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

Okay. We're going to get started. Thank you, everyone, for joining. Very pleased to have Capital One [indiscernible] this year. With me on stage, we have Richard Fairbank, CEO; and Jeff Norris, SVP of Finance. So welcome, gentlemen.

Thanks Terry.

Thank you. All right. So let's jump right into it. Maybe let's begin with the state of the consumer. There's been lots of headlines this year around inflation, energy prices and the health of lower-income households. As you look across your customer base today, how would you characterize consumer health across income cohorts and credit segments?

So if we read the news every day. It's pretty alarming the things we see out there, and I think it's natural for people to be pretty concerned about where the consumer is. But if we actually look at the numbers, some of the macroeconomic numbers and our own portfolio, we see really quite a striking strength. So let's just talk about the macro numbers for a second. Unemployment is low. The new job creation just rebounded very recently. Consumer spending is pretty strong. Bank balances, when we look at bank balances, they are up a little bit over last year on average per person. So the consumer -- I mean, there's a lot of indications that despite all the noise out there and despite the inflation and tariffs and [indiscernible] that are going on, the consumer seems to be in a pretty good place. With respect to our own metrics, if we start with credit, our credit delinquencies continue to come in strong. We just posted our monthly numbers yesterday and delinquencies were coming in right consistent with seasonality. Charge-offs came in, again, better than seasonality and that would be powered really by the high level of recoveries that we are enjoying, which came really from the higher level of charge-offs from the last few years. But really over the course of the -- pretty much the whole 2026, consumer credit has been in a very -- generally slightly improving kind of place. And most recently, looks right there, steady with seasonality. The consumer spending on our portfolio continues to be strong. And the -- with respect to income levels, the -- we see a similar spending strength across our credit spectrum, including some of our lowest income consumers. Now I do want to say that's not the same as a statement about what's happening across the whole economy because income is one of the things that we use in underwriting. So I don't think we have a window into the very lowest income consumers. But overall, the consumer continues to show a lot of strength even in the face of a lot of uncertainty out there. Obviously, we're monitoring it closely, but this would be one of the reasons we continue to lean into growth across our credit businesses.

Got it. That's helpful. You touched on credit, maybe let's just double quick on auto credit. That's been an area of focus. Auto credits really remained benign at Capital One and loan growth has been particularly strong at low double digits. What's your view on the auto market from both a pricing and underwriting perspective? And how sustainable is this double-digit growth?

The auto business is a very competitive business. And if I and it's sort of the swings are amplified relative to our credit card business. Let me compare the difference from our point of view. In the consumer credit card business, we are underwriting each customer, one customer at a time and have a direct relationship with each customer. In the auto business, there's a dealer right in the middle of the transaction, and the dealer is holding an auction across lenders, saying, who can give me the very best deal and included in that is if there is a lender out there who is undercutting and maybe cutting the corners from an underwriting point of view, the dealers can turn to other lenders and say, "You need to match this particular offer. So what we learned long ago in the auto business is we have to take what the market gives us and not lean in too hard for growth. We've got to always a whole firm with respect to what is the credit profile and the margin and the overall resilience of the product that we are booking. And that has, over time, caused us to sometimes be the lowest in the league tables in growth, sometimes being the highest in league table growth. And we have often zigged while others zag. Let me turn to the credit, story in auto. It's really interesting to look back and go back to the -- to pre-pandemic and look at what happened to credit since then. You, of course, -- you had the pandemic and credit performance became amazing all across all lending businesses. But we flagged that there was a, there was a dangerous downside in the form of artificial inflation of people's credit scores because their credit performance was sort of artificially improved by all the windfalls consumers were getting in the form of stimulus and forbearance during that period of time. So we flagged this to investors and we intervened in our own underwriting to try to do the best we could to normalize for credit scores. That caused us to for a period of time to be at the bottom of the league tables in terms of growth. But over time, the industry started seeing some worsening credit performance that we did not observe. And so then Capital One has turned around and now powered do quite a bit of growth, and we're sort of at the top of the league tables these days. While I think the industry has had a lot of volatility with respect to credit, I'm pleased with the stability in credit performance we've had at Capital One not only indicated by the charge-off rate that you can observe over the years. But if we look at the performance of individual, individual vintages over the years. The -- for years now, the -- our origination vintages have come in pretty much on top of each other and consistent with pre pandemic at a time when that would not be the case for the industry. So we -- this is a very competitive industry. We only take -- we only take what it gives us, and it really helps not to have our divisions in the company feel that they are driven by growth targets. We do not have growth targets anywhere across our businesses, people give -- people have growth projections, but they all understand at Capital One, go out and build -- create the business that you really -- that's a healthy business and we'll let the numbers be what they are.

Great. Good color. So maybe we'll switch gears, I wanted to touch on the Discover migration. New Discover originations were scheduled to move on to Capital One's platform this quarter. How has the transition gone? And do you still expect the Discover backlog migration to be complete by early 2027? And what are the biggest lessons learned so far?

Yes. So the Discover migration, let me start with one of the most important lessons. This was not a surprise to us, but I'm still struck as it plays out. the tremendous value of the modern tech stack that Capital One has built because we are -- this would be -- this is a very complex integration, but it really would be tough if we were taking a legacy platform and converting it onto another kind of old-school set of capabilities. So the modern tech stack that we have is very helpful in terms of the ability to do this in the time frame and the cost involved. There are some legacy vendor connections that we're still making that have quite a bit of complexity to it. But anyway, the timing is very much consistent with what you said, Terry. So new originations. So originations of Discover credit cards as of the beginning of this month are now entirely on Capital One's technology. And the conversion of the back book is being done in waves. And starting from the first wave was in July, and the final wave will be in January of next year. So it's a big effort, but we're -- things are moving along and very consistent with the time frames that we had projected.

Got it. And you've also indicated that Capital One should begin rolling out of the Discover related [ brown out ] in the second half of this year. Is that still the expectation?

So let me -- I want to I want to clarify your -- what -- how you characterize it. Let me pull way up. The brown out, that's a term that we coined to describe the shrinking of Discovery's credit card loan portfolio that was going on over the -- has been going on for quite some time. And our point when we coined the phrase many months ago was for people to understand this would continue for a while. So what we're talking about, therefore, is a shrinking in the Discover loan portfolio. Why would this be happening the first big driver of this is Discover ran into some credit challenges in 2023, in 2024 they started dialing back very dramatically, and so you had several years of origination vintages that were just a lot smaller than the ones before that and piling smaller vintages on top of each other tends to lead to a shrinking portfolio. Secondly, not at all surprising to us because it's the thing we had observed from the outside. When we went into really look deeply at the Discover business, we found that some of that we wanted to dial back around the edges of some of their lending to more indebted consumers, and we have philosophically had more of a lean towards spend first portfolios than Discover has. So not surprising to us. We dialed back from some of the more indebted lending, that also contributed to the brown out. Now what will turn the brown out around is bringing Discover on to Capital One. And we just talked about the timing of the front book and the back book with respect to bringing them on. Now when we bring the -- we've been looking forward to getting -- to originating Discover cards on the Capital One platform because there are a number of growth-related opportunities that we have. We have a wider credit box than Discover has. So we underwrite both lower in the credit for a given flow. So imagine all the flow of applications is coming in for Discover. We can underwrite lower than they did successfully with years of experience sort of on the subprime side, and we have a way to lean in and create more opportunity on the upper end as well. Additionally, we have found that compared with Discover, we mine more marketing channels more deeply than they traditionally did. So all of this gives us an opportunity to create growth that otherwise wasn't there for Discover, helping to offset those dynamics that will continue such as our more conservative approach toward more indebted customers. Let's talk about the timing. I -- while I gave you the timing of when the conversions are happening, I don't want people to think that, that instantly creates growth out the other side because, for example, on the originations now that we're originating on the platform, some things we're already starting to roll out and some things we are testing before rolling out. So there's the kind of testing period that we have to account for. And then even when we originate new accounts, it takes a while for the balances to build. So therefore, this effect is very real, but it takes a while to to manifest on the overall size of the portfolio and a similar [indiscernible] observations on the back book. So what we look forward to -- the way we will measure progress comes from sort of the second derivative turning in the sense that the rate of shrinking kind of stabilizes, then the shrinking becomes less, but it's still shrinking and finally, growth happens on either side. So these are milestones along the way that we will look forward to.

And then on a related note, the opportunity to sort of get the growth, address the brand and get the growth going, probably comes with oral [indiscernible], some incremental marketing. .

Yes. great point. Jeff.

Got it. Okay. I wanted to touch on Brex. It's been about 5 months after closing the acquisition. Maybe just talk to us about how the integration has progressed relative to expectations. And just more broadly, can you remind investors how Brex fits into Capital One's strategy to expand across commercial payments?

Yes. so let me start with the strategy side. So think about Capital One, well, so often we talk about we're a credit card company or a consumer lead company or a bank, we really should think in terms of Capital One also is a payments company. And we have, from the funding days of the company, been very focused on payments is the tip of the spirit through which financial services is going to change. And so we, along the way, have been very much working backwards from being a payments company. So we build, of course, a very strong consumer credit card and payments business. We built a small business card business. We are the third largest in purchase volume in terms of Small Business, cards that are underwritten by the owner of the business personally underwrites these. And that's called the personal liability business. Next on the spectrum is credit cards still, but it's corporate liability. In other words, the owner of the business is not personally accountable. And then continuing from there you get into treasury management. So across the spectrum, we have looked to fill out that whole thing. We have a small corporate card business or often called commercial card, corporate card, that's the corporate liability business. That's the business that Brex is in. And we, again, had a small presence there. we saw that the size of that market was as big, like $1 trillion as the personal liability business. And we were always struck that Brex, of course, created a great growth play in that marketplace. But their growth play is not just an ordinary growth play where someone reinvents one aspect of the business and brings modern technology. Brex has actually looked at 3 different marketplaces and said, those are really one, but the industry doesn't treat it as one. These -- they looked at it and said, these are 3 markets, and they are being served by more traditional technology, and they're being served individually. What are those 3 markets. One is the corporate card itself. One is the accounts payables business, and one is spend management of all the employees in the business. And from a business manager's point of view, those are all different parts of the same challenge. So Brex looked at it and said, these are really -- this is really one business, and it's a modern reinvention of how the payment side of the business works. They created their product and have had a lot of success with that. So we were very excited to buy this high-growth company with a great product. We knew down the road. But by the way, that would not only reinvent how the corporate card market is, but that's the very same reinvention we knew that we had to drive on the personal liability side of the business. So again, we get a bit of a two for there. Since the acquisition has happened now that we're 5 months in, I am struck at how we feel the very same as we did at the outset. We are very struck by the management team, very struck by how much the management team is leaning in and all in on this quest, very struck by how good the technology stack of Brex is, very struck by the killer app that this trilogy of capabilities has. And what, what we are focusing on is so far a light integration of the things that absolutely need to be rated. But what we're also doing is putting a lot of energy towards adding capabilities that they can really benefit from Capital One, and that includes our marketing -- well, it includes our brand, our marketing machine, the -- all the marketing channels that we access at Capital One, the huge customer base of small businesses, some of whom are graduating into a need for commercial cards, lower cost of funds. And so that's what we're focusing on right now, and there's some promising green shoots that we're seeing along the way. In the longer run, we also look forward to bringing Brex into our Small Business, our own existing Small Business side of the house and also integrating it with our Travel business, which is a fast-growing part of Capital One and would have a very big opportunity on the commercial side. So we're just as excited as we were before. There's a lot of work and a lot of investment going on, but we like our chances.

Got it. That's helpful. So I want to turn the discussion back to Discover synergies. Capital One has achieved the targeted revenue sales this year. And the focus is now on the expenses -- expense synergies of $1.5 billion. You've mentioned around 1/3 of the operating expense synergies were realized in the second quarter, how investors think about the cadence of the realization going forward?