Capital One Financial Corporation (NYSE:COF) Q1 2024 Earnings Call Transcript

Capital One Financial Corporation (NYSE:COF) Q1 2024 Earnings Call Transcript April 25, 2024

Capital One Financial Corporation misses on earnings expectations. Reported EPS is $3.21 EPS, expectations were $3.25. Capital One Financial Corporation isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good day, and thank you for standing by. Welcome to the Capital One Q1 2024 Earnings Call. Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Jeff Norris, Senior Vice President of Finance. Please go ahead.

Jeff Norris: Thanks very much, Josh, and welcome to everyone. We are webcasting live over the Internet this evening. To access the call on the Internet, please log on to Capital One’s website at capitalone.com and follow the links from there. In addition to the press release and financials, we have included a presentation summarizing our first quarter 2024 results. With me this evening are Mr. Richard Fairbank, Capital One’s Chairman and Chief Executive Officer, and Mr. Andrew Young, Capital One’s Chief Financial Officer. Rich and Andrew are going to walk you through this presentation. To access a copy of the presentation and press release, please go to Capital One’s website and click on Investors, then click on Financials, and then click on Quarterly Earnings Release.

Please note that this presentation may contain forward-looking statements. Information regarding Capital One’s financial performance and any forward-looking statements contained in today’s discussion and the materials speak only as of the particular date or dates indicated in the materials, and Capital One does not undertake any obligation to update or revise any of this information, whether as a result of new information, future events or otherwise. Numerous factors could cause our actual results to differ materially from those described in forward-looking statements. For more information on these factors, please see the section called Forward-Looking Information in the earnings release presentation and the Risk Factors section of our annual and quarterly reports accessible at Capital One’s website and filed with the SEC.

And with that, I’ll turn the call over to Rich — to Andrew. Mr. Young?

Andrew Young: Thanks, Jeff, and good afternoon, everyone. I will start on Slide 3 of tonight’s presentation. In the first quarter, Capital One earned $1.3 billion or $3.13 per diluted common share. Included in the results for the quarter was a $42 million additional accrual for our updated estimate of the FDIC’s special assessment. Net of this adjusting item, first quarter earnings per share were $3.21. Relative to the prior quarter, period-end loans held for investment decreased 2% and period-end deposits increased 1%. Both average loans and average deposits were flat. Our percentage of FDIC insured deposits remained at 82% of total deposits. Pre-provision earnings in the first quarter increased 13% from the fourth quarter or 6% adjusting for the impacts of FDIC special assessments in both quarters.

Revenue in the linked quarter declined 1%, largely driven by lower non-interest income. Non-interest expense decreased 6% on an adjusted basis, driven by declines in both operating and marketing expenses. Our provision for credit losses was $2.7 billion in the quarter, a decrease of $174 million compared to the prior quarter. The decrease was driven by $257 million lower net reserve build, partially offset by an $83 million increase in net charge-offs. Turning to Slide 4, I will cover the allowance in greater detail. We built $91 million in allowance this quarter, bringing the balance to $15.4 billion, an increase of less than 1% from the fourth quarter. The slight increase in allowance balance was driven by modest builds in our auto and domestic card portfolios.

Our total portfolio coverage ratio increased 11 basis points to 4.88%. I’ll cover the drivers of the changes in allowance and coverage ratio by segment on Slide 5. Our baseline economic forecast modestly improved this quarter compared to what we assumed last quarter, which generally aligns with consensus. We continue to consider a range of economic outcomes in our reserving process. In our Domestic Card business, the allowance coverage ratio increased by 22 basis points to 7.85%. The increase in coverage was primarily driven by the denominator effect of the run-off of the fourth quarter’s seasonal outstandings. In our Consumer Banking segment, the allowance increased by $46 million, resulting in a 7 basis point increase to the coverage ratio.

The allowance increase was primarily driven by a higher level of originations in the auto finance business. And finally, our Commercial Banking allowance decreased by $7 million, primarily driven by portfolio contraction. Coverage ratio increased by 1 basis point to 1.72%. Turning to Page 6, I’ll now discuss liquidity. Total liquidity reserves in the quarter increased to $127 billion, about $7 billion higher than last quarter. Our cash position ended the quarter at approximately $51 billion, up about $8 billion from the prior quarter. The increase in cash was driven by continued strong deposit growth in our retail banking business and the seasonality of our card balances. Our average liquidity coverage ratio during the first quarter remains strong and well above regulatory minimums at 164%.

Turning to Page 7, I’ll cover our net interest margin. Our first quarter net interest margin was 6.69%, 4 basis points lower than last quarter and 9 basis points higher than the year-ago quarter. The quarter-over-quarter decrease in NIM was largely driven by the impact of having one fewer day in the quarter. Modestly higher asset yields were mostly offset by higher funding costs in the quarter. Turning to Slide 8, I will end by discussing our capital position. Our common equity Tier 1 capital ratio ended the quarter at 13.1%, approximately 20 basis points higher than the prior quarter. Strong earnings and lower risk-weighted assets more than offset the impact of CECL phase-in, dividends and share repurchases. We repurchased approximately $100 million of shares in the first quarter.

Our repurchase activity in the quarter was impacted by blackout restrictions and daily purchase volume limitations related to the announcement of the Discover transaction. With that, I will turn the call over to Rich. Rich?

Richard Fairbank: Thanks, Andrew, and good evening, everyone. Slide 10 shows first quarter results in our Credit Card business. Credit Card segment results are largely a function of our Domestic Card results and trends, which are shown on Slide 11. Top-line growth trends in the Domestic Card business remained strong in the first quarter. Year-over-year purchase volume growth for the first quarter was 6%. Ending loan balances increased $12.9 billion or about 10% year-over-year. Average loans increased 11%. And first quarter revenue was up 12% year-over-year, driven by the growth in purchase volume and loans. The charge-off rate for the quarter was up 190 basis points year-over-year to 5.94%, about 18% above its pre-pandemic level in the first quarter of 2019.

The 30-plus delinquency rate at quarter-end increased 82 basis points from the prior year to 4.48%. On a sequential quarter basis, the charge-off rate was up 59 basis points and the 30-plus delinquency rate was down 13 basis points. The linked-quarter delinquency and charge-off rate trends were modestly worse than what we would expect from normal seasonality. We believe this is largely driven by lower and later tax refund payments to consumers so far in 2024 relative to what we’ve historically observed. Tax refunds are an important factor in credit seasonality. Each year they drive an improvement in delinquency payments and recovery starting in February. Our portfolio trend generally have a more pronounced seasonal pattern than the industry average.

Last quarter, our view was that the charge-off rate was settling out about 15% above 2019 levels in the near term. That was based on an extrapolation of our delinquency inventory and flow rates over three to six months, and that was the horizon of our estimate. If the trend of lower tax refund sustains, it could raise the level of charge-off somewhat in the near term, but this does not change our view that credit is settling out modestly above pre-pandemic levels in 2018 and 2019. The continuing deceleration in the pace of credit normalization trend, sometimes referred to as the improving second derivative, supports our view. The pace of year-over-year increases in both the charge-off rate and the delinquency rate have been steadily declining for several quarters and continued to shrink in the first quarter.

Domestic Card non-interest expense was up 6% compared to the first quarter of 2023, with increases in both operating expense and marketing expense. Total company marketing expense of about $1 billion for the quarter was up 13% year-over-year. Total company marketing drives growth and builds franchise in our Domestic Card and Consumer Banking businesses and builds and leverages the value of our brand. Our choices in Domestic Card are the biggest driver of total company marketing. We continue to see attractive growth opportunities in our Domestic Card business. Our opportunities are enhanced by our technology transformation. Our marketing continues to deliver strong new account growth across the Domestic Card business. And in the first quarter, Domestic Card marketing also included higher early spend bonuses driven by strong new account growth, higher media spend, and increased marketing for franchise enhancements like our travel portal, airport lounges, and Capital One shopping.

We continue to lean into marketing to drive resilient growth and enhance our Domestic Card franchise. As always, we’re keeping a close eye on competitor actions and potential marketplace risks. Slide 12 shows first quarter results for our Consumer Banking business. In the first quarter, auto originations increased 21% from the prior-year quarter, a return to growth after several quarters of year-over-year declines. Consumer Banking ending loans decreased about $3.1 billion, or 4% year-over-year. On a linked-quarter basis, ending loans were essentially flat. We posted another quarter of year-over-year growth in consumer deposits. First quarter ending deposits in the consumer bank were up just under $10 billion or 3% year-over-year. Compared to the sequential quarter, ending deposits were up about 2%.

Average deposits were up 6% year-over-year and up 1% from the sequential quarter. Powered by our modern technology and leading digital capabilities, our digital-first national direct banking strategy continues to deliver strong consumer deposit growth. Consumer Banking revenue for the quarter was down about 13% year-over-year, largely driven by lower auto loan balances and higher deposit costs. Non-interest expense was down about 3% compared to the first quarter of 2023. Lower operating expenses were partially offset by an increase in marketing to support our national digital bank. The auto charge-off rate for the quarter was 1.99%, up 46 basis points year-over-year. The 30-plus delinquency rate was 5.28%, up 28 basis points year-over-year.

Compared to the linked quarter, the charge-off rate was down 20 basis points, while the 30-plus delinquency rate was down 106 basis points. The linked-quarter charge-off rate improvement modestly underperformed the typical seasonal patterns we’ve historically observed, driven by the tax refund trends I just discussed. Even with the tax refund effects, auto credit performance remained strong. Slide 13 shows first quarter results for our Commercial Banking business. Compared to the linked quarter, ending loan balances decreased about 1%. Average loans were also down about 1%. The modest declines are largely the result of choices we made in 2023 to tighten credit. Ending deposits were down about 5% from the linked quarter. Average deposits were down about 8%.

The declines are largely driven by our continued choices to manage down selected, less attractive commercial deposit balances. First quarter revenue was up 2% from the linked quarter. Non-interest expense was up about 6%. The Commercial Banking annualized net charge-off rate for the first quarter decreased 40 basis points from the sequential quarter to 0.13%. The Commercial Banking criticized performing loan rate was 8.39%, down 42 basis points compared to the linked quarter. The criticized non-performing loan rate increased 44 basis points to 1.28%. Commercial credit risks continue to be most pronounced in the commercial office portfolio, which is less than 1% of total company loan balances. In closing, we continued to deliver strong results in the first quarter.

We posted another quarter of top-line growth in Domestic Card revenue, purchase volume and loans. Domestic Card credit trend continue to stabilize and auto credit trends remained stable and in line with normal seasonal pattern. We grew consumer deposits, and we added liquidity and maintained capital to further strengthen our already strong and resilient balance sheet. Over the last decade, we’ve driven significant operating efficiency improvement, even as we’ve invested to transform our technology, and we continue to drive for efficiency improvement over time. For the full year 2024, we continue to expect annual operating efficiency ratio, net of adjustments, to be flat to modestly down compared to 2023. Our expectation includes the partial year impact of the proposed CFPB late fee rule assuming the rule takes effect in October 2024.

The timing of the new rule remains uncertain. If the rule were to take effect at an earlier date, it would be a headwind to the 2024 operating efficiency ratio. Of course, the biggest news in the quarter was our announcement that we entered into a definitive agreement to acquire Discover. We’ve submitted our applications for regulatory approval and we’re fully mobilized to plan and deliver a successful integration. The combination of Capital One and Discover creates game-changing strategic opportunities. The Discover payments network positions Capital One as a more diversified, vertically-integrated global payments platform. And adding Capital One’s debit spending and a growing portion of our credit card purchase volume to the Discover network will add significant scale, increasing the network’s value to merchants, small businesses, and consumers, and driving enhanced network growth.

In the Credit Card business, we’re bringing together two proven franchises with complementary strategies and a shared focus on the customer. And we can accelerate the growth of our national digital-first Consumer Banking business by adding the Discover consumer deposit franchise and the vertical integration benefits of the debit network. We will be able to leverage and scale the benefits of our 11-year technology transformation across every business and the network, which will serve as a catalyst for innovation and enhanced capabilities in risk management and compliance, underwriting, marketing, and customer service. Pulling way up, the acquisition of Discover is a singular opportunity. It will create a consumer banking and global payments platform with unique capabilities, modern technology, powerful brands, and a franchise of more than 100 million customers.

It delivers compelling financial results, and it offers the potential to create significant value for merchants and customers, and an unparalleled strategic and economic upside over the long term. And now, we’ll be happy to answer your questions. Jeff?

Jeff Norris: Thank you, Rich. We’ll now start the Q&A session. Remember, as a courtesy to other investors and analysts who may wish to ask a question, please limit yourself to one question plus a single follow-up. And if you have follow-up questions after the Q&A session, the Investor Relations team will be available after the call. Josh, please start the Q&A.

See also American Politicians are Selling These 10 Stocks and 15 Best Patchouli Perfumes That Smell Seriously Luxurious.

Q&A Session

Operator: Thank you. [Operator Instructions] Our first question comes from Ryan Nash with Goldman Sachs. You may proceed.

Ryan Nash: Hey, good evening, guys.

Andrew Young: Hey, Ryan.

Richard Fairbank: Good evening, Ryan.

Ryan Nash: So Rich, maybe to just start off on credit. It sounds like you’re running a little bit ahead of what you had outlined last quarter. But when you put aside the timing of tax refunds, can you maybe just talk about what you’re seeing from the consumer? And do you think we’ve now reached the inflection where we can more closely follow seasonal patterns and once the noise settles, do you think we’re kind of back at that 15% level that you had outlined? Thank you.

Richard Fairbank: Thank you, Ryan. Look, I think that the story continues to be one of — well in terms of — there’s sort of the consumer itself, let’s just talk about the consumer for a second and then let’s talk about Capital One’s credit performance. But just the health of the consumer, I think the U.S. consumer remains a source of strength in the economy. The labor market remains strikingly resilient. Rising incomes have kept consumer debt servicing burdens relatively low by historical standards. And when we look at our customers, we see that they have higher bank balances than before the pandemic and this is true across income levels. On the other hand, of course, inflation shrank real incomes for almost two years. And in this high interest rate environment, the cost of new borrowing has gone up in every major asset class.

And I think, at the margin, these effects stretch some consumers financially. But on the whole, I’d say consumers are in reasonably good shape relative — pretty darn strong shape relative to historical benchmarks. So, in terms of Capital One’s performance, we continue to see a settling out. We consider — we believe that for Capital One, I can’t speak for all card issuers, but we definitely have see what we think is sort of a landing and our — so we feel very good about where the credit is. The point that I wanted to make about the tax refunds, let’s just pull up for a second on that. The tax refunds are something that nobody knows for sure exactly what’s behind seasonality, but I think it’s a — we believe a very important driver of seasonality.

It’s a bigger effect for us than other players, because I think tax refunds just play a little bit bigger role in collectively across our customer base. So, the tax refunds in the very near term affect credit performance that Ryan what you’re referring to the 15% guidance that we gave. That was not an annual guidance number, that was saying if we just extrapolate in the very near window of just what we see in terms of delinquencies and delinquency roll rates, that’s where we would see charge-offs and charge-offs tend to be higher in the first half of the year. So, what we’re doing is giving a window to the higher part of charge-offs for the year and we were saying they were settling out — looked like around 15% above 2019 levels. Part of that — and so basically what I’m saying is that includes our assumptions about what happens with tax refund and the seasonality effect.

As we can see in the government data, tax refunds are lower and later than by historical patterns. And so that affects our near-term credit performance. And actually we often talk about well isn’t the six-month window basically once charge-offs start bubbling and going through the roll rate buckets, we can pretty much see where charge-offs are going. Tax refunds actually affect the payment rates in every bucket. So, our point was in the very near term it actually leads to a bit of a higher charge-off rate than we had guided to over that near window. But that doesn’t change our view that credit has settled out. But the 15% was not a guidance for the year. We haven’t really given credit guidance for the year. What we’re really saying is we have seen credit settle out, but we wanted to just flag that both in the credit card business and in our auto business, while credit continues to be very strong and you’ve seen things like really improving delinquencies, we just wanted to point out that in the very near term, relative to what we have seen in terms of historical seasonality and kind of confirmed by what we watch as the patterns of tax refunds, there is a — it’s coming in lower and later and we just wanted to flag that effect because it affects the very near-term numbers that we cited earlier.

Ryan Nash: Got it. Maybe as my quick follow-up for Andrew, I guess given Rich’s answer, what does that mean for the trajectory of the allowance? Seems like we’ve heard a handful of other issuers talk about us being at the peak or maybe even coming down and potentially being below where it ended the prior year. Can you maybe just talk about what you think this means for Cap One given your credit expectations?

Andrew Young: Yeah, sure, Ryan. I’d like to say from my perspective that there’s a simple answer, but there’s not. And then, there’s a host of things that are going to drive allowance from here, not the least of which is growth, but just focusing on coverage and assuming that’s what others are pointing to. The first thing I’ll highlight and I said in my talking points that fourth quarter had seasonal balances, they quickly pay off in the first quarter and therefore have negligible coverage, which we see every year. So, the coverage ratio this quarter up a bit from last quarter is really a result of that dynamic. But if you look at coverage ratio now, largely in line with the preceding quarters. I mean, the biggest driver as we look ahead are the projected loss rates.

And as we’ve been saying for a number of quarters, delinquencies are the best leading indicator of that. And so, every quarter, we’re going to look out over the next 12 months and then the reversion from there. Then, we’re going to take into account a range of outcomes and uncertainties. And so, you’ve seen over the last few quarters keeping the coverage ratio flat. I will note though even in a period where projected losses in future quarters are lower than today and might indicate a release otherwise, you could very well see a coverage ratio that remains flat or only modestly declines as we incorporate the uncertainty of that future projection into the allowance. And so, eventually, the projected losses will — when they’re lower, will flow through the allowance and bring the coverage ratio down, as those uncertainties become more certain.

And under that scenario, you would see a decline, but at this point like I’m not going to be in the forecasting business of when that actually is going to take into account, because, like I said, we really need to take the factor of the uncertainty as we look ahead every quarter that we go through the reserving process.

Jeff Norris: Next question, please?

Operator: Thank you. One moment for questions. Our next question comes from Mihir Bhatia with Bank of America. You may proceed.

Mihir Bhatia: Hi, thank you. Rich, if I could switch for a second to the Discover acquisition? There’s been a lot of talk around deal approval, particularly focusing around potential antitrust issues within the card business. And I was wondering if you could share your thoughts and perspective on that issue, if you’ve heard anything from regulators, but also just to hear how you’re thinking about that issue. Thank you.

Richard Fairbank: Okay. Thank you, Mihir. So, we have filed our merger applications with both the Fed and the OCC, and we are engaged with the — sorry, with the DOJ as they, of course, play a key role in advising the Fed and the OCC on competition questions. We believe our applications make a very compelling case for approval. We believe strongly that this merger will increase competition among banks, credit card issuers and payment networks and provide significant benefits for consumers, merchants and the communities that we serve. While some have raised concerns about competition, we believe that the facts in favor of the deal will be compelling. On the network side, let’s remember that we’re not currently in that business.

If the deal is approved, we will still have four networks just like we do today. But we will be adding new customers and scale to the smallest by far of the four networks and be able to leverage our technology, talent and marketing capabilities to greatly enhance Discover’s competitive viability. Their market share was 6% a decade ago and sits at just 4% today. The significant investments that we are planning will provide substantial benefits for consumers and merchants as we’ve outlined in our regulatory applications. On the credit card side, the regulators have found every time they’ve studied it that the credit card market is highly competitive and not at all concentrated. In fact, it’s less concentrated today than it was 10 years ago. Consumers can choose from over 4,000 issuers, all able to offer products with similar capabilities.

Imagine this, a card issued by a small credit union can be used every place that a card issued by a bank like Capital One can be used, anywhere in the world. That kind of level-playing field doesn’t exist in any other industry and certainly not in airlines or grocery stores or many of the others. There is a reason that we ask folks what’s in your wallet. We compete not only with these 4,000 other issuers to gain your business in the first place, but also with every other card you likely already own. Put another way, we have to compete every day for every single transaction, because our customers can simply choose at any moment to use another card. And if they don’t like the card they have, they can stop using it entirely or close the account or switch to another card with another bank, large or small, in minutes.

We also believe that the facts will show that there are no barriers to entry in the credit card business, as thousands of current issuers and the new ones are forming all the time demonstrate. New and incumbent fintechs backed by significant VC funding are able to leverage the infrastructure of sort of credit card as a service players like Marqeta to achieve instant scale and high growth. Also, any existing bank can choose where in the credit spectrum they play simply by changing their credit policy. Let’s also remember that consumers can choose to use another form of payment entirely, cash, debit or Buy Now Pay Later, which has exploded onto the marketplace. New fintechs are entering the payments in small dollar credit space every day, all looking to take market share from traditional credit card players like Capital One.

We faced this competition for years and we’ll continue to face it in the future. It’s powerful evidence of a healthy and fiercely competitive marketplace. But we have been successful by focusing on the needs of our customers and offering credit card and retail banking products with the most straightforward terms and fewest fees in the industry. We’re the only major bank where all of our deposit products come with no fees, no minimums and no overdraft fees. So, pulling way up, we believe the facts will show that this transaction is both pro-competitive and pro-consumer bringing our best-in-class products and services to a broader set of consumers and small businesses and greatly enhancing opportunities and benefits for merchants. In the end, that is what we believe the regulators will use their very vigorous process to evaluate.

Mihir Bhatia: Got it. Thank you. That is helpful. Just turning back to the health of the consumer for a second for my follow-up. If you could just talk a little bit about the environment for card acquisitions? You did mention, I think, that the growth — you see good growth opportunities in the card business. So, I’m wondering if you could expand on that. Maybe talk about just some of the puts and takes as you consider where to make those investments? Are there parts of the market where you’re being more cautious given the environment? Thank you.

Richard Fairbank: Mihir, we are leaning in pretty much across the board in the card business, powered by a healthy consumer and the traction that we’re getting in our business. We are — really all parts of the card business are seeing very nice account originations, seeing good traction on the purchase volume side. And so, it’s very much a positive time for leaning in as you see reflected in our marketing, as you see reflected in some of the growth numbers, and as I see in numbers behind the numbers that you see just a lot of traction. And just — let’s just savor for a second some of the things that are powering that. Two things that I would flag is, one the continued investment that we are making to win at the top of the market And I think that not only affects our success at the top of the market, but I really believe there is a lifting of all boats from those investments and that traction there.

Also, we continue to just get a — have a lot of success powered by our technology transformation, including not only the customer experience and some of the product capabilities that we’re able to offer, but really impacts on the whole way that we run the business and very notably on the credit and marketing side of the business, the ability to create mass customized offerings and real-time solutions just enables us to have more traction on the growth side. Also, I just want to say that we also are pleased to see things picking up in the auto business, and also we continue to have a lot of traction on our national bank.

Jeff Norris: Next question, please?

Operator: Thank you. Our next question comes from Rick Shane with JPMorgan. You may proceed.

Rick Shane: Thanks for taking my questions this afternoon. Hey, Rich, I want to make sure I fully understand what you’re describing in terms of credit. The framework is that charge-off rates will be about 15% higher than ’18, ’19 levels in the near term. But now with tax refunds, it might be a little bit higher than that. That over time, it will converge back towards slightly above ’18, ’19 levels. When I look at the delinquencies and one of the things we’ve observed is that roll from delinquency to charge-off is actually higher than it has been pretty much at any time in recent history. Does that suggest that delinquencies actually need to get back below ’18, ’19 levels to achieve that level of charge-off performance?

Richard Fairbank: So, Rick, there’s a lot. First of all, let me clarify some of the things that you were saying weren’t exactly, I think, as we intended to state them. So, let me just — so we talked about — so, yes, we talked about credit, we’re saying credit settling out. We said in the very near term, where charge-offs are tend to be higher in the first half of the year, in the near term, based on extrapolation from delinquency buckets and roll rates, we would expect them to settle out at 15% higher than pre-pandemic. That was a near-term forecast, that was not an annual forecast. And then, you — just to clarify, your comments that and over time it will converge back to slightly above 2018 and 2019, I just want to say those are your words not ours.