Capital One Financial Corp (COF) 2007 Q1 法說會逐字稿

Good day, everyone. Welcome to the Capital One first quarter 2007 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. [OPERATOR INSTRUCTIONS] I would like to turn the call over to Mr.Jeff Norris, Vice President of Investor Relations. Please go ahead, sir.

Thanks, Keith. Welcome, everyone, to Capital One's first quarter 2007 earnings conference call. As usual, we're webcasting live over the Internet. To access 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 included a presentation summarizing our first quarter 2007 results. With me today are Mr. Richard Fairbank, Capital One's Chairman and Chief Executive Officer, and Mr. Gary Perlin, Capital One's Chief Financial Officer and Principal Accounting Officer. Rich and Gary will walk you through this presentation. To access a copy of the presentation and press release, please go to Capital One's website, click on "Investors," then click on "Quarterly Earnings Release."

Please note that this presentation may contain forward-looking statements. Information regarding Capital One's financial performance and any forward-looking statements contained in today's discussion and the materials speak only as of the particular date or dates indicated in the materials. Capital One does not undertake any obligation to update or revise any of this information, whether as a result of new information, future events, or otherwise. Numerous factors could cause our actual results to differ materially from those described in forward-looking statements. For more information on these factors, please see the section titled "Forward-looking Information" in the earnings release presentation and the "Risk Factor" section in our Form 10-K which is accessible at the Capital One website and filed with the SEC. Now I'll turn the call over to Mr. Perlin. Gary?

Thanks, Jeff. It's nice to have you hosting the call. And good afternoon, ladies and gentlemen. I'll begin on slide three of the first quarter 2007 results presentation. Capital One's first quarter 2007 diluted earnings per share were $1.62, down 43% from the record high EPS realized in the first quarter of 2006. This decline year-over-year was the result of three principal factors: Continued normalization of U.S. consumer credit; a full quarter impact from the North Fork acquisition; and the effects of a dramatically weaker secondary mortgage market. The first two of these were fully anticipated, while the third was not included in our original expectations for the year. With regard to consumer credit normalization, recall that the first quarter of 2006 had historically low charge-offs in the aftermath of the bankruptcy filing spike. By contrast, the first quarter of 2007 witnessed a continued modest rise in bankruptcies which began in the middle of last year, although current bankruptcy levels still remain well below that experienced prior to the October 2005 spike. You've also seen a related increase in contractual charge-offs as part of this normalization. You've heard Rich and me refer to the latter as the substitution effect, whereby borrowers who might have filed for bankruptcy under the old law are instead becoming delinquent and charging off over time. Next, this quarter's results include a full quarter of North Fork revenues and operating expenses, as well as the purchase accounting and integration impact of that acquisition. Additionally, average share count increased with the inclusion of the full quarter impact of the shares issued in association with the purchase of North Fork.

Finally, pressures in the secondary mortgage market have had a significant impact on our mortgage banking businesses. Like others, we have in recent weeks witnessed reduce liquidity and diminished demand for whole loans in the capital markets, including non-conforming prime loans such as GreenPoint's predominantly Alt-A originations. Although we've been tightening underwriting standards since late last year and are carefully managing costs, the market dislocation continues to impact both our origination volume and net gain on sale margins. While gross margins for the quarter were largely flat to prior periods as a result of having priced loan sale before the market bid compressed, net margins were significantly reduced. This was largely the result of adjusting our warehouse valuation to reflect the declining market bid and increasing our repurchase reserve related to representations and warranties for sold loans. These two adjustments dropped our reported gain on sale margin and contributed to the $13 million first quarter loss in the mortgage banking subsegment.

Moving on, largely as a reflection of the North Fork acquisition, our managed loans grew $38 billion from the first quarter of last year to $142 billion. [inaudible] also grew to $88 billion, and now comprise about 50% of Capital One's managed liabilities. We also delivered several sizeable infrastructure projects during the first quarter of this year. We completed the final phase of converting our cardholder system to the total systems, or TSYS platform. We completed the Hibernia integration with the conversion of their general ledger, and consolidated our legacy and banking wire platforms. We also made significant progress in the integration of North Fork, especially on the financial side. As you can see, North Fork's businesses have all been incorporated into our segment and subsegment financials, including the adoption of all Capital One accounting methodologies. We have integrated our balance sheet management, and completed the balance sheet downsizing that was announced as part of the transaction, which is reflected in the sizable reduction of mortgage loans held for sale on our consolidated balance sheet. We announced an accelerated share repurchase program for the first half of the $3 billion in buybacks anticipated in the North Fork deal, to be financed in part by the first quarter issuance of a $500 million hybrid capital security, representing the final leg of our acquisition financing plan.

Finally, we are revising full-year earnings guidance down from a range of $7.40 to $7.80 per share, to a range of $7 to $7.40. The primary driver of this revision to guidance is a change from our original assumption of a cyclically weak mortgage market to one which now presumes that the unusually compressed secondary market bids we face for Alt-A and other prime products persist over the remainder of the year. Consequently, we expect volumes in margins to remain depressed and that the mortgage banking subsegment contributes no incremental earnings for the balance of 2007. Our other key assumptions, that the yield curve remains flat and that credit normalization continues, remain unchanged. This presumes that the consumer remains relatively strong and that we continue to see no obvious impact in the credit performance of our consumer lending businesses from credit problems in the subprime mortgage market.

Now, if you'll please turn to page four, I'll briefly highlight a few new segment disclosures. As you can see from the tables attached to our earnings press release, we are adding several incremental disclosure items to provide you with a better window into our financials. First, we have changed our primary reportable business segments to reflect our strategy of National Lending and Local Banking platforms. In addition to schedules detailing results in those segments, we continue to provide a similar level of detail for our legacy subsegments within National Lending: U.S. Cards, Global Financial Services and Auto Finance. We have added Mortgage Banking as a stand-alone subsegment within National Lending. Please note that what you see in Mortgage Banking is limited to the legacy GreenPoint mortgage. It does not include Capital One Home Loans, our direct to consumer business, which remains in GFS, nor the mortgages currently held for investments on our balance sheet, which we hold in our Local Banking segments.

Additionally, you will see that in our Local Banking segment, we are breaking out net interest margin on deposits and on held for investment loans. This complements additional subsegment details across our businesses on margins and deficiency methods. While the additional disclosures I've mentioned so far will be included on an ongoing basis, we are at this time also providing historical pro forma numbers for the prior four quarters for businesses impacted by the acquisition of North Fork. This includes the Local Banking segment, along with the auto finance and mortgage banking subsegments. These schedules reflect what the businesses would have looked like given their actual quarterly results, with adjustments for Capital One segment definitions, internal allocations and transfer price methodology. Hopefully this will be useful for those of you modeling us at the subsegment and segment level.

Turning now to slide five, lets look at some highlights of the first quarter income statement. As we look at the income statement, please keep in mind that almost all quarter-over-quarter and year-over-year comparisons are affected by two key factors. First, the bankruptcy filing spike pulled forward into the fourth quarter of 2005 caused us to recognize historically and unsustainably low levels of credit losses and provision expense in the first quarter of 2006, thereby creating a significant boost to earnings in that period. Second, the acquisition of North Fork on December 1st, 2006, resulted in the addition of one month of related earnings to our fourth quarter 2006 results. By comparison, you can see the effects of a full quarter of North Fork-related earnings in the first quarter of 2007.

Net interest income grew quarter-over-quarter, largely as a result of the full quarter of incremental bank results. Net interest margin reflected the addition of the lower margin North Fork assets. Non-interest income also grew over the sequential quarter as a result of both the full quarter of North Fork results and a $46 million one-time pretax gain related to the sale of DealerTrack stock. These positive impacts were offset by several items including two reflecting the dislocation in the mortgage markets that I mentioned. These are, first, a $21 million additional build to our rep and warranty reserve for sold mortgage loans. And, second, a $21 million downward adjustment in the warehouse valuation of our mortgage loans held for sale. Provision expense increased year-over-year as we continued to see effects of the normalization of credit from the historical lows of the prior year. The increased charge-off levels we saw in the first quarter reflected the expected continuing return to more normal loss levels, which I'll discuss in more detail in a moment.

As expected, operating expense rose in the quarter as we incorporated a full quarter of North Fork costs and began to incur the planned integration expenses. Exclusive of these costs, operating expenses were down on the quarter as we moved towards completion on a number of key infrastructure projects. These investments in our infrastructure will provide opportunities to generate efficiency and cost saving benefits in the future. The tax rate, while up on the quarter, reflects a return to more normal levels compared to previous quarters. And as you can see at the bottom of the page, the shares issued in conjunction with the North Fork acquisition have had a full quarter impact on average share count. Please note, our accelerated share repurchase program did not begin until the beginning of April, and therefore does not affect first quarter numbers. We know that many of you model earnings which exclude the effect of purchase accounting and integration expense. If you exclude after-tax CDI amortization of $36 million and integration expenses of $10 million, both of which appear in operating expenses, EPS for the first quarter would have been $0.11 higher than reported.

Now, if you'd please turn to slide six, we'll take a quick look at credit performance. As you can see on the chart on the left, monthly losses from our Local Banking segment, which represent a mix of commercial and consumer loans, remained stable and low. Losses on the quarter in this segment were 15 basis points, down from 40 basis points in the prior quarter, largely a result of the inclusion of a full quarter of North Fork experience. In our National Lending segment, losses for the quarter were 3.65%, relatively flat to the prior quarter, but up 66 basis points from a year-ago quarter, reflecting the expected credit normalization previously discussed. On the chart to the right, you will see managed 30-plus delinquencies for our National Lending segment and non-performing loans as a percent of loans held for investment for our Local Banking segment. The delinquency rates experienced similar trends to those we saw in our managed charge-off rates. While National Lending delinquencies were down on the quarter as a result of normal seasonal trends, they were elevated from a year-ago quarter reflecting credit normalization.

Now, if you turn to the next slide, I'll give you a bit more detail on our allowance. Provision expense increased significantly over the year-ago quarter, driven by the normalization of charge-offs, post bankruptcy spike. As credit normalizes, we would expect to see less variability in provision expense. Overall, provision expense decreased quarter-over-quarter as the result of an allowance release driven by seasonally lower reported loan balances outstanding. Partially offsetting this release was an allowance build in our auto finance business, which we'll discuss auto finance credit in a moment. And with that, Rich, I'll turn it over to you to discuss our individual businesses in greater detail.

Thanks, Gary. I'll begin on slide eight with an overview of the new National Lending and Local Banking segments that Gary outlined earlier. As you've heard us describe for several years, our strategy is shaped by our vision of how financial services markets in the U.S. are evolving. We believe that the winning banks will combine the best of national scale lending businesses and local scale banking businesses. Our new segment disclosure aligns our financial reporting with our strategic vision and how we think about and manage our businesses. This slide shows actual segment results for the first quarter of 2007 and pro forma results for the 2006 quarters. I'll discuss results for each of our National Lending subsegments and our Local Banking segment beginning with U.S. Card on slide nine.

Our U.S. Card business continues to deliver solid profits, despite the expected normalization of credit losses. Net income for the quarter was $495 million, down $108 million or 18% from last year's record first quarter. The continued normalization of delinquencies and credit losses that Gary discussed is the largest driver of this decline. Charge-offs for the quarter were up 106 basis points from the prior year quarter to 3.99% and up 17 basis points on a sequential quarter basis. The 30-plus delinquency rate of 3.48% is up 55 basis points over the first quarter of 2006, and down 26 basis points from the fourth quarter. In the first quarter, we sold $25.5 million in charged-off credit card debt. Increases in market pricing for charged-off debt made the sale NTB positive. The debt sale reduced the charge-off rate by 21 basis points. Without the sale, the charge-off rate would have been 4.20%.

Our analysis of of credit performance indicates no impact from the current mortgage industry credit environment and no fundamental consumer credit worsening. Rather, the increase in both delinquencies and charge-offs is resulting from a modest rise in bankruptcies, plus the substitution effect that Gary discussed earlier. We expect continued charge-off normalization in 2007, which impacts the U.S. Card allowance for loan loss. The allowance release in the second -- excuse me, the allowance release in the quarter was relatively small, as the allowance released from the seasonal decline in loan balances was partially offset by the outlook for continued charge-off normalization. In contrast, the first quarter of 2006 included a large allowance release as charge-offs and delinquencies reached historic lows in the quarter following enactment of the new bankruptcy laws.

Revenue margin for the quarter was down 122 basis points from a year ago, but is down only 8 basis points from the fourth quarter of 2006. Net interest margin showed similar year-over-year and quarter-over-quarter trends. The year-over-year declines reflect the same product strategy choices we discussed last quarter and at our March investor conference. For prime and superprime customer segments, we continue to focus on rewards and transactor products. At the upper end of subprime, our focus remains on competitively priced revolver products, many with no annual fee. Overall, this product strategy generates lower near-term loan growth, lower net interest income, and fewer fees. But our product strategy also drives higher purchase volumes and lower attrition. The net result is lower revenue margin than a year ago, but a portfolio of loans that continues to stick around longer and generate sustainably high returns in this mature consolidated industry. Margins in the quarter also reflect the higher proportion of loans at introductory rates compared to the year-ago quarter. While up modestly from the year-ago quarter, the proportion of loans at introductory rates remains in the very low double-digits.

Operating expenses in the first quarter were up 6% from the first quarter of 2006, as we continue to run both the new TSYS platform and our legacy processing system. We expect to decommission our old operating systems later in 2007, after which we expect to see solid operating leverage. Our TSYS conversion is now largely complete, which drove the reduction in operating expenses on a linked quarter basis. As we've said in the past, we expect the TSYS infrastructure to result in improvements in speed to market, innovation, and customer service, as well as cost savings.

We ended the quarter with $50 billion in managed loans, up 6% from the first quarter of 2006 and down 7% from the previous quarter. Year-over-year loan growth resulted from strong balance build programs and favorable attrition trends. Managed loans declined from the sequential quarter, driven by seasonal patterns and the product strategies I just discussed. U.S. Card accounts also declined from the fourth quarter as we sold a portfolio of 660,000 accounts and $600 million in loans upon exiting a retail partnership. We expect U.S. Card loan growth to be under pressure this year. The competitive environment remains intense across the credit spectrum and we continue to see many competitors marketing 0% balance transfer teaser offers that last for more than a year. We also see competitors offering prime pricing and prime credit lines to customers at the upper end of subprime. As I just discussed, our product strategy may sacrifice from near -- some near-term loan growth, but it delivers sustainable long-term returns through low attrition and low credit losses.

Purchase volume was up $1.7 billion or 7% from the prior year quarter, despite the fact that U.S. retail sales increased only about 4% over the same time period. Growth in our transactor products continues to drive our purchase volume growth. However, given the deceleration of retail sales growth, it is likely that our purchase volume growth for the year will be a bit lower than the very strong growth we experienced in 2006. Despite the headwinds of charge-off normalization and systems conversion costs, our U.S. Card business continues to generate strong results and maintains its strong position for continued success going forward.

Turning to slide ten, I'll discuss our Global Financial Services, or GFS business. Our GFS businesses in North America continue to deliver strong performance, although the charge-off normalization in the U.S. creates headwinds compared to the very strong results these businesses delivered last year. In the U.K., challenges continue. While we're seeing some positive signs in the credit environment, we remain cautious. We continue to expect credit challenges in the U.K., given high levels of consumer indebtedness and high insolvency rates. GFS net income for the quarter decreased $39 million or 34% from the first quarter of 2006. Several factors drove the year-over-year decrease. U.S. credit normalization resulted in increased charge-offs and allowance build in the first quarter. U.K. revenues for the quarter reflected the impact of the 12-Pound card industry fee cap required by regulators in the U.K. And foreign exchange impacts were unfavorable compared to the first quarter of last year.

The charge-off rate of 4.18% for the first quarter was up 55 basis points from the first quarter of 2006, reflecting credit normalization in the U.S. and the continuing challenges in the U.K. relative to the prior year quarter. The charge-off rate rose 29 basis points from the fourth quarter as a result of U.S. credit normalization. The first quarter charge-off rate includes the benefit from a sale of charged-off debt in the U.K. which reduced charge-offs by 22 basis points. Without this debt sale, GFS charge-off rate for the quarter would have been 4.40%. Managed loans grew $3.0 billion or 13% from the first quarter of last year. All of this growth came from our North American GFS businesses. Managed loans declined about $200 million from the fourth quarter reflecting expected seasonal patterns. Overall, our GFS segment is on a solid trajectory and continues to drive diversification in growth of both loans and profits.

Turning to slide 11, I'll review our Auto Finance results. Auto Finance profits for the first quarter were $44 million, down $23 million or 34% from the first quarter of of last year. The decline in net income resulted primarily from a $92 million increase in provision expense based on strong loan growth and the continued normalization of credit from historically low charge-off in 2006. The provision build was partially offset by a $46 million pretax gain on the sale of DealerTrack stock. Managed loans of $24 billion are up $4 billion, or 20% from the first quarter of last year, driven by strong origination volume and the addition of the $1.4 billion North Fork auto loan portfolio. Originations in the first quarter were $3.3 billion, up 12% from the first quarter of 2006. The charge-off rate of 2.31% for the first quarter is relatively flat compared to the year-ago quarter. The negative impact of credit normalization in last year's targeted risk expansion were largely offset by a continued mix shift toward lower loan losses with the addition of prime auto loans from North Fork.

Delinquencies are up over 100 basis points from the first quarter of 2006. The increase is the result of credit normalization, expected impacts of the risk expansion, and the expectation of a modest short-term increase in losses from the transition to an automated underwriting model for the legacy Onyx business. Just as in our U.S. Card business, the rising delinquencies we're seeing in auto finance do not appear to be the result of the current mortgage industry problems, nor do we see any evidence of broad-based consumer credit worsening. Operating expenses for the quarter were up $30 million or 22% versus the year-ago quarter, in line with portfolio growth. We continue to incur integration costs as we work to consolidate multiple origination platforms. We are in the process of integrating the dealer programs of the legacy Capital One, Onyx, Hibernia and North Fork auto lending businesses. We expect to deliver an integrated dealer offering under the Capital One brand using a single sales force and an integrated underwriting and servicing set of platforms. We have tested the new integrated program in a few markets and are seeing positive early results. As we continue the national rollout of this program, we expect to improve our share of wallet with individual dealers and to realize operating expense leverage. We remain confident in the quality and growth prospects of our auto finance business and we believe that this business is well positioned to continue its solid performance as the industry consolidates.

I'll cover our Mortgage Banking business next on slide 12. We've all seen the mortgage industry experience an increasing degree of volatility over the past few quarters. Our mortgage banking business is an originate and sell model, focused on the prime market, with the majority of originations in the nonconforming prime mortgages, like Alt-A. As a result, our mortgage banking operations have been significantly impacted by the reduction in the capital market's appetite for nonconforming prime mortgages. In the first quarter of 2007, our Mortgage Banking business posted a net loss of $12 million, principally driven by lower revenues. This compares to a pro forma profit in the year-ago quarter of $35 million. The decline in revenues was driven by a sharp drop in the gain on sale margin. While base pricing in the secondary market for our products held firm for most of the quarter, the bid for Alt-A and other prime mortgages fell sharply near the end of the quarter. As a result, we made the appropriate warehouse valuation adjustment to a portion of our held for sale mortgage loans. We also increased our rep and warranty reserve. Both of these adjustments flow through the net gain on sale margin, resulting in a 75 basis points reduction to 51 basis points.

Originations for the first quarter totalled $6.8 billion, down 13% from the year-ago quarter. First quarter originations had an average FICO score of 715 and an average loan to value ratio of 75%. In this challenging environment, we further tightened our underwriting in the quarter, which we expect will result in lower origination volumes in the coming quarters. As I just mentioned, we also increased our rep and warranty reserve to $185 million. This represents nearly two years' coverage of the repurchase run rate we've experienced on our 2006 vintages. The last of our 2006 originations are moving through their 90 day early payment default window, and our tightened underwriting on current obligations should make them more resilient to potential early payment default. First quarter Mortgage Banking results clearly reflect the significant risk to volume and gain on sale margins in the originate and sell business model. But, our business model continues to insulate us from longer-term credit risks. Our Local Banking segment includes roughly $12 billion in held for investment mortgage loans. These loans, which we hold on the balance sheet, are predominantly prime conforming mortgages with an average FICO of 727, average LTV of 69%, and very low and stable delinquencies. Our decision to sell rather than securitize mortgage flow results in minimal residual credit risk and a small MSR of $268 million.

As Gary mentioned earlier, we're assuming that the volume and margin pressures in Mortgage Banking will continue through 2007. We currently expect our Mortgage Banking business to post a modest net loss for the year. Should market conditions improve, our mortgage business could generate positive earnings in the coming quarter. Conversely, should volumes or margins decline further from the current market levels, we would expect additional earnings pressure in our Mortgage Banking business. This is clearly a very challenging time for our Mortgage Banking business. We're maintaining the policies that insulate us from longer-term risks, while riding out this adverse part of the cycle.

I'll discuss the results of our Local Banking business on slide 13. I'll be comparing the actual first quarter 2007 results to pro forma results for the 2006 quarter. The Local Banking segment posted net income of $130 million, down $4 million or 3% from the prior-year quarter. Our commercial small business and consumer banking businesses are all contributing to solid segment performance. Net interest income declined $17 million from the first quarter of 2006, driven primarily by lower loan balances. Non-interest income grew by $20 million, or 12% from the first quarter of 2006. Most of the increase resulted from the gain on the sale of Hibernia's insurance brokerage business. Operating expenses grew a modest $5 million or 1%, as higher core deposit intangible amortization was largely offset by lower run rate operating expenses and reduced expenses related to the completed Hibernia integration. Credit performance remained strong, with a charge-off rate of 15 basis points, and nonperforming loans as a percentage of managed loans at 19 basis points. Total deposits grew $3 billion, or 4% to $75 billion.

Our small business and commercial strategies in New York metro and our de novo strategy in Texas are both delivering strong deposit growth. In the current yield curve environment, much of this growth is in higher cost deposits, like money market accounts, but the cost and the resilience of these deposits are still attractive to us as compared to alternative capital markets funding sources. Managed loans declined $4 billion, or about 9%. The decline resulted from the sale of residential mortgage loans, as we executed the balance sheet downsizing associated with the North Fork acquisition. We opened 16 new locations across our banking franchise in the quarter. Our integration efforts remain on track, with the Hibernia integration now completed and the North Fork integration proceeding according to our plan. As we discussed last quarter, our North Fork integration efforts accelerate later in the year, with the deposit platform conversion scheduled for the first quarter of 2008.

Finally, I join John Kanas and all of our associates in welcoming Lynn Pike to our senior leadership team. Lynn will be joining us shortly as Executive Vice President and Chief Operating Officer of our Banking business. She will also be a member of of Capital One's Executive Committee. She's a great addition to an already strong team of leaders at Capital One. Our Banking business continues to deliver solid and stable performance in the challenging interest rate and competitive environment.

Our first quarter results and revised outlook for 2007 for Capital One clearly reflect the significant near-term challenges we've taken on to transform our Company and position ourself to win in the long term as financial services markets consolidate. We always knew that the transformation of our Company would require a significant transition. Like you, I'm disappointed that recent changes in market conditions, primarily in the mortgage markets, have made that transition even tougher than we expected. But I believe we're well prepared to meet the near-term challenges and to execute a sure-footed and successful integration. We're as committed today as we ever have been to our vision of where financial services markets are headed and what it takes to win. And we remain committed to making sure our shareholders get paid along the way. Despite the current challenges, we're confident that the moves we're making position us for long-term success. Now, Gary and I will be happy to answer your questions. Jeff?

Thanks, Rich. We will now start the Q&A session. If you have any follow-up questions after the Q&A session, the Investor Relations team will be available after the call. As a courtesy to other investors and analysts who may wish to ask a question, please limit yourself to your initial question, plus only one follow-up question. Keith, if you'd please start the Q&A session.

Thank you. Chris Brendler, Stifel.

I guess I'm going to concentrate on the Card business. If you could talk, Rich, I heard some of of your comments. Did you see a little bit of an inflection in your -- how you're feeling about the Card business as we stand today? It sounded like you're a little more concerned about the level of competition than you had been recently. And then if I could just look at the numbers a little bit. Still seeing pretty heavy pressure on the yield. Like I said, that's good news from the perspective we're not getting any increase in penalty fees. But the volume was below our expectations that the loan growth fell short. And I think the just the credit numbers seem to be just a little higher than I was looking for. Help me think about how you feel about the Card business. And is that in any way, shape or form, affecting your outlook on 2007?

Thank you, Chris. I think the Card business really is mostly a story of continuity. Now that continuity has included for the last several years, a -- what is clearly a consolidated industry different from the consolidating industry we enjoyed for probably the other 15 years since we started building this business. And what comes with that territory is tough competition. And I think that our IBS strategy is probably the thing I would most like to have as a competitive advantage in this marketplace. And I think we're really well positioned. One of the daunting things that I've been talking about for a couple of years that does make competition a little bit more difficult is that we choose to sit on the sideline with respect to certain practices that are prevailing across credit spectrum in the industry, Chris, which certainly causes us to leave a fair amount of business on the table that we otherwise would pursue. But, we obviously talk a lot about that. But we are very resolved to make sure that we are taking the actions that really build a long-term franchise, and I think we're very happy with the business that we have generated.

The credit situation is actually I think a very -- I think maybe if you're a little surprised by the credit numbers, it may be the denominator effect relative to the sale of our portfolio, with our partnership portfolio. But I think that the most important headline in the credit card business is the fact that despite all that you read in the paper every day about the challenges in the mortgage business, we've analyzed this every way from Sunday, and if people want to ask more questions, we can go into more detail. But we do not see that problem spreading into the credit card business. The consumer I think is holding up very solidly there. At times it's hard also for -- given the credit normalization -- I mean the bankruptcy normalization and the substitution effect, there are so many moving pieces sometimes that probably from where you sit, Chris, it's hard to fully get a handle on that. But you can imagine, we look at vintages, we look at every subsegment, and we are really happy that the credit situation looks very solid.

Maybe just one quick follow-up. Maybe ask this a different way, revenues -- net interest revenues and non-interest revenues, or I guess total revenues are down year-over-year in the card business despite some pretty healthy growth in receivables. Is that just a reflection of competition and continued margin pressure from that competition? Or I think there may have been a one-time benefit last year.

Chris, it's Gary. Why don't I pick up on this, and I think you need to take a look at a number of things. First of all, you will find that as Rich said, a lot of our growth this year has been in the area of balance build with some of our best customers. That tends to depress a certain amount of the level of fees. Although we still do not use a wholesale policy of teaser-based pricing, we have a slight increase from about 10% plus to about 12% in card assets under introductory rates from the first quarter of '06. Again, the very strong credit environment we have faced year-over-year, which has benefited us in numerous ways, also tended to depress the level of of fees associated with it, as well.

And with interest rates having moved up over the course of the years, some of the funding is repriced. And we've kept some of our best assets, have not moved up quite as quickly as we try and make sure that we provide great value to our best customers. But over time, I think we have lots of different ways in which we expect to see that revenue margin improve as we expect it can over time. You saw a little bit of improvement quarter-over-quarter in the interest margin and certainly we're going to work really hard to do what we can to see some strong performance there. You asked if our guidance -- if part of why we adjusted our guidance downs reflected the credit card business. I mean, as we look at our businesses, there are puts and takes on the up and down side in all of our other businesses. But really, the net effect of all of that is pretty much a wash. This revision of guidance is pretty much a one for one correspondence with the decline -- the expected decline in our outlook for mortgage earnings.

Next question, please?

David Hochstim, Bear Stearns.

I wonder, could you talk a little more specifically about the operating expenses, both in -- in both segments, and kind of try and help us understand the increases from the fourth quarter to the first quarter when you had the full quarter of North Fork expenses, and what are some of the one-time investments that were in the first quarter and the benefits you're going to get over the next few quarters? And then the follow-up question would be if you could just give us the dollar amount or the gains from the sale of the charge-off debt in both cards and GFS?

Sure, David. Let's start with the comparison of the first quarter '07 to the fourth quarter of '06. Again, a full quarter of of North Fork in the first quarter of this year meant about $300 million in operating expenses. We only had one month or $100 million in the fourth quarter. So that's a net gain of $200 million. The total of OpEx only grew $125 million in the quarter. So that indicates the fact that the legacy businesses actually saw a small decline in operating expense. We typically tend to see that in the first quarter. And we also are starting to get past the peak of the infrastructure investment curve when it comes to our legacy businesses. And so I'd say the outlook would be for continued improvement in performance on the operating expense side with respect to our National Lending, our legacy businesses over the course of the year.

We do expect to see an increase in the level of operating expenses in the bank over the course of the year. They should tend to offset each other. And that's because the integration of the Bank, as Rich described, is going to really pick up speed at the end of '07. And so the back loaded integration expenses will start to show up there. So I think what you're seeing is that the longer-term sustainable trend of operating expenses would -- should start to improve. It's the short-term integration-related expenses that are probably going to keep us from realizing a tremendous benefit this year in the overall level of operating expense. And so hopefully that will kind of give you a sense of what is going on behind the numbers, and what you might see going forward.

In terms of the recovery debt sales in the card business, which Rich described, that was a gain of about $25 million, which actually shows up through the provision line item. If you take a look at the U.K. business, as Rich said, we also had some debt sales there. That yielded proceeds of about 35 million-Pounds, the bulk of which actually does not hit our bottom line. It actually goes against the securitization trust. Something like about 9 million-Pounds of of that would have improved the provision expense line item, vis-a-vis the U.K. So that should give you a pretty good picture of what's making things move in the operating expense line item. Last reminder is CDI amortization will also show up in operating expense. That's part of what I described earlier with respect to North Fork.

And the dollar basis then, operating expenses could be flat for the next three quarters, or -- ?

I think we've got an offset to look here, David, which is improvement in the legacy businesses, some increase in the bank. I think longer-term that's going to be a very favorable trend for us. Quarter to quarter will really depend on the timing of the integration expense. So I wouldn't look for a steady movement quarter by quarter, but I think the trend over the next period of time, we should start to see the benefits of the investments we've made.

Next question, please.

Richard Shane, Jefferies & Co.

One pattern that's been very consistent over the last several years is the relationship between U.S. card charge-offs and Master Trust card charge-offs. And this quarter we saw more actual U.S. card charge-offs than we would have predicted based on the Master Trust. Does that have to do with the portfolio sale, or is there potentially more lower quality stuff coming on balance sheet that you're not putting into the Trust?

Rick, a couple of things. Again, I think the denominator effect is significant. You heard Rich talk about that with respect to the sale of a portfolio. We've had lots of additions to the Trust. And with a changing mix of assets on the balance sheet at any given point in time which affects the allowance, but doesn't necessarily show up, it's important to realize that the two tend to move in the same direction, but not always a one for one movement. With respect to the addition into the Trust, you know that we were in the process of converting to TSYS from the summer of '06 until the end, which meant that we actually did not add anything to the Trust over that time period. But we have had two additions in the first quarter. So some other technical and incidental differences related to kind of GAAP versus Trust accounting. But I think you've got most of it and the direction should be clear.

Okay, great. Thank you, guys.

Next question, please.

[Tim Ryan], Oppenheimer Funds.

At the investor day last month, you guys put up a chart that showed stock returns since the day before the Hibernia deal was announced, and it showed Cap One's return versus a number of your peers. And I thought it was extremely intellectually honest because you could have very easily shown a chart since the IPO and it would have had a very different look to it. My guess is Cap One would have been at the top, or very close to it. My question is this: Understanding that sort of going from a mono line to a diversified bank is a long journey. But how long do you think shareholders need to wait for outperformance? How long should shareholders be willing to accept underperformance as we go through this transition period?

Tim, I, as a significant shareholder myself, and also one who has been leading this transformation, I take your question very much to heart. I think we have done a lot of really heavy lifting in this transition over the last number of years. And the transition has come in many ways. We sort of focused on the acquisition of a couple of banks. But there are a lot of other aspects to the transition that have happened over a number of years here. And it's really, in some ways, it's sort of an amazing story, because we've gone where other companies have not gone. But I really believe that through the moves that we have made, we have put ourselves in a very different position than where we came from in terms of the of the risk levels of the Company, in terms of the bone structure of the Company, and in terms of the capital generation capacity of this Company. And so I think we're well positioned to grow. I think we have a bone structure that puts us in a position not to get beaten up, but in fact to be a winner. And I think that the capital that we expect to generate will allow us to both continue to invest in growth, but also to pay our shareholders. So, I'm looking forward to not having endlessly long delayed gratification.

I really -- we are bullish that while this is a very tough period right now, and we have in many ways the intersection of transitional costs that have gone on, and a whole bunch of headwinds in both the banking segment and really, in many of the lending businesses. So, but we see line of sight in every one of these things, Tim. We see line of sight to these -- I can't predict when yield curves are going to change. But generally, we look at these things and cyclical things are what are they are. Structural things, I think, are very solid. And I think that we are really bullish for the prospects of this Company. And I don't want to stand up and say, gee, I want to make sure our shareholders get paid, and have people like you remind me of this and to continue to have to show charts, Tim, that show us underperforming our competitors while telling a nice strategy story. So -- .

No, understood. And I guess I appreciate that there are a number of headwinds that have impacted you guys that were unforeseen. And hindsight is 20/20. But those same headwinds impact everybody. And I guess I understand '07 is a transition year. You've made it very clear why that is. I guess it just seems like if we don't get back to some sort of trajectory and growth in '08, would that sort of lead you to maybe rethink the strategy?

Well, Tim, I think that we think we are well positioned for having a strong performance in '08. So again, we didn't anticipate the mortgage issues that we have -- are running into. I think with our gain on sale model, it's particularly creates a lot of short-term earnings volatility. But again, I think that we are well positioned for success and I think we're well positioned for success, frankly, in '08.

Next question, please.

Joseph Dickerson, Atlantic Equities.

Can you just go through again the discussion between the trend in the Master Trust and the [management]. I'm not sure I got it all, particularly with the part that relates to TSYS and how that would impact the differential between the trend and the two ratios.

Sure. I mean, very simply, Joe, again, you had a growth in the overall size of the Trust at a time where there may have been less in relationship to how much was being added on a managed basis. And so the impact of the changing denominator is going to have an effect on the Trust, and it may look at -- may cause, over a short period of time, the metrics in terms of rate, to differentiate between the Trust and the balance sheet. So it's just a small amount of timing. Although if you take a look at the monthly disclosures in the Trust, you have all of the information related to the volumes and so forth. So you should be able to see that happening as we go through it. So remember that taking a look at it maybe in another way, the charge-off rate in the Trust was artificially high during the period of time of the TSYS conversion when we weren't making additions for a variety of reasons. A little bit of a catch-up there, and all of that should be totally observable in all of the data that you get on the Trust every month.

And would you expect to accelerate additions to the Trust now that you seem to have lapped TSYS, and therefore could we see the trend reverse a little bit?

No, I think we're at a normal place, Joe. And so I think what we've done is to, in a sense, correct for the developments that were occurring at the time of the conversion. And now you would probably expect to see a more even pace of growth, both on and off balance sheet.

Next question, please.

Bob Napoli, Piper Jaffray.

On the card business, and then a follow-up. I guess, I think, Rich, you had talked about a normalized credit loss ratio in the range of 4.5% for U.S. card. And maybe now this quarter, the jump up is more denominator -- maybe overlooking the denominator effect a little bit. But you're getting up there faster. I just wondered, if 4.5% is still what you feel -- and it's below where you were a few years ago. But you've moved more towards superprime, is 4.5% still the right level where we hit normalization?

Bob, I think normalization is a process that is not -- that will continue also in 2008, as well, certainly in terms of full year performance. I think in terms of the dollars of credit losses that we expect this year, is very consistent with how we entered the year. I think the charge-off rate will be a function of the loan growth. And I think that as we talked about, I think that we see some pressures in terms of loan growth in the industry this year. And so I think medium -- I think in the middle to high fours is the [inaudible] saying -- no, in the mid to upper fours is the range I think that we would expect in terms of the charge-off rate. It would be just basically driven by the asset growth rate.

Now, the industry growth rate has picked up, actually. It's the highest it's been since 2000, according to government statistics, up 7% year-over-year, and it seems to be picking up a little bit month to month. But you're seeing more pressure in growth where the industry is actually growing faster than it has in five years.

I don't know. As we look at the major issuers, I think they're seeing a lot of what we're seeing here.

Next question, please.

Laura Kaster, Sandler O'Neill.

Just a conceptual question, and if I can just play devil's advocate. If you annualize this quarter's earnings, it's somewhat beneath the range of your lower guidance. Can you help me conceptually get to how we can get to 7 to 740 for EPS for '07?

Sure. Let me just remind you, Laura, that lots has changed to our Company as a result of the transformation, and let me just point to three or four things that you might expect to see that would cause quarterly results in the next couple of quarters to be higher than in the first. So, first if you take a look at the mortgage banking business, as Rich and I both said, it recorded a loss between $12 million and $13 million in the first quarter. And our current assessment is that it will more or less break even for the balance of the year. So improvements quarter-over-quarter -- over the next couple of quarters there.

Secondly, as I was discussing with David Hochstim earlier, we have room for some mild improvement in operating expenditures over the course of several quarters as the result of having passed the peak of our investment curve in our legacy businesses, offset less than 100% by the integration expenses in the bank. Remember that up until the end of the first quarter, we had no share repurchase activity. Starting on the 2nd of April, we began an accelerated share repurchase program for $1.5 billion. And our expectation is still that we will have a $2.25 billion repurchase level over the course of the year. And we will also be looking to try to continue to operate in all of our businesses in a way that allows us to improve revenue. So I think across the board, there are a lot of reasons for 2007 that we can expect to see a different quarterly pattern than we have in years past. And as we become more diversified, and particularly with the addition of our banking segment and as it grows, it tends to have a less volatile quarter to quarter movement. Hopefully that's something we can see longer-term, as well.

Okay, great. Thank you.

Next question, please.

Scott Valentin, Friedman, Billings, Ramsey.

Within the auto portfolio, I understand you've been moving a little bit up-market. I'm just trying to figure out within the subsegments, the credit performance, prime versus subprime, are you noticing any difference in credit performance and a deterioration more in prime versus subprime?

We, Scott, what we see in the auto business, the first thing I want to say is we don't see the spread of the challenges in mortgages. It's again, very consistent with what one would expect. What we see in credit is really driven by three things, headlined by the normalization, of course, in bankruptcies and the substitution of effect that comes along with that. We also have had two -- we had what we call a risk expansion or sort of a risk and underwriting expansion with respect to product, a modest one last year. That was by design. That has increased credit losses. And also relative to the conversion of a judgmentally based platform in the -- basically out of the Onyx portfolio, which is in the near prime state, we have seen higher charge-offs with -- through this interim transitionary period. So, therefore, really, there's across the board bankruptcy normalization and the substitution effect. And in subprime, a conscious risk expansion, a moderate conscious risk expansion, and the credit effects of that. And then the transitionary effect in the near prime space with Onyx.

Okay. Thank you.

Next question, please.

Moshe Orenbuch, Credit Suisse.

Kind of two related questions, or a question and a follow-up. How much of that $0.40 kind of reduction in guidance do you think is the mortgage business in the current quarter and the rest of the year? I think you kind of said it was pretty much the whole [inaudible] of the year. And then I've got a follow-up.

Yes, Moshe, it's Gary. We're taking a look at the expectations we have today versus those which underpinned our expectations at the beginning of the year. And over the course of the last six weeks or so, we've gone from expecting a cyclical downturn in that market to obviously, dramatically weakened secondary market conditions. And although we had a bit more of the impact in the first quarter because of the writedown of what was already in the warehouse and because of the increase in the rep and warranty reserve, over the balance of the year, more of that pressure is simply going to come from volumes and margins.

Okay. Just to follow up, then. There was a $30 million drop fourth to first quarter in the pro forma earnings in the local banking segment outside of mortgage banking. Could you address what the root cause of that was? Because it wasn't -- core deposit intangible was a very small piece of that.

Actually, I think it's a pretty large piece of that, Moshe, in terms of CDI, the pretax CDI in the first quarter was up about $24 million. That would explain I think an awful lot of it. Again -- and the beginning of some of the integration expense North Fork, the last bit of the integration expense out of Hibernia. That's pretty much what you were seeing there.

Okay.

Bob Hughes, KBW.

I thought maybe you could go back to some of the expense questions. Could you give us any sense for what the cost of investing in the Hibernia systems might be in this quarter, and what the curve might be on those costs?

I'm sorry, Bob. You want to repeat that question for me?

Yes. It was a question regarding expenses. I know you've talked about some of your investment -- infrastructure investments. How big of an issue is the investment in Hibernia systems that you're making prior to the conversion next year?

Yes. I mean, at this point, Bob, as I said, the expenses with respect to integrating the former Hibernia are pretty much now all the way through the pipeline. And the investments that we're going to be making in our banking systems generally, some of which will be the legacy Hibernia platform, some will be the legacy North Fork platform, some may be neither, those are really going to show up as integration expenses over the course of this year. So as I suggested, the integration expense in the first quarter was relatively low. It was about $15 million after tax. You'll really start see that pick up over the course of the year. And that's consolidating the former Hibernia and former North Fork onto a single platform. So it was really in the first quarter, the infrastructure investments I was describing, many of which are at now or past their peak, was the card system moving onto TSYS, consolidation of some of of our servicing and origination platforms in auto. Those were the big drivers in the first quarter.

Okay. I didn't realize those would be captured in -- the systems investments would be captured in the integration expense. But as a follow-up, Gary, with the total systems conversion largely complete, I guess we would expect to see a drop in [PWAY] or [inaudible] losses. Can you give us a sense for the size of those in the first quarter?

Probably not a significant number, Bob.

Okay. Thanks.

Well, thanks, everyone, for joining us on the conference call today. And thank you for your interest in Capital One. As I mentioned before, the Investor Relations team will be here this evening to answer any additional questions you may have. Have a good evening.