Capital One Financial Corp (COF) 2004 Q2 法說會逐字稿

Good evening, and welcome to the Capital One second quarter 2004 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. If you would like to ask a question during this time, simply press star then the number 1 on your telephone key pad. If you would like to withdraw your question, press star and the number 2 on your telephone keypad. Thank you. I would now like to turn the call over to Mr. Paul Paquin, Vice President, Investor Relations. Sir, you may begin the conference.

Thank you. Welcome, everyone to Capital One's second quarter 2004 earnings conference call. As usual, we are Web casting live over the Internet. For those of you who would like access to the call earlier than that please log on to Capital One's Web site 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 second quarter 2004 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 o to Capital One's Web site at www.capitalone.com, click on investor's then click on quarterly earnings releases. The company generates earnings from its managed loan portfolio which includes both on-balance sheet loans and off balance sheet 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 the reported basis using generally-accepted accounting principles. For more information, please see the schedule titled reconciliation to get financial measures attached to the press release filed with the SEC on form 8-K 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's 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 as contained in the company's SEC filings including but not limited to the company's most recently filed report on form 10-K for the year ending December 31, 2003. Our Web site contains all of our SEC filings, as well as our mercury asset backed securitization performance data. To access this information, please go to our Web site at www.capitalone.com, click on investors then click on SEC and regulatory filings or securitization information.

With me today on the conference call is Mr. Richard Fairbank, our Chairman and Chief Executive Officer. And Mr. Gary Perlin, our Executive Vice President and Chief Financial Officer. At this time, I will pass the call over to Mr. Fairbank for his remarks. Rich.

Thank you, Paul and thanks to everyone joining us on the call tonight. I will begin my remarks on slide 3 of the second quarter 2004 results presentation. Solid performance across our businesses drove strong second quarter results. We posted fully diluted earnings per share of $1.65. Our managed ROA of 1.84% remains well above the historical ROA average of about 1.5% we've delivered since our IPO and is in line with the quarter-to-quarter variability that we expect in this metric . [ No Audio ] The percentage of loans. Turning to credit, our managed charge off rate continues to improve, falling 41 basis points from the prior quarter to 4.42%. Both the credit improvement and low the low charge off levels create significant earnings power. We have chosen to invest a portion of this earnings power to improve the efficiency of our infrastructure and operations helping us to achieve efficiency gains in the future. You will see some charges related to these investments in our second quarter results, which Gary will cover in a moment.

Our 30-plus delinquency rate stabilized during the quarter at the lowest levels since the third quarter of 1995, while we continue to expect that credit performance will remain at strong absolute levels, stabilizing delinquencies suggest that the charge off rates will stabilize in the second half of 2004 and into 2005 with some seasonal variation. Our managed loans grew at a seasonally-modest $1.6 billion as expected in the second quarter. Diversification beyond U.S. card continues. Diversification businesses now account for 38% of managed loans and 24% of profit. Finally, the strong strategic and financial results of the second quarter have enabled us to further strengthen our record levels of capitol and liquidity.

In summary, we are pleased with the strong second quarter and year-to-date results. Based on this strength, we are raising 2004 EPS guidance to a range of $5.60 to $5.90. This guidance incorporates a number of investments we are making in the business in the latter half of the year, as well as charges related to employee terminations and facilities consolidation, which Gary will discuss in a few moments. Before I continue with the presentation, I would like to pull way up and review how our success in driving two mix-shift strategies has impacted our metrics. Over the past few years, we've seen significant decreases in revenue margins offset by significant improvements in the costs of credit, marketing, and operations as a percentage of managed loans. These metrics have all moved lower as we've successfully shifted our mix-up market and diversified beyond U.S. card. The first of these strategies, our mix-shift up market has largely run its course. Across our businesses, we continue to see attractive opportunities to grow prime and superprime loans and we now expect to resume moderate growth of subprime loans as well. Nevertheless, while Capital One will continue to have a bias toward lower-loss assets, our growth will be more balanced going forward.

The second strategy, diversification of both loans and profits beyond our U.S. card business will continue for many years to come. Because our diversification businesses typically have revenue margins, charge offs and operating costs that are lower than our U.S. credit card business, these metrics will continue to decline, but at a slower pace than we have seen over the last two years. Turning now to slide 4, I would like to take just a moment to frame where we are today as a company and what we're targeting for 2004 and 2005 across three key dimensions that drive our results: Loan growth, ROA and diversification. We're on track to deliver a mid-teens loan growth rate for 2004 and we're targeting a mid-teens loan growth rate for 2005. We expect to deliver this with moderate growth in our U.S. card segment and stronger growth rates in our auto finance and global financial services segment, continuing the trend of the last several years. Our strong year-to-date credit performance and profitability put us on track to deliver ROA of about 1.6% in 2004. We're also targeting an ROA of about 1.6% for 2005. As more modest declines in revenue margin are largely offset by declining expenses as a percentage of loans.

The improvement in expenses as a percentage of loans results from our diversification businesses continuing to bid build scale and from efficiency gains from the investments I mentioned a moment ago. We have been working to lower our cost structure for a number of years and we believe it is prudent to act from a position of strength to build, protect, and improve our future results. Therefore, we have chosen to invest part of the strong 2004 earnings power to achieve improved operating efficiency. We continue to diversify. As of June 30, 2004, our global financial services and auto finance segments held 38% of our managed loans. And they delivered 24% of second quarter net income after tax. Consumer deposits represent 27% of the liability side of our June 30, 2004, managed balance sheets reducing our dependence on the capital markets for funding.

Our diversification efforts Across both sides of the balance sheet are paying off, and we expect to continue diversifying assets, liabilities, and profits for years to come. So, targeting mid-teens loan growth rates and an ROA of 1.6%, enables us to drive strong net income growth this year and next. The continuing diversification beyond U.S. cards and our bias toward lower-loss assets adds stability to our results. In summary, we believe that we are well-positioned to deliver strong results in both 2004 and 2005. With that, I'll turn it over to Gary for a review of the financial results in the quarter. Gary.

Okay. Thanks Rich and good afternoon, everyone. I'm going to address three topics in my presentation today covering just four slides. First topic will be the managed income statement covering the second quarter results in metrics. Second, I'll address the managed balance sheet, which is exhibiting stable growth, fortify liquidity and the strong capital position, third I'll look at the second quarter provision for loan losses and revenue recognition. First, if you would, turn to slide 6, which is a review of the managed income statement and a few key metrics. For each line-item, the slide provides data from the second quarter of '04, the first quarter of '04 and for the second quarter of '03. I will focus on changes in the second quarter of '04 versus the comparable quarter last year.

In each line, you will see the financial impact of the underlying business trends already highlighted by Rich. In other words, our move toward diversified and lower-loss assets. Second quarter, '04, as to, compared to the second quarter of '03 shows modest revenue growth with net interest income up $128 million or 9%, only partially offset by declining non interest income as we have moved toward higher credit quality and less fee intensive products. I should note that this decline in non interest income includes a $21 million loss in the sale of securities as we rebalanced our liquid investment portfolio in reaction to changes in interest rates. Second quarter of '04 as compared to the second quarter of '03 showed a significant decline in provision expense, driven almost entirely by a reduction in net charge offs of $147 million or 16%. There was also a $25 million increase in the release of allowance due to higher credit quality loans on the balance sheet and continued strong credit performance and outlook. More on this in a moment.

Second quarter of '04 marketing expense of $254 million was down $17 million or about 6% from the same quarter last year. And while marketing expense year-to-date 2004 is about flat compared to the first half of 2003, we continue to expect that marketing in 2004 will be higher than 2003. As Rich mentioned, we've realized significant operating efficiencies and continue to invest in our infrastructure. Operating expenses for the second quarter of '04 were up $94 million or 11% as compared to the same quarter last year. While loans grew by over 21%. Our bias toward higher credit quality, lower-loss assets is helping to drive down costs. Note also that over half the increase in expenses or $56 million represents charges in the second quarter of '04 associated with ongoing cost reduction initiatives across our global businesses. Total charges expected for the balance of the year approximate 60 to $100 million and are reflected in our EPS guidance for 2004. In the second quarter, operating expenses net of those charges were $919 million down to just 5.08% of average managed loans in the second quarter of this year from 5.88% in the same quarter last year. All told, net income after tax is up 42% while EPS is up 34%, second quarter '04, versus second quarter '03. The EPS growth rate is relatively lower due to the company's increasing share count, which I will address in minutes.

The company's revenue margin fell 232 basis points over the past year to 12.53% with an 85 basis point decline occurring in the most recent quarter. This reflects our bias towards higher credit quality, lower-yielding loans, our marketing and operations expenses have also improved dramatically as a percentage of averaged managed loans. We expected that revenue margin will be modestly lower over time given our diversification and bias toward lower-loss assets. ROA is up reflecting tremendous credit performance year-over-year and as Rich stated, we are expecting ROA of around 1.6% in 2004 and are targeting the same for 2005. Before leaving this slide, I want to take a moment to focus on the impact of the company's rising share counts. And its affect on EPS. The company's share count has risen steadily over the past several quarters as an increase in share price caused existing associate stock options to be exercised and/or to become in the money. We expect this trend to continue in 2005 when, as most of you know, it will be magnified by the issuance of additional shares in connection with the mandatory convertible security issued by Capitol One, in May 2002. This conversion should account for an additional 9.5 million to 11.7 million shares. I urge to you to contact investor relations if you wish to discuss the drivers of our fully diluted share count growth in more detail.

Now, turning to slide 7. We continue to grow whole building a more stable and fortified balance sheet. As of the second quarter of '04, total managed loans of $73.4 billion were up $12.6 billion or 21% from the same quarter last year. It's important to remember that this percentage increase includes the very strong loan growth we experienced in the second half of 2003. Year-to-date, 2004, our managed loans have grown by $2.1 billion, as compared to just under $1 billion in the first half of 2003. As Rich stated earlier, we continue to expect a managed loan growth rate in the mid-teens for 2004 and target the same for 2005. Capital is at an all-time high of 9.12% of managed assets as of June 30, 2004. Not lost on us that our capitol ratio and share count have increased significantly and will likely continue to increase. We are choosing to retain this capital for now in order to maintain flexibility in pursuing our strategic initiatives. On the bottom of this slide, you can see that we have continued to maintain strong levels of liquidity over the past year. One liquidity component we have chosen to reduce during the quarter was our unsecured credit facility. As our alternative sources of liquidity and balance sheet strength have grown, the usefulness of this type of facility has decreased.

Let's turn now to slide eight. Because, portfolio growth and composition along with improving credit is driving most of Capital One's financial metrics. I would like to end my comments on the focus of the effect of provision expense and our revenue recognition policy on second quarter income. I know from conversations with many of you, that you're interested in what drives these numbers from quarter-to-quarter. That's why the comparisons on slide eight is between the second quarter of '04 and the first quarter of '04. Let's get started with the provision for losses relating to on-balance sheet loans. Provision expense was down some $28 million in the second quarter of '04 from the first quarter of '04, reflecting a $59 million reduction in net charge offs, partially offset by a reduced release in the allowance for future loan losses of $30 million. I will provide more color on the allowance release in a moment. The reported net charge off rate following trends mentioned by Rich earlier, fell from 4.17% in the first quarter of '04, to 3.72% in the second quarter of '04. The ratio of reported balances delinquent 30 days or more rose modestly. I'll discuss shortly the pattern of these delinquencies and their impact on the loan loss allowance.

Provisioning shows up in the reported income statement and loan loss allowance in the reported balance sheet, both addressing collectability of loan principle. I know that most of you are aware that Capital One's long-standing revenue recognition policy also takes into account collectability risks related to finance charges and fees on a managed basis. This shows up as a footnote to our financials indicating this quarter that $263.5 million was billed to consumers but not recognized as revenue. This so called suppression amount was down only 8% from the first quarter of '04, again, reflecting improved credit and collectability. This is a good time to turn to slide nine, which provides greater detail on the factors, which in a formulaic fashion drove these metrics in the second quarter of '04. Let's start with the left column. Looking at the provision expense which largely reflects changes in the forward-looking allowance component. First, we look at the impact of portfolio changes on the allowance. In the second quarter of '04, reported loans grew by $1.4 billion. Taken alone this growth would place upward pressure on the allowance and some more principals at risk.

In this instance however, the impact of growth was more than offset by the change in on-balance sheet loan composition to lower-loss loans. In particular, our diversified businesses represent a greater percentage of reported loan balances at the end of the second quarter of '04. In addition to portfolio size and composition, credit performance remains strong and also drove a release of allowance, although improvement trends are moderating. The second quarter's reported 30-plus delinquency rate of 3.91%, was actually up slightly from the first quarter's 3.82%. Again, taken alone, one would expect this to increase the allowance. But the rise in delinquent balances was concentrated in early buckets, while latter bucket delinquencies actually fell. The impact of these improvements in late-stage delinquencies more than off site the increase in early-stage delinquencies. Lastly, reported charge offs declined by $59 million in the first quarter of '04 and the second quarter of '04 from the first quarter directly affecting the provision. In the second half of '04, we expect that allowance will be dealt based on our current on-balance sheet growth plans and assumed steady credit performance.

Now, let's focus on the right-hand column, where we assess the collectability risk as it relates to finance charges and fees. The so-called revenue suppression amounts on the managed portfolio. While loan balances grew in the second quarter of '04, the fact that the loans were more diversified and of higher credit quality leads on net to a lower level of finance charge and fee billings this naturally causes us to have to suppress less. Improving credit performance in the portfolio also suggests that there is improving collectability of billed charges and fees. This likewise causes us to suppress fewer billings. Simply stated, the suppression amount is falling because we are billing less and intend to collect more of what we bill. With that Rich, I'm going to turn the call back to you.

Thanks, Gary. On slide 11, you will find an overview of managed loan balances by segment in the second quarter of 2004. The first quarter of '04, and the second quarter of '03 as well as growth in both dollars and percentage terms from the prior year quarter. The bottom half of this slide provides a similar overview of net income by segment. U.S. card growth is up 15% from the second quarter of 2003, which includes the strong back loaded growth that we experienced in the second half of '03. This is a normal seasonal pattern for our U.S. card business and we expect 2004 loan growth in the U.S. card business to be back loaded once again. Our diversification of managed loans continues as the growth rates of global financial services or GFS and auto finance continue to outpace U.S. cars. Overall, Capital One remains on track for a managed loan growth rate in the mid-teens for 2004. And we will continue to target a mid-teens loan growth rate in 2005. With respect to net income, U.S. card continues to be our most profitable segment with the GFS and auto finance segments continue to deliver strong and growing profitability, contributing $99 million the second quarter net income.

The next two slides provide data on managed charge offs and delinquencies. I'll be brief in discussing credit since I addressed it in my introductory comments and because this continuing strength in improvement in credit is not a new story this quarter. Slide 12 shows our monthly managed charge off rate on the graph and our quarterly charge off rate along the bottom of the graph. As I mentioned earlier, both quarterly and monthly managed charge off rates continued to improve at 4.42% quarterly managed charge offs are at their lowest level in over two years and have fallen 205 basis points from their peak in the first quarter of 2003. The monthly managed charge off rate continues to improve reaching 4.17% in June. The factors I described a quarter ago continue to drive our improving charge offs performance, including our continuing diversification beyond U.S. card, our bias toward lower-loss assets across all of our businesses, seasonality, a stronger-than-expected consumer payment behavior and strong recovery. We expect the managed charge off rate to stabilize in the 4% to 4 .5% range in the second half of 2004 and into 2005, with some seasonal variations.

Turning to slide 13, we look at the 30-plus delinquency trend. Managed 30-plus delinquencies ended the quarter at 3.76% among the lowest levels we've experienced since the third quarter of 1995. The same factors I just described as the drivers of improving charge off rates also drive delinquencies. As we have already discussed at some length, while we continue to expect that credit performance will remain strong at low absolute levels, stabilizing delinquencies suggests the charge offs will stabilize. On slides 14 through 16, I'll discuss some of the results for each of our business segments. Each of these slides consists of four graphs showing loan growth, profits, charge off rates and delinquencies for the segment. Beginning on slide 14 with U.S. cards, on the first graph you will see that loan growth is up $5.9 billion or about 15% from the second quarter 2003. But relatively flat on a sequential quarter basis. This is quite similar to the trend we observed in 2003 when seasonality and the timing of significant Capital One product rollouts coincided with competitive and market opportunities to drive flat loan growth in the first half of the year and strong loan growth in the second half.

In 2003, industry mail volumes were quite high in the first half of the year and abated somewhat during the second half. So far this year, competition remains intense with mail volumes increasing from second half 2003 levels and several competitors are continuing to drive aggressively-priced offers into the market. For our card business, similar to last year, we have a strong pipeline of products moving from test to rollout and we expect to see U.S. card marketing spend and loan growth pick up in the early fall. The second graph shows profits. Strong second quarter profits of $384 million are up $110 million or 40% from the prior-year second quarter. But relatively flat sequentially. Continued success in targeting and acquiring profitable customers, as well as the continuing benefit of strong credit and lower expenses as a percentage of loans, drives the second-quarter profits, quarterly U.S. card profits are likely to decline somewhat as loan growth picks up in the second half of 2004.

The graph at the bottom of slide 15 shows the strong and improving credit performance of our U.S. card portfolio, resulting from our continuing bias toward lower-loss loans, as well as strong consumer payment patterns. Although we've discussed the strength and improvement of credit performance as recurring themes on this call, it's worth noticing that the U.S. card charge off rate has improved by 253 basis points from its peak in the first quarter of 2003 to 5.19% this quarter. All told our U.S. card business continues to deliver strong profit and credit performance. Turning to global financial services or the GFS segment on slide 15, recall the GFS includes international credit cards, small business, installment loans, and other smaller operating businesses. The first graph shows managed loans growth of $4.7 billion or 33% since the second quarter a year ago. As well as steady loan growth on a quarter-by-quarter basis. This growth helps fuel our asset diversification beyond U.S. card and reflects strong growth across the GFS businesses. We expect strong loan growth to continue in the second half of 2004.

As you will see in the second graph, second quarter profits of $46 million are up 81% or about $20 million from the second quarter a year ago but down slightly from the first quarter. Strong second quarter revenues across GFS businesses were offset somewhat by increased marketing spend in the quarter, resulting in the slight profitability decline. We expect to continue to invest in both marketing and infrastructure in the second half of 2004. These investments, coupled with strong loan growth will reduce GFS profitability in the second half of 2004. As can you see in the graph, the pattern in 2003 was similar. Even with these investments, GFS is on track to deliver solid loan and profit diversification to Capital One in 2004 and beyond. The graphs on the bottom half of the slide show another quarter of solid and improving credit performance across GFS. Overall, we remain pleased with the results of the GFS business.

On slide 16, you will see that our auto finance business delivered strong performance in the second quarter. On the first graph, managed loans grew by $2 billion or 27% over the same quarter last year and $550 million from the first quarter reflecting strong originations across both our direct and indirect channels. We expect managed loan growth to remain strong, driven by the growth and increasing productivity of our sales force. As shown on the second graph, net income of $53 million is up about $9 million or 20% from the second quarter 2003. More striking is the $22 million increase from the first quarter of this year, which is powered by significantly lower credit losses, higher net interest margin and lower expense levels. Similar to the GFS segment, you can see by looking at the quarterly trends in 2003, that quarterly net income in the second half of 2004 will likely be lower than the seasonally strong second-quarter level.

We continued our normal practice of whole loan sales during the quarter with whole loan sales totaling $322 million across our prime and nonprime assets. These sales generated a gain on sale of $8 million after tax, which is included in the earnings of the quarter. Going forward, we expect fewer whole loan sales in the second half of the year as we plan to keep more loans on the balance sheet. The graphs along the bottom of slide 17 show typical seasonality in auto finance credit metrics. Auto finance delinquencies are seasonally low in the first quarter, as can you see in the graph on the lower right, and charge off rates lagged by one quarter to reach seasonal lows in the second quarter, as you can see, on the graph on the left. Our managed charge offs declined by 160 basis points this quarter, driven in part by normal seasonality, as well as our continuing bias toward lower loss superprime loans and the impact of operating improvements. The seasonal pattern for 2003 charge offs on the left graph, as well as the seasonal increase in second quarter delinquencies on the right graph suggest that auto finance charge offs will rise seasonally next quarter. We expect auto finance loan growths and profits to further diversify Capital One for 2004 and beyond.

Turning to slide 17, I would like to summarize by reminding you what you can expect from Capital One going forward. Based on second quarter and year-to-date results, we remain on track to deliver a mid-teens growth great rate in our managed loans in 2004, and we are targeting a mid-teens loan growth rate in 2005. We have delivered strong ROA year-to-date and we expect ROA of about 1.6% for the full year. We're also targeting ROA of 1.6% for 2005. Diversification continues and continues to pay off. We believe our strategy will continue to deliver long-term value to shareholders through solid loan growth and strong ROA all the while adding stability through increasing diversification. Now, Gary and I will be happy to answer your questions.

Thank you, Rich. We will now start the Q&A session. If you have any follow-up questions after the Q&A session the investor relations staff will be available after the call. Miles, please start the Q&A session.

As a reminder, if you would like to ask a question at this time, please press star then the number 1 on your telephone keypad. Please limit yourself to one question. We'll pause for just a moment to compile the Q&A roster. Our first question comes from the line of Matthew Park with A.G. Edwards.

Good afternoon. Just a quick question on the auto finance you talked about the gain on sales, it was helpful but, what is the source of the credit quality improvement? Is that coming from higher value of reprojections or are you seeing something else altogether?

Yes, Matthew, thank you for that question. 160 basis points is a pretty big decline in the charge off rate for auto finance. And it's driven by several things. Of course there is seasonality as can you see from the first quarter, '03 to the second quarter '03 on the chart. There is a strong seasonal component to the auto charge offs. There also, though, is an important mix affect. As we continue to have a bias toward lower loss assets, the charge off rate continues to benefit and there also were operational improvements that we took advantage of in the quarter. Just keep in mind despite the, you know, the great performance of auto charge offs. I, again, want to remind folks that the seasonality will be working against us in the second half of 2004, and we expect an up tick in charge off rates.

Next question, please.

Your next question comes from the line of Kristina Clark with Wachovia Securities.

Thanks a lot. I was wondering if you could tell us how much in untapped triple-A aspect issuance capacity you have now resulting from issuing the dealing securitizations.

Sure, Kristina, I'll be glad to take that question. As of June 30 we have $11.7 billion of triple-A capacity, meaning that the next $11.7 billion worth of credit card asset-backed securities that we issue could be issued in the form of triple-A supported by single-A and triple-B securities already issued.

Next question, please.

Your next question comes from the line of Moshe Orenbuch of CSFB.

Thank you. I was just wondering if you could kind of expand a little bit on the expense reductions. What you'll end up with kind of as those charges are realized in terms of your operating infrastructure and what it could mean financially as we go forward.

Sure Moshe. It's Gary, I'll start and then hand it over to Rich for perhaps a more strategic look at the situation. As indicated in the second quarter we had charges of about $56 million relating both to severance benefits and some facilities closure costs related particularly to our Tampa facility which was announced earlier today. And we have, as I indicated, another 60 to $100 million worth of charges that may be incurred over the course of the rest of 2004 across all of our global businesses. These are part of a very comprehensive program of cost management, which we are engaged in and have been actually for quite a while, as a result of our decision to leverage our capacity to manage certain outsourced functions, particularly in the area of call centers and it will allow us to actually achieve both cost reduction and cost avoidance going forward as we reconstruct our capacity to support businesses that are trending now towards the larger average-balanced, lower-loss assets which really require a different sort of infrastructure to support them. What we intend to do of course is to ensure that what Rich and I have been talking about today, which is the ability to lower costs, as a proportion of our assets is continued to decline, to make sure that our ROA remains stable as the kind of targets that we have, and we expect certainly over the course of the next couple of years to be able to generate the kind of ROA that will demonstrate the return to these kinds of investments in improving our infrastructure.

Next question, please.

Your next question comes from the line of Joel Houck Of Wachovia.

Thanks, good evening. I was just wondering if you might provide a little more color on the revenue margin guidance. I know you said it's, I guess the slowdown's going to stop. The revenue growth, only about 4% year-over-year, certainly not lost in the company that revenue growth has an important implication for valuation and PE. Is there a point where revenues are going to start to grow at a higher rate and is the company, you know, is that, you know, part of the strategy here as we move into 2005.

Joel, as long as our diversification and our bias toward lower-loss assets continues, revenue growth will, you know, we have the phenomenon as we have talked often about that revenue margin tends to decline as a result of that and that's offset by the trilogy of costs, operating costs, marketing costs, and credit costs. And as long as we continue to diversify, this means that revenue growth will lag outstanding growth. This is a natural phenomenon it's in fact, part of the math. The key is to look at ROA, which we are targeting to be stable on an annual basis, and the lower revenue margins, that comes from diversification are offset by this trilogy of costs. So I think that at Capital One we have a strong growth story and we have a strong revenue story when you adjust for the natural math that comes from the unfolding diversification of the company.

Next question, please.

Your next question comes from the line of Ken Posner of Morgan Stanley.

Good afternoon, Rich. I wanted to see if I could ask you a hypothetical question. You guys have expressed the strategy of wanting to purchase a bank. There are also other opportunities out there. Could be international credit card portfolios (INAUDIBLE) been in the news. It could be other opportunities, joint venture diversify what have you. Suppose you had two opportunities at once, how would you choose between them. Would it be whichever has the highest MPV or would you put more weight on the bank acquisition because of your strategy.

Ken, I really don't want to engage in a hypothetical question like that. We have told you that a bank acquisition is one of the components of our diversification strategy and other than -- I really don't want to get into a speculative or hypothetical questions.

Next question, please.

Your next question comes from the lean of Mike Hughes with Merrill Lynch.

Hi, one question and then a clarification. Tax rates now 36% two quarters in a row. Is that now the new run rate and the clarification is you said the big shift was now pretty much complete. Are you thinking of that in terms of dollars or in terms of percentages?

Mike, why don't I start with the tax rate question and, indeed, there has been a slight reduction in the tax rate over the last couple of quarters and it's really resulting from two things, the first of which is the mix in the source of our profits, more of it coming from international where the tax rates are lower. Also, the effects of some tax planning and we're certainly focused on making sure that we achieve as much tax efficiency as we can, and we'll look to try and continue to achieve some improvements there in the quarters coming ahead. You'll be hearing more about that from us as time goes on.

Mix shift question.

Mike, I think Rich hit it pretty much on the button in indicating that it is a point in time now where we are, you know, at -- nearing the end of a journey of a significant mix shift, although we expect continued diversification of assets going forward with a bias towards lower-loss assets with the kind of impact on revenue margin and costs that will allow us to achieve and maintain stability and ROA going forward.

And I think with the fact that the question is it dollars or percentages, our mix shift, we're defining it in terms of outstandings, therefore, outstandings, dollars and, I mean I think dollars, dollars and percentages, I think, it's pretty much the same story.

Next question, please.

Your next question comes from the line of Stephen Schulz of KBW.

Thanks a lot. Just a quick question. Most of my questions have been answered. But, just in terms of the accumulation of capital in light of, you know, your strategic, outlook and considering the 9 to 11 million shares you're expecting to come on next year, do you expect to be more active on the share repurchase going forward?

Thanks, Stephen. As I indicated, we certainly are very aware of the level of our capital, and we are, you know, tracking very carefully to make sure that we continue to be able to invest that in our company at rates that exceed the returns that we believe shareholders could achieve elsewhere and with the kind of ROE we have today, still over 20%, we feel there is good reason to do that. As I indicated, we also are holding on to that capital, not only because it provides us with stability and has allowed us also to demonstrate the strength of our balance sheet and resulted in lower-cost funding and other benefits, it does give us the flexibility with which to exercise some of our strategic initiatives that we have discussed. But, certainly over time we will look at the situation in our capital account as we go forward. We'll take stock of where we are on all of these metrics and make the appropriate judgement as we go along. But, certainly we've mentioned it because it's on our minds. We know it's on yours and we're going to watch it carefully.

Next question, please.

Please hold while we requeue the roster, sir. Our next question comes from the line of Bruce Harting of Lehman Brothers.

On the share cap, you know, Gary, you said the mandatory converts could be between 9.5 and 11 million shares and you also have options that we should be adding in is that correct and then could you just, that's the clarification. I like this technique, clarification, question. And then question, you know, Rich, or Gary, Paul, can you talk about the U.S. credit card business from the perspective of, you know, using net interest margin as a marketing tool and how you see, you know, that playing out in a rising short-term interest rate as the fed is tightening. The ability to hold the line on rates given that it seems to me the average duration of your funding might be a little bit longer. Thanks.

Okay, Bruce. Let's start with the share count. Again, the one thing that we are absolutely certain of is the likely impact of the conversion of the mandatory convert in May of 2005. We certainly expect that we will continue to see at our current share price and given the experience we have had to date, that there will be a continuing increase, perhaps along the lines of what you have seen over the last year or two in terms of additional share count coming from both the exercise of options and the coming into the money. Of course, there is probably been an exaggeration of that latter impact over the course of the last year because of the very significant increase in the share price that we have seen which caused a lot of shares to, a lot of options to come in the money. I'm going to leave it to you to put your own share forecast on next year and decide what that means for the impact of shares, but it's something that we're definitely going to, you know, be watching very carefully.

Okay. Rich, with the question about our, you know, successful marketing in the environment of a rising rate environment, from an origination point of view, all other things held constant, rising rates are less desirable because while we may be offering a really great rate, it just doesn't sound as good. Somebody came to me, you know, and said gosh, you know you're -- what, you're offering isn't as good as what you did at one point. Ironically, we have the same margin it just doesn't sound as good. So we have always found some pressure on origination. The flip side of that is on the existing portfolio. It's actually quite a beneficial affect. Because what happens is we tend to get extra balances that stick around. And while those extra balances in a sense, need to be funded at a bit of a higher rate, we actually get a triple benefit of extra balances, with -- at the margin the credit lines don't change affectively very minimal charge offs at the margin and operating costs and marketing costs that are essentially 0 at the margin. So you get a lot of very high-quality balances that we have found over the, our experiences with rate increases, actually, is really quite beneficial given the size of our portfolio, this is probably a, you know, is a , could be a nice beneficial effect. We have also, I think, seen some pretty aggressive marketing by competitors who may be relatively short-funding their portfolio versus our own, so I think net-net, while we fundamentally hedge ourselves, the absolute best that we can, you know, probably internally our business is, you know, slightly rooting for in some sense a mild preference in the card business to be have a rate increase just because of some of the sort of secondary market dynamics that I talked about.

Next question, please.

Your next question, sir, comes from the line of Bob Napoli with Piper Jaffray.

Hi, good afternoon. A question on your diversifying into many different products. One product you have tested in the past, you're currently not doing it, I don't believe in a significant fashion is the home equity market, the mortgage market seems to be a trend, a long-term trend that the mortgage market is going to grow faster than several of the markets that you are currently in and it just seems like a product that you have to have put a lot of thought into and I just wondered why you're not in that market right now and how important that may be to you in the future in your future thoughts. Thank you.

Thank you, Bob. The home equity business is, I think, one of the really attractive consumer businesses. It's quite a diversified business from our own. Certainly the home equity line part of the business which, of course, includes home equity loans and lines is tailor made for credit-line based companies like Capital One. So I think it's striking that you don't see home equities on our portfolio. The issue to date from our observation is really one about channel. While we would love to be in the home equity business, this has been one that has been fairly stubbornly a more locally-based business. In fact, striking thing as you watch the evolution of retail banks that have, one by one, had their consumer lending portfolio cherry picked by a national scale of players, be it on the mortgage side or on, you know, in credit cards, and we're even doing it now in installment loans. Their most successful consumer lending product tends to be the home equity product because it has such a natural fit within the context of branch marketing. So, you know, I think down the road as we evolve more in the context of branch banking, I think the combination of local presence and the power of IBSs marketing apparatus and data and experience base is something that we relish that opportunity. But in the meantime, we're kind of on the sidelines.

Next question, please.

Your next question comes from the line of David Hochstim of Bear Stearns.

Thanks. I have a request for clarification and then I wanted to try and re-ask Ken's question. The clarification, could you just tell us where the $56 million in the employee benefit termination charges and the other charges are on the expense breakdowns. Are they all in occupancy or in salaries and benefits? If you look at the income statement?

David, let me just clarify for you of the 56 million charged that was taken in the second quarter approximately 35 million was for facilities closure costs and about 21 million for severance benefits that will be paid and if you have seen the other announcement that came out from Capital One today, much and most of the facilities closure costs are related to our potential marketing of facilities in Tampa. Severance benefits would cover employees in a number of locations, including Tampa. Smaller numbers in Richmond and in Dallas. Rich, I'll let you take the follow-up question on the -- I think -- re-ask Ken's question. He wanted to re-ask it.

Oh, I guess -- no. Okay.

Next question, please.

Your next question comes from Peter Monaco of Tudor Investment Corporation.

Good evening, thanks for your time. I noticed that the total number of accounts dropped quarter-over-quarter. To what would you attribute that and granted a quarter doesn't a trend make, but over the medium-term, how does a company grow loans at say 15% if accounts don't grow?

Thank you, Peter. The striking difference between the account trajectory of Capital One and the outstandings trajectory of Capital One is a direct byproduct of the mix change that has been happening in this company for several years. Again, our double mix shift has been the shift up market and also the diversification into other products beyond credit cards. Both of those destinations of those shifts involve higher balances per account. Significantly higher balances per account than the average for our business at the moment. And, therefore, not only is this a trend that is -- that has happened in the past, to some extent it will continue. The reason I say to some extent is because as we announced one of the two mix shifts has mostly run its course. That's the mix-shift up market. But the diversification into other products, all of which have, you know, may have higher balances than card products, will mean that this trend of loan growth relative to, substantial loan growth relative to account growth will continue at some point.

Next question, please.

Your next question comes from the line of Scott Valentin with Friedman, Billings, Ramsey.

Thanks for taking my question. You mentioned earlier that the mix shift within the up market move is substantially complete and there'll be some more some time, I guess additions to the receivables portfolio. Any particular assets class be it credit cards or auto, where you'll emphasize that.

I'm sorry, I'm going to make sure I understand the question. What asset classes are we going to be emphasizing. Sorry.

Sorry, I took Scott's question as asking whether or not the substantial completion of the move up market is limited to one business or whether we'll see that across all of the businesses and Rich, you want to take it from there.

Thank you, Scott. The move-up market has, you know, I mean across our company we certainly have a bias toward, you know, low-risk assets. Most of the emphasis of the move up market has been one that's been in the credit card business. However, if you look at our individual businesses actually we're moving, you know in different directions as we fill out the credit spectrum. In the auto loan business, we entered that business via the nonprime side of the business and so while we have continued to grow the nonprime business, we have really grown the up market side of that business through superprime and now, increasingly prime loans as well. Installment loans, ironically has been the other way. Installment loans has been exclusively a superprime of business. I think, you know, over the long hall we certainly would hope to be more full credit spectrum with respect to that business. We believe that it is a competitive advantage in all the markets that we see to be a full-spectrum player. There is a huge scale benefit and there are, you know, it's a natural once one is in the business, leveraging our IBF strategy across the credit spectrum. We take different entry points in different markets. But at the end, our destination in just about every business I see will be full-credit spectrum.

Next question, please.

Your next question comes from the line of Michael Cohen with Susquehanna Financial Group.

Hi guys. I'm wondering if you could talk to me. I noticed that if you add net income to book value, there was about a -- and subtract off dividends there was about a 28 cents difference. Was that -- I would assume just AOCI related to the rise in interest rates or was that any kind of mark related to retained interest or something like that?

I'm going to suggest that you get with our IR folks right after the call and walk through those numbers with you.

Next question, please.

Your next question comes from the line of Matt Vetto with Smith Barney.

Hi. Thanks. I was wondering if you could maybe characterize to what extent the net interest margin is influenced by the pre funding of the Junior (INAUDIBLE) you mentioned. I get the point about the mix shift. It does look like it sort of ticked down sequentially. I'm wondering how much of that might be sort of opportunistic funding and/or higher liquidity. I'm just noticing that, you know, teasers are a relatively small part of the portfolio and, you know, and a little bit of increase in or a decrease in the amount of suppression in the quarter.

Matt, let me try and take that from the liability side because that's the way you asked the question. And what I would say is that the cost of the pre funding strategy, the dealing strategy on the securitization side is not particularly costly because one thing to remember is that it takes about 15 to 20% of single-A and triple-B asset-backed securities to support a hundred percent of a pool, so that while we have done some pre funding of the triple-Bs and the single-As and that allows us to issue a whole lot of triple-As at a time of our choosing, most of the funding it's still triple-A. So there is really not a significant cost to that pre funding strategy. In terms of the on balance sheet funding, partially because of the improved funding situation we have both on the securitization side, also because of the liquidity, the strengthening view that our company seems to have in the fixed income markets because of the strength of our balance sheet, we're at a point now where the marginal carry costs of liquidity is, in fact, quite immaterial. So, if you're kind of looking for trends, I wouldn't look for them on the liability side. Our strategies are really designed to make sure we have ample funding for the best assets as they come along and from quarter-to-quarter, depending on the mix of products and the mix of offers that we have, you may see some shifts in the net interest income line. But it's not coming from the liability side.

This will be the last question if you would, please. The next question.

Your final question, sir, comes from the line of Chris Brendler with Legg Mason.

Thanks, good evening. I made it. Question for Rich, if you could, just try to characterize a little bit the forecast for credit card or receivables growth second half of the year, relative to the flatness we saw in the second quarter, as well as marketing spent. I'm just wondering if you can comment at all about the spending in the second quarter. Paydown, is there any abatement in paydown that you, that may be refi or home equity related. And the second half, do you expect growth simply from a seasonal basis maybe the fact that you have thrown on a lot of low fixed-rate cards, without teaser rates, those would ramp up over the second half of the year or do you expect to have a big push similar to last year in which case we would take a hit on the marketing side. So just try to give me a little color around that and also a related question on the subprime side, I'm just trying to understand it -- you said that subprime companies are pretty fierce. Not much better than the up market is this a signal that you have seen some abatement in competition or is it just that your mix is now down to where you think that it makes sense to grow subprime credit card a little more aggressively and what does that imply from marketing spend going forward. Thanks.

Okay, Chris. First of all, a payment rate, our payment rates are steady despite what some of the competition has said over the recent period we see pretty steady payment rates. With respect to the seasonality of our growth in the second half of the year, again, it's striking that we, you know, basically shrink a little bit in the first half of the year and then again are talking about significant growth in the second half. It is certainly partly a seasonal phenomenon. We have a lot of programs queued up and it's partly a coincidence in timing with respect to good opportunities that we see and also with respect to things like the holiday ramp itself, the more we have a significant up market component of that business, that tends to, you know, have a significant holiday ramping affect. So we're certainly going to see, I think, a lot of that right at the end of the year as well. All told, I think, you know, we look to, you know, a strong performance for our card business in the second half of the year.

With respect to the subprime business, I appreciate your question because we have said in prior calls that, in fact, the subprime business is not growing and we're talking about our expectation that moderate growth will resume. The, you know, our lack of growth in subprime has been caused by a, the choices we made to move out of some of the segments of subprime, but also fierce competition that puts some pressure on origination and some pressure on attrition in that business. No, I don't think the competition has abated despite the competitors' claims that they don't originate in this space. The way we look at subprime, we see a lot of their preapproved solicitation. Pricing is pretty aggressive and the male intensity is pretty aggressive. The reason that we see, resuming some moderate growth reflects our own responses to the, this marketing and the success of tests that we have had that we're now getting ready to roll out.

Thank you very much, Rich. The investor relations staff will be here this evening to answer any questions you may have. Thank you for being on the call and thank you for your interest in Capital One. Have a good evening.

Ladies and gentlemen, this does conclude today's Capitol One second quarter 2004 earnings conference call. You may now disconnect.