Founder, Chairman, Chief Executive Officer & President, Capital One Financial Corp.
Capital One Financial Corp ($COF) Q4 2024 Earnings Call
Good day and thank you for standing by welcome to the Capital 1 Q4 2024 earnings call please be advised that today's ...
About Richard Fairbank
During Capital One's Q2 2026 earnings call on July 21, 2026, Richard Fairbank stated that the company still expects its earnings power following the Discover integration to be consistent with initial expectations. He described the acquisition of Brex as motivated by its success in the corporate card market, its technology infrastructure, and its talent. Fairbank characterized Brex as having "a tiger by the tail" and pursuing three markets—commercial cards, payables, and expense management—with an integrated solution. Fairbank also addressed the Discover integration, describing a temporary "brown out" in originations that he said would be resolved as Discover customers and operations are moved to Capital One's technology platform. He stated that this transition would allow Capital One to apply its underwriting and spending capabilities to drive higher originations, spend volume, and loan volume over time.
Transcript (70 segments)
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Operator0:00
Good day and thank you for standing by. Welcome to the Capital 1 Q4 2024 earnings call. Please be advised that today's conference is being recorded. After the speaker's presentation, there will be a question and answer session. To ask a question, please press star one on your telephone and wait for your name to be announced. To withdraw your question, please press star one again. I would now like to hand the conference over to your speaker today, Jeff Norris, senior vice president of finance. Please go ahead.
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Jeff Norris0:30
Thanks Josh and welcome everyone. Just as a reminder as always we are webcasting live over the internet and to access the call on the internet please log on to Capital 1's website capital1.com and follow the links from there. In addition to the press release and financials, we've included a presentation summarizing our fourth quarter 2024 results. With me this evening are Mr. Richard Fairbank, Capital 1's chairman and chief executive officer and Mr. Andrew Young, Capital 1's chief financial officer. Rich and Andrew are going to walk you through this presentation. To access a copy of the presentation and press release, please go to Capital 1's website and click on investors, then click on financials, and then click on quarterly earnings release. Please note that this presentation may contain forward-looking statements. Information regarding Capital 1'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 factor section in our annual and quarterly reports that are accessible at Capital 1's website filed with the SEC. Now, I'll turn the call over to Mr. Young. Andrew,
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Andrew Young2:00
Thanks Jeff and good afternoon everyone. I will start on slide three of tonight's presentation. In the fourth quarter, Capital One earned $1.1 billion or $267 per diluted common share. For the full year, Capital One earned $4.8 billion or $1159 per share. Included in the results for the fourth quarter were adjusting items related to Discover integration costs and a legal reserve build. Net of these adjusting items, fourth quarter earnings per share were $39. Full year adjusted earnings per share were $13.96. We also had one notable item in the quarter, which was $100 million of accelerated philanthropy contributions. Pre-provision earnings of 4.1 billion in the fourth quarter were down 13% from the third quarter driven by higher non-interest expense. The linked quarter increase in non-interest expense was driven by increases in both operating expense and marketing spend. Revenue in the linked quarter increased 2% driven by higher non-interest income. Provision for credit losses was $2.6 billion in the quarter, up about 160 million relative to the prior quarter. The quarterly increase in provision was driven by higher net charge offs partially offset by a larger allowance release. Turning to slide four, I will cover the allowance in greater detail. We released $245 million in allowance this quarter and our allowance balance now stands at 16.3 billion. The decrease in this quarter's allowance was driven by releases in our commercial banking and commercial segments. Our total portfolio coverage ratio decreased 20 basis points to 4.96%. I'll cover the drivers of the changes in allowance and coverage ratio by segment on slide five. The allowance balance in our domestic card business was flat. The coverage ratio declined 33 basis points primarily driven by seasonal balances as well as favorable near-term credit trends. In our consumer banking segment, we released $131 million in allowance, resulting in a 22 basis point decrease to the coverage ratio. Vehicle values were stable in the quarter, resulting in an improved recoveries outlook, which drove the release. And finally, our commercial banking allowance decreased by 30 million resulting in a 15 basis point decrease to the coverage ratio. The release was primarily driven by the reduction in criticized loans and to a lesser extent by charge offs in the quarter. Turning to page six, I'll now discuss liquidity. Total liquidity reserves in the quarter decreased by about $8 billion to approximately 124 billion. Our cash position ended the quarter at approximately $43 billion, down about 6 billion from the prior quarter. The decline in cash was largely driven by seasonally higher card loans and funding maturities, which were partially offset by continued strong growth in a consumer banking business deposits. Our preliminary average liquidity coverage ratio during the fourth quarter was 155%. Turning to page seven, I'll cover our net interest margin. Our fourth quarter net interest margin was 7.03%. Eight basis points lower than last quarter and 30 basis points higher than the year ago quarter. The linked quarter decrease in NIM was primarily driven by lower asset yields which were only partially offset by lower deposit and wholesale funding costs. Turning to slide eight, I will end by discussing our capital position. Our common equity tier 1 capital ratio ended the quarter at 13.5%. 10 basis points lower than the prior quarter. Net income in the quarter was more than offset by the impact of loan growth, dividends, and $150 million of share repurchases. As a reminder, the announcement of the acquisition of Discover constituted a material business change. Therefore, we continue to be subject to the Federal Reserve's preapproval of our capital actions until the merger approval process has concluded. With that, I will turn the call over to Rich.
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Richard Fairbank7:20
Thanks Andrew and good evening everyone. Slide 10 shows fourth quarter results in our credit card business. Credit card segment results are largely a function of our domestic card results and trends which are shown on slide 11. In the fourth quarter, our domestic card business delivered another quarter of steady topline growth, strong margins, and stable credit. Year-over-year purchase volume growth for the quarter was 7%. Ending loan balances increased $8 billion or about 5% year-over-year. Average loans increased about 6% and fourth quarter revenue was up 9% from the fourth quarter of 2023 driven by the growth in purchase volume and loans. Revenue margin for the quarter increased 55 basis points from the prior year quarter to 18.6% largely driven by the impact of the end of the Walmart revenue sharing agreement. The charge off rate for the quarter was 6.06%. The impact of the end of the Walmart loss sharing agreement increased the fourth quarter charge off rate by roughly 40 basis points. Excluding this impact, the charge off rate for the quarter would have been 5.66% up 31 basis points year-over-year. And after 20 consecutive months of second derivative improvement, the 30 plus delinquency rate crossed into actual year-over-year improvement. The 30 plus delinquency rate at the end of December was 4.53% down eight basis points from the prior year. As a reminder, the end of the Walmart loss sharing agreement did not have a meaningful impact on delinquency rate. On a sequential quarter basis, the charge off rate was up 45 basis points. The 30 plus delinquency rate was flat compared to the linked quarter. Domestic card non-interest expense was up 13% compared to the fourth quarter of 2023. Operating expense and marketing both increased year-over-year. Total company marketing expense in the quarter was $1.4 billion, up 10% year-over-year. Our choices in domestic card are the biggest driver of total company marketing. We continue to see compelling growth opportunities in our domestic card business. Our marketing continues to deliver strong new account growth across the domestic card business. Compared to the fourth quarter of 2023, domestic card marketing in the quarter included higher media spend and increased investment in premium benefits and differentiated customer experiences like our travel portal, airport lounges, and Capital One shopping.
Slide 12 shows fourth quarter results in our consumer banking business. Auto originations were up 53% from the prior year quarter. A portion of this growth can be attributed to overall market growth while the remainder is the result of our strong position to pursue resilient growth in the current marketplace. As a reminder, our choices to tighten credit and pull back in anticipation of credit score inflation and declining vehicle values were still in effect in the fourth quarter of 2023, resulting in relatively low originations. These choices also drove out, really basically they drove strong and stable credit performance that positioned us to lean into current marketplace opportunities and return to originations growth in 2024. With four consecutive quarters of originations growth in 2024, consumer banking loan balances returned to growth in the fourth quarter. Ending loans increased $2.7 billion or about 4% year-over-year and average loans were up 1%. On a linked quarter basis, ending loans were up 2% and average loans were up 1%. Compared to the year ago quarter, ending consumer deposits grew about 7% and average consumer deposits were up about 8%. Consumer banking revenue for the quarter was up about 1% year-over-year. Growth in loans and deposits was partially offset by a higher year-over-year average deposit interest rate. Non-interest expense was up about 10% compared to the fourth quarter of 2023, driven largely by the unique fourth quarter items Andrew discussed, as well as increased auto originations and continued technology investments. The auto charge off rate for the quarter was 2.32% up 13 basis points year-over-year. The 30 plus delinquency rate was 5.95% down 39 basis points year-over-year. Largely as the result of our choice to tighten credit and pull back in 2022, auto charge offs have been strong and stable on a seasonally adjusted basis.
Slide 13 shows fourth quarter results for our commercial banking business. Compared to the linked quarter, ending loan balances were essentially flat. Average loans were down about 1%. Both ending and average deposits were up about 4% from the linked quarter. Fourth quarter revenue was up 7% from the linked quarter and non-interest expense was up by about 5%. The commercial banking annualized net charge off rate for the fourth quarter increased four basis points from the sequential quarter to 0.26%. The commercial criticized performing loan rate was 6.35% down 131 basis points compared to the linked quarter. The criticized non-performing loan rate decreased 16 basis points to 1.39%.
In closing, we continued to post strong and steady results in the fourth quarter. We delivered another quarter of topline growth in domestic card loans, purchase volume, and revenue. In the auto business, we posted growth in originations for the fourth consecutive quarter and a return to year-over-year growth in loan balances. And consumer credit trends remained stable. Our full-year operating efficiency ratio net of adjustments was 42.35% consistent with our guidance of the low 42s even after incurring $100 million in accelerated philanthropy contributions.
And turning to the Discover acquisition, the shareholder votes are scheduled for February 18th, and we continue to work closely with the Federal Reserve, the OCC, and the Department of Justice as our applications continue to work their way through the regulatory approval process. We remain well positioned to complete the acquisition early in 2025, subject to regulatory and shareholder approval. Pulling way up. The acquisition of Discover is a singular opportunity. It will create a consumer banking and global payments platform with unique capabilities, modern technology, powerful brands, and a franchise of more than 100 million customers. It delivers compelling financial results and offers the potential to enhance competition and create significant value for merchants and customers. And now we'll be happy to answer your questions.
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Jeff Norris16:05
Thank you, Rich. We will now start the Q&A session. Remember, 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, the investor relations team will be available after the call. Josh, please start the Q&A.
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Operator16:25
Thank you. As a reminder, to ask a question, please press star 111 on your telephone and wait for your name to be announced. To withdraw your question, please press star 111 again. One moment for questions. Our first question comes from Ryan Nash with Goldman Sachs. He may proceed.
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Ryan Nash16:46
Hey, good afternoon everyone.
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Richard Fairbank16:48
Hey Ryan.
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Ryan Nash16:49
Hey Ryan. Uh so um you know Rich, you know delinquencies have been in line or better for nine straight months. You know, losses and you talked about delinquencies now being down on a year-over-year basis and you know, losses have sort of followed suit but at a little bit of a slower pace and you know, you've outlined a lot of the reasons, you know, deferred charge offs, the press recoveries, but when you think about credit from here, just you know, broadly, what are you seeing from the consumer and how are you thinking about loss performance as well as any other factors that could be impacting losses and do you think we're on a downward trajectory from here? Thank you. And I have a follow-up.
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Richard Fairbank17:28
Thank you Ryan. So let me start by just talking about the health of the consumer and then maybe I'll turn and talk about the credit performance at Capital One. The US consumer continues to be a source of strength in the overall economy. The labor market remains strong and we saw signs of softening in the first half of 2024, but in the second half of the year, the unemployment rate has been stable and job creation data has shown renewed strength. Incomes are growing steadily in real terms as inflation settles out a bit. Consumer debt servicing burdens are stable near pre-pandemic levels. Consumers have higher bank account balances than before the pandemic. Now, of course, the circumstances of individual consumers and households are highly variable and so talking in averages doesn't always fully cover what's going on. We do see some pockets, as I've been saying for some time now, we do see some pockets of pressure related to the cumulative effects of inflation and elevated interest rates among consumers whose incomes have not kept up with inflation or who have high debt servicing burdens. Of course, there's still some inflation pressure and longer-term interest rates strikingly have increased since the Fed started lowering rates in September. So we do see a bit of a disconnect between the average consumer and the folks closer to the margin. And you can see that for example in payment rates in our card business. On the one hand, card payment rates remain on average meaningfully above pre-pandemic levels. This is true overall and within each of our major customer segments. On the other hand, the proportion of customers making just the minimum payment is also running somewhat above pre-pandemic levels, which is consistent with our card delinquencies running above pre-pandemic levels. Now I should add that we're seeing this minimum payment effect across the credit spectrum. I'm not making a point here about the low end of the market or even about subprime. In fact, if anything, the lower end appears to be doing relatively better at the moment. So, pulling up, I believe we're almost certainly still seeing some pandemic related effects like delayed charge offs from the period of unprecedented stimulus and forbearance in 2020, 2021, and 2022. This effect is impossible to isolate but we can infer it from our own credit trends and industry credit trends over the past several years. But pulling up on the consumer, I think consumers are in good shape compared to most historical benchmarks. There are pockets of pressure that have to work their way through before credit loss levels can get down to pre-pandemic levels, but I think the consumer story is very consistent with what I've been saying for a number of quarters and it is very solid.
So, let me turn to Capital One credit. Over the course of 2024, our card delinquencies have moved in line with normal seasonality with losses following about a quarter behind. As a reminder, earlier this year, we flagged that changes in the level and timing of tax refunds due to tax law changes were probably changing seasonal credit patterns in our card business. We derived new seasonality benchmarks for card delinquencies based on post-pandemic performance and those benchmarks have less amplitude in both directions than in the past. So we've now had a full year to look at what we were hypothesizing as the new seasonality benchmark. And as we now look at the whole year, this experience is very confirmatory and we very much believe that we've got the benchmark right. When we first saw delinquencies settling out, it is clear that for the whole year now we've been calling stabilization. We've not been declaring a peak or declaring that credit would improve from here, but we can now look at the whole year and see a really nice stabilization in the fourth quarter. And again, you saw this in the monthly data we just reported. We saw our delinquencies improve on a seasonally adjusted basis in the quarter for the first time since normalization began. And they ended the year slightly lower on a year-over-year basis. So that's certainly an encouraging sign. Looking ahead, we're not giving guidance on future credit, but over time there are a number of forces that play out. Our recoveries inventory will continue to rebuild and that should be a gradual tailwind to our losses over time, all else equal. Still high interest rates will probably remain a source of pressure for some consumers, especially those with higher debt servicing burdens. And there still is, we believe, the phenomenon of delayed charge offs. This effect is hard to measure and certainly hard to forecast, but over time it should play through. But how long it plays out is just a matter of speculation. I think we will eventually get back to the place where traditional labor market indicators are the main drivers of change in consumer credit, but that will still take some time. And finally, as we move into the new year, we'll keep an eye on the level and timing of tax refunds since we know these can materially affect seasonal movements in card credits.
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Ryan Nash24:39
Got it. Thanks for the call. If I can throw in one high level follow-up. So Rich, efficiency improvement has been a hallmark of Capital One for the last seven or eight years, excluding a small period during COVID. You recently talked about investments you wanted to make in the network. Once the deal hopefully closes at some point in the first quarter, I guess the question is do you expect to continue to be on an efficiency journey fully recognizing that the cost saves obviously make it easier but just curious how you're thinking about efficiency for the consolidated company over the medium term fully recognizing that there's going to be a lot of noise in the results.
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Richard Fairbank25:20
So, we look forward to the completion of our deal and actually getting inside the financials and the performance and all the details of the business, the businesses at this rather remarkable company, Discover. But as we've talked about, when we look still from the outside, we see just a great opportunity there. And of course we have said there are three areas that are going to need continued investment when we think about virtually anything that all the strategic upside of this Discover deal. It's sort of all roads lead through three areas kind of obvious areas of continued investment. The first of course is compliance and risk management. Discover's really been leaning into that and we of course are doing everything we can to prepare to continue to lean into that and we'll do whatever it takes on that front. Obviously that's an investment. The second is network acceptance. We've talked about how struck we are and how struck we were to find out and confirm just how good the acceptance is in the United States for Discover. You can see in fact they've been putting some ads on TV touting that and it's a very good story. And internationally they've been investing there and focusing on where their customers travel and they've made a lot of progress there. When we look at our customer base at Capital One and where we would love to be over time in terms of being in a position to add more and more volume onto the Discover network, we think an incredibly important objective is to increase the depth and breadth of acceptance internationally, sloping the work of course working backwards from where our customers and Discover's travel. So that's going to be a multi-year thing. That's a very important strategic imperative for us. And the third one will be building the network brand. We plan to keep the name Discover for the network. We think it's a great brand and we're really happy with the underlying reality of where acceptance is. We know there are challenges in terms of consumer perception relative to those realities and we know also we need to in fact build the international reality and then the brand perception that follows that. So those are the three strategic investment areas that we've been identifying really since the start of the deal.
And back to your question about how that fits in relative to efficiency ratio. We of course on the Capital One side have had a long decade-long journey of continuing to improve operating efficiency ratio and it's striking that that improvement has come even as we have continued to really ramp up investment in technology. Now the way that paradox works is the technology we're also investing more in technology and at the same time getting all the benefits on the efficiency side both in terms of growth and in terms of cost that come from such an investment in technology. So the engine that drives operating efficiency ratio strategically will continue at Capital One and it should continue with the combined institution as well. Now then you ask will the big three investment areas that we talk about, what will that do to operating efficiency? I think at Capital One we always have strategic imperatives that we're investing in. I think the overall picture of how Capital One's tech journey helps pay, one of the important ways investors get paid is through operating efficiency improvement. I think that story stays strategically intact even as we have new investment areas because we'll also have new areas to capture synergy and growth opportunities and things that really wouldn't have been possible for either of our companies alone. So thanks for the question. Operating efficiency is a really important way that we create value for investors and in the long run we continue to really see increased opportunities there.
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Jeff Norris31:02
Next question please.
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Operator31:05
Thank you. Our next question comes from Terry Ma with Barclays. He may proceed.
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Terry Ma31:11
Hi, thank you. Good evening. I wanted to follow up on credit first. It seems the trend that we've seen for the second derivative suggests there's room for that to continue to go lower. Is there some sort of framework to think about how much lower delinquencies can go trending forward? And is there anything in the near term that can cause this second derivative to inflect higher again? And I have a follow-up.
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Richard Fairbank31:39
So Terry, yes. Thank you for the question. Obviously, since the founding of the company, we've always had our microscopes out looking at delinquencies because they're the single best predictor of credit of all the metrics. There are many metrics we watch, but that certainly is at the top of the list. And it is, I think, a really important milestone to finally have the second derivative cross the horizontal axis, effectively. We certainly note that milestone. The first thing I would say about as we all get our microscopes out to look at trends on a monthly basis is to just talk about seasonality itself. And we don't publish a seasonality curve per se because there's no precise benchmark with which to do it. But we certainly like to guide our investors about how we think about that. Seasonality for Capital One has tended to have more amplitude up and down over the course of a year than most other card players. And one might ask why is that? We believe that the biggest driver of seasonality, while there are several, the biggest driver of seasonality is tax refunds. And since we have a larger subprime book than most other players who really don't do subprime, those customers do tend to have higher seasonality in their credit performance than folks higher up market. So I think that's why Capital One has a greater seasonality effect. And for these customers in particular, tax refunds in terms of the monthly flow of cash can end up creating something very nice that comes seasonally and some of that makes its way into payments. Now, the changes in the tax withholding rules a few years ago led to fewer tax refunds and lower average refund payments and the IRS was also paying certain refunds later than before. So, that created a lot of noise. As I've been saying on recent calls, you'd think it would be easy to reestablish a seasonality curve, but while credit was normalizing so dramatically, it was sometimes swamping the seasonality effect. But we created this sort of detrended seasonal curve from 2023 to the best we could and that turned out to be right on for 2024. If I were to pull up and summarize what we saw in 2024, 2024 settled out with fewer refunds paid than before the pandemic and about 25% lower total refund volume in real terms. Delinquencies moved with our new post-pandemic seasonality benchmarks which have similar timing. But if I were to summarize what this new curve versus the one we've had for many years, it appears to have about 35 to 40% less amplitude in both directions than in the past.
So that's the backdrop for now when talking about the credit performance that we see. If you start with the foundation that the consumer is in very good shape, the economy is in quite good shape overall, you would certainly feel there's a gravitational pull toward even better credit in the business that is helped by the math associated with recoveries. Our recoveries rate has been very constant but the recovery inventory that we have had to collect on got very small during the pandemic and that has been replenishing. So there's a good guy gradually coming as recoveries fully restore. And then that really gets us to whatever effects there are of inflation, whatever effects there are on the consumers on the tails that are not in as good shape as the averages that we all look at. And what we see there is probably the way that the delayed charge offs are actually playing out. They're probably playing out exactly through these consumers on the tail that are still struggling at the margin. So the credit metrics are looking great. We have more solid benchmarks, Terry. The consumer's in a great place, but the bigger picture phenomenon of delayed charge offs still has intuitively to play out. And these effects going on at the tail puts us in a position not to be declaring that things are headed down from here, but it's certainly positive indicators that we see at the margin.
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Terry Ma38:41
Got it. That's helpful. Maybe just to talk about the auto business. You called out the loan book return to growth this quarter. So, we expect you to lean into that and see loan growth accelerate. And maybe can you just talk about the overall profitability of the loans you're booking today versus what you've seen historically? Thank you.
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Richard Fairbank39:06
So, we feel very good about the auto business. The credit performance is really striking. In fact, let's just savor something that is an outlier relative to the industry. Our auto delinquencies have remained consistently below pre-pandemic levels and they've been lower on a year-over-year basis for the past two quarters. So the auto business is, when you compare it to our card business, the degree with which we intervened in the business and trimmed credit around the edges might have been even more dramatic than what we did in the auto business over the last few years. When we were worried about margin pressures in the business as prices were not being passed through from inflation pressures, declining vehicle values, and inflation of credit scores, all of that led us to pull back. And each of those have been resolving themselves. You asked about margins. The margins are much more normal in the business right now. The great inflation on credit scores is resolving itself as credit normalizes. Vehicle values? We'll have to continue to keep an eye on those, but pulling way up on the shoulders of a lot of the changes that we have made and the technology that we have massively invested in this business in underwriting and in originations and in our auto navigator platform, all of those put us in a position to feel bullish about leaning into auto. All the trends that we see on margins, credit, and competition we feel good about, and that lines up to a story of leaning in on the auto business.
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Jeff Norris41:50
Next question please.
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Operator41:55
Thank you. Our next question comes from Rick Shane with JP Morgan. You may proceed.
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Rick Shane42:00
Thanks for taking my question. Hey Rich, you did a great job laying out the factors that have caused the historical relationship between labor and credit to weaken. And one of the factors you mentioned was the impact of rates. And that makes sense. Credit cards are, you know, one of the two largest classes of floating rate consumer debt. As we think about reversion to historical norms, should we expect charge off rates to be structurally higher as long as interest rates are structurally higher, or is it possible to get back to historic loss rates in a high interest rate environment?
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Richard Fairbank42:44
You know, it's a great question. It's interesting how all of us, some of us were around doing similar things back when inflation was really raging the last time. But I think we would be speculating there. But if we pull up and think about interest rates and their impact, we think about how higher rates affect consumer credit. Debt servicing burdens for consumers can get affected. Higher rates as they work their way through consumer products gradually but not immediately make their way into higher debt burdens. So you have mortgages that tend to have fixed rates, auto loans have fixed rates. So you have time delays before interest rates make their way to more pressure on consumers, but still that effect can continue. Most credit cards have variable APRs. So rising interest rates have tended to lead to somewhat higher minimum payments for consumers overall. But if we pull up, I think that if wages stabilize and tend to keep up with inflation, I would think on the credit card side it is plausible that charge off rates could be very consistent with what they've been in a lower ambient rate environment. I think it gets very challenging when they're suddenly in motion up, but if they stabilize, I'm just speculating here at a moderate level that's higher than they were for the last couple of decades. I think as wages stabilize to make real incomes move the way they should, I would think that credit numbers could be very consistent with historical patterns. I think the biggest driver of why they're not right now, if I were to speculate, probably number one on my list is really the unprecedented number of years of which charge offs with all the government stimulus and the forbearance that so many consumers got a lifeline that for those for whom that lifeline was a little more.
temporary in its benefit. Some of those issues are still resolving themselves in terms of current charge offs. It's always an interesting thing to just take a look at the area under the curve in credit losses for, you know, if we look back over the last number of years and look at where credit losses would typically have been versus where they were and you look at the area under the curve and ask yourself, well, what if all of that were delayed charge offs? You know, you still have a majority of that area under the curve that would still have to play out in terms of delayed charge offs. That we don't believe that anything close to all of the area under the curve would need to come on the other side. But I think if you know a one-sentence soundbite to me of why in such a benign environment credit losses in businesses like credit cards are running higher than pre-pandemic. It is the delayed charge off effect and time should be our friend there that should resolve itself over time and there are a lot of positive factors behind that that are putting good gravitational pull in the right direction in this industry.
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Operator47:24
Thank you very much Rich. Next question please. Thank you. Our next question comes from John Pankari with Evercore ISI. You may proceed.
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John Pankari47:39
Good evening. Just on the efficiency side, just a follow-up to Ryan's line of questioning. I know you've guided to an operating efficiency ratio in the low 42% range for 2024. Does this 42% range remain the case as you look at 2025 or do you see a change to the upside or the downside off of this level? Thanks.
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Richard Fairbank48:11
So, you know, we I think the operating efficiency ratio has really been, hopefully our investors share our excitement that this 700 basis point improvement that has happened since we began our tech transformation in 2013 has certainly been a... There are multiple things behind that but the biggest driver is the technology transformation and even as we invest a lot there are also ways to create savings through reduced vendor cost, the really high cost of a lot of legacy technology, the benefits on the cloud, and really the ability to then on the other side of the technology transformation sort of rebuild the company and how it operates on a foundation of modern technology and so that's a journey that continues and so we see benefits there. I do want to say though also we've had a lot of beneficial increase in the ratio in the last couple of years and I wouldn't want people to just draw the curve and say wow that thing almost looks like it's accelerating down and we don't give guidance in the short term. There are a lot of things that very important investments we're making in the business but what I like to do is really just point out that when we stand back over a longer time frame and look at the journey of Capital One, this has been a journey for which the efficiency was never the objective function. It was one of the many benefits of a tech transformation but it's very gratifying to see that continue. But I think the extrapolation from any one year to the next is not something that we would recommend. But it's a great long-term story.
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John Pankari50:45
Got it. Okay. Thanks, Rich. And then one quick second one. I assume this will be a pretty quick answer, but would be helpful if there's any have you made any changes to your expected deal metrics tied to the Discover deal either the 15% or greater EPS accretion in 27 or the expense efficiencies or the timing of adding the 175 billion in purchase volume to the network. Thanks.
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Richard Fairbank51:18
Hey John. Yeah, what I'll say is, you know, it's two independent public companies. We still are operating separately at this point. And there are a number of variables that have moved and will continue to move between now and legal day one. And so I'm not going to specifically comment on how any one of those variables or metrics are changing since the deal model. What I will say is, we considered a wide range of outcomes across each of the line items and we continue to be comfortable with the estimates that we included in the deal model. We feel very good both strategically and financially about the deal today as we did nearly a year ago when we announced it. And so as we get to legal day one and put the marks on the balance sheet, we'll provide updates on the relevant metrics at that point.
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Operator52:27
Next question, please. Our next question comes from Mahir Batia with Bank of America. You may proceed.
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Mahir Batia52:39
Good afternoon and thank you for taking my questions. I wanted to start first by just talking about NIM a little bit. You called out the Walmart impact this quarter. Any other callouts for the quarter? I just feel banks have been quite disciplined about lowering savings accounts interest rates as the Fed has reduced rates. Do you think that continues or are you starting to see some demand for deposits or deposit competition ramping as we start contemplating loan growth here into 2025? I guess just related to that if you could just talk about some of the puts and takes on NIM in 2025 that'd be great. Thank you.
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Richard Fairbank53:15
Sure, Mahir. Well, let me start with just reminding everyone that the one thing for sure we know is that in the first quarter we have two fewer days and so that will drive a 15 basis point roughly decrease in NIM. But if I kind of pull up and think beyond day count and look at a longer term, a lot of the same forces that I've been describing for the last number of quarters as potential headwinds and tailwinds still exist today. So, if you think about the headwinds, first of all, we're very modestly asset sensitive. And so you see a small decrease in NIM if rates continue to decrease and you saw a little bit of that effect here in this quarter. The other one you bring up deposit beta. Of course in our rate risk modeling we make assumptions around deposit betas. So to the extent that betas are lower or slower on the way down, we would be a little bit more asset sensitive in that scenario. So those could be headwinds. But on the tailwind side, the steepening yield curve relative to forwards would be a good guy if that persists. But then probably the single biggest factor and we've seen this play out over the last number of quarters is the card growth and card becoming a bigger percentage of our balance sheet all else equal is a pretty meaningful tailwind to NIM. So those are really the forces at play that I would highlight for you.
M
Mahir Batia55:12
Got it. Thank you. And then maybe just turning quickly to capital return. You've been doing 150 million in buybacks last few quarters. Your CET1 is up to 13.5. We understand with the deal you have to get approval for any capital actions. But I guess the question is two-part question there. Is that approval keeping you a little conservative right now and two once the deal is approved should we assume you be pretty aggressive in getting that down or would it probably fair to assume it stays elevated for a little bit even post deal as you get through the integration.
R
Richard Fairbank55:48
Yeah, I'll wrap my answer to both of those questions into one for you, Mahir. First of all, just go without saying, but I will say it, which is we clearly recognize that over the longer term capital return is a key component of shareholder value creation. And you've seen in prior periods, we've executed substantial share repurchases, but in the near term, our pending deal is certainly influencing our approach to capital in a few ways. As you said, we're still under regulatory pre-approval rules for each of our capital actions. And second, we will need to run our own bottoms up analyses as a combined company to just assess our view of the combined capital need and we continue to be two separate companies and therefore don't have the ability to do that analysis until after close. And then third, we will need the Fed's approval to go back to operating under the SCB framework. So, if I pull up from there and put all of those together, I think it's likely we're going to stay at a slower repurchase pace until we resolve these factors, but after that we'll have more flexibility.
O
Operator57:20
Next question, please. Our next question comes from Bill Garcatchi with Wolf Research Securities. You may proceed.
B
Bill Garcatchi57:31
Thank you. Good evening, Rich and Andrew. It was good to hear all the references to the Capital One arena around the inauguration. I wanted to ask about your ability to better compete against the big banks in debit, assuming the Discover transaction closes as you expect. We know debit rewards for Visa Mastercard issuers essentially went away after the force reduction in interchange under Dodd-Frank. But would reintroducing debit rewards be something that you'd consider given the greater flexibility that owning the Discover network will afford you?
R
Richard Fairbank58:06
Hey Bill. So obviously a really key part of the deal is our excitement about getting the network and being able to add such a key dimension in vertically integrating our business and you know we talk so much about credit cards all the time. The debit business is a really important one and on little cat feet, Capital One has really been investing in our national banking business. So and by the way, having our own network will be valuable there and we'll be able to enjoy the vertically integrated economics of owning a network and the scale that comes from pulling Discover and a bunch of Capital One's volume together.
Now, I just want to pull back and just talk a little bit about Capital One's consumer banking strategy and therefore debit is of course right in the transaction business at the heart of that. If you pull way up and think about consumer banking, way back to when banks began, banks with branches on every corner. And then in the last 15 or 20 years there have been the evolution of direct banks and they have been savings only, offering higher rates, and they have no physical distribution whatsoever. And we of course also through our acquisitions have acquired several banks with branches on every corner and we also acquired the nation's largest direct bank and I announced at the time of that acquisition this is a great financial trade but it is also a strategic game changer for Capital One that was back like 12 years ago. So since then we have been very steadily, systematically, relentlessly and patiently pursuing a business model that actually doesn't really exist right now because we have those two end points. But what we're really trying to do is build in a sense the bank of the future. And we believe that bank of the future is not just a direct bank. It's also not a bank with a branch on every corner. It is a bank with thin physical distribution. For us, we've got branches, but then also in major metropolitan areas, we have put in cafes that are really basically less about coffee, but really more about being sort of a hybrid of a branch and a showroom for Capital One and a place people can go and understand Capital One's there to help them and get a sense for really what this company is about and how it may be able to help them live their life more effectively. So this strategy has been about if we work backwards from what we believe is the bank of the future from a distribution point of view that's thin physical distribution and highlighted by these cafe showrooms.
It also a very central part of that is digital capabilities that enable something that's a very difficult thing to do which is to take just about everything that can be done in a branch and make it available digitally. Now, there's some things like safe deposit boxes. We haven't figured out how to create a digital safe deposit box for your valuables. And there are a few things that you can't get there on a digital basis. But as we've looked at this, we said just pretty much virtually all the activities that people go to branches for, we want to be able to deliver to them through our thin physical distribution plus massive full-service digital capability. And that's what we've been building over these years. Additionally, it requires in order to generate business we need great products and we've been the only major bank out there with no fees, no minimums, and even a recent move of no overdraft fees. And those better deals come from having built the superior economics that come from this physical distribution light model. Now then you ask the question so what will be our debit card strategy? We haven't completed the deal. We haven't fully gone in on the other side of exactly seeing how things are working on the Discover side but we are very pleased with the results that we're having with our current strategy including our current debit card strategy and we are investing heavily to continue to grow that business. You look at the significant increase in marketing over the years. One of the drivers of this is that Capital One is building a national bank organically without a lot of physical distribution and to get there it takes a lot of marketing. So I think the best way to think about it is Discover gives a shot in the arm and a boost to a strategy we've been pursuing for more than a decade. And the best way to think about it I think is picture just more of the same from Capital One with a little bit of an accelerator.
B
Bill Garcatchi1:05:07
I appreciate all the details, Rich. Thank you.
O
Operator1:05:11
Next question, please. Our next question comes from Moshi Orinbuk with TD Cowan. You may proceed.
M
Moshi Orinbuk1:05:22
Great. Thanks. Rich, you talked about better growth in auto and card talked about the high-end card. Could you talk about the non-prime businesses in both card and auto given the improved credit? How you're thinking about growth in those businesses in the coming quarters?
R
Richard Fairbank1:05:42
Mosha, the word that I would use at the lower end of the business, obviously there are parts of the market below where we play but if we sort of loosely call it at the lower end of the non-prime or subprime part of the marketplace, the word that I would use to describe it is stability. And stability of let's look at the key aspects of that on the consumer credit side. Actually the first part of our business to normalize, really to settle out with respect to credit, was the lower end of the market. That's been very stable. Our originations in that segment and really pretty much across our business, they the originations are coming in on top of each other for years. So that has a stability there as well. Competitively it's a very competitive part of the business that has many in addition to regular card players many non-traditional players as well. So the competitive intensity is high but we watch it very carefully and so with the stability of performance and the strength of the consumer, we in both the card and the auto side of the business continue to lean in in a very similar way that we have well for card it's just been very consistent for years with auto, we kind of pulled back quite a bit in that part of the business and we're leaning in as we often have done historically. So, we're leaning into both of them and we're really pleased with the stability and strength of the metrics that underly those businesses.
M
Moshi Orinbuk1:07:53
Got it. Thanks. So maybe just as a follow-up when you think about reserve levels given that you are seeing or likely to see some improvement in credit losses kind of on a core basis or like for like and it sounds like the growth you have in the balance sheet is probably going to come in your lower loss categories not the higher ones. Thoughts about the reserve level as we move forward.
R
Richard Fairbank1:08:21
Sure, Mosha. So what's going to happen in future quarters starts with what happened this quarter. So I just want to reiterate a couple of the drivers of this quarter as a jumping off point. As I said in the prepared remarks, coverage was down 33 basis points by two things. The bigger effect being that we typically have seasonally higher balances in the fourth quarter that require very low levels of coverage and that denominator effect from those balances put downward pressure on coverage. The other effect was that the allowance we needed for what I'll call nonseasonal growth was offset by favorable observed credit performance. And so we added zero dollars of allowance balance to the numerator but the non-seasonal growth impacted the denominator. And so in the first quarter I just wanted to provide that backdrop to say the seasonal balances will run off. And so there will be a corresponding upward pressure on coverage all else equal from that effect. But beyond that, it's really going to come down to growth and our loss forecast and loss forecast specifically for the coverage. And to the extent that loss forecast improves, changes in coverage could be modest in the near term as we just reflect the uncertainty of our projections in the allowance. But eventually the improved loss forecast is going to flow through the allowance and continue to bring the coverage ratio down as uncertainties become more certain. And so while the direction of travel would be down, the pace and timing is going to depend on a variety of factors. One of which will include the mix of businesses as you say but when it's denominated to the whole portfolio, the relative growth of different forecasted loss portions of the book aren't going to have a material impact to coverage just given that the new originations as a percentage of the overall book in any given quarter is relatively small. And then the only thing I also want to remind you of is I know our investors look at history as a potential guide for levels of coverage and I just want to remind we called out the roughly 50 basis points of impact to coverage from the termination of the loss sharing agreement with Walmart. So that created a step function change in coverage relative to our prior history as well.
O
Operator1:11:26
Next question please. Our next question comes from Don Vandetti with Wells Fargo. You may proceed.
D
Don Vandetti1:11:38
Yes, Rich. Your credit card purchase volume growth on a like account basis has picked up. I'm just trying to get a sense if this is a Q4 blip or are you thinking that the consumer is actually more confident here after the election and are you seeing that same improvement in consumer and small business as well?
R
Richard Fairbank1:12:00
Well, we have if we think about our purchase volume, our growth and overall purchase volume continues to be driven by growth in our branded card customer base and the branded card includes both our consumer and our small business. The growth that you see and that we've seen for several years now is certainly a thing powering it has been a strength in originations and some strength in originations at the higher end of the market. But the other way to think about your question is at a customer level, what on a per customer basis what's been happening to spend growth and even as our spend metrics were growing overall, the spend growth per customer in our consumer business have been largely flat through 2023 and really the first half of 2024 and then they started to pick up midway through last year and they grew further in Q4. And I don't have in front of me the small business card numbers, they're embedded in the numbers that I gave you. So the fact that we have seen spend per customer finally pick up here is striking. Whether it will continue and exactly what's driving it is hard to say, but I did want to point out that positive trajectory as the year finished off.
D
Don Vandetti1:13:58
Got it. And Andrew, you touched on this, but your 24 vintage. Can you talk a little bit about how you're feeling, how you're seeing that shape up in terms of credit performance? I've seen some industry data that shows delinquencies are still pretty high for 24.
A
Andrew Young1:14:15
Yeah, Don, why don't I take that? So, recent originations in our card business, we continue to see stability in the performance of our originations. It's really striking here. We've been calling this out consistently over the past few years. Vintage over vintage, we're seeing mostly stable risk levels over time. And also striking is our overall front book of new origination vintages continues to perform in line with pre-pandemic vintages. Now, when you compare with pre-pandemic vintages, you can't look at 2019 because 2019 very quickly got sort of corrupted by the pandemic. So, we're looking at 2017 and 2018 when we make these comparisons. But from a Capital One point of view, I think this stability in origination performance quarter over quarter and the consistency with pre-pandemic is the result of our intervention to deal with inflated credit scores and the high level of industry supplies that were flooding particularly the subprime marketplace back there. So, we trimmed around the edges and continued to very closely watch the origination vintages and that has led to a sustained stability on the part of Capital One and some of our most recent vintages. Now again, we're still looking. You got to look like 6 months in the rearview mirror to see much, but we continue to see some very positive results there. We also have looked at industry data that shows some gapping out in vintages over the last couple of years. So I think the industry effect is not probably consistent with what we have described and if I were to explain why because I think they're very capable companies doing this, I think the I'm not sure that most of the industry adjusted for inflated credit scores and we intervened on our models with a belief that the university was suddenly giving out A's that should be B's basically and so we intervened and then kept validating along the way but for a while we didn't have validation we just intervened because we believed it was the right thing to do. So I think what we have seen if you look at just overall industry originations is as you say some gapping out and I think that would be the biggest driver.
O
Operator1:17:36
Next question, please. Our next question comes from Sanjay Sacrani with KBW. You may proceed.
S
Sanjay Sacrani1:17:48
Thank you. I guess Rich, just one more on the deal. Given the timeline that you've outlined early this year, is it fair to assume like everything's going pretty smoothly in terms of the regulatory approval process and there hasn't been any surprises? I'm also wondering sort of where you guys are in terms of the integration efforts and how much work has been done there.
R
Richard Fairbank1:18:15
Okay. Yeah. So the approval process continues to move forward. We've made substantial progress in recent months. We remain actively engaged with the Fed and the OCC about our merger applications and it is the Fed and the OCC who ultimately decide on our merger application. Late last year we received approval from the Delaware State Bank Commissioner which we needed because Discover is a state chartered bank. We of course had the big public hearing in July and that went very well. Earlier this month we finalized a joint proxy statement with the SEC setting up the February 18th shareholder vote. So that was good progress. We are also engaged with the Justice Department as they play a key role in advising the Fed and the OCC on the competitive aspects of the deal. And we continue to believe that this transaction is both pro-competitive and pro-consumer, bringing our best-in-class products and services to a broader set of consumers and small businesses and really enhancing opportunities and benefits for merchants as well. So pulling way up, it's certainly the deal process is a long labor but we remain well positioned to get approval of the deal early this year and I'm really proud of the work everyone is doing here and we look forward to getting this over the goal line.
S
Sanjay Sacrani1:20:10
Okay, just to follow up on a question Ryan asked some time ago on sort of when you put the companies together and the efficiencies and sort of the investments that need to be made. I guess when you put the two companies together, the efficiency ratio actually goes down. And obviously there's a lot of synergies both on revenues and expenses. Do you think those are sufficient enough to accomplish I'm just trying the question again. Do you think those are sufficient enough to make all of the investments that you sort of outlined or do you think that there's others that you might have to make as you peel the onion a little bit when you have the company?
R
Richard Fairbank1:20:47
So, I don't think we're in a position to it's not just because we want to be coy about it. We're not in a different place than we were at the time we announced the deal. And we should point out that we are working really hard preparing for integration, but we are still separate companies and Discover is working incredibly hard and working on their compliance and I know they're doing preparations for integration as well and we certainly are. We're not getting an inside view of their numbers, their performance, their business model. So, we're mostly sort of where we were at the outset.
But if we pull up to your point, so Discover operates with a significantly lower operating efficiency ratio than Capital One. That's certainly a good thing for the combined company. I think it is also the case that Discover has had a heritage of probably less investment in certain areas than Capital One and in a few cases they're sort of making up for lost time there. But I think having not seen on the other side, we assume that there's some areas that we will and we've assumed this from the beginning. We're going to need to step up the investments in obviously on the risk management side. There's a lot of investment to be done. Whether it is how what ultimately needs to be done compares with what they're investing and all of that remains to be seen. We obviously had assumptions in our deal model about leaning in on that, but what we get so there's going to be a lot of effects that are all pretty significant that just go in different directions. A company with an amazing efficiency ratio, a company that's probably underinvested in a number of areas relative to Capital One, and we would shore up some of those investments. We also get a lot of synergy that comes from bringing overlapping businesses together. That's a very strong effect. And then these three investment areas we are talking about investing in those at a level that's a lot different than what Discover has done traditionally. Obviously, the risk management one, we've all talked about that and they're leaning in hard now on international acceptance. They certainly I again I'm amazed with their not that great scale what they've done but we would expect to invest at a higher level than they have there and in terms of the network brand I want to just make a comment about the network brand and some of this other investment. It is we have sloped we have taken our card business and sloped the business that we think most naturally and easily can go to the Discover network and it involves folks that aren't big international travelers for example. So we've sloped the work. There is we think it's very straightforward to move this business front book and back business to Discover and some of these investments that I'm talking about leaning into are particularly important for the longer term opportunity of being able to move more business than what we put into our deal model. And again in doing that we would we sloped we took our whole customer base and imagined sloping it in terms of what part of the business fits most naturally within the context of the capabilities and the brand of Discover's Network. And then as we want to move more we're going to need the bar to be raised relative to acceptance and brand. And that's why I think these other investments we're talking about will be multi-year. They'll be over time and there'll be things that help make the deal pay off even more so in the longer term.
O
Operator1:25:41
Next question please. And our final question comes from John Hec with Jeffries. You may proceed.
J
John Hec1:25:55
Good afternoon guys and thanks for fitting me in here. First question just you thinking about the mix of the overall consumer book. I mean you've got some new cards like the Venture One and Quicksilver and some of those are attractive to different demographic groups. And then you've got the subprime mix and then you've got auto. Where do we see just given kind of inbound customer mix? Where do we see that going this year as a standalone business? And then Rich, do you have any comments of what the total portfolio might look like assuming the combination with Discover?
R
Richard Fairbank1:26:41
Yes. So, thank you, John. So let me take Discover just in a minute. So if you pull way up on Capital One for a long time Capital One has been a full spectrum player. We have had for several decades a subprime business that is tailor made for the information-based strategy we have because it's all about surviving and winning on the credit side of the business. But also in that business, we've also very much focused relative to others who play in the space to offer exceptionally good deals that it's not just about surviving on the credit side, but really giving great deals, helping people use credit wisely and in fact I think the deals that we're offering are very simple and profoundly better than a lot of the deals that are available in the marketplace. And so that business is a very stable part of what we do at Capital One. And we continue to lean into that. The most dramatic thing that's been happening in the last decade in Capital One's card business is the quest toward the top of the market. And that is a journey that as far out as we can see we will continue to lean into because there is so much opportunity at the top of the market and obviously it takes a lot of investment. But the key indicator to us that when we stratify out the segments of our business by spend levels, the part that's growing the fastest consistently year after year at Capital One is the heaviest spenders. And there's just so much upside north of where we are. We will continue to invest in that. Now, if you stand back, just think about our card business. While our subprime business has been going along and we keep leaning into that, there has been a gradual mix shift up market for the company and even within each segment within the subprime book, the prime book, and certainly the top of the market there has been a gradual mix change with a spender first philosophy that permeates our business and some of that you can see in just some of the structural changes in the payment rates at Capital One. So I believe that what you see and what you have seen for a number of years is a good prognosticator of probably out of the future of legacy Capital One would likely go meaning continued leaning in across the spectrum but differentially an awful lot of investment toward the top of the market and the most growth opportunity there.
Now let me turn to Discover. Discover interestingly has taken a very different approach than Capital One. While we have taken a very broad approach playing in all parts of the market, Discover has had a very focused strategy on the prime part of the business and they've done a very good job there and we certainly always admired them from the outside. So we will be bringing into our company a significant increase in that portion of the market which probably differentially got a little less emphasis if anything. It's not like we weren't playing there but if anything we had a greater emphasis probably north and south of that part of the business. But from a mix point of view, we will be bringing in a business that's very homogeneous relative to the very heterogeneous business that we have. And then on the other side of all of that, I think that if I were to summarize our strategy, it will be to continue everything we were doing as Capital One because we're getting a lot of traction in that and then making very sure that we don't crush the butterfly of this beautiful business model that Discover has in the prime part of the market, but that we go in there and while integrating things like technology and some of the risk management processes and a lot of things, do everything that we can to make sure that we don't directly or even unwittingly sort of crush the really nice butterfly of what they do. And in that way we hope to bring in a growth business that Discover has and add it to the very complementary growth businesses that Capital One has and collectively continue to try to get the best of both worlds, bringing along the way some better efficiencies and really bringing top technology to all aspects of the business.
J
John Hec1:32:34
Great. Very much appreciated. Thanks.
R
Richard Fairbank1:32:37
Well, thank you everyone for joining us on the conference call today and thank you for your continuing interest in Capital One. Have a great night everybody.
A
Andrew Young1:32:44
Thanks everybody.
O
Operator1:32:46
This concludes today's conference call. Thank you for your participation. You may now disconnect.