Capital One Financial Corp (COF) 2007 Q4 法說會逐字稿

Good day, everyone. Welcome to the Capital One fourth 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) As a reminder, today's conference is being recorded. I would now like to turn the call over to Mr. Jeff Norris, Managing Vice President of Investor Relations. Sir, you may begin.

Thank you very much, Cynthia. And welcome to everyone to Capital One's fourth quarter 2007 earnings conference call. As usual, we are webcasting live over the internet. To access the call on the internet please log on to Capital One's website at capitalone.com and follow the links from there. In addition to the press release and financials, we have included a presentation summarizing our fourth quarter 2007 results.

With me today is: 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 the 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 financial performance and any forward-looking statements contained in today's discussion and materials speak only as of a 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 those factors please see the section titled forward-looking information in the earnings release presentation, and the risks factor's section in our annual and quarterly reports accessible at the Capital One website and filed with the SEC. At this time I'll turn the call over to Mr. Fairbank, Rich?

Thanks, Jeff, and thanks to everyone for joining us on the call tonight. I'll begin by summarizing the results of the quarter on slide three. Capital One posted diluted earnings per share of $0.60 in the fourth quarter, and $3.97 for the full year 2007. As you know, we announced our fourth quarter and full-year 2007 earnings per share on January 10th. Today's earnings release adds more detailed financial tables for the company and for our business segments, but it's consistent with our announcements two weeks ago. Given the January 10th announcement and the opportunity we've had to engage with investors and analysts since then, our presentation tonight will focus on key issues rather than our traditional walk through the company and segment financial results. We have included all of the usual financial slides in an appendix for your convenience, but our discussion will focus on the most important issues on investor's minds beginning with the credit and market environment.

Simply put, we're acting divisively and aggressively to manage the company for the benefit of shareholders in the face of cyclical economic headwinds. In essence, we're managing the company today as if a recession were already here. We're pulling back on loan growth, focusing on our most resilient businesses and closely managing credit with the insights and experience we have garnered in prior economic downturns. We're attacking costs and pushing for further operating efficiency gains, we're building revenues and focusing on achieving strong risk adjusted returns across our businesses. And we're being disciplined stewards of capital. We are maintaining our commitment to return excess capital to our shareholders while at the same time building our capital position in today's economic and capital markets environment, and all our actions are designed to ensure that our businesses achieve above-hurdle returns on capital or have clear line of sight to doing so in the near future. Our fourth quarter and full-year 2007 results reflect challenges we faced throughout the year as well as continuing uncertainty in challenges going into 2008, but we remain confident that our strong balance sheet, resilient businesses, and decisive actions will successfully help us navigate an economic downturn and that Capital One will be poised for a strong rebound on the other side of the cycle.

I'll discuss credit beginning on slide four with a look of credit metrics in our national lending and local banking businesses. Because our credit results and how we're responding are best understood by looking at each of our businesses, I'll turn to days cushion of credit performance and the actions we're taking to manage credit in each of our national lending businesses, and in our local banking business. Slide five shows quarterly net income and credit results for our U.S. card business. Fourth quarter net income of $522 million was up strongly from the fourth quarter of 2006, as revenue growth and expense reductions more than offset increased charge-offs and allowance build. Delinquencies and charge-offs increased on both a year-over-year and sequential quarter basis.

Like others in the U.S. card business our delinquency and charge-off increases resulted in part from the normalization of charge-offs following the unusually favorable credit environment in 2006 and from economic weakening evidenced in recently released economic indicators. The sequential quarter increase also reflects expected seasonal patterns. Our rising credit metrics in 2007 were exacerbated by our significant pullback from the prime revolver space throughout the year and by our pricing and fee moves in the second and third quarters. Both the prime pullback and the pricing in fee moves contributed to the increases in our credit metrics several months before the deterioration in economic indicators became apparent. But they also contributed to revenue margin expansion that helped our U.S. card business to post more than $2 billion in net income and returns on allocated capital in excess of 40% in 2007, even with significantly higher provision expense.

Looking forward, we expect U.S. card revenue margins to decline from peak fourth quarter levels in the first quarter and to be in the high teens throughout 2008. There are several reasons for the expected decline. In other words it's the fourth quarter that will be our peak, and we expect a decline in 2008. We expect to assess fewer fees on customers as they continue to adjust to new pricing in fee policies. We're also making planned fee policy adjustments in the first quarter, such as a more generous and targeted fee waiver policy which will reduce fee revenues somewhat. We expect a seasonal decline in purchase volumes and interchange fees. And we expect an increase in introductory rate assets in our card portfolio as we pursue some opportunities we see in superprime revolver segment.

We remain confident that strong revenue margins will help our U.S. card business to weather cyclical economic pressures. We expect the U.S. card managed charge-off rate to be in the mid-6% range in the first half of 2008, consistent with delinquencies throughout the latter half of 2007. Additional we expect the January monthly managed charge-off rate to be a bit higher, around 7%, as the initial aim pact of our move from 25 -- from 30 to 25 day grace period last June completes its move through six months of delinquency buckets to reach charge-offs this month. While we're confident that our U.S. card business is well positioned today, we're also taking action to further strengthen our resiliency and sustain our ability to delivery well above-hurdle financial returns in the face of cyclical credit challenges. We're applying lessons we have learned in prior cyclical downturns. For example,We specific designed product structures and tightly managed credit lines appropriate to each part of the credit risk spectrum, an approach that served us very well in the last downturn in the United States. We're maintaining a prudent and measured approach to underwriting and marketing. In 2008, we expect little to no loan growth in U.S. card, and no change in the mix of our portfolio.

We have ramped up collections capacity and intensity earlier in this cycle. We're taking a more opportunistic and flexible approach to charge-off debt sales as a recovery tool. And we're aggressively pursuing process and efficiency improvements leveraging the new infrastructure platform we implemented successfully in 2007. The choices we made in our U.S. card business over the years have always prioritized profit growth over loan growth with a particular focus on ensuring resilience to credit cycles. Our choices in 2007 and now as we enter 2008 are consistent with this long-standing approach.

Slide six summarizes quarterly results in our auto finance business. Charge-offs and delinquencies in auto finance have followed expected seasonal patterns in 2007, but have continued to worsen from 2006 levels. Because we hold the vast majority of our auto loans on balance sheet, the deterioration in charge-offs and delinquency also results in significant allowance builds. The combination of rising charge-offs and allowance has driven overall 2007 auto finance results that are clearly unacceptable. In the fourth quarter we took decisive action to refocus and reposition the auto business through improved performance through cyclical credit challenges and a return to better profitability and financial returns. Our actions result in a significant growth pullback and a focus on loans with better credit characteristics across the risk spectrum. We have scaled back our dealer prime business by focusing on a much smaller network of dealer with whom we have deeper relationships and better credit and profitability performance.

We focused on originating loans with better credit characteristics by tightening underwriting and steering our originations up market within both the subprime and prime parts of the market. In subprime e stopped originating loans to the riskiest subsegments. We're essentially exiting the riskiest 25% of subprime originations from the third quarter and earlier time periods. In prime, we've almost completely exited the so-called near prime space, which has resulted in dramatic improvement in average FICO scores in our prime originations. Today the average FICO scores of our prime originations are 30 points better than prime originations from the fourth quarter of 2006 and 70 points better than prime originations from the fourth quarter of 2005. We were also able to increase pricing on fourth quarter originations as competitive supply decreased. Thus, while originations continued to grow in October and November, the loans we originated had both better credit profiles and higher pricing. As we continued to pull back in December, originations declined by about 25% from run rates in the first two months of the quarter.

Despite our confidence in the improved credit characteristics, profitability and resilience of the loans we're now originating, and despite the reduction in competitive supply, prudence leads us to scale back our auto business even more given the cyclical credit challenges in 2008. Overall we expect to ramp down origination volumes with origination run rates down significantly by the second quarter of the year. This should result in a decline in auto loan balances in 2008, with further migration to higher quality loans within both prime and subprime. Lower loan balances will have several effects on the optics of our auto business. For example, declining loan balances will reduce the denominator for calculations of metrics like charge-off rates, delinquency rate and operating expense as a percentage of loans. This will put upward pressure on these ratios making them appear more negative than the actual trends in charge-off, delinquency and operating expense dollars.

Declining loan balances may also have meaningful substantive benefit to the net income of our auto business. Because most auto loans are held on balance sheet, lower loan balances means that all else being equal, we won't need to add as much to our allowance for loan losses. While auto finance results in 2007 are unacceptable, we believe that significantly reduced originations, a smaller portfolio with better credit characteristics, improved pricing, and aggressive management of operating expenses should combine to help our auto finance business achieve better financial returns in 2008. We will be monitoring our performance carefully and will be ready to adjust quickly in line with rapidly changing market conditions.

Slide seven summarizes the results of our global finances services business. Credit metrics in Global Financial Services or GFS were up modestly in the fourth quarter. In the domestic GFS businesses, the credit performance and drivers are very similar to the U.S. card businesses that I just discussed. These results are muted by strong credit results in our Canadian credit business as well as stable to modestly improving credit performance in our UK credit card business. Despite the more favorable credit performance outside the U.S., we remain caution in the UK and Canada given the risk the U.S. economic pressures could spread to other parts of the world. In the fourth quarter, GFS continued to deliver solid loan growth. Profits in the quarter were driven by a one-time gain on the sale of our Spanish credit card portfolio as we exited that business.

Slide eight shows quarterly results for our local banking business. Starting with credit, our local banking loan portfolio continues to perform well, though we have seen some charge-off increases from the third quarter. Just as in our national lending businesses, we're coming off of a period of historically low losses, at 28 basis points the level of losses in our local banking portfolio is well within our expectations and continues to represent solid credit performance. The fourth quarter increase resulted mostly from modestly higher losses in our bank consumer real estate portfolio, though they remain very low. Losses were also up in unsecured lending in the bank, primarily due to higher losses on consumer loans in Texas. We have adjusted our lending policy and pricing in Texas, but expect some further increases there as that portfolio seasons. Our commercial portfolio continues to perform very well. We have also looked closely at our exposure to residential real estate and feel quite good about where we are. We are seeing some weakening in construction loans particularly in the New Jersey area, but New Jersey construction loans represent just 1% of our $27 billion commercial book. It should be noted that just under 1/3 of our commercial real estate portfolio is in multifamily housing, which has historically performed exceptionally well through economic downturns.

Finally, it is worth noting that our bank loan portfolio is concentrated in the New York area and in Louisiana and Texas, outside of the real trouble spots in the housing market. Overall local banking delivered solid results and remains on track to complete our integration efforts later in the first quarter. Profits remained solid with the sequential decline driven by fourth quarter provision build, consistent with the credit trends I just discussed. Loans grew modestly and deposits were flat as compared to the prior quarter. Margins were stable. Under the talented and experienced leadership team that is now fully in place, our local banking business continue to deliver solid results and is poised for the final phase of a successful integration. We're taking decisive actions across the company to manage through cyclical credit challenges and slide nine summarizes these actions.

We have pulled back and continue to pull back on our lending programs. We have tightened underwriting across our businesses and we've selectively increased pricing to build more resilience into our loan portfolios. We remain caution on loan growth across our businesses, and we remain low focused on the parts of each of our businesses. In contrast, we expect to grow deposits both in the branches and through our direct to consumer and brokered deposit channels. Some of our most important actions leverage the strength of our balance sheet and the transformation of our company that we completed with our bank acquisitions, which Gary will discuss in a moment. There's no doubt that we, like other banks, will continue to face cyclical credit challenges in 2008. But we're well positioned for the challenges with resilient businesses, experience in managing through prior cyclical downturns, ample liquidity, funding flexibility and a strong capital position. We're not just well positioned, we're actively manage -- managing the company to protect our franchise and deliver shareholder returns over the cycle. Now, I'll turn the call over to Gary, who will pick up on the theme of decisive actions as they relate to our income statement and balance sheet. Gary?

Thanks, Rich. Turning to slide 10, I'll summarize the income statement and balance sheet actions we have taken and are taking to protect the franchise from an economic downturn. On the income statement maintaining our high revenue margins while taking out costs will partially offset the higher levels of provision that result from a weakening economy. On the balance sheet, our diligence in maintaining high levels of liquidity, coupled with enhanced funding flexibility provide us with the wherewithal to support the needs of our business through periods of time of economic weakness. Additionally, our high levels of return on tangible equity provide sufficient capacity to increase our capital base.

Turning to page 11, I'll discuss our revenue and expense trends. Our fourth quarter revenue margin rose 62 basis points versus the prior-year quarter, principally due to the pull back in U.S. card prime, and the pricing actions that Rich discussed a few moments ago. Despite an expected decline in 2008 from our fourth quarter high point, revenue margins should remain at very strong levels going forward. Our efficiency ratio has trended downward in recent years as we have been aggressively streamlining operations and driving costs out of our business. As you can see this improving trend continued in 2007 with the exception of the fourth quarter due to some one-time legal expenses.

We remain on track to deliver the $700 million in cost savings anticipated in the restructuring program we launched just last year, and are accelerating our efforts to drive out cost in this tough economic environment. This is evidenced by the fact that we have already eliminated nearly 2,000 jobs since your June 2007 announcement, not counting those associated with the shutdown of originations at Greenpoint Mortgage, and canceled a substantial number of requisitions for previously planned headcount growth. As a result of actions we have taken and continue to take, we expect 2008 operating expenses to be at least $200 million lower than in 2007. This takes into account the fact that increases in collections and recovery expenses are likely to offset the effects of one-time legal expenses in the fourth quarter of 2007. We continue to target an efficiency ratio in the mid 40% range for 2008. The operating leverage demonstrated here will help to partially offset the higher levels of provision that result from a weakening economy.

Turning to slide 12, provision expense in the fourth quarter was approximately $1.9 billion, which includes $643 million of build in our allowance for reported loan losses. This build raises by 20% our coverage ratio of allowance, as a percent of reported loans, from 2.4% as of the end of the third quarter in '07, up to 2.9% as of the end of the fourth quarter of 2007. The resulting allowance as a percent of 30-day-plus delinquencies is in excess of 100% for all of our unsecured consumer lending businesses, just under 50% for our secured auto business, and almost 300% of the Greenpoint Mortgage originated consumer loans now held for investment in the other category. The allowance is driven by the loss outlook at year end, which reflects fourth quarter credit metrics and a recognition of the weakening trends in the U.S. economy as we entered 2008. At year end our allowance for loan losses was $3 billion, which relates exclusively to loans reported on our balance sheet. This is consistent with an outlook for managed charge-offs including those in our securitized portfolios of approximately $5.9 billion for 2008.

Now moving to slide 13, I'll cover some highlights of our balance sheet strategy. You heard Rich mention several times tonight that our experience in managing through difficult environments in the past provides us confidence that we can do so again in this current market. This is especially true in terms of funding and liquidity, since in the past Capital One had to navigate difficult markets as a smaller, lower-rated company with more modest liquidity and a significantly greater reliance on the capital markets than we have today. One of our core tenants is maintaining the ability to fund our growth and refinancing needs in the wake of major market dislocations. This has lead us to build a substantial supply of committed or readily available liquidity in general in particular for those assets which we typically fund in wholesale markets. At present, we have approximately $29 billion in total liquidity, comprised of $12 billion of cash and highly-rated unincumbered marketable securities, $11 billion of undrawn but committed conduit capacity, the vast majority of which is committed for three-year terms, and more than $6 billion of collateral that we can pledge to the federal home loan bank, using current market advance rates.

Now because other banks are taking significant writedowns on their investment portfolios, I am often asked about ours. The securities portfolio has zero exposure to CDOs or SIVs and includes only $40 million in subprime securities. The value of Capital One's investment portfolio increased nearly $300 million in the second half of 2007, and now has a small unrealized gain as the benefit from lower rates has exceeded the impact of wider spreads, given our modest credit sensitivity. Now beyond holding liquidity for general market conditions, we structure our balance sheet in legal entities to maximize flexibility and to address potential challenges in accessing particular funding markets. In line with this strategy we recently moved Capital One auto finance, previously a wholly owned finance subsidiary of our holding company to become a direct operating subsidiary of our national bank. This move significantly expands the range of funding choices for our auto finance business and improves the holding company's liquidity profile. We fully expect to tap markets throughout 2008.

Still our substantial stockpile of subordinated card securitization notes means that we could limit our issuance to AAA securities for over a year. Even if markets were totally closed, our term conduit capacity would allow us to cover maturities and planned growth without issuing public securities at all into 2009. Now, these are clearly extreme contingencies, which we do not expect to materialize. But even in improving markets, our funding flexibility allows us to achieve favorable results by tapping the most attractive markets and market windows. Finally with our expanding branch footprint and our direct banking channels, we would expect to increase our level of deposit funding over time, especially when wholesale markets are relatively less attractive.

Moving now to slide 14, we ended 2007 with a tangible common equity to tangible managed assets ratio of about 5.8%, within our target range of 5.5% to 6%. Given the current uncertainty in the economic and capital markets environment we expect to manage out TCE ration toward the high end of, or possibly above our target range into 2008. Our business remains strongly capital generative. High margins coupled with slower growth expectations yield significant excess capital even in times of elevated losses. We have modeled a variety of economic scenarios using our direct experience as well as overall industry performance in past recessions. We use these historical stress scenarios to simulate the potential impact of a weakening economy on our earnings and capital forecasts. We model both the percentage increase in consumer charge-offs experienced in past recessions across product lines, as well as the shape and duration of the impacts to charge-offs by product against an even more stressed scenario, one which also includes simultaneous increases in loss rates in our nonconsumer businesses. And normalizing for the unusually low level of consumer charge-offs at which we began the current cycle, we expect our business to remain solidly profitable. Indeed, our portfolio would continue to generate sufficient excess capitol to support our target TCE ratio while allowing us to return an increased level of capital to shareholders.

We have completed our $3 billion stock buyback program by purchasing $772 million in stock in the fourth quarter. We continue to expect our Board of Directors to declare a 2008 dividend of approximately 25% of expected 2008 earnings beginning with the dividend payable in February 2008. Given the increase in our TCE target for 2008, we will likely be foregoing stock buybacks for the next few quarters as we further build our capital ratio through the internal generation of capital. Whether we resume buybacks in the second half of 2008 or into 2009 will depend substantially on how well or how poorly for that matter the U.S. economy performs. As I've said before our top priority uses of capital generation are to support organic growth and to pay dividends, stock buybacks are a secondary use of excess capital and will be used to keep our capital base at a efficient level.

Turning to slide 15, let me end by summarizing our outlook for 2008. Given the significant uncertainty in the U.S. economy, we are not providing EPS guidance for 2008. Instead we will continue to provide guidance on key operating metrics, and will discuss our ongoing view of credit risks as the future unfolds. We believe this represents a more thoughtful way to discuss our business prospects with our investors. Specifically in 2008, we expect balance sheet growth in the low-single digits. While we remain cautious on loan growth, we are bullish on deposit growth. Revenue growth should be in the low-single digits, as the positive margin trends in U.S. card moderates somewhat in 2008. And our efficiency ratio should be in the mid40%, with overall operating expenses coming in at least $200 million below their 2007 level.

From a credit standpoint, we expect continued pressure as the economy continues to weaken. And as I mentioned a moment ago, we expect to hold a bit more capital this year, while continuing our pattern of returning excess capital to shareholders. In closing, I would like to remind you of my presentation at our annual investor conference just a few months ago, when I discussed our expected returns over the cycle. While returns in 2008 will likely be pressured by credit headwinds as the economy weakens, once the economy begins to stabilize, we would expect the rate of growth in provision expense to mirror that of loans. At that point, rising revenue, operating leverage, and ongoing capital via dividends and buybacks would deliver mid-to-high teens total return for shareholders assuming no PE multiple expansion. This in a nutshell is the longer-term value proposition we see for Capital One shareholders. With that we'll open it up for Q&A. Jeff?

Thank you, Gary. We'll now start our Q&A session. As a courtesy to other investors and analysts who may wish to ask a question, please limit yourself to one question plus a single follow-up question. If you have any follow-ups after the Q&A session, the investor relations staff will be available after the call. Cynthia, please start the Q&A session.

Thank you, sir. The question and answer session will be conducted electronically. (OPERATOR INSTRUCTIONS) We will take our first question from Bruce Harting with Lehman Brothers. Please go ahead.

Is the strategy on the dividend to just to inform us of that when you actually have your first quarterly numbers. And can you talk about the various impacts of the [Fed-Es] and I imagine the North Fork brand and balance sheet is probably the most sensitive and most likely to experience the most margin expansion and if you can quantify that, Gary, or some of the moving parts, I'd appreciate. Thanks.

Sure, Bruce. I will be glad to take up both. The timing of the dividend announcement will be as normal for the dividend to be paid in February, as soon as our board has met and made that decision, it will be communicated to you. I do understand that because the board has indicated that their intent is to start the '08 dividend level at around 25% of estimated '08 earnings, pretty tempting to multiply that number by four to come up with guidance, which of course, Rich and I aren't giving you on this call, and the reason of course is because of the degree of uncertainty in this economy. So I'm sure our Board will be looking at the operating metrics I've already shared with you. They will be looking at the uncertainties in the economy, and do recall that the board is not committed to a fixed payout ratio ex-post, but rather to use [ex-anti] some sort of sense of '08 outcomes as a way of starting themselves on a dollar level of dividends that is consistent of our capital requirements and our committment to deliver shareholder value. But I would simply suggest in advance of the Board's decision that you take a look at their dividend decoration as treat that as a commit rather than as a forecast.

With respect to the action by the Fed, Bruce, yesterday, and what might come forward, looking at our balance sheet as a whole, we are mildly liability sensitive, perhaps not as much as some, but we are liability sensitive, so lower rates will be mildly beneficial to us. You won't see those results necessarily in the banking segment. You will see it at the top of the house, because of the way in which we centralized the management of our net interest margin. But we should get some mild benefit at least, depending on the amount of easing the Fed ultimately does. And then, of course, to the extent lower interest rates would help to avert or perhaps soften the impact of possible recession, we would certainly expect the benefit there from lower charge-offs. So whether we get the bigger benefit from our balance sheet or from the potentially positive impact on charge-offs, kind of early to say, but certainly a welcome move as far as we're concerned.

Next question, please.

We will take our next question from Bob Napoli with Piper Jaffray. Please go ahead.

Thank you. First question is on the credit trends at the end of the quarter, and then going in to -- we're getting near the end of January. I mean there was a spike -- I think got worse accelerating pace in December. What are you seeing -- are you seeing that spike continue into January in each of your businesses? Are you seeing moderation? Are you seeing it differently? And what do you think caused that sudden weakness at the end of the quarter?

Bob, it's Gary, I'll start with what we saw. Perhaps Rich will want to talk a little bit about what we're seeing now. Again what we saw in December was quite consistent with our expectations, things that we had signaled because of elevated delinquencies in flow rates through a variety of reasons through the second half. But we certainly wanted to see those results come through in December before we were able to close the books and share the results that we did with you on January 10th. So nothing unexpected in those results. In fact, they were quite consistent with our expectations.

And the month of January -- the trends in January versus December?

Bob, we don't have a -- you may be surprised to hear this, but the way it works in this business, we don't have a great view mid-month on the credit trends. We really -- we, like you, really wait until the end of the month and look at the numbers, so -- but speaking of all our overall card business, when we are talking to charge-offs going to around 7% in January, certainly, that is, so to speak, baking in the oven in a sense, and that's pretty much charge-off math. And we're confident also of the sort of decline off of that peak for the rest of the first half of the year.

Next question, please?

We'll take our next question from Steven Wharton with JPMorgan. Please go ahead.

Hi, Rich, and Gary. I just was trying to get a better sense of where we are from a card charge-off perspective in relation to -- kind of your prior history, and the economic outlook. I mean, we haven't really seen negative job growth yet, and yet, I think maybe in the first quarter 2003, you had card charge-offs of around [$770 million]. I know you had a lot more denominator growth back then, but you also had a lot more subprime and I think that was also consistent with the diabolical spike, with those that remember that verbiage. So I just wondered what you thought going forward from here. In job growth does turn decisively negative, what is the upper range of potential U.S. card losses?

Steve, let me make a comment about -- about unemployment and credit card credit, for example. Because we have talked about the reasonably strong relationships that exist that we have seen in the prior two recessions with expect to this. The -- if you look back at the last two recessions, there was a key difference, in that, the early -- the 2001 recession was sort of an event-based thing that then lead to sort of a rapid set of changes, whereas the '91 recession was more probably similar to the one we have now, in the sense there's a rolling sense of bad developments out there. What we have found, particularly when we have looked back at the '90/'91 recession is interestingly, the credit card metrics moved six months before the -- a lot of the government metrics and particularly the unemployment metric. So when we look back and track the hump from a credit card delinquencies, and then the hump from unemployment, the credit card preceded it by about six months, and also preceded it up, and preceded it down.

Now first of all, analyzing one or two humps on a camel is a little bit risky in terms of making any definitive statements, but I kind of felt as we were going through that recession that I remember saying that the government should be looking more at credit card metrics as one of the indicators that belatedly they come upon. I do believe that gut feel, Steve, that some of the worsening that maybe hasn't shown up in some of the unemployment metrics is already being reflected in the credit card performance that we see now. We also have some unique things related to mix and things like that that are also in our numbers. That said, of course, it would be our expectation that if unemployment worsens significantly, that that would still have a -- from here, negative effect on our credit card metrics.

Next question, please?

And we'll take our next question from Meredith Whitney from Oppenheimer. Please go ahead.

Good afternoon. I just have one quick question. For 2008 do you expect to be profitable in your auto division?

Yes, Meredith, we are doing everything we can to make sure that we achieve the profitability we have been looking for in that business by continuing to reduce our cost, as Rich said, we're going to be focused on the more profitable parts of that business, and pulling back over the course of the year in such a way that we can return to profitability, that's certainly our goal.

To return to profitability by the end -- I'm just -- for modeling purposes -- beginning or end --

For 2008.

That's as far as you will go in terms of --

Well, again, with the uncertainty in the credit and how these things play through in the seasonality of this business, I think it's easier to look at it for the whole year, Meredith.

Meredith, the other thing I want to say that's striking is we live both the credit card business and the auto business. Because auto is essentially all on balance sheet, the impact of changes in the credit outlook are much more dramatic in the vertical P&L of the auto business than they are in the credit card business, because of course we have 70% of our credit card assets securitized and essentialIy off balance sheet.

Next question, please?

And we'll take our next question from Rick Shane with Jefferies & Company. Please go ahead.

Thanks, guys. When you look at the sort of outlook for credit, you are very specific for where you see U.S. card losses in the first half of the year, do you see that as the peak at this point? What is your view? Should we expect in the back half of the year it is going to continue to rise, or -- and if you can sort of lay out, sort of what the case is for whatever you think the outlook would be?

Rick, first of all, we have specifically not given a credit forecast for the year, and when you have watch our experience in giving you some guidance associated with credit, you have seen that we ourselves have been challenged to stay up with some of the changes in the economy. Let me comment, though, just as a general comment. The -- there are seasonality benefits that play out over the course of the first half of the year that then reverse themselves in the second half of the year. So in a typical year, you will see actually higher charge-offs in the second half of the year than in the first half of the year. So -- but I -- we talked a lot about how can we best help you all think through the future credit environment. We don't want to just say, well, gosh, who knows how the economy is going to go, and so we don't want to be in the forecasting business. What we have done is given you our view through the window that is much more reliable for us, which is the first -- is the six months that are essentially cooking in the oven of our credit card business. It doesn't mean that we have be absolutely precise with that, but generally we can be fairly close on that.

Outside of that what is cooking, of course, are bankruptcies and recoveries that are not actually part of that process. But generally we have pretty good reliability in the window for the first six months. Beyond that it really is going to be driven by the economy. And I think your views on that are probably as good as our views on that.

And, Rich, that's a very fair answer, and again, I realize probably that that's exactly why you gave first half guidance. In a lot of ways I think we're struggling with the issue that Steve brought up, which is simply we are seeing this develop relatively rapidly, and by your own admission in ways that I don't think you certainly expected three or four months ago without a rise in unemployment. I mean, what is your intuition here? I mean, I can't imagine that you think that this will decouple from unemployment in the back half of the year?

My intuition -- I certainly believe that some of what we're seeing is early read on economy worsening that may be preceding metrics. I really do believe that that is going on. I do think, though, we're also seeing a really consumer-lead worsening, which in some ways is certainly very different than the kind of sequential dynamics of what happened in the '91 recession. So, it -- it's a funny thing here. We worry all the time, every day we obsess how bad could it get? And the real answer, nobody knows how bad this environment could get. And nobody -- we can't tell you how high our charge-offs will peak. What really does give me confidence is when we stress it, we feel a tremendous amount of resilience, and in many ways what is really happening here is we get a chance to see the impact of choices we have made for, really, 20 years, which is essentially what businesses do we want to be in? And what kind of structure do we want to have, essentially, of our balance sheet?

And what I like -- I tell you what my intuition says, is that sort of the unsecured paradox, I think credit cards are in a particularly good position. It's a bad place to be in general in consumer lending right now. But credit cards -- the paradox of unsecured credit cards is they were underwritten solely and entirely on the basis of a customer's willingness to repay, and have a lot of flexibility in things like dynamic management of the portfolio. As we watch our fixed secured loans, and watch some of the collateral change in value, and the much thinner margins and the absolutely nothing situation that you can do about them, I am again reminded of why we are attracted to credit cards in the first place. I think this is by a considerably margin the best place to be in a challenged consumer space right now. And then I want to look across on the bank side. In addition to buying two banks that I think had very solid underwriting in their tradition, we also were fortunate that we got a good mix geographically relative to where we are right now. So, essentially we all brace for bad times just like you do, but I think deep down within there's a lot of confidence about the resilience that we have.

Next question, please?

And we'll take our next question from Chris Brendler with Stifel Nicolaus. Please go ahead.

Hi, thanks, good evening. I guess on the growth outlook, you're flat or maybe shrinking a little bit in card, you're definitely shrinking in auto. -- bank was growing, so that means that the [largest] growth's going to be coming from GFS. How comfortable are you with the credit trends you are seeing in the GFS business, particularly the domestic installment loans business and small business?

Well, this -- the -- some of our GFS businesses are benefited by macro trends where the underlying business itself is growing nicely, so I'll take an example like small business card. I mean, just left to its own devices, it inherently has a much higher growth rate for the very same credit choices that we make, relative to the much more mature and saturated regular old consumer card. So I think what is empowering GFS is inherent growth dynamics. And then we overlay on that in a sense the same conservatism. So I would say overall with respect to small business card, we are pretty much doing similar underwriting choices that we're doing on the consumer card business. It's just that you can still feel the thrust of just an underlying growth of the business itself. Installment loans. Our installment loan business has been super prime business, so it's -- the good news is, it has got very high credit quality folks, the bad news is it's a relatively thin margin business. So that one we're watching very carefully and are going to be cautious on that.

We have great success going on in Canada. Canada is the -- whole country right now is doing very well. And even though as we mentioned earlier, we worry about things spreading internationally, we certainly feel we're in a strong position to enjoy some growth in Canada. But, overall, the real message you should take away is, we are airing on the side of caution, so on the one hand, while we are confident of our resilience, I'll give you a great example is our subprime card business. That continues to perform nicely, things are coming in consistent with projections as we look at the vintages. But just out of an abundance of caution right now, we just do less than we otherwise would do, and I think that's the prudent thing to do here.

Okay. Just a quick follow-up, does that mean you are not seeing the same level of deterioration in the installment loans business? And also can you give us a little more color -- separate question, just a little more color on the shutdown or exiting of the near prime auto business? And this was an acquisition that was made relatively recently, and I'm surprised to see you just give up on it, if that's the case -- what you're doing. And what is the dynamics there that is causing that decision to exit the near prime auto business?

A comment on installment loans. I think installment loans just as a general statement is seeing the kind of general trends that we are generally seeing in unsecured consumer credit, so -- and we're taking similar measures of caution there. In the near prime auto space, this is a -- I mean, look -- auto is a tough business, anywhere we play in the auto space, it is a tough business. We have quite a few scars on our back from some of the challenges in the auto business, as you well know. The -- I think one of the tough things in auto is to try -- in a thin-margin business, at a time when the economy is so challenged, it's really hard to do repositionings, and changes of share, and -- in the business, so the subprime business, we feel very confident about that, and that feels good. We've got a lot of heritage.

You remember our second stage of evolution in the auto business was in superprime, and then the last part was to kind of fill in between and go into the middle and lower parts of prime. That has been a challenging transition, and at a time when the economy is having so much challenge, and our results are so challenged, we just think the really wise thing to do at this point is to, in some sense, retreat to the high ground, if you will. The very solid performing subprime business, and the low risk, and empirically high-performing parts of our very top end of card, and the other part of this whole thing -- I mean, of auto, excuse me. The other striking thing is we have analyzed dealer relationships. There is a big difference in the profitability between our established long-time and deep dealer relationships, as opposed to the occasional flow that we get from a lot of others. And so part of this in a sense move to high ground is to move to high ground in terms of the credit spectrum, to move to high ground in terms of the dealers that really over -- with a lot of deep data on this thing, we really understand we're not getting adversely selected. And off of that high ground, I think that we're going to be in the best position to weather the current economic storm and still be positioned to have a strong business on the other side of that.

Next question, please?

And we'll take our next question from Scott Valentin with FBR Capital Markets. Please go ahead.

Good evening, thanks for taking my question. With regards to the ABS business, maybe if you could talk a little bit about the depth of liquidity you're seeing in credit card and auto ABS, and also given the more stable deposit funding you have now, maybe discuss the comparison between the return equity you can generate from keeping assets on the balance sheet versus securitizing?

Sure, Scott. Just in terms of ABS, obviously we have to look at both credit card and auto. The market for credit card ABS obviously has been stronger and more resilient in terms of the level of activity and the depth of that market than the auto. Obviously spreads have widened out pretty much across the board. But given the margins in that business, it certainly doesn't jeopardize the economics of that business. We -- we're in the market considerably in the fourth quarter doing things all the way from AAA down to BBB, well over $1 billion, and we did two auto transactions in the fourth quarter, one prime, and one nonprime. I think that market is certainly more tentative now, although we have seen some of our competitors come to market there. We are currently, certainly in dialogue with investors. We have not chosen to bring an issue to market yet in the first couple of weeks of the year. We wanted to see how things moved around a little bit, get things settled out. We're certainly seeing some inverse inquiries. And again we're intent on using the flexibility we have built to make sure we access the market on the best terms at the right time. And I expect you will see us pretty active on the card side over the course of the year.

In terms of auto, again with the movement of the auto finance business into our bank, we certainly have a choice as to how to fund it, whether with deposits or auto ABS. Remember that both are on balance sheet, regardless of whether we securitize or not, spreads are certainly more attractive if we fund it with deposits right now. And so you are going to see -- certainly a better return characteristic in the current market if we fund it with deposits, and again, there's no change in the capital we allocate to the business and it's on balance sheet regardless. So again, we're quite confident that these markets will ultimately sort themselves out, and we are certainly pleased that we have bought ourselves the time to be sure we don't push them any faster than we think they are ready to.

Next question, please.

And we'll take our next question from David Hochstim with Bear Stearns. Please go ahead.

Thanks. Follow up to Chris's question about auto. Is there anything else you have learned about problem credits besides the adverse selection from the dealers? Is there some common characteristics of the borrowers that you ended up with, or the kinds of vehicles or the geography? And then I had a follow-up.

David, I -- in the -- in near -- basically, in prime and near prime, so keeping aside the very top part and subprime. I think generally, our challenge was adverse selection, and the challenges of competing and building up long enough credit histories, and also transitioning judgmental models that clearly were not expensable, to -- into the classic Capital One risk base model. That was particularly in sort of near prime that was a challenge. If I were to comment in general, there has been some industry risk expansion in the auto space, and one of the worries that we have always had -- one of the bad things that sort of can happen to -- one of the bad things to happen is a overly good credit environment, such as we had in 2006. And in some sense, all of the industries are paying the consequences of, in a sense some overconfidence in what we saw, and I think we mentioned several times over the last -- course of the last year, there has been some risk expansion pretty much across the boards in the auto space, and it becomes a little bit -- the table stakes for playing.

It's hard to say, well, if people structure products that way, we weren't offer them that way. And then part of the problem is that in a sense, nobody comes. Now that doesn't mean you just go out and does what everybody else does. But the good thing that is happening now is that practices and pricing is becoming -- and product structures are becoming more sensible, and this is basically positioning this industry to be healthy on the other side of this. The other big insight, David, in the auto space is the housing market correction markets, which is basically 25% of the country, and 25% of our portfolio has certainly taken it on the chin the most.

Okay. And then in cards, could you talk about any difference you are seeing in terms of behavior in spending or credit between the customers that have rewards products and the customers that don't? And how much of the card base by the end of the fourth quarter was in rewards products?

David, I don't have an answer to your question specifically about rewards versus nonrewards customers.

Next question, please?

And we'll take our next question from Brad Ball with Citi. Please go ahead.

Thanks. I'm wondering if you could comment on your deposit growth outlook. Where do you expect those deposits to come from. Are you currently employing a campaign of higher pricing in certain markets? Will you be doing more wholesale deposit growth? Will it come through the branches, etc.? Also a follow-up on Steve's original question on U.S. card credit. If you look at the net charge-offs in U.S. cards right after the '01, '02 recession, I think the peak was around 7.7%, but that was a time when your mix was much higher subprime. I think you had 39% subprime in the middle of 2002. So I just wonder if the different mix that you have today would lead you to expect the net charge-off peak to be below that 7.7% range, or are there other factors consider? Thanks.

Brad, let me take the first question. And again, we are bullish on deposits. Although, I think it is important to remind you this is the quarter in which we will be completing the important conversion of our deposit system at the end of this quarter. And certainly we have been so focused on making sure we get a good sure-footed integration, and making sure that our customers see a seamless integration, that we have been sort of calibrating the timing of our rollout of some of our brand work as well as some of our product policies and strategies to make sure we are able to deliver flawlessly. So I think you'll see a little more of that after the first quarter.

Certainly, I would also recognize that with the very rapid change in market conditions with the Fed easing very dramatically, we have had some products rolling out, and some of our competitors have as well. And I think this is the time that people are watching each other to see whether or not we are going to see the sort of continued normalization of the LIBOR market and what that's going to mean for demand for deposits. Whether banks will use this opportunity as we would intend to try to move down with the Fed, and get some better execution in terms of deposits. We have got a couple of dozen branches being build this year. We are continuing to have good progress in our direct bank, as well as branches. So I think that's something we believe in the current environment is going to be beneficial to us. It's a little early to put numbers on it, but as soon as the integration is complete, I think you can expect our bank team will be going full [bore] in what should be a pretty good environment to try to take advantage across all of the channels both in the branches and direct.

Okay. And let me comment about the question of, if you look back, to just kind of summarize it, if we look back to the '01/'02 recession, our credit card charge-offs were in a zip code not too different from where we're saying that they are going to be in January, for example. And so the question being, well, but didn't you have more subprime there? And shouldn't that have been a lot higher back then? The big difference, if you look at those numbers, is the rate of growth of our assets. So essentially, there is quite -- the peak was a lot higher in '02 -- excuse me -- '03 -- the '02/'03 time period than now if you adjust for growth. Because we're basically in an environment of essentially shrinking our portfolio today, and in an environment of very rapid growth back then.

David Hochstim, you asked a question when I said, well, I'm not really sure on the transactors, versus kind of -- I was thinking transactors versus revolvers. Let me actually kind of grab your question and make a point that I think is an interesting one. As we look across our portfolio at things like super prime and sub prime in different parts of the portfolio and see how they are moving right now and the trends that we see over the course of the year, interestingly, in terms of percentage worsening it is really similar. And of course, superprime comes off of a lower base than subprime, for example, but that is definitely what we see and what we expect over the course of the coming year.

Next question, please?

And we will take our final question from Bob Hughes with KBW. Please go ahead.

Yes, thanks for taking my question. Two questions. The first one, previously, I believe your guidance for '08 laid out late summer or early fall was for managed revenue growth to maybe slightly exceed managed loan growth. I'm curious, what has changed between then and now?

I think it's pretty simple explanation. Bob, you saw a significant increase in the revenue margin through the course of 2007. So I think that was a faster rate of revenue growth than we might have anticipated. So we're just starting from a higher base, and as Rich indicated, there are a couple of things that would cause the fourth quarter of '07 to be kind of the peak, and we'll come down a bit, although still at very high levels. When you compare year to year, we thought more prudent not to assume another repeat of the third and fourth quarter of 2007, in terms of the rate of growth.

Okay. And is that also in part driven by increased fee waivers, etc.? And what is driving the decision to do that?

There is -- there are a couple parts to this, most important is a somewhat mechanical one, Bob, which is that included in revenue is fees, and as the estimate of losses goes up, and certainly we have a higher loss outlook today than we did back in September, that is going to affect the expected collectibility of those fees, and those changes will in fact show up as a reduction in revenue. So again, there is a connection between credit and revenue that is very important for us to anticipate. And again, I think keeping revenue growth in line with deposit growth is certainly our objective. We thought we might have a slightly higher revenue growth at the time, but they are still pretty much in line on an average basis over the course of the next year.

Bob, let me just also -- if I could just pile on here for a second. You notice this sort of revenue changes that we have made in our card business have been a rolling set of changes that really started in the second quarter. There were some in the third quarter. There was some in the fourth quarter, and there are some effects in the first quarter as well. It is all part of an overall plan, but the timing of things have been different. Part of what is going on in our repricing is a bit of a restructuring of how and where revenue -- we get revenues from our customers. One of the things that we used to find when we did customer research is people felt we had annoyingly the most rigid fee waiver policies out there. And sometimes people care as much about, by, gosh, I didn't get that waived as much as sort of overall pricing and other things.

So what we have done, and it just hasn't all happened with the same timing, is done some restructuring of where revenue increased and where relief is provided, both at what stage in the process relief is provided, and also to which customers relief is provided, because there's a lot of sort of targeted revenue benefits that we also have through this plan that we're putting in place. The reason for the last couple of quarters, I have been kind of escalating my cautions to investors, don't get too carried away with the revenue benefits, because an integrated plan was being rolled out over the course of actually four quarters.

Okay. And the follow-up, Rich, I know there has been a lot of discussion about credit trends, particularly in auto, and specifically within the high HPA markets. Can you talk a little bit about how the credit card experience looks in those markets? Is it similar or is it somehow differentiated?

The credit card experience is very similar to what we're seeing in auto. So the only difference that I would say about what we observe in credit cards versus elsewhere is, there's certain things that are happening in credit card that are related to choices that we have made. Those things almost definitionally -- things like modest mix change and some of the repricing effects, those things kind of definitionally don't have a geographical component to it. But when we isolate for those, this is very much across all of our consumer lending businesses, we see this sort of, if you will, the kind of HPA effect that is commonly seen. But I do want to say also that this is not an issue where our customers with mortgages are having unique problems, because actually we find renters and home owners tend to be following very similar patterns. It's just that renters and home owners, in all of our consumer lending businesses, renters and home owners together in the challenged housing price markets are degrading in parallel and together.

Okay. Cynthia, since there are no more questions, we'll conclude our question-and-answer session. I would like to thank all of you for joining us on this conference call today. And thank you for your interest in Capital One. The investor relations staff will be here this evening to answer any more questions you may have. Have a good evening.

Ladies and gentlemen, this will include today's Capital One fourth quarter 2007 earnings call. We thank you for your participation, and you may disconnect at this time.