Capital One Financial Corp (COF) 2003 Q4 法說會逐字稿

Welcome to Capital One's Fourth Quarter 2003 Earnings Conference Call. All lines have been placed on mute to prevent background noise. After the speakers' remarks there will be a Q&A period. If you would like to ask a question press the star key then the number one. If you would like to withdraw your question press star then the number two. Thank you. I would now like to turn the call over to Paul Paquin, Vice President Investor Relations. Sir, you may begin your conference.

Thank you, Cody. Welcome everyone to Capital One's Fourth Quarter 2003 Earnings Conference Call. As usual, we are webcasting live over the internet. For those of you who 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.

In addition to the press release and financials, we have released a group of slides summarizing the fourth quarter and year-end results. Rich Fairbank and Gary Perlin will walk you through these slides. To access a copy of the slide presentation for the purpose of following along, please go to www.capitalone.com click on Investors and then on Quarterly Earnings Releases.

The company generates earnings from its managed loan portfolio which includes both on balance sheet loans and securitized loans. For this reason, the company believes the managed financial measures and related managed metrics to be useful to stake holders. In compliance with 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. For more information, please see the schedule titled reconciliation of Debt Financial Measures attached to the press release filed with the SEC on form 10K earlier today.

The statements made in the course of this conference call that mention the company's or management's hopes, intentions, beliefs, expectations, or projections of the future, are forward-looking statements. It is important to note that the company's actual results could differ materially from the results projected in our forward-looking statements. Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements is contained in the company's SEC filings, including but not limited to the company's most recently filed report on form 10-Q for quarter ended September 30, 2003. Our website contains all of our SEC filings, as well as our monthly asset backed securitization performance data. To access this information please go to www.Capital one.com, click on Investors, then click on SEC and Regulatory Filings.

In order to take advantage of the limited time available to ask questions of senior management during this call, we would appreciate it if you would ask only the more strategic questions. This will allow you to take advantage of senior management's availability. Please remember that Investor Relations staff will be available after the conference call this evening to answer any and all of your questions.

With me on the conference call is Mr. Richard Fairbanks, Chairman and Chief Executive Officer, and Mr. Gary Perlin, Executive Vice President and Chief Financial Officer. At this time, I'll pass the call over to Mr. Fairbanks for his remarks. Rich?

Thank you, Paul. And welcome, thanks for joining us today.

We'll be going through the slide presentation that's available on the website, and we will be starting on Slide 3. We are pleased to report EPS of $4.85 for the full year and $1.11 in the fourth quarter. 2003 was a very important year for Capital One. And what we have accomplished in 2003 positions us very well for 2004. We have stable to improving credit metrics, all of our business segments are growing and are profitable. Our balance sheet has never been stronger, and our regulatory relationships have greatly improved.

As a result of all these factors, we are raising our earnings guidance for 2004 to $5.30 to $5.60 per share. I'll speak to that some more at the end of the presentation. First I would like to review the highlights of our 2003 performance.

Please turn to Slide 4.

There are three macro trends that positively affected our results in 2003, and are setting the stage for 2004. Our diversification efforts, our move-up market and steadily improving credit quality.

First, most of you know we have been pursuing a diversification strategy for many years. Auto finance, small business, installment loans and our international activities now account for 35 percent of our managed portfolio. And these businesses accounted for 53 percent of our loan growth in 2003. Most importantly, our diversification businesses are now gaining traction where it really counts, in bottom line profits. These businesses accounted for 69 percent of earnings growth in 2003.

Second, in 2003, we continued to invest heavily in our up market portfolio in U.S. card. Our growth plans for 2003 were to grow loans with a greater emphasis on prime and on super prime assets and our sub prime. In fact our loan growth in 2003 was almost entirely in up market products so we are ahead of schedule on this front.

Third, our steadily improving credit quality was also a key driver of our results in 2003. And there were three factors contributing to this strong credit performance. The seasoning curves of a fairly large pool of sub prime loans booked in late 2001 and early 2002 came and went. The impact of our mix shift, both in diversified lending and up market continued to drive our credit metrics lower. Finally the macro economy provided some tail wind as unemployment trends improved a bit and they positively impacted consumer payment patterns and bankruptcies.

The natural results of our diversification efforts and our move-up market has been a declining revenue margin. This has been largely offset by reduced expenses as a percentage of loans including operating costs, marketing expenses and charge-offs. The net effect is a relatively stable ROA. ROA in 2003 was 1.53 percent compared to 1.49 percent in 2002. Gary will speak to this effect in greater detail in just a few minutes.

Our investors responded in a big way to these trends in 2003. Stock price, as you know, rose 106 percent in 2003 and most of our debt spreads narrowed to their tightest ranges in our history.

In summary, 2003 was another great year for Capital One. We delivered great results while continuing to transform Capital One into a diversified consumer financial services company.

Now I'm going to turn it over to Gary for a financial review of the fourth quarter. Then I'll provide a business update, and then we'll open it up for Q&A. Gary?

Thanks, Rich and good afternoon to everyone. I'm pleased to provide the quarterly and full year financial update in which I'll cover four topics.

First, a high level overview of financial results with an emphasis on the fourth quarter which illustrate clearly the business themes described by Rich. Second, I'll offer a brief analysis of fourth quarter allowance data highlighting the factors which drive this important component of quarterly earnings. Third, I'll provide a longer term review of Capital One's financial returns in order to demonstrate sustained earnings power in the midst of the company's transformation to a more diversified, full spectrum lender. Finally, I'll highlight the strength of Capital One's balance sheet as we enter a new year of exciting business opportunities.

Turning to Slide 6, you've seen Capital One's fourth quarter financial results with EPS of $1.11. I'd like to highlight two items from the income statement and then focus on the financial metrics which really drive these results. Among the income statement highlights, I'll start with marketing expense which, in the fourth quarter was down about $25 million from the third quarter. You'll recall that quarterly marketing expense hit a high of $316 million in the third quarter as Capital One took advantage of market conditions to roll out a number of innovative products which contributed to substantial loan growth in the second half of 2003.

I'd also like to address the operating expense which rose by 8 percent, or $74 million during the fourth quarter. This was driven largely by non-core items and typical year-end expenses. Chief among these were adjustments in compensation, a small percentage of which reflects the adoption of FAS 123, including the expensing of stock options granted in 2003. Also included in operating expenses are continued site consolidation items, and investments in improved account management.

While we're on the fourth quarter, let me also focus on the allowance metric which shows a positive allowance build of $25 million during the quarter. In fact, let's move on to Slide 7 to get some more color on this very important driver of Capital One's earnings. Now, this slide should be familiar to those of you who were at the debt and equity conference in October and who listened in on the last conference call. Although this time around we've added some additional data which gives additional insight into this very important metric.

As I've indicated before the allowance for loan losses results from a highly disciplined methodology, building on our experience and trends and delinquencies which are the best leading indicators of future charge-offs. For the allowance as a function of portfolio size, and performance. And to demonstrate the interplay of these factors, Slide 7 notes the estimated dollar impact on the allowance of each trend holding all other factors equal.

Starting at the top in the fourth quarter, loans expected to be held on balance sheet rose by some $2.2 billion. Taken alone, this would have increased the allowance by about 160 to $170 million. This impact was largely, but not completely offset by improved credit performance in the quarter.

This is attributable to two items. First the mix shift in the portfolio, which represents both this quarter's performance, and the cumulative impact of the mix shift in previous quarters. And secondly, it reflects our overall payment experience, meaning improved consumer repayment behavior across all of our portfolio. The net effect on the allowance in the fourth quarter was a positive build of $25 million. Although for all of 2003, we did see a negative build.

Moving forward to Slide 8, you'll see all the metrics and income statement highlights for the full year 2003. At this point, however, I just want to focus on a couple of items. First, the capital to managed assets ratio rose to a near high of 8.19 percent. Second, you'll see in these metrics stark evidence of the diversification and move-up market, simply by looking at the facts that loans outstanding grew by 19 percent during the year, while the number of accounts actually fell, reflecting the larger balances consistent with these strategies. Third, revenue margin, as Rich identified earlier, declined over the course of the year by some 228 basis points. Again reflecting our mix shift in diversification, but at the same time, look one line below and you'll see return on assets remains stable, in fact rising by three basis points to 1.52 percent. This dynamic between revenue and return says much about Capital One's earnings power over time, but the message is much clearer if viewed over a longer period of time.

That's why Slide 9 looks at 2003's results with the perspective of the last three years, during which Capital One has become a significantly more diversified and balanced lender across products and especially up market. This period has also seen Capital One move towards slower, more sustainable growth and is also a time during which Capital One has increased its liquidity by building up its investment portfolio which tends to depress reported revenues.

Now, while the bottom line on Slide 9 is relatively stable, it's obvious the components have changed significantly in line with our strategic shift. Revenue as a percentage of assets has decreased as we diversified into lower margin businesses and moved up market. Collectively, however, costs have also decreased for the same strategic reasons. Improving credit has led to lower provision expenses as a percentage of assets. Also, larger loan balances per account plus the scale we have been achieving in new business lines drives down operating expenses and marketing expenses as a percent of assets. The net result is consistent and healthy bottom line returns.

Turning to Slide 10, provides a reminder of why this steady trend in ROA is not always obvious to those more focused on quarterly results. Quarterly returns will show variability due to changes in growth opportunities, asset mix and the influence of seasonality on balances and credit experience. However, over the course of a full year, or over several years, ROA is much more consistent and reflects the sustained earnings power that our business strategies and financial discipline deliver. We continue to expect both quarter-to-quarter variability as in 2003 and relatively stable long-term ROA in 2004 and beyond.

Finally, our balance sheet is strong and ready to support business opportunities in 2004 that Rich will address in a moment. I mentioned earlier that our capital ratios are at all-time highs.

Turning to Slide 11, it's also clear that our fourth quarter funding performance kept a very strong year in the capital markets and in deposit generation. Throughout 2003, Capital One accessed all public funding markets in size, over $20 billion in total and in a very balanced way. Among U.S. card securitizatons, the relatively large issuance of single A and triple B securities allowed us to build a stockpile that as of the end of 2003 means our next $12 billion of charged securitizations could be issued as triple A securities. Clearly the most reliable space in the funding markets. We also saw strong demand for auto loan securitizations, U.K. card securitizations and unsecured funding at the bank and parent level. Deposits outstanding also grew by over $5 billion in 2003 at an average maturity of about 3 1/2 years.

And, as you can see on Slide 12, this funding success was achieved as our funding spreads improved steadily throughout the year. Our triple B spreads improved most dramatically, but the more modest improvement in triple A spreads is actually more meaningful, given its share in our capital market funding.

The result of this funding is that, as we entered 2004, our liquidity position, as seen on Slide 13, is very strong. Available liquidity rose by over 50 percent in 2003. At year-end Capital One's available liquidity was sufficient to cover more than three times our debt maturities for 2004. This, along with our capital and funding capacity prepares us to take advantage of opportunities as the new year begins.

So with that update on a very solid quarter and a solid year, I'll turn the call back to Rich.

Thank you, Gary.

Turning to Slide 15, you can see the composition of our loan growth in the quarter, and in the full year 2003. The last two columns also show the quarterly and annual growth rate in loans for the various businesses. In the lower right corner you can see that in 2003 we grew loans by 19 percent over 2002. You can also see that this growth was broad based both in the fourth quarter and in the full year with all lines of business growing nicely.

We changed our segment definitions in the fourth quarter, which was done to reflect recent organizational changes in the company. These new segments line up with how we manage the business internally.

Our domestic credit card segment was previously included in the consumer lending segment, but we will now report U.S. card as its own segment and, of course, this business is headed up by Katherine West.

You can see that we grew the U.S. card business by $2 billion or 4.5 percent in the fourth quarter. Our growth plan allowed for the possibility of very robust holiday shopping season, which turned out to only really be an average one.

Installment loans and small business have been moved to a new segment called global financial services or GFS for short. GFS also includes our international businesses and a variety of smaller ventures. This segment is headed up by Larry Clain who now heads up all of our diversification activities beyond auto finance.

GFS grew loans by 1.5 billion or 10 percent in the quarter, $400 million of which was due to currency exchange rate effects. Our auto finance segment, which continues to be headed up by Dave Lawson, had another great quarter and grew 21 percent in 2003, not including $1.9 billion in whole loan sales during the course of 2003.

For Capital One overall, growth for the year came in at 19.2 percent in line with our guidance of about 20 percent.

Turning to Slide 16, you can see the growing success of our diversification efforts. Our diversification businesses accounted for $6.1 billion of managed loan growth in 2003, or 53 percent of the total loan growth at the company. And, as you can see by looking at the percentages on the bottom of the chart, businesses beyond our U.S. card business now account for 35 percent of our managed outstanding loans.

But, as you all know, true diversification success is diversification of earnings. Turning to Slide 17, you can see the earnings of our diversification businesses over the past three years. After reaching break-even in 2002, our diversification businesses generated $164 million in profits in 2003. This growth in earnings accounted for 69 percent of the total earnings growth of Capital One in '03. We expect that over time these businesses will continue to grow assets and profits at a faster pace than our U.S. card business, and there by continue to transform Capital One from a mono line credit card company into a diversified consumer financial services company.

Slide 18 shows 2003 quarterly profits for each of our segments. If you look at the first column on the table you can see that U.S. card had a record fourth quarter driven by solid growth and strong credit performance which I'll talk more about in a moment. Auto finance also had another strong quarter and generated -- excuse me $99 million of profit in 2003. You can also see that global financial services segment experienced a drop in profits in the fourth quarter driven largely by an increase in marketing in the quarter. We continue to expect the GFS segment to deliver strong profit growth in the coming quarter and years.

Turning to Slide 19, this graph shows the monthly charge-off rates and the quarterly charge-off rates can also be seen along the bottom of the graph. Perhaps the biggest story of the fourth quarter -- in fact probably the biggest story of 2003 is our declining charge-off rate. We had 6.47 percent charge-offs in Q1. It fell to 6.32 in Q2, down to 5.44 in Q3 and now to 5.32 in Q4.

You may recall in our third quarter conference call that we said a fourth quarter bump up in charge-offs was likely. Well, you can see that while the charge-off bump materialized on a monthly basis, it did not occur on a quarterly basis. It turns out the normal seasonality was more than offset on a quarterly basis by a fundamental improvement in credit.

This fundamental improvement in credit that we have experienced has been very broad based. Our collections and recovery efforts have been strong, keeping delinquencies down and recoveries up. Delinquencies in roll rates improved, which is a bit unusual for the fourth quarter, actually. National bankruptcy petitions in the second half of '03 were essentially flat with the first half of '02 and our experience at Capital One is consistent with this trend.

We are certainly pleased with the strong credit performance in 2003, and we remain cautiously optimistic about 2004. As we indicated in our press release, looking forward we expect our charge-off rate in 2004 to be somewhat lower than the 5.32 percent we reported in the fourth quarter of 2003. This expectation is, of course, based on the current performance of our portfolio and our current view that the overall economy and unemployment rates will not materially worsen.

Turning to Slide 20, we can take a look at lag charge-offs. Nine-month lag charge-offs also show the bump in the fourth quarter, and in general lag charge-offs are holding steady.

Turning to Slide 21, we can take a look at the credit performance by segment. All segments experienced stable to improving charge-offs in the quarter with auto finance experiencing the biggest improvement, 80 basis points. U.S. card charge-offs were essentially flat with the improvement in credit and higher growth rate offsetting the effects of the usual seasonal uptick in the fourth quarter. Global financial services was also essentially flat with a solid credit performance across all major subsegments.

The largest improvement in the quarter came from auto finance, as charge-off rates fell 80 basis points due to mix shift towards super prime and also improvement in auto credit in the quarter. Where seasonal pressure was overwhelmed by fundamental improvement in credit. Additionally in auto, used car prices were slightly improved from earlier in 2003. As you know, this is an important variable for Capital One because it effects the amount we recover on cars that are repossessed and sold at auto auctions. We're still along way from the recovery levels we experienced a few years ago and the captives are still aggressively pushing zero percent financing rates. Nonetheless a little stability in used car prices is certainly a welcome development.

Turning to Slide 22, you will see that delinquencies also improved in the fourth quarter, falling 19 basis points to 4.46 percent despite the normal seasonal headwinds of the fourth quarter. Here again you can see evidence of the mix shift in improvement in credit overwhelming seasonality.

On Slide 23 we can see delinquency at the segment level. In two of the three segments, GFS and U.S. card, credit overwhelmed seasonality and we see a drop in delinquency rates. In auto finance, delinquency seasonality is very pronounced and despite the improved mix and credit performance, we still see the seasonal uptick in delinquencies.

Turning to Slide 24, I'll sum up the key points about 2003 before moving to our 2004 guidance. Credit quality improved during 2003 due to a combination of disciplined underwriting, our move up-market and some macro-economic tailwinds. The diversification business has generated meaningful profits. GFS and auto finance both grew faster than U.S. cards in loans and profits, accounting for 69 percent of earnings growth in the year.

Overall managed loan growth of 19 percent, largely up-market despite a tough competitive environment from both traditional competitors and from the mortgage re-fi boom led to a very solid year of growth for Capital One. As Gary mentioned earlier we raised $5.8 billion in public funding in '03. We hold $16 billion in liquidity capacity and are enjoying the tightest spreads in our history across most of our debt instruments.

We have nothing new to report on the regulatory front. We will tell you our relationships with our regulators have never been better. We have really matured as a company in 2003. Our risk management and governance practices will assist us in continuing to generate solid growth and strong returns for our shareholders.

On Slide 25 we have included a summary of our guidance for 2004. We expect healthy loan growth in the mid-teens. Revenue margin will continue to decline somewhat in 2004, but likely less than in 2003. Our charge-off rate will be lower in 2004 than the 5.32 percent we posted in the fourth quarter of 2003. We expect to have a negative allowance build for the year as a result of the factors we have discussed in detail today. In other words, improving credit metrics, loan growth in the mid-teens, as well as the continuation of our strategy of diversifying beyond the U.S. card business and moving up-market within the U.S. card business.

Overall we expect our strategy to deliver ROA in 2004 similar to the full year ROA we delivered in 2003. However, as Gary explained there will be quarterly volatility in our ROA. As a result overall of all the developments that we have been talking about here at Capital One, we are raising our earnings guidance for the full year of 2004 to a range of $5.30 to $5.60 per share. With that, I'll turn it over to Paul for the Q&A. Paul?

Thank you, Rich. In order to give everyone the opportunity to give everyone the opportunity to ask a question, please limit your questions to one. If you have any follow-up questions, the Investor Relations staff will be available after the call. Cody, please start the Q&A session.

At this time I would like to remind everyone in order to ask a question, please press star then the number one on your telephone keypad. Please limit your questions to one per person. We'll pause for just a moment to compile the Q&A roster . Your first question comes from Mike Hughes with Merrill Lynch.

Looking at your Slide 18, you guys show U.S. card having materially accelerating profits in Q4, and you mention that global had decelerating profits due to heavier marketing. Is it fair to say that maybe you guys De-emphasized U.S. card marketing in Q4 and, if so, maybe you could kind of flush out what was your thinking behind that.

Okay, Mike, this is Rich. I really think the rather spectacular performance of U.S. card in the fourth quarter was really driven by the spectacular performance of credit in U.S. card. The marketing investment and intensity in U.S. card continues at a pretty consistent rate, and we continue to invest to grow the U.S. card business where we believe that we will continue to grow at a rate in excess of other players. Really basically the top of the industry. All that said, on a relative basis, we're still expecting more growth in assets, and ultimately in earnings in -- you know, beyond the U.S. card business and the heavy investment in marketing in GFS in the quarter as a reflection of the bullish outlook for future growth.

Next question, please?

Your next question comes from Bob Napoli with Piper Jaffray.

I was wondering if the 5/10 charge off rate in the fourth quarter in December was indicative of the trends you see in the first quarter. On a bigger picture basis, Rich I was wondering if you could talk about there have been a lot of large mergers, you are getting some bigger competitors, also have been, I guess more frequent rumors about Capital One being involved in the consolidation of the industry. What are your thoughts on the changes that you would expect out of the competitive environment and Capital One's position and desire to continue to go it alone in that market?

Okay. Thank you, Bob. Yeah, I think we are not giving quarterly indications with respect to credit quality. I think that the -- the momentum of positive credit that carried all the way into the December certainly bodes well for '04. But, again, I want to reiterate we see '04 that credit charge-offs will be somewhat lower than the 5.32 that we enjoyed in the fourth quarter.

Bob, obviously it isn't lost on anyone that the major banks are merging with each other and, you know, both from a competitive point of view we perk up at that in terms of looking at companies like J.P. Morgan and Bank One consolidating and probably in the short run, hopefully being a little distracted by the merger activities, but certainly over time creating maybe another potential powerhouse that we have to contend with, and that's not lost on us. I think that there's lots of speculation out there. There's been speculation for many, many years about Capital One. We are not in the speculation business, we're really in the business of focusing on our strategy which has continued, I think, to generate a lot of good performance for Capital One shareholders and we continue to be very bullish about that going forward.

Next question, please.

Your next question comes from Joel Houck with Wachovia.

Hi, thanks. I think you mentioned that in terms of credit quality you are assuming the environment does not worsen. Are you assuming that the environment doesn't get any better, and to the extent that the environment does get better, particularly the labor market, would you contemplate shifting down market, perhaps driving higher revenue growth, a little better balance away from the prime businesses?

Joel, it -- yeah, let me -- the -- it's sort of two questions there. With respect to our outlook, what -- in our numbers, we, in a sense, are sort of freeze-framing credit as it looks in -- as it sort of works its way through our portfolio. In other words, we raised guidance because we see positive things working their way through the portfolio. But, on the other hand, we raised it only to the extent that we sort of see things really happening as opposed to possibly speculate that things might get better. Frankly, of course things could get better, they could get worse. But I think that the slightly improved view of next year in terms of credit performance is based on really things that we see, and that tends to be consistent with how we forecast.

The -- I think it's very unlikely that the -- any changes in here or there in credit performance is going to have a very significant impact on whether we are more up-market or less up-market because, frankly, this, to us, is less about, you know, today's credit environment and very much about looking the -- booking the right mix of long-term business that through thick and thin can have the kind of performance that we want. So we welcome an improving performance in the economy, but our investments do not count on it. In fact, to remind you in all of our investment decisions we assume a significant recession starts tomorrow morning. And for our decisions as opposed to our budget for next year. For our decisions we continue to assume that recession.

Next question, please.

Next question comes from Mike Vinciquerra with Raymond James.

Thank you. Gary I was wondering if you could flush out for us in more detail the operating expense increase we saw in the quarter. When we look at things on a per account we are now at a run rate of about $86 net of solicitations, we were at one point down in the mid-70s. What would you suggest as kind of an outlook for that on a per account basis? And can you run through the line items again as far as what was the drivers of the increase in Q4?

Sure, Mike. Let me start out with your basic premise which is that we should be looking at our expenses on a per account basis. If you recall the comments I made earlier about the changes in our strategy working their way into kind of a different account dynamic much larger balance accounts, I think that metric is going to be, perhaps, less useful going forward than it has been in the past. So what we're really looking at is overall expenses and we're certainly looking at expenses as a percentage of overall loans.

But let me get to your very specific question which is what happened in the fourth quarter, and indeed there were a number of items starting with the compensation items and always at year-end, we get incentive compensation numbers working their way through and, of course, with the higher stock price that was reflected, we also had to book some relocation expenses associated with certain recruitments as well. You'll recall that in the third quarter we had a very substantial increase in the amount of business that was coming in the door, and with growing accounts during the fourth quarter, you saw about 600,000 new accounts in the fourth quarter, booking those also had some impact on our expenses. And as a result, there are just a number of items that show up at year-end that you saw in the fourth quarter.

Looking forward, you know, we believe that we expect really modest growth in operating expenses pretty much in line with revenue projections. How that will play out in terms of per account, will really depend on the mix of business between card, up-market and otherwise, auto and GFS.

Next question, please.

Your next question comes from Christina Clark with Bank of America.

Yeah. Thanks so much. Just wanted to -- some of my questions have been answered. I was wondering if Gary could repeat how much in triple A asset backed capability you have, given the subordinate issuance.

Sure, Christina. Again if everybody just has a quick look back at the funding slide which was on 11. If you take a look there, you'll see that we did significantly more single A and triple B funding over the course of the year than would typically be necessary to support the amount of triple A's that were done. That leads us to have a stockpile at the end of the year. So looking forward, if we wanted to, we could limit our funding and securitizations to triple A.

As of the end of 2003, we had a sufficient stockpile of single A and triple B card securitizations that over the period of time we could issue the next $12 billion of card securitization as triple A securities, and that is what gives us the flexibility to generate the best timing on those triple As in order to get the best funding price. Certainly we intend to maintain a stockpile going forward.

Next question, please.

Your next question comes from Vincent Daniel with KBW.

My question's been answered. Thank you.

Your next question comes from David Hochstim with Bear Stearns.

My question is could you talk a little bit about the change in marketing spending and what's different, where you're saving money and then had a couple of clarifications. The stable return on assets is that from the fourth quarter or from the average for the year? And then were there loan sales in the fourth quarter?

Okay. David, the -- there is -- I mean, first of all, we continue to invest heavily in marketing. I think that, you know, as we diversify beyond U.S. card and move more up market, our diversification businesses and the up market products are much more efficient on a per asset basis with respect to marketing. So, for example in 2003, we increased marketing by only 4 percent but increased loans by 19.2 percent. That's sort of the most important point.

There's a secondary point, also, though there's a lot of work has gone on at Capital One to build the technology and the integrated modeling to be even more efficient with respect to how we spend our marketing. And this, again, is something that has had significant productivity benefits. So we expect that our marketing levels in 2004 will be generally higher than 2003, and although, again, we will do some adjustments at the line of scrimmage, I think in general, the overall trend that marketing as a percentage of loans will tend to decline consistent with the mix changes in the company.

I'll take your question on loan sales. During the fourth quarter we sold $251 million of non-prime auto loans which resulted in a pre-tax gain of $13 million, which is consistent with the kind of experience we've had in previous quarters. Just as a reminder, the gain from loan sales are an extremely -- it's important to understand that those have good quality to them. There's -- the loans are sold off the balance sheet with no recourse, so there's no back end risk. And, as I indicated, we tend to sell loans regularly as a source of funding for our auto finance business. So you should not expect to see any significant change or spike in that number.

And the ROA number we are talking generally -- in fact we were specifically talking about stable ROAs on an annual basis. One doesn't have to look very far to see that on a quarterly basis they have a lot of variation, and we expect those variations to continue on a quarterly basis.

Next question, please.

Your next question comes from Moshe Orenbuch with CSFB.

Thanks. If you could, maybe, Gary talk a little about bit about that liquidity and how it's likely to be deployed in 2004. It would seem you have the ability to put a little more of your receivables growth kind of off balance sheet if that's the case, particularly in light of the fact that securitization spreads are as healthy as they look.

Right, Moshe, well certainly flexibility is the reason we have built the liquidity as much as we have. Certainly we see that liquidity as an important tool to help us respond to opportunities as we go along. As you can see on Slide 13, we're keeping that liquidity in relatively low cost sources of maintaining that liquidity. Much of it is in longer term investments, and in untapped conduit capacity which, again, have very little cost for us.

So the fact of the matter is we are quite happy to have that additional liquidity. It's being built up specifically for the purpose of giving us flexibility to respond to opportunities. It's there for any purpose that may be necessary, and making the calls that we need to make as we go along in terms of our funding strategy on and off balance sheet, we're certainly not expecting any significant change in the share, pretty much across the balance sheet over the course of next year. So simply, liquidity has been built to take advantage of good market opportunities and make sure we're ready for any opportunities that might come.

Next question, please.

Your next question comes from John Baldi with J.P. Morgan.

Yes, good afternoon. Rich, I was wondering if you could comment a little bit on the composition of the $2 billion of U.S. card growth in the quarter. Because I recall at our October conference you had discussed the potential for getting some sub-prime growth back into the business after essentially a year of being on the sidelines. So if you can elaborate on that a little bit.

Yes. The sub-prime growth did resume in the fourth quarter. Actually the fourth quarter growth at the margin of up-market relative to sub-prime was very much consistent with our portfolio at the beginning of the quarter. So in some sense the various pieces of the business, in a sense, sort of held share within the quarter. And in 2004, we do expect to continue to shift our growth up-market gradually, but at a slower rate, and part of this really is resuming moderate growth in sub-prime in '04 relative to the nearly flat condition of sub-prime in '03.

Next question, please.

Your next question comes from Richard Shane with Jeffries and Company.

Can you just go back through the operating expenses? You know, obviously that's a little bit of a surprise how high the number was. Can you help us try to figure out if there's a component of that that's nonrecurring that we should try to understand going forward.

Sure, Richard. Again if you take a look at the course of the year operating expenses were moving pretty much in line with expectations as well as in the fourth quarter. A number of non-core expenses, which indeed could be nonrecurring. As I indicated we've got the compensation expense which, in particular in the fourth quarter reflects the improvement in our overall metrics and stock price, and so forth. We also have started to expense all of our stock related compensation, as I indicated, relatively small number, but again, it's something that would have shown up in the fourth quarter. We've taken all of those assumptions and, of course, pushed them forward into all of our views for 2004.

We made some investments in account management which will allow us to be more efficient going forward. There was a continued amount for site consolidation, which was a continuations of some of the activities I indicated had gone on in the third quarter.

So, I would not look at the fourth quarter as your base run rate to be drawn through all the way through 2004. There are some things that hit at the end of the year, which we saw, and certainly we would expect modest growth on a year-over-year basis, and I would not put too much focus on the individual quarterly outcome.

Next question, please.

Your next question comes from Jim Edelman with Highland Capital.

Hello. Would you be willing to comment on the pluses and minuses of Capital One partnering with a large financial services company?

Jim, I think that's not something that we're going to undertake here. I think Capital One -- we are very focused, as I said before on delivering the continuing success we've had here at Capital One. And I think everything else would be speculation.

Next question, please.

Your next question comes from Michael Hodes with Goldman Sachs.

Hi, guys. Really, one question and one clarification. As the business evolves and you've shifted up-market, could you give us a sense of how we should think about seasonality, particularly in terms of kind of the rhythm as we go through the year? I understand you don't want to comment on specific quarters, but it seems like the pattern, you know, is changing. I was hoping you could elaborate on that. Secondly, just regarding the reserve, are you talking about it coming down in absolute terms in terms of reserve releases, or as a percentage of on balance sheet assets?

Michael, it's Gary. With regard to your question about the impact of the up-market move on seasonality, certainly over the course of 2003, when we experienced a significant move up-market, we did not necessarily see a disappearance of the seasonal trends. As Rich and I have both had to indicate, those seasonal trends weren't as obvious in the bottom line simply because they were overwhelmed by the improvement in credit behavior across the entire credit spectrum and across our entire portfolio. So we certainly saw the seasonal experience this year that we have had in years past. So there's no evidence, at this time, to suggest that we should look at seasonality differently at the current time.

And with regard to the question of reserves, I assume you're talking about the allowance, in particular, coming down. Certainly we have indicated that we believe there will be continued downward pressure on the allowance coming from the existing -- existence of the very positive delinquency rate trends that we've been seeing in the last couple of months. We pull those forward as the best indication of what we expect and that tends to be a put a downward impact on the allowance.

Again, the one unknown we have is what will be happening to overall volumes. Because as you saw from the previous slide the existence of growth in any particular quarter could overwhelm the improvement that we expect to see in the credit metrics coming both from the underlying trends which really demonstrated themselves over the course of the last quarter, as well as the benefit of many quarters of having moved up-market which obviously will continue to have a beneficial impact on our credit experience.

Next question, please.

Your next question comes from Eric Wasserstrom with UBS.

Great. Thanks. Gary, can you -- to follow-up on Moshe's question about the structural liabilities, is there any sense -- are you guys doing anything for example to lengthen duration of your liabilities right now and take advantage of a low interest rate environment that will presumably be coming to an end in the nearer term? And is there any -- given the build in capital you've had, are there any discussions going on with credit rating agencies as an example to possibly raise your status to some degree?

Eric, thank you. First of all, on the question of the, you know, the liquidity build and might we use this as an opportunity to lengthen our maturities, for example. Let me start out by simply reiterating that we are not in the business of taking interest rate bets. It is not something that Capital One does. It's not our competitive advantage and so we really are running a matched book.

And as a matter of course, because we've had, especially over the course of the last year, quite a lot of new fixed rate assets coming on to the books we have been extending the term of our debt and we have been doing it pretty much across the board including deposits. We have been issuing deposits over three years average maturity and we have been doing some similar extensions in all of our funding programs but it is not with a rate view other than to make sure that we are continuing to run a matched book. Certainly the increase in the capital ratios, as you’ll notice, has come largely from the fact that our earnings growth has outpaced our asset growth. Obviously maintaining very strong capital ratios is an important objective of Capital One, and we believe that many in the market are taking notice of it. As far as the conversations with the rating agencies, I'll let them speak for themselves. But we certainly have a very robust and ongoing conversation with them, and we believe that as they see the improvements across all of the important financial metrics of our company, just as you and others in the markets have seen, that they will take due notice of it as they make their judgments as they go along. And we're certainly committed to maintaining that dialogue and making sure we get full credit for what we've been able to deliver.

Next question, please.

Your next question comes from Matthew Clark with A.G. Edwards.

Good afternoon. Just following up on the Michael Hodes question on the reserves. In your new guidance are you assuming a further draw down in your reserves? And if so, do you have any estimate in terms of range? Thanks.

Well, what we have said, Matthew, and I'll just reiterate, is that included in our forecast and in our guidance is an expectation there will be downward pressure on the allowance which comes, again, from the improved credit metrics that we see in our portfolio, in particular you can see it through the declining delinquency rate, most importantly. And if we draw that in to 2004, we see there will be the downward pressure. Certainly we expect that some of the improvement we've seen in delinquencies is not just the strong market conditions, but also it is the result of our very purposeful move up market which should also continue to benefit our credit performance, and the real question mark that we, you know, have, is precisely what the asset growth will be. If the asset growth is in line with our current expectations, market opportunities are as we expect they will be, we expect to see some downward pressure on that allowance over the course of the year, and we will obviously keep you posted quarter-to-quarter as we see how those expectations bear out.

Thank you, Gary. With that we'd like to take only one more question, please.

Your final question comes from Mr. Bruce Harting with Lehman Brothers.

Um -- on the funding side, is there a -- having pre-funded the B and C pieces, Gary, you know those are the more expensive tranches of the securitization so, number one, is there any margin expansion potential as you fill in the 12 billion of availability of triple A and then later in the year, if one were to suppose that rates are to go up at some point, should we believe that you will do better than your competition who may be using a more short funded or swap to floating strategy on their securitization since you seem to use mostly fixed and duration matched funding, and would that give you, Rich, a -- an advantage in your marketing in arising rate environment to continue to use a teaser product? And what are you leading with in that kind of an environment as your lead product in the U.S. market? Thanks.

Okay, Bruce, let me start out and we'll hand it back to Rich at the end. In terms of the expectations for card securitization over the course of the next year, I would not assume, necessarily, that we are going to fund exclusively in triple A. My indication was that we have that option if we were to need it. But again, without getting down to, you know, the very last basis point, about 80 percent of our securitizations will end up being in triple A. So, when we get a head start and we stockpile those single As and triple Bs, they represent a relatively small part of our overall funding. Therefore, I don't believe that you can expect, necessarily, that we're going to give up that stockpile any time soon, therefore you would not necessarily see us funding a huge percentage beyond what we would normally do in triple A. So I wouldn't necessarily count on that margin benefit.

The real benefit to us, Bruce, comes from the ability to time our triple As where the demand is strongest, that's what has allowed us to get the real improvement in those spreads both compared to where we were earlier in 2003, but also compared to our competition. And we feel those triple As now are very much closer to where we want to see them, and I think you'll see that the benefit, overall, but not necessarily coming from the basis point savings in moving disproportionately into triple As going forward.

As far as the interest rate outlook goes, again, we are not funding either in volume or in maturity in order to either, you know, play today's curve or tomorrow's curve. But we certainly want to be in a position to respond to any opportunities that come down the pike. I don't think we would want to comment on the practices of others in terms of matching or mis-matching their portfolio. Our view, however, is that we generate our returns in the area of very strong management of our marketing and credit programs, and we manage our interest rate risk to protect those margins rather than to add a speculative dimension to our business on the interest rate side.

Bruce, with respect to your question about to the extent competitors were shorter funding than we were, and rates rose, what would this give us an advantage? All other things being equal, I think it would. But I do want to stress that rising rates, in general, create a less attractive environment for the marketing of credit because while any company might be offering things with as good a margin to consumers as they ever have, it does -- the rates just don't sound as good. So in general, I have felt that rising rates are less good for marketing. In this particular environment it's possible, Bruce, that your effect might serve as a real counter-balance to that. I really don't want to speculate here. What I really like is that as rates have the possibility of going up, we feel that we have -- we are financially and competitively in a very good place, and we like the prospects.

Thank you very much. At this point, we would just like to mention the Investor Relations staff will be available in a little while this evening to answer any follow-up questions you may have. Thank you.

This concludes today's conference. At this time you may disconnect.