This conference call transcript was computer generated and almost certianly contains errors. This transcript is provided for information purposes only.EarningsCall, LLC makes no representation about the accuracy of the aforementioned transcript, and you are cautioned not to place undue reliance on the information provided by the transcript.
spk01: Good day, ladies and gentlemen, and welcome to the Capital One second quarter 2021 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 would like to withdraw your question, press the star key, then the number two. Thank you. I would now like to send the conference over to Mr. Jeff Norris. Senior Vice President of Finance. Sir, you may begin.
spk02: Thanks very much, Holly, and welcome everyone to Capital One's second quarter 2021 earnings conference call. As usual, we are webcasting live over the internet. To access the call on the internet, please log on to Capital One's website at CapitalOne.com and follow the links from there. In addition to the press release and financials, we've included a presentation summarizing our second quarter 2021 results. With me today are Mr. Richard Fairbank, Capital One's Chairman and Chief Executive Officer, and Mr. Andrew Young, Capital One's Chief Financial Officer. Rich and Andrew will walk you through this presentation. To access a copy of the presentation and 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 in 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 filed with the SEC. And now I'll turn the call over to Mr. Young. Andrew.
spk06: Thanks, Jeff, and good afternoon, everyone. I'll start on slide three of tonight's presentation. In the second quarter, Capital One earned $3.5 billion, or $7.62 per diluted common share. Included in the results for the quarter was a $55 million legal reserve bill. Net of this adjusting item earnings per share in the quarter was $7.71. On a gap basis, pre-provision earnings increased slightly in the sequential quarter to $3.4 billion. We recorded a provision benefit of $1.2 billion in the quarter, as $541 million of charge-off was offset by a $1.7 billion allowance release. Revenue grew 4% in the linked quarter, largely driven by the impact of strong domestic card purchase volume on non-interest income and the absence of the mark on our snowflake investment a quarter ago. Period end loans held for investment grew $6.5 billion, or 3%, inclusive of the effect of moving $4.1 billion of loans to held for sale during the quarter. The loans moved to held for sale consisted of $2.6 billion of an international card partnership portfolio and $1.5 billion in commercial loans. Turning to slide four, I will cover the changes in our allowance in the quarter. We released $1.7 billion of allowance, primarily driven by observed strong credit performance and an improved economic outlook. Turning to slide five, we provide the allowance coverage ratios by segment. You can see allowance coverage declined in the quarter across all segments, largely reflecting the dynamics I just described. However, coverage ratios remain well above pre-pandemic levels due to continued economic uncertainty as our allowance is built to absorb a wide range of outcomes. Our domestic card coverage is now 8.9%, down from 10.5% last quarter. Our branded card coverage is 10.1%. Recall that the difference between branded and domestic coverage is largely driven by the loss sharing agreements in some of our partnership portfolios. Coverage in our consumer business declined about 60 basis points to 3.0%. In addition to continued strong credit performance and improved economic outlook, historically high auto values aided the reduction in coverage. Coverage in our commercial banking business declined about 25 basis points to 1.7%, with the single largest driver being the improvement in our energy portfolio. Turning to page six, I'll now discuss liquidity. You can see our preliminary average liquidity coverage ratio during the quarter was 141%. The LCR continues to be well above the 100% regulatory requirement. Our liquidity reserves from cash, securities, and federal home loan bank capacity ended the quarter at approximately $137 billion. The $14 billion decline in total liquidity was driven by lower-ending cash balances. Our cash position declined in the quarter as it was redeployed to net loan growth, wholesale funding maturities, a modest increase in our securities portfolio, and share repurchases. Moving to page seven, I'll now discuss net interest margin. You can see that our second quarter net interest margin was 5.89%, 10 basis points lower than the prior quarter. The linked quarter decline in NIM was largely driven by lower yield in our card portfolio. where the typical seasonal decrease in revolve rate was exacerbated by higher transactor volume and associated higher payments. These impacts were partially offset by the favorable impact from one more day in the quarter. Lastly, turning to slide eight, I will cover our capital position. Our common equity tier one capital ratio was 14.5% at the end of the second quarter, down 10 basis points from the first quarter. loan growth and capital actions were largely offset by earnings growth. During the quarter, the Federal Reserve released the results of their stress test. Our stress capital buffer requirement, which will be effective on October 1st of this year, is 2.5%, resulting in a total capital requirement by the Fed of 7.0%. While we saw a decline in this year's SCB, It's important to note that the Fed's stress testing results can move around meaningfully from year to year and are only one of many factors that we use in our capital planning process. Based on our internal modeling, we continue to estimate that our CET1 capital need is around 11%. Turning to share repurchases, we repurchased $1.7 billion of common stock in the second quarter, the full amount allowed under the Fed's capital preservation measures. We have approximately $5.3 billion remaining of our current board authorization of seven and a half billion. Now let me move on to dividends. In the third quarter of 2020, we reduced our dividend to 10 cents due to the Fed's capital preservation measures. We chose to continue this reduced level of dividend in the fourth quarter of 2020 out of an abundance of caution. The difference between our historical 40 cent dividend and the reduced level for those two quarters was $0.60 per common share. Therefore, we expect to make up for the reduced level of dividends from the second half of 2020 by paying a $0.60 special dividend in the third quarter of 2021. In addition to the special dividend, we expect to increase our quarterly common stock dividend from $0.40 per share to $0.60 per share in the third quarter. Both the $0.60 special dividend and the increase of our quarterly common stock dividend to $0.60 will be subject to board approval. With that, I will turn the call over to Rich. Rich?
spk09: Thanks, Andrew, and good evening, everyone. I'll begin on slide 10 with our credit card business. Strong year-over-year purchase volume growth drove an increase in revenue compared to the second quarter of 2020, more than offsetting a modest year-over-year decline in loan balances. And provision for credit losses improved significantly. Credit card segment results are largely a function of our domestic card results and trends, which are shown on slide 11. Second quarter results reflect building momentum in our domestic card business. As we emerge from the pandemic, consumers are spending more and continuing to make elevated payments. Accelerating purchase volume growth partially offset the impact of historically high payment rates, resulting in strong revenue growth and a more modest year-over-year decline in loan balances. High payment rates are continuing to contribute to strikingly strong credit results. Domestic card purchase volume for the second quarter was up 48% from the second quarter of 2020. Purchase volume was up 25% from the second quarter of 2019, which is an acceleration from the first quarter when we saw growth of 17% versus 2019. T&E spending continues to catch up to overall spending and accelerated through the second quarter. In June, T&E purchase volume was up 3% compared to June of 2019. At the end of the quarter, domestic card loan balances were down $4.1 billion, or about 4% year over year. Excluding the impact of a partnership portfolio moved to held for sale last year, second quarter ending loans declined about 2% year over year. Compared to the sequential quarter, ending loans were up about 5% ahead of typical seasonal growth of 2%.
spk10: Credit performance remained strikingly strong.
spk09: The domestic card charge off rate for the quarter was 2.28%, a 225 basis point improvement year over year. The 30 plus delinquency rate at quarter end was 1.68%, 106 basis points better than the prior year. Provision for credit losses improved by about $3.5 billion year over year. We swung from a large allowance build in the second quarter last year to a large allowance release this year. Let me turn to domestic card revenue margin. Purchase volume growth outpacing loan growth and strong credit were the key drivers of domestic card revenue margin, which was up 226 basis points year over year, to 17.7%. Revenue margin increased over 50 basis points quarter over quarter, higher than our typical seasonal pattern.
spk10: Total company marketing expense was $620 million in the quarter, up $347 million compared to the second quarter of 2020.
spk09: Our choices in card marketing are the biggest driver of total company marketing trends. As we emerge from the pandemic, we're seeing strong originations and purchase volumes. Our growth opportunities are enhanced by our technology transformation. We are leaning further into marketing to drive future growth and continue to build our franchise. At the same time, we're keeping a watchful eye on the competitive environment which is intensifying. You know, pulling up, our domestic card business continues to deliver significant value and build momentum. Slide 12 summarizes second quarter results for our consumer banking business. Auto growth and exceptional auto credit are the main themes in second quarter consumer banking results. Driven by auto, The second quarter ending loans increased 12% year-over-year in the consumer banking business. Average loans also grew 12%. Auto originations were up 56% year-over-year and up 47% from the linked quarter. Pent-up demand and high auto prices drove a second quarter surge in growth across the auto marketplace. In the context of increased industry growth, our digital capabilities and deep dealer relationship strategy continued to drive strong growth in our auto business. Second quarter ending deposits in the consumer bank were up $4.4 billion, or 2% year over year. Average deposits were up 9% year over year. Consumer banking revenue increased 27% from the prior year quarter, driven by growth in auto loans and retail deposits. Second quarter, provision for credit losses improved by $1.2 billion year over year, driven by an allowance release and lower charge-offs in our auto business. Credit results in our auto business are strikingly strong. Year over year, the second quarter charge-off rate improved 120 basis points to negative 0.12%, and the delinquency rate was essentially flat at 3.26%. In the quarter, elevated used car prices drove an increase in auction proceeds, amplifying the normal seasonal benefit we see from tax refunds around this time of the year. As used vehicle prices normalize, they will become a headwind to the auto charge-off rate. We expect the auto charge-off rate to increase from the unusually low second quarter level. Moving to slide 13, I'll discuss our commercial banking business. Second quarter ending loan balances were down 5% year over year. Average loans were down 7%. Commercial line utilization continues to be down year over year, and we moved $1.5 billion of commercial real estate loans to held for sale. Quarterly average deposits increased 22% from the second quarter of 2020 and 5% from the linked quarter as middle market and government customers continued to hold elevated levels of liquidity. Second quarter revenue was up 3% from the prior year quarter and down 6% from the linked quarter. The linked quarter decline is more than entirely driven by a one-time cost associated with moving the commercial real estate loans to held for sale. This decline was offset by an equivalent one-time gain in the other category and is therefore neutral to the company. Excluding this effect, commercial banking revenue would have increased about 13% year-over-year and 4% from the linked quarter. Provision for credit losses improved significantly compared to the second quarter of 2020, driven by a swing from an allowance build to an allowance release and a swing from net charge-offs to net recoveries. In the second quarter, the commercial banking annualized charge-off rate was negative 11 basis points. The criticized performing loan rate was 7.6%, and the criticized non-performing loan rate was 1.0%. Our commercial banking business is delivering solid performance as we continue to build our commercial capabilities. I'll close tonight with some thoughts on our results and our strategic positioning. Several key themes are evident in our second quarter results. Credit remains strikingly strong. Purchase volume and loans are rebounding. We're continuing to invest to propel our future results. And we're returning capital to our shareholders. We are seeing increasing near-term opportunities to build our domestic card business as we emerge from the pandemic. We are leaning further into marketing to seize these opportunities. We are also increasing our marketing for auto, national banking, and our brand. We are now in the ninth year of a journey to build a modern technology company from the bottom of the tech stack up. Our progress is accelerating, and the stakes are rising. Competitor tech investments are increasing as technology is increasingly seen as an existential issue. The investment flowing into fintechs is nothing short of breathtaking, and the war for tech talent continues to escalate, including levels of compensation. We continue to invest in technology and the opportunities that emerge as our transformation gains traction. Our modern technology is powering our current performance and setting us up to capitalize on the accelerating digital revolution in banking. And now we'll be happy to answer your questions. Jeff?
spk02: Thanks, 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 follow-up questions after the Q&A session, the investor relations team will be available after the call. Holly, please start the Q&A.
spk01: Absolutely. Thank you so much. And again, ladies and gentlemen, that is star one to ask a question at this time. Our first question today will come from John Pancari with Evercore ISI.
spk12: Good evening.
spk05: Hello. I want to see if I can get your thoughts on payment rates. Did you see a peak in the quarter? And if not, if you can talk about a timing of inflection. And then separately, how does that impact your growth assumption for card receivables and the timing on that front? Thanks.
spk09: You know, John, in our card business, payment rates remain at historically high levels. And as you know, government stimulus has been amplifying payment rates. And while these programs have been winding down, customer balance sheets are extremely healthy and payment rates remain elevated. You can see the payment rate trends in our reported trust metrics. And while not a perfect reflection of our total portfolio, Q2 payment rates remain at historically high levels. And these high payment rates are muting balance growth, even as spend is very strong. And of course, the flip side of high payment rates is strikingly strong credit performance, which drives strong profitability and capital generation. So We actually are always happy when our customers are paying at high levels and it's indicative of a healthy consumer. And those high payment rates correlate with the really strong credit results that we continue to see. Now, we are, you know, if we look at the monthly numbers, you know, we can see, John, a little bit of easing. of the payment rates, I don't know if that would be a trend to indicate. It certainly would be very plausible to me that as consumers now step up and spend more and more and they're going out and returning hopefully back to normal, it would be a natural thing that payment rates would you know, ease a little bit here. And that also, you know, credit metrics would move toward normalizing a little bit. So I guess, John, I would say we've seen the earliest of indications of that. It's still running at really quite a breathtaking level.
spk01: Next question, please. Of course. Our next question will come from Mosha Orenbuck with Credit Suisse.
spk08: Great, thanks. Rich, putting together the comments you made about the significant amount of excess capital and then the comment in the release about seeing increasing near-term opportunities to build your franchise, could you talk a little bit about whether you're looking at primarily kind of organic opportunities or inorganic ones as well?
spk09: Moshe, as you know well, because you've been there from the beginning in following us and having great insights, we really built our company as sort of wired for organic growth. We installed in the founding days what I call horizontal accounting, where we track every action and cohort and everything on a lifetime. you know, economic basis, and we measure it before and during and afterward to see how it's going. And so we always put organic at the top of the list. And here's a great example. I mean, while every bank that's, every national bank that's been created has come through many, many acquisitions. We've had some acquisitions in our journey, but we are really leaning into a organically driven national growth strategy in banking. And as I said a few minutes ago, we see good organic growth opportunities, which are partly a function of the market and where it is right now, and very much these opportunities stand on the shoulders of the technology that we've built and some of the innovation that we're rolling out. With respect to acquisitions, we're not putting any energy or strategic focus on doing bank acquisitions. What we are looking at is technology acquisitions. And really, in fact, there's a spectrum on the technology side with respect to fintechs and tech companies. On the continuum, at one end is just, you know, being a partner with them. And then the next notch on the continuum is being a partner and an investor in them. And, you know, you saw that with Snowflake, for example. And then there are sometimes acquisitions. All of those have, you know, we've been active in all of those places on the continuum over the last few years, and I'm struck by the traction and success that we're having. When we look back at some of the, you know, the acquisitions of little fintechs, for example, and tech companies, We are very, very pleased with the performance. And in many ways, these things are generally outperforming. One of the big benefits that we have is that we have a modern tech stack. So do the fintechs or tech companies that we're buying. And so the integration and the compatibility, the ability to attract and then really retain the talent past the contractual period is something that I think leans in our favor. So lots of positives there. There's one big elephant in the room with respect to acquisitions on the tech side, and that's the valuations. So we've recently gone to a few of these conversations and said, love the company, but not at that price. So we're very aware about where pricing is, but strategically, I think, you know, if you kind of open the aperture and don't talk about necessarily this very moment, I think for Capital One, it's an organic first strategy, but acquisitions in fintechs and tech companies at the right price, and there'll usually be little ones, I think will help you know, fill out our business and accelerate our opportunities.
spk01: Next question, please. Absolutely. Next, we'll hear from Kevin Barker with Piper Sandler.
spk07: Thank you. Considering the tightening on the regular whistle in the first, during 2021, do you expect, um, normalized credit to maybe run below pre-pandemic levels as we go into 2022 and potentially into 2023?
spk09: Kevin, yeah, but I think we, we, uh, it was a little, uh, echoey, but I think, uh, we, we, um, Lisa, I felt I heard what you were saying there, Kevin. Um, From where we are right now, which is at an extraordinary benign level that virtually has never been seen before in modern times, it's got a ways to go to normalize. We are not choosing to make a prediction on where that is, not because we want to be coy about it, but because, in fact, I think it's a hard thing to predict these days. What we like to talk about is the drivers. So talking about the drivers, the consumer is in a very strong place right now. And I think what's striking is, and I mentioned this earlier, when you look at what the average consumer, and this is average because the experience for an individual consumer can be way different from what I'm describing on average. But the accumulated sort of surplus that consumers have been able to build up is something that even when the government stimulus monthly benefits ease, I think there is a bit of an accumulated surplus balance there that will be beneficial for the credit performance of consumers. There's really only one way for the credit to go from here, and that is in normalizing. I think it starts with a bit of a head start, and I think that the rate at which it normalizes is going to be pretty linked to consumers' choices on payment rates. And as I've mentioned earlier, I think it's a natural thing for payment rates to gradually decline and for credit to gradually normalize. The directions are inevitable. The timing is speculative. Our view is during this period of time, let's take advantage of the market opportunity that is here, the place the consumer is, but let's also be cognizant of how markets work, how credit markets work in particular, and be on the lookout for some of the natural indicators of overheating.
spk12: Next question, please.
spk01: Thank you. Next we'll hear from Rick Shane with JP Morgan.
spk11: Hey everybody. Thanks for taking my question this afternoon. Um, look, we're, we're in this topics come up a couple of times. We're looking at the reserve rates and thinking about them in the context of day one reserve levels. Uh, I'm curious how you now reflect on day one, uh, allowance coverage. And what that could look like on a long-term basis as we return to normal. I'm curious in particular if you think some of the policy initiatives we've seen during the crisis change your long-term outlook in terms of potential loss rates.
spk06: Thanks, Rick. This is Andrew. I'll take that. And I think as we look at the allowance, every quarter we're going to take into account a large number of variables and assumptions, which would certainly take policy and other factors. And so as I reflect back on the ratio that we had upon adoption, a lot of things have changed since then. And so within every single asset class, the mix is going to change. impact our coverage needs. And then you look at overall the balance sheet mix across each of those asset classes will, will impact things. So, you know, I look at all of those factors and, you know, I don't think that the, uh, the ratio at adoption is necessarily a destination. But I also think that if you put into the formula, like all of the economic assumptions and all of the asset mix, I still believe that the pre-pandemic coverage ratio can still serve as a very rough benchmark of what coverage ratios might look like. But again, it'll take into account each successive quarter all of the things that we're looking at in terms of the mix and broad economic assumptions, including policy, as you mentioned.
spk12: Next question, please.
spk01: Thank you. Next, we'll hear from Betsy Grasick with Morgan Stanley. Hi, good afternoon.
spk10: Hey, Betsy.
spk00: Just a question here on how you're thinking about the opportunity to invest for that account growth. You indicated the account growth is up. Maybe give us a sense as to how much more it's up than usual. I know usually you don't give numbers for that, but it would be helpful to understand the benefit that those marketing dollars is generating today and then how much more you think the opportunity set is here to ramp up the marketing in the back half of the year given, you know, the opportunity set that you have in front of you? Thanks.
spk09: Betsy, yeah, we don't tend to give out the specific account growth numbers, the origination numbers, but, you know, they – They are strong right now. They're not the strongest that we have ever seen. We're pleased that they're really quite strong because obviously there was some weakness a year ago in those kind of numbers. So we have seen very solid performance. We feel really good about the account originations. So we are leaning further into marketing to drive future growth and also to just continue to build the underlying franchise. And, you know, as we've said, these opportunities are partly because of what the market has to give right now and partly opportunities that are enhanced by our technology transformation. And the marketing, of course, is especially going into the card side of the business, but also just look on TV. You've seen us steadily investing in national banking. We're very happy with how that's going. And you may have seen for the first time this quarter that we have now gone on national TV in the auto side. So these are you know, advertising that is, you know, debuting some of the technology innovations that we have, Capital One, some of the exceptional customer experiences that we've built. We're seeing good traction in the origination side of the business. And so we continue to lean in to marketing.
spk12: Next question, please.
spk01: Thank you. Next, we'll hear from Don Fandetti with Wells Fargo.
spk03: Hi, Rich. I was wondering if you could talk a bit about the tech spend outlook. I saw a report that Capital One was hiring a large amount of software programmers to take advantage of the public cloud move. And then, you know, you mentioned FinTech. I was just curious if you thought that the regulatory landscape would ever balance out or if that's sort of something that's not going to happen.
spk09: Okay. Yes, Don, thank you. So let me talk about tech and the tech hiring. You know, winning in technology really kind of begins and ends with one thing, hiring world-class tech talent. And it is the easiest thing to talk about and possibly the hardest thing to pull off in business today. Because while this talent principle is true in any business, it is profoundly true in technology as the demand for world-class tech talent vastly exceeds the supply. So we've built a tech brand.
Disclaimer