Capital One Financial Corp (COF) 2010 Q2 法說會逐字稿

Welcome to the Capitol One second quarter 2010 earnings conference call. (Operator Instructions). Thank you. I would now like to turn the call over to Mr. Jeff Norris, Managing Vice President of Investor Relations. Sir, you may begin.

Thanks very much, Michael. Welcome, everybody, to Capital One's second quarter 2010 earnings conference call. As usual, we are webcasting live over the internet. To access the call on the internet, please log on to Capitol 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 2010 results. With me today are Mr. Richard Fairbank, Capitol 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 the Capitol One website, click on Investors, then click on Quarterly Earnings Release. Please note that this presentation may contain forward-looking statements. Information regarding Capitol 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. Capitol 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 entitled "Forward-Looking Information" in the earnings release presentation and the "Risk Factor" section in our annual and quarterly reports accessible at the Capitol One website and filed with the SEC. And now I will turn the call over to Mr. Perlin. Gary?

Thanks, Jeff, and good afternoon to everyone listening in to the call. Let's go straight to the income statement on slide three. Capitol One earned $608 million or $1.33 per share in the second quarter, with all of our businesses posting a profit. As we foreshadowed in last quarter's call, lower provision expense more than offset the expected decline in preprovision earnings. Total revenue declined $385 million or 9%. As net interest margin was stable, the revenue decline was driven by a 4.5f% decline in average loans and a decrease in non-interest income. The single largest driver of the decline in non-interest income was the absence of the first quarter's mortgage IO bond sale.

In addition, non-interest income was impacted by significantly fewer security sales and a full quarter impact to the reduction in over limit fees resulting from the move to opt-in mandated under the card law. Marketing expenses rose somewhat from seasonally low first quarter levels and will likely continue to rise in the second half of the year, though the magnitude of the increase will depend on the opportunities for growth. Operating expenses increased $114 million in the quarter, which included a number of one-time items, including legal reserves and a tax accrual due to legislative changes in Canada. We expect near-term operating expenses to moderate a bit, with second half expenses approximating a level realized in the first half of the year.

Credit performance continues to improve, and as a result provision expense declined 51% or $755 million in the quarter. Charge-offs declined in each of our businesses, yielding a $301 million aggregate improvement in the quarter. Also benefiting provision expense was the release of just over $1 billion of allowance, up from a $566 million release in the prior quarter. More on the allowance in a moment. One final line of note, on the income statement was a $404 million (inaudible) warranty expense, approximately three quarters of which was recorded in discontinued operations. Wherever possible, we have now incorporated probable future losses on an expected life of loan basis. The single biggest impact of this change was on GSE loans, which are now fully accounted for on this basis.

Turning to slide four, I'll discuss the balance sheet. Total ending loans declined by $3 billion or 2% in the quarter, with more than all of the decline accounted for by runoff portfolios and elevated levels of charge-offs. Our domestic card portfolio is down $1.6 billion in the quarter or 3%, as $1.3 billion for charge-offs and $1.2 billion of runoff of our installment loan portfolio more than offset gross originations in the quarter. With increasing quarterly origination of new accounts, improving charge-offs and a gradually moderating impact of run-offs, we expect domestic card balances to be approaching their lows. The commercial banking loan portfolio continues to hover around $30 billion, although we did have an approximately $500 million increase in unfunded commitments to our commercial customers in the quarter. We expect to see modest growth in this portfolio over the balance of the year. The consumer banking portfolio decreased $1 billion in the quarter, about two-third of which was caused by continued decline in our run-off mortgage portfolio.

Auto finance outstandings are approaching an equilibrium where our level of new originations will equal the runoff of prior originations for that business. We grew our securities portfolio by $1.1 billion in the quarter, with the bulk of growth in agency mortgage backs and floating rate asset backed securities. The portfolio continues to perform well, and our unrealized gain position is now $930 million, up from $482 million at the end of the first quarter. On the liability side, we continue to leverage our commercial and consumer banking platforms to take advantage of strong demand for deposits. By swapping out maturing securitization liabilities and time deposits into lower priced liquid deposits, we drove down our total cost of funds by another 7 basis points in the quarter.

Securitization liability was down $5 billion in the quarter, and we expect it to end 2010 at $27 billion, a 43% decline from year end 2009. Our loan to deposit ratio is now 1.08, the lowest point in our Company's history. As we turn to slide five, I will discuss the allowance. The continuing improvement in credit drove a reduction in allowance balances in all of our businesses in the second quarter, totaling $953 million for the Company overall. $665 million of the reduction was in the card business, the vast majority of which was in domestic card. This allowance release largely reflects the better than expected loss performance in our portfolio during the second quarter and a lower level of delinquencies.

In addition, the $2 billion of lower period end loans requires lower allowance, all else being equal. Despite the reduction in allowance, you will note that our domestic card allowance as a percent of delinquencies remained stable in the quarter. This reflects the fact that while delinquencies are improving, we are not assuming an improvement in the expected losses per delinquent dollar for the sake of the allowance. We continue to see strong credit performance in auto finance, with charge-offs down $41 million quarter over quarter to just 2.09%. This performance, coupled with a modest reduction in outstandings, led to a $158 million reduction in allowance for that business, which accounts for two-thirds of the consumer banking allowance release. After many quarters of building allowance in our commercial banking segment, we released $33 million of allowance in the second quarter.

This release was a result of both improving recent risk trends as well as further segmentation in our methodology to reflect differing credit performance within segments of the business. Despite this release, allowance as a percent of nonperforming loans rose in the quarter and now stands at 149%. Rich will talk more about commercial credit in a moment. All told, despite the $953 million allowance release, we ended the second quarter with an allowance balance of $6.8 billion or 5.35% coverage on our loan portfolio. It's reasonable to assume that our total allowance levels will likely continue to decline over the course of the rest of the year given the historically high levels of coverage and underlying credit trends we are experiencing I will now provide color on our capital ratios as we turn to slide six.

Our tangible common equity to tangible managed asset ratio increased 60 basis points in the quarter to 6.1%, nearly rebounding to the levels prior to the implementation of FAS 167. This increase in TCE was primarily driven by strong earnings in the quarter and an improvement in OCI. Taking into account the allowance, our total risk bearing capacity is now greater than it was at any point in 2009. This increase in our risk bearing capacity has been accompanied by a decrease in risk with ongoing improvement credit performance. Strong earnings and reduced loan balances in the quarter also helped our tier 1 ratios, despite the continued onboarding of risk weighted assets due to the reduction in securitization levels. We still expect a declining trend in our tier one ratios, however, over the near term. Rather than reflecting any fundamental weakness, this declining trend will be caused by two factors. First, the phased in onboarding of remaining securitized assets which begins in the third quarter this year will increase the denominator.

Second, in the first quarter of 2011, we expect a decrease in the portion of our currently elevated DTA that qualifies as tier 1 capital. However, our tier 1 ratios are and continue to remain comfortably above well-capitalized levels. Once the phase-in period is complete in early 2011 and loss levels normalize further, the procyclical tier 1 ratios should proportionately follow the fundamental upward trajectory of TCE. Before I pass the call over to Rich, I would like to note that the recent enactment of the Dodd-Frank Act may have an impact on the tier 1 treatment of our approximately $3.5 billion in trust preferred securities, and provides for a phase-in period expected to begin in 2013.

Given the potential change in capital treatment of these securities, we anticipate that we will determine whether to exercise our rights to redeem our trust preferred securities at or near the beginning of the phase-in period. We look forward to receiving clarity on these issues through rule making and other regulatory action. With that, I will pass it over to Rich.

Thanks, Gary. I will begin on slide 7 with a look at our margins Net interest margin was stable in the quarter. Modest funding cost improvements were offset by a modest decline in asset yield. Asset yield decreased as a result of a greater mix of investment securities versus loans in the quarter. The decline in our revenue margin resulted mostly from the absence of one-time benefits we experienced in the first quarter, as Gary just discussed, as well as the expected decline in our domestic card business revenue margin.

Second quarter domestic card revenue margin declined 48 basis points to 16.6%, as the expectations we described last quarter began to play out. Two factors caused second quarter decline. Overlimit fee revenues declined as expected, with the full quarter effect of the Card Act opt-in requirements, And the revenue benefit from improving credit performance was smaller in the second quarter than it was in the first quarter. In the second quarter, improving credit performance continued to increase the expected collectability of finance charge and fee billings, but the favorable impact on revenue diminished somewhat from elevated first quarter levels. Losing forward, we expect that domestic card revenue margin will continue to decline over the next few quarters. We still expect that quarterly domestic card revenue margin will be around 15% by the end of 2010 or early 2011, as the major impacts of the Card Act and cyclical forces are fully absorbed.

While the overlimit fee impact has largely run its course, we expect that three factors will continue to pressure revenue margin, with each factor driving about a third of the expected decline. As higher margin loan balances charge off or pay down, we expect that they will be partially replaced by new originations with lower go-to and promotional rates, which will result in lower net interest margin. The credit related benefit to revenue we experienced in the first and second quarters is likely to diminish further. Because we were able to recognize more of the finance charge and fees we build in the first two quarter of the year, we'll have a smaller backlog of prior billings that could be recognized in future quarters as credit improves. And our assumptions about declining late fee revenues are essentially unchanged by the Fed's final rules on reasonable and proportional late fee levels scheduled to go into effect on August 22.

We expect that the third quarter domestic card revenue margin will show a partial quarter effect from reduced late fees and that the fourth quarter revenue margin will show the full quarter run rate effect of this new regulation. Longer term, the revenue margin may drift downward modestly as credit continues to improve toward more normal levels. We continue to expect the domestic card revenue margin will remain at a level consistent with very healthy overall returns for the card business. As you can see on slide eight, loan balances continue to decline across our businesses. Expected run-off continues in our installment loan portfolio and domestic card, our mortgage portfolio and consumer banking, and our small ticket CRE portfolio in commercial banking. Overall consumer demand remains weak, despite emerging pockets of improving demand and origination growth in our domestic card and auto finance businesses.

In our commercial banking businesses, we've increased lending and loan commitments, but utilization of committed lines remains low by historical standards, resulting in stable outstanding commercial loan balances. The pace of balance declines is slowing, as charge-offs improve and expected run-off abates somewhat. We expect that loan balances will find a bottom and stabilize over the next several quarters. We believe balances will begin to grow modestly in 2011. The timing and pace of expected growth remains uncertain, because the timing and pace of any rebound in consumer and commercial demand remains uncertain. While we remain well-positioned to gain share in our domestic card business and to grow modestly in our commercial banking business, the overall level of growth will be dependent upon broader trends in overall consumer and commercial demand. In the face of uncertain consumer demand, we will rigorously manage credit underwriting in margins.

We will work backwards from the goal of building businesses with attractive, sustainable and resilient economics, and we will take whatever growth the market will give us rather than misguided efforts to generate growth that are either too risky or uneconomic. Slide nine shows consumer credit trends. charge-offs and delinquencies improved across our consumer businesses, with the exception of an expectant seasonal uptick in auto delinquencies. These seasonal trends suggest that auto charge-off rate will increase in the second half of 2010, but auto finance credit remains exceptionally strong, with significant improvements as compared to the prior year. While our consumer credit results improved in the quarter, recent economic data provides a reminder that the overall economic recovery remains fragile. May and June labor market reports were weak, and we continue to see risks in the housing markets as well as the shadow inventory of homes in foreclosure or with severely delinquent mortgages remain very high.

Our credit results have continued to improve even as the economic recovery faltered a bit over the last couple of months. As we have discussed for several quarters, our economic assumptions have incorporated a view that economic recovery would be fragile and modest at best. While recent economic trends are consistent with our assumptions, we remain cautious, so underwriting remains tight across our lending businesses. Credit performance also benefits from the portfolio turnover that comes with a prolonged recession, and consumer to leveraging by definition means that consumers are paying down debt rather than spending and borrowing. While this pressures loan growth, it also contributes to the improvement in delinquencies and charge-offs. You can see credit trends in our commercial banking businesses on slide ten. Commercial banking credit results improved in the quarter.

In addition to improvement in charge-off rates and nonperforming asset rates, we experienced a quarter over quarter decline in the dollar amount of criticized loans reflecting stabilization across our commercial banking businesses. Largely as a result of improving credit results, our commercial banking business posted a profit in the second quarter. During the second quarter, we saw some stability return to the CRE market. Leasing activity increased and vacancies started to decline in New York, where we have our largest commercial real estate exposure. Traditional CRE investors have begun to re-enter the market, providing needed liquidity, and sponsors have been willing to inject new capital into troubled transactions, which has allowed us to right size many of our troubled loans.

While commercial credit appears to be stabilizing, we are not quite prepared to call a peak in commercial charge-offs or non-performers. We believe that the worst is behind us, but we expect a few more quarters of uncertainty and choppiness in commercial charge-offs and non-performers. There has been quite a bit of interest this quarter in our exposure to the Gulf oil spill given our leading market position in Louisiana. We have very little direct exposure to the most impacted industries like fishing and tourism on the Gulf Coast beaches. Our oil and gas businesses are well diversified and mostly on shore. As a result, our credit performance has not seen a significant impact from the oil spill. Longer term, if the moratorium on deepwater drilling persists, the rigs in the Gulf may be forced to move to other drilling locations. This would not be a good thing for the local economy, as offshore oil and gas drilling provides significant employment along the Gulf Coast. Many of the people, businesses and communities we serve in Louisiana and Texas are facing tremendous challenges from the spill.

Just as we did in the aftermath of Katrina, we are committed to serving them and supporting our customers and communities through the clean up and recovery from this environmental disaster. I'll close tonight on slide eleven. Capitol One is demonstrating considerable resilience through the Great Recession and ongoing legislation and regulatory changes. But economic and regulatory uncertainty remains high. While the modest economic recovery continues, the last two months of labor and housing market data show weakness. Consumer demand remains weak; and while the recently passed regulatory reform law provides some closure, the banking industry now faces the development of hundreds of regulatory rules over the next couple of years to actually implement the new law. Our businesses and our business model are relatively less impacted by many aspects of the Dodd-Frank Act, as we are main street bank rather than a Wall Street bank.

Like all banks, we will be subject to changing capital requirements that will evolve as US and international regulators work to coordinate the capital aspects of the Dodd-Frank Act on the ongoing (inaudible) three discussions. The Card Act and the CFPB are the areas of new legislation and regulation that have the most direct impacts on Capital One. We have been discussing the Card Act for sometime now, and we have incorporated the expected impact into our strategies and our outlook. The potential impact of the CFPB is impossible to predict precisely; but to the extent that it promotes and preserves a truly level playing field for all banks and consumer lenders, we believe that our underwriting and marketing capabilities, as well as our customer practices, will continue to be competitive advantages. Against that backdrop, our near-term and long-term expectations are essentially unchanged from what we articulated a quarter ago. Over the next several quarters, we expect that quarterly preprovision earnings will decline into 2011. We expect the declining provision expense will cushion the bottom line impact of falling preprovision earnings.

As we move past the early part of 2011, we believe that our path to normalized earnings will be more apparent in our quarterly results. We expect that loan balances will stabilize and that preprovision earnings will begin to improve in 2011. Economic and regulatory uncertainty pose obvious challenges. But those same forces are also creating attractive opportunities for Capitol Hill. Many banks are reeling from the financial crisis and from poorly performing assets generated over the last decade. Others are struggling to address revenue and growth challenges resulting from legislative and regulatory reform and the new level playing field that they create. As a result, we are seeing reduced competition in some of our markets. We are also seeing opportunities to acquire asset portfolios, origination platforms or banks.

And with relatively few well-positioned buyers, the potential for attractively priced deals increases. We remain well-positioned to take advantage of emerging opportunities and to deliver significant shareholder value over the long-term. We have weathered the recession relatively well. We have been able to absorb the existing and anticipated Card Act impacts with our domestic card revenue model and business model largely intact. Credit losses are returning to more normal levels, and we have a strong brand in advantage customer access. In our commercial and consumer banking businesses, we have great market positions in some the best local markets in the country. We can grow commercial relationships and loans as the commercial credit cycle improves, and we can continue to grow deposits with disciplined pricing.

Our domestic card business has delivered industry leading profitability and returns through cycles, including the most significant recession in generations. We believe that our domestic card business is well-positioned to compete on the new level playing field that is created by the Card Act. Our balance sheet remains strong and resilient. We are well-positioned for the current interest rate environment and ready to respond quickly as interest rates change. We have ample and resilient deposit funding, and TCE is strong and growing. Now Gary and I will be happy to answer your questions. Jeff?

Thank you, Rich. We will now start the 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 questions after the Q&A session, the investor relation staff will be available after the call. Michael, please start the Q&A session.

(Operator Instructions). And our first question comes from Sanjay Sakhrani with KBW.

Thank you, good evening. I was wondering on balance growth, as far as that's concerned, it seems like total interest earning assets will decline into 2011; is that right? And specifically to your card -- your expectations for growth in card from first quarter levels, what exactly changed there, and maybe I will just ask my follow-up? I mean, should we expect marketing dollars to remain stable to higher relative to the second quarter levels from here on out? Thank you.

Yes, Sanjay, it's Gary. Just taking a look at the future, taking into account some of the run-off portfolios that we have described, taking into account the relatively high level of charge-offs and so forth, we have seen our balances come down. But as Rich and I have both said, we believe that we are quickly approaching the point at which our loan balances should start to stabilize as we move towards the end of the year. Exactly what will happen to our investment portfolio balance and so forth will depend on other opportunities to deploy those resources and the market environment. But certainly from this point on, there is a good chance of seeing some stability in overall loan balances that would mean ending the year lower than we started. But it seems as though we may be able to stabilize from this point.

(Inaudible) marketing spend?

Yes. There is no important change, Sanjay, in our growth outlook from the first quarter. With respect to marketing, marketing -- our marketing levels are going to be very dependent on what the market can give us, essentially really what the demand is. We are certainly prepared for ramping up our marketing investment, and what we are finding with the marketing that we are doing is it's generating the same kind of prospective returns that we always had in our business, and we are growing the marketing gradually in proportion to the opportunities that we see.

The real wild card out here is just how much and how quickly we are going to be able to grow them, because that's really-a demand driven issue. But we are comfortable that the marketing we are spending is generating the same kind of effectiveness and efficiency and return that it has in the past.

Next question, please.

And our next question comes from Bruce Harting of Barclays Capital.

Hi. Can you talk about any potential offsets to any of the card acts or (inaudible) amendments that you may be able to put into place over time? And is any of that included in your revenue margin discussion or outlook for preprovision earnings that you gave us? Thanks.

Well, Bruce, the financial offsets to the Card Act really came prior to the Card Act. And we have talked about that for many quarters now, so we feel a real stability in our outlook for our revenue margin in card. In fact, we have been talking about 15% for a long time now, and it looks like the business is very surefootedly driving toward that destination. So I don't think in the card business we are going to have financial offsets -- any more financial offset.

The big offset, Bruce, that awaits hopefully in the card business is the opportunities from the level playing field. And really my number one haunt by far in this anchor tenant business of Capitol One was how more and more we were felt like we had an arm and a leg tied behind our back because of pulling out of marketing in whole parts of the business and choosing not to do some of the practices our competitors were doing. So I think that that represents a very substantial opportunity, but it also needs demand to accommodate that. So again, that's something we are very optimistic about it, but I think -- so on the card side, what we feel really good about is that we are headed for a destination of a revenue margin that is only a touch down from the kind of basic revenue margin level that we had in the years prior to the recession with a much better competitive environment, and now we just need a little accommodation by the consumer.

I do want to say, though, we've got to be careful what we wish for, because frankly, the very same thing that is causing the weak demand -- which is consumer deleveraging -- is, of course, leading to the consumers to be paying down their debt. And frankly, while I and you would love to see demand pick up, something tells me in my gut we are probably better served by consumers making this choice. And really -- and that's the biggest driver of why credit has really, I think, outperformed the economy during this period of time.

On the banking side, Bruce, with respect to the Durbin Amendment, of course for Capitol One this is a much smaller stakes issue just because of the relatively smaller size of our banking business. I know some competitors are stepping up to make a series of financial moves to accommodate some of these changes. I think we are more in -- we are assessing the situation, but it's just not something that has a really big impact on Capitol One. I think we feel comfortable that our banking business, our banking strategy, is going toi be able to proceed.

Rich, I apologize, I should have been more clear. I meant in terms of, do you see any behavior change coming from the debit interchange reduction where people may move more toward credit? Or any kind of behavioral change on the consumer side? Sorry about that.

Okay, sorry, Bruce. Not that I know of. I think it is early at this point. Intuitively, I think there could be some small effects. But frankly, if I were to predict, I think the -- you are going to see consumer behavior relative to their cards relatively consistent going forward. And the fact that the credit card was not a subject of the Durbin Amendment, I think is certainly a good thing for us and not a coincidence, by the way, that that happened. And the other aspects of the Durbin Amendment -- the discounting and the minimum purchase provisions -- I think will have relatively modest impact.

Next question, please.

And your next question comes from Brian Foran of Goldman Sachs.

Hi, good evening. You mentioned for the sake of the allowance you are not assuming any change in dollars of charge-offs per delinquent loan. First, just to clarify what you mean, are you kind of talking about the ratio between losses and delinquencies right now being elevated relative to history? And then I guess either way, when you think about that charge-off to delinquency ratio, do you think anything has structurally changed in the credit card market, or do you think over time we should migrate back to kind of the charge-offs being 1.1 or 1.2 times delinquencies like it used to be?

Hey, Brian, it's Gary. And your interpretation is exactly right, which is we expect the ratio of losses to delinquency to continue through the horizon that our allowance covers, which for credit cards, as you well know, is full 12 months. Exactly where it goes beyond that, I think is going to be affected by an awful lot of things; but we feel that it is prudent at this time to assume no improvement in that ratio, and certainly we are not assuming any improvement in the overall economic conditions for that matter as well.

And then as a follow-up, I guess just trying to interpret everything you said and tie it to your page 11 near-term trends column, I mean, when we talk about lower preprovision earnings into 2011 and then past two normalized earnings more evident in quarterly results in 2011, I mean, is that all driven by the loan shrinkage in growth trajectory? Or I guess it seems like from everyone's questions on the calls, maybe the underlying theme is, is marketing going to come down? Is expenses going to come down? Are fees going to go back up? Or is it simpler than that and it's just all driven by the loan growth outlook.

Yes, Brian, I think as you look out over the next couple of quarters, it's pretty clear to see what's going to be driving preprovision earnings. We know what's going to be happening to the card margin. Again, as Rich said, we have now got a full quarter impact of the change in overlimit fee regulations. We are going to start seeing the impact of the reasonable proportional fees guidance on our late fees that is going to be driving our margin down. We've talked about the fact that we expect marketing to go up from these currently depressed levels.

Exactly how much it's kind of hard to say; and we know that with continued high levels of charge-offs and run-offs in our business, even if we are able to identify everything else correctly, we know there is going to be some decline in average loan balances for the next couple of quarters as well. So that's why the trend in preprovision between now and the end of the year is pretty clear, because all of the factors are pretty obvious to us and they are starting to play through. Our comment that we expect that you will see through the course of 2011 a path toward more normalized earnings means that it will get to our longer term revenue margin, we will have less pressure on loan balances coming from reduced levels of charge-offs, we will obviously calibrate our marketing, as Rich, said to the opportunities we have to grow. And so it's kind of hard today to say where we will be in the middle of 2011. A lot of that is going to be around marketing opportunities and growth opportunities; but most of the other factors by then will have played through and hopefully will continue towards more normal loss levels, and that's why we say the trend is going to be down in preprovision over the next couple of quarters, even though provision may be cushioning that, and then in 2011 is when we should start to see the fundamentals really more clearly.

Next question, please.

And your next question comes from David Hochstim of Buckingham Research Group.

Hi, wonder if you can just try again to quantify the unusual and one-time items this quarter -- the unusual investments and expenses, and then if you can go over the (inaudible) expense again this quarter relative to last quarter and kind of what was covered last quarter and what this does and how we can be confident this is the last time you'll have it?

Okay. David, it's Gary. On the operating expense side, again, we had a few one-time items. We don't think we've really established a new run rate this quarter. About two-thirds of the increase were one-time items. We had a litigation reserve not related (rep) and warranty. We had an accrual for some recently passed Canadian tax legislation and so forth. So that is what's affected this quarter.

We think that you should really take a look at the first half of 2010 as a whole. That's probably your better guide to run rate expenses. And again, as we have said all through the year, OpEx in the year probably not materially different from it where it was last year. Effectively, we are getting the benefit of some run rate efficiencies in some of our businesses, and we are reinvesting that in ongoing infrastructure to try and improve our ability to serve our customers and build our returns in many of our business lines. So those are the one-timers there. Obviously, non-interest expense will probably be more impacted going forward by whatever happens to marketing, because I believe operating expenses will be relatively stable.

With respect to the rep and warranty reserve, David, again, we increased our reserve, largely because we have extended the time frame over which we estimate our rep and warranty related claims and losses for the various kinds of claimants we have. And wherever we could, we have tried to estimate the ultimate liability over the remaining life of these exposures. Now the vast majority of repurchase requests we have gotten in the past year have come from two groups. One is the GSEs and the other are loans that are wrapped by some of the monoline bond insurers. With respect to the GSEs, they have got some reasonably predictable processes for identifying, submitting and settling claims, and provided that their past behavior is similar to the future, we think we have recognized most of our exposure. There could be some kind of quarterly variability due to ongoing adjustments, but only if there is a material change in the GSE's behavior or if we had a material change in our estimate of future lifetime defaults is that number likely to change materially.

The repurchase liabilities associated with monoline bond insurers and other potential claimants are less predictable and subject to a wider range of potential outcomes where we can. We have predicted those now, or estimated those on a life of loan basis. But there is a little more unpredictability there, and so that is more likely to drive future variability. But for right now, we feel we have got a very healthy reserve.

The difference between what happened in Q1 and Q2?

The difference between Q1 and Q2, David, again, is largely this methodological change to life of loan losses which was informed by significantly better data and better analysis we feel. I want the potential loss content in the loans; it may be it's not because of any significant change in the behavior of claimants.

Next question, please.

And your next question comes from John Stilmar of SunTrust.

Good evening. Rich, I was wondering if we take a step back for a second and think about the past three months where you have really been dropping marketing now, you're gotten to see at least the fourth quarter of '09 and first quarter of 2010. What has been the largest positive and the largest negative you have seen both in the card marketing market today and the level of competition? And then I have a follow-up after that.

John, in the -- I think the biggest positive has been the continued success of the business modal that we really haven't had the change as a result of either the Great Recession or the Card Act. And so we were doing mostly the same thing we used to do, and it's having the same kind of pound for pound success that it did before, and I'm very happy about that. Another positive is just the overall kind of credit environment. That's the context which we originate -- ,and of course we will have to see what the credit performance on our brand-new originations is. But I think everything we see suggests we are pretty confident on the credit side.

The biggest negative, of course, is demand itself, as we talked about. And the other thing that is not a negative in the last three months, but I put a yellow flag of caution out there, is that the pricing -- kind of every quarter I talk about pricing in the marketplace and where it's going. Because of the Card Act and because of some of the practices of repricing that are no longer allowed, it has been a very important -- because fundamentally, the industry is not going to be able to do retroactive repricing, it's very important that go-to rates essentially be destination long-term go-to rates. And so we've been saying for some time keep an eye out what competitors are doing vis-a-vis these go-to rates; and predictably, they started rising both in absolute and on an interest rate adjusted basis over the period proceeding the February implementation of the Card Act and the rose for a little bit after that.

But they have sort of flattened out in the last few months, and for us it's not an absolute thing. Are they at the destination they need to be or are they not? They are in some pockets and they are not in some pockets. Now there is a new sort of overlay that has come into the decisions about pricing that we all make in the marketplace, and that is that the Fed's new rules -- their implementation of this August rule making that they did requires a revaluation of APRs that were repriced in the 15 months prior to the imposition of the Card Act prohibition on retroactive repricing; and the new rules require issuers to compare the pricing of the accounts -- their existing accounts that were repriced to similar accounts that they offer to new customers today.

So I think the stakes of where those go-to rates are have been actually raised by that Fed ruling, and so in other words issuers' go-to rates need to be very consistent with what their existing portfolio rates are. So that's a little yellow flag. We will keep an eye on that. Overall by far, though, the big flag that we are watching is demand itself. That's the thing we worry about. We are comforted by the flipside benefits of weak demand, as I mentioned earlier. But we feel very good about the ability to continue originating with our business model and with the kind of returns and performance that we have had in the past.

Great. And for my follow-up question, Rich, you had highlighted a seemingly new language with regards to your desire to make an acquisition, whether that be a banking platform, or I think you had highlighted a portfolio. Can you put a finer point on what we should start to think about opportunities for Capitol One over the coming couple of years? Are we looking at franchises that will enhance the footprint of your commercial and consumer banking platform? Or are we looking at really more a favoring a purchase of an individual portfolio to augment the balance sheet? Just wondering if you could kind of put a finer point on your comments you made earlier.

Well, I mean, what we are doing is just watching the environment out there. I think if you kind of pull away up here the -- it's not surprising with the game changing dislocation in financial services from both the Great Recession and the great legislation, if you will, that there would be not only a larger number of sort of businesses and parts of businesses for sale, but also potentially ones that wouldn't normally ever come up in the normal course of a robust kind of economy. So it's certainly not lost on us. In fact, it's a central part of how we think, that one of the rewards of coming out of the tsunami in one piece and ready for business on the other side is that we could be one of a relatively small number of potential buyers looking at these things. So we are actually looking across the landscape here, and that landscape -- I know most people tend to think of banks focusing on buying banks. I mean, we are keeping an eye on that.

But I think some of the possibility more interesting opportunities exist in asset acquisitions, pieces of businesses or growth platforms that are being sold by other companies, as well as just distressed banks themselves. So I was more making a philosophical point that the very same conditions that lead to weakness in the banking industry exacerbate the weakness for all of the weak players, so that I think in some sense a little bit of the silver lining of industry weakness is both the credit benefits I mentioned earlier, as well as probably hastening to some extent the sale of businesses or pieces of businesses. So we are just -- we have been talking about this for quite a long time. You've noticed since the entire recession began we have done exactly one acquisition, which was Chevy Chase. So we are being very, very selective, and we just, though, definitely are looking at these opportunities.

Next question, please.

And your next question comes from Chris Brendler of Stifel.

Hi, thanks. Good afternoon. I wanted to discuss the auto business for a little bit. I didn't see much prepared remarks on the auto business. You did ramp up your originations, then we had a major transaction in the space today. How are you feeling about auto and your prospects for growing that portfolio, and any comments you would have on what the AmeriCredit's acquisition and the GM's relationship there may have on your business. Thank you.

Right. I think there are several things I want to say about the auto business. First of all, the auto business in many ways was one of the first businesses to really feel the pressure of the oncoming recession and was kind of the first one to turn the corner out of it. And it's both causally linked to the same thing, and that's because that business has basically less a than two and a half year average life for the asset, the fortunes of the business definitely ride on the choices you made in the last couple of years. So going into the downturn, one was dealing with a portfolio almost entirely originated in the prerecession period. Those tend to not be very good. And now, as Gary mentioned, well over half of our portfolio -- the significant majority in many ways of our portfolio -- is business originated with eyes wide open during the downturn.

Now that is accentuated in Capitol One's case by the dramatic repositioning of the business that we engineered at start of 2008, where if you remember we dialed back to an origination run rate that was down from at its lower -- it was at its highest level .13 billion in annual originations down to about 5.5 running rate. But it wasn't just dialed back randomly. This was kind of dialing back the highest ground of the best parts of the business for us, the best relationships and a lot of other things, with very tight credit cuts along the way. This portfolio has performed extremely well and it is, of course, now a growing part of our entire business. So along the way as we have really stabilized that business and are very pleased with our performance, we are now growing originations, and that will continue. As Gary mentioned, because the back -- the kind of the -- that goes against the run-off of the portfolio from the old $13 billion level of origination.

So auto won't feel like a growth business, but within what we are doing, the originations are growing, and we feel really good about our opportunities there. AmeriCredit, that really was a blockbuster. I can't say I woke up today and said, "I bet you AmeriCredit's going to sell itself to General Motors." But that -- as we tried to get our head around that one -- I think I want to be a little cautious in declaring the impact, but I guess I would probably guess in the near-term we don't expect to see a significant impact on our business. AmeriCredit has already stated that it's going to try to continue doing its business as usual, and it's already, of course, in a (inaudible) relationship with General Motors already.

I think, though, in the longer-term, we certainly believe that depository institutions will continue to be an advantage in the auto lending space; and the GM acquisition of AmeriCredit likely will open up opportunities in the non-GM business that AmeriCredit currently does. Now that could tradeoff with some loss in current GM business for us, but I think all in all, we think this will be probably not a huge amount of impact or may actually represent a positive for Capitol One.

Next question, please.

And your next question comes from Henry Coffey of Sterne, Agee.

Yes, good afternoon. Thank you for taking my question. I would kind of like to continue down this line. You've got four business lines, which obviously if we look at loan balances everything has been contracting, which is to be expected. Can you give us -- and you've given us a little bit of a shadow that you might expect to see kind of a clearer sense of the underlying earnings potential of the franchise in 2011. Is there a turning point for each of these businesses? Or as you look at each of these business lines, is it -- are they sort of mature cyclical businesses that will bounce around with the economy? I guess I'm looking for a sense of, is there a cyclical shift that will drive earnings, or is there sort of a growth machine locked up inside this business that we should be focussed on?

Okay. So let me think about each of the four businesses, Henry. When do they sort of hit -- sort of hit the bottom, if you will, of sort of their earnings, and when do they really start growing and growing earnings? The card business we've talked about -- the card business -- the reduction in -- the card business has to go through the reduction in revenue margin. That's really not a cyclical thing. That's the implementation of the Card Act driving that. That by sort of year end or the beginning of 2011 will be at its equilibrium point.

And then we -- that will represent kind of the low point of sort of earnings for the card business, and then from there I think -- now, well, in terms of core earnings of the business, from there you have growth opportunities and the significant benefit of charge-offs coming down. Now when allowance is release it's like a wild card there. But I think, Henry, in that business -- I don't know if you -- I mean, whether you call it a growth machine, I think it's certainly an earnings machine with the opportunity to gain share, and it's getting close to sort of it's low point in terms of its earnings, and it's very well-positioned for success. The auto business passed its low point a while ago and is powering to a better place. It right now is enjoying a lot of allowance release. It's natural earnings will be down from where they are right now, but I think that's in a very -- in a position to be generating a lot of positive return here.

In our commercial business, it's funny. One would think that commercial, it's hard to sort of grow that business. If you look at our commercial, it's been surprisingly stable in terms of outstandings and revenues given how much of a decline there has been in the commercial business. But I think that there is upside for growth in the business and in earnings that might be a little bit more than meets the eye. And we are at a -- the issue here is we are at a historic low in utilization rates for commercial credit facilities, and so we have been growing our total loan commitments, for example, 10% over the last 12 months. But outstanding loans have stayed essentially flat because of how low utilizations are. So I think there is kinf of built in growth -- not dramatic, but I think there is kind of inherently built in growth in that business without going out and having to beat out other competitors for new originations.

We also have very low share in the Washington, D.C. metro area, where we have a huge branch presence, so we certainly plan on building it there; and we are investing in some target segments like our C&I business like energy and healthcare that have performed very well through the downturn and I think represents a growth opportunity for ourselves. In the mortgage business, if you get passed the -- I mean, most of our portfolio is really toxic mortgages that have come along with the acquisitions. All that is running off, but we were just really starting to build a mortgage origination business where we think over the next number of years we will get our fair share in our existing branch markets, and that represents actually a pretty nice thrust for the Company. So I -- if you find me talking so optimistically here, I kind of speak from 22 years of building Capitol One.

Yes, we are at a time right now where there has been a lot of turmoil and everyone is adjusting to legislation. But when I look ahead, I see the most level playing field and certainly the best bone structure that Capitol One has ever had, and relative competitive position to be successful here. We just need to ride through the revenue margin running its course in the card business, the charge-offs getting back to more normal levels and demand picking up. These are all things that I feel very confident. I can't tell you exact timing other than the revenue margin, but I'm comfortable they are going to happen, and I think on the other side of this is a very well-positioned Company that, frankly, has a lot of advantages over the number of our regional bank competitors.

Next question, please.

And your next question comes from Moshe Orenbuch from Credit Suisse.

Great, thanks. I guess I wanted to focus on the idea that you had said that the kind of the competitive dynamics within the card market hadn't kind of changed all that materially or that your responses had kind of been the same that they have been all around. I mean, we have sort of noticed that on your core product you have raised the rewards component roughly by a third relatively recently. And the industry has gone up probably over the course of the last 15 months in terms of teaser mail by factor of maybe a five, and that number is probably going to be higher within a few more months. So I guess, can you kind of talk about the competitive environment in that context? It seems like it's actually intensifying somewhat.

Yes. First of all, it's a disappointment to me, frankly, that our performance is kind of similar -- pound for pound is similar to what it was a few years ago, because the competition is massively down from what it was before, so I think it's testament to just how weak the demand is. So I mean, I want to kind of pile on to your point here. Card competition, first of all, was a dramatic drop. We witnessed about a 75% drop in mail volume, for example, from the prerecession levels. But to your point, volume now is only about 35% to 40% off of the older highs. So we are definitely seeing competition picking up in the card business, as frankly we are seeing in all of the businesses.

So I think competition across our all the businesses that we are in is less than it was at its most intense time, Moshe, but it is definitely picking up from where it was, and the fact that right now supply and demand are such that we have a similar kind of performance that happened in a few years ago really kind of underscores how weak the demand is. So we are just very disciplined about making sure that our marketing, that we are going to get paid for that, and it's partly why we are cautious about suggesting to you how big that's going to be because we really want to validate every solicitation and every point what it's return is. The -- definitely, Moshe, there is a lot of competition in the transactor space in particular, because the rewards business, frankly, was the top performer during the downturn, and that's not lost on any of the other players there.

So I think that -- I don't want to at all declare that we see -- we see a level playing field. We don't see an open playing field, and I think that's an important difference.

Just a follow-up and like the idea you mentioned -- you made about acquiring platforms. I mean, I guess, could you kind of talk a little about what types of businesses, whether they would be within existing businesses that you are in, or kinf of new areas?

Yes. Well, first of all, I don't want to get carried away with this; it was really our point that -- and I have been saying for sometime now we certainly think that one of the most important thing that is going to happen with the Great Recession is a tremendous amount of dislocation of competitors out there. So Moshe, we have been looking at the gamut. I mean, things right in our core businesses that -- where we have distressed competitors, we have been looking at those. Haven't bought any of those things yet. We have looked in some cases at growth platforms that would allow extension into a new business area that we have always been interested in but didn't necessarily have an easy access to that, and we have been looking at distressed institutions on the banking side.

The point I want to make here is that there are, I think, three aspects about the current acquisition environment that make it better than usual. One is that you have more and different types of things getting stirred up and things that might otherwise not be stirred up. Secondly, there is profoundly less competition. And thirdly is really a result of the second one, and I forgot to mention it the first time I was talking about it. What hat interests us here is the chance to buy properties with significantly better pricing than would normally exist in the frenzied kind of acquisition environment that usually exists. Now again, we have been looking for years during this thing and have exactly one acquisition to show for it. So hopefully you draw from that the discipline that we have, but we certainly have noticed as part of this process that the sort of market clearing prices that things sort of go at is definitely lower than in the frenzy days that we seen in the past. So given that, I think that we want to make sure that we take a good look at what's out there.

Next question, please.

And your final question comes from Matt Kelly from Morgan Stanley.

Hey, guys. Thank you for taking my question. I'm just interested in getting your take on Rule 436 and how that impact the securitization system going forward. Short-term, I know you guys aren't doing much in that space, but longer-term I guess.

Yes, hey, Matt. It's Gary. I understand that news is coming out over the course last couple of hours that suggests that the SEC is looking at least for a temporary solution to make sure that transactions can continue. As you suggest, Matt, for us I think there is minimal impact. We don't have securitization issuance planned in the near future. We hope others can bring them to market, because we have been more of a buyer than a seller. But it appears that the folks are acting pretty quickly to try and resolve the situation.

I think probably a good reminder that every attempt at reform that we see, especially as big and complicated as the one that was signed into law this week, there can be unintended consequences. I'm not sure we expected to see them on day one, but we have, and hopefully we will develop the capacity to respond quickly. But as far as we are concerned, don't expect any impact.

Okay, one quick follow-up from me. In terms of rewards initiatives that you have out there right now, what do you see the best traction getting in terms of what your consumers want with rewards right now?

Well, our rewards initiatives really in two areas. They are in the credit card business and in the banking space. Let me start with banking. I mean, there I think what we are pitching and people are buying is rewards on the -- with people's checking and debit accounts, which is not what most banks offer. So this is something that very few companies -- you really have to have a massive scales in the rewards business to be able to offer something like this, and so it is kind of a natural for Capitol One, and we are committed to that business. And on the on the credit card side, you can see our advertisements on TV for the Venture Card. There what we are trying to do is to play right to a very resonant issue to the consumers regarding the complexity of current reward programs and kind of how rapidly they sometimes change. And we are -- we have created a product that is very, very simple, and that I think is a very resonant thing in the marketplace, and are putting quite a bit of advertising muscle around that.

Okay, thank you all, everyone, for joining us on the conference call today, and thank you for your continuing interest in Capitol One. The investor relations team will be here this evening to answer any further questions you may have. Thanks, and have a good evening.

And that does conclude today's conference. We thank you for your participation.