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?