Capital One Financial Corporation

Welcome to the Capital One third 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, please press the star key, then the number two. 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, Keith, and welcome everybody to Capital One's third quarter 2020 earnings conference call. As usual, we are broadcasting live over the Internet. To access the call on the Internet, please log in to Capital One's website at CapitalOne.com and follow the links from there. In addition to the press release and financials, we've included a presentation summarizing our third quarter 2020 results. With me virtually today are Mr. Richard Fairbank, Capital One's Chairman and Chief Executive Officer, and Mr. Scott Blackley, 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 Investors, and 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. 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. And for more information on these factors, please see the section titled Forward-Looking Information in the earnings release presentation and the Risk Factors section in our annual and quarterly reports, accessible at the Capital One website and filed with the SEC. Now I'll turn the call over to Scott.

Thanks, Jeff, and good afternoon, everyone. I'll start on slide three of today's presentation, where you can see Capital One earned $2.4 billion, or $5.06, per diluted common share in the third quarter. Included in EPS for the quarter were three adjusting items, which are outlined on the slide. Net of these adjusting items, earnings per share in the quarter, was $5.05 per share. In addition to the adjusting items, we had a couple notable items in the quarter. We recorded a gain of $470 million or $0.79 per share related to an equity stake in Snowflake, which recently priced its initial public offering.

We also recorded a $327 million or $0.54 per share allowance release associated with moving a partnership card portfolio to Health for Sale.

Turning to slide four, I will cover the quarterly allowance moves in more detail. Excluding the help for cell transfer, we released $390 million of allowance for the total company in the third quarter, mostly driven by a smaller balance sheet. In our allowance, we continue to assume no benefits from further government stimulus beyond any residual impacts of prior legislation and a correspondingly severe economic outlook with targeted qualitative factors for specific areas of uncertainty. We assume we end this year at a 9.7% unemployment rate, improving to around 8% by the end of 2021. Turning to slide five, you can see that allowance coverage levels were essentially flat as allowance releases were commensurate with contractions in our card and commercial loan portfolios. Our consumer banking coverage ratio declined modestly to 4% from 4.3%, mostly driven by our release in our auto finance allowance, which was driven by updated auction price assumptions. Moving to slide six, I'll discuss our liquidity position. You can see our preliminary average liquidity coverage ratio during the third quarter was 147%, up from 146% at the end of the second quarter and well above the 100% regulatory requirement. Our liquidity reserves from cash, securities, and federal home loan bank capacity is largely flat to last quarter at $148 billion, including about $44 billion in cash driven by continued inflows of consumer deposits.

Turning to slide 7, you can see that our net interest margin declined 10 basis point quarter-over-quarter.

This decline was driven by higher average cash in the quarter, the effects of investment securities, and lower average card balances. In the quarter, we purchased securities to manage down a portion of our excess cash balance, resulting in a quarter-over-quarter decline in ending cash of approximately $12 billion. Given the low rate environment, we also saw our premium amortization expense increase due to increased prepayments on our mortgage-backed securities, driving a five basis point net interest margin decline relative to last quarter. Looking forward, our net interest margin will depend on how the impacts of this downturn in any future stimulus play out across our balance sheet, including asset mix, deposit balances and pricing, and our cash position.

Lastly, turning to slide eight, I will cover our capital position. Our common equity tier one capital ratio was 13% at the end of the third quarter, up 60 basis points from the second quarter.

We expect to maintain our 10 cent dividend for the quarter. Our decision is mainly driven by the fact that we are in the midst of our CCAR resubmission. We continue to accrete capital and we expect to reassess our common stock dividend after we receive the Fed's feedback on our CCAR resubmission. We recognize that capital distribution, both dividends and share repurchases, is an important component of shareholder return. Turning to preferred stock issuances in the quarter, we issued a new series of preferred stock as we expect to redeem our outstanding preferred stock series F in the fourth quarter.

This redemption will result in a one-time charge that will reduce net income available to common shareholders by approximately $17 million in the fourth quarter of 2020.

Following the redemption of Series F, beginning in Q1 of next year, we expect quarterly preferred dividends to be about $60 million, barring any future issuances or other redemption activity.

With that, I'll turn the call over to Rich.

Rich. Thanks, Scott. I'll begin on slide 10, which summarizes results for our credit card business. Year over year, credit card loan balances, purchase volume, and revenue declined in the third quarter, driven by the impacts of the pandemic. The biggest driver of quarterly results was the provision for credit losses, which improved significantly compared to both the prior year, and linked quarters. Credit card segment results are a function of our domestic card results and trends, which are shown on slide 11. Consumer behavior was a key driver of domestic card results in the third quarter. In the current environment, consumers continue to behave cautiously, spending less, saving more, and paying down debt. These behaviors are amplified by the cumulative effects of stimulus and widespread forbearance across the banking industry. We're seeing the effects of cautious consumer behavior across several key businesses' results, including pressure on spending and higher payments rates resulting in declining loan balances. But this cautious behavior is also a key driver of the most impactful domestic card headline in the quarter, strikingly strong credit results. We posted exceptional credit performance in the third quarter, especially in the context of the pandemic. The charge off rate for the quarter was 3.64%, a 48 basis point improvement year over year, and an 89 basis point improvement from the sequential quarter. The 30 plus delinquency rate at quarter end was 2.21%, 150 basis points better than the prior year. The length quarter improvement in the delinquency rate was 53 basis points, even though the typical seasonal pattern is a 40 basis point increase. In addition to positive impacts from cautious consumers, stimulus, and widespread forbearance, our credit performance is benefiting from resilience choices we made before the downturn began, including our avoidance of high-balance revolvers and caution on credit lines. Our own domestic card forbearance is not a significant driver of credit performance because enrollment is low. We've provided updated information on domestic card forbearance on Appendix Slide 17. Purchase volume is rebounding from the sharp declines early in the pandemic. Third quarter purchase volume was down just 1% from the prior year quarter. That compares to a year-over-year decline of about 15% in the second quarter and about 30% in the first weeks of the pandemic. By late September and through the first half of October, year-over-year purchase volume growth was modestly positive. Despite the rebound, purchase volume growth is still down compared to the double digit growth we were seeing before the pandemic. In the third quarter, domestic card ending loan balances shrank by $9.1 billion, or 9% year over year. Average loans declined 6% year over year. On a linked quarter basis, both ending and average loans were down 4%. Cautious consumer behavior drove the declines. Our choices to tighten underwriting and pull back on marketing early in the pandemic were also a factor. Ending loan balances include the impact of two notable factors. We moved $2.1 billion of partnership loans to held for sale in the quarter, as Scott mentioned, which adds to both year-over-year and length quarter declines. And, of course, we added the Walmart portfolio last year which offset the year-over-year decline but has no impact on the linked quarter. Excluding both the move to held for sale and the Walmart portfolio acquisition, third quarter ending loans declined about 13% from the prior year quarter and about 2% from the linked quarter. Third quarter revenue decreased 6% year-over-year in line with average loans. The revenue margin was up seven basis points from the third quarter of 2019 to 16.2%. Non-interest expense was down $274 million, or 13%, from the third quarter of last year, largely driven by our choice to pull back on marketing when the pandemic hit. While total company marketing in the third quarter was essentially flat compared to the second quarter, Domestic card marketing increased from unusually low levels, with most of the increase weighted toward the end of the quarter. Looking ahead, we expect a significant sequential increase in total company marketing in the fourth quarter, powered by the normal Q3 to Q4 seasonal ramp plus the full quarter effect of the increases in domestic cards. As always, actual marketing in the fourth quarter and longer term will depend on our real-time assessment of opportunities for resilient growth in the competitive marketplace. Third quarter provision for credit losses improved by $632 million year over year, driven by the allowance benefit of moving the partnership portfolio to held for sale. and the volume-driven allowance release that Scott discussed. Slide 12 summarizes third quarter results for our consumer banking business. Driven by our auto business, ending loans increased 11% year over year. Average loans also grew 11%. When the COVID downturn began, we tightened our underwriting box in auto to focus on the most resilient assets, We believe several factors are driving the growth we're seeing, even in the context of our tightening. The auto market rebound thus far has been stronger for larger franchise dealers, the part of the market where we are focused. Some of the recent growth is likely driven by pent-up demand from the early days of the shutdown. And our digital products and services are driving growth in direct-to-consumer originations and growth with dealers who want to provide a low-touch car buying experience in response to social distancing. Our dealer relationship strategy and the digital infrastructure and capabilities we've built from the bottom up put us in a strong position to grow high-quality auto loans, even with tighter underwriting. Third quarter ending deposits in the consumer bank were up $43.3 billion or 21% year over year driven by the stimulus driven surge in deposits in the second quarter. Average deposit interest rate decreased 65 basis points as we reduced deposit pricing in response to the market interest rate environment and competitive dynamics over the course of the second and third quarters. Consumer banking revenue increased 9% from the third quarter of last year. Revenue growth from higher auto loans and retail deposits was partially offset by differences in the timing of Federal Reserve rate cuts preceding our deposit pricing moves. Non-interest expense in consumer banking was up 3%. Third quarter provision for credit losses improved by $246 million year over year, driven by lower charge-offs and a modest allowance release in our auto business. Our auto business posted unusually strong credit results in the third quarter. The charge-off rate improved 137 basis points compared to the prior year quarter to 0.23%. The delinquency rate improved 271 basis points year over year to 3.76%. In addition to the same general drivers of domestic card credit strength, auto credit benefited from very strong auction values. And in contrast to domestic card, our own COVID auto forbearance is having a significant positive impact because we've extended relief to customers in later stages of delinquency, and enrollment is much higher. We provided an updated auto forbearance information chart on Appendix Slide 18. Moving to Slide 13, I'll discuss our commercial banking business. Third quarter ending loan balances were up 3% year over year, driven by growth in selected CNI and CRE specialties. Average loans were up 5%. Average deposits increased about 18% from the third quarter of 2019, as middle market customers continued to bolster their liquidity. Third quarter revenue was up 7% from the prior year quarter. Revenue growth from higher loan and deposit volumes, higher non-interest income, and lower deposit rate paid was partially offset by lower loan yields. Non-interest expense increased by 2%. Provision for credit losses improved by $167 million compared to the third quarter of 2019, largely driven by the allowance relief that Scott discussed. The commercial banking annualized charge-off rate for the quarter was 0.43 percent. The criticized performing loan rate for the quarter increased compared to both the prior year and linked quarters, to 8.7 percent, driven by downgrades in multifamily CRE. The criticized non-performing loan rate rose modestly to 1.0 percent. Our oil and gas exposure declined year over year. We've provided a breakout of our oil and gas portfolio composition and reserves on Appendix Slide 19. I'll close tonight with some thoughts on our results in the quarter and our positioning for the future. Capital One posted strong third quarter results. Year over year, revenue growth and lower non-interest expenses drove pre-provision earnings up. And provision for credit losses improved by more than $1 billion as credit results across our card and auto businesses remain strikingly strong. Pulling way up, we continue to be well served by the choices we made before the pandemic. Since our founding days, we've hardwired resilience into the choices we've made on credit, capital, and liquidity through good times and bad. As a result, we entered the downturn with strong and resilient credit trends, a fortified balance sheet, and deep experience in successfully navigated navigating through prior periods of stress, including the Great Recession. And our investments to transform our technology and how we work and our efforts to drive the company to digital are powering our response to the downturn and positioning us for the acceleration of digital change and adoption driven by the pandemic. As we continue to lean into resilience, To manage through the near-term challenges, we also continue to focus on the things that create long-term value when delivered and sustained over time. Profitable, resilient growth, effective investments to transform technology, positive operating leverage, and capital distribution. And 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. And if you have any follow-up questions after the Q&A session has ended, the investor relations team will be available after the call. Keith, please start the Q&A.

Thank you. Ladies and gentlemen, if you would like to ask a question, please signal by pressing star 1 on your telephone keypad. Using a speakerphone, please make sure your mute function is turned off to allow your signal to reach your equipment. Again, star 1 for questions. We'll pause just a moment to allow everyone an opportunity to signal for questions. We'll take our first question from Sanjay Saccharini with KBW. Please go ahead.

Thanks. Yes, I have a question on the net interest margin trajectory going forward, Scott. I know you talked about some contributors that caused the sequential degradation. and the dependency for some items in the future. But looking ahead, if we assume a stable macro, could you maybe just dimensionalize some of the upside levers you have? I know there's a step up in the Walmart share. You have the funding costs coming through, the lower funding costs and the lower liquidity potentially. Could you just talk about those, Scott? Sure. Good afternoon, Sanjay. But with respect to NIM, I think that the current margin is towards the low end of where I would expect to see NIM given our balance sheet mix. And if I just look at kind of the factors right now, cash is elevated, but deposit growth has slowed in Q3. In Q4, we're going to get the full quarter benefit of the deposit pricing actions that we took in Q3. And then auto growth is positive to NIM. I look at just those factors, and those are all positives. When you talk about longer term, more stimulus, the potential there is that that might drive more savings, which would be a headwind to them if we received more cash in the form of deposits. On the other hand, that's going to be a positive to our credit performance, and that seems like a good trade to make. Overall, you know, at this point, feeling like we're towards the lows on NIM and there are a number of factors that would go, you know, in a positive direction if everything in the economy kind of went – was stable from here forward. Okay, great. And I guess talking about the economy, your reserve rates were stable, if not sort of declined a tad. Could you just talk about how you see that unfolding, assuming – things don't change materially in the macro situation. And maybe, Rich, you could chime in on some of the things that you're worried about or not on the macro side, because you mentioned credit quality looks strikingly strong. Thanks. Why don't I start on the allowance, and then, Rich, you can jump back into that question. So when I look at the allowance, there's a couple – important considerations. One is that we build our allowance to exclude the potentially positive effects of stimulus beyond what's already in place. And we've assumed some further worsening in the economy. Second, our delinquency inventories are at really, really low level. So we're starting at a place where it's going to take a while for losses to actually manifest. So I feel really comfortable with our coverage levels where they are today. And, you know, if we just look at going forward, more stimulus could be, you know, a significant positive factor to allowance. And, you know, the economy is another wild card if it worsens beyond our current assumptions. And we didn't get stimulus in that case. You know, in that case, you know, we might be looking at the potential for reserve additions. But you know, in an economy that goes, you know, kind of sideways or doesn't worsen much, or if we get stimulus, I think there's, you know, there's some upside in the allowance. Sanjay, just a comment about the consumer. You know, this is the biggest disconnect that I certainly have experienced in my three decades of building Capital One. between what we see in the economy itself and the actual performance of the consumer, especially from a credit point of view. Now, some things I think always happen in a downturn, and that is consumers tend to get more conservative. So they tend to pull back, spend less, save more. So in some ways, why would what we see here be any different from the past? And look, I still put a high degree of uncertainty around things, so I'm going to give you some views, but don't use this as like a prediction of what the consumer is going to do in the rest of this downturn. But I do think the consumer being in better shape going into this crisis starts kind of on the plus ledger for the consumer. You know, debt levels were lower, payment obligations lower still, supported by the low interest rates. The savings rate over the past few years was, I think, around double what it was before the Great Recession. And so the consumer entered in a stronger situation. Then what happened is, unlike most other downturns, and certainly unlike the Great Recession, which – took a lot of months to sort of build its momentum. This thing kind of came all of a sudden. And the world went into free fall, sort of as I often say, you know, we all went down the elevator together at the same time. Consumers did, companies did, and the government did. And so that I think the reaction by the consumers was, you know, it was was more striking and more conservative than has happened in the past. So they're spending less, saving more, paying down debt. And I think it's amplified relative to the past. Then overlay on top of this, of course, that the swift and unprecedented government stimulus and the widespread forbearance programs across the banking industry were both you know, much greater and much swifter than occurred in the past. And so, you know, the cumulative impact to consumer balance sheets of lower wages offsetting government support and lower spending, you know, is, you know, the Well, some of these effects by their conservatism and some of the benefits that they were granted by external parties has added up to a positive net consumer sort of savings effect of over a trillion dollars or about $10,000 per household. And, you know, obviously The impact across individual consumers and households is highly variable. But we now have the expiration of the expanded unemployment benefit. That's a blow to many millions of unemployed Americans. I think what we're dealing with is accumulation of benefits that the consumer has has had during this downturn such that when suddenly the stimulus was kind of shut off, we didn't see our credit metrics suddenly skyrocket to workforce places. I think the consumer is working through some of that cumulative that has built up. But I think that, you know, we still have to look at, we're talking about electrifying economic numbers an awful lot of job losses, now a lot more of them being more permanent, and the government stimulus at this point not having been renewed. So I think it's just a matter of time before this thing could reverse itself in a significant way. And the other thing I say, I just want to say relative to a metaphor I've been using when I talk to investors is, Every month that there are favorable credit trends, we're sort of burrowing a longer tunnel underneath the huge economic worsening mountains such that even as potentially things revert to significantly worse place for the consumer, I think we've reduced the cumulative losses through the downturn rather than just delaying the impacts. Those are some thoughts, Sanjay, on what we're seeing. It's certainly not something collectively that I've observed before. No one should look at this and feel... I'll speak for myself. We certainly feel really good about the performance we're seeing, but we feel quite cautious about you know, what could happen.

Next question, please.

We'll take our next question from Betsy Krasick with Morgan Stanley. Please go ahead.

Hi. Good evening.

Hi, Betsy. Hi.

I wanted to dig in a little bit on the auto results. I know that you mentioned You have very strong auto results both on the loan side as well as on the credit side. First question here is just around the used car prices. They're clearly up a lot at about 15% year-on-year. And I just wanted to understand how much that piece of the equation impacted your net charge-offs and your name around auto and what you're assuming for used car prices going forward from here.

Okay, Betsy, there's been unprecedented volatility in auction prices since the start of the pandemic. At the start of the pandemic, we saw a sudden collapse in auction prices as, you know, stay-at-home orders basically froze markets and auction houses rushed to move online. By the end of the second quarter, we saw auction prices rebound to pre-COVID levels. And, you know, as the stay-at-home orders were lifted, consumer demand experienced sort of a V-shaped recovery in the auto space, and supply remained constrained by lease delays and the decision of most lenders to suspend At the start of the third quarter, there was a massive amount of uncertainty around the stability of these trends, particularly whether consumer demand would remain strong with the expiration of stimulus and whether it would be enough to offset projected increases in supply. As it's turned out, through the third quarter, consumer demand remained incredibly strong, resulting in supply constraints that drove up auction prices as dealers struggled to maintain inventory levels. Over the last couple of weeks, we've seen the industry start to work through these supply constraints with auction prices declining slightly and dealer inventory starting to recover toward the pre-COVID levels. So, Going forward, we would expect auction prices to normalize over the next several months as the industry fully works through these supply issues. We're underwriting to an assumption that they're going to be significantly adverse from there, just to be cautious and because of the extreme volatility. To your question about how important was this in the results, it was... One of the – it was one of the factors. So, for example, in the credit results, there really were three auto – so why was auto credit so good? Beyond what we're seeing in CARD that we've talked about, there are three auto-specific effects. You know, one is our COVID loan extension programs having a more meaningful impact on our credit metrics than it is in CARD because the program's got a bigger proportion of customers in it and because we extended relief to the impacted customers in later stage of delinquency. And then we've got the used car auction prices which basically reached all-time highs in Q3. And we've also seen somewhat higher auto recoveries from the catch-up from our temporary suspension of repossessions earlier in the downturn. So it's definitely sort of a bunch of planets aligning in the auto space, driving performance that is extraordinary in some sense, certainly on the credit side. much of the things I talked about are more temporary in nature.

Got it. Okay, that's super helpful. Thanks for all that color, Rich. The follow-up question I have just has to do with what you're seeing with regard to the accounts that are exiting forbearance in the various product sets that you have. Some other folks' earnings cycle have been suggesting that accounts exiting forbearance are exiting with a higher rate of delinquencies. I'm wondering if you are seeing the same thing and if you could put a number on what that difference is between accounts that were in forbearance and aren't. Thanks.

Yeah. So, by the way, I would put a, let's say you told me a downturn of any kind was coming and we installed a forbearance program. I would with 100% confidence say customers who enter a forbearance program and exit it will have higher delinquencies than those who never did, only because you take a population and you now create a filter, and this is an important filter. Did you raise your hand and say, you know, I'd like some of that forbearance? It's, you know, versus one minus that group, it would be extremely rare for that group not to have higher delinquencies. Interestingly, probably the biggest driver of the delinquency number, it's like, you know, what percentage of them are, you know, when they leave and they stay current. But probably the biggest driver of that is how wide the funnel was in the first place by which the company was inviting customers to come in and take the forbearance. The wider the funnel, the more likely regular, very low-risk customers sort of took advantage of the program. So in our business, let me just look this up here. If we look at the customers in our card business, we look at the customers who are no longer enrolled but were previously. 88% of them are current. In auto, it is 86%. And the other thing, you know, again, I just want to say I'm not sure how much information content there is in that only because one has filtered a population. The most telling thing would be the overall delinquencies that you see on our portfolio because all these customers who have entered forbearance are basically part of the delinquency metrics that you observe.

Next question, please.

We'll take our next question from Ryan Nash with Goldman Sachs. Please go ahead.

Hey, good evening, guys. Hey, Ryan. Hey, Ryan. Rich, you noted that we could see a significant ramp in marketing in 4Q. Can you maybe just clarify what the expectations are in terms of the quarter-over-quarter increase? And second, just more broadly speaking, when competition is historically pulled back, you've used it as an opportunity when you've seen a window to accelerate growth. And I was just wondering if you could just talk about your approach to increasing marketing spend at this point and, you know, Are things still too uncertain for you to do that? Do you have any sort of visibility at this point? Or is it more just seasonal in nature and we should expect it to remain low as another issue we talked about this morning? Thanks. Yeah. So, look, our saying that marketing could be higher in the fourth quarter than the third is not a declaration that, you know, we see all the light at the end of the tunnel. We're all in. You're right at Capital One, we sometimes zig while others zag. We also sometimes zig while others zig. And, you know, it's all a situational kind of thing. The primary, the reason that we're kind of leaning into this marketing guidance relative to the next quarter is more just how low it is now, not to look at that and say that at that low level it's going to sustain itself. So let me just give you a little more context here. You know, we pulled back in certain channels early in the crisis in response to the decreased opportunity for quality growth and just given the unprecedented uncertainty early on. We've since reentered most channels. And, you know, it's interesting. While marketing was flat overall in the company, within CARD, marketing increased through the quarter. Again, it was mostly just coming off such a very low level. And so what we are saying is you have the seasonal ramp that always happens in the fourth quarter at Capital One. And then on top of that, because even though our marketing was flat within the quarter company-wide, within CARD, it was quite sloped. And so we're really saying just the full quarter effect of that will also pull the numbers a fair amount higher. So it's really more a pulling up from being so low as opposed to a statement of a big transformation in how much marketing and growth we're going after here. In your prepared remarks, you talked about capital return being an important part of the picture for shareholders. If we look, the capital ratios are at 13, and once we get through the next few quarters, it should be at least 13.5 or over 20% of your market cap in excess. Now, I know we still have a handful of things that we need to get through, you know, the Fed stress test, but it seems like, you know, if we have the minimum from the SCB of 10-1 and your internal target of 11, you know, it seems like you have the potential to get pretty aggressive on returning capital. So if you maybe just talk about the capital priorities and how quickly do you think you can manage the capital down once we have clarity on where the economy is headed? Thanks. Yeah. Thanks, Ryan. Well, As you know, all the large banks are going through CCAR 2.0 right now, and as I mentioned, we're going to get through that process and get our feedback before we make any adjustments to our capital situation. I think that, as you talked about with the stress capital buffer, the buffer for us under that framework or the total capital accord under that framework is 10.1%. we want to operate in most environments with a buffer above that. So, you know, probably over 11%. I think that, you know, what I'm hoping is that we'll start to see the Fed move away from the current level of restrictions and that, you know, in the first quarter, they will migrate to the stress capital buffer framework, which should allow us to manage our capital distributions, you know, both dividend and share purchases on a much more dynamic basis. And, you know, as we talked about and you mentioned in the comments, you know, we do appreciate that this is an important component of shareholder return. And so, you know, we're looking to get back into the business of having, you know, an appropriate amount of capital and making sure the shareholders are receiving distributions.

Next question, please.

We'll take our next question from Rick Shane with JP Morgan. Please go ahead.

Hey, guys. Thanks for taking my question this afternoon. Rich, you, in response to Sanjay's question, touched on something that I think is really interesting.

You mentioned diversions between labor markets and credit markets and credit performance.

And you hypothesized whether or not what we've seen is a delay in credit events or we're actually going to see moderation from all of the policy initiatives. And you alluded to the fact that you think it's the latter. I want to understand in part what drives that view, and then I want to turn the question to Scott and ask, where is the reserve or the allowance in that context?

Are you still more reserved in the delay scenario at this point? So, Rick, I want to make sure that I articulate for a second your two points. To circulate for a second, your two scenarios, the delay scenario, describe what you're saying that is. That would be it's going to get as bad as ever. It's just delayed in getting there. And the moderation is moderated. Yeah. So I'll let Scott talk about the allowance. Just sort of it's there. There have been, well, certainly right now there is, you know, the divergence between the two is extraordinary. I do think that, you know, and the most common thing everybody's talking about is government stimulus. Right. I believe that is an important effect. I wouldn't underestimate the collective impact of forbearance across the banking industry as well, and to some extent in rents and other things. But between the strength of the consumer entered the downturn and the various things that are providing some relief, it is clearly disconnecting the relationship that we would otherwise see between unemployment and the consumer's financial health and credit performance. I think it is very plausible that this sort of bank account, if you will, of cumulatively some good things that the consumer has had available is something that is finite and very plausibly can't last for an extended period of time. I think it still buffers for a short period of time, but if we don't see stimulus and if the economy continues to really be hurting. I have trouble envisioning how the consumer doesn't end up getting in a worse place from here. My points are I think that timing of that can still be buffered by the accumulated benefits And then my other point is that I think burrowing through the tunnel, you know, I, I picture a big, uh, a big mountain, which is the, you know, the, the bad economy going up and then going down on the other side, burrowing through the tunnel. And even then, if, if, if the consumer has to rejoin that, uh, bad mountain, if you will, it's a strange metaphor. I think that some of the worst aspects of that downturn will have been averted by virtue of every month that passes. What I want to do is pivot to Scott to comment on how we've handled the allowance. Yeah, thanks, Rich. Rick, so if you think about what we have to do in the allowance, we're starting with delinquency levels that are not connected to the level of unemployment that we're seeing. And so one of the things that we have to do in the allowance is to take those delinquency levels and over time kind of get them to link up with unemployment levels. One of the reasons that we are... thinking that's happening is that some of the stimulus actually comes in in a form where it's replacing income. And so even though you've got elevated level of unemployment, you basically are, you have a consumer who may be unemployed, counting in the unemployed, you know, calculations, but is receiving benefits that allowing them to stay current as if they, you know, were fully employed. So as we start to see stimulus unfold here, the real question that we face in the allowance is just how long is that income replacement going to continue, and what does that mean to the total loss content? So those are the kinds of issues that we would face with the allowance. That's very helpful, and Rich, I do appreciate the metaphor as well.

Thank you, guys.

Next question, please.

We'll take our next question from Bill Karachi with Wolf Research. Please go ahead.

Thanks. Good evening.

Rich, can you discuss the competitive landscape as you think about the potential threats on one hand from the neobank, sort of the chimes of the world that operate exclusively online without traditional branch networks in this sort of post-COVID environment?

And on the other hand, the buy now, pay later, like the Klarna's and Afterpay's, How do you see their presence impacting the competitive environment in the card business, say, over the next two to five years? And is there any potential benefit to deploying some of your excess capital into M&A in one of those areas? Or are those sort of capabilities things that you think you can build on your own?

So, well, Bill, it's certainly quite fascinating and striking to see what's happening on both the banking side and the lending side. with respect to these new competitors. Let me talk about the buy now, pay later phenomenon. You know, there has been point of sale lending for forever, basically. And it's always been there as another form of financing. And it's interesting, in many ways, the credit card became the disruptor in point of sale lending. I never forget when early on in the Capital One journey, I ran into this guy who said, hey, you ruined my business. I said, I'm so sorry. How did we ruin your business? And he said, I ran a furniture store. I made my money on financing and the credit card has kind of put me out of business. And so The credit card has been an incredibly efficient tool, even in a world where point of sale financing has continued, and there's logical reasons they both would coexist. I think it's really striking what has happened recently with respect to the buy now, pay later, which there's a couple of striking things going on that are not – haven't been part of the historical context. One is just the technology, the ease of the whole thing, and with a single click, you can kind of buy now, pay later. That has been one aspect of this. And the other is that merchants are paying the lenders at this point, the way the marketplace works, merchants paying the lenders, which has, you know, allowed this to be a pretty – you know, financially attractive business for some of these NEO players and has helped keep that industry unassailable. A lot of times you have a race to the bottom in terms of, you know, how high the short-term pricing gets, et cetera. So this is something that's growing rapidly, and I think that it's – It's something that we are looking carefully at and watching and trying to assess where that market is going. We wonder how sustainable the revenue model of that is with respect to the merchant subsidies in a more competitive marketplace. We'll have to keep an eye on that. But I think the This is another example of how digital technology and the real-time instant solutions is where the entire world is going. The history of banking is to deliver solutions on a batch basis to consumers, and I think this is another example of how real-time solutions are here in all banks. If they don't increasingly figure out how to leverage data in real time and bring instant customized solutions to consumers, they find themselves in a bad place. Then you've got the whole banking side of the marketplace, the chimes and some of the other players that I think also have created a disruptive model. We tend to root for their success because we are also a disruptor in this marketplace and the more collectively all of us can, you know, get at the, you know, make progress against the highly inertial entrenched behavior of Americans to always bank with their branch bank. The more we can chip away collectively with that, I think the more opportunity there is for all of us digital players, Capital One included. But we're certainly inspired by some of the things that we see by some of the neobanks. That's super helpful, Rich. Thank you. If I can squeeze in another quick one on auto. Can you discuss how your mix of new versus used originations has evolved? and whether there's any particular area that you've been leaning into more heavily. There's not – well, there's been a lot of use, of course, just some of the market conditions have led to the, you know, a – a lot of used car buying. So I, I, I don't have in front of me data with respect to that. So, you know, the used car opportunity is a sweet spot for most banks because the captive, the captive lenders, you know, tend to subsidize their new car purchases. So, you know, a, The majority of our entire business is used, and the more the used car market thrives, the better it is for Capital One. I think the bigger effect that's going on that we're struck by, in addition to just how all the tide of auto has risen, all the votes for all the players, and it's just kind of a strikingly good time in the industry for parenthetically, or we should all know in the middle of a massive pandemic, so we got to be very careful here. But kind of on little cat feet, the traction that we're seeing with our digital strategy is particular we're seeing in auto because of the very physical nature of how the product is bought. And this is an example of where the pandemic is accelerating things that would happen anyway. But in the auto space, the more they accelerate the sort of direct side, not necessarily the pure direct where no one ever goes to a dealership, but the semi-direct or the hybrid direct, the thing that just involves faster, more digital solutions. That plays into the hand of Capital One because we've invested for years in real-time automated solutions and being able to underwrite any car in America on any lot in less than a second and to be able to provide that information to consumers before they go into a dealership and to also lessen the amount of hard work and waiting once you get it.

Next question, please.

We'll take our next question from Don Fendetti with Wells Fargo. Please go ahead.

Rich, I was wondering if you could talk a little bit about what you're seeing in your commercial real estate portfolio and also, you know, given the stress, are there any opportunistic opportunities that you see coming to market?

Yeah. So our commercial real estate is $30 billion across a range of property types. Relative to most banks, their overall portfolio is more concentrated in multifamily, which we view as more resilient, while it's underweight in more volatile sectors like hotel, retail, office and construction. So in the multifamily space, we have $18 billion in exposure to multifamily, about $13 billion on balance sheet and about $5 billion in agency law share. And of that, of The $13 billion we have on balance sheet, about half of our exposure is in the New York metropolitan area. And as you know, Don, there are real borrower challenges in the market with low rent collections and eviction moratoriums. So our focus and the significant majority of our portfolio is in rent regulated and class B properties, which have been historically more resilient in recessions. Um, so, um, we, uh, you know, the, the, the big increase in criticized, uh, performing loans was in the multifamily portfolio. We feel really good about the LTB, uh, uh, the low LTBs, uh, that we have a backing of this book, but it certainly has our attention that, uh, you know, New York's got a number of challenges on the real estate side, and so we'll very carefully monitor how this plays out. But we feel collectively very good about our overall real estate portfolio and the choices that drove us to where we are. Okay.

Thank you. Next question, please.

We'll take our next question from Moshe Ornbach with Credit Suisse, please go ahead.

Moshe Ornbach Great, thanks. Richard, with the front end of the questions, you talked a little bit about some of the differences between this and the Great Recession. I guess another one would be that the banks and card issuers themselves are actually in a better position than they were at that point. And I'm just wondering if you could kind of talk a little bit about how you think that impacts the competitive opportunity and what, you know, you're willing to talk about, you know, what Cap One's plans are with respect to that.

Yeah. You know, it's a really insightful comment that you make, Moshe, because one of the things that we know that happened in the Great Recession is the consumer... was more levered up, but you also had the banking industry, both banks and non-banks, were providing products that were not nearly as well underwritten, that often had complicated features with them, and there was just a lot of disequilibrium to sort out. And that really compounded the consumer's journey through the downturn, that their own their own condition and also working through some of the things. The most extreme, of course, Moshe, was the mortgage products and all the issues there. And what happened is a lot of the bad lending practices, I say bad from a credit risk point of view, and also certain consumer practices that got driven out in the Great Recession. And on the other side of it was a very rational, high-performing credit card marketplace. And I've said for years on the other side of the Great Recession, I think this is a strikingly rational marketplace. I find it more rational than the other lending marketplaces in which we compete. And You know, each of the players there sort of has carved out a particular niche, and they're doing well. So I see, Moshe, very rational behavior even right now in the pandemic. Virtually everybody pulled back. First of all, you start with card players have something happening to them that basically is pretty unique across lending products, and that is that our portfolios are shrinking pretty dramatically, right? You know, here in commercial in general, you know, people drawing down on lines increase the volumes. So I think that we card players are struck by, oh, my goodness, just with the less spending and all this conservative behavior by consumers, we've been going backwards pretty rapidly, pretty much all of us have. But I think that... That is the flip side of what comes from the strikingly sound and conservative behavior of our consumers. So where does the industry go from here? I think the industry has pulled back, and I think all of us in our own way are trying to figure out no one's going to fully step on the back gas. No one is all the way pulled back. I think for everyone, it's how to find the selective opportunities where you can continue to lean into this thing and book business that's going to be resilient even if things get a whole lot worse. And, you know, some of the tried and true strategies, Moshe, we've had for many years, our conservatism on credit lines, the avoidance of high-balance revolvers and so on. Our strategy has been so resilience-focused. I think that for us, the opportunity to continue to book accounts, be very conservative on credit lines, build up the potential energy, but being careful on credit lines, grow the potential energy, and delay the release to some extent into kinetic energy through a lot of line growth until you know, we see more clarity on where this economy is going. So that's how we're continuing to lean in, even in the context of this pretty electrifying economy.

Thanks, Richard. Maybe a follow-up question for Scott. I noticed that revenue suppression had improved fairly significantly. I guess that works relative to actual delinquencies, and maybe could you talk a little bit about how that's going to look going forward?

Yeah, you're right. The suppression is a shorter coverage period than allowance. It really only goes through the point of charge-off. And when you've got low delinquencies, that's improved. So as long as we see stability in our delinquency levels, that would stay at about the levels where it is now.

If we started to see delinquencies worsen, that would increase the amount of suppression.

Thanks. Next question, please.

And for our final questions this evening, we'll come from Brian Frone with Autonomous. Please go ahead.

Oh, hi. Pretty much everything's been asked. I guess just on marketing, you know, I guess a normal seasonal increase would be maybe $100 million, $150 million, maybe $150 million, $175 million actually. A normal level would be maybe more like $500 million or $600 million increase. So are there any – I know you're not going to give a point estimate, but are there any guardrails you could give? Maybe are we thinking more like a normal seasonal increase to the low $400 million, or are we thinking more like a normal seasonal level to the mid-$500 million in terms of something to pencil in on marketing for the fourth quarter?

Brian, we're probably going to leave – our guidance where it is. But the main thing we wanted people to just know that it's been unusually low at this point and don't get too used to the unusually low level. And that's why it's the double effect. We're calling for the double effect of the normal significant seasonal increase that we have in the fourth quarter around things like our sponsorships and a lot of things that happen late in the year, as well as the continuation of what happened late in the quarter. Marketing levels in CARD, a phenomenon that was not visible in the aggregated credit numbers because it just turned out by coincidence. Some of the marketing elsewhere in the company around retail, which had really been sort of higher right out of the gate with all the deposit inflows that we've had, we pulled back somewhat on retail. Yeah.

And I think there was once a quarter in 2009 where you did 90 million in marketing, and I built that into a normalized earnings model. So it's fair to remind people that. Okay. Well, Brian, thank you.

Thanks, Brian, and thanks, everyone, for joining us on tonight's conference call. Thank you for your interest in Capital One. And remember, the investor relations team will be here this evening to answer any further questions you may have. Have a great night.

Ladies and gentlemen, this does conclude today's conference. We appreciate your participation. You may now disconnect.