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

All right. Let's get started. Thank you, everyone, for joining this afternoon. My name is Terry Ma. I cover consumer finance here at Barclays. I'm very pleased to have on stage with me the gentleman from Capital One. I have Rich Fairbank, CEO; and Andrew Young, CFO. So welcome.

Thanks, Terry.

Yes. So we'll jump right into it. Maybe let's just start with the state of the consumer. How do you think the consumer is positioned as we head toward the end of 2025? And can you just talk about what you're seeing across the different cohorts of your consumer base?

Okay. Thank you. Thank you, Terry. Good afternoon, everyone here and to those listening in on the webcast. So as I've been saying for a long time that I still very much feel that the consumer is an anchor of strength, I think, in our current economy. There are a number of indicators that continue to be very strong. I mean, I think wage growth, low unemployment, the debt burden. Consumer debt burden is very comparable to pre-pandemic levels and historically at a relatively modest place. Obviously, we noticed the new job creation continues to be pretty modest and maybe with some restatement of some of the numbers as well. So we'll certainly have to keep an eye on that, although we have not seen a corresponding thing that often comes along with that, which is waves of layoffs and things like that. So we'll certainly keep an eye on that. But the consumer, I think, continues to be in a strong position. We certainly see in our own metrics continued strength. And so we like what we see. If we didn't read the paper every day, I think just looking at our own consumers and their performance, I think one would have a pretty positive view of where we are. Obviously, there's a lot of noise out there in the marketplace. We'll continue to keep an eye on that.

Okay. Great. So turning to credit. Delinquencies in the domestic card book for both legacy Capital One and legacy Discover declined for 8 straight months year-over-year. So where are we on credit? And as we look forward, how long can this improving year-over-year trajectory continue for?

So let's think about sort of the larger arc of what's happened with credit, go back to the pandemic itself. When the pandemic came, all of us in the credit business sort of braced for impact and what actually happened was extraordinary, some of the best credit performance we had seen in the history of our industry. And I think what was driving that clearly was the massive government stimulus and the very widespread forbearance on financial products and rents and things like this for consumers. And during that period, not only did consumers have low credit, but they also built -- they saved a bunch of the excess. And so there was a consumer surplus that was built up as well. Now at that time, while we were enjoying the good credit numbers, we were out saying there will be an echo from all of this or in many ways, really a delayed charge-off effect that we -- not just the normalization of credit back to where it was, but there's going to be what we call delayed charge-offs, which would conceptually be there are a number of consumers that were in a vulnerable situation during the pandemic. Some of them charged off, but many of them were rescued by the influx of funds that they got. Now for some of them, that brought them sustainably to a good place. But for others, we expected it would be a deferral of potentially a charge-off. So we said we'll never be able to measure it, but we predict there's going to be, in addition to normalization, a delayed charge-off effect. So what happened is credit normalized and sort of headed back to pre-pandemic levels in sort of an economy that's consistent with pre-pandemic. But credit numbers, credit losses just kept on going for the industry higher than pre-pandemic. And we've been saying that again, these things don't carry labels, so we'll never be able to quantify, but we believe this is a very natural effect of delayed charge-offs on top of normalization. And that at some point, that should start to ease. And I think what we've seen since then is that exact effect that, as you say, Terry, just month after month, Capital One and other people in our industry have seen charge-offs -- delinquencies and charge-offs turn around and improve quite a bit year-over-year. So at Capital One, I want to talk about Capital One and Discover separately for a second. At Capital One, we certainly have seen this effect. We're also benefited at Capital One by when we look at our new originations and where the losses on those vintage curves, they're actually coming in even better than the vintages of the few years before that. So there's -- some of the origination choices, credit choices we're making are adding to the strong credit position that Capital One is in. If we turn to Discover, many of the same effects are going on, but a little bit on a magnified basis. Discover had significantly more worsening than we did during the normalization period. That's primarily, I think, driven by the fact that in 2022 and 2023, they ended up originating business that was a lot riskier than what they had historically originated. And so they peaked quite a bit higher relative to where they had been before. And they started curing about a quarter or so later than Capital One. But since then, it's really been the same effect. Both companies have seen curing on a quarter-over-quarter basis. And I think it's driven in each case by the same phenomenon. Again, I think the Discover has been sort of an amplified story because of the worse originations they did in the 2022 and 2023 period. But now in 2024 and continuing into '25, they pulled quite a bit back on their credit policy. They tightened it significantly. And we see the 2024 originations coming in way better than '22 and '23. And I think that can help power some particularly improved performance on the Discover side. It does come with the flip side of some weakness on the growth side because Discover has just pulled back quite a bit on the originations. So one other thing I just want to say about consumer credit. I just want to just put a little flag out for student loans. And just to pull up for a moment on student lending to share things I think most people know. But there's been something like a 5-year forbearance on student loans, no requirement to pay back, no reporting of delinquencies or anything. And then in October of -- if I get my dates right, in October of '23, the message went out [Audio Gap] sort of job creation issues that I would hesitate to predict too much from here.

All right. That's helpful color. Maybe we'll just touch on auto for a second. Delinquencies there have been declining year-over-year. Capital One was one of the earlier ones to tighten. So what are you seeing in auto credit now? And how do you approach kind of growth and underwriting going forward? And how does tariffs kind of impact your thinking on auto?

So if we dial back to a few years ago, Capital One actually pulled back, I think, more than most players in the industry, pulled back on our -- we tightened our underwriting and pulled back on originations, and we did it for several reasons. What we saw several effects. First of all, we were very concerned about what we called credit score inflation, where all the forbearance was causing consumers scores to look better than the underlying actual credit performance of that we expected from people. So we, in normalizing for that relative to the industry, we dialed back quite a bit there. We also saw a lot of margin compression in the business because the inflation wasn't fully being passed on into the pricing of loans. And Terry, to your other point, we were concerned about higher vehicle values and the potential sort of affordability issues that come along with that as well as some of the risks in collateral when vehicle values start high, there could be just one way for them to go. So we dialed back -- while the industry was leaning in, we dialed back over like 2 and 3 years ago. And then in the last year or so, we have found a lot of these issues sort of settling out. We find our originations are performing at a very strong level, even lower than pre-pandemic. So we have been leaning in harder now, and we see good growth opportunities in the auto business. To your question on tariffs, while tariffs affect all consumer businesses conceptually, they can have a very big impact in the auto business because they can have a direct impact on car prices. So we have an eye on that. We saw what we thought was some bringing forward of purchases before the tariffs came. But the impact, if tariffs really impact the car prices, what that means for Capital One is in the short term, it actually is beneficial with respect to recovery values if we're recovering on charge-offs. But more importantly, over time, it creates more risk because there are affordability issues and the higher prices bring more challenges on the ability to pay and more risk to the value of the collateral.

Okay. Got it. Maybe we'll switch gears and talk about the Discover acquisition. The network opportunity is the key benefit of the deal. You targeted $175 billion of debit and credit volume to kind of move over and you've identified revenue synergies from that. So can you just update us on how that process is coming along? And what is the expected completion date for that volume on migration? And then looking out longer term, how should investors think about the time line to start moving over the rest of cost credit volumes?

Okay. At the time of the deal, we announced $175 billion. That's the sum total of debit and credit volume that we would be moving. We announced we would move our entire debit business, and we would move a portion of our credit card business. Where we are on the implementation of that. We have started now migrating our debit business in late August, it began, and it will continue on a daily basis into early next year, and then we will have our entire debit business on the Discover network. The credit card migration is going to be sort of a year later. Well, actually, really, it's not going to be until early 2027, where we're going to be moving that declared portion of the credit card business. The reason it is taking longer, there are certain infrastructural things that we need to put in place and certain testing that we want to do and make sure that on the credit side of the business that we're in really good shape. So that's a 2027 migration. And then the other big thing going with respect to your question, how do we move more of our business over to the Discovered network. Let's talk about, first of all, why would we move more of our business to the network. A network business is not just a scale-driven business. It's an extremely scale-driven business, as you can imagine, because you have all the fixed cost of the network and then the volume at very low marginal cost flows through there. So there are a lot of benefits to move the business over there. What lies between us and moving more business over there is we need to address what is right now the challenge, the biggest challenge that we have, which is that Discover's international acceptance still -- I mean, it amazes me with their small scale, how much they were able to build of international acceptance. But relative to where we would want to get before we start moving more of our internationally traveling cardholders over there, we want to get it to a higher level of acceptance. The good thing is that we know the playbook for how to get there because it's the same playbook Discover used to go from 0 to where they are, and that's through partnerships with merchant acquirers, getting individual merchants to -- in some cases, to accept, it's network partnerships and sometimes local issuance by banks. So we will continue with that playbook and invest to build international acceptance to get it to that. You know when you see a point that we feel comfortable then moving more of our credit card business over there. The other thing that we need to do, though, is we need to build the global brand of the Discover network. It has amazing U.S. acceptance, and I'm pretty struck again by its international acceptance. But as we build it to an even better place, we then, at the right time, would lean into advertising to really build the credibility and confidence in the Discover Global brand.

Okay. Got it. That's helpful. So let's touch on integration. There was a lot of focus on the last earnings call around the acquisition and integration expenses. You called out those expenses were going to be somewhat higher than the initial $2.8 billion guide. So first, any way to kind of quantify what that means and then on the synergy side, you guided to $1.3 billion of operating expense synergies and $100 million of marketing synergies. How are those tracking to date?

So on the integration side, there's a number of things that fall under that umbrella from the deal and transaction costs, bringing Discover onto our tech stack, bringing the other processes and teams and bringing their compliance and risk to Capital One's standard, all while taking care of associates along the way. And so we made assumptions about those costs at the time we announced the deal. And now that we find ourselves on the other side of close, which I'll note was 5 months or so after we initially expected with -- which brings with it some cost in and of itself. But now that we're on the other side, as we do more granular planning, have access to information we didn't have at the time of the deal announcement as we look around looking out over the next couple of years, which is what it's going to take to complete the integration, we think that it's going to be somewhat higher than the $2.8 billion. It's not any one thing in particular, it's sort of the totality of all of the factors that I just described. In terms of synergies, you highlighted, Terry, the expense synergies. Of course, we have the revenue synergies that Rich just talked about. So in total, $2.5 billion of synergies that we had announced at the time of the deal, we still very much see those as being intact. On the revenue side, like Rich said, the predominance of the revenue synergies are coming from the debit conversion, which is already in flight, and we expect to complete early next year. So the revenue synergies will be more front-loaded on the expense side, just given what it takes to actually achieve those synergies in terms of bringing together applications and data and canceling third-party contracts and bringing teams together, those expenses will be -- the synergies associated with the expenses are going to be more backloaded in line with what we had included in the initial deal announcement. But overall, Terry, say that's completely intact, and we feel really good about our ability to achieve all of those synergies.

Okay. Got it. So as we look out longer term, how do we think about the cost and time frame of the incremental investment opportunity that you, Rich talked about on the last earnings call?

Yes. So on the earnings call, I highlighted that we see a really, I think, striking number of opportunities across our businesses and then, of course, with adding Discover as well that these opportunities are really the result of years of investing and building our tech stack and investing in brand and other things to put ourselves in a position to capitalize on opportunities like these. But I'm struck sort of by the breadth and nature of these opportunities. So just to talk -- just to highlight again what I did on the earnings call. So on the Discover side, of course, after we do the initial move of some of our business to Discover, as we announced sort of in our deal and the synergy discussion, we do -- as I talked about just a little bit earlier, we do see opportunity to move more of our business. But again, it has the investment requirements we talked about just a few minutes ago. So that's sort of the increased investment that we see on the Discover side for long-term opportunities. On the Capital One side, that's where the bulk of the opportunities are, and they really do stand on the shoulders of our 12-year technology transformation that we have done, which is to highlight some of these opportunities, our national bank. Capital One has a very differentiated strategy in building a national retail bank, which, by the way, I think is one of the retail banking along with credit cards, just 2 of the sort of really incredibly great businesses right at the heart of consumers' lives and right at the heart of winning in banking. Anyway, almost all banks out there are either a branch on every corner bank or they are banks that offer savings accounts, but they don't really have full-service banking Anyway, Capital One has built a full-service digital-first retail bank, and we've been investing for years in building the capabilities and in growing that business. We're not on a quest to go buy banks to grow that business. We're growing it organically, but it requires marketing -- now with the Discover deal and the collective opportunity we have across the company, we're continuing to lean into and even lean into more our growth of the national bank. Then we have our quest to win at the top of the market, competing against really big players who are heavily funding and investing a lot to win there. That's been a strategy we've been pursuing since 2010 when we launched our venture card. But we continue to get a lot of traction and success as we move up the market, but we also look around and know that requires quite a bit of investment in customer experiences, in providing unique access in building airport lounges, building our travel business, our digital customer experiences and our brand. So there are a very small number of players really competing to win at the very top of the market, and Capital One is one of those, but we certainly need to lean in there. We've got some young business opportunities going on at Capital One, building Capital One Shopping, Capital One Travel and our Auto Navigator business. These, again, have been something we've been building for years, but they have very nice momentum, and we're continuing to really lean in to grow those opportunities. And then, of course, we have the tech opportunity itself. We have rebuilt Capital One in a modern tech stack. There still is modernization we're doing, particularly with respect to vendor technology that we use, that we still rely on. So there's continued investment there. And then finally, the one everybody is talking about is AI itself. And I think Capital One, our tech strategy has had as its objective function, be in a position to really capitalize on AI. So as AI really takes off, that's a great thing for Capital One, but there's quite a bit to invest in to get there.

Great. Helpful color. So let's turn to earnings power. You had initially guided to 15% adjusted EPS accretion by 2027 when you first announced the deal. On the second quarter earnings call, you indicated the power of the combined entity is consistent with what was assumed at deal announcement. So how should investors interpret those 2 comments and think about the earnings power of the business?

So earnings power has been a thing that we're very obsessed about at Capital One. And when you think about Capital One, most banks have been around for 100 or 150 years or whatever, and they tend to do all the businesses. Capital One does like half the business is banking, but we're all in on that half, and we built national businesses in all of those. But like I said about retail banking, the quest there, the credit card business, auto, you've seen the -- what we do there. And so we have been -- but we built a company that is very focused on identifying long-term opportunities and working -- where is winning? Where are great opportunities, then we work backwards from that and figure out how we get there from here. And then along the way, very rigorously calculate before, during and after how these investments are going and make sure that our investors are getting paid. So if we go back to the time of the deal, the opportunity to take the earnings power of Capital One and the really great earnings power of Discover and bring them together in a business model that still doesn't do everything banks does, but does some of the very advantaged businesses, particularly well, we saw a great opportunity and great earnings power to pull these companies together because you get the earnings power of 2 companies with strong earnings power plus we get synergies. So obviously, investors have noticed that's quite a bit of earnings power to work with. So at the time of the deal announcement, we gave estimates for sort of what we thought coming out the other side of integration, sort of what the financial earnings power of this business would be. Since then, a few things have happened. Well, a lot of things have happened, but both at Discover and at Capital One, things have moved. Some have moved positively, some have moved a little bit backwards. But sort of collectively, I would describe the net drift in our businesses as positive. At the same time, the investment opportunities that I just described, our sort of the imperative to invest, the opportunity that is on the other side of those investments, that has also grown over the last 1.5 years. And so my comment was to sort of ground what can sound like an unbounded sort of conversation about investment is to say that these things sort of net out to where the earnings power that we saw that we estimated coming out of the other side of integration and pulling these 2 companies together. The earnings power that we estimated back then is about the same as what we see now.

Okay. And maybe this is a good point to just pause for the 2 ARS questions I have. I think the first one is queued up already, so you can just register your responses. Capital One will earn adjusted EPS of what in 2027? First Choice, $21 and $24 per share, $24 to $27 per share, 3, $27 to $30 per share or 4, $30-plus per share. So 42% are at $24 to $27 per share and 33% at $27 to $30 per share. Next question. And then over the next year, would you expect your position in Cap One to increase, decrease or 3, stay the same? So pretty bullish 50% increase, 42% stay the same. So pretty good signal. Let's maybe just talk about capital. So Capital One is in a position of excess capital at 14% CET1. It's been a few months since you closed the acquisition. So maybe, Andrew, can you update us on the latest thoughts on target capital levels and timing of capital return?

Sure. As we went through the application process, as you all know, we were not operating under the SCB. We required Fed preapproval for our actions. We are now back to operating under the SCB and have flexibility with our actions. We recently got the results from this year's CCAR. As you also saw, our SCB effective October 1 is going to be 9%. I do note that when you look over the last 5 years, there's been over a 300 basis point swing in our SCB from a high of 10.1% to a low of 7. And that's one of the reasons why the SCB is a consideration for us, of course, but we work back from what we determine is our internal assessment of our capital need. In order to do that, we needed Discover's loan level data to put it through all of our models, which we got at close about 4 months ago. We've been working as hard as we can to do that analysis. We are getting to the final stages of that. As a result, I think we are stepping up our share repurchases in the third quarter, and we expect to have more to say about capital on the earnings call next month.

Great. That was helpful. We have about 3 minutes left. I'll just open it up to questions from the audience, if there are any. We have one in the front over here.

You talked about looking to raise international acceptance of Discover. I think domestic acceptance is 99% plus. Can you tell us where international acceptance is now and where you hope to get it in, say, 3 years and how much that might cost?

So I don't -- even determining a number. First of all, we're not going to give out a number, but even determining the number, it turns out you can, do you just add up all the countries and all the acceptance or to us, the most -- that's sort of one way to do it, but then it can be very lopsided, very high in one country, low in another country. And so is that the right thing? And then we also kind of are looking to take all the traveling and all the merchants that all of our customers go to around the world and what would have happened, do they accept Discover there and so on. But I think -- so I would describe it this way. I'm amazed that they got it to where they've gotten it to. But to have it on, when you see it basis where we can really lean into our advertising with respect to global acceptance, we still want to get it quite a bit higher. We certainly don't need and nobody has acceptance everywhere. So this is going to be sort of a feel thing about what we're going to need. So there's not going to be a declared number that we have to get to. But to me, it's more of a you know when you see it feel because I always believe I'm going to go back to my advertising philosophy. Capital One is a huge advertiser. And we work hard to have fun and cool ads and that kind of thing. But underneath them, an incredibly important thing is that the reality, the story that we're telling, it's incredibly important in building a brand is that the underlying story be that reality. And so we have a little more work to do on the international side. So we want to lean into that when that reality matches exactly what we're saying. And that's been the journey of Capital One brand building since we started building a brand in the late '90s. So it's going to be a feel thing, but I think that we can see the playbook for getting there, and it's not going to be easy. It's going to be a lot of work. But I just wanted to -- as we always do with Capital One, we're often -- unlike a lot of banks that tend to stay in their lane and keep a pretty consistent business model. We're always really trying to identify where the great opportunities are and working backwards from that. And I know it's a bold quest to really take something that is the size of Discover and make it build the network to a place where we can move a bunch more Capital One volume there, but that's -- but it's something that I think has a very great strategic opportunity. And it's typical of us that what we do share with our investors, this is where we're going. We don't exactly quantify what it's going to take because we don't yet know, but you'll be able to watch along the way. And in the meantime, what I'm excited about is that we can take the low-hanging fruit of the Discover acquisition, go ahead and go forward and get those synergies and the benefits and start to build the network and then go from there.

Okay. I think we're right out of time. So thank you.

Thanks, everybody.

Thank you.