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

Capital One managed the pandemic better than most just given prudent risk management and the benefits of its tech transformation, which I think is now in its 9th year. More recently, this transformation has helped drive best-in-class growth across its card and auto businesses, which we expect to continue. While competition is heating up as both legacy players and fintechs look to gain share, Capital One remains well positioned to capitalize on the opportunities in the marketplace. Here to tell us more on the line is Chairman and CEO, Rich Fairbank. Today's presentation will be a fireside chat virtually. So welcome, Rich.

Ryan, thanks. It's great to be here. I don't know how many years straight you and I have been doing this, but it's great to do it again, and welcome everyone on this webcast.

Great to have you, Rich. Rich, the industry spent a lot of time talking about payment rates, which obviously was a concept and now my years covering the space, never got much airtime. However, they've remained hundreds of basis points above pre-pandemic levels and recent commentary, including at this conference, is that they haven't really moved down in a meaningful way. So can you maybe just talk about your expectations for payment rates? How much is being driven just by higher balances being paid off? Are you seeing any changes across your portfolio? And what are your exceptions for what could happen, I mean, for growth for the year ahead?

Yes. So Ryan, there are 2 main drivers of elevated payment rates. One is the impact of healthy consumer balance sheets, driven by stimulus and increased savings. And the other driver is the extremely strong spend that we're seeing from consumers. Now the elevated payment rates put pressure on loan growth, but that comes with the exceptional credit that drives strong profitability and capital generation. Now we don't have a forecast for where payment rates will go from here. But I would note that they've come down very slightly from the record high levels that we saw in July. So this could be the beginning of gradual normalization. And while it's not a perfect proxy for all of Capital One's portfolio, you can see that our payment rate trends in our trust metrics where our payment rate is currently, let me see here, 46.3%, which is down about 100 basis points since June. Now turning to the impact on growth. High payment rates will, all other things be equal, hold back loan growth. But there's a lot more to the growth equation. And one of them is purchase behavior. We showed in Q3 that purchase volume was up 28% year-over-year. And even more striking to me is that when you do the comparison to 2019, where it's up 27% since 2019. So real strength in purchase volume helps on the outstanding growth side. And another driver of growth is the traction we're getting in the marketplace. And we continue to see attractive opportunities to grow our customer franchise. And as we've announced, we're continuing to lean further in on marketing. Also, we continue to gradually increase credit lines. So kind of pulling way up growth in our card business continues to rebound nicely. And even loans, which have been the laggard in the sort of all of the growth metrics, because it's been held back by higher payment rates. We saw that even despite higher payment rates, loans returned to positive year-over-year growth in Q3 and were up around 4% from Q3 of 2020. And that compares to the second quarter, where they were down slightly year-over-year. So we -- so even this most laggard of the growth metrics has been showing more strength. And I think it's just all part of -- I think, right now, we're in a place where we're leaning into growth opportunities. And again, our growth -- our marketing is really focused on originating accounts. But even loan growth itself is showing more strength.

Rich, you mentioned a few times leaning into marketing and that the areas that you've been investing in are much broader, including card, the National Digital Bank and the auto business buyer or Auto Navigator. And if we look near term, I think you're slated to spend over $1 billion on marketing in 4Q, which would be a record by almost 25%. So can you maybe just talk about how you measure the return on those investments, what it means for customer acquisition? And second, how much of the increase is being driven by competition, which is pushing up the cost to acquire versus you seeing an opportunity to meaningfully increase the size of the customer base?

Well, we should all note that Capital One is not the only player that's talking about leaning further into marketing. So it's hard to quantify the competitive effect. I've just been around long enough to know that when everybody is talking about more marketing, it is going to get a little more expensive to get the accounts that we want. But what -- but I do want to say that we -- the consumer is in a very good place right now. And I think that especially as a product of our tech transformation and the -- a lot of the good opportunities we're investing in, we see good origination opportunities even in spite of the increased competition right now. Marketing is the primary engine for originating those new accounts. And so we continue to lean in strongly on the marketing side. And actually, the marketing efficiency that we're seeing is compelling. And we're also spending on some new things like Capital One Shopping and Auto Navigator, which are new emerging growth opportunities for Capital One that I don't think are nationally very well branded yet. And so that -- those are things that we want to make sure that we put some wind at their back so they can grow the way that the opportunity warrants. So with respect to the competition, we're keeping a very watchful eye on what's happening with the competitive intensity, with pricing, with underwriting practices. And we feel now there's a good window for growth right now. But we know that the physics of how markets change and especially environments where credit is unusually strong, you can have competition ultimately oversaturate the market, and there can be consequences. So we've been through a number of these cycles, are absolutely vigilant about that even as we lean in pretty hard right now into the opportunities.

Rich, we'll come to credit in a minute, but maybe just sticking with the theme of competition. Can you maybe just talk about what you're seeing across different parts of the market, whether it's subprime -- whether it's superprime or near-prime? Do you feel the market is getting ahead of itself at all in terms of rewards or bonuses from a competitive perspective? And then second, you recently rolled out the Venture X, which was a travel-based card. What was the driver behind that? And what was the market opportunity that you saw?

Yes. So competition in card has definitely intensified, especially in rewards. Marketing and media activity are approaching pre-pandemic levels. Competitors are -- continue to lean into marketing and originations. I was looking at a report the other day that showed direct mail is back to 2019 levels. But I think this is all more the natural and healthy side of competition. Pricing continues to be mostly stable. Rewards offerings have definitely become richer, and we continue to watch that closely. We saw some modest increases in upfront bonuses mainly in the form of limited time offers especially in the travel space. The earn rates for rewards have increased with some new product structures introduced recently, particularly in cash back. And then you also, let's not forget, have the fintechs and the buy-now pay-later effect and various things that are going on there. So as I said before, even in the context of the increased competition, we continue at this point to see good opportunities for growth. Now with respect to the Venture card -- Venture X. This is not a thing that a few months ago, we said, wouldn't it be cool to do a Venture X card. This has been years in the making as part of a journey for Capital One to continue to move upmarket to the very top of the heavy spender marketplace. But to do that is not just a matter of coming up with a product because we could have created this product years ago. It's really a part of a journey to build absolute top-of-the-line servicing capabilities, digital capabilities, product features. We launched our Capital One travel portal, which has an exceptional customer experience. We opened our first Capital One lounge in Dallas as part of a journey of expansion there. And so the Venture X is kind of an important milestone on a journey that we've been -- that's been many years in the making to continue to go up market and build a brand that is consistent with that. Going after the top of the market is not something that a bank can do a little here and then pull off for a bit and a little there. This is really a matter of being all-in after that marketplace. A subset of all the big card players have chosen to go after that business intensely. Capital One is one of them. And I think we are well positioned for success. And we're very pleased with the initial reception of Venture X and the early engagement by customers has been very strong.

Rich, recently, credit has been pristine. But over the past few months, we started to see delinquencies upticking in line with seasonal patterns. I think they were up 25 basis points last quarter. Where do you think we go from here on credit? Are you expecting a gradual normalization? What are you most concerned about, either from a marketing or an underwriting perspective? And what are you doing at Capital One to manage these risks?

It seems inevitable that losses will increase from the exceptionally low levels of the past year, especially now that the bulk of government stimulus is behind us. And many of the forbearance programs are -- across the industry are winding down. And I think we're seeing the leading edge of that normalization in our own numbers. And again, that's no surprise. It would be surprising if we didn't see it because we start with the phenomenon that credit is just at kind of all-time best levels, consumer credit in general and certainly at Capital One. So here's what we've seen. Over the past few months, card delinquencies have increased gradually, a bit more than the normal seasonal trend. So there's a little bit of normalization probably in there. If you look at our individual delinquency roll rates, which is the rate at which people move from one delinquency bucket to the next one, we're seeing some modest increases month-over-month. Now that's still in the context of very strong credit. And the delinquency metrics remain well below pre-COVID levels. But my point is that -- and I've been saying this for some time, we need to expect normalization to occur. And we should be very surprised if it doesn't. Now there are natural forces to drive the normalization, the ending of the stimulus benefits and forbearance programs, like I said, also strong competitive activity and also some of the recent price inflation that we've seen in the marketplace as well. And you also have auto vehicle values that at some point, have to come down from the unprecedented levels we've seen over the past years. So we are on the lookout to watch for the things that inevitably come at a time like this. And we have a real watchful eye for competitive behavior to look for the signs of looser underwriting, more aggressive lending practices and any adverse selection that can come as a byproduct of all of that. But we have a very watchful eye on this, but we are very much like what we see. And even the normalization that we see looks on the very gradual side and so we're leaning in to our opportunities. And we like to capture those opportunities when they're available in the marketplace.

Rich, maybe we'll come back to credit in a bit. But I wanted to shift gears and talk about -- more about the environment. You recently announced you'll be testing a beta version of a buy-now pay-later product. Can you talk about what drove the decision? Are you seeing the impact becoming broader than just things like debit? And as you look out over an intermediate timeframe, what are the key things that you're watching that will influence how much you're willing to invest in this product?

So the buy-now pay-later market continues to evolve quickly, and we continue to study it very closely. Even over the past quarter, we've seen an uptick in velocity in several dimensions. A number of large players have announced plans to enter the market or have entered it via acquisition. There had been a number of reports and analysis that have come out saying what we have also observed in looking at our own customer data and that is that, in general, the consumers applying for buy-now pay-later loans are more coming from -- much more from the debit side of the business than from the credit card side of the business. And I think it's not so much because they are the personality types to favor debit. I think it's because despite all the talk about buy-now pay-later being a payment revolution, I think the most striking thing to me is it's an access to credit play. Now that's not -- it's not entirely that, but it certainly leans in that direction. And so I don't think it's -- it stands to really transform the credit cards role in the marketplace. But I think buy-now pay-later has had a number of innovations that are here to stay. The placement on the merchant website is fantastic, the great customer experience. That we see, the way they're using data, often doing repayment through bank accounts. And really even supplying the merchants with kind of the results and demonstrating the lift to merchants is also a very clever kind of a thing, and all that's contributed to the success of buy-now pay-later. So when I look at the buy-now pay-later market, I think the 2 biggest risks for the players in the marketplace are; a, what happens to the merchant subsidy, the merchant discount that is currently way -- on average, way above interchange rates with all the people masking at the border of this. It's logical that the margins coming from the merchant subsidy are going to fall maybe pretty dramatically. And the other thing to keep an eye out for is what happens to the credit side of this business. I don't think the paying for over a period of a few weeks is really much of a credit business. That's more like a charge card in many ways. But increasingly, the market is going toward and the merchants are pushing for longer loans. That's the installment lending business. That's the credit business. And I think the challenge that we should keep an eye out for all the players out there is the credit policies that are being used, the data looking in the rearview mirror of the most extraordinary period of consumer credit in history, the data window for a number of the buy-now pay-later companies is -- and it's no fault of their own, it just happens to be an unusual and extraordinary credit time. So I think therefore, the second risk is what happens on the credit side of this business. Now with all that said, we're not sitting still. We've been very impressed with what the buy-now pay-laters have done. And as we announced a few months ago, we'll be testing a beta version of our own buy-now pay-later product. That will be available to a subset of consumers at the point of sale across several merchant websites. So we will continue to work through our testing agenda. We'll continue to watch the marketplace carefully. And it's really an example of how innovation coming from fintechs can really have an impact on the overall financial marketplace. And there's lots of lessons to learn and lots of opportunities to capitalize on.

Rich, you just mentioned a lot of things happening in fintech. I think at earnings, you talked about the pace of investment that was coming in, that was 2x prior levels. Can you maybe just talk about beyond buy-now pay-later, what are the areas where you're seeing investments being made that are the most concerning from a competitive position? And how will increasing investments on your end allow you to win against these new entrants?

So the fintechs are really working to transform a lot of different parts of banking and financial services. And so let's just look at some of the plays. You have the platform fintechs, who are creating the capability for payments or for financial products to be offered by other fintechs on much more of a turnkey basis than was available, say, to a Capital One, when we were an original fintech way back in '90s, we pretty much had to build everything ourselves. So I think it starts with platforms that the shoulders that the fintechs can stand on are great and not only accelerate their move into the marketplace. In many cases, it puts them in a stronger position than many of the banks they're competing against because those banks have old world technology in many parts of the company. So you've got the platform players. We've seen electrifying developments on the payments side, how PayPal has become payment button of the Internet. And one of the very attractive things for fintechs is that the payments business is relatively less regulated, and it's also where a lot of the action in the eyeballs are. So there's been a huge investment there. And frankly, the fintechs have had extraordinary success. You also see people -- you see the buy-now pay-later sector. You see the neobanking area, and there is also the cryptocurrency players. And all of them are seeing some pretty good traction. If I pull up and think about what the fintechs that I've talked to and when I read what they're saying, it's a striking pattern with virtually all of them. They start in one product area. Very typically, it's hard to make any money in that product area. And a number of the fintechs are losing money in whatever their initial journey was. And virtually all of them have the same playbook. And in many ways, maybe this wasn't that different from our original playbook in Capital One, but that is to build a much more broad financial services company, using their first product as the gateway into doing that and the customer relationships as the springboard. So that's going to be an interesting journey to watch. But what it likely will mean, implications for Capital One. There are going to be a bunch of players entering the businesses that we are in, like the credit card business. A number of players doing lending, who didn't even start as lenders. We'll have to keep an eye on the amount of credit exposure and the credit choices they're making. And -- but the flip side of all of this, I look at what's -- on an annualized basis, the $120 billion that's going in venture capital into fintech as the biggest single sector of investment of venture capital. The market is voting with their feet that the opportunities to transform financial services are very big and they are now and I agree with that. And so I just think the market is all over the place. The signs are there. The times, they are changing. And the window is compressing. And I love Capital One's position, but this is why I've said we're all in, and we need to move with the speed of the market to take advantage of the opportunities that we see.

Rich, because of this, you talked on the last earnings call about expecting the efficiency of the company could potentially rise. And I wanted to ask you, is this just a slowdown on the efficiency journey? Or do you think the reality of the market has sort of moved the goalpost and reaching destination levels that you had previously articulated are likely to prove challenging?

This is -- there's no change in our sense of the destination or the journey that it takes to get there or what's driving it. So let's talk about why we have been, for years, driving toward increased operating efficiency. There are some companies that get there by just trying to squeeze more and more pennies out of the system. But it's a tough way to sustainably create huge operating efficiency improvement. To us, the engine of doing this comes from our tech transformation. And the two things that, that enables over time. One is to build a much more digital company and create real operating cost efficiencies through just operating way better with way more modern technology. And that savings in operations, that savings in tech costs -- the legacy tech costs and huge vendor costs in the past and going to not only more modern technology but technology that's a lot cheaper to operate. The other big benefit of our tech transformation with respect to the efficiency journey is the opportunity to grow faster, to grow our revenue faster, standing on the shoulders of a modern tech stack and having the kind of opportunities that a lot of the tech companies have to create attractive products, move quickly, leverage data and create a competitive advantage. And so the tech transformation is the engine for the long-term efficiency improvement of the company. It's been the engine so far. It's the engine for the future. My point in the recent earnings call was that the marketplace is speaking right now about -- and the opportunities are very significant, but the timeframe for opportunities are compressing as there's so much investment in fintechs and the pandemic has accelerated the consumers' digital transformation. So we love the opportunities. These are all manifestations of the size of it, but our point is that we're going to need to lean into investing in these opportunities to be sure that we can capitalize on them in a timely way. But then also my other point was that also as a byproduct of the hyper fast tech revolution in the world, the cost of tech talent is going up everywhere. And there's just -- so basically, all the investment in tech -- you got the big tech companies, the massive amount of venture investment, all the money chasing tech innovation. And now all the legacy companies of the world saying, "Oh my gosh, it's an existential matter. We've got to invest more in technology." What it's doing to the supply and demand for tech labor is something that I have not seen in a labor market to this magnitude before. And so if we pull way up, while we're very excited about the opportunities, the increased tech labor cost right now and the need to, in the near term, lean into our opportunities, that will pressure our efficiency ratio journey in the near term. But it's not a comment at all about the long-term destination or the nature of the opportunity.

We're down to about 40 seconds here, Rich. And maybe I'll just throw in one hopefully quick question here. The company remains very well overcapitalized at almost 14% CET1. How aggressive can you be in returning capital given that it sounds like efficiency improvement is on plus for the time being?

So as you know, our Board authorized a $7.5 billion share buyback program in January. And we -- mindful of trading volumes, we were able to repurchase half of our remaining authorization in the third quarter for a grand total of $4.9 billion of our $7.5 billion authorization. We understand the importance of capital return, as you can see through our share repurchases and last quarter's dividend increase. So when we think about destination capital levels, we continue to believe that 11% CET1 is the right long-term capital level. And our goal is to ensure that we're appropriately capitalized to withstand the full economic cycle and remain resilient. But we believe that capital return is a very important part of the value proposition for investors in Capital One, and we continue to see opportunity there.

Great. Well, we're unfortunately out of time, but please join me in thanking Rich.

Thank you. Always a pleasure.