Capital One Financial Corp (COF) 2009 Q3 法說會逐字稿

Welcome to the Capital One third quarter 2009 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. (Operator Instructions). Thank you.

Now I would like to turn the call over to Mr. Jeff Norris, Managing Vice President of Investor Relations. Sir, you may begin.

Thanks, Melanie. Welcome, everybody, to Capital One's third quarter 2009 earnings conference call. As usual, we are webcasting live over the Internet. You can access the call on the Internet by logging into 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 third quarter 2009 results. With me today are Mr. Richard Fairbank, Capital One's Chairman and Chief Executive Officer; and Mr. Gary, Capital One's Chief Financial Officer and Principal Accounting Officer. Rich and Gary will walk you through our presentation.

To access a copy of that presentation and the press release, please go to Capital One's Web site, 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 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 which are accessible at the Capital One Web site and filed with the SEC. Now I will turn the call over to Mr. Perlin. Gary?

Thanks, Jeff. Good afternoon to everyone listening to the call. In the third quarter, Capital One earned $426 million or $0.94 per share. Earnings per share improved 77% from the linked quarter, excluding the second quarter cost of repaying the Government's preferred share investment.

The improved bottom line performance was largely driven by three factors that boosted revenue by $482 million or 12% quarter-over-quarter. First, higher yield, more than offset lower balances in our domestic card business and drove approximately $180 million of the revenue increase.

Second, better performance in our credit card trusts and market conditions in general led to a $150 million sequential improvement in the valuation adjustment to our retained securitization interests.

Next, we opportunistically reallocated portions of our investment portfolio to lower risks, more capital efficient securities, while recognizing $150 million of gains in the process; about $100 million more than last quarter.

In addition to increased revenue, the bottom line benefited from a 6% sequential decline in non-interest expenses, driven mostly by not having an FDIC special assessment in the quarter, as well modestly lower marketing and restructuring expenses. While pre-provision earnings were up $600 million, this was partially offset by a $296 million increase in our provision expense quarter-over-quarter.

Net charge-offs were up modestly as expected, but the primary sequential change was a shift from an allowance release in the second quarter to a small build in the third. The modest allowance build was a result of a material increase in our commercial banking allowance, mostly offset by releases in both our credit card and consumer banking allowances. More on the allowance in a moment.

Our tax rate fell to 25% in the quarter, as we released some of our tax reserves in recognition of a favorable court ruling for the treatment of the timing of interchange income. All told, the $1.03 of continuing operations earnings per share in the quarter was flat to the year ago quarter despite the significant challenges we have all faced over the past 12 months.

The $44 million after tax loss in discontinued operations includes $83 million of expenses related to repurchase obligations under reps and warranties made principally by GreenPoint in connection with its mortgage sales before it ceased originations in 2007.

As we turn to slide 4, I will describe our economic outlook, and our allowance associated with continuing operations. Unemployment and home prices have been and continue to be the economic variables with the greatest impact on our results. We still expect the unemployment rate to hit the low 10% range in the first quarter of 2010 and now believe it is likely to remain stubbornly high.

To date, the Case-Shiller 20-city housing price index has declined by about 31% from its peak. Despite a couple of months of promising news we continue to assume home prices will fall by about 42% peak to trough. Our overall allowance rose by $31 million as a result of larger, mostly offsetting allowance changes across our businesses.

First, our Credit Card business had a $78 million release in allowance, more than entirely driven by the $2.1 billion decrease in reported card loan balances. Consistent with our cautious economic outlook our coverage ratio of allowance to reported card loans rose to 10% in the quarter.

The slight decrease in allowance to delinquencies was caused both by the increase in delinquencies off second quarter seasonal lows, as well as a change in the delinquency mix as early stage delinquencies rose during the quarter and caused overall levels to rise while late stage delinquencies that typically require higher allowance coverage ratios have improved.

In the consumer banking segment, the better than expected credit performance of the auto finance business and modest loan shrinkage in the quarter led to a $190 million release in our allowance for that business. This was partly offset by a $66 million build associated with the other consumer banking businesses. So the segment overall had a modest decline in coverage of delinquencies.

Finally, degradation in collateral values especially in the construction portfolio and the impact of rising charge-offs caused us to build the commercial banking allowance by $256 million in the quarter. The coverage ratio of allowance to loans rose over 60% or 90 basis points to 2.3%, while the coverage of allowance to NPLs now stands at 85%.

Excluding the run-off small-ticket CRE portfolio, the allowance coverage to NPLs in this segment is 108%. Rich will discuss credit trends in the commercial banking segment in greater detail in a few minutes.

It is also important to note that none of these coverage ratios factor in the assets that were acquired and marked as part of the Chevy Chase Bank acquisitions. Those assets continue to perform in line with our expectations, at the time of the mark and, therefore, did not impact our allowance in this quarter.

Overall, the $31 million build of the allowance coupled with the shrinkage of our balance sheet led to a 24-basis-point increase in our overall coverage ratio and positions our balance sheet to absorb high levels of losses in the quarters ahead.

Turning to slide 5, I will discuss the balance sheet. Average managed earning assets decreased by $6 billion in the quarter, as we had varying degrees of shrinkage in each of our lending businesses. Our domestic card portfolio was down about $2.6 billion driven by elevated charge-offs, lower loan demand in revolving card businesses card business and the continued run-off of our installment loan portfolio.

The 4% shrinkage in our consumer bank loans was the result of a decline in the size of our mortgage portfolio and lower outstandings in the repositioned auto business. Despite the decline in the percentage of the typically higher returning domestic card assets, weighted average yield of assets improved 73 basis points in the quarter. I will discuss this in more detail when I talk about margins in a moment.

Average liabilities declined $5 billion in line with the decrease in average earning assets. While our funding mix was stable, and our managed loan to deposit ratio decreased slightly to 1.23, we continue to trend toward lower cost retail deposits, as we let higher cost brokered and retail CDs run off. By replacing the run-off of higher priced time deposits and securitization liabilities with lower cost liquid and time deposits, as well as benefiting from lower overall interest rates, our cost of interest bearing liabilities declined 12 basis points to 2.28%.

These funding cost improvements helped improve margins which I will now discuss on Slide 6. For the second straight quarter we saw significant improvement in both our net interest and revenue margins. The NIM improved by 84 basis points, about half of which was driven by an increase in card yield and lower finance charge reversals.

The remainder of the NIM improvement was driven by the lower funding costs I just described, a purchase accounting impact associated with the Chevy Chase Bank acquisition and asset yield improvement in both auto and small business. In addition to the drivers of NIM improvement, the revenue margin benefited from a $150 million sequential increase in the valuation adjustment to our retained securitization interests as well as a $100 million increase in the gain from the sale of securities in our investment portfolio.

Turning to the efficiency ratio, we remain committed to disciplined cost management. With expanding margins and a $120 million decline in non-interest expenses, the efficiency ratio dropped nearly 7 percentage points in the quarter to 38.4%. However, it is important to note that this percentage will almost certainly increase in the fourth quarter as expected year end increases in operating expenses, costs associated with the implementation of the card law, and increased marketing will affect non-interest expense.

It's also likely that some of the revenue benefits we saw this quarter will not recur. And as a result the denominator in our operating efficiency ratio will decrease.

I will discuss the investment portfolio briefly on slide 7. As I've been saying throughout this part of the economic cycle our investment portfolio is a source of tremendous liquidity strength and balance sheet flexibility and those characteristics were once again clearly evident in the quarter. While the size of the investment portfolio was essentially flat in the linked quarter, there were some material changes to our allocation of securities.

Early in the quarter, we took advantage of market movements to swap out of some Fannie Mae and Freddie Mac securities into capital efficient zero-risk weighted Jenny Maes. We also took advantage of improved market pricing to exit our CMBS holdings and decrease our position in non-agency MBS in the quarter. While these moves contributed a 13-basis-point decline in portfolio yield to 4.27%, they also provided a $150 million gain in the quarter and reduced the capital required to support this portfolio.

In addition to the recognized gains, we also had a $642 million improvement in the value of the portfolio, which now stands at a $343 million gain position.

We continue to position the investment portfolio to maximize both liquidity strength and balance sheet flexibility by investing in highly liquid, low risk securities that will enable us to quickly reallocate space on the balance sheet to higher returning assets as lending opportunities arise.

Speaking of balance sheet strength, I will discuss capital on slide 8. Solid earnings, strong appreciation in our investment portfolio and a decline in ending loan balances led to a 52-basis-point improvement this quarter in our ratio of tangible common equity to tangible managed assets. Our TCE ratio now stands at 6.2%. This is the first time since the third quarter of 2008 that our TCE ratio is above 6%.

I needn't remind any of you that was before the worst of the financial crisis. Unemployment was at 6.2%, our allowance balance was some $1 billion less than it is today and before our purchase of Chevy Chase Bank. The increase in common equity along with the proceeds of a $1 billion trust preferred issue early in the quarter also drove a significant improvement to our Tier 1 ratio which increased 210 basis points to 11.8%. Our Tier 1 ratio is now higher than it was before we repaid TARP in full in the second quarter of this year and our Tier 1 common ratio is now 9.7%.

The composition of reported capital and reserves will, of course, likely change considerably when FAS 166 and 167 are implemented. Although consolidation of many securitized assets and liabilities is scheduled to take place in the first quarter of 2010, it is still too early for anyone to know exactly how this accounting change will be reflected in their financial statements.

For example, there's still some uncertainty in the industry about precisely which assets and liabilities will need to be consolidated. And the impact on regulatory ratios cannot be known until federal rulemaking is finalized sometime later in the fourth quarter. But in light of the intense focus we are all giving to this accounting event, I would like to spend a moment describing how we are evaluating the consolidation process and how it might be reflected in our financial statements.

Although changes in accounting standards do not change our overall capacity to absorb risk, they can represent a significant shift in our reported balance sheet. At this point, we are still assessing the options included in FAS 167 for electing either a book value or fair value approach to consolidating securitized assets and liabilities.

We are confident that our capital positions us well to make this important accounting election solely on the basis of what best reflects the economics of our business. While accounting standard setters are debating a move toward fair value at some point in the future, most of our balance sheet, like that of the majority of banks, is currently accounted for on a book value basis.

So assuming we apply a book value approach to consolidation then the biggest impact would be an increase to our allowance with a corresponding reduction in retained earnings. Taking the conservative assumption that the allowance for expected losses on securitized and non-securitized loans would be the same, and rolling forward our current balance sheet trends to the first quarter of 2010, we expect that our TCE ratio would remain above 5% and would likely grow thereafter.

Of course, any reduction in TCE arising from consolidation would at least be matched by the size of the allowance build. Or taking into account tax effects, the allowance builds could be even greater than the reduction in capital. On the other hand, if we were to elect a fair value option provided for in the new accounting standards our allowance would not change as the result of consolidation.

The impact to capital would depend on the market value of the liabilities at the time of consolidation, as well as the present value of assumed losses and relevant revenues expected over the life of the receivables. Even though a fair value election would likely have a less negative impact on TCE than book value consolidation, it would not have a corresponding impact on allowance because the assumed losses would then be incorporated into the fair value mark.

I know that many of you, like we, would prefer to know today how all of this will play out over the next couple of months, but there are simply too many variables to predict the exact result. In any event, we remain highly confident in the overall risk bearing capacity of our balance sheet, and our ability to navigate the coming consolidation or any other changes in accounting standards now or in the future.

Before I hand the call over to Rich to discuss the performance of our businesses on Slide 9, let me just remind everybody about our segment reporting realignment that was described in an 8-K filed last Friday. We believe these changes in segment reporting better reflect the manner in which the performance of the Company's operations is evaluated, enhance visibility into the performance of our key businesses, and provide investors with greater comparability to pure bank reporting.

Rest assured, however, we will continue to provide the same monthly credit disclosures for the Company's lending businesses. With that, I will pass the call over to Rich. Rich?

Thanks, Gary. Our credit card business posted net income of $292 million in the third quarter. Improving revenue margin and revenues in our domestic credit card business drove the improved profitability.

The commercial Banking business had a net loss of $130 million entirely driven by higher provision expense which resulted from a significant allowance build in anticipation of future credit losses. Pre-provision earnings in commercial Banking increased by about $6 million as revenue improvements outpaced the increase in non-interest expenses.

Consumer banking profits grew to $185 million for the quarter. The largest contribution came from auto finance profits which were helped by an allowance release that resulted from credit trends that continued to outperform our expectations and from declining loan balances. I'll discuss results and key performance trends for our new reporting segments beginning with our credit card business on slide 10.

The results of our Credit Card reporting segment are driven by the Domestic Credit Card business. Ending loans in our domestic card business declined by about $3 billion. The continuing run-off of nationally originated installment loans drove about 40% of the decline although installment loans comprised just 13% of the domestic card loan balance.

Our domestic card business includes about $8.1 billion in installment loans, down from about $9.3 billion at the end of the second quarter. We essentially stopped originating installment loans late last year so the portfolio will continue to shrink as outstanding loans amortize.

We may see an inflection point and opportunities to increase originations in part of domestic cards sometime in the next few quarters. But we expect to domestic card loan balances will continue to decline in the fourth quarter and into 2010. We expect that weak demand from creditworthy borrowers, continuing caution in underwriting, elevated charge-offs and the run-off of the installment loan portfolio will more than offset new originations.

Revenue margin in the domestic card business improved to about 16.8%. Better revenue margin drove an increase in revenue dollars despite declining loan balances. Net interest income improved as a result of revenue enhancement actions we took earlier in the year and fewer finance charge reversals. Non-interest income benefited from fewer fee reversals.

We expect domestic card revenue margin will remain above 16% in the fourth quarter. In 2010, we expect quarterly revenue margin to moderate modestly but remain close to its fourth quarter 2009 level.

Slide 11 shows credit results for the domestic and international card businesses. Domestic card charge-off rate for the third quarter increased 41 basis points to 9.6% as a result of several offsetting factors. Three quantifiable factors drove about 140 basis points of charge-off rate increase in the third quarter. These factors include declining denominator, the implementation of OCC minimum payment policies and the absence of the one-time second quarter benefit from a change in bankruptcy process.

Favorable seasonal trends especially in the first two months of the quarter drove an offsetting 75 basis points of charge-off rate improvement in the quarter. The net result of combining all of these quantifiable factors is an estimated third quarter charge-off rate increase of about 65 basis points. The actual increase was only 41 basis points.

This difference suggests that the underlying charge-off rate actually improved by about 24 basis points in the quarter. The domestic card delinquency rate increased 61 basis points to 5.4% at the end of the quarter. Some of this increase was seasonal.

The second quarter is a seasonal low point for card delinquencies coming off the tax refund season, while the third quarter is a seasonal high point. In addition, we are seeing some impact from pricing actions we took earlier in the year. Based on past experience, we expect this delinquency increase to be temporary although we do expect it to lead to higher charge-offs early next year.

We continue to analyze test sale data to refine and update our estimated impacts of implementing OCC minimum payment policies in our domestic card business. We expect the OCC minimum payment impact to drive around 20 basis points of charge-off rate in the fourth quarter and into 2010. This is down from the estimated 80-basis-point impact this quarter. So the fourth quarter charge-off rate is expected to benefit by approximately 60 basis points as the OCC minimum payment impact abates.

Overall we expect further increases in the domestic card charge-off rate throughout 2009. The economy continues to weaken and we expect the usual fourth quarter seasonal headwinds. We believe we will reach the peak of charge-off dollars in the next couple of quarters, although declining loan balances are likely to drive rising charge-off rates for a bit longer.

But to be clear, nearing a peak does not necessarily mean that we're nearing the beginning of a robust recovery. As Gary discussed, we expect that unemployment rate and, therefore, domestic card charge-off dollars are likely to remain stubbornly high throughout 2010.

The international card business posted net income of $2 million in the third quarter. Profits declined from the second quarter as higher provision expense more than offset revenue gains. Elevated charge-offs in delinquencies in the international business reflect continuing economic deterioration in the UK and Canada. We have been retrenching the UK business for some time now and we have been cautious in Canada in anticipation of the credit worsening that began in the first half of 2009.

Despite the significantly elevated level of charge-offs our credit card business is demonstrating its resilience by delivering industry-leading profitability through the cycle. As we discussed last quarter, we continue to believe we are well positioned for life after the implementation of the new card act and that our revenue model will remain largely intact.

Managing our business to both weather the recession and respond to the coming changes in the credit card industry creates risks and potential profitability pressures in the short term. But in the long term, we believe the new law and the market and competitive environment it will create could open up opportunities and be a net benefit for Capital One.

Slide 12 shows commercial banking loan and deposit trends. Average loans declined to $30 billion. Modest declines in commercial real estate as well as middle market were partly offset by modest growth in specialty lending. The expected run-off of small ticket commercial real estate loans, a business we exited some time ago, also contributed to the decline in commercial banking loans.

Average deposits grew 4% to $17.8 billion. Deposit interest expense rate was stable at about 75 basis points. Revenue grew $17 million in the quarter despite -- excuse me -- deposit growth with disciplined pricing and modest improvement in loan yields contributed to revenue growth.

Slide 13 shows commercial banking credit trends. While solid revenue and non-interest expense drove an increase in pre-provision, pre-tax earnings, commercial banking posted a net loss for the quarter due to the increase in provision expense. Provision expense increased more than $250 million largely as a result of a large allowance build in anticipation of future credit losses.

The two most important drivers of the allowance build were the significant decline in collateral values, particularly in our construction portfolio, and recognizing the effects of higher charge-offs. Charge-off rate for the commercial banking segment increased by 53 basis points to 1.42%. Excluding the run-off portfolio of small ticket commercial real estate loans the charge-off rate in our continuing commercial lending businesses increased a more modest 28 basis points to 1.08%.

Nonperforming asset rates increased 37 basis points to 2.83%. Rising nonperformers and charge-offs in the CRE portfolio drove the third quarter deterioration in our core commercial lending businesses. Credit performance in the middle market portfolio was relatively stable.

Construction loans continue to be the main driver of CRE nonperformers. Although construction loans comprise only 18% or about $2.5 billion of the commercial real estate portfolio, almost three-quarters of the nonperforming loan balances are construction related.

In the third quarter, we also began to experience an increase in nonperformers in office and retail loans. The nonperformers have been project and sponsor-specific situations and it is too early to determine if a trend is emerging. Declining asset values were an important driver of higher charge-offs in the quarter.

Commercial real estate values declined broadly during the quarter, but the most dramatic declines occurred in construction properties. We expect continuing declines in commercial real estate values.

We believe that the continuing recession will drive further increases in nonperformers and charge-offs across our commercial banking businesses. Compared to most large banks, commercial loans are a much smaller percentage of our total Company-managed loans. And we also believe that our commercial banking loan portfolio is well positioned to weather the recession.

We have a favorable loan mix with a relatively small exposure to construction lending. Since credit deterioration is most pronounced in construction lending, our relatively small exposure to construction is a key reason that the absolute level of our CRE charge-off rate is lower than many other banks.

We also have a relatively large exposure to New York City multifamily. Because of rent controls and supply limitations, our New York City multifamily portfolio has been relatively resistant to recession. We have disciplined lending standards and we underwrite to in-place cash flows and rents. And we follow a relationship-oriented approach that focuses on borrowers with whom we've had a long experience and deep relationships.

You can see loan and deposit trends for the commercial banking business, excuse me, the consumer banking business on Slide 14. Average loans declined about $1.7 billion. Auto finance loans declined as a result of our earlier efforts to retrench and reposition the auto finance business.

Mortgage loans fell as we continued to experience expected run-off. Loan yields improved 98 basis points to 9.5%, driven by improving margins in auto finance and purchase accounting adjustments on the mortgage portfolio. Average deposits declined about $1 billion.

We continued our strategy of optimizing deposit mix to focus on deposit customers that drive the best long-term profitability. Improved deposit mix and favorable interest rates drove an 18-basis-point improvement in deposit interest expense in the third quarter.

In the third quarter, consumer banking revenues increased $56 million with revenue improvements across the consumer banking businesses. Provision expense declined $46 million driven by an allowance release in the auto finance business. Non-interest expense declined $43 million as a result of improvements in retail banking operating expense. Note that non-interest expenses in the consumer banking segment include about $46 million of CDI amortization.

Slide 15 shows credit results for mortgage and auto, the two largest components of the consumer banking loan portfolio. Consumer banking includes our $16 billion portfolio of mortgages and home equity loans, net of the credit mark on the acquired Chevy Chase mortgages.

About $7 billion or 44% of the portfolio are Chevy Chase loans including about $4 billion of broker originated option ARMs. The Chevy Chase portfolio is inherently riskier than our legacy mortgage portfolio.

The substantial credit mark we established on acquisitions insulates us from most of the credit risk of the Chevy Chase portfolio. There is some risk that we will have to increase the mark or add an allowance of actual credit trends exceed the assumptions we made in establishing the mark. But so far performance is within our expectations and we remain comfortable with the mark.

The remaining $9 billion, or 56% of the mortgage portfolio, consists of well seasoned, high FICO, low LTV mortgages that were originated for North Fork by GreenPoint as well as branch originated home equity loans mostly in Louisiana. Credit results for this part of the portfolio remain in line with our expectations, and with industry credit trends for similar high quality portfolios. Delinquency and charge-offs for this part of the portfolio continue to degrade along with the industry.

Our current priority for the mortgage portfolio is aggressively managing defaults. We also are building infrastructure and developing strategies in anticipation of opportunities to grow input print mortgage originations as the mortgage market shakes out and the economic cycle turns.

I should also note that the mortgage portfolio in the consumer banking segment does not include the remaining $517 million of GreenPoint originated Alt-A HELOCs which are held in the other category. These loans were originated for sale but GreenPoint was unable to sell them when we shut down GreenPoint originations in 2007. They continue to perform very poorly as they run off and we have allowed for them accordingly.

As Gary mentioned earlier, we added to our rep and warranty reserve in the third quarter as a result of ongoing repurchase risk with respect to GreenPoint mortgage loan sales.

Capital One auto finance contributed the largest share of profitability to the banking segment. Our auto finance business delivered another strong quarter of profitability despite continuing economic headwinds. Profits in quarter were aided by an allowance release that resulted from declines in loan balances as we continued to reposition and retrench the business, as well as continued favorability of credit trends versus our expectations.

Our 2008 and 2009 origination vintages are delivering strong results. We have been able to 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 and 2009 originations will yield above hurdle risk adjusted returns and their performance to date is tracking at or above our expectations.

Auto finance charge-off rate increased 73 basis points in the quarter to 4.38%. The increase resulted from expected seasonal patterns and the impact of the decline in the denominator. These factors were partially offset by continuing strength in used car prices and recovery values and by the continuing success of our investments in auto finance collections and recoveries.

Auto finance delinquency rate increased 63 basis points from the sequential quarter following expected seasonal patterns. We expect auto finance charge-offs and delinquencies to increase in the fourth quarter of 2009 in line with expected seasonal patterns. Also we have observed a decline in used vehicle prices in the last few weeks. So there's growing uncertainty about the sustainability of favorable used vehicle prices.

Pulling up. We have worked for years to position our Company to be resilient. And we are demonstrating that resilience through the most challenging economic cycle we've seen in generations. We delivered solid pre-provision, pre-tax earnings throughout the recession. We passed the Government's stress test, and we were among the earliest to be able to repay TARP.

In the third quarter, we delivered solid growth in both revenues and bottom line profits despite increasing provision expenses. We also built additional balance street strength, allowance as a percentage of reported loans increased, and our TCE and Tier 1 capital ratios continued to improve.

While third quarter results were strong, we expect that loan balances will continue to decline in the fourth quarter and into 2010. Thus far, the revenue pressure from declining loans has been partially offset by increasing revenue margins, and allowance releases have helped to mute the bottom line impact of declining loan balances.

Going forward, we do not expect continuing revenue margin expansion. We are weathering the storm, but the storm is not over. And we continue to face several significant risks. While the pace of deterioration appears to have slowed, labor markets have yet to actually improve.

In past downturns, unemployment has often recovered quickly after the peak. But in this recession, there are several reasons why the recovery and the job market may be slower and more prolonged. Looking beyond unemployment rate, the reduction in hours worked creates even more slack in the labor market than is apparent in the unemployment rate. The average time to find a new job is at an all-time high, a sign that the job market is more frozen than in past recessions.

Because this recession is so geographically broad, workers are less able to find new jobs by moving. And the housing crisis further reduces mobility as many workers cannot sell their current houses in order to relocate.

Similar to labor markets, the housing sector remains severely dislocated despite some signs of stabilizing home prices. There's a growing backlog of foreclosures and inventories of homes in foreclosure or with severely delinquent mortgages are increasing. This is likely to put downward pressure on home prices as the foreclosure inventory hits the market. Continued weakness in housing puts pressure on the broader economy and makes any emerging recovery fragile.

For our retained mortgage portfolios, continued housing weakness drives higher credit losses and adds to the risk that we may need to increase our credit mark. Even as things eventually cure, we will continue to face for some time the risk of additional repurchase requests for alleged rep and warranty on GreenPoint and Chevy Chase Bank mortgage loans that were originated and sold years ago.

Some of the apparent improvements in the economy may not be sustainable as Government stimulus programs like "Cash For Clunkers," the first time home buyer tax credit, and other direct cash payments to consumers may have only fleeting effects.

Legislative and regulatory uncertainty remains high with Congress continuing to debate bank regulatory reforms and specific limitations on traditional bank products. The current debate includes the possibility of accelerating the effective date of the Card Act, limiting interchange fees on credit and debit cards and regulating overdraft fees on checking accounts. There are large numbers of new regulations that need to be developed and adopted in 2010 to implement the laws recently enacted by Congress. And we won't even know what agency or agencies will be developing the regulations until Congress finishes its work on regulatory reform.

Because the storm is still with us, and we continue to face these risks, we continue to make the tough decisions and take actions that we believe will put us in the best possible position to manage the Company through the downturn for the benefit of shareholders. We have tightened underwriting standards across the board. We have exited the least resilient businesses like national lending installment loans and small ticket commercial real estate.

Even as we have invested in increased collections intensity we made great process to reduce our cost structure and improve operating efficiency to enhance our long-term competitive position and build resilience to rising credit costs. Our strong and transparent balance sheet remains a source of strength in these turbulent times. Allowance coverage ratios remain high. Funding and liquidity remain rock solid, and TCE ratio at the end of the third quarter was 6.2%, its strongest level since the third quarter of 2008.

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 commercial and consumer banking deposits. And as opportunities for profitable and resilient loan growth emerge, we expect that we will be able to grow loans by rotating our earning assets from investment securities back into new loan growth.

As a result of our actions, we believe that we remained well positioned to weather the storm and to deliver shareholder value over the cycle. Now Gary and I will be happen happy to answer your questions. Jeff?

Thanks, Rich. We will 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.

Now we got some feedback from all of you after last quarter's call that while many of you really appreciate Rich and Gary's willingness to spend so much time answering your questions that the call was a bit long. So tonight we're going to take as many questions as we can up until about 6:30.

Now if you have follow-up questions after that the Investor Relations staff will be here after the call to answer them. Melanie, please start the Q&A session.

Thank you. (Operator Instructions). We will pause for just one moment. We will take our first question from Andrew Wessel of JPMorgan.

Hi, guys. Good evening. Just one quick question on the observable performance impact you've had so far across the increasing rates in credit cards. For those customers that have been seeing a significant rate increase on -- that have existing balances, can you give us any early feedback on what the credit performance has been like there, if you've seen a lot of fallout or not?

You know, Andrew, what we look for on any of these things is we look at effects on attrition and we look at credit, and, of course, there's a slight interaction between those. The attrition rates have been actually so far a little less than expected. They're certainly very, very manageable.

The -- we believe there is a, like you've probably seen in prior revenue change impacts, we, there is a small effect that we believe is making its way through our delinquency buckets. That's what contributed to the 3o to 59 bucket being higher than otherwise you would expect it to be over the last couple of months. So, we believe that effect will make its way, while it's moderating a little bit.

As it makes it's way through charge-off, there will be a charge-off effect that will happen from that. But over a period of a few months we believe that effect based on years and years of experience will sort of resolve itself. So all in all it has been a really quite a modest impact on the externalities from this decision.

Great. And then as my follow-up, just looking at the auto business, I think your comments around there. Obviously, there's been some solid enough performance to release that level of reserves and margins have expanded, LTVs have gone down and the quality of the borrower is better.

Do you see the opportunity to grow that business now? Or is it still very much in a kind of contract and defend type of position?

No, we are definitely, in fact we have not despite all of my use of the C word of contracting, I actually want to say that for some time now we have been pretty stable at about; in originations, at about $1.5 billion per quarter. So what is contracting is the underlying portfolio, and that will continue to contract for an extended period of time.

I think the thing to focus on, Andrew, is the originations. And we have been, because we have been on the one hand so concerned about the economy and everything and all of the amazing developments occurring in the auto market but on the other hand, so impressed with some of the performance of our originations. In the business, we have kind of been steady at about $1.5 billion. I think that from here, we, I think that we might modestly grow that from here.

But one thing I want to caution is that part of the reason that we are able to generate the success we have in the auto business is we very carefully chose which dealers and to certain underwriting standards that we would do this.

So we don't want to turn around and sort of undo that which got us here. So we think the auto business is a fairly healthy business, and from a lending point of view industry right now I think you will see some cautious growth from Capital One growth in originations but it is still going be within the context of something pretty modest.

Next question, please.

Next we will go to Chris Brendler from Stifel Nicolaus.

Hi. Thanks. Good afternoon. I had a question on the revenue margins in the U.S. card business. I think, Rich, on the last quarter's call you had guided to 15%, above 15% in the last two quarters and below 15% for the year. With the performance this quarter on your new guidance it looks like you've done a little better than that or quite a bit better than that.

So I was wondering what drove that change over three months since we last talked on revenue margins. And also (inaudible) for the [suppression] number this quarter, it fell sequentially despite a pretty significant increase in delinquencies. Does that reflect maybe some confidence that credit might be getting a little bit better? And that some of your comments about the delinquency increase we saw in the third quarter just being mostly related to some pricing activity?

Can you just give me some color on what's going on in the U.S. card business? Thanks.

Yes. Our revenue margin in the third quarter came out a little higher than probably our own expectations. I think probably the driver of that was actually what happened on the fee and finance charge side with respect to reversals.

So kind of positive developments on the credit side made its way into the fee and finance charge reversals which actually flow through the revenue line. So as you look at it, envision that the underlying sort of revenue measures that we took in the business are going exactly as expected, but we had that extra overlay.

With respect to delinquencies, let me just make some comments about the credit card performance. It is certainly, it has tended to a little bit outperform our expectations now for probably the last five or six months.

Here is where it has been performing particularly well relative to our expectations. On the recovery side we have actually seen some improvement in recent months, slight improvement in recent months in recoveries. Bankruptcies have been stable. I mean they, of course, have been just up, up and away for a long, long period of time. So that has been good.

And the other striking thing is the -- some improvement in late stage flow rates, which again we have not seen -- we have been mostly dealing with the reverse of that for a long, long time during this downturn. So, those have been a real positive.

The only sort of thing on the other side of the argument, Chris, is the bit of a bubble in the second bucket and into the third bucket delinquency and there are multiple causes of that. Seasonality, you would expect that anyway.

We actually made a change in our collections practices after a lot of testing. We kind of shifted where we put the intensity with respect to which delinquency stage gets a certain amount of intensity in terms of collectors and everything. And we've actually found there was more leverage to kind of backload a little bit more the intensity.

That actually causes an increase in early stage delinquencies. That is more of a slight permanent effect. But it doesn't actually, we believe there's a net positive on charge-offs there. And then the other thing is, of course, the impact of the revenue actions that we took. And that one that, while we can all have our beliefs about that impact, we want to keep an eye on it just to, just to be sure that that thing washes through the delinquency bucket.

Could I ask a follow-up, please?

Yes.

I think also previously you had talked about the Card Act. A new brown out in the second quarter when it went into effect. And it seems from your guidance tonight that you are feeling a little more confident about your ability to weather the new rules. Can you give me any sense of if that's true and what's changed?

Chris, we basically -- the more we have really gotten our head around the Card Act and what are its many, many impacts on how the business works and on us. I think we are increasingly bullish that the -- you are not going to see a big striking effect once the Card Act goes into effect.

I think that we believe the revenue margin, that the kind of fourth quarter revenue margin that you're going to see is pretty typical for what we would expect in the card business for next year.

Next question, please.

Next we'll go to David Hochstim from Buckingham.

Just sort following up on that. So basically you are saying that from where we are today, next year with the opt-in requirement on over limit fees we're just not going to see much of an effect on the income statement?

Yes. They're offsetting, there's a series of offsetting factors, but basically, yes, David, there would be more or less we think the revenue margin that you're going to see probably next quarter, which will be pretty representative of the revenue margin for next year.

Okay. Could you or Gary just clarify what the tax rate was on the gains on the revaluation and then how much of the purchase accounting adjustment impacted the margin?

Sure. There are a variety of items there. The purchase accounting adjustments were about $50 million more or less, some of that will continue. But there was a bit of a catch up this quarter. Again, the gain on security sales was about $150 million pre-tax. It was about, that was $100 million over the previous quarter. And on the valuation adjustment, a similar amount of improvement. It was a small positive, but remember last quarter we had a big negative that resulted from the fact that a lot of the cash that had been trapped when our master trust had reached some lower levels of excess spread earlier this year, improved. That both released some cash, and also the rate of collectability is now considered to be higher.

Finally on the tax. The ruling we had in tax court in late September around treating interchange as interest subject to tax deferral rules, that favorable ruling, there were a couple of other rulings that kind of offset the impact. So it was a net positive for us. Given the favorable ruling we had from the court we released some of the reserves associated with this matter.

But because this is still an ongoing process there could be an appeal. We have not released all reserves against that matter. We have to see what happens over the next several quarters to get to a final resolution to determine the ultimate impact.

Next question, please.

Next we'll go to Mike Taiano from Sandler O'Neill.

Hi. Thanks for taking the question. I guess the first question has to do with the charge-off rate in the credit card business. You guys have talked a lot about the potential for decoupling earlier in the year where charge-off rates increased more than the unemployment rate and I guess for the most part that hasn't happened. But I was wondering is there any way in your mind if the unemployment rate does, in fact, stay stubbornly high through 2010 where you could see a decoupling in the opposite direction where charge-offs actually start to decline relative to the unemployment rate?

You know, I -- Mike, I think my overall answer would be that as unemployment goes, so go the card charge-offs. Now let me put a few nuances around that. Also an important driver is what happens to home prices. So if for some reason they rebounded while unemployment didn't, I think there would be some positive effect.

But frankly we are still as worried about potential latent challenges with respect to home prices in many ways as we are about unemployment. The other thing I would say though is this, the thing you are referring to, the old proverbial one-to-one relationship between domestic card charge-offs and unemployment rates that has been seen in the last two downturns and that we have talked a lot about in prior earnings calls, in some ways the more things change the more they stay the same.

I think this downturn will show a pretty strong close to one-to-one relationship between those two. But it will -- the only thing we have seen of late is that there seems to be a bit of reduction in a sense of the coefficient of impact from unemployment to the charge-off rate that would explain some of the better than expected performance that we have seen.

Now, this could actually be, in some ways a kind of simple interpretation of it is it may just be a manifestation of something that didn't matter very much while everything was worsening, but matters a lot when you get to the peak. That is which comes first, in a sense, the peak of credit or the peak of unemployment. And the lag effect of unemployment, of credit being a -- moving somewhat earlier than unemployment may be what's being manifested here.

But I think the other thing just to kind of add a little more complexity to this thing, the other thing that could be explaining the better than expected kind of credit performance in this seemingly slight reduction of impact of credit vis-a-vis the unemployment number could be a lot of these sort of temporary impacts of tax stimulus and "Cash For Clunkers" and a lot of other things going on.

So overall I think we view that as unemployment goes, so goes the card business.

Okay. And if I could have just a quick follow-up. Gary, on the, in terms of your liabilities now, in terms of duration, has it changed dramatically now, like this quarter versus say a year ago as you shift somewhat away from securitizations into deposits?

You know, Mike, our overall approach is still to try to run as close to a match book as makes sense. Although certainly given the extraordinary environment we are in right now we are trying to keep ourselves as, at least somewhat liability sensitive.

But when you take a look at the nature of our assets, between credit cards which are now overwhelmingly floating rates, and certainly most of our commercial loans also have a floating rate. In order to get to the position we are looking for we have some longer duration in our investment portfolio. And on the liability side, we have been obviously taking advantage of the opportunity to bring our costs down by going more towards deposits. And in terms of duration there hasn't been a significant shift other than the benefit that comes from the roll-off of some of the higher cost CDs.

So net-net, slightly liability sensitive, but still probably a little more matched than many of our peers.

Next question, please.

Next we will go to Rick Shane from Jefferies.

Thanks, guys. Marketing continues to trend down. I am wondering, normally there's a surge in the end of the third quarter beginning of the fourth quarter related to getting cards in people's pockets for the holiday season.

Should we expect any surge in the beginning of the fourth quarter, and given all of the changes to the operating environment, what are you guys seeing in term of response rates? Thank you.

Thank you, Rick. No, I mean you're right on the normal patterns with respect to marketing. I don't think you will, you might see a little bit of an uptick. I'd never use the "S" word surge to describe this low level of marketing that's going on here.

So more I think what you will see out of Capital One on the credit card side is pretty cautious, a combination of our caution and in many ways the lack of demand that's out there for high quality borrowers as they continue to ramp up their savings rate.

Now, with respect to response rates, response has increased during this period of time. I mean the -- there has been such a dramatic reduction in supply out there as you can see from the mail monitor data, for example, that not surprisingly, there would -- we are seeing some increases pretty much across the board everywhere we are marketing some increase in response.

Great. Thank you very much.

Next question, please.

Next we will go to Moshe Orenbuch from Credit Suisse.

Great. Thanks. Rich, could you talk a little bit more about the suppression and its effect on income given the comments you made about expectations for delinquencies and losses kind of -- I guess -- it sounded like they wouldn't be better going forward so how does that reflect itself in the suppression and what happens to that number kind of in Q4 and Q1?

Yes. Moshe, it is Gary. First of all, I don't think we should read too much into the amount of suppression. By and large we are simply reflecting the kind of experience that we have been seeing in terms of consumer behavior.

And also, quarter-over-quarter we are going to see what quantity of charges are being made because obviously we have to assess before we suppress. So by and large, I don't believe that suppression will have a major impact, but certainly, it was a small contributor, the lower suppression coming from fewer finance charge reversals. Certainly it was a small contributor to the improvement in the card business revenue margin this year but it is not a major driver.

Right. But you certainly, I mean your revenue margin is up. It is not like you are charging less interest, right, on, and your delinquent accounts, I guess. It is not clear to me how the suppression amount could be down unless you are expecting fewer charge-offs of accounts that would have had those fees and finance charges billed, right?

And the -- again, as with the allowance you have to take a look, Moshe, at the reserve. It is not just the experience we are having. It's the experience we are having versus the expectations that were previously built.

And so even though we are not necessarily looking for a significant improvement, there is a combination of factors that would make us believe that perhaps the amount of reserve that we had already posted or some amount that we had already suppressed was more than appropriate.

But by and large, if you see the allowance going down, you can usually expect to see the finance charge and fee reserve also coming down a small bit.

Next question, please.

Next we will go to [Aaron Sagonovic] from Ladenburg, Thalmann.

Hi. Just wanted to ask about the competition, we are seeing kind of one of the larger card competitors introducing some new products into the market kind of focusing on affluent in the prime segment, and also the small business and seeing marketing expenses going down a lot, just wondering what you are thinking about in terms of competition, and whether you're worried about market share at all?

Yes. Let me make a few comments here about competition. First of all, the striking thing is competition has mostly drifted to the really the upper end of the market. So, it is not surprising that the new cards and kind of new things that you see out there almost entirely are being pitched to the top end, frankly, more heavy spender part of the marketplace.

And I think what you should continue to expect that from everyone, including Capital One, a lot of emphasis on this. This segment has performed well during this downturn. It was always a [blood] segment beforehand and it will be as or more [beluft] going forward. So this will be intensely competitive. There has been just a massive reduction in supply into the heart of the revolver marketplace.

Industry mail volume, now it is not a perfect metric, Aaron, because, of course, increasingly people get their credit cards ways other than mail, but the effect is so dramatic it certainly is telling here, and that is that versus a year ago, industry mail volume is down by more than two-thirds. So, that I think that will probably, I wouldn't expect that to turn around dramatically any time soon.

The other thing that I would really point your attention to is the pricing in the marketplace. We have been saying that, for a long time, industry go-to rates really will tell you a lot about the future health of the card business because with the new Card act, go-to rates really are the destination rates and they kind of evolved where they weren't necessarily that in the world of penalty-based repricing, which is essentially going to be a thing of the past after the Card Act.

So, what I have said is watch the go-to rate, and if you look at that, actually, it's interesting, the go-to rate itself, if we go back to say July of 2008 the go-to rate has gone from, the purchase go-to rate has gone from about 11.7% to about 13%. So, on the face of it it looks like about 130 basis points of increase, but we have to adjust for the significant decline in interest rates, and, therefore, cost of funds during this period of time.

So the most telling one is go-to minus prime. And go-to rate minus prime has gone from, by our tally, 6.69% up to 9.75%. So it is basically 300 basis points over this period of time. And it has been interesting the first -- so in the summer of last year, it was around the mid-6%'s, this it being go-to rate minus prime. In the latter part of the year it went to the mid-7%'s.

For much of this year it has been in the 8%'s and in the last couple of months, in August/September basically it went into the mid-9%'s on dealing with existing portfolio. So I think what you're seeing is the industry, I think, has been spending most of its focus on dealing with its existing portfolio. But, and frankly not doing a lot of marketing.

But I think the industry both is recognizing, these are really early stage of recognition that the go-to rate is the defining kind of indicator of origination pricing health. But let me also say that based on our calculations and for our originations we certainly would believe that it needs to go quite a distance farther to really get to the kind of destination we would look for.

Great, thanks. And just a quick follow-up for Gary, housekeeping. The $150 million valuation adjustment this quarter on the residual, how does that compare to last quarter and just for clarity, the 150 from the securities sale that you are saying that about $100 million of that is unusual run rate number?

No. To be clear on the second question, the $150 million worth of securities gains, I was just trying to help you out quarter-over-quarter. We had about a $50 million gain in the second quarter. There was a delta pre-tax of about $100 million. Now, with respect to the security valuations, or sorry, the retained interest valuations, remember in the second quarter, we had a negative adjustment of about $115 million.

About half of that came from the fact that we had increased the amount of retained interest. We had done some additional public issuances, and we were trapping cash because we had a very short moment there where we went below a trigger on our Class C and that requires us to post a valuation charge against it. And then the other half was based on the negative credit trends that we were seeing at the time, and certainly the valuation in the marketplace of those interests.

So, it was a negative $115 million adjustment in the second quarter. We had a positive adjustment of $37 million in the third quarter. Hence, the $150 million more or less pre-tax swing and, again that's the same two things that drove the negative adjustment last quarter, reversed this time around.

So, a smaller quantum of retained interest, a reduction in the amount of cash that was trapped and an improvement in the valuation of those interests.

Next question, please?

Next we will go to Bruce Harting of Barclays.

So there's been a lot of emphasis on the operating margin, and what you were saying about the go-to rate just now, Rich, I mean when you look at the average balances, average yields and average cost of funds table, you had a remarkable increase in your average yield, and a good decline in the cost of funds.

So, you said that you've migrated most of your cards now to floating rates. So, and the margin is unlikely to increase in next year. But I guess that assumes flat Fed funds.

If rates start to go higher, then we should expect to see average yields go up from there on these floating rate credit cards, and deposit costs probably be more sticky then we might start to see some further margin expansion?

Hey, Bruce. It is Gary. I mean, look, obviously, figuring out the duration of deposits is an art and not a science. So certainly we factor in when we assess the sensitivity of our balance sheet to movements in interest rates.

We assume some degree of stickiness. And, of course, on the card side there may be a variety of considerations in the way. Promotional rates are offered to people so that while the underlying rate on the card is floating it may be that the customer is assured of the rate for a period of time.

So by and large I think movement in rates is unlikely to have a significant impact on the net interest margin in the card business, but you can rest assured that both our balance sheet management functions and our all of our bank are out there trying to beat the beta when it comes to deposits and we will do our best. But I am not sure that I would project that.

In the Barney Frank protection agency bill that came out today, any comment on the potential for eliminating the preemption where states and municipalities may be able to set their own rates, any comment on where that may go?

Bruce, it certainly is something that we are very concerned about and I think there was a -- relative to the original proposal there was a little bit of lightning of that one. So it softened a bit as it made its way through the House Financial Services Committee. But it is certainly still, not to, the destination I think that is extremely important vis-a-vis classical preemption.

Just to remind us all why we care so much about this, in subjecting national lenders to every state legislature in the country, the risk of many different regulatory barriers coming across 50 states which -- even the anticipation of potential legislation in 50 states could actually lead to reduced lending even before, in a sense, it actually happened in a particular state.

And the cost of compliance on all of this as well. So I think this is a very, very critical issue. There's a lot of, I think, very widespread opposition by large and small in many, many quarters to this, and we will see where it goes, Bruce. But that is a top issue on our list.

Next question, please?

Next we will go to Sanjay Sakhrani from KBW.

I just wanted to make sure I understood your commentary around the revenue margin and the Card Act. So do you guys actually think that there will be an impact to the ROA of the U.S. card portfolio from this law?

Well, yes, let me -- so we. Look, the law has a tremendous sweeping impact on the industry. And so we are not spending 200,000 IT hours for nothing here trying to get ready for this thing ourselves. So, in the way the business works, it is a very sweeping set of changes.

Now, some impacts that I think are going to be very hard on other players will be relatively lighter for Capital One. The, I think a number of our competitors were pretty reliant on very extensive penalty-based repricing as a core basis for the business model. That really never was the basis of the Capital One business model and that practice is really at the absolute bull's eye of what the Card act is trying to address.

There are also other practices like universal default and things like that as well. The Card Act, though, even as Capital One has a relatively intact revenue margin on the other side of this thing, I do want to say that for us, and, I think, for the industry there will be substantial redistribution of sort of where revenue comes from in the sense that, and I think this is in many ways what the Act is trying to achieve.

It is less, there's going to be less income coming from fees and things like this and particularly things like over limit fees and I think that the revenue model of the business is going to go back to more of the way it was in the 90s which is more focused on headline rates of APRs, and in some cases, annual fees.

So I think there's a very important, very healthy redistribution that will be going on. But with respect to Capital One, I think that preparation that we did for years with respect to our work on credit card practices, you can probably remember some of my presentations years ago, some of the work we have done over the prior year.

And then the implementation of opt-in that -- opt-in itself, and I'm a big believer that for a lot of customers they want the ability to go over limit and I think it is a very appropriate thing to have an explicit opt-in on this and we believe that will also make sure that every customer is where he or she wants to be. But net-net, when you pull up on this while there's a redistribution of where revenue comes from it's a very healthy one and I think overall Capital One is positioned to have our revenue margin be intact through this period of time and into the future.

So maybe just a follow-up to that question, or to that response. If we looked at the mix of the portfolio maybe a year from now would it look any different than it looks today?

Within subsegments of segments, I would say, yes. But I think, I don't think you will see a dramatic change for Capital One. The thing that's an unknown -- let me talk about the elements of uncertainty in all of this because I believe deeply that our revenue margin is intact through this process, but let me talk about the uncertainties.

First of all, on the legislative and regulatory side, there is still miles to go before we sleep with respect to even what agency is the regulator, the actual final interpretation of laws, of the card law that is still waiting to come out and then all of the kind of things that still loom out there for things like interchange and other things. So, there is a tremendous uncertainties, so when I talk about intact revenue margins I am talking about relative to that which we know right now. I feel quite good about that.

The other big uncertainty that, to me, that will affect our mix as you asked, but also a lot about the size of our business going forward, is where does the industry go with respect to pricing? And the -- my, it has been so long since the industry really had to fully focus on the essential long-term nature of the initial offer. As I said before, where this go-to rate goes for is going to make a big difference to the health of this business and our appetite for origination in some of the segments of the business.

But my kind of sound bite summary of where I think the business is going is that we are going back to the 90s. This is back to the 90s without the industry growth component. So the 90s was a wonderful period of a very level playing field. It did have the nice overlay of additional of tremendous industry growth. But the competition was very much based on headline rates.

And it was very much -- the credit card issuers who succeeded during that period of time were those that I think had the strongest underwriting models. I think that this is, that the situation evolved in a troubling way during this last decade to where the leverage was not on underwriting because people would sort of self select through penalty-based repricing into a price level that reflected ultimately their risk.

We are going back to the 90s. It's all about up-front underwriting. I think that places the strength of the whole information-based strategy model that our Company is built on.

But in addition to kind of playing to our strength I think it is such a positive with respect to the opportunity to go back and really build a franchise with consumers where the debate is not about industry credit card practices, and it is really about adding value to our customers and building cornerstone relationships in credit card that can be expanded elsewhere. So we are incredibly looking forward to this and it is back to the 90s.

Next question, please.

Our next question will come from Scott Valentin from FBR Capital Markets.

Good evening. Thanks for taking my question. This is a little bit of an esoteric question, but there has been some confusion regarding FAS 166 and 167 with regard to FDIC Safe Harbor on securitizations. I was curious if you guys had any insight, maybe if you've had discussions, preliminary discussions, or heard anything regarding which way the FDIC is leaning on granting Safe Harbor going forward without the gain on sale accounting treatment?

Scott, it is Gary, and unfortunately we don't have much insight that we can offer you. Obviously, we are dramatically less reliant on securitization as a funding tool. We have some securitizations in our investment portfolio, but they have relatively short lives and I know that this is going to basically work itself out over the near term but I don't have any insights to give you.

Okay. And just a follow up, if I may. Regarding any failed bank acquisitions, you guys are making money, you're in a good position, you have good capital position, any thoughts on failed bank, would it be in market or out of market or is it something you are interested in?

Scott, we certainly believe that we are going to be one of the financial institutions that's emerging with relative strength, and one of the benefits of that is there are going to be a lot of banks that are struggling and potentially may need to sell themselves and a small number of buyers. That said, we would be very selective. We don't feel any need we have to do this, and we've taken a look at some of the failed bank deals that have unfolded so far.

But I do want to say that there is a lot of hair on a number of these things, even in the cases where the credit losses are actually protected. And a lot of times the franchises have been very, very badly revved up and damaged. So our view here is we would be extremely selective and we are not in a rush to go try to snap up the first opportunity that comes by.

Next question, please.

Next we will go to Don Fandetti from Citi.

Hi. Good evening. Sort of a follow-up to the comments earlier. There seems to be a very divergent views on where the card receivables could go and how we look at normalized earnings.

One view is that receivables fall off dramatically, 25% to 30% type percent. Is there a scenario where as you get comfortable with the go-to rate that that portfolio balance may actually be a little more stable than we think?

Don, I have been preaching from the high mountaintop to anyone who will listen cautioning people over the last basically year and a half or so, say just you will find a very, very striking reduction in balances in the card business from a variety of factors. I don't say the same thing looking forward. I don't think the rate of decline that you have seen in the past is necessarily going to reflect.

I think going forward, the way I look at it is until we, until we, so speaking for ourselves, in a sense, I think I speak for the industry on this one as well. Until we see the inflection point at which, for us, the card business would really look like something where we really want to step up originations and as long as charge-off rafts are where they are you will continue to see pretty much the same rate of decline you have seen in the past.

I think that inflection point is near, it's not here, it's probably near. When that inflection point comes, it takes quite a bit of origination to offset the sustained pretty darn high level of charge-offs. So I think the destination post-inflection point for card players like ourselves is a more flattish kind of near-term outcome than anything that would show a lot of growth.

But I do think post-inflection point, unless the industry just is stubbornly not getting its head around what go-to rates need to be I think that the steep decline would be stemmed.

Okay. Thank you.

Next question, please.

Next we will go to Bill Carcache from Fox-Pitt.

Hello. My questions have been asked and answered. Thanks.

Next question?

Next we will go to Bob Napoli.

Thank you. Rich, Capital One's U.S. card business has historically generated ROAs way above the industry, 3% to 4%. The view has been that a lot of that has been due to the smaller loan sizes with the higher fee-based components, especially late and over limit fees.

Under the new, certainly one of the bull's eyes of the credit card legislation was some of those fees especially over limit fees and I guess we will see where late fees come out. But it seems like you don't feel like your ability to generate those types of very high returns in the future are going to be impaired by this legislation.

Do you think the entire industry is going to have higher ROAs because of the big increase you mentioned, you pointed out in go-to rates, and, or what is going to allow Capital One to continue to generate much higher return, much higher returns than the industry?

Thanks, Bob. Let me talk about the destination of some of these fees for starters. I think OLs destination, over limit fees destination, is in terms of fee amount, is down. We certainly expect and plan for that, down but not out in a sense.

But down, okay. I think that the -- the so the number of occurrences of them is also down because companies like Capital One will be moving into an opt-in. I believe opt-in can be a very positive thing and like I talked about earlier, the net effect is also going to be down with respect to that. I think with respect to late fees, late fees, I think, are kind of one of the classic forms of risk-based pricing that I think that are extremely well understood in the consumer marketplace.

The credit card is more just very typical of how virtually all financial instruments have credit cards. So it will be interesting to see over time. Part of the unfinished business here of the Federal Reserve or whatever agency ultimately weighs in on this is how they view the quote/unquote reasonability of some of these fees. So that one I think we certainly keep an eye on.

Capital One has generally been cautious with respect to credit line extensions, Bob, and as a result, sometimes I think had a higher incidence of over limit fees than some players, but I think that we have been more than -- any changes here are going be more than offset by the benefit of having a lot less, I think, sort of changes to make, a lot fewer changes on some of the other things.

Back to your question then, will we be able to make, I don't want to shingle myself for what ROA we are make in the long term. My view is this, it's back to the 90s, as I would say, that it's a level playing field.

I think the way Capital One has been able to generate exceptional profitability is really more one customer at a time. The credit and pricing decisions one customer at that time with the use of an information-based strategy that we have not only spent 20 years building the entire Company is designed to be able to , execute on this.

So I look at that and say I don't see anything changing in a negative way vis-a-vis that. Frankly, the ability to go back to an underwriting differentiated business is a positive and I look forward to a business where truly the competition is more on headline rates and more on upfront underwriting and I'm pretty optimistic about our ability to generate strong

Follow-up question, are you building and at this point are you starting to think ahead to ramping up some strategic marketing plans? Do you have, I know American Express obviously ramping up marketing, many of the other larger players are not, maybe JPMorgan is. But where do you see the opportunities? Do you see it in this subprime space as everybody moves to the upper side?

Are you getting to that point, are you thinking about ramping up marketing or are you going to -- and otherwise I think you're going to see, you're going to shrink a lot faster than the industry.

So, first of all it won't be a switch, that is on/off relative to the card business. We kind of view this one subsegment at a time. We look for this proverbial inflection point as I call it. It is not just about when the economy turns.

Because if it were just when the economy turns then, frankly, we would have one inflection point across the Company. To us it is really about the supply and demand dynamics in a particular subsegment of a business, what's happening with positive or negative selection, the competition and price levels at the time. And how the consumer is performing in that business.

So, I would expect over the -- not too long from now we would selectively on the consumer side of Capital One be hitting those inflection points. But what I would expect on the other side of that, Bob, overall what you would see would not be a big bang, breathtaking increase in marketing, but rather something that is more gradual and measured because it is my deep belief that there's still a lot of pretty darn bad stuff waiting to happen in the economy.

I don't think we have to rush to go anywhere and I want to see demonstration of what the pricing and competitive dynamics are in the business post this Card Act. And I think that's going to say a lot about the growth prospects for all of us.

Next question, please.

Our final question of the evening will come from Henry Coffey of Sterne, Agee.

Henry, are you there? Well, in that case, I would like to thank everybody for joining us on the conference call today. And thank you for your continuing interest in Capital One. As I said before, the IR team will be here this evening to answer any further questions you may have. Thanks, and good night.

Ladies and gentlemen, that does conclude today's call. Thank you all for your participation.