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

Hello. This is Jason Goldberg. I cover the U.S. large-cap banks here at Barclays. Thank you once again for joining our Americas Select Conference. We're very pleased to have with us once again, Capital One. From the company, we have Andrew Young, who just became CFO on March 1, but been with Capital One for a quarter of a century. So certainly not new story just to roll. And also with us, Jeff Norris, who's EVP of Global Finance, and has been in that role for quite a while and does a great job.

Between us, we've got half a century of experience.

Andrew, given you've been at Capital One for 25 years, but only in the CFO role for 10 weeks, maybe now you're in the seat, maybe just talk about how you define the role that you and the finance function will play.

Well, thanks, Jason, for having me. I will say 25 years, somehow, sounds less than 1/4 of a century. But nonetheless, it's been a remarkable ride. And one of the things that's kept me excited and proud about being at Capital One for so long is we're constantly evaluating it where the world is going and building an enduring franchise along the way. And so I feel like my role -- and the role of all of our finance colleagues is primarily to just help the company create and drive that strategic agenda. And I'd say that, that takes a few forms. One is just making sure that we are carving out the investment capacity necessary to create that better tomorrow and get to our strategic goals. And two is constantly driving savings opportunities in the business across the entire P&L to help pay for those investments. And then third, optimizing our balance sheet and our capital allocation to drive growth and returns for our shareholders. And so one thing I've shared with the team is as the pace of change and the competitive landscape requires companies to pivot even more rapidly than we have in the past. And something we've certainly seen in spades over the last 12 months. I think our goal is to do all of those things that I just described in a disciplined yet flexible way.

That's a helpful intro. Some years with Capital One, we start with loan growth; some years, we start with credit. I think fortunately, this is one of those years we get to start on the lending side. And maybe if we could jump off with credit card. But if you look, the domestic card purchase volume, started to show signs of improvement, we started to see year-over-year growth return. Maybe just talk to which categories have kind of been leading improvement in spend, which has kind of been lagging. And maybe as we kind of approach the summer months, just kind of any changes you're seeing and how to think about maybe the next couple of quarters?

Well, as you alluded to, Jason, in the first quarter, we did see some growth after a few quarters of spend being quite a bit down. Domestic card purchase volume was up something like 8% year-over-year. And as we talked a little bit about on the earnings call, the pace of growth accelerated throughout the quarter. And so that 8% is just the average for the whole quarter. Most categories at this point have rebounded from those lows, really in the second quarter of last year and are now exceeding pre-COVID levels, the one exception being T&E. And so that's a space where we all know the spend -- this declined precipitously in the second quarter of last year, I think it was either the second or third quarter where it was down something like 80% from pre-pandemic levels. And it has grown from there. But as of March, I think it was still down something like 25% from pre-pandemic levels. So we're seeing traction there as things are opening up, and people are venturing out. But that's the one category that really has been lagging. And so the non-T&E spend for us has looked pretty strong as a result of the traction that we were getting before the pandemic. And what we're really looking for is to continue not only that growth but to really see the benefits from consumers picking back up on the T&E side.

All right. I guess while we've seen that improvement in spend, it's yet to translate into propensity to revolve balances in card. Although, I guess, if we look at the monthly data from yesterday, the year-over-year decline, and even the linked-quarter decline, kind of slowed for the second consecutive month. But I guess, ultimately, what do you think is the catalyst that will change consumer behavior to kind of return to more normal patterns of revolving?

Well, the more normal patterns are really going to be driven, as you said, by spending and payment behaviors. So we just talked a little bit about spending trend that we and everyone, frankly, are keeping a close eye on. The payment rates has really been the anomaly over the recent past. I mean, they're historically high. And even as spending has gradually resumed and we saw growth there in the first quarter, payments have more than offset that and put pressure on the low balances. It's worth noting that the flip side of those high payments is this amazingly strong credit performance. And so that's a great trade for both us and consumers. So we like seeing that. But it definitely does put pressure on the loan balances. To your point about the catalyst, though, of what is going to kind of create the change, probably a couple of things I'd speculate, Jason. One is just consumers being more confident and getting out there and spending and feeling more confident in taking on loans. But the other is probably a little bit less of a choice, which is the effects of stimulus and forbearance that have really helped strengthen consumers' balance sheet and, I think, driven the elevated payment rates, presume over time that those effects -- artificial effects, I'll call them, will wane. And so the combination of consumers starting to spend again and consumers feeling more confident in their balance sheets, kind of getting back to what I'd categorize as a more normal level, will likely drive things getting back to where they were.

I'd like to just add a couple of points, if I may, Andrew. The first one is that -- well, confidence is a big factor, and the spending increase is a hopeful indicator that it's starting to return. It's pretty fragile, right, if the pandemic takes a turn for the worse. The gains in confidence could evaporate. But even if that happens and the return to more normal payment behaviors takes a lot longer, as Andrew mentioned, we feel like we've put ourselves in a position to deliver pretty good value in an environment with high payment rates by generating profitability and capital. And also in a good position as we've been trying to get back into the growth of spending and new account originations, pretty good position for when the payment rates actually finally do normalize and we can morph more into a growth story. We feel well positioned in both of those cases, which is a good place to be at the moment.

Well that makes sense. One thing we've been hearing a lot about is just the competitive landscape and what we're kind of seeing in the rewards space and how that has evolved post the pandemic. Can you maybe just kind of update in terms of kind of what you're seeing and how Capital One is situated against that.

Let me take a step back and paint kind of a broad picture, Jason, of competition that I would categorize in 3 dimensions: One is marketing intensity. Two is the product competitiveness that includes the rewards element that you just described. And then three is underwriting. And so on the first dimension, with marketing and media spend, they dropped significantly in the second quarter of last year across the industry. And we've seen that gradually pick back up over the last few quarters, and it's now effectively at pre-pandemic levels and something that we're keeping a close eye on in terms of the opportunities there, but also competitive dynamics. The second category, in terms of product competitiveness, I guess you brought up rewards. I'd say that there's 2 parts of the product. One is just upfront bonuses, which we've seen have been relatively stable. People seem to be leaning in a little bit. Competitors seem to be leaning in a little bit to that, mostly in the travel space, I think, as there's an anticipation of demand returning there. And then in terms of rewards, other categories like groceries and restaurants are places where we've seen competitors come to market. But this is a place where competition is always relatively elevated. We seem to see people leaving in perhaps a little bit more at this point, but the reward levels are high, but rational. And then the last piece is with respect to underwriting, and that's something that clearly we don't really get that much visibility into from a competitive perspective, really more looking at -- that are trends there and the discipline that we apply to create a resilient franchise and look for resilient growth opportunities. But putting all of that together, we like our positioning and our brand, and we'll continue to lean into growth opportunities, but make sure that we keep an eye on what's happening on competition and across the industry.

I guess, you mentioned competition. It kind of brings to mind the whole buy now, pay later space, which has gotten, I guess, a lot of attention recently on kind of big growth numbers, albeit off of a very small base. Can you maybe talk about any impact you've seen from that, particularly on kind of bigger ticket items? And just any competitive response necessary and just how Capital One thinks about that segment.

Well, you bring up an important point in terms of the relative size at this point, Jason, which is the whole buy now, pay later industry is something less than 1%. We've seen a statistic that suggests it's 0.5% of overall credit card industry purchase volume. So I think it's important to put it in context. But it's also very important, as you also alluded to, to be mindful of the growth rate of it. And so it's something that we are keeping a close eye on. We are a company -- you followed us for a long time. We are very much focused on marketplaces and where industries are going. And given the rapid adoption here, something that, despite the relative small size at this point, certainly don't want to be dismissive of. And I think there's a few trends that's likely driving the pace of growth that we've seen, one being over the last 12 months, just the rapid adoption of e-commerce in the pandemic, right? Where I think consumers were much more apt to spend from home than going out and paying for things. Number two is just advancements in technological and digital capabilities that have allowed merchants and Buy Now, Pay Later providers to get the real estate on websites and create a seamless experience for customers. And then the last thing I'd say is merchants' willingness to pay for these loans and try to drive additional volume by giving up a little bit of the economics. And so I think there's really 2 things in terms of what does it mean for us and the competitive implications. One is we want to really keep a close eye on the margins of the business. And if somebody is willing to pay 4% or 5% or 6% to give that up, what prevents somebody else from stepping in and competing that margin down to say, if you're willing to do it for 5%, I'll do it for 4%. And if I'm doing it for 4%, will somebody else be willing to do it for 3%? And so that's a place where the BBs settle out is going to be important to the economics. And the other thing I'd say is credit, where over the last year, we've seen credit card loss rates be roughly half of what they have been historically. And so not surprising that buy now, pay later has performed well on that dimension. And so with high margins and good credit performance, very attractive today. We are keeping a close eye on it and trying to learn everything we can, and we'll see where we go from here based on what we learned.

The cautionary thing about the margins being competed away is that we've seen credit industries evolving this way before. And once the margins competed away, that puts you in a position where you're getting more of the economics from the customer, which can incent some customer practices, which are not necessarily sustainable. We really want to avoid that and can lead to loosening of underwriting as competition moves from margin to practices to actual credit risk. So it's a thing to watch out for. But the digital experiences that these buy now, pay later firms have created are really pretty cool. And I do think we can learn a lot from that.

No. That's good point. I guess, Andrew, the other thing you mentioned, you touched on it, so I'm going to have to follow-up is just marketing. And as spending improves, I guess how do you kind of -- you talked about marketing kind of getting return to pre-pandemic levels. But I guess as you think about the remainder of the year, how do you think marketing spend plays out, just given where we are in the cycle?

Well, Jason, I'd say it's not so much tied to spending as it is trying to drive account originations and generating enduring and resilient customer relationships. And so what we're seeing is some opportunities to lean in, in segments where we see signs of strength. And I think for us, it's really aided by our technology and data transformation, and our ability to really look in real-time what's happening across a number of different dimensions and tailor our offerings to people in such a way that we feel really confident about the underlying -- underwriting and the relationship that we would establish. And so we're seeing momentum there. On the card side, we also -- you've seen us over the last couple of years investing in our national banking strategy in our brand. And so I'm not here to give you a specific, kind of, cadence of how that's going to play out because marketing is always, for us, going to be mostly a line of scrimmage call based on what we see in some of the competitive dynamics that we talked about earlier. But at this point, we see some places to continue to lean in.

All right. And then maybe just shift gears for in second, no pun intended, but to auto lending. But used car prices at all-time high, new vehicle production has maybe been pressured a bit. But demand for vehicles continues to be strong. Maybe just talk to your kind of outlook here. And then also, it does feel like competition has gotten a little bit more intense. If you could speak to that as well.

Well, maybe I'll continue your pun point, Jason, here. I'll start by looking in the rearview mirror, if you're going to switch gears. Looking in the rearview mirror at the industry, the second quarter of last year, we saw a pretty dramatic pullback. But unlike card, in auto, the rebound was much more rapid. And I think what we saw was, if you bifurcate the industry -- oversimplifying, of course, but kind of bifurcating the industry on the prime side, where you have many lenders who are awash with deposits and liquidity and capital and looking to put that to use. And so that's created some pressure on margins in the prime space. And in subprime, we've seen, particularly on the capital markets side with securitization and benign credit, seeing players really leaning in on subprime growth. And so what has helped overall auto levels, though, is the total pool has been growing, right? And customers have been purchasing vehicles at really high levels. But getting to your question then of where do we go from here, from an industry perspective, we're all familiar with the challenges that manufacturers are having in the supply chains, from chips to rubber to other disruptions. And we're also seeing rental car companies buying used vehicles, and it's creating some additional strain on dealer inventories that, at this point, looking at the most recent data in April, are down something like 30% or 40% from a year ago. And so I think it's reasonable to assume that overall supply will come down and dampen volume from what we've seen over the last number of quarters. I think the question, in many ways, relates to share. And so our relationship with dealers, our differentiated technology, I think, puts us in a position of relative strength. But we also need to remain vigilant, and we're going to maintain our credit discipline and take what the market gives us. So for us, in many ways, it's going to be dependent not only on overall industry trends but where competitors are willing to go and stretch, and we'll see what happens for us in that context.

Makes sense. If we could put the brakes on lending in terms of credit quality.

I don't know if I can keep up with these puns, Jason.

I looked at yesterday's monthly data. I mean, you had delinquencies and charge-offs for both domestic card and auto, so all 4 of those numbers at, I would say all-time lows, our data set only goes back to 2007. But certainly, historic lows. Obviously, all the stimulus has helped auto, as you mentioned, kind of what you've seen in your car prices has also helped there. Obviously, we're going to work through the stimulus just -- can you just talk to just how both these loan-loss buckets play out? Your crystal ball is definitely better than mine.

Not so sure it is, Jason. I think that's the $64,000 question for all of us. But the credit metrics, as you suggest, have been and continue to be just quite remarkable. We keep calling it strikingly good. And as you think about the cumulative effects of the things that you just referenced from early in the pandemic, a pullback in spending to stimulus effects, coupled with forbearance, we saw consumers really strengthen their balance sheet. And that has certainly been an enormous tailwind across the industry with respect to credit. Within the walls of Capital One, our credit strength relative to that industry strength is, frankly, a result of choices that you well know. We talk a lot about what happens in challenging times is really driven by the choices you make in good times. And we feel like the added credit strength for us is really a result of the choices we made long before the pandemic and aided by the capabilities that our technology and data transformation have enabled. And so where we go from here is largely just going to be a function of unemployment benefits wearing off forbearance, particularly with student loans and mortgages, wearing off spend, continuing presumably to grow, will likely offset some of the cumulative benefits of the things that I described. So going back to where I started, I think it is a $64,000 question of exactly how that plays out. But we do believe that every month that the consumer remains healthy, that we've been using this analogy of burrowing through a tunnel of still high unemployment. And what history would have otherwise suggested is the relationship between unemployment and losses that we haven't seen. We feel like we're reducing the cumulative losses through the downturn with each passing month rather than just delaying those impacts.

Maybe ask it this way. Are there any potential catalysts or warning signs that you're keeping an eye on for the kind of the inevitable turn in credit? And kind of what are you doing to kind of maybe stay in front of it?

Well, I think to some extent, normalization is inevitable. Whatever that exactly means, we'll have to wait to see. But the things that we're really keeping a close eye on is what others are doing. I referenced earlier in competition, one of those elements is in underwriting. And I think there is a risk that other people in the industry are relying on the credit characteristics and data based on recent patterns. And I think that could lead to loosened underwriting standards and create some adverse selection. And might even be exacerbated by the liquidity and capital phenomenon that I described earlier when talking about auto. And I think the credit cycles tend to be driven by people overreaching and going after less resilient business. We saw it in the Great Recession with the subprime mortgages. And so I'd say that, that's probably the thing that we're most closely focused on. But we can control, in many ways, our own destiny there. And it's by using the power of data and technology and 30 years of history to focus on resilient underwriting choices that go way beyond recent trends and FICO scores to help us carve out where those opportunities truly, truly lie.

And I guess given this benign credit environment, which I think continues to outperform everyone's expectations. But on top of that, so as unemployment, so as GDP growth. And it looks like a lot of the banks, even kind of some of the inputs they've used for their CECL calculations, it's running better than that or should run better than that. How are you thinking about the appropriate level of reserves against that?

So one thing we've certainly seen over the last 12 months is the pro-cyclicality of CECL, and in some ways, the challenge with getting it right when you extend the duration of the forecast running through your P&L. And so why don't I just spend a moment, Jason, because with investors, it's often a question of how should we, to your point, expect this to play out. And I think it's important to really talk about the component parts of the allowance under CECL. So just like we had under the incurred allowance model, we have the near-term forecast of what's largely flowing through the delinquency buckets, right? From there, though, we pivot to what I'll label is more of a midterm forecast, where we've talked about our models assuming that the relationship between economic variables and credit revert to historical norms, and so kind of picking up from the short-term forecast to that medium-term forecast. And then ultimately, the gradual reversion from there to long-term cycle averages. And on top of all of that, we apply qualitative factors to address the uncertainty with each of those 3 components. And so what you're seeing play out now in the marketplace is not only are people approaching those 3 components somewhat differently, they're also applying qualitative factors to all of them at different levels that really makes one-to-one comparisons difficult. But as we sit here today, of course, we've seen actual credit performance be strikingly benign, and we released a bit of allowance last quarter. But it's important to note that there's still a lot of uncertainties out there in terms of the pandemic, the economy, how consumer credit will play out, as we just discussed, on the other side of stimulus and forbearance. And so we're maintaining large qualitative factors for those uncertainties. And therefore, if favorable credit continues and those uncertainties subside, we could certainly see further allowance releases in the coming quarters. But it's really dependent on what observed credit does and whether those uncertainties gradually disappear, that will ultimately drive the allowance from here.

Helpful. Let's maybe turn to NI margin deposits. But we've seen strong deposit growth. Obviously, you have pretty high cash balances, large investment portfolio all kind of weighing on margin. Maybe just talk to the extent that loan growth maybe -- or credit card loan growth takes time to come back. Just how you think about just managing the balance sheet and NIM as this kind of interest rate backdrop evolves?

Well, the growth in deposits, coupled with the shrinking of the lending book certainly put us in a position where the inflow of cash that you saw last year, we increased the size of our investment portfolio by roughly $20 billion. And the portfolio is one tool that we have at our disposal. But we also need to be mindful of some of the expected outflows that we're going to have coming forward, including we've got something like $13 billion of wholesale maturities over the course of the next year. We have the share repurchase authorization. We're hoping for loan growth. And so while there's clearly an opportunity cost of not deploying cash in the short-term to the investment portfolio, there's also an inherent benefit that comes from the flexibility of that cash and avoiding the market risk of rates moving against us, and all of the things that I just mentioned in terms of uses of cash in the relatively near term. So it's a trade off we're constantly evaluating, but feel like we're striking the right balance.

Got it. You mentioned share repurchase. So I'm going to have to jump to that. I think you did $490 million in Q1. If I did my math correctly, you could do, I think, $1.7 billion in Q2. But even if you say you did that, you still have like $5-billion plus left. How do we think about the timing? Do you all want to finish that buyback this year? And then maybe with that, you obviously got the dividend back to that $0.40 number. How are you thinking about that going forward as well?

Yes. It's always important for me to start with an acknowledgment that capital distribution is a critical component of shareholder returns. And so I really can't emphasize enough how excited we are to hopefully get under SCB in the third quarter. As you said, we're locked into the capacity in the second quarter of roughly $1.7 billion of repurchases in Q2 and locked into our $0.40 dividend. How quickly we distribute beyond the second quarter, of course, presuming we move under SCB and have flexibility, it's a function of not only constantly evaluating our capital position, but also just stock trading volumes, right? That's an important thing for people to understand, just the sheer capacity to buy back shares. And so it's -- the amount in the form of capital distribution in Q3 will certainly be a topic of conversation as that flexibility returns, but putting it in the context of some of the constraints that exist. We're eager to get it out as quickly as possible, but also need to be mindful of a highly uncertain environment. So we're, like I said, really looking forward to much more flexibility a quarter from now.

Makes sense. And I guess, Capital One has kind of been pretty active doing kind of smaller fintech tuck-in acquisitions, although I guess I haven't seen anything in the recent past. Can you maybe just kind of talk to kind of your thoughts around that and just talk on acquisitions in general, just given you have this slug of excess capital.

So yes. I'd say, first, we really like the bone structure, as you've heard Rich, for many years, use that term, the bone structure of our businesses, to have national scale and that play to our strength. And so I don't think you'll see us searching for something that is looking to somehow alter our bone structure. What I can say is we've had a lot of success over the last few years with -- on the fintech side and also with, kind of, some bolt-on capability acquisitions. In things like KippsDeSanto, which got us into the defense contracting M&A business in commercial. And one thing that is maybe a little bit of a hidden benefit of the tech and data transformation is, for us, it's particularly easy to bring in fintechs that were born in a modern tech stack, and snap them in and have their capabilities immediately be additive. As opposed to somebody who's not operating in that fully cloud world, who may not be able to fully take advantage of those capabilities. And so what we do is really look for where the world is going, what our customer needs. And then look for companies that share our values, share our culture, have those capabilities and bring them into fold to accelerate the journey in those particular dimensions or attributes that we're looking to create. And as you said, we've had success, and we're constantly looking for them, but we also don't feel the need to go do anything if it doesn't enhance our capabilities.

I guess said another way, that's mostly smaller opportunistic acquisitions as opposed to looking at M&A as a transformational vehicle.

I guess, maybe sticking with kind of that fintech-y theme. And just maybe -- obviously, Capital One's always been investing heavily in technology. I guess, where do you see yourself kind of along that journey?

Yes. It's been -- I guess we've been talking about it for the better part of 9 years here, Jason, and it's a tough transformation to go through, in that it requires us to -- or required us to kind of fundamentally rethink our technology stack from the bottom up, as opposed to doing more of the presentational layer of things that the outside world can see but don't fundamentally, kind of, change the nature of how we operate. And as we've been on that journey, we know we're on the other side of getting out of the data centers. And we're really seeing some of the powerful benefits of the investments, things like we talked about auto, the capabilities with auto and dealer navigator, some of our underwriting capabilities. You can point to some of the acquisitions that we made or -- partnerships like Walmart, largely a result of the technology transformation we've been on. But I think that there's a lot ahead of us. And the capabilities that we'll still be making investments to build out, not necessarily infrastructure as we're entirely in the cloud, but just the analytical capabilities, the data capabilities. And we think that those benefits that I just described will continue to accumulate and allow us to move to a place where the whole world is moving to real-time intelligent. And being in a cloud environment with streaming data enables us to fully take advantage of that and compete against those who have those capabilities, but may not have the scale and brand that we have. And so I think it really puts us in a sweet spot to break away from the pack.

And I guess, against that backdrop, for my final question, I'm going to go with -- obviously, you kind of -- you had your 40% -- I'm sorry, 42% operating efficiency ratio target. Although, I guess, uncertain actually when you can get that, you're obviously running a bit above that. Can you maybe just walk through some of the main drivers and kind of steps you're taking to kind of help achieve that figure against the current revenue backdrop? And when do you think you could actually get there?

Well, having followed us for a long time, you've seen that improving operating efficiency for a number of years coming down something like 400 basis points. And we were on the path to achieve 42% in '21. The pandemic clearly interrupted our progress there, particularly as revenue growth, mostly on the back of lower loan volume, in part, by the higher payment rates we were discussing before, which, by the way, has virtually no marginal costs. We also saw the rate environment pivot from the trajectory it was on, which all else equal, creates a headwind to revenue. And so from here, there's 2 parts to the efficiency journey. On one hand, you've got the cost side where I'd characterize it as us having cross currents. So we are going to continue to invest in the technology journey that I just described in growth opportunities. But on the other hand, we're going to be really disciplined about driving out costs, analog customer costs, driving out manual processes internally in the way that we work and the way that we report and do analysis. And so the net of those 2 cross currents, we're going to be making trade-offs every day. But the other variable in the efficiency journey, and the elephant in the living room here, is revenue. And so we're working really hard to drive new accounts and generate spend. But revenue will be a function in many ways of consumer behavior, particularly in the near term. And so while we see payment rates high, we're reaping the benefit in the credit line. It's not helping on the revenue line, but that's a trade that we and our customers would make every day. And so we'll have to keep pushing on the revenue side and expect to see growth over time. And we'll remain focused on delivering that positive operating leverage. And again, I think much of this really goes back to our digital transformation and the capabilities in both revenue and expenses that are being enhanced by where we are on that journey. But we recognize it's an important element to delivering long-term value, the it being continuing to deliver operating leverage over time, and that remains a focus of ours.

I think that's a perfect place to leave it. Andrew, Jeff, thank you so much for taking the time to join us today and looking forward to doing this event next year back in London.

Thanks so much. Really appreciate it.

Thanks, everybody. Take care.