Capital One Financial Corp (COF) 2004 Q4 法說會逐字稿

Welcome to the Capital One fourth quarter 2004 earnings conference call. Today's call is being recorded. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question and answer period. [OPERATOR INSTRUCTIONS]. I would now like to turn the call over to Mr. Mike Rowen, Vice President, Investor Relations. Sir, you may begin.

Thank you very much, Steve. Welcome everyone to Capital One's fourth quarter 2004 earnings conference call. As usual we are webcasting live on the Internet. For those of you who would like to access the call on the Internet, please For those of you who would like to access the call on the Internet, please logon to Capital One's website at www.CapitalOne.com and follow the links from there. 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 presentation summarizing the fourth quarter 2004 results. To access a copy of the presentation please go to Capital One's website, click on investors then click on quarterly earnings releases. The Company generates earnings from it's managed (inaudible) 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 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 GAAP.

For more information please 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 managements hopes, intentions, beliefs, expectations or projections in 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 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 ended December 31, 2003. Our website contains links to all our SEC filings as well as our monthly asset backed securitization performance data. To access this information please go to our website, www.CapitalOne.com, click on investors, then click on SEC or 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.

Thanks, Mike. As usual I will begin my remarks on slide 3 of the fourth quarter results presentation. 2004 marked our tenth year as a public company as well as our tenth consecutive year of strong earnings, loan growth and return on equity. We posted fully diluted EPS of $0.77 in the fourth quarter and $6.21 for 2004, a 28% increase over 2003. Our managed ROA of 1.73% for full year 2004 is well above our historical managed ROA of 1.5%. In 2004 declines in managed revenue margin were more than offset by benefits of improving credit and operating efficiency resulting in the higher managed ROA. Fourth quarter managed ROA was below trend at 0.83%, due to seasonal factors and the timing of several expense items. We will elaborate on these items in a few moments.

We posted managed loan growth of $8.6 billion or 12% year-over-year including $4.4 billion in loan growth in the fourth quarter. We also grew net new accounts by more than 1.5 million in 2004, including more than 1.3 million in the fourth quarter. Diversification continues to drive our loan and profit growth.

Our diversification businesses accounts for 39% of managed loans as of December 31, 2004, and 24% of 2004 profits. In addition to strong growth in profits and global financial services and auto finance, we continue to actively manage our portfolio of businesses through a disciplined approach to acquisitions and divestitures.

We completed our acquisitions of Onyx and HFS Group earlier this month. We also completed the acquisition of a small auto insurance broker, InsLogic, and we expect our acquisition of eSmartloan to close in the first quarter of 2005. We focused our diversification efforts by divesting our businesses in South Africa and France.

Credit quality remained strong and stable. While the managed charge off rate shows normal seasonal increases, managed 30+ delinquencies are holding steady, decreasing by 8 basis points from the prior quarter. Both the managed charge off rate and the 30+ delinquency rate have improved significantly compared to the fourth quarter of 2003. Once again our balance sheet remains rock solid, with capital and liquidity at historically strong levels.

Slide four shows how our strategy and results position us for continuing success in 2005 across the same key dimensions that we've discussed for the last two quarters. Loan growth, ROA, and diversification. We believe our strategy will continue to deliver long-term value to shareholders through solid loan growth with a strong ROA, while diversification adds stability and long-term growth potential for business. We expect a 12 to 15% loan growth rate for 2005. We expect our U.S. card business to grow at a rate faster than the industry.

While our diversification businesses are expected to contribute the majority of our asset growth again in 2005. We expect managed ROA between 1.7 percent and 1.8 percent in 2005. While we continue to expect quarter-to-quarter variability in this metric we believe annual managed ROA will remain relatively stable, reflecting the sustained earnings power of our business. In 2005 we expect our continuing diversification to again result in modest revenue margin decline, offset by improving operating efficiency, resulting in a managed ROA between 1.7 and 1.8 percent.

Finally we expect to gain further traction from diversification across loans and profits. We expect that our existing diversification businesses will continue to deliver and we've added strength with our new diversification acquisitions.

In summary we feel Capital One is well-positioned for a successful 2005 and we are projecting 2005 EPS to be between $6.60 and $7.00. Now Gary will review our financial performance in 2004 and the fourth quarter.

Thanks, Rich. Good evening to everyone. I will be addressing four topics in the next five slides. First I'll reviewed the managed income statement for the fourth quarter 2004, including results and metrics as compared to previous quarters. Second, I'll review fourth quarter provision for loan losses and revenue recognition. I will then review the full year 2004 managed income statement including results and metrics as compared to previous years. And finally I will briefly review highlights of the managed balance sheet which continues to exhibit stable growth, fortified liquidity and a strong capital position.

Let's turn to slide six and review the managed income statement and some key metrics for the fourth quarter 2004. As a reminder the slide provides for each line item data from the quarter just ended, the previous quarter, and the fourth quarter of 2003. I will primarily focus on changes in the fourth quarter of 2004 versus the comparable quarter in the prior year.

Let's start with revenue. Fourth quarter 2004 results show total revenue growth of 6 percent compared to the fourth quarter of 2003. Net interest income increased $130 million or 8 percent driven by higher average loan balances. Noninterest income was up $22 million or 2 percent driven by a one time pretax gain of $41 million for the sale of our French business.

Relative to the fourth quarter of 2003, the fourth quarter of 2004 showed an increase in tradition to loan losses of $24 million or 3 percent. This was driven by an $85 million increase in allowance billed which was almost entirely offset by a reduction in net charge offs of $74 million or 8 percent . While we are on the subject of charge-offs let me pause for a moment to discuss the policy change in our auto business that we mentioned in our press release. In the month of December we aligned our policy for charging off bankruptcies which was 180 days past due, with our overall charge off auto policy of 120 days past due. This one time acceleration in charge-offs amounted to $20 million. This charge while relatively small, does move the credit metrics so we felt it was important to tell you about it.

Rich will explain the impact of this policy change on the managed credit metrics in a moment. We discussed our expectation for a significant increase in fourth quarter marketing expense. On last quarters call and at our annual investor conference in November. As you can see marketing expense of $511 million in the latest quarter was up $193 million from the prior quarter and up $221 million, or 76 percent, from the fourth quarter of last year. Rich will also provide some additional context on our marketing in a few moments. Operating expenses in the fourth quarter were $1.05 billion, up $46 million or 5 percent as compared to the same quarter in 2003. There were $42 million of one-time restructuring charges included in the fourth quarter of 2004.

All told quarterly net income after taxes was down 27 percent, while quarterly EPS was down 31 percent from the prior years fourth quarter. The difference between net income and EPS change year-over-year is driven by the Company's increasing share count year-over-year. During the fourth quarter of 2004 Capital One's effective tax rate fell to 30.9 percent compared to 33.3 percent in the third quarter of 2004 and 37 percent in the fourth quarter of last year. The decline in the tax rate was largely driven by a number of one-time impacts. Despite the lower tax rate in the fourth quarter we anticipate that the full year effective tax rate for 2005 will be similar to the full year 2004 rate of 34.6 percent. All-in-all managed ROA at 83 basis points in the fourth quarter of 2004 is compared to 130 basis points in the comparable quarter of the prior year, reflects the significant increases in allowance billed and marketing investment as compared to the fourth quarter of 2003. While return on managed assets is subject to considerable quarter-to-quarter variability as Rich said, our annual managed ROA is expected to be stable around 1.7, 1.8 percent in 2005.

Turning to slide 7, I'd like to quickly review provision expense and revenue recognition experienced in the quarter. Consistent with previous presentation the comparison on this slide is between the fourth quarter and third quarter of 2004.

Let's start with the provision for loan losses that you saw on the previous page. Provision expense for managed loans was up by $239 million or 33 percent reflecting an $86 million or 11 percent increase in managed net charge-offs and a $140 million increase in the reported allowance.

Moving to the allowance and the factors which drive it the reported net charge off rate increased to 3.82 percent from 3.43 percent driven primarily by expected seasonal patterns. The ratio of reported dollar balances delinquent 30 days or more declined modestly to 3.85 percent from 4 percent, as expected seasonality was more than offset by the increase in new loans held on balance sheet. These credit factors coupled with the strong on-balance sheet loan growth, drove the allowance billed in the quarter of $110 million, an increase of $140 million in the prior quarter. For 2005 we expect the likely net allowance billed for the year with an expected seasonal release in the first quarter.

Now turning to revenue recognition the level of amounts billed to customers but not recognized as revenue in the fourth quarter, was relatively unchanged from the prior quarter. $276.8 million was billed to customers but not recognized as revenue. This revenue suppression amount was up $7.1 million or 3 percent reflecting relatively stable credit and collectability.

Turning now to slide 8, I'll review the full year 2004 managed income statement and some key metrics. I'll focus on changes in 2004 versus the prior year. Let's start with revenue. 2004 results showed total revenue growth of 6 percent compared with 2003. Net interest income increased $597 million or 10 percent, driven largely by higher average loan balances. Noninterest income was essentially flat. However, after the pretax gains on sales from our South African and French businesses are backed out, noninterest income was actually down about 1 percent. This is consistent with the shift for the higher credit quality and more diversified portfolio.

As compared to 2003, 2004 showed a significant decrease in provision expense of $378 million or 11 percent driven by a $432 million or 12 percent decrease in net charge-offs from the prior year. Marketing expense of $1.3 billion was up $219 million or 20 percent from the prior year; driven by the increased marketing spend especially in the fourth quarter. Operating expenses in 2004 were almost $4 billion, up $246 million or 7 percent as compared to 2003. These expenses include $125 million in one-time restructuring charges taken in 2004. All told net income after taxes was up 36 percent while EPS was up 28 percent from 2003.

I'd like to address the revenue margin and ROA metrics in some detail on slide 9. The first line on slide 9 reflects managed revenue as a percentage of average managed total assets. This is revenue as a component of ROA, rather than the revenue margin we showed on the previous slide which is a percentage of average managed earning assets.

The Company's revenue as a percentage of average managed assets has declined 155 basis points over the past year, and 366 basis points over the past two years, 12.13 percent as the Company has moved up market and diversified beyond U.S. card. This decline in revenue has been more than offset by the reduced provisioning and operation costs associated with those same marketing strategies and resulting from our focus on operating efficiency. As a result of improving credit in our portfolio, the provision as a percentage of total average managed assets has decreased 120 basis points from 2003, and 241 basis points from 2002 to 3.55 percent.

The movement towards assets with higher average balances and less operational intensity has also reduced operations expense 127 basis points over the past two years, even as we've made investments in operations in 2004 to reduce future costs. Marketing expense as a percentage of average managed assets has declined since 2002 but remains stable with 2003 levels given the increased direct mail, advertising and brand campaigns that occurred in the fourth quarter of 2004. Managed ROA was 173 basis points in 2004, well above our historical average of around 150 basis points. We expect a similar managed ROA of around 170 to 180 basis points in 2005. It's improved operating efficiency continues, while credit and margins remain relatively stable.

With that let me turn to slide ten. Capital One continues to grow profitably while maintaining a strong balance sheet. As of the fourth quarter of 2004, total managed assets of $94.8 billion were up $10.8 billion or 13 percent from the fourth quarter of 2003. Capital, which has grown by $2.3 billion in 2004, or 34 percent, is at an all-time high of 9.74 percent of managed assets as of December 31, 2004. As I've stated previously, we are choosing to retain this capital for now in order to maintain flexibility as we continue pursuing our strategic initiatives. On the bottom half of this slide, you can see that we have continued to maintain consistent levels of strong liquidity. All of these factors combined with strong market demand for Capital One paper, maintain and builds the strength of our balance sheet. With that, Rich, I will turn the presentation back to you.

Thanks, Gary. I will pick up the discussion on slide 12. On the top of the slide you will see an overview of managed loan balances by segment for 2004 and 2003. On the right side you see growth in both dollars and percent from the prior year. The bottom of the slide shows a similar overview of net income by segment. We will look at the sequential quarter amounts and changes when we discuss each line of business.

Let's begin with a look at managed loans and managed loan growth on the top half of the slide. As a result of solid loan growth across our businesses in 2004, Capital One had nearly $80 billion in managed loans as of December 31, 2004. Managed loans are up $8.6 billion, or 12 percent on the year. Our U.S. card business delivered managed loan growth of $2.3 billion, or 5 percent. Global Financial Services or G.F.S., and auto finance continue to be strong growth engines. In 2004 G. F. S. Managed loans grew $4.7 billion or 29 percent. Auto finance managed loans grew $1.5 billion, or 18 percent.

In total our diversification businesses now account for 39 percent of Capital One's managed loans, up from 35 percent at the end of 2003. And showing that the diversification of our assets continues as expected. Gary outlined the increased level of marketing in the fourth quarter and I'd like to elaborate on that just a bit.

Marketing expense includes both direct marketing and brand investment. Direct mail and advertising increased significantly in the fourth quarter as we launched several new products and marketing campaign, like the prime lock card, the Island Giveaway and the no-hassle rewards. We also increased our investments to build and leverage our brand.

As I discussed in our recent debt and equity investor conference call conference we continue to believe that brand not only makes today's direct marketing more effective, it also forms the key pillar of our long-term diversification strategy. In 2005 we expect full year marketing spend to be in line with full year 2004 levels with quarter-to-quarter variations possible as we assess market competitive and product opportunities throughout the year.

Turning to profits, on the bottom of the slide U.S. Card continues to be our largest profit contributor. But our diversified businesses continue to close that gap with very strong earnings growth. U.S. card profits grew by $206 million in 2004 to $1.4 billion, a 17 percent increase from 2003. Strong and improving credit through 2004 and improvements in operating efficiency drove U.S. card profit growth.

Global Financial Services profits were up $148 million or 229 percent, aided in part by the gains from the sales of our South Africa and France businesses. Netting out these one time gains G. F. S. profits were up $96 million or 148 percent. Auto finance profits grew $65 million, or 66 percent from the prior year, to $164 million for 2004. Loan growth, strong and improving credit and growing scale powered the profits of our diversification businesses in G. F. S. And auto finance. Diversification businesses contributed 24 percent of 2004 profits, up from about 15 percent of profits in 2003.

In 2004 our diversification businesses continued to deliver where it matters most, on the bottom line. Slide 13 shows monthly managed charge off rates on the graph and quarterly managed charge off rates along the bottom. Quarterly charge off rate increased 32 basis points to 4.37 percent and remains comfortably within our guidance of 4 to 4.5 percent; The monthly chare-off rate also increased in December, up 28 basis points to 4.63 percent.

Gary mentioned the change in our policy for recognizing auto charge-offs from bankruptcy. This change caused a one-time increase in the Capital One's December managed charge off rate of 30 basis points and one-time increase in our fourth quarter managed charge off rate of 10 basis points. In other words, Capital One's December charge off rate would have been 4.33 percent and our fourth quarter charge off rate would have been 4.27 percent had we not made this change. We've said for some time now that our credit improvement trends would eventually cease, and that normal seasonality would return to this metric.

The normal fourth quarter seasonal uptick in charge-offs was muted in 2003 by the profound credit improvements from our mix shift up market. As the mix shift up market abated in the second half of 2004, the fourth quarter charge off rate once again reflects expected seasonality. It is important to view our credit performance in an annual context as well. Our managed charge off rate has improved by 95 basis points since the fourth quarter of 2003. Charge offs reflect continuing strength and stability in the credit quality of our managed loan portfolio. Going forward we expect the quarterly charge off rate to remain between 4 and 4.5 percent throughout 2005. While we see signs of measured growth in the economy, our charge off expectations are based on a slightly more cautious assumption that the economy will remain relatively stable throughout the year.

Slides 14 shows the trend in our total managed 30+ day delinquency ratio. On an annual basis managed 30+ delinquencies have improved by 64 basis points since the end of 2003. This metric has basically been flat for nine months, which provides confidence that charge-offs will remain strong and stable going forward with normal seasonal patterns consistent with what we saw on the last slide.

Slides 15 through 17 show results from each of our three reported business segments. Each slide shows managed loans, profits, charge-offs and delinquencies for one of the segments. Beginning on slide 15 with our U.S. credit card business, the first graph shows loans up by $2.5 billion from the third quarter, and up $2.3 billion from the year ago quarter. Growing in today's consolidated U.S. Card market is tough in the face of heavy mail volumes, long dated teasers and other aggressive offers from competitors and, of course, pressure from alternatives like home equity lending.

Despite these pressures, our U.S. card business was able grow moderately by developing innovative new products and leveraging our brand. Nearly all U.S. card growth occurred in the fourth quarter aided in part by the traditional ramp in year end consumer spending and balance billed. We expect similar seasonal patterns to hold in 2005. The second graph shows the decline in profit in the fourth quarter. Fourth quarter profits are down $213 million as expected, due to the normal seasonal uptick in charge-offs, increased marketing expense and the increased operating cost and reserve build associated with the growth in new accounts and loans. As I just mentioned U.S. Card profits for all of 2004 are very strong and we expect another year of strong profitability in 2005.

The graphs on the bottom of this page show the strong and stable credit performance of our U.S. card business. With charge-offs up seasonally on the quarter and delinquencies improving modestly. In 2004 our U.S. Card business delivered growth, profitability and strong credit performance om a very tough market environment, all the while continuing to invest to improve our infrastructure and operating efficiency.

The results of our global Financial Services or G. F. S. Businesses are shown on slide 16. The first graph shows G. F. S. Loans of $21.2 billion, up $1.6 billion, or 8 percent from the prior quarter. Netting out favorable foreign exchange rates growth on the quarter would have been just under $1 billion or about 5 percent. Growth in the quarter was strongest in our small business, U.K. and Canada credit cards businesses driven by the same seasonal spending and balance increases that drive U.S. card seasonality. Loan growth for the year was strong across all of our G. F. S. businesses.

Profits as shown on the second graph decreased in the fourth quarter as expected. Fourth quarter profits of $29.2 million include the one-time gain from the sale of our French business. Without that gain the G. F S. Business would have been close to break even on the quarter. Seasonally strong loan growth and the related marketing reserve build and account set-up cost explain the vast majority of the decline. We also made investments in improving the operating efficiency of our G. F.S. businesses and took advantage of marketing opportunities we identified in our small business U.K. and Canada markets. The G. F. S. Charge off rate was basically flat from the prior quarter and down 39 basis points from the prior year quarter as shown on the first graph on the bottom of slide 16.

The final graph shows delinquencies up a modest 16 basis points from the third quarter and 11 basis points from the fourth quarter of 2003. Credit quality remains strong and stable across the G. F. S. Businesses. We added strength to the G. F. S. Portfolio through targeted acquisitions and divestitures in 2004. HFS Group, eSmartloan, and Inslogic each have strong and experienced management, proven business models, and are a great strategic fit with Capital One. They are additions that provide meaningful inside learning and growth platforms in key consumer financial markets. Yet they are small and focused enough to minimize execution risk.

We also focused our G. F S. Portfolio by diverting our South Africa and France businesses. These businesses were not demonstrating sufficient long-term profit potential or strategic fit to warrant further investment. We believe the type of active portfolio management is critical to optimizing the growth and diversification of Capital One. All in all our G. F S. Business delivered growth and diversification in loans and profits, maintained strong credit performance and demonstrated effective management of our portfolio diversification businesses in 2004.

Slide 17 summarizes the key results from Capital One auto finance. The first graph shows steady loan growth continuing in the fourth quarter. Managed loans grew $263 million in the quarter to nearly $10 billion. The 18 percent growth rate for the full year outpaced our total managed loan growth rate for the Company. 2004 loan growth was pressured by continuing and intense incentive activities from the captives, falling auto refinance volumes in a rising rate environment, and generally intense competition across the dealer channel. We believe the strength of our business model was direct in dealer channels and product offers across the risk spectrum, enabled our growth in highly competitive markets.

Further we've taken key strategic steps to build a platform for stronger growth in 2005, adding Onyx to our auto business fills out our prime and near prime product offers, strengthens and expands our dealer network and sales force and builds operating scale. And like the GFS acquisitions I just discussed, Onyx brings proven business results, strong and experienced management, and great strategic fit with Capital One. Fourth quarter profits of $25.1 million shown in the second graph were down as expected, driven by the one time impact of the accounting policy change on bankruptcy related charge-offs. Smaller gains from fewer whole loan sales and some modest expense increases in the fourth quarter.

The graphs on the bottom of slide 17 show continuing credit strength in our auto portfolio. Fourth quarter net charge off rate of 3.87 percent includes the one-time 81 basis point impact of our policy change for bankruptcy related charge-offs. In other words, auto charge-offs for the quarter would have been 3.06 percent had we not adopted the change; a 124 basis point improvement from the year ago quarter. 2004 credit improvement in our auto finance businesses resulted from our mix shift up market, relatively stable used car auction prices, and operational improvements in our collections process.

The thirty-day delinquency shown in the final graph also reflect the one-time impact of the change. The delinquency rate of 5.5 percent is basically flat from the prior quarter. Had we not made the change delinquencies would have been 20 basis points higher at 5.7 percent; which is more consistent with the normal seasonal trends evident in the third and fourth quarters of 2003. Delinquencies have improved by close to 200 basis points on the year.

In summary our auto business delivered strong results on all key metrics in 2004 and completed bold strategic moves to build the scope and scale of our auto lending platform. We believe Capital One auto finance is poised for continuing success with growing national scale, a unique multichannel, full spectrum lending platform, innovative products like the blank check, continuing strength in IBS marketing and credit management, cross-selling opportunities with close to 50 million accounts at Capital One and, of course, the Capital One brand.

I will summarize tonight's call on slide 18. We believe our results and strategic position is very strong for 2005. We expect our businesses to deliver managed loan growth between 12 and 15 percent in 2005. Our core credit risk management targeted marketing and product development capabilities continues to drive U.S. card success, and we've worked hard to add new capabilities including rewards and value-added products, increasingly efficient operations, and a powerful brand. We expect that our traditional strength and our new capabilities will enable us to profitably and prudently grow our U.S. card business in 2005.

Our portfolio of GFS businesses continues to gain traction and grow organically and through focused acquisitions. And our auto finance business has emerged as a consolidation force in a fragmented industry, thanks to our unique multichannel business model and growing national presence. We expect bottom line profitability to hold steady at about 1.7 percent managed ROA in 2005, continuing diversification will result in modest margin declines, but these will be offset by improving operating efficiency as our diversification businesses continue to gain scale and as our 2004 and ongoing efforts to improve operating efficiency continue to pay off. And while our credit improvement trend is stabilizing with expect credit metrics to remain at strong levels throughout 2005:

Finally we remain confident in the progress and benefits of our diversification strategy. We expect further diversification of both loans and profits in 2005. Based on 2004 results, and the expectations I've just laid out, we expect 2005 EPS to be between $6.60 and $7.00. Now Gary and I will be happy to answer your questions. Mike?

We will now start the Q&A session. If you have any questions following up after the Q&A session, the Investor Relations staff will be available after the call. Steve, please start the Q&A session.

[OPERATOR INSTRUCTIONS]. We will take our first question from David Hochstim, Bear Stearns.

Thanks. Wondered, could you give us a breakdown of loans by business segment on-balance sheet and off-balance sheet at year end and how that changed over the course of the year?

Sure, David. I'll be glad to pick up on that. As Rich and I have both indicated we've got the growth overall in the balance sheet of -- the managed balance sheet, of approximately 12 percent. You will see as well that the amount of securitization has actually come down somewhat. And I am going to actually ask you to check in with the IR staff after the call to get the exact breakdown business by business.

We will take our next question, Bob Napoli, Piper Jaffray.

Good afternoon. Your marketing, could you just give your out look for US car growth in '05 but the marketing expense is up 60 percent in the fourth quarter. I'd like a little more color on the effectiveness of that marketing, the mix between brand marketing and direct account marketing. So if you could give more color on the effectiveness, mix of marketing and just briefly your outlook for U.S. industry card growth. Thank you.

Thank you, Bob. Let me first of all, just talk about what we did in the quarter because obviously that is pretty eye-popping number when the marketing is over $500 million.

Several components of marketing went up in the quarter, Bob. U.S. card direct mail volume was up as we launched several new products and marketing campaigns like the prime lock card, the Island Giveaway, and our no-hassle rewards campaign. Supporting those specific launchings we also did a lot of product specific advertising on television.

And in addition to the product specific advertising we also did, saw a fairly significant increase in just general brand spend, much of it seasonal with fourth quarter events like the Capital One bowl and Capital One bowl week. And also we took advantage of some opportunities we identified in the quarter like great deals on media buys, some market opportunities we saw in small business and U.K. credit card business. So kind of across the board there was a real surge in the marketing opportunities and the marketing investment. And for all these reasons marketing in the fourth quarter of 2000 was unusually high.

With respect to your question of what it's going to be going forward we expect 2005 marketing to be similar to full year 2004 marketing levels. Now let's talk about sort of, what do we get for all of that. And the benefits, Bob, are really in several categories. First of all I want to caution that the direct linkage in a particular quarter to marketing spend and precise net growth rates are always directional at best. But nonetheless, first of all we saw significant growth across our businesses, most notably 1.3 million new accounts in the quarter and, of course, we grow our loans by $4.4 billion, now certainly some of that was seasonal. Let me just finish for a second, Bob. Did you want to say something there?

Please go ahead.

Now, the brand spend, when we try to do our very best to ascertain the benefits of the brand spend, this, part of the benefit of the brand spend is in lifting response rates. So even in the context, for example, of a very competitive credit card market, the evidence that we have is that our brand spend lifts response rates making direct marketing more effective. The brand marketing also does some other things, not as measurable but very significant in terms of what we are trying to do.

There are a lot of things that we can see tangibly from the brand benefit that, not so much measurable but last week I had dinner with the sales force of our auto finance business, the national sales force and they were saying, thank you for the TV advertising, I cannot exaggerate the power that that does for not only opening doors with dealerships but really building the credibility of our relationship and having us stand out relative to the composition. You can feel across the board that credibility benefit, in terms of marketing and things beyond that for the Company. And we are comfortable that the short term benefits of brands real do fully justify the spend.

Now, in addition to that there's another whole benefit, Bob as you know well we are very focused on working backwards where consumer Financial Services are going, and consumer Financial Services as they go from local to national businesses, the role of brand I think is going to be very central to that. A few companies are breaking away from the pack, and that's certainly part of our strategy. So a lot going on in marketing. I think that for us it was a very important and successful quarter and next year we will return pretty much to the average levels of '04.

Next question, please.

We will go to Chris Brendler, Legg Mason.

My question is really a little bit on the revenue side, trying to get a little more color on the noninterest income line. You've typically seen some seasonal benefit in the fourth quarter, I know it's more difficult as you diversify away from U.S. card to pin down exactly what's happening but if you can give us a little more color on the revenue on the noninterest side, specifically I'm looking at interchange which you do report separately on a known basis up 27 percent year-over-year yet even including the French gain, you are flat year-over-year on a managed basis.

I'm wondering is it credit quality continues to improve so you are not getting as much late fee income, are you waving more fee income and a lot of the regulatory environments on the credit card side? Obviously you moved away from annual fees on the marketing side.

And then the diversification obviously has an impact, as you don't get much fee income from auto or some of the GFS businesses. Can you give some color there and what we might expect from the fee income side in '05? Thanks.

Chris, I would be glad to take it and I can now tell we've been spending some time together, because the kernal of the answer is in fact was included in your question, and that really has to do with the magnitude of the shift up market and to the diversified businesses over the course of 2004. And as Rich mentioned earlier, we are seeing that start to show up in all of our metrics. And certainly when we move into the lower loss, lower yielding assets the proportion of the yield that comes from noninterest charges is clearly diminishing and it is something that you can expect to see as long as we continue to grow our diversification businesses, falls to maintain that bias towards the lower loss assets. You are going to see it more in the interest income than in the noninterest income.

But remember that we are getting the benefits that go along with those moves, hitting the bottom line through the reduced provisioning operating and marketing costs.

It's hard to project forward exactly what to expect in terms of the mix between interest and noninterest revenue over the course of next year. But I think in all of the metrics that we have guided you on, you can get to the overall revenue line item and that obviously will be a mix between the two, based on the continued evolution of the shift in our businesses.

Thanks.

Next question, please.

We will go to Moshe Orenbuch, Credit Suisse First Boston.

Hi. I was wondering if you could address the other expenses. If you net out not, non personnel but net out the charges in the third and fourth quarters it looks like it was up in the neighborhood of $100,000,000 third to fourth quarter. I was wondering if there is something in there besides charges that you could break out for us that would account for that.

Sure, Moshe, it's Gary again. Okay, what you are seeing of course is an increase of some $51 million from the third quarter to the fourth quarter. And if we take out the one-time expenses both the restructuring charges as well as some other kinds of one-time expenses we mentioned for the third quarter of '04, some write downs of software and other fixed assets, the run rate operating expenses from Q3 to the fourth quarter of '04 were actually up $73 million. That is very consistent with what we typically see in the fourth quarter.

In fact, $73 million of core expense increase in the fourth quarter of this year, last year that was $74 million. We do tend to see a seasonal uptick in terms of professional services, the cost of new account set up, Rich mentioned, the increase in accounts. So if you net out all of the one-timers, you would see that this years experience was very similar to the previous years, in terms of the quarter to quarter move. Overall, again, operating efficiency is improving.

Next question, please.

We will go to Richard Shane , Jeffries and Company.

Hi, guys. Can you just put sort of what you are seeing in terms of your marketing spend in context of what's going on out there? Are you seeing your competitors get as aggressive as you've been in the fourth quarter and if not, why do you feel that this is the right time to be stepping up there?

Let me make -- I think that I don't necessarily have a precise answer for exactly what the competitors did in the fourth quarter. Let me just make a general comment about competitors and their investment in marketing. There continues to be intense competition in terms of direct mail in the credit card business and also not only is the level of mailing still very intense, the intensity of the pricing is certainly very strong, Citibank for example is out marketing a 0% thirteen-month balance transfer introductory rate, and some of the other competitors are increasingly going well over 12 months in duration for these introductory rates. It's pretty intense there. There is a lot of marketing by our competitors as with Capital One as much as with us also, with respect to rewards products. About 60% of the industry mail volume includes reward offers and our mix is pretty consistent with that as well.

The other striking thing that's going on and it varies a lot by quarter is that especially Citibank, but certainly also Bank One Chase has really stepped up the investment in its television advertising. So while we may flip flop from quarter to quarter as to who is the big one you see out there, it's very obvious that they have very much internalized, correctly quite frankly, the need in the evolution of the marketplace to really step up and invest significantly in brand advertising.

So while again, we see someone disappear for a quarter and wonder if they've turned the other way, I think you are seeing, at least for the three of us, a sort of structural move toward the national brand game. And I think that will help us over the longer haul differentiate ourselves over the competition. We have to work for a living out here. It's a very intense marketplace. But I don't really see anybody backing down.

Next question, please.

Scott Valentin, FBR.

Thank you for taking my question. I had a question regarding growth in the sub-prime card space. You mentioned going against out market shift in card was pretty much complete and you were refocusing on sub-prime space. Can you talk about growth in that area?

Yes. Let me just put it for a minute in the context of over the last couple of years we have really focused our Company on a shift up market. And what we said is, we are not going to be leaving the sub-prime business, it's just that we are really going to be disproportionately growing some of the lowest risk asset areas. And we also said we are going to moderately grow the sub-prime business but at a lower rate.

As it turned out over a number of quarters, up to sort of middle of this year, there really wasn't a lot of growth of our sub-prime business. And so I think it accentuated the mix shift. What we said at the middle of this year is that the shift up market has mostly run its course, and you are going to see more balanced growth now in the credit card business, growth across all the segments with a bit of a bias towards the up market. This is exactly what in fact has happened now in the third quarter and again happened in the fourth quarter. Balanced across these business segments, definitely the growth of sub-prime has returned and yet the very, very slight up market mix shift also continues to be occurring.

Next question, please.

Next question, Mike Hughes, Merrill Lynch.

Thank you. A couple of the banks mentioned that the regulators may be pursuing getting rid of negative amortization on cars and/or perhaps adjusting payment rates. Have you heard anything about that from your regulator and any thoughts on what you might do there?

Thank you, Mike. This has been an initiative very much a crusade of the OCC and, of course, we are regulated by the Federal Reserve. So a lot of what we hear we more infer from what's going on with other competitors. So I think all along I think in our own relationship with our regulators and with respect to FFIEC guidance I think that we have been comfortably in compliance with that.

But we have certainly watched with interest at developments going on with respect to the OCC and their banks. When we saw the announcement, for example, yesterday I think it was when Bank of America talked about the impact of their adoption of changes in minimum payment practices, we watched that with interest. What I want to say with respect to Capital One again because this initiative really has been driven by the OCC we feel in equilibrium with respect to what we are doing here even though we are watching the trends with the OCC.

What I can do is tell you what our minimum payment practices are, Mike. About 90% of our accounts have a minimum payment of 3 percent of outstanding balances. The remainder have a minimum payment of 2 percent. And we believe our minimum payment practices are very appropriate and that we are in compliance with the FFIEC guidance.

Next question, please.

Our next question, Jim Edelman, Island Capital.

Thank you, my question has been answered already.

Next question, please .

Stephen Schultz, KBW.

Can you talk a little bit about the cost of funds, looks like top funds increased only about 2 basis points on the quarter, and how were you guys positioned at the year end in terms of funding exposure, in particular on the off-balance sheet funding?

Certainly Stephen this has been a major focus of ours in terms of fortifying our funding capacity over the course of the last couple years and frankly what you see in the fourth quarter is the return to that investment that we've made as noted both by Rich and by me. We continue to maintain a strong level of liquidity which is giving us a lot of flexibility in terms of the timing of our funding and we've been able to take advantage of that to try to certainly manage our cost of funds very effectively. In terms of the off-balance sheet funding, as you know we have been doing a number of things to try to achieve better funding execution. Their part of it has been to expand our relationships with a number of new investors and a substantial portion of our funding this year actually went to those new investors and the additional demand has allowed us to realize some funding savings there as well.

You also know that when it comes to our off-balance sheet funding we have made good use of the dealing structure to take advantage of good opportunities to stockpile the subordinated traunches and then to use the strength provided thereby to issue our AAA traunches at the best possible times and at the best possible yields. As of December 31, 2004, we have issued enough Single A and Triple B asset backed securities to issue the next $12.8 billion of card ADS in the form of AAA. And it is that amount of flexibility, combined with the better reception that we've been getting in the market for Capital One as a result of upgrades and other things, we've been able to use all of the tools at our command to get the very best execution and put us in a very good competitive situation in terms of funding and we believe that we are fully fortified to be able to achieve that in the next year as well.

Next question, please.

We will go to Joel Houck, Wachovia Securities.

Good evening. I was wanted you to comment on the loan growth guidance for '05, 12 to 15 percent is obviously a little more robust than '04. Is that an indirect comment about U.S. card industry growth or if we kind of look at the '04 metrics is it more of a mix shift in, continuing mix shift in '05 towards GFS and auto?

Joel, I think what is, it's more of the latter really. I mean I think that similarly as we did the year before, we believe that we will grow faster in the U.S. card business than our competitors, still within the context, though, of pretty tough competition.

I think the two most striking things that we see as we look at our loan growth opportunities for next year, are the continued trajectory of our diversification businesses. And also the, of course the benefit of the Onyx acquisition, for example, in helping to make that number as well. So net/net I think we sort of see a continuation of the kind of feeling of the U.S. card business and the intensity and kind of growth trajectory in that business and a pretty wide open opportunity in our diversification business.

Next question, please.

Our next question, Peter Monaco, Tudor Investment Corporation.

Good evening, thanks for your time, two quick ones if I may. Can you give us any way to think about how net interest and revenue margin will evolve from here, in light of the fact that the diversification and the quality bias appears to continue, but at the same time there is sort of a renewed initiative in sub-prime?

And then secondly and relate the to the latter part of that question, would you expect to build reserves over the full course of '05?

Peter, let me answer the second question if I could and then I will hand it over to the first question. In terms of building the allowance, the expectation at this point is that we will see a positive allowance build over the full course of 2005, although I'll reiterate that during the first quarter we are likely to see a release as the result of some seasonal trends. But certainly over the course of the year having run the course through the very significant credit improvement over the last year and the stabilization we see we would expect to see those allowances start to build again.

In terms of the overall revenue margin again I think you have the math down very well, which is that we should expect to see the top line revenue margin continue to move down modestly as a result of largely the diversification. As Rich said the move up market in U.S. Card has largely run its course over the course of the year, but the continued diversification towards lower loss, lower yielding assets will have it's affect modestly over time on the revenue margin, which is why we are focused so much on making sure that we generate the benefits in terms of lower provision expense, operating and marketing expense to go along with it in order to maintain the kind of strength in the ROA bottom line that we've been showing you.

Next question, please.

Our next question, Michael Hodes, Goldman Sachs.

Hi, good afternoon. My question I guess is for Gary and it's on capital levels. I recognize that you are trying to stockpile capital here in light of potential acquisition of a bank, but maybe you could give us a sense of what you feel the appropriate capital level would be, given your current mix of assets absent an acquisition, and give us a sense what if the timeline is as you balance this trade-off between building capital, and potentially doing thins like buying back stock or raising the dividend.

Thanks, Mike, I appreciate that. Certainly it's not lost on us that the pace at which our businesses are now generating capital has increased markedly over the course of the last year. It is a relatively recent phenomenon but a very significant one as you point out , and I would take pains to say thank you for that part of the question, that the growth in our capital ratio has actually occurred at a time when the risk profile of our business is actually diminished, which of course is, has strengthened our balance sheet considerably but also requires us to pay much closer attention to looking at the full range of possibilities for how to deploy our capital. So I can't give you a precise timeline at this moment. Certainly we expect that the capital generation trends will continue as our profitability growth exceeds that of our balance sheet.

You know we've got the mandatory convertible security will convert creating about 9 to 11 million shares in May of this year. And some continued exercises of options, especially those which were issued back in 1995 and might otherwise expire in 2005. So certainly the pace of the generation of capital we expect will continue. We believe that the risk profile of the Company will continue to diminish. And although we've chosen to retain the increased capital for the current time to maintain the flexibility actually across a whole range of strategic initiatives I can assure you that our board and our management are keeping the matter under very active review and we will certainly keep you posted as we, as we move on to the next steps.

We have time for one more question. Last question, please.

Our final question, Bruce Harding, Lehman Brothers.

On figure nine, Gary, it's interesting that the decline in revenue margin as a percentage of average total assets over the last two years totaled about 363 basis points, and that matches off against the decline in provision and operating expense. And then marketing declining by 30 BIPs is equal to the increase in ROA. I just wondering with targeting ROA at 170 or better again in '05, can you just go through each of those line items?

You said you pretty much run the course on your mix change and therefore provision probably has bottomed. Do you still see any movement their way in the revenue line, the operating expense and marketing line and I find it interesting with all the focus on this big marketing spend in the fourth quarter your marketing costs as a percentage of assets are actually down from two years ago. So maybe you could just comment on that trend. Thanks.

Thanks very much, Bruce. Let me be very clear on the combination of moves both in card and at the top of the house. When you take a look at card we've had again the move up market largely run its course, always changing quarter to quarter and that would tends to obviously lead to a relatively stable experience both in terms of revenue and in terms of provision.

But if you have to overlay on top of that the macro trends towards greater diversification, Rich mentioned nearly 40% are of our assets now from our diversified businesses and nearly a quarter of our bottom line coming from those businesses, that move will be the principal source of the downward pressure albeit more modestly than you've seen in the last couple of years on the revenue it should have as well a modestly positive impact in terms of our charge off experience and our provision expense. Although still within a relatively wide range.

So those should continue to net each other out more or less and as you've identified marketing has also stabilized as a percentage of total managed assets again reflecting the greater efficiency in term of scale that we are getting there. And so really the most positive impact we are getting in terms of ROA is the continuation and the improvements in operating expenses, as the result of investments we began to make in 2004 and we are continuing to make to scale the economies that we are getting in many of our businesses.

So I think in terms of looking at 2005 and expectation of a continuation of this sort of above historic trend kind of ROA, it's really going to come from the netting out of relatively more modest moves in revenue and provision, continued improvement particularly in operating expenses as a percentage of average total managed assets and that's where we are getting a lot of the continued positive momentum. And hopefully that kind of gives you a sense of what to look for over the course of the next couple of quarters, and in fact throughout the year.

Last thing I might also mention is that having achieved what looks to be a very optimal level of liquidity more or less, that as we continue to grow loans while liquidity does not grow as much, that may also have a slightly positive effect in terms of the positive revenue here. So all of those things give us confidence about our ROA expectations for the year.

Thank you for joining us on this conference call for today. Thank for your for your interest in Capital One. The Investor Relations staff will be here this evening to answer questions you may have. Have a good evening.

This does conclude the conference. Thank you for your participation. You may now disconnect.