Capital One Financial Corp (COF) 2009 Q1 法說會逐字稿

Good day, everyone, and welcome to the Capital One first quarter 2009 earnings conference call. All lines have been placed on mute to provides. After the speakers' remarks, there will be a question-and-answer period. (Operator Instructions). Thank you.

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, Jamie. Welcome everyone to Capital One's first quarter 2009 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 Web site at 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 2009 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 the press release, please go to Capital One's Web site, 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 factors section in our annual and quarterly reports accessible at the Capital One Web site and filed with the SEC.

Now I will turn the call over to Mr. Fairbank. Rich?

Thank you, Jeff, and good evening, everyone. I'll begin on slide three. Capital One posted a net loss from operations of $87 million or a negative $0.39 per share. Total company net loss for the quarter was $112 million or negative $0.45 per share. Continuing economic deterioration through the first quarter was the biggest driver of our quarterly results. While first quarter and near term results remain under significant pressure at this point in the cycle, we continue to make tough decisions and take the actions that we believe will put our company in the best possible position to weather the storm and create shareholder value over the cycle. The results we are reporting today reflect the decisions and actions we took in the first quarter.

Charge-offs increased across our lending businesses with the exception of our auto finance business. I'll discuss credit performance in just a moment.

In the first quarter we took several actions to further fortify the company and build future earnings power. For example we continued to increase our capacity to absorb future credit losses by adding $124 million to our allowance for loan losses increasing our coverage ratio to 4.8%. We made choices to shift the mix of the earnings assets and liabilities on our balance sheet. We made these choices to further strengthen our position to weather the storm and to create sources of long-term value but these choices also impacted revenues, margins and balance sheet metrics in the quarter. We added $14 billion in deposits with our acquisition of Chevy Chase Bank. With strong and growing access to local banking deposits we were able to increase our funding from core deposits and allow higher cost whole deposits to run off as this matured in the quarter. The combination of adding Chevy Chase deposits and optimizing across our deposit channels resulted in net deposit growth of about $12 billion to $121 billion at the end of the quarter.

We saw unprecedented opportunities to generate revenues by purchasing investment securities at attractive levels so we grew our portfolio of high quality investment securities to say $36 billion. And we originated billions of dollars in new loans while maintaining disciplined underwriting standards. Loan originations were more than offset by falling purchase volumes in loan demand, by the run off of loans related to businesses we repositioned or exited several quarters ago, as well as by normal attrition and, of course, by rising charge-offs. Our loan to deposit ratio has improved from 1.7 to 1.0 a year ago, to 1.2 to 1.0 at the end of the first quarter.

First quarter pre-provision, pre-tax earning were relatively stable compared to the fourth quarter of 2008. Revenues declined due to a combination of factors related to the weakening economy and choices we made about the mix of our loans and earning assets. Revenue declines were mostly offset by improvements in non-interest expense that resulted primarily from our actions to improve operating efficiency and because we saw limited opportunities for new marketing in the current environment. Against the backdrop of economic worsening and volatile markets, our strong and transparent balance sheet remains a source of strength in these turbulent times. Despite higher charge-offs, further additions to our allowance and the completion of our acquisition of Chevy Chase Bank, our tangible common equity to total managed assets, or TCE ratio, at the end of the first quarter was 4.8%, an improvement of 20 basis points from its pro forma level of 4.6% at the end of last year.

But the strength of our balance sheet is not just about weathering the storm. We also expect our balance sheet to generate shareholder value as we emerge from the storm. Our balance sheet can contribute to higher margins over time as capital markets funding and wholesale deposits mature and we replace them with lower cost local banking deposits. And when the cycle eventually turns and opportunities for profitable and resilient loan growth emerge we will be able to grow loans without the need to raise additional capital by rotating our earning assets from investment securities back into new loan growth.

I'll discuss credit performance and the profitability of our businesses on slide four. Economic deterioration continued at a rapid pace during the first quarter driving increasing delinquency and charge-off rates across most of our lending businesses. US card charge-off rate increased to 8.4% for the first quarter, above the 8.1% charge-off rate expectation we articulated a quarter ago. Expected seasonal increases in bankruptcies and declining loan balances resulted in higher charge-off rates compared to the fourth quarter of 2008. The increase in charge-off rates beyond our expectations resulted from several factors related to the pace of economic deterioration in the quarter. Bankruptcies were higher than expected, increasing charge-offs directly without impacting delinquency rates. Recoveries on already charged off debt were lower than expected. We also observed an acceleration of later stage delinquency balances slowing to charge-offs in the quarter.

For context, recall that when we articulated our expectations last January the unemployment rate was 7.2% and we assumed it would increase to about 8.7% by the end of 2009. The unemployment rate has already deteriorated to do 8.5% and is expected to move beyond 8.7% well before year end. Even though our US card charge-off rate was higher than the expectation we had last quarter, delinquencies in charge-offs were a bit better than we would have expected given the actual economic worsening we've seen in the quarter. Our US card business posted just over $2 million in profits in the first quarter. Profits of about $50 million in our revolving card businesses were mostly offset by a $48 million net loss in the installment loan businesses.

As we discussed last quarter our US card business includes about $11 billion in installment loans. Installment loan performance has been significantly worse than that of our credit card businesses. We essentially stopped originating installment loans late last year so the portfolio will continue to shrink as the outstanding loans amortize. We expect the drag on US card profits to continue as the installment loans continue to run off. We expect further increases in US card charge-off rates through 2009 as the economy continues to weaken. It is likely that our US card charge-off rate will increase at a faster pace than the broader economy as a result of the denominator effect and our implementation of OCC minimum payment requirements.

While many credit card issuers will see declining loan balances in the current environment we expect that our denominator will decline even more than the industry as a result of installment loans running off. While installment loans account for just 15% of US card loan balances, we expect that run off of installment loans will drive about a third of the expected denominator effect. We expect the total denominator effect to increase second quarter charge-off rate by about 50 basis points.

As we've discussed in prior quarters we are the only major credit card issuer implementing OCC minimum payment policies now as we were not regulated by the OCC when the policies were put in place several years ago in a wholly different credit environment. We've been analyzing test sell data to estimate the expected impact of implementing OCC minimum payment policies. Based on three months of additional data and test sale results, the size of expected OCC minimum payment impacts has not changed although the expected timing has shifted a bit. We previously estimated that implementing OCC minimum payment policies could add ten basis points to the US card charge-off rate in the first quarter, and 50 basis points to the charge-off rate in subsequent quarters in 2009 before curing somewhat in 2010.

We now expect the impact to be around 20 basis of charge-off increase in the second quarter, 80 basis points in the third quarter and 50 basis points in the fourth quarter. We continue to expect some curing of the OCC minimum payment impact in 2010. Taken together we expect denominator and OCC minimum payment effects will result in about 70 basis points of higher US card charge-offs in the second quarter before any charge-off rate increases from continuing economic deterioration. We expect monthly US card charge-off rates to cross 10% in the next couple of months.

Credit trends in the international businesses reflect increasing economic deterioration in the UK and Canada. While the Canadian portfolio had been relatively stable for several quarters, the Canadian economy and credit trends began to show signs of weakness in the first quarter. We've been retrenching the UK business for some time now, and we've been cautious in Canada in anticipation of the credit worsening that began in the first quarter. As a result, international loan volumes have been declining. The international businesses posted net income of $2 million in the first quarter.

Auto finance credit trends improved in the first quarter driven by several factors. Charge-offs in delinquencies exhibited expected seasonal improvements in the first quarter. Used car prices and recovery values have been improving for several months resulting in lower charge-off severity. Our investment in auto finance collections and recovery operations are paying off. And our 2008 origination vintages continue to outperform our expectations. We've been able originate loans with lower LTVs to customers with higher FICO scores. At the same time we've been able to improve pricing and margins in the current competitive environment. As a result we expect that the 2008 originations will yield adequate risk adjusted returns through cycle and their performance to date is tracking at or above our expectations.

We realized improvements in charge-off rates even though the denominator declined by more than $800 million as a result of our actions to retrench and reposition the auto business in late 2007. Capital One Auto Finance delivered net income of $71 million in the first quarter. Although the first quarter auto finance results are encouraging we remain cautious. By definition, the seasonal elements of strong first quarter credit performance will not persist so do not expect this level of profitability to be our run rate for the remainder of 2009. It is uncertain how long we will continue to benefit from rising used vehicle prices and recovery. And the continued strength of the economy in the auto industry creates increasing uncertainty about the near term results of the auto business.

In our local banking business, non-performing loans as a percentage of managed loans increased while charge-off rates decreased in the quarter. The increase in non-performing loan percentages resulted from continuing economic stress in the metro New York City market, and to a lesser degree in Louisiana and Texas. In our commercial portfolio the increase in non-performing loans was concentrated in for sale residential construction loans. Construction lending comprises only $2.4 billion and less than half of that is for sale residential construction. The rest of the commercial portfolio continues to perform relatively well, and the consumer portfolio, continuing economic pressures on our residential mortgages drove the increase in non-performing loans. The increase in non-performing mortgage loans was exacerbated by our decision to suspend foreclosure action in anticipation of the announcement of the Administration's mortgage modification program.

The improvement in first quarter local banking charge-off rate was driven by the fact that we took several sizeable charge-offs related to specific loans in our construction portfolio in the fourth quarter of 2008, as well as the reduction in residential mortgage for closures I just mentioned. The local banking business posted a net loss of $36 million in the quarter. Provision expense remained elevated in the current economic environment and local banking revenues declined as a result of falling interest rates. While falling interest rates benefit loan margins they hurt deposit margins because we cannot reprice demand deposits that already pay no interest. These interest rate impacts pressure revenues in our local banking business because it has nearly twice as many deposits as loans.

Before moving on to loan deposit volumes I'll update our economic outlook. Unemployment and home prices have been and continue to be the economic variables with the greatest impact on our credit results. We now expect unemployment rate to increase to around 9.6% by the end of 2009. Our prior assumption for home prices was for the Case-Shiller 20 city index to fall by around 37% peak to trough. We now expect a modestly worse peak to trough decline of around 39%. Based on economic deterioration in the first quarter and recalibrated economic assumptions, we believe that managed charge-off dollars in 2009 will be higher than the $8.6 billion outlook for 2009 that we articulated last quarter. We've chosen not to specifically update our outlook for managed charge-offs given significant uncertainty in the economy.

I'll discuss loan and deposit volumes on slide five. While we originated several billion dollars of new loans and added $9.5 billion of Chevy Chase loans in the first quarter, ending loan balances grew by only $3.4 billion. Several factors had a negative impact on ending loan balances in the first quarter. These factors include falling purchase volumes and loan demands, the run off of loans related to the businesses we repositioned or exited several quarters ago, normal attrition and rising charge-offs. Together these factors more than offset loan originations in the first quarter before the addition of Chevy Chase loans.

Consumers and businesses are behaving defensively and rationally in the current economic environment. For example credit card purchase volumes fell by 14% from the fourth quarter of 2008 and 12% from the first quarter of 2008. Since credit card loan balances typically begin as purchases, defensive spending behavior effectively reduces credit card loan demand. Demand from creditworthy borrowers for other types of consumer and commercial loans was also weak in the first quarter.

In 2009 we expect continuing weakness in loan demand from creditworthy customers as the consumer behaviors we observed in the first quarter continue in the current economic environment. We also expect the other factors that offset first quarter originations will continue, driving a decline in managed loans for the full year. We expect that the decline in earnings assets will be more modest resulting in a mix shift from loans to high quality investment securities backed by mortgage and consumer loans.

Total deposits grew to $121 billion including the addition of $14 billion in Chevy Chase deposits. Deposits in our local banking business grew by $176 million. With declining loan balances and the addition of Chevy Chase's deposits we shifted our local banking focus from growing deposits to optimizing our deposit strategy. We maintain disciplined pricing and focused our efforts on the deposit segments that drive the most profitable and enduring customer relationships.

Continuing deposit growth opportunities across our local banking franchises, now including Chevy Chase, reduced our appetite for wholesale deposits. Maturing CDs resulted in a modest reduction in wholesale deposits in the quarter. Over the long-term we expect deposits to benefit earnings as maturing capital markets and wholesale deposit funding is replaced by lower cost local banking deposits.

Slide six summarizes margin trends. Revenue margin declined 62 basis points in the quarter to 8.03%. In turn, falling revenue margin was the primary driver of the $221 million decline in revenues in the first quarter. Trends in US card revenues and revenue margin had the biggest impact on total company revenues. Credit and consumer behavior impact contributed to the decreasing revenue margin in our US card business. As I just mentioned, we see consumers behaving defensively in the current economic environment, spending less, exercising caution to avoid fees, and working hard to remain current. While defensive consumer behavior is a benefit to credit performance, all else equal, it also reduces fee revenue.

Falling purchase volumes in the quarter reduced interchange fee revenues. Early stage delinquencies declined in the quarter as fewer borrowers moved from being current on their payments to the first delinquency buckets, the bucket we call one to 29 days late. As a result we assessed fewer late fees. We also observe a decline in the number of customer attempts to go over their credit limits. As a result we assessed fewer over limit fees. While early stage delinquencies improved in the quarter, later stage delinquencies increased, and the rate at which deliberate customers flowed through to charge-off accelerated in the quarter.

With higher late stage delinquencies, the amount of finance charge and fee revenue deemed uncollectible increased, and we don't recognize revenue on finance charges and fees we don't expect to collect. So in the first quarter of 2009 billed but unrecognized fee revenue remained elevated at $540 million. This compares to $591 million in the fourth quarter of 2008 and $408 million in the year ago quarter. We first observed this phenomenon of a steeper flow rate curve and the resulting revenue brown out during the first half of 2008.

Deteriorating credit trends also drove the write-down of our retained interest in securitization trusts. At the end of the first quarter the remaining value of retained interests in our I/O Strip was down to just $13 million. We expect the first quarter to be the low point for US card revenue margin in 2009. During the first quarter we took several actions to enhance future revenue. We expect the second quarter revenue margins will begin to benefit from these moves with more sizeable increases in US card revenue margin in the second half of the year. We expect full year US card revenue margin will be around 15%, a bit below the full year 2008 revenue margin of 15.5%.

In addition to credit and consumer behavior impacts, changes in the mix of earning assets reduced revenue and net interest margins. The primary mix shifts were the addition of the lower yielding Chevy Chase loan portfolio and the continuing shift from loans to investment securities. The negative impact to net interest margin was partially offset by favorable moves in the prime LIBOR spread during the first quarter and our continued efforts to manage our interest rate risk position. So net interest margin declined a modest 15 basis points.

As you can see on slide seven, our efficiency ratio for the first quarter improved to 46.3%. First quarter non-interest expense declined about $200 million as a result of our continuing efforts to achieve operating efficiency improvement and lower marketing expense in the current economic environment. These favorable trends were partially offset by the decline in revenue I just discussed. Going forward we will continue to benefit from our ongoing efforts to reduce costs and improve operating efficiency including the synergies from the Chevy Chase acquisition. We also expect that we'll continue to find fewer opportunities to effectively invest our marketing dollars while the economy continues to deteriorate and loan demand remains week.

We expect several factors to offset these underlying improvement trends in the non-interest expense and to create quarter to quarter variability in non-interest expense and the efficiency ratio. Collections and recoveries expense will increase as we maintain an increased collections intensity in the current economic environment. Integrating Chevy Chase will add one time deal and integration costs as well as ongoing Chevy Chase operating expenses. And the FDIC special assessment of deposit insurance premiums is expected to increase non-interest expense in the second quarter.

Slide eight summarizes a pre-provision pre-tax view of earnings. Pre-provision pre-tax earnings were just under $2 billion as the decline in revenue was largely offset by improvement in non-interest expense. Despite significant economic and credit headwinds each of our national lending businesses posted a modest profit for the queer. The modest quarterly losses in local banking was more than offset by national lending profits. Credit impact drove the operating loss for the total company. As you can see on the first slide, first quarter revenues were pressured by credit driven I/O Strip write-downs and revenue suppression. And provision expense remains very high as a result of rising charge-offs and further allowance build in the first quarter. At this point in the cycle we expect provision expense will continue to be the largest single determinant of our overall results.

With that I will turn it over to Gary.

Thanks, Rich, and good afternoon to everyone listening on the call. Rich just walked you through the primary drivers of our income statement which reflect not only the current economic environment but also the ongoing de-risking of our balance sheet. We are confident this strengthens our ability to confront near-term economic challenges while positioning us to deliver long-term value when the storm begins to abate.

Allow me to begin by discussing the near term de-risking. As Rich discussed a moment ago, we built our allowance by a further $124 million in the quarter. And our allowance now stands at $4.6 billion to protect us against expected future principal losses in on balance sheet loans. You'll note that while our reported net charge-off rate increased by 20 basis points in the quarter, our allowance as a percentage of reported loans was up 36 basis points in the quarter to 4.84% as we continue to reserve for anticipated future higher losses. This percentage does not include approximately $9.5 billion of Chevy Chase Bank loans that were added to the balance sheet in the quarter after those loans were fair valued to reflect anticipated losses and therefore do not carry an associated allowance.

Within each of our national lending businesses we increased the coverage ratio of allowance to reported delinquencies to historically high levels as increases in bankruptcies, degradation in recoveries and worsening of late stage flow rates have led to an assumption that a greater proportion of delinquent balances will eventually charge off. Our US card allowance is now equal to two times the level of reported delinquencies. Also, the credit pressures Rich described earlier have led us to increase our allowance coverage ratio in the banking segment by nearly 30% from 110 basis points to 140 basis points. As you are all well aware, these increases to our coverage ratios are bringing forward anticipated future losses for on balance sheet loans. Future allowance levels of course will be driven by the size of our reported loan portfolio and assumptions about future losses. It's for this reason we believe that our balance sheet is well fortified to protect against near term risks while positioning us to perform when the cycle begins to turn.

Another aspect of balance sheet strength is the low risk and steady performance of our investment portfolio, which I'll discuss on slide ten. Our $36 billion investment portfolio performed well in the quarter as we accelerated much of our planned purchases for the year into the first quarter to take advantage of highly attractive opportunities in the agency MBS and consumer ABS sectors. This approach appears to have been the right one as fixed income spreads narrowed materially through the course of the quarter largely in response to government actions. Quarter end spreads were in substantially relative to year end so we saw a $498 million improvement in our unrealized loss position from last quarter with the net unrealized loss now standing at $615 million.

It's worth reminding you that the related $526 million improvement in OCI does not impact the income statement. And I'd also like to highlight that we did not adjust our valuation methodology to use mark to model allowed under recently issued accounting guidance.

In these highly uncertain times we believe it is prudent to continue to invest in highly liquid low risk securities to ensure we have ample liquidity to fund our business. While investing in low risk securities inhibits the leveraging of our portfolio to reap high risk gains we avoid many of the pitfalls experienced by others of having to realize significant unexpected losses when outsized bets don't work out.

While I'm on the subject of unexpected losses let's move on to a discussion of capital which underpins all the risks on our balance sheet. Looking at slide 11. On a pro forma basis, our TCE ratio improved by 20 basis points in the first quarter, primarily due to the improvement in OCI and the pro forma shrinkage of the balance sheet. While our announced intention in early March to reduce our quarterly dividend $0.05 per share has not yet affected the balance sheet our future capital ratios will benefit from that dividend reduction.

As expected our TCE ratio fell by approximately 100 basis points upon closing of the Chevy Chase acquisition. Please recall that the purchase accounting for Chevy Chase Bank marks the first application of FAS 141R which requires all acquisitions after January 1 of this year to mark the entire portfolio for both credit and interest rates at the time of closing. The credit mark on the Chevy Chase loan portfolio turned out to be a couple hundred million dollars higher than originally estimated. This was offset by a more positive interest rate mark. We've included a schedule in the supplemental tables to size the currently estimated impact of the acquisition in the quarter and intend to provide in future quarters a lens for recognizing the impact of purchase accounting on our results.

Our capital ratios continue to be meaningfully above regulatory well-capitalized minimums. Our Tier 1 risk-based capital ratio is estimated to be around 11.4% in the first quarter, up approximately ten basis points from the pro forma prior quarter. Without the preferred stock and warrants issued to the US treasury under the TARP capital purchase program, that ratio would be about 8.5% or approximately 250 basis points above the well-capitalized threshold.

As we continue to build allowance in anticipation of higher expected losses, conservatively manage our investment portfolio to avoid large unexpected losses, and having fair valued the entire Chevy Chase Bank loan portfolio, we are very comfortable with the cushion provided by our current levels of capital. At this point in the cycle it is only prudent to assume that economic headwinds may continue to create short term earnings pressure. However, we believe that disciplined growth and active management of our balance sheet will enable us to maintain healthy capital ratios and position us to perform well through the cycle.

I'll discuss our balance sheet management philosophy in greater detail beginning on slide 12. Deposits continue to increase as a percentage of our funding as disciplined growth in our existing channels has been supplemented with the addition of Chevy Chase Bank deposits. Our ending loan to deposit ratio improved from 1.68 to 1.24 from just one year ago. This deposit expansion continues to decrease our reliance on wholesale funding, providing us with tremendous flexibility to choose from a variety of funding vehicles to optimize cost.

To evidence this point, you'll note that our weighted-average cost of funds decreased 139 basis points from the year ago quarter. While the decline in overall funding rates certainly provided a tailwind in our efforts to reduce funding costs, you'll note that a large driver of the overall decline is from the change in liability mix. In fact if you compare the annualized funding costs from the first quarter of this year versus what the annualized funding costs would have been had the liability mix of the year ago quarter stayed the same we are saving approximately $240 million a year. And it's worth noting that because marginal wholesale funding costs would have been relatively high in the first quarter, the savings estimate is likely understated.

In addition our funding flexibility has enabled us to be entirely self reliant. We have chosen not to participate in any government assisted funding programs such as TLGT, CPFF, or TALF, as we have cheaper all in options at our disposal. We fully expect that we will maintain access to attractively priced funding necessary to support lending, consistent with the demands of creditworthy borrowers and our own prudent lending standards. We will constantly use the most economical way to fund our business, and I fully expect that cheaper retail deposits will continue to replace expensive wholesale funding as it matures over time further improving our funding costs.

Let me now move to the left-hand side of the balance sheet to discuss our migration to lower risk assets. As you can see on slide 13, our investment portfolio continues to become a greater portion of our earning assets, having increased from approximately 12% a year ago to 18% today. As I mentioned when describing the portfolio in detail, we continue to take advantage of attractive securities investment opportunities in the quarter to replace lower yielding assets expected to mature over the coming quarters. While we saw many investment opportunities that exceed the marginal returns on many lending opportunities given the current environment, the 4.62% average yield for the total investment portfolio is, as you'd expect, less than the 9.44% average return on our portfolio of loans held for investment.

While we are confident that we have made the right decisions in building our strong liquidity positions and in the marginal investments we are pursuing, growing our investment portfolio certainly brings down the weighted-average yield of our total assets. However, given the confidence we have in our funding profile as marginal lending opportunities become more attractive we believe a migration to a more typical asset mix will provide a meaningful financial tail wind. To put this prospective asset shift into perspective, if we were to assume we returned to a 12% investment portfolio mix, by increasing our loans by six percentage points at our current average yield, we would experience an annual increase in revenue of approximately $500 million a year without the need to raise capital to support the loan growth.

Our plan is to eventually shrink the investment portfolio back to its historical share of earning assets by taking advantage of attractive lending opportunities when the environment turns. However if we don't see a sufficient amount of attractive risk adjusted lending opportunities to fully swap out our investment portfolio assets we also have the choice to bring down the size of the investment portfolio and further bolster our capital ratios. If we were to shrink the investment portfolio back down to achieve a 12% proportion of total earning assets, our TCE ratio would increase by approximately 30 basis points. Although we believe it is not prudent to take action against either one of these options today due to the current economic environment, suffice it to say that this optionality has a great deal of strategic and economic value.

Turning to slide 14 I'd like to conclude and pull all of these pieces together. We continue to manage the company to confront short term pressures while delivering long-term value. And we believe the best way to address both of these goals simultaneously is to maintain a strong and resilient balance sheet. To confront the short term economic pressures we continue to build our allowance to stay well in front of the possible future degradation in credit. We also are conservatively managing our investment portfolio to ensure we have ample liquidity while avoiding taking outsized risk to reap unsustainable trading gains. And we continue to manage our capital to levels well in excess of any regulatory minimums even assuming a worsening environment.

As we think about the future we are confident that the de-risking of the balance sheet will provide both strategic and economic long-term value. We are building our deposit franchise with a strong customer value proposition and disciplined pricing, affording us a great deal of funding flexibility while building enduring relationships with our consumer and commercial customers. In addition to bringing down our overall funding costs these deposits provide the ability to grow a resilient investment portfolio. The capital which supports this portfolio can then be reallocated to higher yielding loans when the opportunity arises. So while we remain cautious about near term economic challenges, we are confident that our balance sheet will not only provide us the stability to get us through the storm but also the power to generate value when the storm abates.

With that, Rich and I welcome your questions.

(Operator Instructions). We'll take our first question from Brian Foran with Goldman Sachs.

Hi, good afternoon, guys. When you talked about removing the guidance for the rest of the year in terms of losses, is the uncertainty around the unemployment forecast, because you gave one but everyone realizes obviously there's a wide range of variability around that spot forecast? Or is the uncertainty more around the relationship between charge-offs and unemployment and you're just not sure if it will stay roughly a one to one relationship? Or is it a little bit of both?

Brian, we really work hard to try to see how we can give the best window into our business for our investors. And we've taken various forms of -- getting out on a limb just a little bit with different ways of forecasting here. For example, we went for the six-month window in our credit card business. As uncertainty grew we went to the three-month window into that thing. We are a little bit struck by, I mean not surprised by but still it's noteworthy that the most near term baking in the oven part of our forecast of the credit card business still was, even that forecast turned out to be off somewhat by virtue of things around the edges that really weren't so much in the oven.

And we then looked at all the competitors and they are out of the outlook business. And then finally, to your point, we are at a striking point right now where unemployment in many ways is raging in its bad direction. You've got other data starting to show even some positive signs. And so all in all we just felt maybe we were better served just trying to give you a window into how our business works and maybe at this point not be in the twelve-month outlook business. If people are interested on a follow-up question I can certainly talk about the relationship between credit card and unemployment, credit card charge-offs and unemployment, which bottom line we don't see any reason to believe that that relationship has changed.

That was going to be my follow-up question so I'll follow up. When we look at some of the markets where we do have 11% and 12% unemployment around the country and you drill into your portfolio by state, I guess what you're saying is that relationship is holding, it's just a factor of having really high unemployment in those states?

Yes, let me give you a fairly robust answer to this thing because it's very, very important to I think anyone who is trying to assess the card business. We are junkies about trying to gather everything we can from economic variables and how they drive our credit card charge-offs. And what we have, Brian, in our universe of data available to us is what I often call the two humps of a camel. We have the '90, '91 downturn and we have the early in this decade downturn. And there, if you look at by eyeball, this thing that we commonly call the one to one relationship between card charge-offs and unemployment where unemployment, if it goes up 100 basis points card charge-offs go directionally up 100 basis points.

Our best read of that is that that relationship is somewhat less than one to one. In other words, card charge-offs would go somewhat less than 100 basis points. But anyway there is a pretty close relationship there, and also credit worsening has tended to be a lead indicator relative to unemployment.

Then one of the benefits of this downturn, Brian, is we have very rich database of cross-sectional MSA data that we can use, and also what's relevant about this one is this is this downturn, it's not yesterday's downturn, it's this downturn. And so what we have done is cross sectionally modeled MSAs and exposed it to as many economic variables as we can. Some of the data is limited. But what one is struck by is that both HPA and again unemployment tend to be the key drivers.

We have found from even in the most stressed gloom and bust states generally the kind of relationships that we, by eyeball, saw on the last two downturns are still the same, generally that there is a somewhat less than a one to one relationship with unemployment but it turns out, by the time you're done with HPA, in a sense average out to one to one. We have a phenomenon right now. I guess you've seen this quarter, there's a bit surge in unemployment and as we said we didn't see our credit metric in the very moment be as responsive as they might have been to this. But we don't necessarily see any evidence of a change for that.

We've also looked for interactive effects, Brian, between unemployment and HPA, the thing that says, boy, if they are both bad is the interaction of those something a lot worse. We see small interactive effects but not anything that really changes the fundamental relationships we've seen. I would say that what you've operated in your assumptions up to this point we don't see too much that would change that.

What we did go out of our way in the up front talking points there was to say with respect to the credit card charge-off rate because of the denominator effect most importantly, and to some extent because of the OCC minimum payment policy you will essentially see our charge-off rate exceed the normal relationship. But that's not a substantive point about the economy, that's really more just a point about our metrics.

Next question, please.

We'll go next to Craig Maurer with CLSA.

Good afternoon. A couple questions. First, regarding the international card portfolio, I was hoping you could go into a little more detail regarding the trends you are seeing separately in Canada and the UK

Yes, let me start with the UK. If we adjust for debt sales, the UK losses are higher than a year ago. And most of that increase is from higher contractual charge-offs but also insolvencies have been trending up recently after being pretty flat for 2008. Insolvencies are essentially the UK equivalent of bankruptcies. As we look at the UK environment, certainly the economic environment looks pretty troubled there. Consumer indebtedness remains at record levels. House prices are declining rapidly. Unemployment is rising. And it's a worrisome environment.

There is one potential benefit that's bigger in the UK than in the US and that is the lower interest rates may help owners more in the UK because the majority of them have variable rate mortgages. We haven't seen this effect nor are we counting on it. We expect further credit worsening in the UK businesses and we're in very much hunkered down mode. We've even stopped doing teaser rate marketing in the UK. We're very much in hunker down mode and you will see for the foreseeable future a steady decline in that portfolio.

In Canada, Canada has been the one part of our world that has seemed to ostensibly not be suffering a lot of the issues that the rest of the world is suffering and we have just in our underwriting assumed that it will behave the way the US and the UK have gone. Capital One Financial Corporation And our point here in our conversation today about this quarter is we've started to see both the economic measures jump up somewhat in Canada and our own losses in the Canadian portfolio went up about 74 basis points, as I recall, in the business. So for Canada it's still for us a very profitable business but we are underwriting assuming Canada ends up going the direction of the UK and the US. But at this point it's still performing at quite a higher level.

Okay. And if we can continue on the card theme for a minute, looking at your purchase volume in the quarter, down 12% year on year, you certainly outperformed some of your large bank competitors despite the fact you had 15% contraction in the account base. So I was hoping you could talk a little bit about spending for active accounts.

Basically our purchase volume, you're right, declined 12% year over year. About half of this decline, Craig, is due to a reduction in active accounts on file and the rest is driven by the economic environment. So what we have seen in our purchases per active account is they appear to have stabilized levels about 6% lower than a year ago. And this is consistent with overall decline in retail sales and consumer spending.

Next question, please.

We'll go next to David Hochstim with Buckingham Research.

Thanks. I wonder if you could just clarify what you were saying we could expect in terms of expense changes? Trying to relate the expense outlook to what seemed to be further declines in revenues or I guess an improving margin offset by lower balances. And then rising credit costs would suggest that first quarter earnings might be among the better quarters this year and I was just wondering what I might be missing.

Hi, David. Let me just focus exclusively here on the question about what we might see in the way of non-interest expense. As Rich has said, we have experienced some good improvements in efficiency in the first quarter. This started a couple of years ago, as you know, and we are continuing to make good strides in efficiency in all of our businesses. There have been some near term elevations coming from things such as the intensity of our recovery and collections efforts, but by and large we've been benefiting quite substantially from the improvement in efficiency.

As we look particularly at the next quarter, remember that we will have a couple of things that you should keep an eye out for. The first is that the expected special assessment in terms of what's coming out of the FDIC will be affecting Capital One, like all banks, if that hits. It's likely to hit all at once here in the second quarter. We also will, as we rapidly start to integrate Chevy Chase, remember that their efficiency ratio was substantially higher than that for Capital One as a whole and that's going to have an effect for awhile to come. Those expenses are a little bit exaggerated certainly in the first quarter. As Rich indicated, the expenses related to the deal under new FAS 141R all have to be expensed rather than going to goodwill. And so you saw some elevated level of expenses in Chevy Chase and you'll probably see some integration expenses coming through over the course of the next couple of quarters. Of course we are rapidly trying to make that integration work and move quickly towards getting some of those synergies.

But I think the biggest two drivers of any movement away from the improvement trend, at least in the next quarter, would be the FDIC assessment and the impact of Chevy Chase. Going forward towards the end of the year we are going to try to make sure that we continue to see the benefit of our efficiency efforts.

Can you give us an idea of how big those two things are?

I would rather not suggest what the FDIC assessment is going to be. That obviously has not yet been determined and there's quite a wide range. You know what the size of our deposit book is so you can probably figure out that the range there can be from tens of millions to a couple hundred million. And with respect to Chevy Chase, run rate of expenses there prior to our being able to start to realize the synergies, which again we are going to try to do pretty quickly, a run rate of somewhere at or just around $150 million a quarter. Again that may be higher or lower based on the level of integration expense and the speed of achieving the synergies but certainly after a couple of quarters we are going to start to try and make sure those synergies are showing through.

Next question please.

We'll go next to Andrew Wessel with JPMorgan.

Hi, thanks for taking my call. My one question was on card repricing. Just taking the average spread that you recorded against prime during the quarter over the last few quarters, it looks like pricing's moved up a little bit but maybe with the last three quarters it's stalled. Could you talk about just what you are doing in repricing the portfolio ahead of the Fed mandated rule changes?

Andrew, I think like all banks we continue to manage our portfolio dynamically across all of the metrics. I think some players moved earlier with respect to a number of things. Our various efforts on account management will be more manifest in the second half of the year. You will start to see some impacts in the second quarter and more significant impacts in the third and fourth quarter. But that was part of the conversation where, by the time we are done, if you pull up on the whole year, that's where I gave the indication on the overall revenue margin which will be just modestly lower than last year, full year over year.

Thank you very much.

Next question, please.

We'll go next to Don Fandetti with Citi.

Just a quick question on FAS 140 changes. Any change in your thought process on the potential for a delay or are you okay in terms of capital how the regulators will work it out?

Hey, Don, it's Gary, and we of course keep a very close eye on what's happening, and a lot of mixed signals coming out on FAS 140. Of course the meeting that was scheduled for this month for the FASB has been delayed so we'll just have to wait and see what happens. Overall, as we approach FAS 140, my watchword here is that it's a change in accounting, it's not a change in our economic position. The accounting impact could, of course, be quite significant but that will depend a lot on a bunch of things starting with timing. And so, given the percent of our portfolio that is off balance and how much of that is declining quarter over quarter, the impact of FAS 140, when and if 140R, when it comes, is likely to decline over time.

Secondly the nature of the accounting guidance is going to be extremely important as to how we bring those off balance sheet securities and assets back onto our balance sheet. Could have a material impact on the short term impact on the bottom line. And certainly from a capital perspective as you say, Don, look, we mostly managed our business with tangible common equity ratio as our guide. We've always had managed assets in the denominator. So from a capital standpoint we've always been blind as to whether or not assets are on or off the balance sheet so we are confident that our level of capital would be appropriate regardless of the accounting change. Obviously we'll have to wait and see what FASB does and what the regulatory outcome might be, but even if we take the very worse outcome on every dimension of timing and structure and regulatory response and so forth, I'll simply repeat what I said before which is it would not require us to raise either common equity or really any other form of Tier 1 capital even without TARP.

Okay. Thank you.

Next question, please.

We'll go next to Bob Napoli with Piper Jaffray.

Thank you and good afternoon. Rich, I'm wondering if you could give any thoughts around the meetings going on in Washington, DC later this week?

Yes, good afternoon, Bob. The meeting Thursday at the White House is a working session, was basically set up as a working session among the executives who manage the credit card businesses of various banks to work with Treasury and Administration officials. And we appreciate the opportunity to participate in Thursday's meeting and welcome the constructive dialogue including now that the President apparently is going to attend this, as well. Ryan Schneider, our President of US card business, will be there representing Capital One.

Fair access to credit is an issue of great importance both to banks and to consumers, and Bob, you know the importance that we place on that. So we are really looking forward to an open exchange of views, and I think that it's really important if the various parties can really get a common set of understandings and also understand the impact of choices and possible developments on the regulatory environment, and legislative environment. So that's what the meeting is about.

Okay. Thank you. A follow-up question just on the credit side, Capital One has not historically sold charge-offs. You suggested, I think, maybe you did sell some in the UK. Are you doing anything different from a managing the credit loss perspective both on selling charge-offs, maybe on increasing use of deferrals? Two different items but if you can touch on your intent to sell charge-offs which is historically something you have not done, and if the level of deferrals are increasing which I think it's also something that Capital One has generally been a light user of deferrals in the past?

Yes, Bob, charge-off debt, we have been, probably relative to most of the industry, a pretty light user of debt sales. I think there are a few folks in the industry who got rather used to some of the benefits that came from a large continuing flow of debt sales. We try to not get that dependency. But also, really most importantly, just looked at debt sales as a sort of MPV-based calculation to see when can someone else do it effectively for better economics than we can manage it. And debt sales also are a good way to manage the capacity of in-house recoveries where there can be capacity constraints sometimes in a worsening credit environment. So that's how we look at debt sales.

We are glad we've not had a big dependency on it because the debt sale market has really declined. Interestingly, it held up last year so over the past year we've seen our liquidation rates decline by 20% to 40% depending on the segment of the credit card business. And it was striking to us that the debt sale market hung in there for most of last year in terms of its pricing, but really the bottom fell out of it in the first quarter and so we don't have much in the way of plans for debt sales. For three-age policies, which would be the industry term for some of the extensions that you are talking about, Bob, for us we are in line with the industry and this has not changed, and it's pretty tightly regulated by the OCC.

Next question, please.

We'll go next to Sanjay Sakhrani with KBW.

Just by my math, I think the dividends on the preferreds were about $64 million this quarter. Is that a quarterly run rate that we should use for the rest of the year?

Yes, Sanjay.

Great. Just to follow up, on the broader question on the regulatory proposals as they've been outlined, could you help us think about the economic impact if they are implemented in July of 2010 versus if they were implemented earlier than that date? Thanks.

Okay. First of all, the big issue in the debate about the implementation of these federal reserve rules which are commonly called Reg AA or UDAP rules, the big debate, as I'm sure you know, relates to the ability to implement any earlier than the proposed date. So all the issuers, ourselves included, are scrambling to do a very substantial amount of technology and operational changes associated with the sweeping proposals. So it's a very important issue to us, in fact that the timing is very important just in terms of literally the ability to pull it off.

The impact of this, if it comes earlier, I suppose it will bring forward some changes that otherwise I think I've always said will be in the cards, no pun intended, over the course of the industry for the next year. But I do want to say that the account management changes, some of the revenue moves that the various issuers have done, make it, I think that is going to mute some of the near term immediate impact that otherwise you would have seen when July of next year came along. But I think the big question is how much is the industry going to adapt its pricing relative to these changes, and the most important issue is what happens on the front end.

So let me give you an example. This is the thing I'm watching so closely. Given that retroactive repricing of existing balances will not be allowed post the implementation of this, it means that, and because of the very, very low rate of amortization of these cards, effectively, while it's a slight over statement, credit card issuers will be stuck with the rate that they have for revolvers for the foreseeable future. And so I think the industry is addressing that with respect to their existing file over the course of these months. But for new originations, the thing to watch is the go to rate. Because while the industry can use teasers and even teaser down from the go to rates in the future, the go to rate will be the defining rate that determines the long-term resilience we are going to have in the business.

When I look at the go to rates that the industry is competing with right now, it doesn't look like it nearly covers the kind of long-term, it's not at the level that you would need for long-term resilience. Frankly, go to rates, if you look at mail monitor data, have actually been declining over the last number of months, very slightly declining, but so have interest rates. If you adjusted for interest rates they have actually gone up about 150 basis points which is good news but it is still well below where the go to rates need to go to. So I think I suggest all of us, we certainly are very closely looking at that metric in terms as a predictor of the future resilience of the card business.

Next question, please.

We'll go next to Chris Brendler with Stifel Nicolaus.

Good evening. Can you talk about the reserve level in the US card business relative to the installment loan business? That 9.5%, is the installment loan business a large portion of that? Because at 9.5% in the US card business that would be a pretty significant impact if you were to reserve at that kind of level or anywhere close to that kind of level on your off balance sheet loans if FAS 140 were to go through. Thanks.

Yes, Chris, it's Gary. We don't disclose the allowance in individual parts of the various portfolios. I would say that, again, with the installment loan portfolio we've been seeing a rising level of allowance because of the increasing loss rates. But remember that there's a countervailing effect coming from the impact of the reduction in the outstandings in the ILs. Remember also that the ILs are entirely or almost exclusively on balance sheet already so they are not going to have an effect there.

As far as FAS 140 goes, Chris, the impact of the allowance is going to be dependent on what the lost outlook is at the time. And in terms of the impact of that loss allowance build at the time that we bring everything back on balance sheet, there may or may not be many countervailing factors depending on the way in which we bring those other things back on the balance sheet. So again it's all accounting and we will certainly walk our way through it if and when we need to.

That answer doesn't make sense. Is a US card, a 9.5% reserve rate on balance sheet or is installment loans driving that level of reserve because if it is 9.5% that's a huge number for US card.

Again, the 9.5% allowance for reported loans in the US card segment covers both card, the revolving card as well as the installment loans. If you take a look at the loss rate that we are experiencing on a managed basis in that externally reported US card segment that was at 9.3% in March. Remember, as well, that there is not necessarily an equal amount of credit card assets across the credit spectrum that are on the reported balance sheet for which there's an allowance versus that which is securitized. Again I think the closeness of the coverage ratio to the reported loss rate should at least suggest that we are in the right ballpark. Exactly which product is contributing what amount is going to change over time.

Next question, please.

We'll go next to Bruce Harting with Barclays Capital.

Yes, your cost of deposits has dropped nicely along with other core deposit funded banks. And if you could just go back to the discussion you had on loan shrinkage or reconciliation, I think I heard you say you're planning to shrink the US card business, but the installment loans would be a bigger part of that shrinkage. Could you just clarify in terms of that that? And I'm just trying to connect with when we see the monthly trust data coming out in the next few months, the denominator effect that you are talking about, 50 basis points higher in the second quarter from denominator and shrinkage of loans, and that ties into my question, and then the OCC minimum payment, 20 basis point impact. So just from those two that's a 70 basis point impact that we will see coming through the monthly 8-K data. Is that correct? And then just on that loan question, I hate to go with too many of these tangents but if you are going to have shrinkage in loans, as you said, but you are going to keep, I think I heard you say you are going to keep earning assets flattish, just wondering what the rationale is for that and why not go ahead and shrink earning assets as well to get the tangible equity up. Thank you.

Bruce, as you suggested, there's a bunch of different comments and questions there. Let me just start with a couple of facts to make sure that we are all on the same page here. So although the installment loans as unsecured consumer credit on a national basis are included in our reported US card segment, there are no installment loans in our credit card master trust. The only thing in the master trust would be consumer and small business cards. So the effect of the shrinkage in the IL portfolio is not going to have any impact at all on the card master trust. So let me just stop right there. Maybe get a better view here, Bruce, on how I can take that forward here for you.

Bruce, can you ask the question again, I'm not sure we got it all.

Two parts. I'm just trying to get at the overall logic or thinking behind what's your philosophy right now with regard to asset liability management? You've got a great funding source in your deposits and it just seems like it would be a good time to shrink overall earning assets. That's one question. And get the margin up and take advantage of the deposits and get the loan to deposit ratio down a little bit. Then the other part of that is you made some comments about just trying to tie into your monthly data that I know apart from the trust now you are showing total managed charge-offs, right?

Right.

So just trying to get a sense of how quickly we are going to see those credit numbers develop from the denominator effect and then get to that 10% charge-off number you were talking about. So two, I wasn't clear, you're right, one question on the charge-off and credit numbers as they evolve the next few months and another question on funding philosophy and why not shrink the earning assets as well as the loans. Thanks.

Okay. Bruce, why don't I take both of those in order. In terms of the overall earning assets, as Rich indicated, if not for the acquisition of Chevy Chase we would have shrunk overall earning assets in the quarter. Obviously there has been a shrinkage in the loan book coming largely from what Rich described, which is the charge-offs, the runoffs as well as the reduced demand purchase volume and the like. We had a couple of billion dollars of securities in our investment portfolio roll off in the first quarter. However, knowing that we have another $6 billion of investment securities rolling off for the balance of the year, given what we saw largely in the first couple of weeks of January with agency mortgage backs at incredibly attractive levels and a lot of consumer ABS which we know extremely well, at very attractive levels, we chose to reinvest the proceeds of the roll-off of some of our investment securities and also some of the deposits we were taking in.

We chose to invest those in our investment portfolio in the first quarter effectively to anticipate the roll-off over the next three quarters of lower yielding investment securities. But certainly as we go through the course of the rest of the year, having, in a sense, pre-invested some of those proceeds,you are likely to the see a decline in the level of investment assets, and therefore if we have shrinkage in loans and along with some mild shrinkage in the investment portfolio, you could well see precisely what you would predict given our strong balance sheet, our strong funding sources which is a shrinkage in overall earning assets. The timing is really more or less our response to what we perceive to be the right kind of market opportunities.

With respect to the shrinkage and how it plays through into the monthly data, again, as I indicated, remember ILs are not in the COMET trust, and what you are going to see in the trust data is less a matter of the denominator effect. You will see some of the OCC min pay effect that Rich described, and you will tend to see that with a slight lag because of the way trust accounting works. That's on the downside, on the credit side. On the upside, what Rich described in the way of revenue moves that are going to benefit the overall card business, you will also see that come through into the trust, as well.

Bruce, let me just make one small clarification also just to be precise here. We ourselves also are talking about two slightly different things when we talk about the monthly managed and the quarterly impact of this denominator affect. So the quarterly impact on the US card managed loss rate, this is the denominator, the 50 basis points denominator effect on average for the Q2 quarter and the OCC min pay effect, on average 20 basis points for the second quarter. The monthly, we also said the monthly managed numbers, that charge-off rate will cross 10% over the next couple of months. So that's a monthly number. The other is an average. There are slight differences in the effect per month. I just wanted to make that point.

Before we move on to the next question, Bruce, the thing that's driving the monthly manage rate to cross 10% in the next couple of months is the combination of economic worsening, the denominator impact and the OCC min pay impact. Next question please.

We'll go next to Moshe Orenbuch with Credit Suisse.

Thanks. I understand not wanting to give guidance on charge-offs, but given the way your reserve is established, how should we think about the reserve addition both this quarter and in subsequent quarters relative to what you might be expecting for an increase in losses on the on balance sheet portfolio?

Happy to take that question, Moshe. The allowance build in this quarter is entirely consistent with the assumptions that Rich gave of significant further economic deterioration. You see that in this quarter alone, with the reduction in loan balances, the increase in the allowance, not only are we increasing our allowance but we are increasing our coverage ratios, both of the allowance to reported loans and in the national lending businesses, the allowance to delinquencies.

The factors that drive allowance are often hard to predict but I can tell you for the first quarter, just looking back here, that there were two factors that really accounted for the relative size of this quarter's allowance in relation to the degree of experience and expected economic weakness that we are seeing and expect to see in the labor market. The first, I believe Rich indicated that our own results in the quarter were generally in line with the expectations we had when we set the allowance at the end of the fourth quarter. Despite the fact that the economy overall has degraded more sharply than we would have expected at that same time. And so, again, we are going to constantly be calibrating to make sure we have the right kind of expected loss rate for any given move in the economy.

The second effect is that although our overall credit during the quarter was more or less as expected, it was differentially better in auto. I think that's pretty clear from the numbers. And auto is entirely on balance sheet, and that's going to have a relatively helpful effect when it comes to allowance. It was differentially worse in card, as Rich described. And because that's not on balance sheet, that's not going to drive the allowance overall.

So what I would say is that our first quarter allowance build, it still reflects a pessimistic outlook. Certainly more pessimistic than the one in which the fourth quarter allowance was built, but it's one that recognizes a wide range of outcomes for the next 12 months. I think, as we go forward what you are going to have to do is take a look at the potentially offsetting effects. If there's a potential for further degradation in the outlook, that would tend to push things up. But if the balances of loans are shrinking, that's going to have a depressive effect on the allowance. And it's really going to be the relationship between those two that you see.

And I think, based on my conversations with so many of our investors and analysts, when they look back at the very large allowance build we had at the end of the fourth quarter, remember the step change in the outlook that took place, all of the indicators pointing in the same direction at the end of the fourth quarter. Although things have degraded, they've been a steady degradation this quarter. We've seen our performance pretty steady and we see mixed signals on what's coming on in the future. And I think when you put all these things together you can understand how we came up with this quarter's allowance.

Okay, just a follow-up question. The contribution from Chevy Chase, how should we think about the progression from this point forward, second quarter through the balance of the year?

Yes, taking that question here quickly Moshe, again, we showed you for this quarter and this quarter only, as we often do, the impact of the acquisition in the quarter that it happens it shows up in the other category. It will be rolled into our local banking segment starting in the second quarter. Remember the huge effect on the accounting results that's coming from FAS 141R. So you had truly elevated expenses all to do with the integration with the deal itself showing through in the first quarter that won't necessarily be there for very long.

The other thing that will change quite dramatically is Chevy Chase, not unlike many local and regional institutions, tended to have an asset sensitivity on their balance sheet which, given the very sharp decline in short term interest rates over the last several months, really hurt their performance in the first quarter. As we now have consolidated the management of the assets and liabilities, we are going to transform that into a more liability sensitive position which will allow us to benefit more from those Chevy Chase deposits. And, again, hopefully we will be able to demonstrate the ability to get some of the synergies pretty quickly, as well. So clearly we are going to look for an improving impact from Chevy Chase as we go through the course of the year, and you will you see that and we will talk about it showing up in the local banking segment including some unique effects of purchase accounting because of the new standard. And when we get there we will break it out so you can see it.

Next question, please.

We will go next to Bill Carcache with Fox-Pitt.

Hello, I have a couple of questions relating to your trust. First, is the entire $118 million decline in the fair value of the I/O Strips, that you mentioned in your release, driven by the decline in the excess spread that we've been seeing in the trust? And given the value of the I/O Strip has fallen so much, what should we expect to happen to the non-interest income line item next quarter if losses continue to rise? And also what's the maximum cash trapping that would occur if the average excess spread falls below 4.5%? Along the same lines, what are the key trigger points, what does cash trapping do to earnings and book value? And finally, would you provide support for the trust as excess spreads continue to fall?

Bill, that was four or five questions but I'll give it to you because they are all about the same subject. So we will count that. Let's just start with the impairment of the I/O Strip. I believe Rich indicated the impact about $120 million, leaving a balance of just $10 million or $20 million left, so needless to say when that no longer has any value attributed to it, it it can't go down any further. That's not to say that you won't see some impact on our P&L should there be continued degradation in the trust. That would come from two sources. The first would come from a reduced valuation of any of the trust interests that we have retained on our balance sheet. Also, if there is cash trapping, which we will get to in a moment, we have to discount that and that can also have an impact on income.

So we may continue to see some impact on non-interest income. I would tend to doubt that we would see anything close to the kind of impact that we've seen the last couple of quarters in the I/O Strip but just when the I/O goes away I don't want you to expect that you might not see any non-interest income impact from what's going on in credit.

Which takes us to the trust. So just a couple of facts, Bill, make sure everyone is level set. For the Class C, that means the Triple B securities in our master trust, we start trapping cash when the three-month average excess spread goes below 4.5%. The three-month average excess spread for March, at the end of March was 6.23%, or about 1.75% higher than the trigger. So we are not trapping cash in relationship to that class C at the present time. Of course we have seen a very marked degradation in excess spread over the course of the quarter, down to just over 4.8% in March. And looking back at prior year trends, April trust data, which you are going to released in the middle of May, would typically be the seasonal low point for both yield and excess spread in the trust, so I think it would be prudent to expect to see a further seasonal decline next month.

Now, as Rich discussed a little bit earlier, in order to support the strength of our business we've taken a number of moves on the revenue side which will become obvious starting in the second quarter, and probably more markedly in the second half of the year. And although those moves were taken simply for good business reasons, they will tend to benefit the trust, and we think that although they may show through with a little bit of a lag, because of how trust accounting works, those actions will return the trust to a healthier position relative to recent near term performance.

Finally, in terms of the amount of cash trapping, again that will depend on what the excess spread level is. We are not there yet. If and when we were to get there, it will fluctuate quite a bit. We may trap cash and then we may release depending on what's going on at any particular point in time.

In terms of the financial statement impact of cash trapping, there could be an impact, there would be an impact on earnings if we were to be there. As I suggested earlier, a spread account established in order to trap the cash is discounted at a rate that is commensurate with the risk associated with other kinds of receivables, retained interest, and so we could see an impact on non-interest income for those periods of time when cash is trapped. Of course if it then gets released and it could easily have an offsetting impact on non-interest impact.

The only other impact on cash trapping is really on the regulatory capital impact because the excess spread that's trapped in the account is considered at risk from a regulatory capital standpoint, and we back out capital by holding dollar for dollar capital against it from a regulatory standpoint. And when we do any of our stress tests, we assume that our trusts are going to perform more or less like the rest of our balance sheet. And under those scenarios where the trust might be in a position of trapping cash, our judgment about the adequacy and the resiliency of our capital takes into account the prospective hit that would come from that kind of situation. Again that is not necessarily once and forever because we expect that cash that gets trapped at some point in time gets released, but certainly in the short run we want to be prepared for every eventuality. I hope that covers the landscape for you.

Next question please.

We'll go next to Scott Valentin with FBR Capital Markets.

Good evening. Thanks for taking my question. Just a real quick question on the bank, net charge-offs were down linked quarter but non performing assets were up quite a bit. And it looked like the provisional expense did not really increase that much. And I was hoping maybe you could reconcile the thought process behind the provision expense versus the non-performing assets, and maybe you just don't see that much in the way of embedded losses in those assets. And maybe provide a little more color about the New York market and what you are seeing in the loan categories.

Sure, Scott, it's Gary. Let me take the first part of your question and then I will hand it off to Rich to give you some color as to what we are seeing in the New York market or any of the others. Remember, there's a real seasonality to what goes on in the provision for the bank. So if you go back to the fourth quarter you would have seen a relatively elevated level of charge-offs. These are very lumpy kinds of things. As we do our review of the portfolio and move things to charge-off we tend to see that rise in the fourth quarter. You clear out a lot of the NPLs as we get into the first quarter. Again we are going to reassess on a quarterly basis loan by loan everything that happens.

With the overall level of performance in the markets, not surprising that you'd see a decline in the level of charge-offs but an increase in the level of NPLs. And so if you saw the fourth quarter allowance build, that was really done on the basis of the economic degradation. As that continues, it's not surprising to see a level of provision that's more or less the same.

The only other thing I'll remind you about, in our local banking segment, and it's broken out in the table so you can see it, is there is a run off portfolio. It is called the small ticket commercial real estate portfolio. Those were loans that were originated by the old GreenPoint Mortgage for sale into the secondary market which we ended up having to hold when the secondary market pretty much shut down. Remember that a lot of the overall bank statistics are going to be driven by that run-off portfolio. But I think to really understand the quality of the commercial book I will hand it over to Rich and I would look at that separately.

Okay. Scott, it's not lost on any of us just all the bad news that seems to keep coming out with respect to jobs, particularly high paying jobs in the New York area. The city has lost about 87,000 jobs, from what we can gather here, and it is projected to lose another 150,000 jobs if the recession plays out. That's a projection by the Office of Management and Budget. I think that one very good thing is that New York entered this downturn in much better shape than in past recessions. In the early '90s, when New York got creamed on the commercial side, they started wid a big oversupply of office and residential real estate. This is not the case today and one reason for that is a byproduct of September 11.

In our portfolio, our New York portfolio, it's still performing really quite well. There's one exception to that which is the for sale construction portfolio which I talked about in our talking points. But quickly dividing this up, we've got the multi-family business, it's about $5.4 billion. And this multi-family segment which is apartment rentals has historically been very resilient to economic downturns, and I think we expect the same this time around. About 70% of our multi-family properties are subject to government mandated rent restrictions and it provides a level of stability that doesn't exist in other markets in America. So that one is probably the very best performing, the one we are the most optimistic about it.

Our office portfolio is largely composed really of sort of class B and C properties located throughout the five boroughs, and they have a really quite diverse tenant base. And we have stayed away from some of the biggest signature kind of office buildings, I think are a little more challenged at this point. We have, over the years, and this is a great heritage from John Kanas and John Bohlsen have, the underwriting standards for this portfolio are rigorously, uncompromisingly based on in place cash flows. They don't bet on the come with respect to rent rate escalation. There were relatively low LTVs in the structure. And so far this is performing pretty well.

Our retail portfolio is composed mostly of neighborhood and community centers that are grocery anchored. In particular, the grocery anchored retail centers tend, in these downturns, to be doing a little bit better so that's working pretty well. The construction portfolio again is a big exception to that. The most important thing about that is it's just relatively small. And I mentioned the for sale construction properties there under significant pressure but I think we've tried to be pretty disciplined in working through our portfolio and identify those that are weak.

On the C&I side, we are really pretty well diversified across many industry's and middle market borrowers, and this is also performing really quite solidly. So we are going to watch very close the developments in New York. It's obviously, no matter how good the numbers can be, it's obvious that New York has a long way to go in this downturn, but I think New York itself and we with our underwriting at least start in a pretty good place as we weather what could be a big storm in New York.

Next question please.

We'll go next to John Stilmar with SunTrust Robinson Humphrey.

Good evening, gentlemen. Quick question with regards to the balance sheet. Clearly your strategy of favoring liquidity and preserving the ability to allocate capital to different businesses seems to be very evident. But can you put some fence posts in around your guidance of flat earning assets? First of all, is it managed flat earning assets or reported? And secondly, can you talk about the dichotomy between the actual core commercial lending book, consumer lending book and then the liquidity portfolio and roughly what we can expect for dynamics of that over the next 12 months as your base case or fairway assumptions right now?

Sure, John, it's Gary. Just with respect to your first question, the flattish earning assets is on an average managed basis with Chevy Chase. With respect to the dynamics going forward, again I think we would expect that this may or may not be the high watermark for the percentage of our portfolio that's in investment securities. If not, we are probably pretty close to it based on the opportunities that we see in the markets. So I would expect to see that portfolio starting to come down.

The question that's tough to answer is when we will see the loan portfolio grow, net of all of the attrition and charge-offs and so forth, and that's really going to be dependent more on the economy. So, just looking forward, things stay more or less as they are. You can see a little bit of shrinkage. Most of that you would see it coming from both investments and loans unless we see opportunities surprisingly show up on either side. Longer term I think you will continue to see shrinkage in the investment portfolio but certainly we would expect to see some growth in the loan portfolio. I wish I could give you the dates on which all of that's going to happen but I would need a crystal ball that's a lot better than the one I have right now.

Perfectly understandable. I hate to bring up the securitization trust again, and it's nothing regarding accounting, but one of the things we've noticed is that over the past couple of months there's been at least a divergence between the managed statistics, credit statistics, and the trust statistics. They've always been a little bit lower but that difference has become more amplified, or the difference has become greater. Can you help me think through what some of those reasons may be, and how should we think about that as we are looking forward and gauging future credit expectations given some of the detail that's provided in the trust?

I can give you a couple of hints. They won't always work, John, but in your own mind, if you see things coming out differently than you expect, first thing you should keep in mind is the managed US card statistics that you see every month include all of our unsecured nationally originated consumer loans. That includes ILs. And so you are going to see that affecting what's going on in the managed, but that doesn't necessarily affect the trust.

Secondly, a month lag under normal circumstances usually doesn't create a lot of disconnect, but given the speed with which things are happening, both on the credit side and maybe on the revenue side, just having a lag of a month or so in the trust could also have an impact. And then. finally, just remember that the trust and the managed book are not exactly a mirror image of each other and so we can have slightly different performance on the balance sheet versus off. And then finally on the balance sheet you are going to have more of a denominator effect, as well. So ask yourself all of those questions, and I'm sure you'll ask our IR team those same questions, those are the ones you should be asking.

Next question, please.

We'll go next to Richard Shane with Jefferies and Company.

Hi, guys, thanks for taking my question. You guys provided guidance on January 20. And let's assume you had pretty good outlook into what was going on for the month of January at that point. When you look at what's happened in February, in March and in April, where was the break point? Where was the point where you said, "You know what? Our loss guidance, our credit guidance, needs to be revised"? I don't mean this from you have an obligation to go out and update that but what happened during the quarter? Are things continuing to get worse? Where was the break point?

Richard, I don't know if I would really use just the word breakpoint but when we give guidance about our credit card business charge-offs, it's really based on this what I call what's baking in the oven which is basically driven by delinquencies. And roll rates from one delinquency bucket to another. And the final charge-off numbers, of course, include recoveries and they include bankruptcies. So bankruptcies just come in, in a sense, out of the blue, and they don't even march through the buckets. So, too, with recoveries. Relative to our own forecast, the three things that deviated precisely from our forecasts were bankruptcies, which came in higher, and they, again, don't go through the oven, recoveries which came in lower and don't go through the oven, and then also late bucket roll rates increased somewhat also and that, yes, is part of the oven but it's the latter part of that. But that's how the number ended up being I think 30 basis points higher for the quarter.

And, of course, at the same time -- so that was from a metrics point of view -- at the same time, of course, Richard, unemployment was massively accelerating during the quarter. So it is both the case that we said we exceeded our own internal estimates with respect to the card business, but I think it's also the case that the electrifying increases in unemployment have not thus far been associated with electrifying increases in some of the credit numbers.

Got it. And that's actually a very helpful answer because I think what it suggests is that it was somewhat linear. The follow up to that is you saw three -- let's ignore unemployment for a second -- you saw three anomalous events within your portfolio. You guys have an enormous amount of data and you are very good at mining it. Historically, the anomalies that you saw -- the spike in bankruptcies, the deterioration of late stage roll rates, and the deterioration of recoveries -- is that a sign that things are getting worse or is that a sign that the problems are starting to burn out? Where does that occur in the credit cycle?

Richard, I don't even think these things rise to be called really anomalous events. This world has so much uncertainty around there. When we try to guide you with what's baking in the oven, it is still an imprecise thing. I don't think any of us would characterize the developments in BK roll rates or recoveries to be anything more than just, in a sense, worsening. The thing that probably most has our attention in the quarter, really, are none of these things. It's really the very significant increase in unemployment rates.

So if you also go back and just track how all the contributors to losses have gone -- contractuals, bankruptcies and recoveries -- the one that is most strikingly degrading over time is bankruptcies. And recoveries is probably, recoveries moving closer to contractuals but a little bit worse. It's just an example, Richard, despite all of our good efforts to try to carefully forecast this stuff, it's just a reminder, at the end of the day, that this is an imprecise science, but I wouldn't get too carried away with the anomalous nature of these events.

Next question please.

We'll take our final question for the evening from Ken Bruce with Banc of America-Merrill Lynch.

Thank you. Good evening. And appreciate your taking the time to answer all the questions. We discussed the nature of the installment loans and I was hoping you might be able to provide some qualitative information about what is in that portfolio. I know you've said in the past that they were high FICO, higher indebtedness borrowers. Can you provide any additional clarity as to what's in that installment loan book, why it's performing as bad as it is, why you are or if you are concerned that the broader consumer revolving portfolio will begin to demonstrate similar trends, please.

Yes, Ken, these loans went mostly to high FICO customers, a lot of them fairly super prime customers. But the key thing is, Ken, they tended to be relatively more indebted customers than in our card business, and that's why they've proven to be ultimately more vulnerable in this downturn. Now it's not that in doing the installment loan business we sought more indebted people. It's really the nature of the selection that happens with respect to this product. We attracted people who had very good credit records but had higher indebtedness. And this has always been something we've been very cautious about, frankly, across our whole business. It's a key reason we've had a relatively low mix on the revolver side of more indebted folks. But here is an example probably within our portfolio, an example of the part of our business that attracted relatively more of the higher indebted folks here.

However, there is another thing about this, Ken, though, that is really charge-off mass, and that is the relative growth of the installment loan business was a fair amount higher over the last, probably in the '07, '08 time period than the credit card business, which really didn't basically grow at all. And the installment loan business started off with a much smaller base. So you have just the mass of more recent vintages here that is also really affecting the metrics. And we have certainly found with respect to -- it's almost a universal thing one finds across all the credit businesses. The vintage that you originated right in the penultimate days before the downturn, those tend to be performing the worst, and that has a lot higher mix in our installment loan business, and we are probably less than the average card company have that kind of mix in our card business.

Then, finally, the installment loan metrics have a big denominator effect because we are basically shutting down the originations of these things. So all of those are conspiring to give this effect, but we are junkies about analyzing where you get positive and negative selection in credit. This is one of the wonderful and awful things about lending. It's not like actuarial prediction of things in the insurance space. This is about things at the intersection of supply and demand, and it's all about whether you attract positive or negative selection.

One thing that I've always liked about the credit card business is that it attracts people who are not solely there just for a loan. The product, by being a combination of a transactional product and an occasional or opportunistic borrowing product, it tends to have better selection sometimes with respect to credit and also a better opportunity for revenue. And a greater resilience for things that we've talked about. So that's the IL. story, Ken.

Okay. And when you walk in on Thursday to this working session with the Administration, are you at all concerned that they are going to be bullying the credit card industry to be more lenient on credit and doing some things that are, frankly, counter-productive given the economic cycle?

I don't know if we really know quite what to expect from the meeting on Thursday. But as a macro point, we are very concerned about the highly politicized environment right now. One thing about the credit card business, this is a very complicated business. Witness the fact that the regulators in doing Reg AA, UDAP rules took basically two years, 65,000 comment letters, and many what feels, I'm sure, to them like life times to pull together the consumer issues and the safety and soundness issues in a very, very thoughtful set of rules.

And now we enter the political environment and the intersection of a lot of controversy about credit card practices at the very same time, of course, of the big downturn. And I think this is a high stakes environment. And the most important thing is to get past the rhetoric to focus on really what's going on in the business, what is already being achieved by the Federal Reserve rules that haven't even been implemented yet, and also to understand the consequences of what may happen with respect to consumer credit availability by virtue of some of the ideas that have been proposed in Congress.

So this is a high stakes time for card companies. It's a high stakes time for what happens with respect to consumer credit availability and we look forward to a good conversation on that.

That concludes our earnings call for this evening. Thank you very much for joining us on the conference call tonight and thank you for your continuing interest in Capital One. The Investor Relations staff will be here this evening to answer any further questions you may have. Have a good evening.

That does conclude today's conference call. Thank you for your participation. You may disconnect at this time.