Capital One Financial Corp (COF) 2002 Q1 法說會逐字稿

Good afternoon. My name is and I will be your conference facilitator. At this time I would like to welcome everyone to the Capital One financial first quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer period. If you would like to ask a question during that time, simply press star and then the number one on your telephone keypad and questions will be taken in the order that they are received. If you would like to withdraw your question, press star and then the number two on your telephone keypad.

Thank you. I will now turn the call over to Mr. Paul Paquin, vice president of investor relations. Mr. Paquin, you may begin your conference.

Welcome, everyone, to Capital One's first quarter, 2002, earnings conference call. As usual, we are webcasting live over the Internet. For those of you who would like to access the call on the Internet, please log onto Capital One's home page at www.capitolone.com and follow the links from there.

The statements made in the course of this conference call that mention the company's management's hopes, intention, beliefs, expectations or predictions of the future are forward-looking statements. It is important to note that the company's actual results could differ materially from those in such forward-looking statements. Additional information concerning factors that could cause actual results to differ materially from the those in the forward-looking statements is contained in the company's SEC filings, included but not limited to the company's report on Form 10-K.

Our Web site at www.capitalone.com contains all of the recent SEC filings as well as our annual reports, quarterly earnings information and monthly asset backed securitization performance data. The investor relations staff will be available after the conference call this evening to answer any remaining questions. When you do call, you can ask for me, Jenna McCabe or Jim Rothberg. We would appreciate any comments you may have regarding the conference call and any suggestions for improvement on future calls.

With me today on the conference call are Mr. Richard Fairbank, our chairman and chief executive officer, Mr. Nigel Morris, our President and Chief Operating Officer, and Mr. David Willey, our executive vice president and chief financial officer. At this time I'll pass the call over to Mr. Fairbank for his remarks. Rich?

Thank you, Paul. And thanks to all of you for joining us on the call today. Capital One reported record earnings per share of 83 cents in the first quarter of '02. This was our 19th consecutive quarterly earnings record, despite spending a record $354 million on marketing. We posted the best credit performance in the industry with a charge-off rate of four percent. In addition, we strengthened our balance sheet by adding $150 million in equity capital through our dividend reinvestment plan and by adding $150 million to our allowance for loan losses.

We continue to find excellent growth opportunities. Our managed loans grew by $3.3 billion during the quarter to $48.6 billion and our accounts increased by $2.8 million to $46.6 million.

So what's driving our growth at Capital One? We are enjoying success from a much more diverse range of sources than we did just a few years ago. We then and beyond our domestic card business. Auto finance, installment loans and our international business are each now growing faster than domestic credit cards.

Auto loans in the quarter increased by $1.3 billion or 127 percent annualized. Installment loans grew by $390 million or 54 percent annualized. And international loans increased by $264 million or 26 percent.

Our domestic card business also continues to grow successfully as well, growing by $1.8 billion or 16 percent annualized. We have achieved penetration into the U.S. card market. Beyond our earlier segmentations along credit risk dimensions we now are focusing our efforts by product, by channel and by customer segment with great results. We have made major inroads into businesses such as retailer cards, lifestyle cards, charitable giving cards, small business, young adults, students, Hispanic, Internet and airline mileage programs for example.

In fact, Capital One has become passably the most broad based player in the domestic credit card business, quite a journey from our role as sort of a niche player a few years ago. Our growth is also driven by the success of our brand strategy which has moved Capital One from a relative unknown into the awareness levels of the top few players in the credit card industry.

Finally, our growth is driven by offering best -- in-class products in every segment including the lowest APRs in the nation and credit cards, installment loans and auto finance as well as the lowest cost APR in the United Kingdom. Our low-price strategy is enabled by exceptionally low charge-offs. Our charge-off rate in the first quarter declined to four percent from 4.42 percent in the previous quarter. This decline is due partly to the expected seasoning of a large number of accounts booked in the latter part of 2000 for the accounts have in fact moved past their charge-off peak. So this is sort of the other side of seasoning when you get on the other side of the charge-off peak.

We also enjoyed some seasonality benefit in our recoveries business that we tend to see in the first quarter and our credit performance is also in part due of course to the fact that the consumer has held up strikingly well in a weak economy.

Despite the growing prospects for the improved economy we still expect Capital One's charge-offs to rise, especially in the second half of the year. Just like last year, the expected increase is due to the seasoning of a large number of accounts we booked at the end of last year. This seasoning will be augmented by the fact that loan growth this year, while strong, will be well below the 54 percent rate of last year.

Although charge-offs increased significantly from the temporary low of 4 percent this quarter, we expect that Capital One will remain one of the credit quality leaders in the credit card industry.

Also, as we look out over this year and begin to examine the growth opportunities available to us, we know that we need equity capital. In January of last year, for example, as we started to grow our managed loans at a rate significantly faster than retained earnings, we issued $413 million in common stock to support our growth into 2002. And today, we announced the launch of a mandatory convertible security transaction for $500 million in capital that will help support the growth opportunities that we now see.

Dave Willey will provide more details of this offering in a moment. At this point I'd like to pass it over to Nigel for his remarks. Nigel?

Rich, thanks very much. Good afternoon, everybody. I'd like to add to what Rich said with a few comments about the outstanding results we posted this quarter.

In the first quarter, our revenues surpassed $2 billion for the first time ever, growing at a 32 percent annualized rate. Revenue per account rose to $184 annualized, up from $172 a year ago. Our revenue margin declined from $18.62 in the fourth quarter of '01 to $17.83 this quarter due to a more modest contribution from non-interest income.

The net interest margin improved by 19 basis points from $8.68 to $8.87, up 19 basis points due mainly to lower funding costs on the margin. The margin was negatively impacted by the improvement in delinquency, a trade that we will willingly make any time. The share of the portfolio at introductory rates of interest rose modestly from 12 percent to 13 percent. Approximately $4.1 billion of these balances are scheduled to reprice equally over the next two quarters.

Non interest income grew at a modest 8 percent annualized during the first quarter, consistent with seasonal trends income fell back from the fourth quarter and as our risk pitch improved, our over limit income also diminished. Annual membership fees and cross sell income grew substantially during the quarter.

Despite a banner charge-off number which improved 42 basis points, our risk adjusted margin fell modestly from $12.96 to $12.78 due to the relatively modest growth in non-interest income. Even so, Capital One continues to have the strongest risk adjusted margin among the major players in the industry.

Turning now to our expense picture. Excluding our record marketing investments, our expenses rose just 4 percent during the quarter while our accounts grew by 6 percent. Consequently, our cost per account continued its historical trend of improvement. Operating cost per account fell from $74 in the fourth quarter to $71 this quarter. In the last 11 quarters, our cost per account has fallen by 22 percent. In the last 12 months, by nine percent. Today, we have the lowest cost per month in and now rival our peers amongst the banks. Our cost are falling across all business lines and all geographies and we have been able to harness technology, process improvements and selected outsourcing opportunities as well as taking advantage of scale to drive these number down and we have done this while continuing to improve our service delivery to our customers.

Now, the gains in the first quarter were achieved despite continued incremental investment in collections and recoveries. Our recoveries unit set record gains this quarter for dollars recovered where we continue to achieve tremendous paybacks against our gross charge-offs.

Going forward, we expect to increase our investment even more in technology to improve our cost position and anticipate that our unit cost improvements will be more modest throughout the remainder of the year.

We were honored in the first quarter by a number of magazines. "Card Marketing Magazine" named us "Card Marketer of the Year" recently for the second time in the past three years and recognition from the likes of "Fortune" magazine who named us to the list of the "100 Best Places to Work for in America" for the fourth consecutive year, and the "Sunday Times" who named us to the list of the "100 Best Places to Work in the U.K." for the second consecutive year allows us to continue to attract and retain the best and brightest talent on the planet.

We have been successful in adding a number of hires to our senior management team this year and our voluntary attrition rate is running at a very low nine percent year to date. Our business model is clearly hitting its stride. We are proving that we can profitably grow through a recession, something that we have relentlessly prepared for since our IPO in 1994. Our unique information based strategy has enabled us to maintain our discipline when some others have lost their way and we look forward to the opportunities that a mending economy will give us in the year 2000. With that, Dave ...

Thank you, Nigel. Good afternoon, everyone, and thanks again to all of you for participating today. I'll share some comments on our balance sheet and funding activities and then I'll turn it back over to Rich for some closing comments and question-and-answer.

In the first quarter we once again succeeded in accessing diversified financing sources in large volume despite volatility in our markets reflecting the uncertain economy and concerns about other consumer lenders.

We continue to be a leading issuer in the credit card asset backed market. In January we priced a $1 billion, seven-year credit card deal and followed that success with a $600 million, five-year issue priced last week. Both transactions were initiated in response to investor interest in a subordinated class which is typically the most challenging the place.

We further expanded our global funding reach by pricing our first public credit card securitization in the U.K. earlier this month. the transaction supported the growth of our European bank and at 357 million pounds or about $500 million, the transaction was the largest sterling denominated credit card transaction ever. All three asset classes met with strong investor demand creating positive momentum for future U.K. securitizations.

We also are continuing to grow our auto securitization efforts. Earlier today, in fact, we priced a $1.2 billion transaction, our first auto deal of the year. In response to heavy investor demand, the transaction was actually upsized by $200 million and priced at a narrower than the levels for our competitors. This transaction will be accounted for as financing and will therefore remain on the balance sheet.

Overall, off balance sheet loans constituted 50 percent of total managed receivables at the end of the first quarter, down from a more typical 54 percent at year end. We expect this ratio to return to the mid 50 percent range over the next several quarters. Meanwhile, our deposits grew by $1.8 billion to $14.6 billion during the quarter and now constitute 28 percent of managed liabilities or 53 percent of our reported balance sheet.

The past quarter also demonstrated our continued commitment to maintaining a strong balance sheet. We approved our parent company liquidity in late January through the issuance of $300 million of five-year debt. -- a $150 million increase in loan losses, as Rich mentioned, was a record, bringing the allowance to $990 million or 4.05 percent of reported loans.

We also continue to be conservative in our revenue recognition. We make conservative assumption in the calculation of FAV140 gains on our off balance sheet securitizations and have chosen to keep our auto deals on the balance sheet, avoiding gains entirely. In addition, since 1997, we have always reduced our current finance charge in fee income and our loan receivables balance for amounts that we have billed our customers but do not expect to collect. We will continue to focus on maintaining conservatism in our revenue recognition and reserving policies.

We also strengthened our balance sheet by increasing equity capital during the quarter. We raised $150 million of common stock during the quarter in several transactions through our dividend reinvestment plan or DRIP. The combination of the DRIP issuance and earnings retention contributed to the addition of over $350 million in equity during the quarter, increasing the ratio of capital to manage assets by 30 basis points to 6.82 percent at quarter end. The DRIP provides a low-cost channel for raising modest amounts of equity as needed without the market disruption that can result from larger transactions.

Now, as Rich mentioned, we have chosen this time to supplement our capital base further and today we launched a public offering of mandatory convertible securities and there will not be any effect on ROE before the conversion and no immediate impact on EPS. This issuance will not affect our ability to achieve our 20 percent EPS growth target for 2002.

The rating agencies view this structure as a strong source of financial flexibility. According the mandatory convertible issuance will provide the capital strength to support our needs in the foreseeable future. The expansion of our funding programs, a conservative loss reserving and revenue recognition and our capital that will continue tomorrow, we very well positioned to support our profitability growth in our businesses. We look forward to executing on those opportunities during the rest of the year.

And now, back to Rich.

Thank you, Dave. These are interesting times for all of us. We've seen September 11th, the weak economy, the fall of Enron, Arthur Andersen, the troubles of Providian and others. And the fallout of an uneasy business climate that is likely to last well after the recession ends. In our own industry, in credit card, the challenge continues. The first quarter witnessed declining growth by most of the major card players. In this environment, we have been very well served by the conservative approach that we have taken to credit quality, accounting and overall risk management.

And we are also benefiting from years of investment in our future. Vigilant as always about the risks and uncertainties of today's environment, we still though can't help but feel particularly good about our situation at Capital One. We are enjoying tremendous earnings power. We are deploying lots of this earnings power into our future in the pursuit of exceptional marketing opportunities. These marketing opportunities are coming from a much broader range of sources than a few years ago. Credit quality continues to be strong, and the prospects for the economy are improving.

We are benefited by the interest rates environment supporting our marketing strategy and our brand campaign is working beyond our expectations. We believe that we are very well positioned to continue the growth trajectory of Capital One. And this point I'll pass it back to Paul to start the Q&A session. Paul?

thank you very much, Rich. And, Mitch, could you start the Q&A session, please?

Ladies and gentlemen, at this time I would like to remind everyone, if you would like to ask a question simply press star and then the number one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster.

Your first question comes from of Deutsche Bank.

I'm surprised. I'm usually never first. The growth in the auto -- the $1.3 billion which accounted for about 40 percent of the total growth in the first quarter -- could you -- do you have an idea of what you expect the full year percentage of auto to be?

I think, , that this quarter is a higher growth rate than we will see in the rest of the year. I think we'll have a strong year of growth in auto finance. I think this was an exceptionally strong quarter and we took advantage of certain opportunities that existed in the marketplace.

Next question, please.

Your next question comes from , KDW.

Good afternoon, guys. If possible, could you talk about some of the terms of the $500 million convert and go through the philosophy of the convert versus straight equity and raising equity capital?

Vincent, I'll tell you, we'll respond to frankly only part of that. The terms of the offering and all of that will be determined in the marketing and through the underwriters. So I think a lot of the specifics will be there. The basic thrust of it is, it's really a unit of two securities, a bond and a forward purchase agreement. The forward purchase agreement has a -- in circumstances do we issue equity below today -- the price at which the stock is when the deal gets done. And on the upside scenario we issue fewer shares accordingly.

The philosophy of it is that it's an efficient way to capitalize the company. As I'm sure you know, the capital base of the company is almost entirely in common equity and retained earnings. There's really very little -- actually really no preferreds or anything like that. We were looking for a security that would be -- both have high equity content and which it does due to the mandatory nature of the conversion. And it would also be a bit more investor friendly to our current holders in the sense that it does not produce EPS dilution and so the share price escalates quite a bit and has no impact on ROE internal conversions. So it's an efficient way to capitalize the company and as we've always said, we felt like it addressed the needs of all the different constituencies that we're interested in taking care of.

Thank you.

You're welcome.

Next question, please.

Your next question comes from of Goldman Sachs.

Hi. Maybe this is for Dave or Rich or Nigel too, but given some thought about how we -- you would guide us or how we would think about the capital mix allocation adequacy versus the new regulatory guidelines and, you know, on installation, auto, sub-prime, you know, and how we think about capital allocation and mix in that context on a go forward basis.

Bob, it's Dave. I'll take a cut at it. I think the -- the first thing to note I think is really not -- I don't see anything different, particularly going forward from here. And broadly, when we think about our capital models and capital allocation we pay an awful lot of attention to the development out of the marketplace, both regulatory certainly but also rating agencies and everybody else who has an opinion about Capitol.

And the regulatory developments that we see going on in particular have actually been under way for a number of years and if you pull way up on it, you know, just the nature of consumer lending has changed a lot over the course of the last decade from the advent of securitization to the lending to folks that didn't used to be lent to in the old days. So a lot of the developments that you see that have been unfolding over the course of the last couple of years are really regulators trying to adjust the way they're looking at the world to reflect the changes that are happening there. So we've been taking all of that under advisement and into account as we figure out for our own economic Capital motto of how it is we ought to be capitalizing our business.

So when you look at our capital ratios over time we've always been well in excess of the regulatory amendments so clearly the models we've been using are much more oriented towards the kind of direction that the environment is going now. So just broadly, we clearly put more capital against our assets with higher credit risk and less capital against those with lower ones. So you know where the products you mention fall out so I won't recap all that. But, you know, we continue to be very cognizant of the developments in the marketplace and as you know from following us for so long, you know, we like to anticipate this stuff and be ahead of it. So we feel like that's where we are.

Next question, please.

Your next question comes from of Legg Mason.

Hi, thanks. A couple of hopefully quick questions. One, can you address if there are any sort of mix issues that are affecting interchange income. We only get it on an owned basis, but it's only up 31 percent year over year with the owned portfolios, up about percent. I would expect the interchange would increase given the superfund additions to the loan mix. I'm just hoping that issue. And then also your comment on the recoveries is quite interesting. And should we expect recoveries to maybe not fall in dollars but sort of contribute less to the net charge off rate as the year progresses? Thanks.

Hi, . This is Nigel Morris here. Let's deal with the issue of interchange. There's been a shift in the portfolio over the last year or so as we have built the Miles One agnostic frequent flyer programs which have very high interchange volumes. And that's led to a movement -- a trend across the year. Now, in the fourth quarter, last quarter, you know, as seasonality would dictate there was a huge increase in interchange which has dramatically fallen off on the fourth quarter. And what we expect to see as the year flows through is that the second quarter will bounce a little bit in interchange, buoyed by the fact that the -- as we build the portfolios in the airline sector and we'll see interchange grow as a piece of the P&L as we go through the rest of the year.

We -- Dave is going to add to that -- register with the recoveries issue. And what we've seen in recoveries is, you know, the benefit I think of tremendous investment in this area over the last few years. We have levied the full power of our information based strategy against recoveries. We've taken it very seriously as a business while I think many of our competitors have just actually sold their charged off debt which has led to extraordinary performance.

And what we saw in the first quarter was a step function in terms of the performance of our recoveries unit. Now, we think that's down to, one, our investments, as I mentioned. Two, down to the fact there was no recession and of course we anticipate that the recoveries would be a canary in a coal mine here and that -- the recoveries would start to diminish fast if the recession impact really hits us.

But thirdly and very improvement is the seasonality of recoveries which we have seen actually accelerate over the last few years. I think the advent of taxes being able to be filed and monies moved around electronically means that people have more money earlier in the year and I think that has really encouraged our recoveries efforts in the first quarter. We do not expect to see the same kind of gains in recovery performance in the second and third quarter though we'd be very happy to the kind of performance that we got in the first quarter.

I'd like to elaborate a little bit on Nigel's comment about interchange. You're clearly looking at page five of the press release that is the reported income statement and one of the things for comparability purposes you should be aware of is that a year ago we were in the midst of changing the nature of the on and off balance sheet asset mix and in fact at the end of March we were not yet complete with that. So to your point, when you look at it on a managed basis, the growth rate in interchange is much more consistent with the growth rate in assets which I think you're referring to.

Next question, please.

Your next question comes from of SBR.

Good afternoon, guys. Understanding the conservative platform that you've created at Capital One -- I'm just looking at the growth in the portfolio over the last couple quarters and the respective excess provisionings that have gone along with the growth in the portfolio. What I'm trying to reconcile is your excess provision methodology as it pertains to making a decision. What goes into that versus what gets dropped to the bottom line? And I think based on our calculates, 40 cents of additional earnings went to the excess provision. How is the methodology structured by way of dropping that into excess provision versus allowing the earnings growth to be modestly higher than what we saw this quarter?

Well, I'm getting all the questions today. This is Dave. Yeah, the methodology is consistent across the quarters and I think you're -- there's a couple of different ways to look at it. On the one hand, you rightly note that a lot more broad dollars went into the provision or I should say into the reserve this quarter. You know, 150 versus 110 last quarter. I'd also point out that actually slightly more than all of our net asset growth was on balance sheet. In other words going from 54 to 50.

So what you're seeing is there, the amount of assets on the balance sheet are much higher and you'll also note that the relationship of reserves to on balance sheet holdings is really unchanged last quarter to this quarter. There are some parts to it that focuses on the of assets -- of delinquent assets as well as an assessment about a current bucket -- how much in the current bucket is likely to go bad as well as a focus on the anticipating securitizations and other activities that will take assets off the balance sheet.

So the methodology is consistent. We do revise it from time to time to make sure we're being perfectly conservative and capturing all the changes in the world that I mentioned earlier. But there's a couple of moving pieces there that I think may -- if you examine, are a little more clear to you.

Thank you very much. Next question, please.

Your next question comes from .

Hi, guys. I had two questions. The first question has to do with -- can you expand a little bit more on the reason for the change in mix on the reported and securitized loans going to . And the second question is on the marketing expense. Can you kind of guide us for what you expect to spend this year in terms of marketing expense? And how much difference you're seeing from now as opposed to maybe last year or the year before in terms of how much you're having to spend to create new accounts outside of the auto loan area?

Yeah, I -- if I understood you correctly, and I hope I did -- you were cutting out a little bit. The question was I guess triggered by something I said a moment ago regarding the change in the mix of on and off balance sheet over the course of the last year.

Right.

About a year ago -- oh, good. I got it right. About a year ago, we mentioned on a conference call -- I guess it was either for the Q4 or the first quarter a year ago, that we were recognizing the fact that our on and off balance sheet portfolios were diverging from the managed portfolio. You know, we ourselves with more low-risk assets off balance sheet and a mix on and off balance sheet was not really winding up with our overall business. So we embarked on an effort to write that and to make it a little bit more consistent in the process of which we brought those much more into alignment. So the net effect of all of this is we moved a more representative mix of our managed portfolio off balance sheet so in fact the on and off and managed look much more like each other than they used to. They're still subject to monthly variations and that sort of thing but they're all much closer together than they used to be.

And the second question?

Yeah. , your second question regarding marketing spend and cost to book accounts -- clearly this has been a very substantial quarter in terms of marketing spend. It reflects the very significant opportunities that we see across the board, you know, within our credit card portfolio and beyond. You know, it's -- you know, marketing expenditures by quarter are certainly a line of scrimmage call depending on what we see, but I think that, you know, marketing levels of this magnitude or in this zip code are certainly plausible for the upcoming quarters.

Secondly, we respect to the cost to book an account -- this of course is always a tough thing to generalize about because our portfolio has products that vary by a factor of ten in booking. But if I could generalize, first of all, about our credit card business -- you know, it's a funny thing. Despite pull backs like Providian and the alleged challenges that some players in our industry are having with marketing and you hear from time to time -- GE, you know, they're kind of -- you know, they're not going to invest so much. What we saw last quarter was the biggest quarter of solicitation levels in the history of the credit card business and this quarter anecdotally we would guess that we're seeing a record.

Now, you know, it takes a few months to get the mail monitor data, but this is intense in its quantities. And the other striking thing that has happened is that finally, and strikingly all -- almost all at the same time -- virtually all the big credit card players or most of the big credit card players have moved their go-to rates down to 9.9 percent, for most cases fixed. And the majority of them have 0 percent teasers. So certainly the stakes have been raised with respect to price competition in the industry.

Now, that said, the good news we have to report is that in our credit card business, the sort of net effect of all these kind of things plus new opportunities is that our response rates are in fact up from the quarter by continuing good strong pricing that is still coming under the competition at 8.9 and 7.9. We're -- our go-to rate is down a little bit in response to some of the pricing competition.

The other thing though is that you saw the growth of business most importantly installment and auto . They are much, much more expensive to book. But within those businesses, in fact, the cost to book those accounts is in fact declining as well. But it's raising the overall mix, the average cost as the mix of those increases.

OK. If I could follow up real quick on the first question on the reported and securitized loans, the shift from last quarter going from 54 percent to 50 percent reported and securitized -- that's, if I understood you correctly, a -- just from a shift in what you want to keep on an off balance sheets or bringing some of the more conservative loans on balance sheet. This is just kind of an in-process situation?

I fear I haven't been as clear as I had intended. The shift I was talking about actually occurred a year ago last year.

I'm sorry?

It's a by-product of the funding choice out that we made in this quarter and doesn't relate to the mix of assets on and off balance sheet. It relates to the proposition of overall assets that are on and off balance sheet.

OK. Thank you.

Next question, please.

Your next question comes from of Sampson Strategic Management.

No one there? Could you go to the next question, please? ?

Yes, sir. Your next question comes from of Sachs Capital.

Hi, Paul.

Hi, there.

I've got a question. Can you just tell me, now that you've got the equity range -- I guess can you give some color -- what kind of equity credit you're getting from the agencies and now going forward -- are you close maybe to talks of a ratings upgrade or something?

This is Dave. The equity credit aspect varies a bit. Agency, as a ballpark number, 80 percent or even better by some -- for some of them. So it's quite --

Pretty good.

Yeah, it's quite substantial and that's one of the reasons we've . Yeah, the ratings upgrade -- there's actually a lot of information out there from the rating agencies. None of them cite a capital weakness as the critical issue to an upgrade so I wouldn't want to leave that impression. They have lots and lots of things to say so I would just but this is really about funding the growth opportunities that we're seeing for the foreseeable future. And, yeah -- the upgrade conversation is really on a channel.

Thank you. Next question, please.

Your next question comes from of .

Hi. This is just a pretty amazing quarter, guys, and the only little thing I just picked up that I wanted maybe a little commentary on is the non-interest income. It seemed to be -- I mean you mentioned a little bit that it was a weak quarter for interchange and obviously there's been a mix shift towards, you know, accounts. But, you know, where does that kind of growth rate go to going forward because it's kind of sliding into the -- you know, 30 percent range year over year and it seems to be on a negative trajectory and the per account is -- you know, it's kind of hanging in there but maybe you could give some commentary about that.

Yeah, Riley. This is Nigel. We don't target any particular part of the revenue equation in terms of our business. We add or -- you know, fees and spread together and take out the cost and then use the net present value methodology in determining exactly what business to book. But if we look at the non-interest income I think we saw, as I mentioned in my remarks, you know, two pretty big occurring.

Firstly, as a result of risk coming down, delinquency is very highly correlated over limit activity. Over limit fees are in the fee equation here so over limits came down very substantially in the first quarter as indeed risk out on the whole portfolio and, you know, I'll take a reduction in fee income from over limit and late any day of the week because in the end it means lower charge-offs. So that was clearly one issue.

The second one is that interchange came down in the first quarter, technically seasonally based. You know, we see it all the time. Big boost in interchange in the fourth quarter, comes down substantially in the first quarter.

On the privileges, you know, we saw an increase in your membership fees as we built our business there and we saw our cross sell business grow substantially too. So as we look forward, you know, one's outlook on the overall risk dimension I think we believe that we won't see the same kind of drop off on the non interest income as we go into the second and third quarter. But it's not something that we particularly target and it's not something we spend a huge amount of time focusing on.

Thank you. Next question, please.

Your next question comes from of Thomas Weisel Partners.

Good afternoon. Two quick questions. One, what gives you confidence about the current growth and how the is holding up. I mean this -- compared to all your peers you have a superb growth this quarter even if you x out the autos and others. And I was wondering what gives you the confidence about the credit quality going forward.

And then second, given kind of the amount of excess earnings power you've got here, is there a reason why you may not be increasing your guidance? Thanks.

OK, . This is Rich. You know, it's a very striking thing that Capital One is on the growth trajectory that it is. And I want to say that it is not lost on any of us ever since we began our growth trajectory many, many years ago, that the world of financial services is the graveyard of financial services, littered with companies who have grown rapidly. And, you know, we obsess about that issue every day.

Now, there are many reasons that we feel confident. But I'm going to say we start by a philosophy that says, you know, everything that can go wrong, can. Adverse selection will creep up in ways no one can anticipate. Competitors will degrade markets, recessions will happen in very negative ways and so on. So a lot of the foundation of what we do comes from this extremely conservative, hyper conservative growth philosophy.

But the other sort of half of the success and our confidence that comes from this comes from the IBS itself, and at the heart of that is this concept of testing. Every cm that I know that's lying in the graveyard of growth companies has grown without testing what it is that they're growing. And an interesting example. Recently I think by their own admission, Providian has said that in certain things related to line increases and the in-bound television channel and super prime growth itself, they rolled out things without testing. I don't want to, you know, do their conference call for them, but I think -- that's what I gather from their own admissions.

And what we -- the underlying foundation of every single thing we grow is that we have to see it in the incubator, right there where we can look at it, see the results, see the quality and then we hardwire -- not just -- we don't just give speeches about credit risk; we hard wire substantial worsening of the credit performance that we've shown in previous . Things like 50 percent worsening of charge-offs. In many of our businesses we put in degradation, market degradation, adverse selection degradations and so on.

The striking thing is that with this methodology which is never compromised, we find a continuing source of tremendous growth opportunities. But -- and all this growth is -- you know, always adheres to the same underwriting principles. And it is in this context that is striking to all of us that we're able to grow very high quality assets with very strong returns, and I think it's testament to the power of things we've been building for many, many years. Nonetheless, we obsess every day to look backwards at all the programs, all the roll outs and test cells and make sure that if we see anything that looks different from forecast on any program that we will step in and immediately take action. Because -- your question is great one. Thank you.

And with respect to earnings power itself, , you know, we do have very strong earnings power at Capital One. It's I think very evident in the numbers and that is a fact. And it's great news for our shareholders. Now, as far as what we report, that depends, of course, on how we deploy the earnings power. At this point, we see exceptional demonstrated marketing opportunities with high return and strong credit quality and a bunch of our stuff really has a wonderful window associated with low interest rates and the ability to market very low rates to consumers. And so that's, as we've often talked about, a particularly nice window at this moment.

So we'll deploy our excess earnings power into marketing to the extent the opportunities are there. We will also continue to build a very strong balance sheet. We are confident that we'll be able to deliver 20 percent earnings per share growth this year but I think it's premature to discuss changes to this target at this time.

Thank you. Next question, please.

Your next question comes from , Raymond James.

Thanks very much. I'm just really curious if you could give us a little more detail on how the auto portfolio and the growth in the auto is affecting the other metrics. For instance, when you look back at what you guys started out with, it was more of an underserved market that you went after with from the beginning and then you brought in and that really brought in more of a super prime aspect. Can you talk about what the mix is within the auto loan portfolio and how it's impacting things such as your reported loss rates and your net interest margin? Thanks.

OK, . First of all, a quick -- a comment about where we are on the credit spectrum with respect to auto finance. This thing began several years ago in really the non-prime business which is really a combination of near prime and sub prime with acquisition a number of years ago. over time has migrated somewhat north in terms of their roll outs and you can see this also in the evolution of the vintage curves and so on if you follow the securitizations. So they've been on kind of the northern end of what we might call the non-prime market and they have been testing into the prime market. Those are not roll outs; those are tests.

Two other things have happened subsequently that effect the metrics. One is the acquisition of which has almost single-digit charge-off rates and I'm talking about a single digit, so obviously that's tremendously -- single digit basis points of charge off rates. Thank you for the clarification. These are territories that one doesn't normally see out there. And so that has been very strong is testing into the prime market from their platform as well so that we are really from two sides through entering the prime market.

The other thing that has happened is that Capital One has implemented the technology of direct marketing on a growing basis using all the methodologies we use in the credit card business to go out and proactively target folks that are going to be prime customers, excellent customers for a Capital One auto finance product. And this has been growingly successful and has very strong credit performance, more consistent in many ways with the prime market.

So, you know, slowly but surely we are really becoming a -- just like in the credit card business, a spectrum which is why, you know, you'll see us over time not so much talk about the individual pieces, be it under served or super prime, but really the whole integrated business which the auto finance business and credit card.

Next question, please.

Your next question comes from of Lehman Brothers.

You know, at this point would a rise in rates actually be better for your businesses? You know, we look at the last display in your press release showing yields and cost of funds. Maybe you can just talk about -- you know, it looks like the securitization liability cost of funds is by far the best of your options and I wasn't clear on whether you said you will increase the securitization percentage. It sounded like you're going to decrease it but from a cost of funds perspective it looks like that would be the best execution.

And, you know, if you could just talk about what you're paying in the senior and subordinated right now and, again, with a forward-looking perspective. Also from, you know, kind of an account development as you see your super prime versus prime and under served coming in, it sounds like the greatest margin pressure is coming from the super prime. So, you know, is there any strategy change on account distribution with regard to margin? Thanks.

, . Let me handle the front part of that question. I guess I'll go to -- I will flip it to Richard and Nigel for the back half. It's just, you know, it's the understanding of what's going on in the managed interest expense chart on the last page of the press release that you referred to.

Really, across the board you're seeing similar things going on in all of the categories. You see it in , you see it in deposits. You see in other borrowings and frankly the senior note side as well. You're seeing the effect of higher coupon securities that are maturing rolling off the back side and a substitution of new -- newer, lower coupon numbers rolling -- you know, rolling in. So on all the coupon stuff, like a margin being added, how to keep rolling off the back side as well as the -- just the effects of generally and where it's going in the various -- in the different periods.

In terms of pricing, you know, on cars -- we're -- top tier pricing. We did a five-year deal recently. We got LIBOR at 15 or so on the senior piece. Yeah, and we're typically top tier on that. But we had -- you know, .

So, yeah. It's an attractive funding source and I did in fact -- I mean to say that we do expect to increase the proportion of our funding that is coming from credit card securitization. So in fact you should expect to see that ratio that went from 54 percent last quarter to 50 in this quarter creep back up into the middle 50s in terms of percent. So, yeah. I did mean to say that and you heard it correctly.

Yeah. , if I understand your question, and jump in and say if this is not the question, I've given my talk about pricing, aggressive pricing by the competition in the upper end of the market. Would we change the mix in response to that? If that was the question, my first answer is always, you know, mix change RUs. I mean that's what we do all the time. We take every business and look at the marketplace and very frequently make changes.

No, all I can do is really comment on what we see and that is that we're continuing to see, you know, good response -- in fact better response than last quarter at the upper end of the market and, you know, benefit by low rates and fabulous performance in terms of the charge-offs. The business that we are generating continues to deliver performance that is well, well in excess of hurdle rate. And therefore I think that we would plan to continue that.

That said, I've always said that the up trend of the market where price is such a critical factor, we -- you know, one's got to continue to make line of scrimmage calls and we're ready to make changes as necessary. But none in the worst moment.

Next question, please.

Your next question comes from of JP Morgan.

Hi, good afternoon. Just a couple of quick questions here. First of all, could you just give us a sense -- the $500 million you're looking to raise here in the mandatory convert -- I guess what are the long growth implications of that, given your desire to stay in a 6.5 to 7 percent equity and managed assets basis?

And then if you could just quantify for us the margin impact from improved delinquency in the quarter and then lastly just the reason for the difference between your reported managed charge-offs of four percent and I guess it will look like an average of 3.82 in the trust. I guess try to quantify for us whether that was, you know, cards on balance sheets behaving differently or whether it was the auto business or something else. Thanks.

Thank you, . On the mandatory convert, I think the considerations to think about there are there's sort of a minimum efficient size of transaction that you want to -- you know, if you're going to do this kind of thing, you want to do it in a particular size. Yeah, the sizing that we are after, together with a DRIP equity that we did in the quarter was intending, as I said, to take care of the capital needs for the foreseeable future. So there's not a particular loan growth target that we're trying to or anything like that. In fact, Rich addressed that in his remarks. So -- it's intended to be a bite of capital that we'll take care for the foreseeable future.

In terms of the charge off numbers, there's a couple of things that were going on here all this time. As I mentioned earlier, the funding decisions that we made had all the net asset growth, in fact a little bit more than the net asset growth of the company showing up on balance sheets. These are a lot of new assets and as such had relatively lower charge-offs associated with them.

So you've got a little bit of an unusual quarter in trying to decipher the pieces that are . This is actually precisely the reason that we often caution folks to not over read the master trust results because there's a lot of things that happen -- choices we make for lots of different reasons that will cause the master trust numbers to divert from the managed numbers in the quarter. So it's just -- you know, the by -- product of the choices that we make on funding that drives that.

, let me just deal with me delinquency here. As you rightly said, our delinquency fell in the first quarter to 4.8 from 4.95 and we were very, very pleased with that number. We also said that we're very happy to have less fees that come from delinquent because it bodes well for the future and helps us manage the real arch nemesis of this business which is charge-offs.

Correlated with a reduction in delinquent fees are of course the over limit fees. And we sometimes put them together and say it was risk reduction on the portfolio that led to a substantial reduction in revenue, some of which is showing in the fee line, some of it showing in the spread line. But to put them together, it's a pretty substantial number.

The delinquent piece itself -- you know, it's hard to specifically disclose the amount of that, but you probably can back into it. But it was a big enough number that it made a difference for the overall spread in the quarter so a pretty big number. But I do want to emphasize here as we sort of talk about risk, you know, we feel very, very pleased with what occurred in the first quarter in terms of delinquent, in terms of charge-offs and in terms of what we see. And I think we were very -- you know, as we look at these numbers, they came in better than we had thought that they would come in. We feel good about that.

We have to make sure that we don't lose sight of the fact that even though delinquent is down in the first quarter we are anticipating for all the reasons Rich mentioned earlier that charge-offs would arise through the rest of the year, particularly in the second part of the year and that's going to be very dependent upon what happens to the economy, what happens to our exact rate of growth in our business as well as a number of other factors.

All right. Last question now. Next question, please?

Sir, your final question comes from of Merrill Lynch.

Hi. Going back to something that Rich said in the very first question -- he talked about auto being particularly strong in Q1 due to "opportunities" which I would presume means something like Ford disappearing. But then said it slowed down. And I guess I don't see in the next three quarters what else is changing in the market. You have people like already going full tilt. We don't see anyone else entering, so why would it be slowing down?

You know, I smile at that question, . First of all, let me make your case for a second about why it shouldn't slow down and then talk about why it will. Or why shouldn't it slow down, again, because things are really working spectacularly well in our auto finance business. The success of the credit management and beating adverse selection and all of those things -- the power of direct marketing that we've added to the mix now, the stunning, stunning reduction in operating costs that are occurring.

This quarter, for example, our operating costs, Capital One Auto Finance, fell by 60 basis points in the quarter. And what's happening is we are basically at or by the end of year will be well into the zone from everything we can gather of having the lowest costs in the industry which will be very, very helpful as well.

And now we're increasingly playing the full spectrum game again. That's a little bit more of a -- we're going to get there than we're there at the moment. But that's also very powerful as well.

So -- and we just look at the performance and probably of all the segments at Capital One the one that keeps coming in, you know, better than budgeted on practically every single dimension is our auto finance business. It is enhanced by a marketplace that has low interest rates and, you know, not the most intense price competition right now as competitors have kind of backed off.

So, that's the case for it. The reason that we're not going, you know, grow this year at rates, you know, that -- you know, 100 percent type rates is really more just our management of the overall mix of our portfolio and, you know, for all the things that I tried to say about managing growth and risk and so on, at some point we think a lot of these opportunities will still be there. Later, we have tremendous opportunities in other parts of the business.

So what we're going to do is just kind of temper the percentage growth rate somewhat in that business while I think frankly we will continue to look at the fundamentals as very much what you're talking about there, . So -- and this is happening in parallel with a lot of other great innovations that are in the works across the rest of the company that we want to make sure that we give room to as well.

So, really what we're doing is in fact cherry picking in the auto finance business the best opportunities everywhere as we slow down our growth a little bit and all it does is I think it will make our metrics even better.

So, let me just wrap up here and just very briefly -- in many ways, I think what we're seeing is the result of Capital One, you know, taking a mindset we've had from the very beginning that this is all about building for the long run. I've always said to folks, you know, Nigel and I and many of our management team -- we plan to be around. So, you know, don't manage for today's results or tomorrow's results. Everything we've done is to build for a great Capital One in the future.

And I think right now as some other companies struggle a little bit, what we're seeing is that the power of investment in things like 65,000 tests last year, the investment in marketing for so many years that really creates earnings that allows us to invest in our future and still deliver great bottom line results. And finally and most importantly, and this is always at the top of the list, the power that comes from having the overall best credit performance -- not just on average, but really most importantly by segment. And that's where we wield the power of pricing and that's what's I think increasingly allowing Capital One to grow. So we feel pretty good about it. Thanks a lot.

Thank you very much, Rich. Just a reminder -- the investor relations department will be open this evening. Anybody who needs anything, just give us a call. Thank you.

Ladies and gentlemen, thank you for participating in today's Capital One Financial first quarter earnings conference call. You may now disconnect.