bigger force, I should say, of the allowance really comes from everything that's happening in the outside world, so further stimulus, the trajectory of the pandemic, the pace of vaccine delivery, how much the world opens back up and we kind of lift some of these restrictions on travel and entertainment, GDP, the expiration of forbearance. I know I'm giving you a laundry list of things, but I'm kind of doing so intentionally to say, there's a lot of judgment that goes into the allowance, particularly in a CECL world, given the time horizon going to lifetime as opposed to 12 months. And so we run a bunch of scenarios and we've conservatively allowed for more of the tail scenario by applying kind of qualitative factors to some of the metrics that if you just let models kind of run their course, the whole historical relationship for the last 25 years of unemployment rate and card losses literally being on top of one another, those have completely diverged in opposite directions. And so there's a lot of head scratching going on. Rich has used the metaphor of the mountain of losses. Are we going to burrow through the mountain? And so those are all of the things that we have to take into account. But each passing month that we see good credit is helpful. And I think the single biggest consideration that I'll put a fine point on for you is certainty. There's a lot of uncertainty out there. The more that we see certainty on those variables that I just described, the more likely you'll see the allowance getting kind of released back into the P&L.

Jeff, anything to add there? All right. Last question, we've got 2 minutes left. Obviously, we talked about the significant capital return that you guys have indicated. Are there any other uses of capital as you look ahead or is it pretty much best to, I mean, obviously, if you can grow the portfolio and hold capital against it, that makes sense. But in terms of just inorganic type opportunities, do you see any other uses of capital outside of organic growth and returning capital?

Sanjay, you've followed us for 20 years now at this point and heard us talk about bone structure. And going back to your first question, right, the kind of strategic tenets of how we operate. It's being in businesses where we believe that we can have scale and generate attractive returns over time. And we've been very deliberate in choosing the businesses that we're in. We very much like the bone structure. So if you think about the big organic things we've done over time, particularly in buying the banks, primarily as a means to diversify funding so we weren't so capital markets-dependent. What you've largely seen us do recently is much more surgical than that. So acquisitions to hire particularly tech talent through acquihires or small complementary things to existing businesses like BlueTarp or KippsDeSanto or buying specific tech functionality, buying companies that will help accelerate our journey. And so I think our transformation into a tech company has made us a more attractive acquirer of those types of organizations. And it's probably the place where I would say, if you see us doing anything, it will be much more on that space than anything else.

All right. Well, we're out of time. I really appreciate all your insights. It was a great conversation. And again, good luck next week, if not good luck today and everywhere. And thanks again for attending our conference. And hopefully, next year, we can do this in person.

Look forward to it, Sanjay. Thanks so much for having me.

Bye-bye.