Capital One Financial Corporation

Welcome to the Capital One first quarter 2020 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer period. If you would like to ask a question during this time, simply press the star key, then the number one on your telephone keypad. If you would like to withdraw your question, press the star key, then the number two. Today's conference is being recorded. Thank you. I would now like to turn the call over to Mr. Jeff Norris, Senior Vice President of Global Finance. Sir, you may begin.

Thanks very much, Matt, and welcome, everyone, to Capital One's first quarter 2020 earnings conference call. As usual, we are webcasting live on the Internet, something that's not quite as usual in a time of social distancing. We're each webcasting from our own home, so please be patient with us if there's an occasional awkward pause or dog barking. To access the call on the Internet, please log on to Capital One's website, CapitalOne.com, and follow the links from there. In addition to the press release and financials, we've included a presentation summarizing our first quarter 2020 results. With me today are Mr. Richard Fairbank, Capital One's Chairman and Chief Executive Officer, and Mr. Scott Blackley, the Capital One's Chief Financial Officer. Rich and Scott will walk you through this presentation. To access a copy of the presentation and the press release, please go to Capital One's website, click on Invest and click on Quarterly Earnings Release. Please note that this presentation may contain forward-looking statements. Information about Capital One's financial performance and any forward-looking statements contains today's discussion and the materials. Speak only as of the particular date or dates indicated in the materials. 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 titled forward-looking information in the earnings release presentation, and the risk factor section in our annual and quarterly reports, accessible at the Capital One website and filed with the SEC. And with that, I'll turn the call over to Mr. Fairbank. Rich?

Thanks, Jeff, and good evening, everyone. Before we get into first quarter results, I'll begin tonight with an overview of COVID-19 and its impact. In roughly the last two weeks of the first quarter, the world changed abruptly as the spread of COVID-19 accelerated. Like all of you, we're watching with empathy and gratitude as people and communities take extraordinary action, care for the sick, support first responders, and slow the transmission of the virus. At Capital One, we're focused on the well-being of our associates, our customers, and the communities we serve, and we've fully mobilized to do our part to make an immediate positive impact. Enabled by our technology transformation, about 80% of our associates and 98% of our non-branch associates smoothly transitioned to remote working arrangements and are now securely and productively working from home. For our associates who must be at Capital One location, we've taken steps to improve social distancing, adopted flexible attendance and leave policy, and increased hourly pay. For our customers, we're offering a range of forbearance options and taking steps to make it easier for banking customers to access their money while social distancing. COVID-19 has catalyzed three unprecedented events that are sweeping the world with breathtaking speed. A global pandemic, a partial shutdown of the global economy, and the fiscal intervention of a magnitude not seen since the Great Depression. It is difficult to predict the magnitude and duration of the disruption. Capital One is well positioned to weather these challenges. Throughout our history, we focused on resilience in all of our choices on liquidity and capital. As a result, our balance sheet is strong. We have deep liquidity reserves and a strong capital position. We've also been obsessed with resilience in our choices of businesses and segments and in all of our underwriting decisions in good times and bad. We've avoided or exited less resilient businesses and segments. We built stress testing into our underwriting decisions years before the advent of industry-wide annual stress tests. We model, measure, and analyze the resilience of our loan portfolios from origination throughout the life of the loans. And as always, we're focused on resilience and long-term value creation in the choices we're making today to manage through the pandemic and its impact. Our businesses have demonstrated a track record of successfully weathering recession, including the Great Recession, and emerging in a position of strength on the other side. We are working hard to help our customers who have been impacted by COVID-19. That help takes different forms depending on the business. In card and auto, forbearance is primarily in the form of short term payments, deferrals, fee waivers. In the retail bank, we are waiving selected fees for impacted customers. And in commercial, we are working with our clients on a more customized basis. As of April 17, domestic card forbearance enrollments covered about 1% of active accounts or 2% of loan balances. And in our auto business, about 9% of our customers or about 11% of balances. Our investments to transform our technology and how we work are powering our response to the pandemic. I've already mentioned our quick and essentially issue-free transition to working from home, which was enabled by our move to the cloud and our broad integration of mobile technology. Digital and data capabilities are also powering rapid changes and enhancements in underwriting and modeling and expanding the scope and effectiveness of real-time monitoring. Turning now to guidance. Because of the economic disruption and uncertainty caused by COVID-19, we are withdrawing our efficiency ratio guidance. including our guidance of annual operating efficiency ratio of 42% in 2021. We're only a handful of weeks into the pandemic and its economic effect, and there is a wide range of possible outcomes. It is difficult to forecast specific efficiency targets or timeframes while the pandemic runs its course, but we remain focused on delivering positive operating leverage over time. It's one of the most important payoffs of our digital transformation and a key element of delivering long-term shareholder value. We are also withdrawing our guidance on 2020 marketing. We continue to make marketing decisions at the line of scrimmage based on our dynamic assessment of market risks and opportunities. Consistent with our long-standing focus on resilience, We're pulling back on marketing in the near term based on our current view of COVID-19 risks. Pulling up, we're entering a time of significant challenges spawned by the global coronavirus pandemic and the near shutdown of economic activity across our country and the world. The largest government stimulus in decades and increased forbearance should help to mitigate some of these challenges but it's difficult to predict how it will all play out. On top of that, it's even more difficult to predict the course of the pandemic and the length of time that economic activity will remain shut down. As we manage through what lies ahead, I believe we will continue to be well served by our strong balance sheet, our resilient businesses, our digital transformation, and most importantly, our deep experience and learnings from managing through good times and bad times for two and a half decades. We are ready to take on these challenges. Now, I'll turn the call over to Scott. Thanks, Rich. Capital One lost $1.3 billion or $3.10 per share in the first quarter. Net of adjusting items, our EPS loss in the quarter is $3.02, driven by a $3.6 billion allowance bill. Turning to slide four, I'll cover the allowance in more detail. The adoption of CECL increased our allowance by $2.8 billion as of January 1st, 2020, in line with previously communicated expectations. Our first quarter allowance bill, the $3.6 billion, consists of $2.2 billion in card, approximately $600 million in auto, and approximately $700 million in commercial. We modeled several economic scenarios, and then we added some judgmental overlays in determining our allowance. The most heavily weighted of these economic scenarios included a sharp increase to a peak unemployment during Q2 2020 of 9.5%, followed by an improvement into 2021. I would encourage you not to get too focused on the headline unemployment rate because it was just one of the many variables impacting our allowance. For example, after we completed our modeling, we added qualitative overlays reflecting risks and uncertainties due to the more severe economic forecasts we saw around and after quarter end. On slide five, you can see that our coverage ratio in domestic card has more than doubled. since December 31st to almost 9%. Our U.S.-branded card coverage ratio was 10.1%. The difference between these ratios is driven by loss-sharing agreements in our partnerships portfolio, where we only allow for our portion of the estimated losses. Our auto coverage now stands at 3.4%, over two times the coverage at year-end. And commercial reserve coverage has also doubled to almost 2%. driven primarily by oil and gas. We have included an oil and gas slide in our appendix with deals on that specific business. Next, I'd like to discuss our capital and liquidity positions. Rich mentioned we focus on the resilience of our liquidity and capital positions in good times and in bad. And accordingly, we enter into the COVID-19 situation with strong levels of capital and liquidity. On slide six, you can see our preliminary average liquidity coverage ratio during the first quarter was 145%, up from 141% at year end, and well above the 100% regulatory requirement. At the end of the quarter, we had total liquidity reserves from cash, securities, and federal home loan bank capacity of $106 billion, including about $25 billion in cash. Turning to slide seven, I will cover capital. Our common equity tier one capital ratio was 12.0% at the end of the first quarter, well above the regulatory minimum requirement of 4.5% and about $3 billion above our 11% long-term capital target. In the first quarter, we purchased approximately 312 million or 3.7 million common shares prior to suspending our share repurchase program on March 13th. In terms of the impact of new regulations, in Q1, we adopted the Federal Reserve's final tailoring rule and elected to opt out of including AOCI in regulatory capital measures. We also elected to adopt the five-year CECL transition to regulatory capital. These impacts of the elections are included on slide seven. Lastly, turning to slide eight, you can see net interest margin was 6.78% in the quarter, eight basis points lower than the prior year quarter. On a quarter-over-quarter basis, net interest margin decreased 17 basis points, largely driven by lower day count, a higher average cash balance that I mentioned previously, and lower yields on our loan portfolio. This was partially offset by lower interest expense paid on deposits. Looking forward, our net interest margin will continue to be impacted by a variety of factors, including our asset mix, deposit pricing, cash positions, and day count. And as we have previously mentioned, we generally view a continued low rate environment as a headwind and a higher slash positively slope yield curve as a tailwind. All else equal, significant decrease in rates and our elevated levels of cash are likely to create a headwind to net interest margin in the near term. With that, I will turn the call back over to Rich. Rich. Thanks, Scott. This quarter, there is an obvious recurring theme in each of our businesses and for the company. First quarter results reflect two distinct time periods, January 1st through mid-March before COVID-19 impacts took hold. and the last two weeks of the quarter, and COVID-19 drove sharp changes in many metrics and trends. Pre-COVID-19 results generally show solid momentum and strong performance on growth, credit, and efficiency that have put Capital One in a strong position. Post-COVID-19 trends show a clear inflection, but there's too much uncertainty to simply extrapolate recent trends. With that context, I'll pick up on slide 10, which summarizes first quarter results for our credit card business. Pre-provision results were solid in the first quarter with continued year-over-year growth in loans and purchase volume. Credit card segment results and trends are largely driven by the performance of our domestic card business, which is shown on slide 11. Domestic card ending loan balances increased 8.4% year over year, driven by the addition of the acquired Walmart portfolio. The emergence of COVID-19 impacts late in the quarter caused a deceleration in the growth of ending loan balance. First quarter average loans grew 11% year over year. First quarter purchase volume was up 8% from the first quarter of 2019, with strong growth through most of the quarter, partially offset by sharp declines near the end of the quarter. By the end of the first quarter, weekly purchase volume was running at a year-over-year decline of about 30%. Consistent with industry trends, our largest declines were in travel and entertainment, restaurants, and discretionary retail. These category decreases were partially offset by an increase in spending at supermarkets and discount stores. Through April 17th, weekly purchase volume continues to be down about 30% year over year. Revenue increased 2% year over year. Growth in average loans was offset by lower revenue margins. The revenue margin declined 129 basis points compared to the first quarter of 2019. A majority of the decline was driven by the expected impact of the revenue sharing agreement on the acquired Walmart portfolio. The expected math of comparing to the first quarter of 2019, which benefited from a rewards liability release and low net interchange revenue resulting from the late quarter drop in purchase volumes. Non-interest expense was up 2% from the prior year quarter, in line with the trend in revenue. The charge-off rate for the quarter was 4.68%, a 36 basis point improvement year over year, driven by the addition of the acquired Walmart portfolio. Because the delinquency rate is not affected by the law sharing agreement, the addition of the Walmart portfolio put upward pressure on the first quarter 30 plus delinquency rate. Despite this upward pressure, the delinquency rate improved by three basis points year over year, 3.69%. There were no significant COVID-19 impacts on domestic card delinquency and charge off metrics in the first quarter. However, we had a significant allowance billed in the quarter, reflecting the expected credit impacts of the shutdown of economic activity. Pulling up, in the first quarter, our domestic card business delivered solid results and quickly mobilized to respond to COVID-19 impacts. Slide 12 summarizes first quarter results for our consumer banking business. The auto business posted 9% year-over-year growth in ending loans and 8% growth in average loans. But by the end of the quarter, leading indicators of growth started to show COVID-19 impact. Weekly dealer applications were down an average of about 35% year-over-year in the second half of March and down about 25% year-over-year in the first half of April. Weekly dealer originations were down an average of about 25% year over year in the second half of March and down about 45% year over year in the first half of April. Pending deposits in the consumer bank were up 6% year over year. Average deposit interest rate for the quarter declined 12 basis points compared to the prior year quarter. and 14 basis points from the sequential quarter driven by the market interest rate environment. Our average deposit rate paid going forward will depend upon several factors, including the market interest rate environment, our deposit mix, our funding needs, and competitive dynamics. Consumer banking revenue decreased from 3% from the first quarter of last year. Underlying revenue growth from higher auto loans and retail deposits was more than offset by two factors. Differences in the timing of Federal Reserve rate cuts versus our deposit pricing moves pressured revenue in the quarter, and our deposit mix continued to shift toward higher rate products. Noninterest expense was essentially flat year over year. First quarter provision for credit losses increased $625 million year over year, primarily as a result of an allowance bill in the auto business driven by COVID-19 and CECL. The auto charge-off rate increased five basis points compared to the prior year quarter to 1.54%. Moving to slide 13, I'll discuss our commercial banking business. Ending loan balances were up 14% year over year. About half of this growth resulted from customers drawing down lines late in the quarter. After peaking in March, line draws have subsided thus far in April. First quarter average loans were up 7% compared to the first quarter a year ago. Average deposits also increased about 5%. First quarter revenue was up 8% from the prior year quarter, driven by growth in average loan balances and strong non-interest income. Non-interest expense was essentially flat compared to the prior year quarter. Provision for credit losses increased $787 million compared to the first quarter of 2019, driven by a significant allowance build. A little more than half of the allowance bill is related to pressure in the oil and gas portfolio caused by the sharp drop in commodity prices in the wake of the shutdown in economic activity. The remainder of the bill is related to COVID-19 impact across the portfolio. We've provided a breakout of oil and gas portfolio composition and reserves on slide 16. The commercial banking charge-off rate for the quarter was 0.57%. The criticized performing loan rate for the first quarter was 3.6%. And the criticized non-performing loan rate was 0.6%. Pulling way up in the first quarter, Capital One rapidly mobilized to respond to COVID-19 and the disruption it is causing. with a focus on our associates, our customers, and our communities. We are in a position of strength to weather the pandemic, and we're closely monitoring conditions and managing our businesses for resilience and long-term value creation. I am struck by how fast, how unpredictably, and how much the world can change in just two weeks. Rapid change can leave companies scrambling to make choices in the heat of the moment in a swirl of uncertainty and anxiety. But so much of the leverage is in the choices one makes before coming face to face with sudden challenges. I've often said that it's the choices you make during the good times that have the most impact on how you weather the bad times. and that's a core tenet of how we manage Capital One every day. From our founding days, we have hardwired resilience into every choice we make on credit, capital, and liquidity. Our balance sheet is strong. We've built resilient businesses and a resilient loan portfolio. We have invested to transform our technology and how we work, and we're taking decisive actions to aggressively manage credit risk and further strengthen resilience, leveraging what we've learned over two and a half decades. There are certainly challenges ahead for the economy, for our customers, and for Capital One. At this point, it's very hard to predict how great the challenges may be or how long they may last, but we're well-positioned to navigate through these uncertain times and to emerge with the strength to find the opportunities on the other side. Now we'll be happy to answer your questions. Jeff?

Thank you, Rich. We'll now start the Q&A session. 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. If you have follow-up questions after the Q&A session, the investor relations team will be available to answer them. Matt, please start the Q&A.

Thank you. Once again, if you'd like to ask a question, please signal by pressing star 1 on your telephone keypad.

If you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, we ask that you limit yourself to one primary and one follow-up question only, please. Our first question will come from Betsy Gracek with Morgan Stanley.

Good evening. Thanks for taking the call, and I hope everybody is safe there. Rich, I guess I just wanted to understand how you're thinking about the card business as we go through the next couple of years in particular, how to integrate the new Walmart portfolio and relationship into the business that you've got and what it means for growth in that portfolio with that customership.

So, Betsy, good evening. You know, the Walmart integration has really happened dominated by the economics of the backlog portfolio that we acquired and that's fully integrated and, you know, that's performing as expected. And we have been working very hard with Walmart to put in place the elements and the channels and the opportunities for originations. You know, COVID-19 coming along is a bit of a, you know, a challenge in the middle of this, and so probably, you know, that business will, like all of our businesses, probably be subject to some of the demand impacts and, you know, changes I mentioned relative to what typically happens in a downturn. But we're still very focused on moving forward with them. And what I'm struck by also is that we take the very same perspectives on how to manage credit in this environment, how to, where to find the opportunities. And so we'll be continuing to move forward.

Okay, thanks. And then as a follow-up, I just wanted to turn to the outlook for the reserve. You went through very detailed segment by segment. It was just very much appreciated. I wanted to understand how you think about that reserve as we, you know, as the next couple of quarters unfold. I realize, you know, the 9.5% peak unemployment is 22 to 20, but that you put the qualitative overlays on. So I You know, how much more unemployment do you feel like you've baked into the current reserve level? Just so we can get a sense as to when we see the numbers come out how we should be flexing future reserve bills, if any.

Hey, Betsy. Thanks for the question. You know, I think that I would start off by saying The reserve, when we talked up the reserve at the end of the quarter, we actually didn't go and do another model run. We just did an overlay. So I can't get too precise in saying, like, hey, here's a specific number that I would tie to our reserve in terms of unemployment level. And just in general, in terms of how to think about the reserve going forward, I would just say that, you know, that may not be quite as simple as just making the headline unemployment anti-methodicides of the allowance. I just, you know, was talking about the fact that we did do this, you know, late add to the reserve based on some of the worsening economic forecasts we had. And then the second thing I would just say is that, you know, we've got I think we're just going to see a lot more data in the next 90 days, you know, before we have to close the books again and, you know, thinking about kind of the path of the country's response to the virus, how the consumer is going to, you know, react to all the stimulus and, We'll actually also have some credit data by the time we close the books next quarter, which, of course, we're going to use all those things to refine our allowance estimate. So at this point, you know, I'd really like to see that data before I speculate on where the allowance might be headed.

Next question, please.

Next question will come from Don Fandetti with Wells Fargo.

Thank you. So Scott, thanks for the color on the reserve building. If I look at your allowance, my personal view is that you guys took a more conservative approach. So we appreciate that. I think some of the card issuers may have a bigger reserve next quarter. But Rich, I was wondering if you could talk a little bit about loan growth and what your plans are in cards. I know if I go back to the credit crisis, your loan growth declined significantly. And can you just provide some thoughts on stimulus in terms of what the offset might be and how we could think about that?

Yeah, thanks, Don. So, the first thing that I think is striking, well, from my experience across several downturns and then you know, thinking about how to interpret this downturn. Of course, we haven't seen anything as precipitous as this particular one. But, you know, a couple of things tend to naturally happen in cards. You know, the lower purchase volume, obviously very striking, particularly in this downturn at this point. But, you know, lower demand for credit, lower requests for credit line increases. And I want to pause on that because I think there's a kind of, intuitive logic people would think, well, wait a minute, you know, when customers feel the strain of a downturn, surely a lot of them have to be beating a path to try to get more credit. And what I've seen in the past and what we're already seeing here is, you know, that consumer behavior tends to be, you know, in general, one of you know, battening down the hatches a bit, being more conservative, you know, increasing their savings if they have an opportunity to do that, sometimes paying down debt. Now, obviously, there's a huge gradient across customers, but I just wanted to say that our expectation and what we're seeing in a matter of weeks is something that is left on the demand side And, you know, I think I would guess that, you know, during the period when consumers feel a lot of uncertainty, I think that at least for that period of time, that demand will be less. You know, it's also really quite plausible that, you know, as things settle out on the other side, consumers will still carry that cautiousness with them. We saw some of that after the Great Recession that there was some behavioral changes, you know, in that particular case. Then I want to overlay, you know, on top of that what we're doing at Capital One. You know, we're making here very, very early and into the sort of free fall period of the economy, we're making choices that, you know, are, you know, right out of our playbook in downturns and certainly I think make a lot of sense in this downturn, tightening our extension of new credit to avoid the heightened risk of adverse selection. And then we're also pulling back on near-term marketing in response to the decreased opportunity at this very moment for quality growth. And, of course, the decreased marketing has a bit of a, you know, that, you know, will itself flow into, you know, a little bit on the growth side. So, the combination of these natural trends and our actions put downward pressure on loan balances. I really want to stress that this is a moment in time and this is how the market's reacting, you know, that the consumer is reacting and the choices we're making at this moment in time. We have really structured our business and our playbooks to be, you know, always, you know, testing and, you know, looking for inflection points. and to see where the opportunities can come and we will pounce on them when they do. One other thing I want to say is it's not like there's going to be a single inflection point and then suddenly sort of the sun is going to come out. The way opportunities will emerge will be probably really quite sloped by, you know, by product area. we found across business line the sort of inflection point varied by many, many months in our business. And then it will vary by segment, probably by geography. So, you know, right now it's a time to be cautious and but we're very, very, closely monitoring where opportunities and where and when opportunities will present themselves.

Next question, please.

Our next question will come from Sanjay Sethrani with KVW. Thanks. Hope you guys are doing well. Rich, you talked about pulling back on marketing, and obviously that wasn't as evident in the first quarter. But when we think about magnitude that you could pull back on marketing and even other expenses, could you just walk us through how you're thinking about it over the course of the period that we're going to experience this weakness as a result of COVID-19? Yeah, let me talk about the – Let me start with the marketing first. So, you know, right now, we're pulling back in a number of areas to avoid the heightened risk of adverse selection. So, you know, these areas include some pullbacks in digital and online origination channels, direct mail, on the advertising side, certain, product-oriented national advertising. You know, at the same, you know, we're continuing to originate, you know, through some channels. We are, but we're also, you know, continuing to invest in our brand, although the overall brand investment is down. And we are at full levels of marketing on our national banking side. In fact, you know, the whole, you know, most of the things that are going on, the incredible importance of digital banking experiences, the, you know, just about all the trends are sort of consistent with an acceleration in the kind of things we've been looking for in consumer behavior. relative to our national bank. So, we're full green light on that one. So, and again, I'm talking moments in time and these things are line of scrimmage calls like I have always said. So, this is not, you know, these are not predictions are more around our choices of credit risk at the margin, the marketing, that we're doing, we are tightening up on hiring and tightly managing operating expenses as we continue to monitor the trajectory and character of this downturn. Okay. And I appreciate slide 16 which goes through some of the commercial oil and gas portfolio exposures. I don't know, Scott, if you could just help us think through the sensitivities around this because, you know, we were hearing all sorts of stuff happening with the price of oil. Maybe you could just help us think about how that sort of translates into this. And also, you know, there were lots of news articles about hedging and derivative contracts and how it affects you. Maybe you could just, you know, clear the air on that as well. Thank you. Sure. Thanks, Sanjay. So just starting off on E&P, On, or excuse me, the energy business, so, you know, that business you see in the slides is really predominantly an exploration production business. And when we did the allowance, we based, you know, a lot of the allowance on where the revenue stream that those producers are going to have, which is basically the forward oil prices. And even with this near, you know, the short-term disruption, you know, that was all about spot prices and not so much about, you know, the longer-term prices. So I wouldn't get too worried about kind of that short-term disruption in the market. Overall, you know, when I look at that industry and where we are and what is going on with, you know, just the incredible reduction in the use of oil and gas, I would just say this. When we set this reserve up, the significant portion of it, we added some nonspecific reserves. These aren't reserves associated with, you know, specific names that are struggling. We did a pretty healthy amount of qualitative reserves just based on the risk of a number of these names just continuing to struggle. So, you know, I feel pretty good about the level that we put in there in spite of everything that we've seen in the last several weeks. And then moving on to your other questions about, you know, kind of what is going on with the commodities. So, you know, Capital One has a business which does commodities trading on behalf of our customers. Our net exposure to commodity price risk is minimus. We did ask the CFTC for temporary, you know, relief from being designated as a major swap participant, which is the lowest level in that regulatory hierarchy. And we did that mainly because, you know, there could be some, the price volatility could move some of our positions into levels that would trigger that registration. And we really do appreciate the speed that the CFTC granted relief for us against not having to necessarily register. However, because the request was really broadly misunderstood in the marketplace, we did notify the CFTC that we're not going to rely on that waiver, and we're going to go ahead and register if derivative volumes reach the threshold that would require us to register. I just have a couple other comments there. So, you know, one, our commercial bank does not engage in speculative derivative trading. You know, since 2015, we've provided, as I said, commodity price edges as a service to our oil and gas customers. And then when we do these trades, we basically have back-to-back trades. We enter into a trade with our customer, and we enter into an offsetting trade with Wall Street. And so, we're really, you know, sitting here in a very low-risk position. And I would just say, at the moment, there's no outstanding margin calls. You know, we reduce our risk exposure to commodities essentially to zero. And, you know, you can look at our 10-Ks and Qs and see that, you know, this is normal hedging activities. And, you know, if there's any updates on that, you know, we'll point that out there. But hopefully that clears the air a bit.

Next question, please.

Our next question will come from Eric Wasserstrom with UPS.

Thanks for taking my question. Can you hear me okay, Jeff?

Yep.

Yeah, okay, good. Thanks. So I'll say that I also have a credit question. You know, as you think about the reserve adequacy in the card segment, I know that you indicated that it's a portion of the program in which you actually bear the risk, but is the loss content in those programs significantly different than it is in your overall portfolio such that it would significantly skew that ratio in some way?

Eric, the thing I would just say there, so one, the loss sharing in those arrangements, we only recognize in our allowance and in our charge-offs our portion of the loss. And, you know, some of these loss sharing arrangements, we talked about that the Walmart loss sharing arrangement includes significant loss sharing. And so, as a consequence, it really does decrease the amount of coverage that is necessary and required to cover our portion of those losses. You know, while the book itself may have losses that are, you know, perfectly reflective of the types of customers that are in there, we end up having a much smaller portion of losses that we recognize in our coverage levels are appropriately lower given that relationship.

Okay, great. Thank you for that. And just as a follow-up, you know, maybe to reframe some of the questions that have been posed, And I think one of the things that the investment community is struggling with is that subsequently, of course, to the close of the quarter, I think economic conditions and expectations have continued to deteriorate. And so, in that context, you know, again, like how should we think directionally about the adequacy of reserves across the different products? Is there a greater likelihood of needing to do another true-up under the FISA provisions of forward-looking, you know, economic expectations? Do you feel like you had a lot, you know, a good enough look into ACIPA trends such that the first quarter provision really compensated a lot of that already?

Well, you know, we did, I mentioned this, we did make some adjustments to our model reserve as we closed the books in, you know, the first week of April. I really want to just emphasize that I, we have certainly seen some scenarios, particularly, you know, economic scenarios that are more severe than what we modeled. But on the other hand, you know, we've seen more stimulus that's been brought to bear since then as well. And I said this earlier, but I really think that we, it is very hard for us to predict where this, you know, like allowance may be headed. There's such an important relationship of government stimulus and hardship programs that, you know, really are going to work to help offset some of the economic challenges that we're seeing right now. And I just don't have a good sense about, you know, if the alarm's going to be bigger or smaller. I really just want to see a little bit more data before we have a lean in either direction.

Next question, please.

Our next question will come from Ryan Nash with Goldman Sachs.

Can everyone hear me? Yes, we can, Ryan. Hey, good evening, everyone.

So maybe one question, a follow-up for me. So, Rich, if you look, you know, the stock's trading at a $30 discount to tangible capital since this pandemic began on concerns that, you know, this could obviously end up eating into the capital base of the company. You know, when I look, you're at 12% CP1s amongst the highest in the industry, even after building. significant reserves. So, when you just think about, I know it's hard to predict this from, you think about the different range of outcomes combined with the fact that you're halting buybacks, the balance sheet sounds like it's going to be shrinking.

How do you think about capital and capital progression in this kind of environment?

Well, Ryan, I think we answered this downturn you know, I think about the choices that we have made over the years and, you know, coming from the sort of risk management philosophy that's deepened in the way this company is founded and even a number of choices that were made over the last few years. And I think we enter this downturn in a really good position. And, Ryan, would it be useful possibly to open the aperture of your question and sort of compare, you know, do a little bit of a calibration about, you know, going through the Great Recession and calibrate to how I feel about this time around. Not that we can predict this downturn, but in other words, though, just thoughts that experience and comparing some of the resilience dynamics, would that be helpful in the question? Well, my follow-up question was actually going to be, and I think everybody's kind of alluding to this on this call, the fact that, you know, as we see unemployment reach certain levels, there's an underlying assumption that losses are going to rise to similar amounts. So I actually think it would be helpful for you to compare and contrast this to the financial crisis. What's different and what are the factors, whether it's the CAR Act or anything else that's changed across the industry, that you think will make those relationships no longer hold? Yeah, so knowing, of course, that, you know, this particular downturn is so early, you know, nobody knows how prolonged this will be, how severe it will be, what the recovery will look like or how much government support and forbearance, you know, there will be and how it mitigates the economic effects. So, you know, with those caveats, Let me talk a little bit about, you know, the marketplace as we enter the downturn, some of the things on both sides of the ledger at, you know, in terms of resilience levers and opportunities. And then so let me start with the marketplace. Let me start with the consumer. I think the U.S. consumer is in... much better shape than at the outset of the Great Recession. You know, consumer debt levels are lower on a per capita basis. Payment obligations are lower still, supported by low interest rates. The savings rate over the past few years is double what it was before the Great Recession. And we're not dealing with a structural problem in the economy like the housing sector pre-Great Recession that had to work itself out over multiple years before we could see a sustained recovery. In corporate markets, as we've mentioned in earnings calls over the last few years, there are some mounting kind of competitive challenges, including higher debt levels, lower, you know, lower interest coverage, weaker covenants. all of which, you know, feel weaker than before the Great Recession. You know, on the other hand, the banks have been a smaller part of this trend in increasing leverage with capital markets and non-banks taking an increasing share of this growth. At Capital One, we weathered the Great Recession very well. and demonstrated the resilience of our business model. Today, we have a stronger capital position and a stronger liquidity position than we had going into the last quarter. And let me comment briefly about each of our major lending businesses. There are some offsetting factors that impact the resilience of our card business relative to the last downturn. The CART Act has leveled the playing field, but it has negatively impacted resilience by banning the repricing of existing balances. And changes to accounting rules now dramatically amplify the volatility of allowance, although this doesn't change the underlying resilience of our lending portfolios. Of course, there we're talking about both as 166, 167 and . And our returns, while still very strong, are somewhat lower than they were prior to the Great Recession. But we have changed the mix of our portfolio, reducing our exposure to high-balance revolvers, and significantly growing our spender business at the top of the market and building a stronger customer franchise across the portfolio. And we built law sharing into most of our partnership deals, which improves our resilience. In the auto business, we have lower charge-offs, higher returns, a strong franchise built, you know, one deep dealer relationship at a time, and a more resilient strategy. Our commercial business did exceptionally well in the Great Recession, but was aided by a business mix and a geography that did not get severely impacted during the downturn. You know, our commercial portfolio, you know, was still in a developing stage in 08. It looks pretty different today. We've exited or reduced exposure to several less resilient segments like small ticket commercial mortgages and equipment finance. We've invested in building specialty businesses to generate better risk-adjusted returns. And we've increased noncredit revenue significantly. But we think the overall commercial sector is in worse shape as companies have taken on more debt and increased leverage in the creditor. So that's, of course, 2020. At this point, we know very little about how the COVID-19 pandemic and its economic impacts will play out. We know, of course, that the onset was more abrupt and that the initial worsening is likely to be steeper, faster, and deeper. We also know that the downturn is being met with a more rapid and much bigger fiscal, particularly fiscal and monetary intervention, the largest fiscal intervention we've seen since the Great Depression. We know that forbearance is available to customers on a much greater scale than it was last time around. So, our strategy in the face of the current challenges and uncertainties is to aggressively manage credit and resilience, you know, from a decision-making point of view because downside risks can be, you know, nonlinear. We take a very cautious approach at this very moment while the economy is, you know, descending. Also, though, while very proactively positioning for opportunities that may emerge on the other side of this. And that's why we've said we're tightening our extension of new credit with a real eye toward the probably. high adverse selection that would be prevailing out there and pulling back on near-term marketing, tightly managing expenses and being, you know, really ready to be responsive as this downturn evolves and knowing that we need to evaluate that on a segment by segment basis across our business. So, you know, pulling way up, Ryan, we feel really good about the choices that we made over the years. We feel very good across liquidity, capital, and credit resilience choices as we enter the downturn. With the tech transformation, we've been able to have a company that can move very quickly. You know, I feel very good about where we are. It's hard to predict exactly what will happen here, but, you know, I think the choices, you know, I wouldn't change just about any. I really wouldn't change any of the choices. Knowing where we are now, I would not change the choices we made leading up to this, and I really like our chances.

Next question, please.

Our next question will come from Moshe Orenbach with Credit Suisse.

Moshe Orenbach Great.

Thanks. Maybe, Richard, Scott, could you give us just a little bit of a little more detail about the specific forbearance programs that you have in CARD and auto in particular, how long they might last and what the take-up has been in terms of, you know, has it peaked?

You know, can you talk a little bit about that in a little more detail?

Yeah, Moshe, so for carbon customers who enroll, we are allowing them to skip one payment with no late fee on a month-to-month basis. Interest continues to accrue. And as of April 17th, as we said, you know, 1% of active accounts have received assistance representing 2% of balances. For auto, customers can skip one to two payments with initial interest continuing to accrue and payments added to the end of the loan. And I want to comment there, when I say things are monthly or every two months, this is not like that's their only chance, but we wanted to give ourselves more flexibility to evaluate the situation, knowing how fast things are changing. But, you know, it's certainly likely that customers who are on a monthly program will, you know, be extended if the opportunity calls for that. And as we said before, as of April 17th, 9% of customers have received assistance representing 11% of balances. You know, it's striking look between auto and a card. how much higher the requests are on the auto side. And I think that while it's striking, I don't think it's necessarily surprising. You know, we have found, in fact, across our businesses, if, you know, a, you can see visually that the size of the payment amount, is a key driver of the number of requests that we get. And, of course, auto payments are typically much higher than credit card minimum payments. And the other reason, of course, is that in auto, the stakes are higher for the customer. They're very motivated to make sure that they can keep their car.

And as a follow-up, maybe could you just talk a little bit about, you know, you talk about the things you're doing to tighten in the car business. Any changes that you would either think about making or see within the industry with respect to competitiveness of rewards and the kind of products you might see as we, you know, in the next several quarters as we, you know, kind of one hopes come out of this process?

Well, I think we, you know, the rewards marketplace was very competitive in terms of offers and early spend bonus and things like that. But it had kind of settled out into an equilibrium, you know, with purchase volumes down and, you know, probably for most card issuers, you know, some tightening up in this very moment. You know, I don't think we would, I think that I would expect the competitiveness to be in terms of products and product offers to be probably stable. The intensity of the competition is probably going to lighten up just probably because people are going to cut back on marketing and, you know, certain of the products when you think about it for the reward industry and for Capital One, are, you know, oriented towards the things that people aren't able to do right now, you know, travel, entertainment, dining, and a lot of things like that. So, I think that this will be a period where I think issuers will be focused on meeting the needs of their customers. and be planning for opportunities when things change. And, you know, opportunities can emerge much sooner than the entire economy recovering. Again, as I said, this is a segment by segment and situation by situation kind of thing. So, we're already working to, you know, figure out where opportunities, individual opportunities can be there possibly even that have become bigger opportunities because of the, you know, situation the world is in.

Next question, please.

The next question will come from Bill Garchesi with Nomura. Good evening. We've seen other banks this quarter generally set their reserves at levels sufficient to cover about 50% on average of the cumulative losses contemplated in their severely adverse scenarios under DFAST. Can you share any thoughts on why you guys might differ on this metric?

Yeah, Bill, thanks for the question. Obviously, there are different scenarios. That's the starting point. I won't go into all of the, you know, the differences there. But just to kind of a few points as you think about if you're calibrating less against others, the first is that when you think about our allowance versus the way the Fed models , one of the issues that impacts that comparison is that the Fed uses industry average recovery rates. And as I mentioned last quarter, our practice is to work recoveries, which results in a longer tail. And that's really important under CECL because in CECL, you take the undiscounted recoveries as an allowance offset. So, our CECL recoveries, I believe, are going to be quite a bit higher versus the Fed and their industry average recovery rates. The second point I would make is when these partnerships that we talked about that have loss sharing arrangements, you know, that meaningfully reduces the losses that are attributable to Capital One. And we only have to allow for our portion of those losses in our allowance and in our provision. And so, you know, that is how we do our resiliency modeling processes. While we don't have visibility into the FED modeling approaches, I don't think that the FED necessarily gives us credit in DFAS for that offset because they've historically not collected all the data necessary to make those adjustments. So it's just a couple of factors that you should consider in terms of how we set relative to others.

Next question, please.

Next question will come from John Hecht with Jefferies. Good afternoon. Thank you for taking my questions. First one is I'm just trying to think through how stimulus might be different this time. I mean, if you think about it, there's some information put out in the Wall Street Journal today that for a lower-income worker, stimulus, to the extent they have unemployment, is a pay increase for a period of time for them was for, you know, a prime consumer undergoing unemployment and receiving benefits of the credit, it's still a substantial decrease in, you know, compensation for a while. How do you guys think through that in terms of relative performance in your non-prime book versus your prime book as you go around?

John, the I think what's striking about the fiscal stimulus here, there are many things probably striking to all of us about it, but when we've gone back and specifically calibrated to the Great Recession, I don't have the numbers right in front of me, but I was struck by the fact that the benefits for those who get like unemployment benefits, the unemployment benefits are higher. It's across the, you know, across a range of relevant incomes, the entire line is higher. And the eligibility is significantly higher. So those two things, you know, are, It's hard to quantify, you know, how much of an impact that will be because no one can quantify, you know, how much of an impact it was the last time, but intuitively, I think, you know, that effect can have quite a bit of impact in a good way on people's ability to weather their, you know, individual storms and make it to the other side. with respect to subprime versus prime, the first thing I always say is, I think if I showed you the, you know, by income, if I, prime or if it takes you to prime, prime and subprime, you know, you've got at the top of the market, there tends to be some very, you know, high income folks. But I think you would be, you know, surprised that there's not as much slope as one might think, you know, relative to things like income on, you know, across our business as you move along the credit spectrum. There is some slope, but not all that much. All of that said, though, the fact that I think the the government is working hard to create a safety net for people who, you know, don't necessarily have all of the, you know, buffers some people might have in life and the fact that that net is extending wider and broader and deeper, I think that, you know, that will, you know, should have a pretty positive benefit for consumers and their ability to, among other things, pay their, you know, pay their bills and their credit card bills. And then a separate question is tied to

Hey, John, I'm sorry to interrupt you.

You're breaking up. We can't understand the question. Can you?

You guys hear me now?

It's better. Okay.

As we've been in this environment for a while, Have you seen any real change with respect to your consumer banking? And that's pretty heavily in that opportunity.

Wow, John, I'm so sorry. Let's try one more time, and then we might have to move on.

Well, John, were you saying, given that we've invested heavily on our consumer bank in terms of the digital side of the business, are we – You know, are we seeing, you know, anything particular there? Would that be close to the question that you asked? Yeah, particularly given that we're a stay-at-home situation and, you know, you're going to have a greater opportunity to interact with the visual channel. Well, you know, an interesting thing is we are probably in the best position, you know, in America to have a calibration about because we not only have a digital bank, we also have, you know, a branch-based bank in some of our geographies as well. And so we certainly can see the calibration. There is, look, the first thing I would say is there certainly are a core of customers who still, you know, need and want Well, they very much want to use the bank, and we've been able to keep most of our branches open by like 75% of them by having drive-throughs and some glass windows for some social separation. So, we've certainly seen a continued volume there, but if I pull up, I think that this moment is You know, some people say, you know, they predict, gosh, people will have very different behaviors on the other side of this moment. I'll make a different prediction. I think this is going to be an accelerant to the behaviors that we were all as a society heading for anyway. And the advantage, I think, that the banks who have, you know, really driven their customers to digital and built the capabilities that can help a customer pretty much do everything digitally. It was always where the world's going, but I think it just, you know, an acceleration of, you know, the bell curve shifted in terms of, I think, the number of folks. This is me talking more intuitively than empirically. But this is why I said earlier when I talked about we're going to keep our foot on the gas with respect to the, you know, the marketing and the investment in our national banking strategy because, of course, what that is, you know, as I've often called it, we're trying to build the bank of the future. And I think that you know, years in the evolution of America and consumer behavior possibly just got compressed here.

Next question, please.

Our next question will come from Rich Shane with JP Morgan. Hey, guys. Thanks for taking my questions. Two questions. First, in the past, you talked about at 25 basis point,

benefit from the law sharing the Walmart agreement throughout 2020.

I'm wondering if there's any cap on that or how much we could expect that to flex as charge-offs rise related to COVID-19.

Hey, Rick. How are you? Look, if you think about Walmart, we did talk about a 25 basis point impact to delinquencies and, you know, on an ongoing basis, you know, about that same level going forward. And I think that there's the, yes, we could absolutely see variability in the impact of that to the total just given, you know, movements in the loss rates of either part of that calculation. I would anticipate them to be relatively small because the loss sharing is so significant with Walmart that it could move up a bit and still not really impact our overall loss rate all that much.

But there's not a cap.

There's not a cap in the contract if by chance you were asking that. So this loss share is on a percentage basis. it will stay that way. Okay, great. Hey, and then Rich for you, look, you're a serious student of human behavior and I'm curious what you have seen in terms of consumer behavior so far that has surprised you the most? You know, I'm not sure anything has been surprising. I'm certainly struck by – here's the thing that's interesting about this particular downturn. Almost all other downturns, you know, most other downturns have the following characteristics. They kind of happen on little cat feet, and then, you know, things start picking up, but it's a slow kind of descent into that. And the other thing is so often there are structural problems, and this is an economy point, but structural problems in markets that sort of lead to that, and then the resolution of it needs to fix those structural problems on the way to fixing all the other problems that come from this. So, I think what's so extraordinary about this is the just swiftness of this thing and the fact that it's really the entire world going through this and the sort of vertical descent from an economy point of view that happens so quickly. So things that I'm struck by on the consumer behavior side, I have been really struck at the early behaviors that I see that are consistent with the model that we have believed. In fact, let me back up for a second and say there's a saying that I used that I've said for years is that, you know, consumers are a lot more rational than the institutions who serve them, including the financial institutions who serve them, you know, often over the years. I have always been struck over the years, despite all the things that are written and speculated about consumers, just how rational they are. And so, you know, I was struck during the Great Recession at their rationality. There was some irrationality before the Great Recession. This time around, the consumer was in a solid, very balanced shape going into this downturn. And the little things that I have seen, behaviors on the savings side, you know, on our bank side, behaviors on the payment side, the purchase volume side, even on the delinquency, you know, side of things. And what I see is a rational consumer, and I think that what we all should think about as we calibrate to any other recession. This is a downturn that came to the whole world right at once, and it's a downturn without a bad guy. That's the other part of this thing. And so what's the implications of a downturn without a bad guy? It's a lot easier politically to mobilize solutions for consumers. That's a political and economic point, but I think that is going to be a good guy in this downturn and its resilience. The other thing, the other final thing I'll say about human behavior or the behavior that we've certainly seen, I am amazed, I'll talk about our company, this isn't really a point about consumers, it's a point about people. I am amazed how productive people are and You know, we just did an associate survey and engagement and morale is still at very high levels. People are all in. They're engaged. And the productivity is extraordinary from people working from home. This doesn't mean that everybody, you know, when the world opens up, everybody's going to just stay home. But I think that, you know, back to my earlier point, I think there's a compression in years in the learnings and the behaviors associated with digital. And I think every company is going to walk away from this experience struck by the extraordinary productivity that or certainly most companies or certainly ones that are digitally, you know, in a good position by what just happened on the productivity side and, you know, that there's some learnings for all of us there.

Next question, please.

And our final question will come from Brian Ferrand with Autonomous.

Oh, hi. I know the call's gone long, but just on the OpEx, you know, totally understand pulling a target given how much flux there is. But on the core effort of moving to the cloud and retiring the data centers. Is any part of that core expense dollar effort and timing changed or is it more just revenues and flux, maybe some call center volumes and stuff like that? You know, has the data center strategy changed at all I guess is the crux of the question.

No, not a single bit. I mean, you know, we are incredibly well served by our move to the cloud. the ability to scale up for some extraordinary things that have happened, so many things. So the cloud strategy, the technology transformation, everything about it, we felt this experience is validating. With respect to the data center exit itself, we are on the very same timing of later this year. I mean, we are already fully in the cloud. So what, but the data centers are still open because there is, you know, you'd think once you get out, well, then you just, you're done. But there's a period of much of a year to actually do all the wind down activities associated with the data center. So we're 100% in the cloud and the wind down is going right on schedule and we're talking later this year. and the associated economic benefit of those moves.

Okay. Well, I think that wraps it up for this evening. Thank you for staying with us. Thank you for joining us on the conference call today. Thank you for your interest in Capital One. The investor relations team will be available later this evening to answer any further questions.