Capital One Financial Corp (COF) 2004 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Capital One 3rd 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 the star key, then the number 1 on your telephone keypad. If you would like to withdraw your question, press star, then the number 2. Thank you. I would now like to turn the call over to Mr. Paul Paquin, Vice President Investor Relations. Sir, you may begin your conference.

Thank you, Miles. Welcome everyone to Capital One's 3rd quarter 2004 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 website 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 3rd quarter 2004 results. Mr. Fairbank and Mr. Perlin will walk you through the slides. To access a copy of slide presentation, please go to Capital One's web site at www.capitalone.com, click on Investors, then click on "Quarterly Earnings Release." The Company generates earnings from its managed loan portfolio which includes both on balance sheet loans and offbalance sheet securitized loans. For this reason the Company believes the managed financial measures and related managed metrics to be useful for stakeholders. 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 see the schedule titled reconciliation to GAAP 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 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-K for the year ending December 31, 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 our website at www.capitalone.com, click on "Investors" and then click on "SEC and Regulatory Filings" or "Securitization Information." Before we start, I would like to mention that our annual debt and equity conference is being held in New York City on November 3rd and 4th. We hope to see many of you there. If you are interested in attending and have not yet received an invitation, please e-mail Investor Relations at investor.relations@capitalone.com. 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?

Thanks, Paul. I'll begin my remarks on slide 3 of the 3rd quarter results presentation. The 3rd quarter was another strong one for Capital One, characterized by the continuation of key themes and strengths that we have been discussing for some time. We posted fully diluted earnings per share of $1.97. This number, as well as all of the results we posted this quarter, reflects a number of one-time effects which Gary will discuss in a few minutes. Our managed ROA of 2.17% remains comfortably above both our historical average of 1.5% and our revised target of 1.7% for 2004. Credit quality is strong. The managed charge-off rate is down 37 basis points to 4.05% for the quarter and the managed delinquency rate is beginning to reflect expected seasonality. Revenue margin improved by 50 basis points to 13.03% in the quarter. Revenue margin was bolstered by the slowdown in our mixed shift upmarket, the sale of our South Africa business and normal seasonal revenue patterns. Despite the uptick in revenue margin in the quarter, our continuing diversification beyond U.S. cards is likely to result in modest revenue margin decline going forward. Our diversification beyond U.S. card continues to drive both loan growth and profits. About 60% of our $2.1 billion and 3rd quarter loan growth comes from our Auto Finance and global financial services segments. I know that both the U.S. credit card industry growth and Capital One growth are on the minds of many investors. So I will say more about our growth and growth prospects in the business segment update in a few minutes.

You may also have noticed that we made a number of have strategic moves within our diversification businesses recently. We entered into an agreement to acquire Onyx Acceptance Corporation and we sold our South African and French businesses. Gary and I will provide some financial and strategic context around these transactions as well. And once again, our balance sheet remains rock solid with capital and liquidity holding steady at historically strong levels. Slides slide 4 frames where we are today and what we are expecting for 2004 across three key dimensions: loan growth, ROA, and diversification. You may recall a similar slide from last quarter's earnings call. Based on 3rd quarter and year-to-date results, we are revising our 2004 loan growth rate expectation from the mid-teens to a rate of 10 to 13%. We have revised our 2004 expectation based on the realities of slowing growth and overall U.S. consumer credit and intense competition in each of our business segments. We are meeting these challenges head on with continuing product and marketing innovations across our businesses and with strategic moves like the acquisition of Onyx to fill out our full credit spectrum auto origination platform. We remain confident in our ability to deliver solid and sustainable managed loan growth. In 2004 we expect that our U.S. card business will outgrow the industry by a few percentage points and our global and auto financial services businesses will deliver stronger growth rates. Because lower growth cost and improving operating efficiency more than offset modest revenue declines, we are well ahead of our previous ROA expectation of 1.6% for 2004. Thus we are raising our ROA expectation to about 1.7% for this year. We continue to diversify beyond U.S. card.

Our global financial services and Auto Finance businesses hold 39% of managed loans as of September 30, 2004, and delivered 29% of 3rd quarter net income after tax. We are making strategic acquisition and divestiture decisions that better focus our diversification efforts. And retail deposits represent 28% of the liability side of our September 30, 2004 balance sheet, reducing our dependence on the Capital Markets for funding. Today just as quarter ago, our diversification efforts across assets, liabilities and profits are paying off. We are enjoying strong net income growth year-to-date, driven by our loan growth, our above-trend ROA, and asset and profit diversification. Therefore, we are raising our 2004 EPS guidance to a range of $6.10 to $6.40. I'll return to our guidance, including expectations and guidance for 2005 at the conclusion of tonight's call. Now Gary will review our financial performance in the quarter.

Thanks, Rich. And good afternoon to everyone. I will be addressing four topics in the next four slides. First, I will review the managed income statement, including 3rd quarter results and metrics and comparison to results in previous periods. Second, I will look at highlights on the managed balance sheet, which continues to exhibit stable growth, fortified liquidity and a strong capital position. Third, I will take just a brief look at 3rd quarter provision for loan losses and revenue recognition. And finally, I will review our 2004 guidance and more specifically what that implies for the 4th quarter of 2004. Let's turn to slide 6, and review the managed income statement and some key metrics. As a reminder, this slide provides for each line item data from the quarter just ended. The previous quarter and the 3rd quarter of 2003. I will focus on changes in the 3rd quarter of 2004 versus the comparable quarter last year. Third quarter 2004 results show solid revenue growth of 9% compared with 3rd quarter 2003. Net interest income is up $170 million or 11% driven by higher average loan balances. Noninterest income was up $51 million or 5%, primarily driven by a $31.5 million one-time pretax gain in connection with the sale of the South African business. Relative to the 3rd quarter of 2003, the 3rd quarter of 2004 showed a significant decline in provision expense of $124 million or 15%, driven almost entirely by a reduction in net charge-offs of $112 million or 13%. Marketing expense of $318 million in the latest quarter was up $2 million from the 3rd quarter last year and marketing expense year-to-date 2004 is flat the same period in 2003. Rich mentioned the continuing improvement in operating efficiency.

Let's look at the 3rd quarter. Operating expenses in the 3rd quarter were $994 million or up $69 million, about 7% compared to the same quarter in 2003. Adjusting for one-time charges of $63 million in the 3rd quarter of this year, however, operating expenses are essentially flat year-over-year, while loan balances have grown considerably. The one-time charges are detailed in the statistical summary which accompanies the earnings press release. Let me just mention a couple. $27 million of the increase in expenses this quarter represents one-time charges associated with ongoing cost reduction initiatives across our businesses. We also booked other one-time charges in the 3rd quarter including $21 million related to a change in asset capitalization thresholds and $16 million related to impairment of internally developed software. Netting out the $63 million in one-time charges this quarter, operating expenses in the latest quarter were $931 million or 5.02% of average managed loans, down 79 basis points from 5.81% in the 3rd quarter one year ago. All totaled, net income after tax is up 78% while earnings per share is up 68%. The difference is accounted for by the Company's increasing share count year-over-year. I should also note as you will see in the press release that the effective tax rate in the 3rd quarter of this year was 33.3% compared to 37% in the 3rd quarter of last year. This results in part from the fact that Capital One began to recognize tax credits from its section 29 limited partnership investment. Lastly the Company's revenue margin fell 133 basis points over the past year to 13.03%, reflecting the shift towards lower loss and lower yielding loans. The most recent quarter the revenue margin benefited somewhat from a one-time gain from the sale of the South African business. Without this gain, the revenue margin would have been 12.88% down from 14.36% in the 3rd quarter of 2003, but up from 12.53% in the 2nd quarter of this year.

Return on managed assets at 217 basis points remains as Rich said above its historical average of just over 150 basis points on an annual basis. While return on managed assets is subject to considerable quarter-to-quarter variability, it is running above trend because the modest decline in revenue margin associated with our diversification and bias toward lower loss assets is more than being offset by substantial improvements in credit and operating expenses as a percentage of averaged managed loans. With that, let me turn to slide 7 in the balance sheet. Capital One continues to grow profitably while building a more fortified balance sheet. As of the 3rd quarter 2004, total managed loans of $75.5 billion were up $8.2 billion or 12% from the same quarter last year. Capital is at an all time high of 9.57% of managed assets as of September 30. As I stated last quarter, we are choosing to retain this capital for now in order to maintain flexibility in pursuing our strategic initiatives. On the bottom half of the slide you can see that we have continued to maintain consistent levels of strong liquidity over the past year. All these factors, combined with strong market demand for Capital One paper, further enhanced just this quarter by an upgrade from Standard & Poor's which, like the other leading rating agencies now assigns an investment grade rating to all senior obligations of Capital One Financial and Capital One Bank supports our prudent balance sheet growth. Quickly turning to slide 8, I would like to review provision expense and revenue recognition experienced in the quarter. Consistent with previous presentations, the comparison on slide 8 is between the 3rd quarter of 2004 and the 2nd quarter. Let's start with the provision for losses relating to on-balance sheet loans. Provision expense was down $9 million in the 3rd quarter from the 2nd quarter, reflecting a $46 million reduction in net charge-offs.

Almost entirely offset by a reduction in the release in the allowance for future loan losses of $40 million. The reported net charge-off rate fell to 3.43% from 3.72% in the previous quarter, reflecting improved recoveries and continued favorable trends in the risk profile of on-balance sheet loans. These factors more than offset the effect of modest growth and the volume of on-balance sheet loans which helps to explain the allowance release of $30 million. The ratio of reported balances delinquent 30 days or more rose modestly from 3.91% as of June 30th to 4.00% as of September 30, 2004, reflecting expected seasonality. However like last quarter, the effect of an increase in 30-day-plus delinquencies on the allowance is more than offset by improvements in later-stage delinquencies. The level of amounts billed to customers but not recognized as revenue in the 3rd quarter was relatively unchanged to the prior quarter, as $270 million was billed to customers but not recognized as revenue. This so-called suppression amount was up slightly by 2% from the 2nd quarter this year, reflecting stable credit and collectability. Now before I turn the call back over to Rich, I would like to highlight slide 9 in our 2004 guidance. I will focus particularly on the implied outlook for the 4th quarter. This increase in our guidance for 2004, as with previous changes in guidance, is tracking the steadily improving credit performance of our portfolio. This reflects both the impact of a faster-than-expected move-up market in U.S. card and diversification into lower loss asset businesses and the effect of positive economic tailwinds. Year-to-date managed loans have grown $4.2 billion or at an annualized rate of 7.9%. We expect outstanding loans to grow by 10% to 13% for the entire year which implies 4th quarter growth of $3 billion to $5 billion, a number commensurate with the 4th quarter of 2003, a quarter where which we grew $3.9 billion in loans. While return on managed assets is showing consistency on an annual basis, we continue to experience quarterly variability in this metric.

Thus, while year-to-date returns have been well above trend reflecting the lower [inaudible] expenses associated with the steadily improving credit and improved operating efficiency, we expect that significantly lower 4th quarter returns will bring us closer to but still above trend as we grow our loan portfolio and make additional investments in marketing and in making our operations even more efficient. All told, our current expectation for 2004 EPS of $6.10 to $6.40 implies 4th quarter EPS of 65 cents to 95 cents. This reflects all known one-time charges and gains, as well as the following assumptions. Loan balance growth as I said of approximately $3 billion to $5 billion in the quarter. A significant allowance build to accompany this loan growth. Marketing expense, including brand investments, significantly above 3rd quarter '04 levels. Reorganization charges in the $30 million to $50 million range. And a pretax gain of some $4 3 million on the sale of our French loan portfolio per the agreement which was signed in early October and is expected to settle later in the 4th quarter. In sum, we expect to deliver a strong 2004 and as Rich will confirm, we are well-positioned for 2005. Rich?

Thanks, Gary. I'll pick up the discussion on Slide 11. On the top of the slide, you will see an overview of managed loan balances by segment in the 3rd quarter of 2004, the 2nd quarter of 2004, and the 3rd quarter of 2003. On the right side, you see growth in both dollars and percent from the year-ago quarter. The bottom of the slide shows a similar overview of net income by segment. I'll talk about each of the segments in turn so I would like to highlight a couple of overall points on this slide. Let's begin with a look at managed loans and managed loan growth on the top half of the slide. This is the 3rd quarter of 2003, our U.S. card loans grew by 4%. Our diversification businesses continue to deliver stronger growth rates. Global financial services grew 31% and Auto Finance grew 22% from the 3rd quarter of 2003. Diversified loans now account for 39% of totaled managed loans. Managed loans across all business segments grew 12% in line with the 10 to 13% range I mentioned at the beginning of the call. Clearly, the 4% growth in U.S. card managed loans is below our historical growth rate and below our expectations. This is the primary reason we lowered loan growth guidance in 2004 and 2005. I'll discuss U.S. card growth and our growth outlook in just a minute when I review quarterly results by business segment. Gary just mentioned our plans to make significant marketing investments in the 4th quarter. We have several marketing programs tested and ready to roll out in the 4th quarter. Additional brand marketing also contributes to the expected 4th quarter increase. In the 3rd quarter, we chose to increase our investment to build and leverage our brand and we are planning to increase that investment again in the 4th quarter. Remember that brand investment is included in our marketing expense number. We believe that brand helps make our card direct marketing more competitive and economic and that brand provides a similar competitive advantage to us as we market in global financial services and auto businesses as well. Further, the brand equities that we are building form a key pillar of our long-term strategy and vision to diversify beyond U.S. card into other national scale lending and financial services business.

We will discuss our strategy and how brand fits into it at our debt and equity Investor's conversation on November 4. Turning to profits on the bottom of this slide, U.S. card continues to be the largest profit generator. The diversified businesses continue to close that gap with very strong earnings growth. Global financial services profits tripled from the same quarter a year ago, aided in part by the South Africa gain on sale, while Auto Finance profits doubled. The bottom line payoff of our diversification continues. Slide 12 shows monthly managed charge-off rates on the graph and quarterly managed charge-off rate along the bottom. Quarterly charge-offs continue to reflect the long-term improvement trend falling 37 basis points to 4.05%. While we believe that the mixed shift up market has largely run its course. Some of the quarterly improvement is attributable to the residual effects of this mixed shift. Credit performance is strong and stable across our business segment, and you will see that in a moment. We have said for some time now that our credit improvement trend would eventually cease and that normal seasonality which has been muted by the profound credit improvements from the mixed shift would return. The slight uptick in the monthly charge-off rate for September reflects the beginning of the normal seasonal increase that typically occurs in the latter part of the year. Going forward, we expect the charge-off rate to stabilize between 4% and 4.5% through 2004 and into 2005. Slide 13 shows our trend in total managed 30-plus-day delinquency rates. This metric, up 14 basis points since June 30, 2004, has been basically flat for several months. This suggests that charge-offs will stabilize going forward with normal seasonal patterns resuming, which is consistent with what we saw in the last slide.

Slides 14 through 16 show results for our three reported business segments. Each slide shows loan growth, profits, charge-offs, and delinquencies for one of the segments. Beginning on slide 14 with our U.S. card business, the first graph shows loans up a modest 4% or $1.7 billion from a year-ago quarter and 2% or $835 million from the 2nd quarter of this year. As I just discussed, these growth rates are below our historical trend and our expectations. This is driven in part by slower industry growth which we believe is the result of a cyclical slowdown in the growth of nonmortgage consumer credit overall. Also, the credit card industry is more consolidated. Competitive intensity remains quite high, with high mail volumes and aggressively priced offers across the risk spectrum. Even in the face of these challenges our U.S. card business delivered modest but profitable growth. We expect stronger growth in the 4th quarter resulting from increased marketing and seasonal balance build. Moving to the second graph, we grew profits by 50% or $138 million from the 3rd quarter of 2003. Profits are up about 8% or $30 million from the 2nd quarter of this year. Our strong profitability is driven by strong credit performance and by continuing operating efficiencies and the slower growth that I just discussed. The third graph shows the strong credit quality of our U.S. card business. The charge-off rate improving to 4.68%. In addition to our ongoing credit risk management capabilities, our mixed shift up market and a favorable consumer economic trend may have all contributed to a 148-basis point improvement in our charge-off rate since the 3rd quarter of 2003 and a 51 basis point improvement from the 2nd quarter.

The final graph shows solid delinquency performance with the expected seasonal uptick in September. This trend is consistent with the trend in the total managed loan portfolio. The mature, consolidated and intensely competitive market our U.S. card business continues to delivers prudent growth, outstanding profitability and strong credit. Slide 15 presents the results of our global financial services or GFS business. Installment lending and small business is the primary domestic GFS businesses, while our UK and Canadian credit card operations are the primary International GFS businesses. The first graph shows strong and steady loan growth continuing in the 3rd quarter. Managed loans are up $4.6 billion or about 31% from the 3rd quarter a year ago and $900 million or about 5% up from the 2nd quarter of this year. Growth has been strong across both the domestic and the International GFS businesses with International growing at a slightly faster clip. The second graph shows net income after tax of $87 million, more than triple that of the 3rd quarter of 2003, and up almost 90% from the prior quarter. This net income reflects about $31 million -- $31.5 million of pretax gain from the sale of our South African business. But even without this game, -- this gain GFS would have delivered record profits in the quarter.

We expect that the sale of our French business will generate 4th quarter gain of about $44 million pretax. Let me talk for a moment about our decisions to divest in South Africa and in France. These decisions do not signal a move away from our International diversification. International expansion continues to be an important long-run part of our diversification strategy. And we believe it is important to be disciplined in the management of our portfolio of diversification businesses and our decisions in South Africa and France reflect this discipline. After years of testing in each market, we determined the potential profit opportunities did not warrant continued investment. We learned a great deal from our experience in both countries, and these learnings will help us focus and improve our International expansion in the future. For the moment, we continue to see strong opportunities to expand the scope of our UK business, and we continue to test in selected countries in continental Europe. Moving to the bottom two graphs, GFS continued to deliver strong and steady credit performance as charge-off rate continued to improve in the quarter while delinquencies rose 15 basis points. Overall GFS continues to deliver loan growth, asset and profit diversification and strong credit. Finally, I'll review our auto business as shown on slide 16. Starting again with loan growth in the first graph, strong and steady growth continued in the 3rd quarter. Auto loans -- the growth of auto loans in the quarter was pressured by intense competition in the prime space, aggressive incentives from the captives, and some pressure on our direct channel refinance business in a rising interest rate environment. Our expectations for growth remains strong, bolstered by continuing improvements in the effectiveness of our indirect channel sales force and progress on strategic partnerships in our direct channel. The addition of Onyx is significant for our longer term growth strategy.

Onyx is a great fit for us filling in the prime, sort of prime, near prime space and giving us a truly full-credit spectrum origination platform. Onyx also fills in our geographic coverage across the United States, especially in key states like California. Both our direct and indirect channels will benefit from these additional product offerings. Turning to net income on the upper right hand graph. Profits are up $28 million which is double the net income from a year-ago quarter. Compared to the 2nd quarter, profits are up $2.6 million or about 5%. Strong credit and solid margins drive the profitability of this segment. The bottom left graph shows charge-offs rising slightly in the quarter which is the normal seasonal pattern. This year, the seasonal effect is very modest as our continuing bias for upmarket auto loans and some firming and used vehicle prices and, in fact, improvement in our bankruptcy experience all help to keep the overall level of charge-offs very strong in the 3rd quarter. The last graph shows a relatively stable delinquency rate in the quarter. Like GFS, Capital One Auto Finance continues to deliver growth, profits, and strong credit. I would like to close today by returning to our guidance for 2005. And here I turn you to page 17. We believe our strategy will continue to deliver long-term value to shareholders through solid loan growth and strong ROA, while diversification adds stability to our results. We expect a 12% to 15% loan growth rate for 2005, down slightly from the mid-teens growth rate that we discussed last quarter. We are raising our 2005 ROA expectation to about 1.7%, up from the prior level of about 1.6%.

And as I said last quarter, diversification will continue and continue to pay off in 2005 and beyond. Based on these expected results and the strategies that drive them, we expect 2005 earnings per share to be between $6.60 and $7.00. This EPS range includes the expected closing of the Onyx acquisition in the 1st quarter of 2005. It does not include any specific expectations for additional acquisitions or other deployment of capital. We hope to see many of you at this year's conference on November 3rd and 4th in New York City where we will discuss our strategies and expectations in greater detail. Now, Gary and I will be happy to take 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 session.

Ladies and gentlemen, as a reminder please press star, 1 if you would like to ask a question at this time. Due to the number of people who would like to ask questions at this time, please limit yourself to just one question. We will now pause for a moment to compile the Q&A roster. Your first question comes from the line of Bob Napoli with Piper Jaffray.

Good afternoon. I was wondering -- just two quick questions. One on the account growth you had in the quarter if you can comment on that. That was the strongest account growth we have seen in a while and then secondly, more big picture wise, the earnings trajectory that -- and while the earnings performance is very strong in '04 and '05 versus expectations. If you look at the earnings trajectory between '04 and '05, one might say well, gee, the loan growth rate is only 8% to 9%. If you take the bottom of the ranges. And the top of each range, what is your view on the long-term growth rate of Capital One, and would you view the '05 growth as '04 being especially strong and needing to build reserve -- reserves and the like in '05 as the reason for the growth that you see -- you currently forecast in that year. Thank you.

Bob, it's Gary. I'll take your question. Let me start with the second one first, and I think as far as long-term expectation, the conference that takes place in two weeks from now is really the right time for us to have that kind of conversation in -- in greater detail, but certainly 2004 has represented a very significantly above-trend kind of growth year. I think we have identified it as the year has gone on especially as a result of the transformation that you've seen coming through, the credit metrics in particular, and I think if you take a look at our expectations for 2005 and take them back, for example, against 2003 results, look at that on a compound basis, you would see, you know, healthy annual growth rate of about 16%, 17%. Just a little bit above the growth rate in assets and I think that, you know, gives you more of a sense of what the history is -- has been of late and is likely to be over the course of the next year, and we will look back on 2004 and be able to identify those things which made it a year of extraordinary growth. As far as the account growth, as you know Rich, I believe, has indicated, particularly with respect to many of our businesses in the global financial services segments as well as U.S. card and auto, that we have been, you know, highly focused on generating growth in all of those markets. We have a lot of targeted marketing efforts out there. And we are seeing the results come through and seeing it happen really across the spectrum.

Bob, let me just add one thing -- to add perspective on this. Clearly in 2004, we kind of shot right through our earnings projection. We started with 520 with 540 and we raised it to 610 to 640. If we sort of compare this year with next year, you know, this year we have 10% to 12% loan growth and an ROA of about 1.7%, well up from the sort of historical average of 1.5%. Next year, instead of the 10% to 12% loan growth we are actually looking at 12% to 15% loan growth and the above-average 1.7% ROA neighborhood. So, you know, I think there is pretty strong thrust for the Company, in terms of earnings per share growth, diluted a little bit about the convertible preferred event that is happening next year of course. But in addition to the trajectory that -- that continues strongly, I think from a positioning point of view, I feel that we are very well-positioned to continue a nice trajectory into the future. With diversification taking off, with our cost position more competitive than it has ever been before and enjoying the fruits of the brand investment that we have now done for many years. So, you know, I think this is a good time for Capital One and I think we are well positioned for success not only in 2005 but certainly into the future.

Next question please

Your next question comes from the line of Chris Brendler with Legg Mason.

Hi, good evening. Thanks for taking my question. Rich, my question is for you. I would like to get a little bit of your color and thoughts on the outlook for the credit card industry from a growth perspective. You know, I -- I sense that we are a little more concerned about what kind of growth prospects we are going to see, but at some point, you would expect mortgage rates to start ticking up and people stop using that -- their house as a piggy bank and maybe the underlying fundamentals of the credit card industry and the growth prospects therein start to shine through. Is that something that you think is still in the cards? Or are we looking at a permanent slowdown in the saturation in the credit card industry?

Chris, it's a great question. And one obviously there is a lot of discussions in the industry about this. You know, first of all, as a macro comment about the credit card business, you know, pulling way back beyond any one year, I think the credit card business has been an amazing growth business over many decades now as it continues to take share from cash and checks and retailer cards and oil company cards, and so on. And I think the fundamental macro trend is the credit card becoming the vehicle of choice in the consumers' wallet and giving space to debit cards, certainly,which is doing well. I think it is a macro point that makes this an attractive growth industry over the long run although not -- you know, not the, you know, sort of torrid growth that it was when it was a smaller business. If you look at the growth, you know, right now there is sort of two big things from an industry point of view that are striking about the growth situation. One is cyclical, and I think will -- will pass, and one is structural. One might argue two structural points, Chris. The cyclical one relates to what you are talking about. We are at a place in the consumer cycle that is great from a credit point of view and weak from a growth point of view as consumers are sort of pulling back and so on and there is the refi activities. I can't predict exactly when that will pass, but clearly that is a temporary phenomenon and is partly holding back growth at this point.

The two more structural things is one is the rise of the home equity business, which certainly -- partly powered by, you know, debt consolidation and the aftermath of the credit card business, as well as by, of course, the tremendous growth and equity in people's homes, but I think we all have to keep an eye on the home equity as one of the inherent competitors in the business, not just sort other credit card companies. And the final striking thing is another structural one, which is this industry is -- has really changed a lot in the last few years from a fragmented industry where a lot of the growth any one player got was, you know, really coming at the expense of a sub-scale, you know, regional bank in some sense. And now, you know, with 90% of the business in -- in ten companies, all of who are, you know, well-funded and certainly not planning on, you know, losing share, this is a structural condition that I think, you know, will continue. And -- so I think a really important question that -- that any company has to ask ourselves, and I am going to talk about this in a second is, how do you win? What does it take to win in a business that has certain of these structurally evolved components? And that's where I think that while it is harder work for us, we are really particularly well-positioned. I start with the fact that IBS while it has helped us to get to where we are is absolutely, I think, what the doctor orders in a sense in terms of competing in a thinner margin tough competitive business. The ability to deaverage economics, target very carefully, targeted, segmented marketing, innovation getting out there first ahead of the competition. Credit risk management across the credit spectrum, optimizing relationship management and so on, these are very, very important tools to bring to the table. Obviously we spent 15 years building these. But these are not enough in our minds to really, you know, to be successful here. There are other things that we have felt we need to bring to the table to really be a force in this business and that is, in fact, what we have invested in over time. One is the cost structure more competitive. The tougher the market gets the more costs are really going to be important and we have made significant moves and will continue to to be more competitive in that space.

Secondly, our evolution to a much broader portfolio of value-added products in addition to our historical space that we continue to occupy with price competitive products and so on. Things like reward products, lifestyle products and so on, a lot of investments there and where a lot of our growth is coming from right now. And finally the investment in brand, and, you know, as you will hear more at the debt and equity conference, I think, you know, that -- that certain players -- that the card players actually are going to invest in brands and that will cost money but ironically it's going to put the card players in terms of the evolving, you know, financial services industry in an unique advantage position because we have a national scale business to supports our brand investment. So these are the changes that we have made in anticipation of a tougher card business. Pulling way up on this, if we think about what we have been saying for years, Chris, is that we want to diversify our company and -- and go after other industries in an earlier stage of consolidation so we can take our card business increasingly it moves from being the primary growth platform to now being the -- the -- the central thing that allows us to -- we leverage the card business, and its strength, its position, and its customer base to build our diversifying businesses who are at an earlier stage in the life cycle. So we have spent years preparing for this. It is harder work now, but I -- I really like our chances.

Next question, please.

Your next question comes from the line of Mike Vincequerra with Raymond James.

Thank you. Good afternoon. My question actually kind of goes to the volatility in earnings more so than the business question, but I wanted to see what you guys think about this. I mean when we look at your stock obviously the valuation has come down substantially over time partly because of slowing growth. But also in talking with investors it seems that the volatility in the earnings is something that has kind of turned some people off. And you know, when we look at the 3rd quarter to the 4th quarter progression that you guys are lying it out, the low end of your guidance would be looking at a, you know, two-thirds reduction in earnings per share and you kind of walked us through some of the metrics there. Is this just inherent to your business because when we look at a lot of the metrics like credit losses and loan growth, those are relatively stable, your margins don't change that much quarter to quarter, but we have tremendous volatility that has been happening over say the last six quarters in your earnings, and I was just wondering if you could comment on that and whether or not it is something that you -- essentially out of your control in some of the numbers we report. Thank you.

Great question, Mike. And I hope you understand that at least in my history with the company, I haven't seen the valuation come down. So I will just take your word for it. Over the course of the last year, I think we have actually been able to build a lot of understanding about the capacity of our company to deliver relatively stable returns, you know, on an annual basis year after year, and unfortunately, it has been masked by a lot of the quarter variability and it is something that obviously we have had to learn to live with. And let me just say as far as this particular point in time between the 3rd and 4th quarter of 2004, you know, what we are seeing is more or less what we had expected coming into the 2nd half of the year, but with a couple of things happening to make it more backloaded than we might have expected. So we are seeing the kind of growth as Rich has said perhaps a little bit slower than we originally expected, but even within the growth that we expect, very much more heavily loaded towards the back end of the year. That's where we are going to get the growth. That's where we're going to get the allowance build, and that, of course, does contribute to the quarter-to-quarter variability, but, you know, as you know we don't have a lot of degrees of freedom in terms of how we manage and report all of the associated accounts that go along with growth and allowance, and so there is a certain variability that we are going to have to accept. Also as Rich has indicated, we are looking to make some additional investments in marketing including brand investments during the 4th quarter, we see that's where the opportunity is coming from, and we are not going to really allow ourselves to get straight jacketed by the quarters when in fact, strategic opportunities will sometimes force us to move in such ways that we are going to see a little bit of that variability. I do believe that there was a heavily exaggerated, you know, amount of volatility during the course of this year, which really was the result of the transformational year that this has been in terms of recognizing the impact of moving up market and card and diversifying. And so really the credit improvement, which was very mindful on our part, combined with the positive effect of the economic tailwinds at our back is actually created some volatility, perhaps some lack of predictability that is actually in retrospect been, you know, very understandable but not something we would have gotten out in front of and been able to predict. I think where we are now in terms of the kind of leveling off of the credit metrics that you have seen in both what Rich and I have said. I think the steadiness of our investments, you know, over time I think on an annual basis, we can continue to show some good, stable strong earnings and recognize that from quarter to quarter, there may be some variability, perhaps a little bit less than we are seeing in the current quarters, but where that variability occurring, hopefully it will be in the context of building towards much longer-term stability.

Next question, please.

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

Thanks. I have actually two questions. One, can you give us an indication of where the AAA issuance capacity was related to the dealing securitization structure and if you could talk a little bit about the overall environment for bank acquisitions. I know you guys have talked for a while now about looking for a U.S. kind of retail deposit network for franchise. You know, not talking specifically, but if you can just give us an idea about the environment you are seeing out there given -- you know given that you are looking.

Christina, let me start with the first part of the question. We have enough stockpiles such that the next $12.8 billion worth of credit card securitization, if we needed to or chose to, could be issued in the form of AAA securities. And I will let Rich take the other part of the question.

Okay, Christina, I think the bank acquisition market is one that, you know, it's certainly an intense market out there. I think there are a number of players who are seeking to do acquisitions, and most of the banks that -- the significant banks that are out there, that, you know, have not sold is because they have chosen to do so. So you have an interesting market of -- of people in pursuit of acquisitions, and many of the banks not necessarily with an intent to sell. But I think that -- so -- I think, in other words, it is something that has been going on for a number of years. I think that a few major acquisitions have probably heightened the sort of attention on this thing, but, of course, our approach at Capital One is something I have been saying for the last year with respect to banking. And that is it's a -- an important part of our destiny over the long run and I think that, you know, what you're are seeing in our patient efforts here is, you know, we are not going to do anything rash. We are, you know, continue to patiently and prudently build for our long-term destiny and as we've said, we think a bank acquisition are a part of that.

Next question, please.

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

Thanks, Rich. A couple of the questions that I was thinking of were answered already. But one that was kind of interesting. Can you talk a little bit about what didn't work with the joint ventures and how much they had in assets and how much -- or why someone was willing to pay a big premium for them if they weren't working?

Thank you, Moshe. You know, I think that one of the things that is -- has been striking about building this company is that how, you know, we've learned as much from the things that didn't work in some ways as we learned from the things that work. In fact I have often said, you know, one thing I have learned in life is I learn, you know, that successes don't seem to teach a lot, but it is the things that don't quite work out as what you had in mind that give that you feedback, sort of more clearly. So -- the -- the -- France in particular I think is a -- is -- you know, there are some striking lessons there. In France, what we tried to do, Moshe, was sort of -- we tried to do three tough things at once, and it's sort of collectively hard to pull it off. We in many ways were trying to -- we were trying to change consumer behavior. Obviously the credit card is used in a very different way in France and certain other -- many or most other countries than it is in the places that we have really succeeded. So we are certainly trying to be out in front of that. We were marketing through distribution channels that France was not as well evolved in direct marketing as certainly many of the places that we have succeeded. And we were doing it probably most importantly we were doing it from a sub-scale platform, and I think trying to really change consumer behavior typically from a sub-scale platform is a difficult thing to do. It doesn't mean that you can't succeed, but when we compare all of our investment opportunities, looking at continuing -- looking at what it would take to really succeed in France, you know, we just didn't feel in the marketplace of investment. It competed as favorably as the very striking investments we had in other places. So too in South Africa we -- we -- one benefit we had in South Africa that we didn't have in France is we had a scale partner and that was Nedcor, of course a huge player in South Africa, but the issue there was really more in a country far away from where we are, it was a nice little business but it didn't sort of meet our goals for growth and profitability going forward and wasn't really on the bull's-eye of where we are really trying to take this company. So as we -- you know, in terms of the -- the -- why did people, you know, want to pay for these things? I think actually the assets that got created in each case, you know, and the customer relationships had value, and we are not leaving these businesses because they didn't have value. We are leaving the businesses because in the marketplace of investment, they just don't stack up as much as favorably as many of the extraordinary investments that we face in -- in other businesses. You know, and you -- if you -- if you watch what Capital One is doing, watch a business like the Auto Finance business, you will actually see our strategies shaped by the learnings from other -- from other things. For example, the acquisition of growth platforms so that we get threshold scale to start with. The -- you know, the focus on expanding where we already have a strength, you know, into laterally, you know, expanding, for example, in Auto Finance, starting from a threshold scale position in one part of the credit spectrum. We have now gone full credit spectrum. We have -- another key thing about Auto Finance is we met customers where they are. We didn't go into that business to try to change to a direct marketing format. We met them with indirect -- you know, the way the business works, but the funny thing is, the striking thing is that we met customers where they are, yet half of our business is actually now direct, but it was built on the scale back of meeting customers, you know, where they are. So, you know, the nice thing is we were able to exit these businesses and make a gain along the way and take the learnings to focus on the significant agenda we have to continue to diversify our company.

We will spend a little extra time this evening on the telephone with you, simply because we got a lot of people wanting to ask questions. So we are going to go a little bit past the usual 6:00 time. Next question, please.

Your next question, sir, comes from the line of Ken Posner with Morgan Stanley. Ken, your line is open. Ken, are you there? We will now go to the line of Bruce Harting with Lehman Brothers.

You know, just two quick ones. Can you talk about -- you know, you are saying taking an additional $30 million to $50 million of charge for continued corporate wide cost reduction. You know, can you just talk about what's left there? I think you talked about it a little bit in your prepared remarks, but any specifics as to the mix change that has gone on in your business and how that is impacting, you know, costs. And then what the fed tightening to date and the fed tightening yet to be done, if there is any, can you talk about how that plays through both the funding side and what you are doing on the pricing side of the card? Thanks.

Sure, Bruce. It is Gary. I will try and take both of those from you very quickly. Let's go back to the original statement that we made back in the 2nd quarter about some of the focus we were going to put on creating greater operating efficiencies and in the context of that taking some restructuring charges. Our original expectation was that we would recognize charges this year somewhere between about $115 and $165 million. You'll recall we got kind of a running head start in the 2nd quarter. We had 56 million in charges. Heavy dose of those related to consolidation of our site and some of the costs related to that. We recorded, as you know now, $26 million in the 3rd quarter, and we are looking at $30 million to $50 million in the 4th quarter. That would actually put us at the low end of our original range. So $115 million to $135 million worth of charges this year and again, a mix between employee, you know, severance as well as some real estate charges and we may have some additional charges going into the 1st quarter of '05 and we will update you on those next time, but I think by and large what you are seeing all along is a response to a recognition on our part that as our business has changed, as we have gone after not only lower loss assets but also higher average balance assets. Assets that required different amounts of customer service so that the difference between a credit card that has an ongoing balance and a lot of interaction with customers versus an auto loan in which there is a lot of interaction at the beginning and then very little service responsibility, you know, going on. So in a sense, there is a rationalization going on in each of the businesses. I think Rich has described several times that the way we have gone about this is actually to benchmark each of our major business lines against the competitive benchmarks that we believe we are going to have to meet in order to stay competitive in each of those businesses and that has required quite a bit of change, a lot of really pulling together on the part of our associates and a recognition of the need to stay on top of things. So I think we are well along in this program, and we expect that we will continue to look for opportunities to make sure that we are at the -- the levels we need to be in terms of operating efficiencies to stay competitive in all of our businesses. With regard to interest rates and what that means both for our company and for our products, Bruce. You know, let me just, you know, remind you as I always do that we have extremely, you know, conservative guidelines within which we try to manage our book.

We try to leave our risk taking for credit where we think we have a real comparative advantage, and, of course, we remain within those conservative limits right now. Again, a quick reminder, those limits -- we want to make sure that even in the event of an instantaneous shock of 300 basis points across the curve either up or down that our net interest income will not vary by more than 3% over the following year. As it turns out we have been for the last several quarters and we are still slightly asset-sensitive on a static basis meaning all else being equal, if rates were to go up, it would be slightly beneficial to us. That assumption, by the way, also expects that there is no change in consumer behavior. So we have not in those calculations taken into account the likelihood there might be less attrition, for example, as rates go up. Nor does it take into account, you know, any change in our pricing policy so that that which we have marketed as fixed rate will stay fixed rate for the period of match funding which, as you know, tends to be relatively long compared to the rest of the industry. So our pricing will certainly, you know, mirror the market to the extent that we have got some variable rate business, and to the extent that some of our old fixed rate match funding might roll off, and certainly we continue to look at our accounts one by one and look to make sure that they are appropriately priced for the risk and for the profitability that we are looking at. But by and large, we have for several quarters, as you know, been very focused on being prepared for any movement in interest rates and we remain there today.

Next question, please.

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

Good evening, gentlemen. Thanks for your time. If one really tries to sort of sort through all the items in the quarter, it seems to me if there was one material difference between the report and my sense of what folks who do detailed models were expecting, it is that rather than a reserve build this quarter, there wasn't one. I am looking at a model which anticipated a $930-odd million provision this quarter and the guy is usually pretty accurate. What exactly happened there? You pushed it out a quarter, and if so, why? And then finally and separately, after sort of guiding to continued sort of decline in net interest and revenue margin, the net interest margin jumped up rather significantly quarter over quarter, and I apologize. I didn't hear an explanation for what I gather was sort of an unexpected jump.

Okay. Peter. It is Gary. I am very happy to take that, and I actually had the same observation that you do, but let me true up to the expectations that some may have had and in fact, you'll recall that at the time of our 2nd quarter call we indicated that we would be building allowance over the course of the 2nd half of this year and in fact we still expect that to be the case. We might have expected it to be a little more balanced between the 3rd and 4th quarter. We now expect that it's going to be actually much more heavily weighed toward the 4th quarter. Why in the 3rd quarter did it not happen? Well, two obvious reasons, the first is that growth was less than we might have expected if you were looking for a steady growth over the course of the 2nd half of the year rather than being more backloaded as we've suggested. With slower growth than some might have expected and with credit being better than many might have expected. Take a look at the charge-offs coming down. Take a look at the, again, the improvement in our late-stage delinquencies. The fact that the growth that we are seeing tends to be coming in the lower loss asset, although there has been some modest volume growth. You know, the allowance is still being driven by the performance in terms of charge-offs and the risk profile. So by and large, slower growth, better credit, lower allowance than one might have expected and certainly, given what we expect for the 4th quarter, we expect to see a balanced build especially because of the growth in loans. As far as revenue margin goes, again, part of it is a result of the one-time benefit from the gain of $31.5 million, recognized in the sale of South Africa business. There has been some additional improvement in the revenue margin just this quarter. Again, a result of kind of a skewing to slightly higher yielding instruments over the course of the quarter. But we don't particularly see this as the change in the trend, although certainly it is a change from what we have seen in past, but we believe that with the kind of movement toward more diversified business, we might expect to see a mild decline in revenue margin over time.

Next question, please.

Your next question comes from the line of Matthew Park with A.G. Edwards.

Good afternoon. I have two questions. One is just wondering whether you had any auto loan sales during the quarter and second one is a little more qualitative. I guess this is for Gary, just following up on the previous answer. I mean I would like to have some more details of how the drivers of reserve build you're expecting the 4th quarter and perhaps contrast them with the 3rd quarter and what we have seen. I'm just curious as to why we should expect a relatively large swing in the excess provision given the fact that provisional data credit losses trends will be relatively stable here and I'm just curious about whether you're expecting some kind of shift in your expectation or change in the late stage deliquencies or something that's going to make you change your cost. Thanks.

Okay, Matthew, let me take your auto loan sales and Gary will do the reserve build. We sold post, prime and non-prime auto loans during the 3rd quarter totaling $253 million. This compares with auto loan sales of $323 million during the 2nd quarter of '04. These sales generated a gain on sale of $7.7 million in line with the $7.1 and the $8.5 million of gains that we had in the 2nd quarter and 1st quarter respectively, earlier this year. And it is of course included in the earnings of the quarter. For the balance of the year, we expect fewer whole loan sales as we plan to keep more loans on the balance sheet.

Okay, and I'll take the second part of your question, Matthew. As far as the 4th quarter goes, again we are assuming that our credit performance will be in line with the credit performance we have seen now for the last quarter or two in terms of general trends. Obviously, there is going to be a seasonal impact. And we do tend to see a seasonal uptick in delinquencies which might occur in the 4th quarter, but by far and away, the biggest impact in our expectation of an allowance growth in the 4th quarter was really a result of both the volume that we're looking for, $3 to $5 billion of additional loans and the composition of that loan growth which will be more heavily weighted toward cards than it has been in recent quarters and card as you can see from our segment statistics always carries with it, you know, the highest sort of expected loss rate which drives the allowance. So it's really all about volume in the 4th quarter, Matthew. This will be the last question we take for the evening and as I said, please call Investor Relations. Next question, please.

Your final question of the evening, sir, comes from the line of Craig Moore with Fulcrum Partners.

Yea, hi. I was hoping you could address the stories yesterday regarding European scrutiny of the fee structure, specifically in the UK and the possible impact that could have fee structure for the industry overall. Thanks.

Okay. Craig, the -- just to give context for folks here, the treasury select committee which is of course cross government body comprised of members of Parliament in the UK, has been conducting a wide ranging review of transparency of credit card company marketing and customer communications within the credit card industry. And at this week's hearing a question was raised that would [inaudible] Capital One about the transparency of certain of our marketing communications related to things like the sizes of type with respect to certain disclosures and so on. And we certainly are looking into that particular question. I think with respect to the broader issues about fees and so on, I think it's an ongoing dialogue, you know, in the industry, the OCC of course has also been very interested in the subject of, you know, the ranging from account management guidance to the pricing practices in the industry. So in addition to very carefully monitoring what is going on, you know, I think that if it's much too defensive a posture and reactive a posture to be monitoring what's -- what people are working on, let me talk about what we're doing at Capital One. We care greatly about customer value. We care greatly about, you know, issues of compliance and so on, and you know, in fact, you know, our whole philosophy, what our strategy is about is delivering, you know, breakthrough solutions to customers. And we even hang out our brand promise, you know, on the national television both here and in the United Kingdom. A great value without the hassle. So for us, I think that the really most important strategy is to, you know, focus as a company and be way ahead of where regulatory or legislative issues go and be focused in terms of what we do, in terms of customer value and living up to our brand promise. And then also, as an industry leader, working to really have a voice in the debate and helping to shape, you know, in whatever way we can the collective practices of the industry so that in the end we can manage our, you know, so we don't have, you know, other people trying to step in and then in the end, manage the industry. So these are all important issues and we continue to monitor them but you know, really in many ways, it goes to the heart of how we think we're going to succeed and I think that great, again, great value without the hassle is a very strong brand positioning and we're very committed to live up to that.

Thank you, Rich. As I said, 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.

And ladies and gentlemen, we do appreciate your participation in joining this Capital One 3rd quarter 2004 earning conference call. This call is now concluded and you may now disconnect.