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

All right. So good afternoon, everyone. Thanks for joining us. We're very pleased to have Capital One with us. As everyone knows, they're a leader in the credit card business, both branded and private label cards and auto finance as well as digital banking. I think Cap One's, I think, biggest success has been able to grow rapidly when competition is low and moderating that growth when it intensifies something that they've done in the past year kind of in the auto finance business. We're very pleased to have with us Rich Fairbank, CEO and Founder; and Jeff Norris, Head of Strategic Planning and Investor Relations. So maybe we'll start off talking about the Credit Card business. And you and many in the industry are marketing at or close to peak levels. Clearly, there have been signs of stress to the consumer. There's been signs of health of the consumer. How do you think about that -- your marketing strategy in that context?

Thank you, Moshe. Thanks for being here. I don't know how many years you and I have been doing this together, but it's many. And good afternoon, everyone. The -- when we think about the card business and how much to lean into the opportunity in that business, we kind of start with where the consumer is, which I think is in quite a strong place. The consumer obviously generated, for a variety of reasons, quite a bit of savings during the pandemic. Those savings are running down, of course, but the consumer starts in a good place with a low debt burden relative to really the last 30 or 40 years. And I think the consumer also is a little scarred from both the global financial crisis and the pandemic. And I just see a lot of rationality in how the consumer thinks about credit. And then we look at the marketplace. I think there's a stability in the credit card marketplace, a competitive environment where we see opportunities. And then most importantly, we look at our own credit results. And when we look at how our originations are performing, we see good solid performance there and stability in that performance that has us -- even in the context of, of course, really quite uncertain economic environment, I think we see good resilience, good opportunity and good demonstrated performance of our own various programs. And so we're leaning into this. Moshe, you commented that we often zig while others zag. I think several players in the card business probably are zigging at the same time. But this is an opportunity that we're leaning into. And it's striking at the -- it's the same company and a lot of the same people were -- actually have been kind of pulling back in the auto business. So we have both gears sort of engaged at the same time.

And as you kind of think about -- as your -- a lot of the spending that you're doing on marketing in the card business comes at the higher end of the credit spectrum because those customers get big rewards, bonus upfront, which you expense, obviously. Can you talk a little bit about what the state of that competition is? Is it going to be those upfront bonuses? Is it going to be the other things, the benefits you're adding to the card? And how confident are you that you're keeping -- going to be able to keep those customers in order to generate those returns over a long period of time?

Well, a lot of our spending is going right after the top of the market. Although, again, we do invest a lot in marketing across the whole credit spectrum. But certainly, there's a lot of it going in our quest to more and more move up to the very top of the market, our strategy for going after heavy spenders. It is a business that is very hard for a bank to go in and out to sort of get a flavor of the month and lean into it and try it for a little while because this isn't just about a product that you throw out there or put on national television. It's really about working backwards from what it takes to win with very heavy spenders who aren't necessarily inclined to go switch their providers. But it's across a whole spectrum of product and really high-end customer experience, digital experiences, and then real life experiences in their own life events like travel associated with the entire life cycle of going on a trip, from planning it, to booking it, to taking it, all the experiences along the way. It's about access that you can't sort of otherwise get in life. It's about we declared some years ago that we were going to go after that space. We were going to do it on a sustained basis. But we weren't going to just declare it and close our eyes. We are very vigilant looking at the performance of what we are booking and what's the nature of the franchise we're building and the brand that we're building. The -- one of the best things that we are seeing -- well, we're very pleased with what's happening in that business. But the nature of these annuities, how low the attrition is, the first in wallet rate, which is really strong. So what we see reinforces our belief that we can win in this business and that we're getting a lot of traction building the capabilities and the brand that we have at Capital One is a very expensive upfront business because not only does it take quite a bit of marketing. But as you said, Moshe, the upfront early spend bonuses we take these and we book them at the time that we originate them. It's a lot of costs upfront for a really great high engagement, high spend, low loss, low attrition franchise. And we're very happy with our results. You also commented about -- or maybe I'll just make a comment about the industry competitive dynamics right now. It's very competitive, but it's strikingly stable at the moment. I think early spend bonuses are flat to down over the last year or so. And again, I think every one of our competitors, certainly, those at the very top of the market, are leaning in hard. But I still see collectively a stability in that marketplace and a rationality to the choices being made that I think reinforces the opportunity that we see.

And you are, by far, the most balanced broad-based kind of credit card issuer out there. Talk a little bit about your non-prime business. Where are you in that? And how do you -- do you think differently about the economic situation for that customer base? And what is it going to take to drive growth there?

Yes. So -- we founded our company on what we call an information-based strategy, that -- we said increasingly credit cards and really financial services in general are going to be about technology and data and analytics and, in many ways, sort of scientific testing, statistical modeling and being able to take one-size-fits-all industries and drive highly customized solutions based on deep analytics. So that was the founding idea of the company. And here we are more than 3 decades later, and we're still on the very same path. Analytics are valuable at the very high end of the market with spenders, for example, but where the lower you go in the credit spectrum, the greater the value and the leverage is there because it becomes more and more about can you live to tell about it from a credit point of view. And so that is why it's not an accident that Capital One has for really 3 decades, set our sights on winning at the -- in addition to our quest higher in the marketplace to win with -- in the subprime marketplace. So it -- first and foremost, is about gathering a lot of data and doing a lot of testing and building models that demonstrate their resilience over time. And what I'm struck by really in the 3 decades we've been going after that part of the marketplace is the stability and consistency with our own strategy there and the resiliency of the results. So here we are now at a time when the consumer, as I said, is in a strong place, but the economy is, of course -- has a lot of uncertainty around it. We go back to our basic playbook here that we test very rigorously. We use a strategy of low lines and having customers prove themselves, and we look very carefully at the results every month of what is happening. And we continue to see solid results in that segment. The subprime consumer for a while in our public announcements, we were saying the subprime customer is normalizing faster than folks that are higher up on the credit spectrum and strikingly actually in the last 2 or 3 months. The -- if you take any sort of income level or credit segment and compare where, say, delinquencies are right now compared to pre-pandemic, pretty much every income segment and every credit segment is about the same percentage normalized at this point, which really means that the normalization began with subprime, but it's actually the rest of the marketplace is catching up. So this is a broad-based normalization.

So as you think about managing the portfolio in that context, what changes have you made over time? And what -- also what should we be looking at to get sort of comfort that, that process is working the way you expect?

Well, we continue to look at the business in segments and micro segments and do our testing and our monitoring at that level. And we -- but we don't just look at the data. We also look at the marketplace and intuitively try to identify where we think the risks are, and then we check the data and so on. So it's a combination of a very analytically driven process and a sort of intuitive behavioral explanation. We try to do both of those at the same time. Over the last year, 1.5 years, as we were projecting normalization would begin and it pretty much had to go. We also very closely looked for things that were unusually that, that might be diverging from a normal path of normalization. And using machine learning-driven monitoring models that are looking at a lot of variables. We were able to identify in our card business, certain segments that were -- subsegments that were gapping out well beyond what was normal. And we immediately kind of closed those down. We also looked for sort of the behavioral explanations that would make it -- help us understand logically why that segment in particular was challenged. So this is a phenomenon we call trimming around the edges and we have been trimming around the edges all along this journey of normalization. It's -- and it's been an important factor in why our vintage curve performance continues to be strong because some of the things that we did clip away from the edges in fact, ended up gapping out quite a bit.

Wouldn't be able to miss having some discussion of the whole late fee situation. I know that there's a lot that's still unknown. But how are you approaching it from kind of a management standpoint at this stage? What are your thoughts as to the right way to move forward?

So the CFPB in going after late fees is, it's not just an ordinary fee, this is a fee that is very much tied to a consumer behavior and the fee serves as a deterrent to folks getting themselves in trouble by not paying on time. So we want to all watch carefully what happens in the context of significant change in that fee, so one thing no one knows for sure, but we'll have to keep an eye on whether that, in fact, alters consumer behavior, which would be an unfortunate thing. But the late fees are important source of revenue for Capital One. And if the consumer financial protection bureau proposed rules go in, that's going to have a sizable impact on that revenue stream. And we are looking at the various choices that we have to respond to that and over this year since the implementation would be next year. Over this year, we're going to be testing a variety of things that would be part of our response from a revenue point of view. So these are very early days, but this will be a year of testing.

Talking a little bit about the auto finance business. I mean, you alluded to it before. You've talked publicly about kind of retreating from the subprime auto space. Is there something that you might see at some point? Or what would you be looking for to see to kind of go back into that space and is it used car values? Is it employment? What are the indicators that you need?

Yes. Well, first of all, we have not pulled out of the auto business. We just pulled back from -- in the years prior, we were leaning quite a bit into that. Our originations and our overall portfolio grew a lot. So on a relative basis, we're kind of dialed back, but I want to start by saying we're certainly not out of any important part of that business. The -- let me talk about the credit side of the auto business and the marketplace/pricing side of the business. So part of our dial back a smaller part, but still important part of our dial back came on the credit side of the business, where we saw in the lowest end of the subprime that we would originate. The lowest end was having significantly more normalization than the whole rest of our auto book. So sometime like a year ago or so, we dialed back quite a bit at the very bottom of the marketplace, which would be the top or middle of the marketplace for a number of other subprime players. The -- and with those dial backs actually, our auto originations have come in with very solid credit performance, obviously, normalizing. But we feel good, and we like the stability of what we're seeing on the origination side, having trimmed around the edges and, in fact, trimmed more on a relative basis than we did in card. The second part of the conversation and the bigger reason for our pullbacks is on the pricing side. So of course, when interest rates went up dramatically, one would expect in any lending business that over time, the pricing would reflect the increase in the cost of funds. In the card business, these changes happened more quickly. In the auto business, the money center banks and Capital One essentially reflected in our pricing, our increase in cost of funds. But we were struck that outside of the money center banks and Capital One, we didn't see much movement in pricing, which meant that margins were compressed. Now, I want to draw a distinction between the card business and the auto business. In the card business, we can make choices about what we do and what we price and different things. And it might affect our volume a little bit here or there, but we're very much sort of -- it's kind of us and our decisions. In the auto business, you have a dealer in the middle of the buying decision. And the dealers put a lot of pressure on lenders with respect to what their product pricing is and so on. And so what happens is if you price -- changes in price being off of the prevailing rates can cause a significant impact in volume, much more than on the card side in the short term. So -- and so therefore, we were not immune from the pricing impacts that happened to the marketplace. So when we looked at it, we saw that our pricing and really our margins -- and therefore, our resilience, was going down in the auto business. And so we -- they're around the -- we didn't just totally pull back, but around the edges, these sort of lowest resilient, lowest margin stuff we pulled back on. And that's why collectively, in the auto business -- even as our card business we've been leaning into the auto business, has been in pullback mode. I will say that in the last few months, we have seen significant progress on the pricing side in the marketplace. And it's the kind of thing that one would expect would resolve itself faster than where you see credit disequilibriums.

Got you. It's interesting and very good to hear about that. Cap One has always been very intent on managing to a low loan to value as part of the auto business. And so therefore, the potential for weakness in used car price is not as big a deal. But your thoughts as to how that's impacted both yourselves and the industry?

Well, so in the short run in the auto business, when used car prices go up, it's a very good thing because what happens is our customers tend to pay more on time because they have more equity in the vehicles. And if they don't pay on time, we will end up with more equity in those vehicles. So that's a good thing, but be careful what you wish for because the problem with high used car pricing is when it becomes the new kind of normal for the industry. Then the concern is that the market clearing price is underwriting -- the market clearing lending price is underwriting to higher used car prices, and they might have only one way to go, which could be down and down a lot. So what we do is that we ourselves assume significant reductions in used car prices. But I do feel that, in general, there's higher risk in the industry in this marketplace when used car prices just are at the higher levels that we see now.

Got it. Just talk a little bit about deposit growth. I mean you're somewhat of a unique situation and that you did really transition from your deposit base into an increasingly digital -- an increasingly digital deposit base. And can you talk about where you are in that process and how you think about competition for online deposits today?