Capital One Financial Corporation

Ladies and gentlemen, welcome to the Capital One fourth 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'd like to ask a question during this time, simply press the star key, then the number one on your telephone keypad. If you'd like to withdraw your question from our queue, please press the star key, then the number two. Thank you. I would now like to turn the conference 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 fourth quarter 2020 earnings conference call. As usual, we are webcasting live over the Internet. To access the call on the Internet, please log into the Capital One 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 fourth quarter 2020 results. With me 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 the presentation. To access a copy of the presentation and the press release, please go to Capital One's website, click on Investors, then click on Quarterly Earnings Release. Please note that this presentation may contain forward-looking statements. Information regarding Capital One's financial performance and any forward-looking statements contained in today's discussion and the materials speak only as of the particular date or dates indicated in the materials. 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 Factors section in our annual and quarterly reports, accessible at the Capital One website and files of the SEC. Now I'll turn the call over to Mr. Lockley.

Scott? Thanks, Jeff, and good afternoon, everyone. I'll start on slide three of tonight's presentation. In the fourth quarter, Capital One earned 2.6 billion, or $5.35 per common share. For the full year, Capital One earned 2.7 billion, or 5.18 cents per share. Included in EPS for the quarter were two small adjusting items which are outlined on the slide. Net of these adjusting items, earnings per share for the quarter, was $5.29. Full year 2020 adjusted earnings per share was $5.79. In addition to the adjusting items in the quarter, we recorded an equity investment gain of 60 million, or 10 cents per share, related to our equity stake in Snowflake. For the full year, the investment gain was 535 million, or around 89 cents per share. Turning to slide four, I will cover the quarterly allowance moves in more detail. In the fourth quarter, we released $593 million of allowance, primarily in our card business. Economic assumptions underlying our allowance included unemployment of around 8% at the end of 2021 and the impacts of the $900 million stimulus package passed in December. The release was driven by the strong credit performance we have observed and by the new stimulus bills. In our allowance, We continue to assume that the relationship between economic metrics and credit quickly reverts to a historical norm and we've added significant additional qualitative factors for COVID related uncertainty. In our commercial business, we charged off certain energy loans and released allowance for the specific reserves that were previously established for those loans. Turning to slide five, you can see the allowance coverage levels declined modestly from the prior quarters across our segments, but remain well above pre-pandemic levels. Our domestic card coverage is now at 10.8%, while our branded card portfolio coverage is 12.7%. Recall that the difference between these metrics is driven by loss sharing agreements in our partnership portfolios. Coverage in our consumer and commercial businesses also remained elevated at 3.9% and 2.2% respectively. Moving to slide six, I'll discuss our liquidity position. You can see our preliminary average liquidity coverage ratio during the fourth quarter was 145%, well above the 100% regulatory requirement. Our liquidity reserves from cash, securities, and federal home loan bank capacity declined slightly from the third quarter to end the year at approximately $144 billion, including about $41 billion in cash driven by continued strong deposits. Turning to slide seven, you can see that our net interest margin increased 37 basis points quarter over quarter to 6.05%. The increase was largely driven by higher card loan revenue margin, as strong credit results led to lower suppression, the impact of third and fourth quarter deposit pricing actions, and a modest decline in our cash balance, which was partially offset by lower yields on cash and securities. Lastly, turning to slide eight, I will cover our capital position. Our common equity tier one capital ratio was 13.7% at the end of the fourth quarter, up 70 basis points from the third quarter and 150 basis points higher than a year ago. We continue to estimate that our CET1 capital need is around 11%, which includes a buffer over our capital requirements under the FCB framework of 10.1%. As we close out 2020, we have approximately 270 basis points or around $8 billion of capital in excess of our CET1 target. Following the latest stress test results released by the Federal Reserve last month, and in light of the strong capital position I just described, we expect to restore our quarterly dividend back to 40 cents per share in the first quarter, pending board approval. Our board of directors has also authorized the repurchase of up to $7.5 billion of the company's common stock. inclusive of share repurchase capacity of up to approximately 500 million in the first quarter, based on the Fed's current trailing four-quarter average earnings rule. The timing and amount of stock repurchase activity will be informed by our outlook on the economy, as well as actual forecasted levels of capital, earnings, and growth. And with that, I'll turn the call over to Rich. Thanks, Scott. As I think everyone on this call knows, Scott shared with me in November that he would be leaving Capital One to join a tech startup. While he will be here through March 15th, this will be Scott's last earnings call. So I want to take a moment and thank you, Scott, for giving so much of your life to Capital One over this past decade, including the last five years as our CFO. You've built strong relationships with our shareholders and across the investment community. And you've always brought their external perspectives to our work inside of Capital One. You've been a key advisor and partner for me and for the board and a strong leader in our company. I'm particularly grateful for the legacy you've built, transforming finance technology, strengthening processes and controls, building a great team of talented leaders, including your successor, Andrew Young. We will miss you and I'm sure you will continue to do great things. With that, let me turn to our domestic card business. Exceptional credit performance was the biggest driver of domestic card financial results in the quarter. The domestic card charge-off rate for the quarter was 2.69%, a 163 basis point improvement year over year, and a 95 basis point improvement from the sequential quarter. The 30-plus delinquency rate at quarter end was 2.42%. 151 basis points better than the prior year. The delinquency rate was up 21 basis points from the length quarter, consistent with typical seasonal patterns. Fourth quarter provision for credit losses improved by $1.1 billion year over year, driven by the allowance release that Scott discussed and lower charge-offs. Several factors are driving continued credit strength. Consumers are behaving cautiously, spending less, saving more, and paying down debt. These behaviors have been amplified by the cumulative effect of unusually large government stimulus and widespread forbearance across the banking industry. Our own longstanding resilience choices put us in a strong position going into the pandemic. And our strategic investments in digital technology and transformation are paying off in enhanced capabilities and underwriting that are powering our performance and response to the pandemic. Strikingly strong consumer credit has persisted throughout 2020, even after the expiration of several parts of the CARES Act. Uncertainty about future credit trends remains high, especially in the context of an evolving pandemic that is difficult to predict. As Scott discussed, that uncertainty informs our allowance for credit loss. We believe that each incremental month of favorable credit reduces the cumulative losses through the downturn rather than just delaying the impact. At the end of the fourth quarter, domestic card ending loan balances were down $20.1 billion, or 17% year over year, driven by three factors. Cautious consumer behavior reduced spending and demand for new credit and drove payment rates to historically high levels. Our marketing pullbacks at the outset of the downturn put additional pressure on loan balances. And we moved a partnership portfolio to held for sale in the third quarter. Excluding the impact of the move to held for sale, ending loans declined about 15%. Fourth quarter average loans declined 16% year over year. On a linked quarter basis, the expected seasonal ramp drove ending loans up by about 3%. Purchase volume continued to rebound from the sharp declines early in the pandemic. For the full year, purchase volume was down 2% in 2020. Fourth quarter purchase volume was essentially flat compared to the prior year quarter. That compares to a year-over-year decline of about 30% in the first weeks of the pandemic. Quarterly purchase volume increased 10% from the sequential quarter consistent with the expected seasonality and the continued rebound. Despite the rebound, purchase volume growth is still down compared to the double digit growth we were seeing before the pandemic. Fourth quarter revenue declined 7% year over year as a result of the decrease in average loans, partially offset by higher revenue margin. The revenue margin was up 121 basis points year over year to 16.91%, largely driven by two factors. Strong credit drove lower revenue suppression, and year over year, Net interchange revenue in the numerator of the margin is essentially flat, while average loan balances, the denominator of the margin calculation, are down 16%. Non-interest expense was down $186 million, or 8% from the fourth quarter of last year. largely driven by our choice to pull back on domestic card marketing when the pandemic hit. Total company marketing trends are largely driven by domestic card. Fourth quarter marketing for the total company was down 21% year over year. On a sequential quarter basis, total company marketing increased significantly in the fourth quarter. Looking ahead, Future marketing will be impacted by how things play out with the pandemic and the economy. In the midst of the pandemic, we're finding opportunities and we are leaning into them. These opportunities are enhanced by our tech transformation. The ultimate level of our 2021 marketing will depend on our continuing real-time assessment of the marketplace. Slide 12. summarizes fourth quarter results for our consumer banking business. Driven by our auto business, ending loans increased 9% year over year. Average loans grew 10% for the fourth quarter and 9% for the full year. When the COVID downturn began, we tightened our underwriting box in auto to focus on the most resilient assets. We believe that several factors drove our growth. The auto market rebound has been stronger for larger franchise dealers, the part of the market where we're focused. Our digital products and services drove growth in direct-to-consumer originations and growth with dealers who want to provide a low-touch service. car buying experience in response to social distancing. And our dealer relationship strategy put us in a strong position to grow high quality auto loans. Fourth quarter auto originations were down 2% year over year. Competition picked up late in the third quarter and continued to increase in the fourth quarter. Fourth quarter ending deposits in the consumer bank were up $36.7 billion or 17% year over year driven by the stimulus driven surge in deposits in the second quarter. Average deposits were up 19% for the fourth quarter and up 15% for the full year. Our average deposit interest rate decreased 73 basis points year over year and 19 basis points from the linked quarter as we reduced deposit pricing in response to the market interest rate environment and competitive dynamics. Fourth quarter, consumer banking revenue increased 18% from the prior year quarter. Annual revenue was up 4%. Both increases were driven by growth in auto loans and retail deposits. Annual growth was negatively impacted by differences in the timing of Federal Reserve rate cuts preceding our deposit pricing reduction. Non-interest expense in consumer banking was up 1% year over year. Fourth quarter provision for credit losses improved by $275 million year over year, driven by lower charge-offs and a modest allowance release in our auto business. Fourth quarter credit results in our auto business remain unusually strong, even after seasonal linked quarter increases of 24 basis points in the auto charge-off rate and 102 basis points in the delinquency rate. Year over year, the charge-off rate improved 143 basis points to 0.47%, and the delinquency rate improved 210 basis points to 4.78%. Strong auto credit is the result of several factors. In addition to the same general drivers of domestic card credit strength, auto credit also benefited from very strong auction values. And our auto forbearance is having a temporary positive impact, particularly on delinquency rates. We've provided updated auto forbearance information on appendix slide 18. We expect auto credit metrics to increase from their unusually low levels as auction prices normalize and the temporary impacts of COVID forbearance play out. Moving to slide 13, I'll discuss our commercial banking business. Fourth quarter ending loan balances were up 2% year over year, driven by growth in selected CNI and CRE specialties. Average loans were also up 2% for the fourth quarter and 6% for the full year. Quarterly average deposits increased 21% from the fourth quarter of 2019, and average Annual average deposits grew 14% in 2020 as middle market customers continued to bolster their liquidity. Fourth quarter revenue was up 10% from the prior year quarter. Annual revenue was up 6% for the year. Annual revenue growth from higher loan and deposit volumes and higher non-interest income was partially offset by lower net interest margin. Non-interest expense for the quarter increased by 1% year over year. Provision for credit losses improved by $90 million compared to the fourth quarter of 2019. The allowance release that Scott discussed was partially offset by higher charge-offs largely related to our oil and gas portfolio. Our oil and gas exposure declined year over year. We provided a breakout of our oil and gas portfolio composition and reserves on Appendix Slide 19. The commercial banking annualized charge-off rate for the quarter was 0.45%. The criticized performing loan rate for the quarter increased compared to both the prior year and linked quarters to 9.5%, driven by downgrades in our commercial real estate portfolio. The criticized non-performing loan rate rose modestly from the prior year quarter to 0.9%. I'll close tonight with some thoughts on our results and how we're positioned for the future. It's not a surprise that the pandemic shaped our 2020 results. For the full year, total company loan balances declined 5%. Annual revenue was essentially flat, including $535 million in gains on our Snowflake investment. Non-interest expense was down 3%, with a decline in marketing and relatively flat operating expense. Provision for credit losses increased by $4 billion, and earnings per share rebounded from negative territory early in the year to $5.18 for the full year, down significantly from 2019. Three key themes are evidence evident in our 2020 results. The pandemic pressured top-line loan balances and revenue, particularly in the first half of the year. On the bottom line, strikingly strong credit resulted in a return to positive trajectory and record profitability in the second half of the year. And our longstanding strategic choices put us in a strong position to respond to both the near-term challenges and the emerging opportunities. Turning first to the near-term challenges, domestic card loan balances declined sharply as cautious consumers, stimulus, and widespread industry forbearance drove historically high payment rates and reduced demand. Lower loan balances put pressure on revenue, efficiency, and scale. The operating efficiency ratio net of adjustments was 46%. It was 46.9% excluding snowflake gains. The flip side of this top line pressure was exceptionally strong consumer credit performance, which drove two consecutive quarters of record earnings in the second half of 2020. And strong second half earnings coupled with a smaller balance sheet enabled us to increase our CET1 ratio to 13.7%. Today, we've announced our intent to raise the quarterly dividend to its prior level of 40 cents per share, subject to board approval. And we've also discussed our plan for up to $7.5 billion of share repurchases, which our board has already approved. Throughout 2020, we have been well served by the choices we made before the downturn began. 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 navigating through prior periods of stress, including the Great Recession. Our investments to transform our technology and how we work and our efforts to drive the company to digital are paying off, Our transformation is powering our response to the downturn and putting us in a strong position for emerging opportunities as the pandemic plays out. Pulling way up. Despite the pressures of the pandemic in the near term, nothing has changed about where we think our businesses are headed or the long-term strategic opportunities that are being created as sweeping digital change continues to transform banking. As we 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. Continuing to transform our technology from the ground up, capitalizing on our transformation to drive innovation and growth, generating positive operating leverage and improving efficiency. and managing capital efficiently and effectively, including significant capital distribution. And now we'll be happy to answer your questions. Jeff?