Capital One Financial Corp (COF) 2009 Q2 法說會逐字稿

Good day, everyone, and welcome to the Capital One second quarter 2009 earnings conference call. (Operator Instructions). At this point, I would like to turn the conference over to Mr. Jeff Norris, Managing Vice President of Investor Relations. Sir, you may begin.

Thanks very much, Ericka. Welcome, everyone, to Capital One second 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 website at capitalone.com and follow the links from there. In addition, to the press release and financials, we have included a presentation, summarizing our second quarter 2009 results. With me today are Mr. Rich Fairbank, Capital One's Chairman and Chief Executive Officer, and Mr. Gary Perlin, Capital One's Chief Financial Officer and Principal Accounting Officer. Rich and Gary will walk you through this presentation. To access a copy of the presentation and the press release, please go to Capital One's website, click on Investors, and 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 day 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 the actual results to differ materially from those described in forward-looking statements. For more information on these factors, please see the section entitled Risk Factors in our annual and quarterly reports filed with the SEC, and accessible in Capital One's website, and also the forward-looking statements section in the earnings release presentation. Now I'll turn the call over to Mr. Perlin. Gary?

Thanks Jeff, and good afternoon to everyone listening to the call tonight. I'll begin on slide three. In the second quarter, Capital One earned $224 million or $0.53 per share prior to impacts from the government preferred share investment. After including a $462 million accounting impact of the June redemption of the shares, and $38 million in preferred dividend payments in the quarter, deposited $0.53 per share becomes a loss of $0.65 available to common shareholders. These quarterly results also include a pre-tax expense of $80 million for the FDIC special assessment. partially offset by pre-tax gain of $65 million from the sale of MasterCard stock. Performance in second quarter continuing operations primarily reflects the economic environment, and our actions to manage the Company through the downturn. Revenue increased $418 million in the quarter driven largely by two factors. First, our margins improved. This improvement was driven primarily by reducing our funding cost through better pricing, and managing the mix of our liabilities to bring down our weighted average funding cost by 36 basis points. More on funding costs in a moment.

And second, we posted a full quarter of Chevy Chase bank revenues. Let me point out that while Chevy Chase bank results remain in the other category in the segment reporting supplemental tables, we've also included a specific schedule in the tables to outline it's results for the quarter. Chevy Chase bank will be merged into Capital One NA on July 30th, and the results will be integrated into our existing business segments in the third quarter. While they didn't materially impact the quarter-over-quarter revenue change, we also recognized a negative $127 million valuation adjustment to our retained securitization interest, and suppressed $572 million in fees assessed, but deemed uncollectible in the second quarter. About half of the valuation adjustment was driven by an increase in the amount of subordinated asset backed notes we retained, in conjunction with the issuance of new public ABS in the quarter.

And the other half of the valuation adjustment was driven by an increase in the size of the spread accounts, as we slipped just below our three month average 4.5% triple D trigger in the common securitization trust. The overall improvement in revenue was partially offset by an increase in non-interest expense, which resulted primarily from a full quarter of Chevy Chase bank expenses, and the FDIC special assessment. Provision expense was down $228 million quarter-over-quarter with an expected modest increase in charge-offs, more than offset by the swing from the $124 million allowance build in the first quarter, to a $166 million allowance release in the second quarter. US Card more than accounted for the entire allowance release in the second quarter where $1.9 billion of reported loan contraction led to $183 million release in that business, despite the fact that we maintained card coverage ratios.

The $68 million build in the local banking segment driven mostly by worsening of credit trends in commercial, was mostly offset by the $61 million release in auto to reflect both improving charge off trends and declining loan balances. As we turn to slide four, I'll discuss how the changes to our allowance have impacted our coverage ratios. For the total Company, our allowance as a percentage of reported loans remain flat in sequential quarters at 4.8%, up 143 basis points from the year ago quarter. In the second quarter, we maintained or increased our ratio of allowance to both reported loans and reported delinquencies in nearly all of our businesses, as we anticipate higher losses than today's levels. With a coverage ratio of allowance to reported delinquencies at historical highs for unsecured lending businesses, our allowance anticipates a full 12 months of losses that are higher than today's levels.

Let's turn to slide five where we see the both cost and revenue margins improved in the quarter. On the revenue side we saw significant improvement in both our net interest and revenue margins. Our NIM improvement of 30 basis points was driven by a reduction in our cost of funds. Despite the continued mix shift of assets from loans to lower yielding investment securities, we managed to maintain a stable average weighted asset yield allowing the cost of funds improvement to benefit NIM. It's also worth noting that this 30 basis point improvement is actually understated. It's a full quarter of the lower yielding Chevy Chase bank portfolio decreased NIM by about ten basis points, quarter-over-quarter. In addition to the factors driving up NIM, revenue margins improved, as gains from the sales of securities through our investment portfolio and the shares and MasterCard were accompanied by season gross interchange income stemming from 10% higher purchase volume in the quarter.

We continue to aggressively manage our costs bringing down our efficiency ratio, while absorbing a full quarter of the historically higher efficiency ratio of Chevy Chase bank, the FDIC special assessment and ongoing integration expenses. Looking ahead, while our efficiency ratio may fluctuate as a result of these integration expenses and potential swings in revenue, we remain committed to driving run rate efficiencies over time. Since our results will continue to be influenced by the composition of the balance sheet, I'll discuss our asset mix and funding in more detail on slide six. Our strong and flexible balance sheet continues to reflect both a secular shift from the strategic choices we've made especially the transformation of our funding mix, as well cyclical trends caused by the current economic environment, especially the impact of lower rates and reduced demand for loans. The average earning assets increased by approximately $5 billion in the quarter, more than entirely accounted for by the effect of a full quarter of Chevy Chase bank loans.

Excluding Chevy Chase loans, average manage loans and legacy segments declined by about $4 billion, despite about $5 billion of new originations. Loan balances to fall in the quarter including the run off of over $2 billion in loans related to businesses we repositioned or exited several quarters ago, such as auto and installment loans. In addition, rising charge-offs, low purchase volumes, particularly in revolving card businesses, weak loan demand and normal attrition also contributed to the decline in loan balances. Our average securities portfolio grew by approximately $3 billion in the second quarter, and now represents 20% of our earnings asset from 18% in the first quarter. While lower yields on the securities we purchased in the quarter led to an overall yield, a lower overall yield on the investment portfolio, the weighted average yield on all earning assets remains stable, because of margin expansion and our loan book. I'll provide more color on the securities portfolio in a moment, and Rich will speak to loan margins later.

On the liability side, we rolled approximately $4 billion of securitization maturities in the quarter, including the issuance of a $1.5 billion of new public securities, marking our return as an ABS issuer as spreads tightened to the best levels in the year. We also access the capital markets for a $1 billion of senior notes and a $1.5 billion of subordinated bank debt, both deals done without government backing. As we've noted before Capital One has not had to rely on any of the government programs created to aid capital market access on TALF or TLGP. As a result of these moves, our funding mix remains stable in sequential quarters. The full quarter effect of Chevy Chase bank increased average deposits by approximately $7 billion, although period end deposits were down $4 billion, as we allow higher cost deposits to run off in the face of a contracting loan book. As a result, our ending period loan to deposit ratio remains stable. Our actions significantly reduced our average interest bearing deposit cost which drove down our overall cost of funds by 36 basis points to 2.40%.

As we turn to slide seven I'll provide a more detailed view of our investment portfolio. This portfolio continues to be a source of both strength and flexibility for Capital One. The quarter end investment portfolio grew by $1 billion dollars in the quarter. We continue to believe it is not only prudent to maintain excess liquidity, given today's market uncertainty but also that we can generate attractive risk adjusted returns while doing so. While lower yields on the securities we purchased in the quarter brought down the yield on the investment portfolio by 22 basis points to 4.40 , the rally in the fixed income market in the quarter enabled us to recognize some modest gains from sales of securities as well as improve the unrealized loss position by $316 million. In fact, our unrealized loss position has improved by approximately $800 million since the beginning of this year.

Although securities are currently generating attractive returns we expect that when attractive lending opportunities present themselves in the future, we will be able to finance those opportunities without the need for additional capital by reducing the size of our investment portfolio. I'll discuss capital in more detail on slide eight. Our TCE ratio improved by 90 basis points in the quarter to a healthy 5.7%, driven by our $1.5 billion common equity raise in May, and the a $6 billion decrease in our tangible managed assets. Redeeming the government's $3.55 billion in preferred shares reduced our Tier 1 ratio by approximately 300 basis points in the quarter. However, our period end Tier 1 ratio was only down 170 basis points to 9.7% as our common equity raise in May, along with reduction in risk weighted assets partially offset the return of the government investment. Our Tier 1 ratio now stands at 9.7% or 370 basis points above the regulators well-capitalized threshold.

We know that many of you like we, are paying close attention to the prospective impact on issuer balance sheets of the consolidation of securitization assets required by FAS 166 and 167 currently scheduled to take place in early 2010. It would be an understatement to say there are many uncertainties as to how this would affect regulated financial institutions. Because of the implementation options available to issuers under the accounting standards, recent notices from the FAS B about their intention to move even further towards fair value accounting for all loans, and the absence of relevant rules by banking regulators. As for Capital One, we are hard at work planning for each of the many alternative outcomes. Given the range of potential changes in accounting, it's important to true back back to the ways in which we assure our capacity to absorb expected and unexpected losses.

The most important of these are maintaining an appropriate allowance for expected losses and managing capital to a healthy TEC ratio. The TEC calculation is blind to on or off balance sheet treatment of assets in the denominator. In the numerator includes only common equity. Under scenarios in which we might build additional allowance as a result of the consolidation, this could reduce the TEC numerator. But such an accounting change if it happened would simply move resources to absorb future losses from one part of our balance sheet retained earnings, to a different part of our balance sheet, the loss allowance, thus these accounting events, however or whenever applied do not affect our true economic earnings power, our risk position or our capacity to bear that risk. That's why we are confident in the accounting change in and of itself, will not require us to add to our common equity.

Unlike TEC regulatory capital calculations are more complex and subject to change. Our ratio of Tier 1 capital to risk weighted assets, and similar regulatory ratios are strong. As you can see in slide eight, they are comprised of very high quality capital. They've been validated by our supervisors, as evidenced in our s-cap results, and our recent redemption of the TARP preferred shares. We still value however the flexibility provided by strong regulatory capital ratios especially in uncertain times like these. Therefore we've strengthened our regulatory capital base with a $1.5 billion of subordinated debt, and we'll continue to look at similar opportunities as appropriate. Turning to slide nine, I'll touch on the financial performance of our other category before turning the call to Rich. We experienced a $40 million loss in the other category in the second quarter, and $86 million improvement from the prior quarter. There were a number of largely offsetting items. Strong revenue from our Treasury, and a modest profit from Chevy Chase bank were more than offset by the FDIC special assessment, losses from the GreenPoint HELOC portfolio and restructuring costs. I'll now turn the call over to Rich to discuss the performance of our national lending and local banking businesses.

Thanks, Gary. Our US Card business posted $168 million in profits in the second quarter. The primary driver of US card profits in the second quarter was lower provision expense, as the pre-tax allowance release of $183 million more than offset rising charge-offs. As Gary described, the allowance in US Card was entirely driven by the decline and reported loan balances. The allowance as a percentage of reported loans was flat, and the allowances of reported delinquency actually increased. US Card net interest income improved as a result of lower funding costs, and a modest improvement in finance charge revenue, from the revenue enhancement actions we took earlier this year. The improvements in net interest income were offset by a decline in non-interest income, as we continue to see customers behaving defensively in the economic environment, spending less, exercising caution to avoid fees and working hard to remain current.

Revenue margins for the second quarter improved to 14.5%. We continue to expect that US Card revenue margin will increase in the second half of 2009. We anticipate that revenue margin will be above 15% in each of the last two quarters of 2009. For the full year, however, we now expect the average revenue margin will be a bit below 15%, as revenue improvements will be partially offset by the effect of defensive consumer behavior, and early implementation of some aspect of the new card law that we expect to complete later this year. The international businesses posted net income of $5 million in the second quarter. We've been retrenching in the UK business for sometime now, and we've been cautious in Canada in anticipation of the credit worsening that began in the first half of 2009. As a result, local currency international loan volumes have been declining.

The dollar increase in international loan volume in the second quarter resulted entirely from foreign exchange impact. Capital One Auto Finance delivered net income of $97 million in the second quarter. Second quarter net income was helped in part by a $60 million pre-tax allowance release, driven by declining loan balances and better than expected credit performance. Our 2008 origination vintages are delivering strong results. We've been able to originate loans with lower LTV to customers with higher FICO scores. At the same time we've been able to improve pricing and margin in the current competitive environment. As a result, we expect that the 2008 originations will yield above hurdle risk-adjusted returns and the performance to date is tracking at or above our expectations.

Although auto finance results through the first half of 2009 are encouraging, we remain cautious. By definition the seasonal element of strong first half credit performance will not persist. So we don't expect this level of profitability to be our run rate for the remainder of 2009. It is uncertain how long we'll continue to benefit from rising used vehicle prices and recovery. And the continued strength in the economy and the auto industry create continuing uncertainty about the near term results of our auto business. The local banking business essentially broke even in the second quarter, despite cyclically high provision expense. Pre-provision, pre-tax earnings increased, as revenue improvement outpaced the modest increase in non-interest expenses. The revenues increase in the quarter resulted from favorable loan and deposit pricing, higher average deposit balances, and improving deposit mix.

Provision expense remains elevated at this point in the cycle, but declined from the sequential quarter as the allowance build in the second quarter was lower than the allowance build in the first quarter. Our local banking allowance coverage ratio as a percentage of reported loans increased. Slide ten shows credit performance in our national lending businesses. Economic deterioration continued during the second quarter, although the pace of deterioration was partially offset by seasonal tailwinds, and our ongoing efforts to aggressively manage credit risk. As a result, delinquency and charge off rates increased across most of our lending businesses although the pace of deterioration slowed. In fact we saw a modest improvement in our US card delinquency rate and our auto finance charge-off rate. US Card charge-off rate increased to 9.2% for the second quarter. About 45 basis points from the second quarter charge off rate resulted from declining balances, and about 10 basis points resulted from implementing the OCC minimum payment policy. The second quarter charge-off rate also includes an offsetting positive impact of 35 basis points from a change in our bankruptcy recognition process that we noted in our monthly credit AK filings during the quarter.

While our internal guidelines require bankrupt accounts to be charged off within 30 days, our practice had been to charge off customer accounts within two to three days of receiving notification of bankruptcy, due in part to increase in the volume of bankruptcies, we have extended our processing window to improve the efficiency and accuracy of bankruptcy related charge off recognition. The new process remains within Capital One's guidelines as well as regulatory guidelines that bankrupt accounts must be charged off within 60 days of notification. This was the one-time impact limited to the months of April and May. It is now run it's course, and the June monthly credit results were not affected. Without this processing change, second quarter charge off rate would have been 9.6%.

The US Card delinquency rate improved modestly to 4.8% at the end of the quarter. Second quarter charge off and delinquency trends were generally consistent with expected seasonal patterns, and in line with the expectations we articulated last quarter. We expect further increase in US Card charge off rates through 2009 as the economy continues to weaken. We also expect that our US Card charge off rates will deteriorate at a faster pace than the broader economy, as a result of the denominator effect, and our implementation of the OCC minimum payment requirements. While many credit card issuers experienced declining low balances, we expect that our denominator will decline more than the industry in the second half of 2009 as a result of installment loans running off.

As we discussed over the parse couple of quarters, our US Card business includes about $9.3 billion in installment loans, down from about $10.6 billion at the end of the first quarter. We essentially stopped originating installment loans late last year, so the portfolio will continue to shrink as the outstanding loans amortize. Installment loans account for 14% of US Card balances but we expect that run off of installment loans will drive about a third of the expected denominator effect. Combining both revolving card and installment loans, we expect the denominator effect to increase third quarter charge off rates by about 40 basis points for the US Card business. As we've discussed in prior quarters, we are the only major credit card issuer implementing OCC minimum payment policy now, as we are not regulated by the OCC when the policies were put in place several years ago in a wholly different credit environment. We continue to analyze (inaudible) sell data to refine and update our estimate of implementing OCC minimum payment policy.

We now expect the OCC minimum payment impact to drive around 80 basis points of charge off rate in the third quarter, and 20 basis points in the fourth quarter and into 2010. Taken together, we expect the denominator effect, the OCC minimum payment effect and the absence of the bankruptcy processing benefit will result in about 150 basis points of higher US Card charge off rate in the third quarter before any charge off rate effects of continued economic deterioration or seasonality. Switching from quarterly to monthly charge off rate, we expect that OCC minimum payment effects will be significant in each month of the third quarter. Beginning with June to establish a baseline, we estimate that the June monthly managed charge off rate for US card included about 20 basis points from the OCC minimum payment effect. We estimate this impact will be about 120 basis points in July, 80 basis points in August, and 50 basis points in September.

Credit trends in the international business reflect increasing economic deterioration in the UK and Canada. While the Canadian portfolio has been relatively stable for several quarters, the Canadian economy and credit trends continue to show signs of weakness in the second quarter. Auto finance charge off rate continued to improve in the second quarter driven by several factors. Charge-offs exhibited expected seasonal improvements in the second quarter. Used car prices have been improving for several months resulting in lower charge off severity, And our investments in auto collection and recovery operations are paying off. We realized improvements in charge off rate even though the denominator declined by nearly $800 million as a result of actions to retrench and reposition the business in late 2007. Auto finance delinquency rate increased modestly from the sequential quarter, following expected seasonal pattern. We expect auto finance charge off and delinquencies to increase in the second half of 2009, in line with expected seasonal patterns, continuing economic deterioration, and uncertainty about the sustainability of favorable used vehicle prices.

Before moving on to commercial credit, I'll update our economic outlook. We now expect unemployment rate to increase to around 10.3% by the end of 2009, up from our estimate of about 9.6% last quarter. Our prior estimate for home prices was for the Case-Schiller 20 city index to fall by about 39% peak-to-trough, we now expect a modestly worse peak-trough decline of around 42%. To date, this index has declined by about 31% from it's peak. been and continue to be the economic variables with the greatest impact on our credit result. Slide 11 summarizes credit performance in our local banking business. Charge off rates and nonperforming loans as a percentage of managed loans both increased in our local banking business in the second quarter. The increases resulted from continuing economic stress in the metro New York City market, and to a lesser degree in Louisiana and Texas.

In our commercial lending portfolio, the increase in nonperforming loans and charge-offs was primarily driven by our middle market portfolio, and the construction segment of our commercial real estate business. While nonperformers and charge-offs in our construction portfolio have been elevated for the last three quarters, nonperformers and charge-offs in our middle market portfolio has been increasing only modestly until this quarter. The recession which hit construction and consumer portfolio some time ago has finally started to have its impact on the middle market portfolio. In the consumer portfolio, residential mortgage nonperformers and charge-offs increased in the quarter, as home prices continued to fall.

Let me pull up and spend a few minutes providing more detail in what is in our commercial lending portfolio. Our largest portfolio is commercial and multi-real estate at $13.6 billion, 81% of this portfolio is in the New York metro area. Most of this is permanent loans from multi-family, office and retail real estate. Construction lending comprises only $2.3 billion or a little under 10% of our overall commercial lending business, and less than half of that is for sale residential construction. This is far less than what you would find at most other large banks. In our CRE business we are a relationship based cash flow lender. We underwrite to in place cash flows, and not to aspirational rent increases. Our average debt service coverage ratio remain strong averaging 1.7 times. And our average LTV a origination is about 60%.

To date, the CRE portfolio has performed better than the industry averages. Our nonperformers and charge-offs have nevertheless been rising, but the deterioration is concentrated in the construction sector. We expect credit losses to remain elevated for the balance of the recession, but we also expect that our CRE portfolio will continue to outperform the industry as a whole for several reasons. We have discipline lending standards and relationship oriented approach. We have a relatively small exposure in (inaudible) and a relatively large exposure to New York multi-family, because of rent controls and supply limitations, New York City has been relatively resilient to recession. Our second largest portfolio is middle market at $9.8 billion.

These are typically C&I loans made to private middle market companies. Approximately half of the portfolio is in Louisiana and Texas, and a third is located in the New York metro area. Our portfolio is diverse with less than 10% of the portfolio in any single industry. We expect that continuing economic deterioration will drive further increases in middle market nonperformers and charge-offs, although we expect that the portfolio will continue to outperform the industry average for several reasons. Our lending strategy focuses on hard asset collateral coverage and proven cash flows.

We have steered clear of more risky loan products, such as enterprise value lending, and broadly syndicated loan participation. And we follow a relationship driven strategy that focuses on borrowers with whom we have had long and deep relationships. We believe that the continuing recession will drive further increases in nonperformers and charge-offs across our commercial lending businesses. But we also believe that our conservative underwriting, relationship-driven strategy, and favorable portfolio mix within commercial lending, results in a commercial lending portfolio that is well position to weather this recession. And when compared to large banks, commercial loans are more smaller percentage of our total Company managed loans.

Beyond the commercial lending business you can see credit trends in other parts of our local banking business in the second quarter press release table. Small ticket commercial real estate was part of the GreenPoint Mortgage origination business we shut down in August 2007. Although we are no longer originating these types of loans, we still have a $2.5 billion portfolio of loans on our books. It's a weak portfolio and we are working it out. The significant rise in nonperformers is the result of the long and involved work out process, due to the nature of the collateral, and the fact that the court system is clogged, and the simple fact that delinquency rates are rising. Similar to residential mortgages, this causes significant accumulation of nonperformers prior to foreclosures. We are increasing the resources dedicated to this portfolio, which will help us resolve bad loans faster, but we expect nonperformers to remain elevated for the foreseeable future.

The increase in charge-offs is a function of more loans going to foreclosure, combined with falling collateral values. We expect further worsening in the credit performance of this portfolio and have incorporated these expectations in setting the loan loss allowance in our local banking business. Our small business lending portfolio includes about $4.6 billion in loans to small businesses in our local banking markets. Similar to our middle market business, our strategy is to focus on borrowers with whom we have broad-based banking relationships. We have seen a moderate increase in nonperformers and chargeoffs, as expected at this point in the economic cycle, and we expect that this portfolio will continue to show elevated nonperformers and charge-offs for the balance of the recession.

Our consumer lending portfolio in local banking is comprised primarily of residential first mortgages and branch based home equity loans. The mortgages in this portfolio are high FICO, low LTV and relatively well seasoned. These home equity loans are entirely within our branch footprint, and are mostly first liens. As I mentioned earlier residential mortgages nonperformers and charge-offs increased as home prices continued to fall. Credit trends for branch based home based equity and other consumer were relatively stable in the second quarter. The local banking consumer lending portfolio does not include the Chevy Chase bank mortgages or the run off portfolio of GreenPoint HELOC. Most of these are held in the other category.

Turning to slide 12. I'll discuss a key piece of news from the second quarter of 2009. The passage and signing of the new loan on credit card industry practices. As you expect, we are very hard at work at developing and testing new strategies to anticipate and respond to the new law, and the new credit card market it will create. Based on our work thus far, we can draw several high level conclusions. We believe the new credit card industry law will profoundly change the structure and competitive landscape of the entire credit card industry. We expect new law will lead to a constriction of credit, and the reduction in the resiliency of the industry

With respect to revenues, we believe all issuers will see a significant redistribution of where credit card revenue comes from. There would be a shift away from penalty fees, penalty repricing and the use of practices like double cycle billing and payment allocation.. Instead the economics will be embedded and in clearly disclosed headline prices like annual percentage rates and annual fees. In our view, that's really at the heart of the new law. As a result of this redistribution of the model, it's likely that long zero percent teasers which relied on agressive penalty repricing to make the economics work will essentially disappear. We expect that teaser offers will continue, but they are likely to look more like they did in the 1990s when teasers were generally for shorter periods of time, with higher go-to rates. Relative to the industry, we believe our US Card business will be less exposed to the new aspects of the law, because we never relied on practices like aggressive penalty repricing, universal default or double cycle billing.

We do expect to see a redistribution of where credit card revenues comes from in our credit card business but in aggregate. We believe the revenue model will remain largely intact over time. We expect the returns in our card business to diminish modestly from prerecession levels, but to remain very attractive and well above hurdle rates. The timing of implementing these changes coincides with the great recession. Managing our business to both weather the recession and respond to the coming changes in the credit card industry creates risks and potential pressures in the short-term. But in the long term, we believe the new law and the market competitive environment it will create could open up opportunities and be a net benefit for Capital One.

Slide 13 shows the trends in credit card industry used of 0% long teasers on the left, and trends in Capital One market share on the right. We believe that the up front underwriting and pricing for risk has always been one of our most enduring and powerful competitive advantages. The widespread use by some of our competitors of some of the soon to be banned industry practices diminish the power of that advantage. One example of this was the industry practice of using aggressive penalty repricing and payment allocation in conjunction with very long zero percent balance transfer teaser offers. These graphs show the rise of long teasers coincides with the leveling off of Capital One's market share gain. You may recall our quarterly earnings call from this era on which I consistently spoke about the unattractiveness of the prime revolver segment of the credit card market. We felt that the market clearing headline prices zeroed, combined with heavy use of penalty repricing and payment allocation was not a sustainable business practice. Even though the vast majority of the industry in direct mail included these types of offers, we mostly stayed on the sidelines.

Now that the new law has effectively ended these practices, we expect we'll be able to reenter parts of the credit card market like prime revolver. After the new law is implemented many industry practices will be cleaned up, and the playing field would be leveled. This environment will play to our strength including up front underwriting and pricing for RIF, resilient and low cost deposit funding, continuing opportunities for efficiency improvement, and a leading brand. The new law will clearly drive significant change. It creates risks and uncertainties, particularly in the near term when we'll face both the recession and the transition to the new environment. In the long term we expect the constriction of credit, returns that are somewhat lower but still very attractive, and potential opportunities because of the more level playing field, and more sustainable customer practices. All in all, if we had the choice between today's statute quo and the new quo, we definitely would choose the new law.

I'll close tonight on slide 14. Second quarter and near term results remain under significant pressure at this point in the cycle, and we continue to make tough decisions and take the actions that we believe will put our Company in best position to weather the storm, and create shareholder value over the cycle. We tightened underwriting standards across the board. We retrenched and repositioned the auto lending business, and we exited the least resilient businesses like national lending, and installment loans, and small ticket commercial real estate. We maintained our increased focus on collections, with earlier entry, higher intensity and new tools. Even as we invested in increased collections, we made great progress on our efforts to reduce our cost structure and improve operating efficiency to enhance our long term competitive position and build resilience to rising credit costs. And we are taking action to maintain and improve our margins by optimizing the mix of our earnings assets and liabilities.

Collectively, these actions put us in a better position to manage the Company through the downturn for the benefit of shareholders.. They also influenced the second quarter results, in particular the effect of shrinking loan balances are apparent in many of the results Gary and I discussed today. Declining balances impact both the optics and substance of our. second quarter and near term results. An example of optics is the divergence between dollar trends and rate trends for metric like delinquencies, charge-offs and margins. An example of substance is the income statement of benefit of allowance releases that are possible even as we continue to build our coverage for future losses. Against the back drop of economic worsening and volatile markets, our strong and transparent balance sheet remains a source of strength. Allowance coverage ratio remains high. Funding and liquidity remain rock solid, and our TEC ratio was 5.7%, an improvement of about 90 basis points from the prior quarter.

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's markets funding 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 loans emerge, we expect that we'll be able to grow loans by rotating our earning assets from investment securities back into new loan growth.

One of the keys to successfully weathering this storm, is getting to the other side with our franchises intact. Despite declining loan balances, we still believe that our businesses continue to have more than sufficient scale, and that our core national lending and local banking businesses are very valuable franchises. Despite significant economic challenges and legislative uncertainty, we believe that we remain well positioned to weather the storm, deliver shareholder value over the cycle, and achieve our vision of combining great local banking with sustainably high return credit card business. Now Gary and I will be happy to answer your questions. Jeff?

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

(Operator Instructions). Our first question will come from Chris Brendler -- I apologize -- our first question will come from Craig Maurer.

Good evening. First I was hoping you could clarify your thoughts on credit losses. And there's so much noise in the actual rate, I was hoping you could describe what your thoughts are regarding the trend in actual dollar losses.

Craig, a quarter or two ago, we got out of the business of giving forward guidance on dollar losses, just because of all the uncertainty that is out there. That said, the dollar losses actually have been coming in pretty consistent with our expectations. Basically what's happening -- with respect to our view of future credit losses, the economy is in many ways worsened a little more than our expectations, and our own credit performance has come in a little bit, a little bit better than expectation. So in some ways, these are offsetting. So our view of dollar losses has been pretty steady over time. The big thing we want to stress is when you look at loss rates, which is most of the cross calibration among players have, I think for a lot of the players, and even more so for Capital One, the denominator effect is going to become actually, possibly the most significant impact ,even in an environment where we still see credit worsening gradually over time.

Okay. And if I can just follow up. One of the differentiators in Capital One it seemed to me, is your low exposure to C&I lending, especially concerning what the expectations are for that. That segment, can you just discuss what your long term thoughts are with regard to exposure to commercial credit?

Yes, Craig. We have of all the major banks in the United States, we have the smallest percentage of our portfolio in commercial lending, and I think probably a representative portion of that is in C&I lending. Our view is that commercial in the long run is a good diversifier, relative to the flip side of our small exposure in the commercial is of course larger than most other banks exposure, on the consumer side. So long run, Craig, we think that a very conservatively managed commercial business both C&I and local commercial real estate will, I think, lower the overall charge off rate of the Company, and be an important form of diversification. That said, we are not in any rush to get to that destination. Our commercial business is generally flat these days with respect to loans. Our loan volumes even as on the consumer side leveraging the inherent sort of faster run off that happens in the consumer side, we in fact have been shrinking.

Our next question comes from Brad Ball with Ladenburg FSG.

Thanks. Rich, it sounds like some of the early stage delinquency improvements that you guys have noted, and others have noted as well, it sounds like you are not predicting that will translate into much in the way of improvement in the charge-offs at least over the foreseeable future. Could you talk about why that would be? Is it because those early improvements are driven by factors other than improving underlying credit?

Yes. So Brad, when we talk about early stage delinquencies, let me make a few points here. First of all, kind of, the conventional wisdom of how credit works in a card business is -- consumers enter the first stage of delinquency, and then of course make their way through the six buckets to charge off. And when there's improvement, it will show up in lower entry into these buckets, and that will, six months later make its way into lower charge-offs. By far the most important thing, relative to that conventional view that we have seen in this downturn, and continue to see it in the second quarter was the entry into the first bucket of delinquency.

That is the bucket that you don't even see in the 30 plus delinquency, Brad. That is strikingly the rate of entry into that bucket is strikingly down. For example, at Capital One the proportion of our card holders entering that first bucket, relative to a year ago is actually down like 11%. And this is the phenomenon we think of sort of changed behavior by consumers, that the people who have the means to do it are just being extra careful to avoid going into delinquency, to avoid going over limit and other things as well and that had the revenue impacts we talked about. So up until this last quarter, Brad, we saw the stubborn effect of very low flow into the first bucket. And then frankly degrading flow across the rest of the buckets, and so even as the first low rate with respect to the first bucket was declining, all the other roll rates were rising, and this is what we talked about the increasing slope of the roll rate curve which created a sour spot of fewer revenues and more charge offs.

The only thing that I do want to flag here, is that in portions of the card business, there is a small, and I say a small effect, where we've now seen some benefits of the early buckets making their way through the next couple of buckets. This is a small effect. We don't think it indicates any really important, green shoots in the credit performance of consumers, but relative to the alternative, it's a slight positive. But mostly I think what the second quarter is about, is really about seasonal benefits. I think some benefits from the stimulus direct cash to consumers pocket, stimulus, and collectively a slightly better than expected credit performance.

Thank you. That's very helpful.

Next question please.

Our next question will come from Chris Brendler with Stifel Nicolaus.

Hi, thanks. Can you talk about the card act? You mentioned some early implementation that may happen this year. Can you talk a little about that, and then sort of more broadly it seems like the biggest impact immediately to Capital One, is the over limit fee opt in. Can you talk about some of your strategies there to offset there? How agressive will you be in trying to get consumers to opt in? Do you have any pricing strategies that may offset that? Do you care to quantify that? And then a broader view question I have after that. Thanks.

Okay. Brad, the card law, of course all the conversation everybody has about the card law is sort of the policy impact -- behind that, they are not very extensively talked about thing, its just breath taking the kind of logistics and executional challenges associated with just such a comprehensive set of changes. There are for Capital One about 200,000 IT hours that we are going to need to put in to achieve that compliance on things like statement design, delivery date, things like this. There are massive changes in communications with customers, statements to account in recoveries. And so these costs are many tens of millions for Capital One. But of course other than a lot of hard work by very talented people,, that's something that we certainly expect to do.

And with respect to, on the policy side, as we have said, we believe we are less affected from the vast majority of the things that are in the card legislation. Because of our lower credit lines, we do think there's more impact on us on the over limit side. But I think that what we would expect there -- even that impact, Brad, is moderating -- I mean Chris, excuse me, is moderating because ironically the whole phenomena of changed behavior that we are seeing during this recession, actually lowers the size of the impact sort of ironically on Capital One. But with respect to over limits, we are extensively conducting testing right now on OL opt in -- I think it's our expectation where the industry is probably going to go. Probably some blend of lower fees and that will help achieve higher opt in rates. So we are still testing it, and we'll go from there. Do you have another question?

I do. Thank you. Just as I look back at Capital One success in the card business, it seems to me that a lot of your success has been using a very steep slope on the risk-based pricing. You were able to offer -- really offer really agressive rates, and sort of invented the whole super prime segment by forecasting which customers would not only experience good credit trend, but if -- they got into trouble, you had to go to your price --so you could offer the 409 fixed rate card back in '03 or '04 that was, in the subprime business you had a very low price up front in subprime loans, like 12.9 I think was the prevailing offer. That's going to change with the new law. The price base strategy that you were so good at over the years, I think really becomes a challenge now. My thinking is maybe that cap one in the card business may benefit from a level playing field, but without the ability to reprice, you just join the rest of the pack, and have to offer more prime like offers, more middle of the pack type rates. What do you think about that?

Brad, I think that I would probably take the precise opposite of the description that you made. I would point to the difference between the '90s and the 2000s, those decades. In the '90s, Capital One came out with a very aggressive pricing to an industry that had pretty entrenched higher pricing. We differentiated our selves on very careful underwriting repricing, well in that decade. And this decade has not been about something that you do to consumers soon after you book them, but rather something that one saves for extreme circumstances, like the economic shock that we are going through. So what you described that was the characterization of this decade, has been the exact thing that has troubled us with respect to the competitive environment using very low prices, not so much driven by very discriminating underwriting, but rather low prices that come from being able to have such steep slope of-- in many cases almost immediate, a trigger base repricing. And that enables players -- it doesn't put such a premium on the up front underwriting. It's more about just marketing these kinds of products.

You have seen in our vocal conversations to everyone who will listen, we have been so concerned about, the impact on the industry, on consumers, and on -- in a sense the sustainability of franchises in the context of this. What I am saying is going to happen, going forward is a return more, I think get your head around the way the '90s, without the rapid industry growth in credit card that corresponded with the '90s. But it was about upfront underwriting, if you were going to go for it with an agressive price, you need to back it up with solid underwriting. And to your comment that there would be no repricing in the future, I want to clarify there. It's not that there will be no repricing. There would be no retroactive repricing of existing balances.

The law is explicit about allowing forward repricing for new balances. So the impact of any repricing that happens in the future, would be something that would play out over a much longer period of time . And when I talk about resilience, vis a vis repricing, therefore what I've said, if one is counting on repricing to lead to significant revenue impact, right when a shock to the system comes, forward repricing, the new form of repricing posed by this legislation that is going to have a fairly muted impact, And Brad, sorry --Chris --this will get back to I think a really good healthy competitive business the way it was in the '90s and we are really looking forward to

Next question please.

Next we'll hear from Steven Wharton with JPMorgan

Hi, guys. I just wanted to follow up on the allowance from the US Card business. Based on your revised unemployment forecast, factoring the elements you mentioned in the third and fourth quarter from the OCC changes and such, I guess you are basically saying the charge-offs will go up north of 10% in US Card. And I just want to make sure that the allowance that you established today, and it actually went down a little bit of course sequentially, factors in that higher loss outlook.

Hey Steve. It's Gary. You've obviously heard us correctly with respect to our outlook. And let me just remind you, that the decrease in the allowance with respect to the card business is entirely driven by volume. So if our loan balances had stayed the same, we would have been building allowance, in order to improve our coverages ratios. And just take a look at the increasing coverage ratios both, particularly with respect to delinquencies. It does actually comport with a notion of higher losses in the quarters to come. But again it's all about the volume in terms of this quarter's allowance release. Just take a look at the coverage ratios.

So the OCC law changes don't have any impact on the delinquency rate?

When we look out, Steve, both at expected losses from delinquencies that are already going through the buckets. And when we take a look at the past six months because we allow for 12 months of expected losses, we include in our loss forecasting, losses from wherever they come, including the effect of OCC. And I think Rich went through that in pretty good detail about how much of our expected losses are going to come from that, but they are -- they will definitely be covered in the allowance.

And our next question will come from Joe Mack with Meredith Whitney Advisory.

Good evening. This is Joe, from Meredith's team. I just have a quick question regarding about your unused card commitments, or your open to buy. We have seen that you reduced your lines, but maybe a little bit less aggressively to your peers, and I was wondering given the regulatory restriction and the economic outlook, has that changed how your unused lines are going forward?

Joe, I think the TARP disclosure data was actually very interesting with respect to open to buy, Capital One was among the least -- we restricted open to buy less than I think a lot of other players did. It's think its just a reflection more of the line setting strategy that we had over time, general conservatism with respect to credit lines. and it's also one thing that lowering lines, doesn't have the same benefit as credit and not having them as high in the first place does. So there's some negative selection with doing it which is why we've been cautious, but we have done some line reduction. Do the new regulations, will that affect our view about our open to buy? I would say I don't think that would be that material of an impact to us.

Okay. Thank you very much.

Next question, please.

Your next question comes from Henry Coffey with Sterne, Agee .

Good evening everyone, and thank you for taking my question. The hardest thing to get our hands around is the expected impact of 166, 167. If it's being done at book value, obviously you have to put the full 12 months of reserve. Can you give us some sense of what sort of numbers we should be using to try to quantify that impact?

Henry if you think that is confusing, you should be sitting in our seats. These things are changing as we go along. Regardless of how consolidation takes place under the new accounting guidelines, the one thing that is quite clear, is you add to the denominator, all of the off balance sheet assets which we show in our managed financial reports, and which we include in our TEC ratio. When it comes to the numerator, you are right. If you bring it back at book value, then you have to post an allowance, and that allowance we believe, as with the implementation of all new accounting standards would probably run through retained earnings rather than through the P&L. The size of that allowance is something that will be based on our outlook at the time, and the size of the book at the time.

I'm sure that just taking a look at our current book of securitized assets, and our current coverage ratio, you can calculate what that would be. But again, we are talking about how much of our current retained earnings would migrate through the income statement into, and the balance sheet into allowance. It will still be there. It will just be in a different place. Now, whether or not these assets will come back on balance sheet at book value, is something that we are still studying. Issuers have the option to elect either the book value or fair value. FAS has came out recently with some new statements that suggest all loans may be moving towards fair value, valuation adjustments going through other comprehensive incomes. So exactly where we are going to be when we get to the implementation date, it's kind of hard to say, but you have it right when it comes to the book value approach.

One of your competitors actually disclosed the expected impact based on book value. Are you going to be likely to be doing the same thing on your 10-Q?

If you want to calculate what the impact would be, I think you can do it with the information that we give you. I would just remind you that GAAP does not lead you to do that today, but it will be based on balances at the time of implementation, and it will be based on the election that the issuer makes. But we will be when the time comes, to be sure to give you full and complete disclosure.

Next question please.

Next we'll hear from Moshe Orenbuch with Credit Suisse.

Thanks. I wanted to go back to the question of relating to the issue of how you would fair long term under the new environment. And looking at your slide 13, I mean wouldn't another interpretation of the industry behavior there just be that the industry is willing to take some poor returns, in the hopes of getting them at a later date? And I guess, it's not clear to me why you wouldn't assume that same sort of behavior would persist in an environment under the new legislation. Once the banking industry is healthier, particularly when you think about the fact that most of your big competitors in the business have cards 15% to 20% of their earnings as opposed to some significantly higher number.

Moshe, its certainly -- it's a great question, because one of the things that I've certainly learned over the years about lending, is not just about what we think about a business, the attractiveness is so driven by the behavior of competitors. I actually believe that our competitors have been mostly economically rational over the last decade. I think that frankly, a lot of the irrationality I saw in the last 20 years in the card business related to smaller players, who ended up flaming out. I think the, generally our card competitors are fairly sophisticated. I think they view their card business as an important part of the franchise and their whole Company doesn't depend on it. But our issue with what has happened over the last ten years is less about the economics of doing what has been going on. It's really about the impact on the franchise, and the customer franchise. And I think actually if you look at the returns of the card business, our competitors card business until this very, very severe downturn, during a lot of this period of time they made quite decent returns.

So I don't want to get too far on the other side of your argument because I worry greatly about how the industry will respond here, and I think a very important indicator is to look at what happened to go to rates because in a world where repricing could not be something that sort of happens overnight kind of thing and any repricing would be in the form of very muted and ultimately forward repricing, the go to rate becomes a very, very important destination in a way that it really used to be in the '90s and wasn't necessarily during this period of time, and if we look at the great work that you did, that with great interest would look at your analysis of the mail monitor data that comes in. One thing I immediately look at is what is happening to the go to rate. And go to rate, from your own analysis here, Moshe, if I can read your analysis back to you, the go to purchased APR has been generally over the last,maybe since late last year, it's gone from 11.5 to 12.40.

So it's gone up 90 basis points. But if you adjust for prime, go to minus prime has gone up from about 7% to about 915. So the sort gone up from about 7% to about 915. So the sort of effective economic price in the card business as reflected in go to rate is slowly going up. It's certainly not in my opinion, Moshe,it hasn't arrived at its destination -- a destination that would cover the risk of this business, but I think that would be a key indicator to look for.

Okay. Thanks.

Next question please.

Our next question comes from Bruce Harting with Barclays.

Just a follow-up to Steve Wharton's question. So the decline in provision is due to volume. Are you saying that loans outstanding in the card business will continue to fall, and then a follow-up question would be, same methodology to banking and auto? Are you expecting -- it looks like from the managed balance sheet statistics, you had a sharp drop in total assets at the very end of the quarter. So should we model continued decline in assets? You guys both speak very quickly. I can't write as fast as you speak. You might have covered it, but trying to -- in terms of getting a handle on the allowance connection to where you go with total assets, given that you said look, the important thing would be the denominator effect.

Sure, Bruce. Let's start with the card allowance and the dynamics there, and then talk about the likely trend of loan balances going forward. So within the card book, we had kind of a steady level of decline in reported balances over the course of the quarter, with coverage ratios stable relative to loans going up, relative to delinquencies. All in all, the lower level of balances leads to an allowance release. But let me be clear that, there is no factor in the allowance for an expectation of what balances will do in the future. So this is not a change in our outlook for the future. It is simply the recognized decline in the balances to date. on a reported basis.

So that is what is going in on the card book right now. Again, for the rest of the allowance remember there was a build of about $60 million, $65 million in the bank. Most of that is commercial. That is largely raising the level of coverage ratio. That is not being driven by volume, and that was more or less offset by the decline in the auto allowance, which was really a combination of both better credit and therefore lower coverage ratios, as well as lower volumes. Now going forward, looking at loan balances overall, and Rich mentioned a couple of these items. But just to -- kind of remember, when you add some natural run off in our portfolio, our installment loan business, we are not originating, those are rolling off at about $1 billion every quarter. You see that in the US card segment.

Auto loans given our current level of originations versus how much amortization we have, those are declining anywhere between sort of $700 million to $800 million a quarter. If you take a look at the residential mortgage holdings, in our local banking segment, those are legacy loans, very well seasoned, mostly brought on from Northport, those balances are running off at more or less $500 million, $600 million a quarter. So you have the effect of those three businesses, just to give you a starting point, which is well over $2 billion of shrinkage during the quarter. And then in card, because of the factors that Rich and I both talked to, which is the impact of lower loan demand, the impact of just higher charge-offs. There are a number of factors that are causing a shrinkage in card loans, which is more of a cyclical factor rather than a secular factor having to do with our choice about whether to be in or out of a business, and to what extent. We start off with shrinkage, and then on top of that, certainly in the current economic situation, we would expect to see card balances to kind of continue to shrink. So you can expect to see that going forward. Wherever we happen to be at the end of the quarter is going to drive our allowance, but the allowance in and of itself at any given point in time, is not looking forward to what future balances may be.

Was the local banking, was that the rational for the local banking provision dropping as well, that the loan balance dropped at the end of the quarter?

No, Bruce. The provisioning was lower in the second quarter than it was in the first quarter, but there was still a built in the second quarter even though volume didn't go up. So effectively what you had in the second quarter in the banking segment ,was simply a reflection of the degrading credit environment particularly in commercial.

Thank you.

You bet.

Next we'll hear from John Stilmar with Suntrust.

Good evening. Rich, not to retread on the card topic, but one question I had about the industry going forward, and the repricing and the ability and flexibility with regards to managing a customer, certainly it will be limited to card. Does that give rebirth to the installment lending business, that is something that you have been in and out of the life's Capital One, by virtue of the fact, that the product itself and installment loans defines the terms, and is more programmatic in its features, relative to a credit card, where it seems that the consumer has a lot more of the choice rather than the lender? And I do have a follow up for that.

Yes, John. It's an interesting question. Call me skeptical on this causing that much of a change, the installment loan business. The credit card is a remarkable product that -- I've always loved for so many years and what I like about it, mostly its persist here, but the fact that there's a transaction product, and a borrowing product wrapped into a single product is a very special and unique utility for a customer. The ability to manage that product on a continuing basis is still largely intact after the card act, because a lot of the management relates to dynamic line management. And there is also just the ability to do many customized offers, and to take advantage of the continued rich information that we see with the customer, and therefor to dynamically respond to that. And the repricing is now going to be constraint to more forward repricing. But that's okay as long as you are not counting on a very immediate revenue change in the event of a shock to the system like a downturn.

Installment loans, thinking of it right now, installment loans, and we are living it right now John, you just sit there and watch them, its like watching paint dry, because there's not much you can do about it. The entire product is sort of frozen, and in fact the relationship with the customer is mostly not there. So I think the credit card will continue to be a fabulous cornerstone product. And frankly if I look around our Company where we have the best businesses is where there's the intersection of transactional business and broader financial opportunities. That is in credit cards. That's in the checking account with the consumer. And it's in the cash management and broader commercial relationships that we enjoy. And you look, wherever you see cornerstone gateway transactional relationships you tend to see the -- that's where a lot of the exceptional returns in banking are.

Thank you, And my follow-up question has to do with operating leverage from here. It seems like if you ex out some of the banks, we saw a lot of improvement was in the non-interest expense. Where should we think operating leverage from here for the business? Clearly, the balance sheet will continue to shrink. Should we think about it -- how should we think about it on the dollars versus a relative proportion to balances on the whole, as well as specifically in US Card?

John, its Gary. I think -- it's hard to pinpoint exactly where the operating leverage is going to go. Some of the decline in operating expenses in the card business are simply going to be reduction in variable cost. Especially when volume is down. But there's some real improvements in efficiency in that business as well, which we've seen kind of play through as you've seen and we expect we will see it there. On the banking side, again we've had a certainly a higher efficiency ratio than in our card business, although it's much closer in line with other banks. We are going through still today a rather significant amount of integration.

We are going to be integrating Chevy Chase bank. We are just kind of through the integration of our up -- and we are really trying to make sure that we have a truly sustainable and scalable banking model for the long run. We didn't inherit that from any of our banks, because none of them was as big as we are now, and we got a little bit of catching up to do. And I think we've got some investments there to make, to make sure we serve our customers and build bigger scale. So I think the operating leverage will be an important part of delivery from Capital One over time. I think you are going to see it at different paces in our different business lines. But I think if you take a look at where we've come from over the course of the last couple of years, and our commitment to continue going there, I think you will see operating efficiency as an important hallmark of where we go over the long run.

Next question please.

The next question will come from Andrew Wessel with J.P. Morgan.

Hi. Good evening. I guess my main question is more strategic long term. Looking at the balance sheet in the securities portfolio that will grow, and you mentioned lower loan demand, and the fact that you will be shrinking the credit card portfolio pretty aggressively in the back half of this year. I mean what should we think about kind of 2010, 2011 in terms of where you expect asset growth to really come from? And this kind of ties in into the card act, and how you think about competition going forward for I guess borrower's dollars, as everybody moves up the credit card. Really -- is Capital One is going to look much like a regional bank or a credit card company, or do you expect that to come back in time?

Andrew, I think that Capital One is going to look like it does now. The defining thing would be when the economy turns. So until the economy turns what you will see at Capital One because we take from an originating point of view we look at the economy. And you know how bearish we get on things like that . And for our underwriting we overlay, worse, a lot more worsening on top of the economy that is already worsening. So you'll see generally continued shrinkage across our consumer businesses. You won't see that on the banking side, because they don't lend themselves to -- on the bank commercial side doesn't really lend itself to shrinking. And the interesting phenomenon here is that this shrinking is just another element in the resilience of a thing like the credit card business, and it helped preserve capital and so on. That is -- until now the kind of the inflection point, that's the world that you will see at Capital One.

I believe that the best part of the credit cycle based on a lot of experience on being on the back side of the last two recessions. I think the best part comes from that inflection point for a fairly extended period out after that ,where you have the competitive supply has been the most reduced. You kind of hit an inflection point where from a consumer point of view, adverse selections tends to dominates the credit performance, as you are sliding down in a cycle, tends to flip over to relatively more positive selection. Credit people have taken over every institution in a sense, so it is the most conservative time. In this case you have the overlay of a huge amount of investment by the country in addressing the practices that otherwise would haunt us about the more aggressively in something like the card business. So I think that a lot of planets are going to align at that time. Now to take advantage of it, that we have to make sure we have all the wheels on the bus. That we are not in a capital deficit kind of a situation.

That we are frankly, robustly prepared to take advantage of it. And a lot of our focus right now is just making sure that the Company weathers this storm very sure-footedly so we can be in a position to take advantage of this on the other side. I'm pretty optimistic about that. I think we should all take Moshe's challenge to heart though. There's so much of a change in the US card business, that how the competitors and the timing with which the competition adjusts to the kind of new pricing levels for new originations, and other things will also I think have a sizable impact. But the destination for Capital One, I think is, Capital One is going to be a successful, significant local banking business, in combinations of local markets, but powered by a national credit card business that I think will allow us to generate exceptional returns. And that's been our model for a long time, and I think it will be on display on the other side of this

Just adding on to that for a second Andrew, this is Gary, a little more short-term, our securities investment portfolio is unlikely to grow dramatically from where it's at. We are comfortable with where we are right now. Maybe the opportunities won't be quite as compelling as we've seen in the past. But with a contraction in loan balances, I think what you might see is the investment portfolio staying more or less stable, perhaps loan balances going down. And so the percentage of the balance sheet that is in the investment portfolio might go up for a short period of time. But again the investment portfolio is there to make sure we have the capital and funding to flip over the loans when that opportunity comes. So I think you might expect that over the next period of time.

Great. Thanks. That's very helpful.

Next question please.

Our next question comes from Brian Foran with Goldman Sachs.

Good evening. On the delinquency term, I guess the seasonal impact is quantifiable. Have you run any tests on the stimulus impact to help us understand the way we measure it? It was 20 basis points better this quarter than you would expect it seasonally, roughly for you and the industry. So of that 20 basis points how much may have come from the stimulus and how much just might be the consumer getting a little better?

Brian, we have done a lot of analysis of the impact of stimulus on credit behavior. The way we have done this is to go back to prior times where things like cash rebates were given, where it was identifiable to what consumers got it, at what time. And what we have done is to -- we have gone back and traced the stimuluses that were given by month, and we can absolutely visibly see an effect on consumer delinquency. And that effect actually makes its way through the charge-offs. It's also an effect that not surprisingly, sort of goes away after the stimulus goes away. So what -- so with the stimulus that is going on right now, it is not identifiable as clearly per customer. So we are more extrapolating from the old effects where we had better data to sort of now magnitude.

So for example, in the first half of this year direct government's payment to consumers, including tax refunds, social security checks, things like that were about $140 billion higher than for the same period in 2008. And when we then kind of estimate the size of that impact compared to prior stimulus checks, we believe that there -- that an important part of what seems to be better about credit right now is attributable to this. There's a lot of estimation involved here, but it's one thing that gives us caution about kind of declaring a turn or really the full leveling off of things. So I think that we should all be cautious about that.

There's another effect also going on right now, that's not government stimulus. But it's the equivalent of that with respect to customers, which is what is happening with respect to energy prices versus like a year ago. Now the government stimulus which was $140 billion over the prior period for the first half of the year. For the second half, we calculate that is going to be around a $100 million dollars higher. So this stimulus is going to last these effects. Even if it is the case, Brian, that the stimulus is causing a good part of this better than expected performance, this is still real in the sense it will make its way into the charge offs. It just may not herald quite as significant turn in the economy as what people might otherwise think.

Just a follow-up on that.

Did I say a million? Yes, a $100 billion, excuse me.

I mean there's been a lot of questions about the long term and obviously the card act is important. But just in the near term provision dollars are down two quarters in a row. Revenue is inflected. The balances are shrinking, but you sound pretty bullish on the revenue margin. The preferred dividend is going away. Isn't there some room for optimism about the relative change for near term net income results, or what am I missing in that equation?

Brian, this is Gary. I mean, you have to fill in all the blanks, and certainly you have clarity on what is going away in terms of some of the coupon payments. But I think you have to keep in mind that while provision expense was positively impacted by the allowance release this quarter, and the charge offs went up. And seasonally we should expect to, that are not going to get much relief on that score, certainly with where we are in the year. And where we are in the cycle. Rich talked about the challenges in terms of fees.

So I I think -- I mean when you put it altogether, I think our results are reflective after combination of what you are seeing in the economy along with the actions that we've taken, taking advantage certainly of the lower rates, and improving our funding cost. We think that's going to stick around for a while. Rich talked about the overall margins in the business, but the the countering factor would be volume. A lot of offsetting factors. This is a very difficult time to call the future. It probably feels a little better than last year in terms of direction where everything kind of seemed to be pointing down. Now that we are down, we got arrows pointing all sorts of different ways. But we feel confident that we can manage through it with all the tools that we have at our hand.

I think that there's a number of things that are going on that we feel very good about. I mean just to put a few cautionary comments in here. The worsening of unemployment, and to a small extent HPA as well. That is worsening faster than ours and many people's expectations, and frankly the credit performance that we are observing at Capital One is a little bit at odds with the pretty breath-taking amount of degradation that actually occurred in some of the economic variables.. So for one thing that suggests that there's more than the usual uncertainty. I also said unemployment and credit performance are very correlated, whether you are looking at path downturns,S or whether you are looking cross -sectionally across MSA with respect to this downturn. What didn't matter for most of the ride, but now starts to matter more, is actually the timing of which comes first in a sense. A credit turn or an unemployment turn. And one possible explanation for better credit performance would be warranted by the economic numbers could be some indication that consumers with their own credit behavior actually front run potentially lagging indicators like unemployment. But the other -- so -- Those are some thoughts we have on both sides of that discussion. The other thing I am starting to increasingly believe, is even as it becomes more plausible that we are getting near a peak -- I think in some ways, a lot of the government actions, and things that have happened in this economy may have traded magnitude for length, and I'm growing, getting a growing belief that we may be looking at extended -- even as we reach a peak, an extended challenges. To the extent that we don't have a peak, prior bad recessions have had a sharp peak followed by a sharp decline in unemployment. This may be more of a plateau and that would create obviously a pretty sluggish recovery for all of us.

Next question please.

Next we'll hear from Sanjay Sakhrani with KBW.

Thanks a lot. Gary, as it relates to the reserves is there any reason why securitized loans would decline with the declining balances this year?

Sanjay, again what you saw, let's just take a look at what happened in the second quarter, which we had about $4 billion worth of securitizations maturing. We rolled those $4 billion, either through public issues or conduits, but the overall volume in the business went down. So there was a higher percentage of our book was securitized, but the big driver of where we are going to end up would be a result of what happens in terms of just the managed loan volume itself.

Okay. And then maybe just a question on the trust. I mean we've been looking at the excess spread kind of degregate. And I guess one of the questions I wonder is, do you guys anticipate providing subordination like your peers have, and the only reason I ask because of the implication to rate cap ratios.

Yes. Look, we are a very long active standing participant in the capital markets. We are an issuer of fixed income securities, and we are also a big investor in fixed income security. So whenever there are either downgrades, or threats of downgrades, including those that we don't agree with, we take it pretty seriously, especially if that causes investors to take a loss, realize run-- and even when we are confident the securities will be as good as we are. So I'd say right now, that although the excess spread in our trust has come down somewhat ,and we did just dip below 4.5% three month average level in which we start to trap a little cash which we now have, the strong actions that Rich described about what we are doing in our business, improving revenue margins, agressive loss mitigation efforts, they are designed to bolster the performance of the trust. And for now we are going to see and wait, wait and see how those things kind of play through.

Remember we just issued a $1.5 billion of new non tail hard-backed AAA securities in the quarter, at spreads in the very low one hundred range, hundreds of basis points inside of where secondary paper was just a few months ago. As you say, pretty obvious to us that other issuers with less robust performance and less structural enhancement in their securities has stepped in to provide additional support to their trust. And now we are seeing that those moves may not prove sustainable in terms of insuring a particular ratings outcome.

While I would rather not speculate on specific motives of issuers who have taken extraordinary actions with respect to their trust, in general I assume they were concerned with liquidity, or the strength of their balance sheets, which caused them to step i, and those are things which we have a great deal of confidence. And we'll maintain the strength of our balance sheet. We'll watch how our business performs, how our securities perform, we will see how the world changes. When we get consolidation of asset backs, and in the meantime we'll continue to take whatever steps we feel are appropriate in light of market developments. We'll be aware of what others are doing, but we'll do what's best for all of our stakeholders.

Thank you very much.

Next question please.

Our next question comes from Ken Bruce with Banc of America Merrill Lynch.

Good evening. Rich, we've had an ongoing dialogue as to the performance of the credit card with respect to other assets. And we continue to see mortgage related assets in particular deteriorate. and I was wondering if you have any update to analysis that you performed where customers are making choice decisions to pay back credit cards, relative to other debt.

Yes, Ken. For example, we have told you over time about our examination of our -- of our card holders who are 90 plus day delinquent on their credit cards, and what's happening with respect to them. Typically, we have found the somewhat striking finding that about two-thirds of our US card customers who were still delinquent or their mortgages remain current on their credit card. As of May, this figure was 72%. So it may be less of a comment about how much people are really holding up on their card payment, as much as it is on how they are not holding up on their mortgage payment. I think we've seen inferential evidence that auto and the payment hierarchy can -- and has done pretty well Ken, that as I often joke, people still have to drive to their job interviews, but we have seen some behavior Ken that's been quite striking.

It's almost the reverse of this steepening slope that we have that we have in the card business, where consumers seem to be so earnest to try to do everything they can to pay back their card debt, that we've seen some fairly positive things happening that we infer are telling us something about the payment hierarchy on the with respect to auto. The other thing I would say is that we always also track what is the performance of overall, on a credit card business, the relationship between mortgage holders and nonmortgage holders overall. And there has been a very sizable gap for years to the positive with respect to mortgage holders. That gap still exists but Ken, that gap continues to close, so that it is actually plausible for credit card overall, that these things will touch each other by the time we get to the end of this downturn, and that gap is steadily closing, and continuing over the last six months.

So what a lot of this says to me is just the pressure from mortgage is extraordinary. Consumers knowing that there are options for other debt like auto are really doing everything that they can to pay their debt. If you then go back to the prior commentary about the stimulus effect and the possibly slightly better than expected credit that we are seeing. I think it can be a manifestation of consumers in their choice with their lives, they are really tightening up, increasing savings rate, doing a lot of things to be very careful, and a beneficiary, a modest beneficiary of this has been the providers of unsecured and auto loans.

And last time we spoke you might have felt a little more optimistic in terms of getting through an inflection point in the auto business. Are you able to confirm that at this point, or how do you feel generally speaking in terms of your ability to grow in the auto side. It sounds pretty clear like credit card is still up --

Yes, I think the auto business is certainly, to any of us who look and I'm sure to you as an investor, it sort of continues to provide pleasant surprises to us. In some ways it hits partly because everything that could go wrong in auto has kind of gone wrong. So particularly with respect to probably the biggest single driver of why auto, the industry has done better lately is, just the substantial rise in used car prices, than the massive decline in the past. So we are benefited at Capital One by very, very good performance in our post 2007 vintages, where we really pulled back to the highest ground and did the restructuring of auto that we talked about.

The other benefit auto has, and frankly so does credit card but maybe stronger in auto, is the revenue benefit that comes from so many competitor exits. So as we look at inflection point, Ken, it's not just about when the economy is turning but when the economics of a particular business turn and looking at the economy, vintage results and the negative or positive that we are getting, competitive environment and pricing. So this is an individual analysis. We are not ready to declare that yet in auto, but it's probably the one that has -- shows a bit more promise there.

Thank you very much. Have a good evening.

Next question.

Our next question will come from Bob Napoli with Piper Jaffray.

Good evening. Obviously with two calls going on I don't think somebody asked this question, but did you give any color on the level of over limit fees that you currently are generating, and what you feel kind of the effect of the legislation would be on that?

Yes. Bob, we talked a little bit about it before, but we don't give out that segment expectation of revenue data. But the level of over limit fees has been declining solidly through this cycle. Also that is permanent or temporary, I don't know, it may be slightly academic. But just as consumers have been a lot more careful with their management of their credit. Bob, we are doing our lot of testing of over limit opt in and things like that. Certainly there would be some impact on Capital One with respect to our over limit revenue. But I think overall what is really happening in the business is a redistribution of where revenue comes from, and more and more away from penalty fees, and more APRs and annual fees. To us we are more focused on the net effect of the redistribution of revenue in the near term and in the longer term, and I think we feel quite bullish about that.

I guess the American Express is talking about charge-offs declining in the back half of the year. I think they are the first ones to say that. Are you seeing better performance out of California and Florida? Why do you think the charge-offs are declining and yours are not? You both have similar denominators effect.

I can't speak for American Express. We have the very substantial OCC minimum payment effect that we itemized in the early part of this call, that would be a third quarter effect. But additionally -- in our reported card business, we also have our installment loan business that is in pure run off mode. And that also -- and that plus continuing declines in the size of the card business is causing a substantial denominator effect. We are not even close to having credit -- and also you have seasonality which makes losses higher in the second half of the year. So we're not -- it's not even a close call as to whether the collective impact of those effects will be offset by such dramatically improving credit that you would have the loss rate go down. So you can expect our loss rate to be going up.

Thank you very much.

Thanks everyone for joining us on the conference call tonight. And thanks for your interest in Capital One. The Investor Relations team will be here this evening to answer any further questions you may have. Have a good evening.

That does conclude today's conference. We do appreciate your participation.