Capital One Financial Corp (COF) 2003 Q1 法說會逐字稿

Good afternoon, my name is Corey and I will be your conference facilitator. I would like to welcome everyone to the Capital One earnings conference call. After the speaker's remarks there will be a question and answer period. If you would like to ask a question during this time, simply press star then the number one on your telephone key pad. If you would like to withdraw your question, suppress star then the number two. During the Q-and-A, we ask that you limit yourself to one question each time your line is opened. If you have a follow-up question, please re-enter the queue by pressing star 1.

At this time I would like to turn the conference over to Mr. Paul Paquin, Vice-President of Investor Relation.

Thank you very much, Corey. Welcome everyone to Capital One's first quarter 2003 earnings conference call. As usual we are webcasting live over the Internet. For those that would like access to the call on the internet, please log on to Capital One's home page at www.capitalone.com and follow the links from there.

The company generates earnings from its managed loan portfolio which includes the on balance sheet loans and off balance sheet loans which the company has retained significant risk and rewards. For this reason the company believes the managed financial measures to be useful for shareholders. In compliance with newly adopted regulation "G" of the securities and exchange commission, the company is providing a numerical reconciliation of managed financial measures to comparable measures calculated on a reported basis using generally accepted accounting principles. Please see the schedule entitled reconciliation debt financial measures attached.

The statements made in the course of this conference call that mention the company's or management hopes, intentions, beliefs, expectations or projections of the future are forward-looking statements. It's 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 those of the forward looking statements is contain in the company's SEC filings included but not limited to companies report on form 10-K. Our website contains all of the SEC filings as well as our earlier reports, quarterly earnings information and monthly asset backed securitization performance data. To access this information, go to www.capitalone.com, click on investors and then on financials.

In order to take advantage of the limited time available to ask questions to senior management during this call, we would appreciate it if you would ask only the more strategic questions. This would allow you to take advantage of senior management's availability. The data questions and questions related to the contributions of various variables made to the reported data can be obtained at any time by calling investor relations. The investor relations staff will be available after the conference call this evening to answer any and all of your questions.

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 Lawson, our Senior Vice President and Chief Financial Officer. At this time I would pass this call over to Mr. Fairbank for his remarks. Rich?

Thank you, Paul. And thanks to all of you for joining us this afternoon on this call. In this call we will address both announcements we made this afternoon. I hope everyone has had an opportunity to see our two announcements regarding quarterly earnings and my long time partner Nigel Morris. Later in the call we will talk about his decision to scale back on his management responsibilities.

First, with regard to our earnings announcement. As you may have noticed we exceeded the consensus estimate for earnings for the quarter. We reported earnings per share of $1.35 driven primarily by our improving credit performance and outlook. This strong credit performance helped Capital One in a number of different ways. It produced a manage charge off rate at the low end of our guidance. The net charge off rate on the managed portfolio rose 26 basis points to 6.47% in the first quarter of 2003. Which was on the lower end of our stated mid to high 6% range.

Better credit performance in the U.S. lending segment was delivered by lower delinquency and stronger recovery results. Recent improvements in the delinquency rates support our forecast for next quarter and the second half of the year. In fact, delinquency rates which were at 5.60% at year end have fallen each of the past three months to 5.56%, 5.30% and finally to 4.97% at March 31st. With that in mind our charge-off guidance for the second half of the year is below 6% range were previously it was the low to mid 6% range.

The drivers of our credit losses remain the same as we discussed last quarter. Rising charge-offs in the second half of 2002 and into this quarter is driven by the seasoning of large number of sub prime accounts that we book in the fourth quarter in 2001 and early in 2002. And by our slower growth. Now that we have passed through the seam, we were seeing delinquency fall and see charge-off coming down as well. As a result of the improving credit outlook, we were required to reduce our allowance by $85 million. From $1.720 billion to $1.635 billion. It is important to note that our allowance methodology has remained consistent over the last four quarters. It is also important to note that there is an unusual amount of economic uncertainty for 2003. The economy continues to struggle and further deterioration United Nations could have an adverse impact on our credit performance in the second half of the year. Alternatively if the economy shows improvement we could see a beneficial effect.

Outstandings in the first quarter fell by $533 million. As you know, the U.S. credit card market has become intensely competitive, particularly in the super prime segment and mail volumes have topped the one billion piece mark in the last several quarters. We are also in an era of low interest rates, which have fueled the unprecedented mortgage refinance activity, which has taken the wind out of the sails of credit card industry receivables growth.

Amidst this challenging growth environment we have chosen to narrow our marketing a little bit to target, as we always do, the most profitable customers in a sense moving just slightly higher ground in the midst of this competitive environment. You can see the effects of this in our first quarter marketing spending and you may see it again as 2003 continues to unfold. This migration to higher ground will likely result in somewhat lower loan growths of 15 to 20% versus our prior guidance of 20 to 25%. And also a little bit less marketing that we had previously indicated. Suffice it to say with improving credit and less marketing we are confident that our 2003 earnings per share will be at least $4.55. Capital One's diversification continues to increase substantially. Our business is beyond U.S. card continues to grow as a percentage of our total [INAUDIBLE].

Auto loans increased to $7.7 billion at the end of the first quarter. Which represents a 48% year over year growth. International loans increased to $5.4 billion. 27% year over year growth. And installment loans which are included in the U.S. lending segment increased to $4.6 billion, 40% year over year growth. Combined these three businesses now comprise 30% of our total loan portfolio up from 27% a year ago.

Our non-U.S. card portfolio now stands at $17.7 billion. This product credit and geographic diversification reduces our concentration risk and allows us to take advantage of growth opportunities in markets that are less saturated. This increased flexibility bows well for Capital One and has been part of our diversification agenda for many years.

As we gain more confidence and clarity in the credit outlook and understand better the competitive and economic environment, we will be able to more confidently evaluate our likely performance in 2003 from an earnings point of view and we certainly hope to shed more light on the year as we report our second quarter results.

With that, I would like to turn it over to Nigel for his remarks.

Thank you, Rich. Greetings to all of you joining us on this call this afternoon. It is indeed our belief that we have now passed through the period of choppy metrics that we had previously referred to as the seam caused by the rapid slowing of our loan growth and shift up market during the latter half of last year and we are pleased to report that all of our metrics and most importantly our charge-off rates came in as in as expected or better than expected during that time period. Rich has talked about the charge-off rate, but I would like to focus on the other metrics affected by the theme beginning with revenues.

Our revenues increased by 17% on a year-over-year basis but up 1% on an annualized basis versus fourth quarter '02. This slower growth is a direct result of the following factors. Firstly, a decline in interchanging the fourth quarter stemming from weak consumer spending which I will discuss in a moment.

Secondly, our ongoing shift toward super prime which results in fewer accounts which annual membership fees and smaller contribution from cross sell revenues and the absence of substantial securities gains we had in the fourth quarter of last year. What this indicates for the remainder of the year? Obviously, as the delinquencies decline, late and overlimit fees will decline too. The net interest margin which includes late fees will stabilize in the low 9% range going forward and the risk adjusted margin should stabilize at around 10% in the second half of 2003.

You are wondering how it's possible for the charge-off picture be improving given the highly uncertain economic and political environment in which we are operating during the first quarter. As you know, one of the events we all watched closely during the first quarter was the war in Iraq. The impact of the war on our business has been short lived and contained. We did indeed observe some slow down in consumer spending during the days at the beginning of the military actions largely due to the so called CNN effects. As the news from the golf has improved and spends has picked up and within our forecast. We believe the end of the war puts the U.S. economy on a positive trajectory. The job market remains soft but the unemployment rate has stayed at a relatively stable rate between 5.6 and 6% over the last year.

The consumer debt burden is down as consumers continued to take advantage of the refinance boom and locked in low fixed rate mortgages. Lower energy prices and tax cuts should further help consumers. In short, thus far there has been no recession related deterioration in credit quality. Our losses associated with bankruptcy remained unchanged quarter to quarter although some forecasters have [INAUDIBLE] It rising by 7% in 2003. For the increase we saw in our charge-off rate over the past six months was almost purely result of the seasoning and growth related factors that Rich discussed earlier.

Let's return to the other metrics on which we have given you guidance. Our account base decline by 950,000 this quarter reflecting the last vestiges of the scene. We expect little or no account growth for the rest of the year given the lower loan growth forecast that Rich mentioned and our ongoing shift up market. With regard to operating efficiency, cost came at $79 this quarter reflecting the decline in the account base as we continue to shift up market. On quarter to quarter basis, operating expenses rose by $21 million during the first quarter. So we think we are doing a decent job of keeping the lid on expense growth. The upward pressure on our cost per count stems from three sources. The fact that at the moment we were growing into the excess capacity caused by our slow down in growth.

And secondly, we are spending more on collections and recovery activities now compared with previous quarters. That's a tradeoff I will make all day long investing a dollar to recover more than a dollar is a good bet. And had a record quarter for recovers again. Though the first quarter is always a strong one for recoveries on a seasonal basis.

And finally, our mix shift toward more extensive service international and auto loans adds to the upward pressure on the cost per count. Put those together of a changing mix, increased collections and recoveries expense and modest account growth they will persist into 2003 with the results we expect our cost per account of around $80 to the remainder of the year. Rich commented earlier on our non U.S. card business and how they are growing and I would like to point out something you will see in the segment data in our press release at this time and in particular I would like to point to the international business as profitable for the first quarter ever in the first quarter of this year and we expect good things from the international business going forward.

With that I would like to introduce for the first time our interim Chief Financial Officer, Dave Lawson.

Thank you, and thanks again to all of you who are participating today.

This quarter was characterized by the increasing strength in our balance sheet. Record capital levels, solid funding access and abundant liquidity, the racial of capital demon to assets reached a new record high of 8.3%. The ratio of capital plus reserves to managed assets and alternative measure of capital strength also reached a record high of 10.7%. This record was achieved despite the modest $85 million reduction in our loan loss allowance. Our bank and thrift maintain the regulatory capitalized status after application of the sub prime capital guidance with risk based capital ratios continuing to exceed both the regulatory 10% threshold and are more stringent internal standard of 12%.

I would like to elaborate on our loan loss allowance. Our procedures for determining the allowance are consistent from quarter to quarter and comply with regulatory guidance and industry practice. The allowance level must reflect projected charge-offs in the reported loan portfolio as of the reporting date. We build the allowance by almost -- we built the allowance by almost $500 million during the second quarter, second half of 2002. Reflecting loan growth and the expected increase in charge-offs as we went through the seam. In contrast, since reported loan balances grew only slightly during the first quarter of the year and charge-off rates are projected to decline from first quarter levels, the allowance declined modestly.

Turning to funding. We access key securitization markets in size despite market uncertainty regarding the economy and war in Iraq. In March, we completed our first public securitization to super prime auto assets. This $1 billion deal in all end of fixed rate cost of funds of 2.22%. The lowest fixed rate cost we recorded on any term funding transaction. Reflecting the pristine quality of the underlying loans, this transaction was our first auto securitization executed without an insurer wrap and had amongst the lowest credit enhancement levels of any securitization ever.

Early this month we executed a $1.2 billion triple-A securitization of our U.S. credit card portfolio in a transaction that was oversubscribed even after being upsized significantly. While the transaction did feature a wider spread, the all in fixed rate cost after swapping the deal was 2.98%. The lowest fixed rate we realized on any term credit card securitization. Performance of our credit card master trust continues to be solid. With the excess spread like our managed risk adjusted margin remaining among the highest in the industry. However, I would like to remind you that as the company has increasingly diversified, the trust performance is becoming less representative over overall managed loan performance.

The deposits continue to play an important role on our funding. Deposit balances increased an impressive $1.1 billion during the quarter to $18.5 billion. And deposits continue to be a source of stable long term funding with average original maturities greater than three years. Liquidity remains strong. At the end of the quarter we had $10 billion total liquidity including 6.2 billion of cash and liquid investments with about 4 billion in available credit facilities and conduits. Liquidity at the end of March was approximately four times our term debt refinancing needs over the rest of 2003. Our liquidity position and demonstrated access to funding in good markets and bad gives us tremendous confidence in our ability to finance future growth.

Finally, I would like to make a point of a small change in our income statement that we signaled three months ago. Our tax rate declined in the first quarter to 37% from 38%. Adding $5 million to net income or two cents a share. The tax rate change reflects the growing profit contribution or international business and is expected to remain at this lower left level for the rest of 2003.

Now back to Rich.

Thank you, Dave. In addition to our strong earnings report, I would like to update you on the important developments on the leadership front at Capital One.

After much soul searching, my partner for over 15 years, Nigel Morris has decided to pull back, slow down and invest more time with his young family. Effective May 1st, Nigel will move from his Chief Operating Officer role to Vice Chairman of Capital One. In this capacity Nigel will continue to devote consider time and energy to the company, providing leadership in three important areas. International business, enterprise risk management, and external communications. Additionally, Nigel will continue to serve as a member of the board and as senior advisor to me and our senior executive team.

Obviously this is a very significant and emotional moment for myself and for everyone at Capital One. Nigel has been a tireless leader and most trusted colleague of mine. Our success today financially and culturally is a huge testimony to Nigel's incredible leadership skills. I think it's important for all of us to hear directly from Nigel about his important decision.

Nigel?

Thanks, Rich. And for several years now I have been considering dialing back on my time commitments here at Capital One, to prepare for my eventual departure. I have been running very hard for the last 15 years. Seven years at Signet and eight years at Capital One.

I felt for sometime now that the day was going to come when I would want to spend more time with my family and pursue some new direction that is increasing of interest to me personally. I have a long list of activities that I'm looking forward to exploring including philanthropy and some small business interests. The challenge is to find the right time and last year was not that time. Our plate was full as you will recall and the company required my own divided attention. I now believe those days are over, we're turning the corner with charge-offs. Our earnings power is undiminished. Diversification is increasingly successful. Our brand name is one of the finest in the industry and our costs are stable in a no account growth scenario.

We are also closing in on wonderful new hires. The wind is clearly at our backs and the right time for me to initiate this transition. But all of strengths of Capital One that gives me the comfort is the strength of our management team that really stands out.

I'm proud to have helped recruit them. I'm proud of what they have accomplished. And I'm very proud, so proud of what I have learned from them over the years. And I'm confident that they will create a great future for Capital One, one that is brighter than I could have imagined when I began this journey 15 years ago.

I also want to salute Rich, not only for his tremendous flexibility and understanding of my desire to step back, but the skillful way that he has put this company in such strong position to embrace the next exciting chapter of Capital One's journey. I also like to thank our board of directors and grateful to them for their help and support in enabling me to make this change.

Now, from now until the end of the year, I will focus consider attention on several areas that are critical to the company's future. International, a passion of mine is an important growth area. And enterprise risk management, which has made great progress over the last year and the work continued momentum is critical. Rich has been extraordinary partner to me over this long road we have traveled together and I'm entirely committed during this transition period to preparing the company for its future continued success.

Rich?

Thank you, Nigel. Let me say that working with Nigel has been one of the most rewarding aspects of my career. We started together over 15 years ago with a dream about how to transform financial services using this crazy thing called IBS. Nigel's contributions to bringing this dream to a reality have been immeasurable. His inside and leadership impacts can be found throughout this company.

This journey has been exceptionally demanding, especially over the last few years. And I think I speak for all of us on our management team who look at this and respect someone who can pull up, reassess what's most important in his life and make what is really the courageous decision that Nigel has made. And I am sure that Laurie and the children are excited about his greater presence and involvement in their lives. We will miss Nigel's engagement in the day to day operation in the business are fortunate to have his continued leadership in our international efforts, as well as his oversight of the enterprise risk management and corporate governance and controls activity.

Not surprisingly with Nigel's move to Vice Chairman, we will be restructure the senior executive team in several ways. This will insure continued strong leadership and also facilitate a significantly more streamline decision-making process which we hope to make a real standard of good governance. First, we are pulling the U.S. card function into a single group. This was to be split between Nigel and myself. I asked Catherine West, who has led our U.S. consumer operations group, to move on an interim basis to head the card division. Catherine will report to me and work in close partnership with our U.S. card executives to continue drive superior results in this major operating division.

Meanwhile, we are launching an external search to recruit a world class business leader. To join Capital One as President of our U.S. card division.

Second, I'm taking advantage of this unique opportunity to redraw the structure of our senior team. And the way we govern. Rather than filling the COO role we will build a ten person executive committee composed of myself and Nigel, along with the heads of our operating division and our key staff functions. This will broaden the role of our top executive and streamline the decision-making process. The executive committee will report directly to me and play a central role in shaping our overall strategy as well as in overseeing the financial and operation performance of the company. Specifically, the committee will include myself and Nigel. The President of the U.S. card division, Catherine West, President of Auto Finance, Dave Lawson. Dave is serving on an interim basis as CFO. When we bring the CFO on, Dave will return to be running the auto business and will continue to be on the executive committee.

Also on the executive committee will be the President of our thrift, which is Capital One FSB and also the one who runs other diversified businesses, which is Larry Klane, who will include our General Council. And the heads of our major staff groups including IT, human resources, credit, and of course, the CFO.

With regard to the CFO, we have been working very hard to go out and find the highest of standards a CFO to fill this incredibly important role in this company. And we have made an offer to a truly outstanding and exceptionally well qualified individual to fill this critical position. We have received strong indications that he will accept our offer soon, and notify his current employer so we can make a public announcement shortly.

As Nigel mentioned earlier, he is focused very hard on helping us navigate through the scene. Now that we have clear line of sight, it seems to us like an appropriate time for him to make the change. Nigel's continued role in the executive committee and the important areas of international growth and risk management will help ensure those transitions.

We are excited about moving forward into a new chapter for Capital One. We have fabulous momentum as discussed earlier. Tremendous earnings power. Improving credit trajectory, growing diversification businesses and continued ability to attract world class leaders. We have a strong and very talented executive team that is committed and energized about the future and it continues to deliver the outstanding results that have characterized our history with Capital One.

With that, I will turn it over to Paul for the Q-and-A.

I would like to start the questions now. Corey, please do so.

Yes. At this time I would like to remind everyone if you would like to ask a question, please press star then the number one on your telephone key pad. Also, as a remind, please limit yourself to one question a each time your line is opened. If you have a follow-up question, please reenter the queue. We'll pause for a moment to compile the Q-and-A roster.

We will take our first question from Caren Mayer with Bank of America Securities.

Nigel, sorry to hear about the news but focus on a business question. When you originally gave your loan growth guidance, Rich, you said that sub prime was going to grow 10 to 15% and prime and super prime were going 20 to 25%. Should we assume the same sort of magnitude of growth in the segments or has there been a mixed shift as well given the competitive environment? Could you talk where you expect the growth to come.

Thanks for the question. We are going to keep the same proportionality with our growth that we had before. What's really happening is just a little bit and again I don't want to overrate the dial back here, but a little bit of tampering of the growth we continue to -- we continue to be very confident that the super prime can continue to still have significant growth in the business and we grow the other businesses proportionally with that growth. Everything we have said about moving up markets, the gradual share change that again won't happen overnight, obviously, by the math of this growth rate. But nonetheless, the gradual move up market, it will continue in the card business very proportionally and that will also characterize our growth across the board at Capital One.

And again, Nigel, sorry to see you go. Good luck to you.

The next question is from Mike Vincinquerra with Raymond James.

Thank you. I guess this question is probably for Dave. Can you give us an idea in auto sector exactly what your plans are going for as far as securitization, what you will hold on, balance sheet versus off? If you move more loans off balance sheet and see where that's expected to go forward. Thanks.

As you know, we all of our sub prime business excluding what we sell on a serviced released basis is on balance sheet. 100% of our sub prime business is on balance sheet excluding what we sell under a flow through agreement to another financial institution that is servicing release. On our prime and super prime business, which is generated on the through the internet channel, that we are retaining approximately one-half of that business and we're selling approximately the other half of that business. We are retaining servicing on what we are selling. Everything we securitize it of the super prime and the prime business is on balance sheet.

Next question, please.

The next question is from Bob Napoli with US Bancorp Piper Jaffray.

Good afternoon, and you guys don't bore us with your results. Wanted to ask the question about your earnings outlook for the year and suggested that there could be upside to see how the economy unfolds. But your earnings power in the first quarter, $1.30, well above annualized that number.

How do you see kind of the model shifting throughout the year? Is the lower earnings as you go through subsequent quarters primarily as you are adding to reserves? I know you talked about marketing to be below what you had said. And I know this is somewhat of a separate question, is your goal to still have long term earnings growth and are we of 20%? Thank you.

Okay. Bob, thank you. First of all, at $1.35, if you multiply that by four, that's a really big number. So it generates the obvious question about what does this mean for the rest of the year? And I want to say a few things.

First of all, if we deliver a $4.55, then on average the subsequent quarters are going to be substantially below the earnings number that we have here. And certainly an important factor in the earnings number in the first quarter is the very robust effect that's happening with respect to reserves and that's the product of the great news on the credit card side. As we go through the year, particularly in the third and fourth quarter and as growth kicks up significantly, we will again be back to adding to the reserve instead of seeing a reduction in the reserve. And additionally, I really want to stress that we -- while marketing may be less than what we otherwise might have done, we will still have a robust marketing program and the key thing we will do is watch this thing from the line of scrimmage. This environment reminds me of the environment we saw in 1999 with tremendous price competition in the middle of it, for those that were there with us back then, we talked about retreating a little bit to the high ground to make sure that we don't just set growth targets and no matter what deliver these things. As we move to what will we might call slightly higher ground to the most profitable customer acquisitions, we will pursue this quality until such time we see the competitive environment easing. There are a couple of indicators that may suggest that some of our competitors are rethinking the intensity of their mailing plans. I think it's too early to say for us we look at this as a very robust first quarter. It certainly sudden solidifies our financial performance for the year and we will watch the economy and the watch the competitive outlook in the end to determine if there is upside on the 15% earnings per share growth that we have set at this time.

Could I chime in here and emphasize one variable that Rich mentioned at the end and that is the overall charge. As we said, the first quarter came in blisteringly well and the rest of the year looks really tremendous based on the trajectory of the delinquency as Rich mentioned. But we don't want to give the impression that this economy is in the bag. There are some clearly some evidence that it's healing. The war being over, I think it's tax rebates and they will help a great deal. But we want to be cautious about how this economy will pay through the year and how quickly the healing process will go on. We want to see a few more months under our belt before we can be really clear that we are out of the woods yet.

Bob, and thank you. I forgot to deal with the other question about the long term goal. Everything that we see continues to be consistent with our being able to deliver on our 20% long term EPS goal.

Next question?

Our next question is from Rick Shane of Jefferies & Co.

Thank you. Nigel, I wish you the best. One quick question, one trend we are noticing during the quarter is a slight improvement in net interest margins but a slight decline in fee margins. Is that driven by new pricing policies following FFIEC and how does that reconcile with the shift of market in terms of credit?

Thanks for your kind words. I appreciate that. I think that it's fair to say that we have been entirely untouched by FFIEC guidelines. You remember a year ago the regulators spent a lot of time with us. Reviewed the critical aspects in terms of the way that we would organize or re-aging minimum payments and negative ARM and we looked at that and thought we were in excellent shape and haven't changed thing one wit as a result of that. No, there is no changes as a result of FFIEC and continue to believe we were in a tremendous position there and we see our competition having to deal with certain issues. If I turn to what's been going on in the quarter in terms of the revenue, what we are seeing is we have less interchange income and I think that's partly the CNN effect and seasonal. We are seeing the -- numeric of less new accounts being booked and those accounts and the accounts are more upscale and they don't carry membership fees and harder to cross sell to them which puts pressure on the nim or the fee components.

On the spread side, I think as we shift upscale, we will see increasing pressure on the spread in the business because we will be bringing in more loans on lower prices. And I gave some guidelines.

Next question, please.

Our next question from Michael Freudenstein from J.P. Morgan.

You both commented about having navigated through passed through the seam here. I'm trying to piece that together with your credit has within a big positive surprise here relative to your expectations a few moments ago. But revenues at 1% annualized and growth coming down and marketing coming down a bit relative to the expectations you said. I'm trying to put having passed through the seam contact together with what your out lack is in terms of the real revenue growth potential. Are we through on the top line as well as the credit line?

The seam -- the seam was about was seeing sort of bizarre and very volatile performance across a four or five variables that we highlighted. I think coming out of the seam what you will see is a Capital One that has more stability to the measures but is characterized a little bit somewhat different before we entered the seam. From the sort of high growth, high loan growth, high account growth, lots of sub prime company with very strong revenue growth. What you will see now is a more moderate growth company with -- but certainly still at the high end of financial services companies but with more stable but yet robust growth on the key variable. The things that will drive the earnings growth of the company as we shift up market will be the underlying loan growth which kind of sets the base line. But -- and from that we will see steady, generally steady revenue growth, but it's going to be powered in this mix shift by continued improvements in credit quality that not only happen through the year but in fact we will continue to see into next year. And the combination -- so a medium level of outstanding and revenue growth and strong improvements in credit quality, that will provide the basis for continued strong growth and earnings.

Also I want to say that the card business we expect to continue to gradually lose share to our -- and that's a good thing, to the other diverse at this -- business that we have. The card business will grow in the mid teens in some sense. What you will have is the international business, the auto business and the installment loan business over the horizon that we can see will continue to gain share from an asset perspective.

Your next question is from Richard Manwell with American Express.

Echo that I'm disappointed to not have you stick around, Nigel but great job over the years. I was wondering if you could give us a sense of how the reserve will come down with losses coming down as you described? Where does the reserve start normalizing with loan growth given that loss will come down so much? Thank you.

Again, thanks for your kind comments. I will make a couple of comments and then I will hand it over to Dave.

It's a really tremendously difficult thing to call because we are having to make estimates of what charge offs will be 12 months from now. What drives that? What is happening to loan portfolios that are growing. Does it not? Does it mix that portfolio, prime, super prime and what is happening to delinquency which is an important driver and off leaf difficult to predict and the roll rates through the process. I think we are looking for and the allowance to continue to come down in the second quarter but perhaps not by anywhere near the amount that it did in the first quarter and then our estimate, depending on what the growth would be would be for the allowance to be built again. Built in the third to some extent and perhaps a little extensively in the fourth quarter. That would be my take of the situation.

Dave, you want to add?

I think you are right on the button. Literally if you track the delinquency rates and realize how we build the reserve looking at a account migration over time, you can see it's pretty rational and logical why it does increase or decrease. And it's likely to go up for the remainder of the year as we grow because as you grow the portfolio, you have to build reserve. As you grow the reported assets on the balance sheet. I think you will be able to track the growth in the portfolio and the delinquency rates and be able to predict whether the reserve will increase or decrease.

Next question.

The next question is from Vincent Daniel with Keefe Bruyette & Woods.

Two questions if you could. Is it possible that you could give additional cover on the overlimit fees and the reason I ask that is that your net interest margin hung in there very well and relative to some of your competition which we saw tremendous emotion. Could you reconcile what we are looking at relative to the competition?

Vincent, this is Nigel here. When we look at what happened to over limit things, we found that the assessed amount of over limit fees, ie, the amount that would build declined a bit. However, because the portfolio became less risky, less delinquent, that means that we had to reserve less in terms of the finance charge reserve which meant net, net the amount of over limit fees that went to the revenue line actually slightly increased. Now I won't comment too much on what happened to the competition here. Of course, the number of accounts that we have went down while the amounts of average earning assets went up which would lead to the non-interest income being slightly down.

Next question, please.

Take our next question from Adam.

Good evening, I did some quick numbers and forgive me for these being off-the-cuff, but based upon my calculations, you will probably have to raise your marketing budget to about 350 and a quarter to get the account base stabilized. Then you will have to grow it from there to grow accounts. That also suggests to offset that you are looking for a real improvement in asset quality. Could you go through with us how you think in terms of asset quality improvements how it basically compensates you for the needs kind of replace the portfolio and what your targets are on the account growth given that once you get a certain growth target it becomes more expensive and difficult to grow.

Adam, first of all, we never have defined our business in terms of counting how many accounts we have and working backwards from what it takes to replace those. In an environment where we are seeing a significant mix shift, up market and two other products, products that have a massively different profile in terms of their revenue structure, in terms of batter balance per account, the account number is something that falls out from the calculation. It's not part of the objective function. That's why I would respect you ask the question about the accounts growth target. It's not a proactive target but a result of what we do. But we see it in the low single digits annual growth rate over time as we move through the seam where it sha rank and I think now it will move to a more stable but relatively lower or near zero kind of level.

What is happening again, is that the accounts that are being generated have pound for pound fantastic dynamics to them. They have strong revenues supported by the larger balances. We are talking about both credit card and on the other products, installment loans, auto loans and so on. And also the attrition dynamics are significantly stronger in all the other markets than the sub prime market. I want to stress the highest attrition levels we have experienced over time have been in the sub prime marketplace and a lot of the attrition is not voluntarily it includes charge offs as well. Net-net what's happening and it gets tricky to go one variable at a time and to truly follow this whole thing, is that the very substantial mix shift that we are systematically doing is going to a show off in terms of strong balance growth. Steady revenue growth, and very systematic steady reduction in charge offs. Because everything that we are booking in higher quantities, one of the big benefits is that it has lower charge offs.

The net effect of all of this is something that by our projections by at this year cap far out into the future that we can see has the very nice combination of strong earnings power and I think better and better metrics with respect to the things like charge offs and diverse --. The other thing that enters our equation is the marketing dollars. Here again we -- we had set out the target of $300 million a quarter as we came through the seam. It's not a way off.

You will see quarter by quarter a gradual increase in our marketing dollars from where we are. Marketing will continue to be an important item in the future. Overall, I think that the -- what our company is gradually morphing into is a company that will look more like some of the traditional financial institutions you are used to looking at, but with very strong earnings power and revenue growth potential.

The next question is from Matt Vetto with Smith Barney.

Good afternoon. Wondering if in a scenario where we get to get the makeshift that we are expecting the interchange environment you talked about a little bit having seen a drop off in spending and now recovery from that, maybe a little bit slower loan growth target than maybe where we started the year, should we expect the non-interest income line to grow sequentially from here? Or should we expect it to hold water. You seen a couple of quarters of sequential declines. There are some other stuff in there, too. With that back drop, should we expect to see the line item grow?

Echo some of the themes that Rich talked about with his last answer. We don't spend a huge amount of time predicting the individual line items in the revenue equation. And this is a large portion of the equation. As we look to the makeshift and the issues that you talked about with the slightly slow loan growth, we are not expecting a gigantic increase in that variable. And I would expect a very modest increase as you look through the year.

The next question is from Brad Ball with Prudential Securities.

Good luck, Nigel. I wanted to ask about the regulatory MOU and the status of that. Nigel, I thought you were the point man on working through that process. Could you update us on that and whether or not the new CFO would play a role there? And where do you stand on hiring an enterprise risk manager?

Thank you for your kind words. I have been playing a role with the controlling governance within the company but a lot of other people have been working with me including our counsel and our head of enterprise risk management. And they like me will continue to play a major role in this area as it continues.

The MOU status is a very good story. Our relations with our regulators are good and strengthening and we have had several exams that have gone well over the last quarter or so. And it's really kind of impossible to predict when the MOU will be listed because it's not something we control. We are increasingly hopeful that we are very much on track and that we will be looking for increased clarity around that as time goes by.

I will say that incredible shot in the arm in this quarter is the turn or turning of credit risk which we predicted last year. There are many managements of credit card companies that predicted a turn and haven't been as fortunate. We are good about that and that will help a great deal.

On the recruitment effort, we have several strong candidates that are in the pipeline. We are in final stages of talking about them and bear expecting to be able to go out with some offers and we are going to be looking to try to put this recruitment opportunity to bed quite soon. Now, I can't give you any guarantees there, but we have great people and we were hopeful we can put somebody over the goal line. Thanks for the question, Brad.

Next question is from Chris Brendler with Legg Mason.

One question I wanted to ask and let me get a better sense is the competitive environment. Can you give us a little better sense of what changed from the time you published your 10 K and had your growth targets and long growth 20, 25% and account growth 5 to 10. And I noticed the teaser rate -- the accounts on teaser is dropping over the last five quarters. Is that also reflective of the competitive numbers? Something you can't get the traction that you were going and sort of as a summary, does it mean at some point and maybe it's on the last question, once the MOU is not part of the picture, can you go back to sub prime and flip the growth mix back toward sub prime where there is more fertile ground?

Thanks. The competitive environment actually I think has been very stable for the last probably nine months. And the -- I would characterize it as particularly focused in the super prime and especially in super prime and also in the prime part of the marketplace. Even extending interestingly a little bit into the sub prime marketplace. There are two things going on. Partly we got to be honest. We met the enemy and he is us.

With respect to low rate card, certainly we continue to be the lowest long term fixed rate player in the nation. We back it up with fabulous credit performance and now six or seven years of targeting history, pro active and reactive attrition management, and low customized operating cost in that segment and we know how to do that business and we still through it all are able to maintain the lowest long-term fixed rate. Probably the biggest competitive pressure that is out there is actually what Citibank is doing, not so much on the fixed rate side but with their teaser rate that have gone to 18 months teasers and then going to a go to rate of up closer to the 10% range. 18 month teaser rate certainly -- combined with the volume that Citibank is mailing. They are month in and month out. This is the largest mailer in the country. It certainly something that having a significant impact there.

With respect to our own quote-unquote dial back, I don't want to get too carried away with the extent of this quote-unquote dial back, we projected in the latter part of last year as we tried to map out the entire year, something in the neighborhood of 20 to 25% growth. As the intensity of this price competition does not abate, we believe a more practical level of growth consistent with never compromising in terms of being above hurdle rate and everything we are doing and even putting recessions into our forecast as we originate accounts, we believe that 15 to 20 as opposed to 20 to 25 is the prudent thing. And we are also not of the -- things are tougher in the super prime area but we will make it up with sub prime. Because again back to the questions at the beginning, we are very rigorous about maintaining at the margin the more up market shift that we have talked about in the past. Now if I look back if I'm a student of how these markets work, it's -- if I had to guess, this is not our official company policy, this is me speaking. Sometime over the next this year there will be abatement in the competitive pricing because I think competitors will find it tough to play in this -- with these price levels. Nonetheless, our assumption is that the marketplace does not improve and therefore working backwards from that we get to the 15 to 20% growth range.

Let me go back to your question about sub prime. Once the MOU is over, can we do more sub prime? The regulators have not dictated our growth in the sub prime marketplace or really our overall growth as a business. If the MOU is listed tomorrow morning, while we be happy about that, it wouldn't change whatsoever our strategy here because our strategy of going up market is one that far beyond the regulators one that we think will be a winner with every contentness will make Capital One a stronger company and with respect to the sub marketplace and some sense it's not going anywhere. It's our opportunity to generate business will be there. One thing that will happen is that as we move through the seam, as the charge offs really come down and people are able to say, I see how Capital One didn't fall foul to what happened to all the other players who play in the sub prime marketplace, our credibility and the acceptance of our sub prime business I think will increase. Nonetheless, we will continue to pursue our steady up market tilted growth strategy.

The next question is from Mark from Access Capitals.

I want to tack on with everybody it's wonderful to know you all these years. The question is, one of the things I'm not quite sure of in terms of the thought process, obviously the numbers this quarter, the earnings, the bottom line were much stronger than expected and prior to that was due to or a lot was due to the lower provisioning and lower reserve and yet there is a acceptance that it also means sticking to the guy and saying you will have lower quarter earnings going forward because the part to build up the reserve as growth grows. So the question is why did you bring down the reserve this quarter as opposed to kind of looking out for the full year and trying to see where the pieces fit?

Mark, thanks for the question. Actually, the reserve is actually driven by the actual credit performance of delinquency rate, migration rate. And we followed those policies consistently which the accounting principles require us to do. And so we have in fact done that and in the reserve is supposed to go down when credit is better and losses will be reduced. And I don't know if you can anticipate that trend not only in our own financial reporting, but pretty much in the financial services company out there, that has to build an allowance for loan losses.

We'll make this our last question at this point.

Our final question is from Moshe Orenbuch with Credit First Boston.

Thanks. I was wondering if you could talk about the plans and little more detail about the other businesses, perhaps auto, how the arrangements are going in international expansion. Thanks.

This is David Lawson. Il will cover the auto business. The floor arrangement is going well as we described on the last call. The flow arrangement was to ramp up throughout the year and with it is progressing on target in the first quarter something somewhat less than $100 million was sold on a flow basis and for the entire year we anticipate selling between 800 and $900 million on a flow basis of the sub prime loans. That's going well. And we anticipate continuing to -- in particularly the latter half of the year seeing that flow accelerate quite a bit.

This is Nigel, just a couple of quick words on international. International is doing very well and as I mentioned in my prepared remarks, the first quarter profitability on a segment basis is really nice. You can see there was not much growth in terms of dollars and about $60 million. Exchange rates moved slightly against us and season at.

The two big markets, UK and Canada, the credit risk are coming in better than expected. Costs are falling. Good opportunities in super prime and underserved and they continue. Profitability is strong.

Things to worry about, and building brands like we have in the U.S. Things to worry about would be rising rates in a world where mortgage debt is principle variable and could hurt debt burden ratios and cause risk to rise. As well as the UK market is on hold the last month or two with what's been happening in Iraq. I have not seen recent data to how it's springing back. I would assume it's springing back in the UK. Canada, the second biggest market doing well. Ahead of profitable in terms of schedule. Good growth response rate steady and I think we have some securitization activity plans there.

Other testing in France and continues to be -- jury is still out. We are hopeful to crack the code there. Won't say grand statements at this point but we continue to see good solid progress Marching toward our goals there. I think international business is 10% of our portfolio. And faster than that in the U.S. card business. Returns at the margin in terms of accounts that are similar or slightly better than with a we perceived in the U.S. A good deal of momentum with the wind in our back in this business.

Paul, let me just wrap up with a comment here. I think all of us feel that we have aged several years in the past year because this has been really an extraordinary year and I know many of you who follow us and invest in us have certainly could echo that. But between the industry blowups, the regulatory environment, the challenges in the stock market, the very challenging competition out there, with a we have done is to just take a strategy and just keep on doing what has made Capital One successful while being sensitive to the needs of the many different environments out there. And there have been times that I think a lot of people have questioned whether Capital One was like some of those companies that were going the wrong way and whether in fact the business model that had led us to enjoy so much success really could -- sort of perfect storm that unfolded over the past year. And there is an incredible energy and excitement that we all have in this company as we really get to the other side of the seam and while we all feel like we have aged quite a bit, we have learned a lot.

Frankly what's happening is Capital One is coming out of this thing in tremendous financial shape having consistently delivered and with the prospect of the future as far as we can see is delivering great financial numbers. The diverse -- -- efforts that we worked to many years to get traction are materially really getting traction at this point and the traction begins with diverse -- -- of assets. Moving this year into substantial diverse -- -- of earnings and that's into other geographies and products and up market itself. And now as charge offs turn and we take this opportunity, even as we mark the passing of such an extraordinary executive as Nigel, folks are galvanizing around the new executive team, the opportunities that we face and the chance to really right the next chapter of Capital One in a story that the best chapters I think are still remain to be written.

Thank you very much. Anyone that has any questions at all please call investor relations this evening. And any time in the future. Thank you.

This concludes today's Capital One first quarter earnings conference call.