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

Good afternoon, everyone. Thank you for being here the afternoon. We're going to kick off with Capital One and familiar face to most of you, Jeff Norris. And we're just pleased to have you here, Jeff. Thank you. I know you've been in a lot of meetings this morning, and I hope you're not talked out.

Not yet.

Not yet, okay.

Not yet? Okay. Well, let's just start with the question that you always get to lead things off, give us the Jeff Norris Capital One view of what you're seeing on the economy and what you're seeing for the consumer?

Sure. Happy to do it. Let me add my thanks for everybody who's here and everybody who's listening on the webcast. In general, when we start the description with the health of the consumer, the consumer still feels like they're in a really pretty strong place. Labor markets are still really robust, which is one of the biggest macro drivers of consumer health. Debt burdens are still low even in a rising rate environment. I think we still see some accumulated savings that were built through the pandemic. Although inflation is kind of eating away at that, there's still some of that left in the picture. And we're seeing relative conservatism from the consumers, which is what we expect to see through economic cycles, consumers are often the most rational player. And we're seeing a little bit of a deceleration in spending, which you'd expect to see as they're dealing with uncertainties on the horizon. And so they start from being in a pretty good place. In our own credit metrics, we're seeing the thing that we've done normalization, the rising delinquencies and charge-offs that are now approaching their pre-pandemic levels after being unsustainably strong through the pandemic. I think in our card business, we're probably at about 85% of pre-pandemic delinquency levels, maybe a little closer than that in auto. We had noted earlier that we had seen that normalization trend more pronounced in the subprime or lower income demographic segments. But over the last 2 months or 3 months, it's really become a more portfolio-wide, business-wide observation as we've seen the other segments kind of catch up on that trend, which is aligned with what we'd have expected. And so I'll just finish by saying the normalization of credit in our consumer businesses has probably happened at a pace that was a little more slow and gradual than we would have expected. And we would have expected a faster and steeper move in the subprime or low-income segments because they're generally first-movers, both on the improvement and the normalization front. So things are pretty much consistent with what we would have expected, maybe slightly -- have been slightly better up till now. And I think we're still in a place where we see good growth opportunities in card and continue to lean in there. And a little more cautious on auto for a number of reasons that I think we'll get to maybe later. But that's the state of the world as we see it.

Okay. Why do you think it was slower for the subprime or lower income consumer to normalize?

Well, so they've normalized faster.

Okay.

But the overall normalization has been a little bit more gradual. And there's a number of things that could explain that. For example, it's reasonable to believe that there was maybe a little bit more scar tissue left from people experience a great recession and pandemic, which has made them a little bit more cautious in managing their finances. There's the ongoing support that was provided through stimulus and widespread forbearance and things like moratoriums and student loan moratoriums that as they expire and move a little bit more to the rearview mirror, we could see some distress manifest itself now that was prevented by some of those interventions and that could be accelerating the normalization trend across the segments. But I'm not sure there's a definitive explanation. We're just -- when a trend of rising delinquencies and losses happens more gradually than you'd expect, that's a good thing. And we don't try too hard to parse it out.

Anything else that's been surprising in terms of the normalization trends?

No, I don't think so.

That follows your typical pattern that you expect to see?

So I'm not sure there is a typical pattern because every economic cycle, every credit cycle plays out a little bit differently. But -- and so we kind of establish a range of expectations and what we've seen here on a segment-by-segment basis or on a total portfolio basis is either aligned with or a little better than what we would have expected. I don't know that, that changes the ultimate destination. And like all things in the credit risk management business, it's evolving as the world evolves. And we update our view fairly frequently based on actual performance trends.

Okay. And as always, like all of these sessions, we encourage questions. So if any of you have questions, put your hand up and we'll get to you as well. You talked about leaning in on card. What are some of the opportunities you see there? And is it attractive today to do that? What drives that view?

So our view is to assess market opportunities on a fairly continuous basis. And we continue to see really good strong opportunities to grow resilient and profitable loans basically in the places where we've been emphasizing for years in that business. So at the upper end of subprime and in through prime with customers who revolve but are not high-balance revolvers, not more heavily indebted folks. And what we've talked about a lot is the heavy spender segment at the very top of the card marketplace where we've had a focused strategy to pursue growth and share gains in that space over the last decade or more. And we just, in the last year or 2 have made some particular traction with earning our way into the space and building credible and compelling product structures, we're able to launch into the super premium space, if you will, with a venture X card. And that's got a lot of traction. So the best opportunities we're seeing are kind of in the lanes that we've been running in for quite some time now. And they continue to look attractive.

And what would change your approach on that?

Well, I think the thing that -- the obvious thing that we have our eye on the most is credit trends, both the actual credit trends in our portfolio and the implications of, call it, high or maybe even rising uncertainty in terms of the macroeconomic picture. If our projection of credit cost rises, that would sort of tend to naturally limit the size of the marketable universe that we'd be looking to make offers to. And I think there's nothing new or unusual in that approach. So I think as trends that are a foot today are gradual. The great thing about the card business is you have some front-loaded costs in terms of customer acquisition and the front-loaded sort of credit cost, but then you create a revenue annuity that lasts for years and years. And that makes it an attractive economic proposition, attractive not only from a profitability standpoint but from the opportunity to build resilient economic floats. And I don't think that, that -- the attractiveness of that opportunity is particularly high at certain points in the cycle and then veins a little bit as the cycle or a downturn plays out. And we don't have a prediction about whether we're headed to a soft landing or a hard landing or wherever it may be. But we monitor the performance of our portfolio continuously and in real time on the other side of our digital transformation and watch for things in the trends that might change our view. But so far, we haven't seen them.

Okay. Ultra competitive still or has the competition eased or intensified at all?

So I think the interesting thing about the credit card market is it's a mature market with 6 or 7 sort of big players. And that makes it, on the one hand, intensely competitive because all the competitors are highly capable, well funded, lots of experience. But it also tends to make the competitive environment rational. You don't get a lot of sort of one-off craziness that you see in some smaller lending markets. And so we like that relative stability and the cost of that relative stability is being up against some pretty tough competitors.

Yes. Okay. All right. Auto, a lot of us can't make a lot of sense of what's really happening in auto across the industry and some of these values seem to just defy logic. But what is your view on auto at this point leaning out a bit, but maybe leaning in as well? Talk a little bit about [indiscernible].

It's a really interesting contrast. In the card marketplace that I've just been talking about, we still see really good opportunities and continue to lean in. We're almost making the opposite choice in auto. But maybe for some reasons that are a little bit surprising. So we first pulled back on originations a couple of quarters ago. And that was a decision driven by margins in the industry, where we had noted some fairly large competitive blocks, which, in our view, were not fully reflecting the rising cost of funds in their marginal pricing. And that sort of -- the way things work in the auto business, if a competitor does something that sort of cuts price in card, that will have an impact on our origination flow, that's sort of modest to moderate. But in the auto business, if a set of competitors is offering a much lower price because of the auction that a dealer holds to originate a loan, all of the loans tend to immediately and swiftly flow to the competitors that are being more aggressive on the pricing front as the case may be. And so there's a natural pullback in originations. And the other thing about margins is that's an important aspect of our view of resilience of a consumer loan. That you have sufficient margin to absorb the potential unanticipated increase in credit losses. And so when the margins were a little thinner than we were comfortable with, we pulled back. Now that sort of funding costs, finding its way into the pricing is a temporal thing. It's kind of a lag that you see sometimes as opposed to a permanent condition. And we had always expected that, that would sort of resolve itself over time. And I think we're seeing some signs that it is resolving itself. But in the meantime, we've also observed some delinquency and credit loss increases. At the part of the subprime auto business, that's kind of below where we originate. But in response to that and out of a view of caution, we're tightening our credit box a little bit. So I won't make a prediction about if and when we sort of return to more of a growth posture. But it's become multiple variables as opposed to just the margin, and we'll watch these trends play out and...

Pricing helps certainly.

It helps a little. Yes.

Yes. Been surprised by the resiliency in used car values?

I'm not sure our -- yes, we still have an expectation that the price of used vehicles will eventually fall from their heights. Even though we had a couple of strong data points recently, we assume in our underwriting a sharper and faster decline as part of that's another key aspect of our view of how to build resilience into our originations is to assume that, that variable in auto and a number of variables across our underwriting decisions across our businesses will actually worsen more than actual trends would predict. And we build that assumption in so that we'll have a little bit of buffer in our originations to absorb things if they actually turn out to be worse than we had originally modeled.

Okay. I just -- I had a used car, I was trying to sell during the pandemic, and I think it was the best performing asset in my portfolio. I just hung on to the very end.

That's funny.

It was fantastic, Jeff. Commercial business, I don't want to say it's overlooked, but it's certainly less attention than card. But what's going on in commercial? And I'm curious on commercial real estate as well how you're feeling about.

So our commercial bank is -- in the beginning of 2022 was on a fairly high growth trajectory relative to regional peers. And I think although credit remains -- if you look at the charge-off rate and the delinquencies in our commercial book, the credit is still quite attractive and resilient. We are seeing some risk migration and some rising trends in nonperforming loan metrics. And as a result of that and out of an abundance of caution, we've been slowing down the trajectory of loan growth in commercial to the point where from Q3 to Q4, it was kind of approaching sort of roughly flat. And I think we're comfortable with our positioning in our posturing commercial at the moment. We tend to approach the market less through geographies and more through industry verticals. And the thing we have our eye on the most right now is probably the office portfolio in commercial real estate. That's not a surprise. I think everybody would say the same thing given the change in how we work. But we don't have an outsized exposure there, and we're just keeping an eye on things and managing that credit risk to the best of our ability. We are -- but away from that, there's no news, I think.

Okay. So the Capital One adjective would be leaning out a little bit on commercial?

Well, I'm going to sort of reject that premise. So we're leaning in on card. There's kind of no lean one way or the other. We're leaning in a little bit of a term of art. But our posture in auto is to be more in pullback mode until we see some of these trends sort of normalize and heal. And in commercial, I think we're -- I think it would be an overstatement to say we're leaning out, but we're -- we've moderated the growth somewhat.

Yes. Okay. Okay. I mean, 1 second here -- just I want to talk about funding before we get to this. But there's a lot of focus on deposit betas from the commercial banks, it's not as much in consumer finance, but it's everything in the commercial banks at this point. And you're somewhat in between a little bit of both. How are you feeling about your deposit gathering ability? How you're feeling about deposit pricing in general?

Yes. We feel great about our retail bank franchise and our commercial deposit franchise. Just pulling up and looking at the funding picture of Capital One, we're about 80% core deposit funded and about 20% from a variety of capital market sources. And that's a ratio that I expect to sustain over some time that -- we're very comfortable in that range. We've seen some pretty good deposit growth actually relative to peers even over the last couple of quarters. A large -- we're meeting our customers where they are in our branch footprint, which covers about 20% of the U.S. and we love that deposit franchise. But in 80% of the U.S. where we don't have branch infrastructure, we have a great growth strategy that's built on the back of the old ING direct-to-consumer book. And what we've done there is we've developed and executed a strategy where as opposed to solely focusing on funding and liquid savings products, we're really building a digital bank of the future that has very light distribution in the form of Capital One cafes, which are very different than branches. Think of them more as like digital showrooms -- physical showrooms for our digital capabilities. We've developed products and product structures that replicate the vast majority of things you can do in your bank branch. We're seeing some growth in checking products as opposed and in addition to the savings growth. And that is a little bit higher rate pay versus a branch-based deposit and a little bit higher marketing costs because you invest in marketing to drive customers to that digital bank, but much lower in terms of fixed infrastructure and branch costs. And we believe that we're building a franchise based on a great digital customer experience and a brand and not just the rate paid. And that's a sustainable franchise that will provide funding benefits, but also deep and compelling customer relationships that we can benefit from that customer franchise over time as well. So we're liking the deposit business quite a bit these days.

Just touching again on a follow-up on the Cafe strategy. Is that one that you're leaning into? I know some of your peers have had success opening like de novo branches in certain regions. Do you expect the to be a meaningful part of your business and a share gainer?

So I want to be a little bit careful on how I answer the question because I want to really distinguish between the expansion of cafe locations versus de novo branch expansion. I can't emphasize enough that a cafe is way different than a branch. So you don't really measure the success of a cafe by sort of product sales and throughput. It's a carrier of the brand. It's a showroom for digital experiences. It's a community gathering place. And so you need far fewer locations to be on an expansion strategy kind of in the national deposit business. So there's an order of magnitude fewer cafes on our planning horizon than there would be if we were building branches. But I do think that our cafe locations are -- we expect to be building more in the coming years.

How about some of the bigger banks that are opening branches in Denver, Minneapolis, Charlotte, in a way, almost mimicking your strategy? It may not be only retail, but do you view that as a competitive threat? Or is it a form of flattery?

I think we -- for all years in the business, I think we view everything as a potential competitive threat and take all of that very seriously. But I don't -- I don't have any real specific comment on that.

Okay. It's as easy as picking a [trails Barclay] for pickup basketball, right?

Or flash to be in your garage.

That's right. That's right. Plenty of other things to ask, but go ahead. I enjoyed the commercials by the land.

Maybe just one more on deposits and funding. You had to make that comparison with bigger commercial banks. Bunch of them have a ton of consumer-facing deposits at 0 or extremely low rates. You in a cohort of online banks have sort of taken rates up. And I don't know if you feel like that diversions between big money center retail, physical presence banks and the rates offer in those direct channels enables you to gather deposits, enables you to not have to pass the next wave of rate increase as well?

So again, just to generalize about our sort of pricing strategy in retail banking. We want to offer our customers a compelling rate but not necessarily a rate that incents people to join us just because of the rate. We really want to build a full-service customer franchise with deep and lasting customer relationships across multiple banking products as opposed to just going for the highest rate paid deposit. So our rates are on average higher in the direct bank than in the branch infrastructure. But they're very rarely sort of the market-leading rate, and I wouldn't expect that to change.

All right. Maybe an annoying topic for you to answer, but late fees, what -- what's your latest thinking on late fees and how you react to it and what the time line might look like for resolution on all this?

Sure. So I'll caveat this answer by saying I don't have a lot of specifics to share because we're at the forefront of figuring out kind of the impacts and the actions that we might take in response. I do think that we've been on a multi-decade journey as a company to really be on the right side of customer issues. We've reduced our reliance on fee-based revenues over time and are really trying to drive a customer franchise as so the customer relationships that are not overly dependent on fees, particularly penalty fees. As cited in the example. We're the first and one of the very few really large banks to totally eliminate overdraft fees in the deposit franchise. That's just one example. The late fee is a little bit of a different [lever] because it has -- it's not primarily a revenue lever. It's primarily an incentive for customers to make payments on time and it's not go late, and it's a key part of credit risk management and serving all the populations that we serve. So we were really trying to figure out the holistic impacts that might result from this and how we would respond to them across a number of dimensions. And we may have more to say on that over time as we kind of do our work. But not a lot of specifics to share on that.

It's difficult.

Yes.

Okay. Anything on capital and buyback appetite? It feels like you're more focused on growth, but how are you feeling about that?

So we've long said that our kind of long-term target for CET1 capital ratio is probably around 11%. We're running a little bit higher than that now. I think we've been well served in the past across a number of environments to have a little bit of a buffer at times of uncertainty. For both offensive and defensive reasons, it's always good to have a buffer when you're facing some economic uncertainty. But part of the reason it's good is because it enables us to sort of be well capitalized for the growth opportunities we're currently seeing and taking advantage of, be well capitalized for opportunities that tend to emerge as the cycle plays out. And what we found is that some of the very best organic origination opportunities happen right after the sort of peak of a downturn or trough of a downturn, I guess, it will be the right way to describe it and to be well positioned relative to peers and a strong capital position to take advantage of those opportunities is part of our calculus. And so I think we're thinking that our capital levels position us to thrive in a number of environments and a number of potential outcomes as we see this cycle play out.

It's been interesting. We've all been waiting for the downturn. And it just doesn't seem to happen. And we had a short discussion on this, but GDP is better than it was a quarter ago. The unemployment rate has come down. It's difficult to handicap all this. But do you have a view on whether things are getting better or worse? Or is this just too short of a time period to draw any conclusions on that? Not a trick question, but...

No, no, I understand. I don't have a great grounded answer to that question. It would be sort of Jeff Norris' speculation and opinion as a very distant amateur economist, which is probably not insightful or relevant. Our view of how we run business at Capital One is we don't want to base our decisions based on predictions of the economy. We want to base our decisions on things that will be resilient to a range of outcomes and stress scenarios. So we've kind of -- we talk about it inside the company as hardwire and resilience in all the choices we make. We've learned a long time ago that the choices you make during the good times have a much bigger impact on how you fare through the bad times than anything you make sort of in the heat at the moment. So that has us avoiding certain businesses. It has us deemphasizing more heavily indebted customers in our card and consumer lending businesses. It has us it has us pulling back in auto, even though there was no credit impetus to pull back when we started that. It has us leaning into growth in card, but at the same time, fine-tuning and trimming at the margins to always kind of stay in real time looking for signs of increasing risk, and it has us pricing things in a way that we think provides margin coverage, among other things while holding really strong levels of capital. I think the way to sustainably deliver value in the businesses we've chosen to be in is to make some tough choices during the good times that puts you in a strong position if and when the cycle comes. And we've done that since the founding days of the company. We continue to do that today.

Okay, any last questions for Jeff?

I'll ask one more. I think you guys have articulated and your peers have too, that DFAST stress tests are not really direct drivers of your view of your own capital adequacy? And you have a new scenario and that slingshot to 10% gets wider, the better unemployment gets -- is that framework kind of still the right one to have?

Well, I think with the stress capital buffer regime, we have a little bit more degrees of freedom and flexibility to sort of assess and set our own capital levels. I think the DFAST and CCAR exercise is still an important part of our total view of capital. And -- we're in the midst of executing that exercise as we speak. So I don't really have much to say about that until the results are out. But as I said, I think capital is an area of relative strength for us. And that's as a result of our own internal frameworks as well as the DFAST exercise.

That's all the time we have for today. Jeff, I want to thank you for being here, representing Capital One. Good luck rest of the day in the meetings.

Really appreciate you being here.

Thanks, everybody.