Capital One Financial Corp (COF) 2010 Q4 法說會逐字稿

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

Thank you very much, and welcome, everyone, to Capital One's fourth-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 Capital One's website at CapitalOne.com and follow the links from there.

In addition to the press release and financials, we have included a presentation summarizing our fourth-quarter 2010 results.

With me today are Mr. Richard Fairbank, Capital One's Chairman and Chief Executive Officer, and Mr. Gary Perlin, Capital One's Chief Financial Officer and Principal Accounting Officer. Rich and Gary will walk you through the presentation tonight. To access a copy of this presentation and the press release, please go to Capital One's website, click on investors, then click on quarterly earnings release.

Please note that this presentation may contain forward-looking statements. Information regarding Capital One's financial performance and any forward-looking statements contained in today's discussion and the materials speak only as of the particular date or dates indicated in the materials. Capital One does not undertake any obligation to update or revise any of this information, whether as a result of new information, future events, or otherwise.

Numerous factors could cause our actual results to differ materially from those described in forward-looking statements. For more information on these factors, please see the section titled forward-looking information in the earnings release presentation and the risk factors section in our annual and quarterly reports accessible at the Capital One website and filed with the SEC.

Now I'll turn the call over to Mr. Perlin. Gary?

Thanks, Jeff, and good afternoon to everyone listening to the call. I'll begin on slide three.

In the fourth quarter of 2010, Capital One earned $697 million, or $1.52 per share, down from $803 million, or $1.76 per share, in the third quarter, as a reduction in net interest income and increase in non-interest expenses were partially offset by improved provision expense. Compared to the fourth quarter of 2009, earnings were up $321 million, or 85%, driven entirely by lower provision expense.

A modest decline in revenue over linked quarters, coupled with a 5% increase in non-interest expense, mostly driven by an increase in marketing, led to a 7% decline in pre-provision earnings during the fourth quarter. The continued improvement in charge-offs across most of our businesses offset the reduced quarter-over-quarter allowance release, resulting in a 3% drop in provision expense.

At this point, I actually think it's more telling to focus on year-over-year trends. You'll find these on slide four.

2010 earnings reflect, in large part, where we've been in the economic cycle and the impact of recent changes in the regulatory environment. After-tax earnings were up over 200% in 2010, from $884 million to $2.7 billion, and following the redemption of TARP preferreds in 2009, EPS in 2010 was up more than sevenfold, from $0.74 per share to $6.01.

The biggest driver of this change was a striking improvement in credit, whose impact was heightened by FAS 167 consolidation on January 1, 2010, offset by several other factors. These include reduced non-interest income, largely as a result of implementing the Card Act; declining loan balances resulting from consumer caution, portfolio runoffs, and still elevated charge-offs; and an increase in non-interest expense, especially as we ramped up marketing and integrated Chevy Chase Bank. We expect that some of these trends will continue to affect our 2011 results, given the outlook for a slow-paced economic recovery and the full-year effect of legislative changes.

Let's look a bit deeper into recent trends and what they say about the future. Pre-provision earnings declined in 2010 over 2009 levels for several reasons. Revenues were down, but only 4% on a year-over-year basis, even in the wake of a 9% reduction in average loans and the implementation of the card law in 2010 as well. These negative headwinds were partially offset by margin benefits associated with a lower cost of funds.

On the expense side, marketing increased over 60%, largely in the back half of 2010 from very low levels in 2009, as the opportunity to acquire new accounts grew during this year. While operating expenses were up modestly year over year, the increase was primarily related to the full-year effect of the Chevy Chase Bank acquisition.

The year-over-year improvement in earnings in 2010 was primarily driven by a 50% decline in provision expense, as we experienced a dramatic improvement in both losses and allowance expense. As credit improved over the course of the year, we saw charge-offs fall by some 20%, or nearly $1.8 billion in 2009. The combination of a consistently better outlook for future losses and a smaller managed loan book also led to a 33% reduction in our loan-loss allowance from the beginning of 2010.

Looking ahead, the lingering economic and regulatory impacts of 2010 will likely impact the full-year income statement in 2011. We'll experience the full-year impact of card law-related changes, which were implemented over the course of 2010, and expect that the lower starting point for loans will cause the average book in 2011 to be comparable to that of 2010, even as balances grow over the year.

Margins will be affected by crosscurrents as the on-boarding of lower yielding and lower loss assets are offset to some extent by a lower year-over-year average cost of funds and higher transaction volume. Non-interest expenses are also likely to increase in 2011, assuming increased market opportunities seen in late 2010 continue through this year.

While it's harder to predict provision expense, recent trends suggest that we should expect charge-offs to continue their downward trend, although the outsized allowance releases of 2010 will abate at some point.

It's hard to say exactly when these transitions will be complete, but several things are becoming clear. We are near the end of the card law-related changes and we expect relatively less impact from other aspects of recently-enacted financial legislation. Loan balances are stabilizing. Marketing and partnership opportunities are evident, and headwinds such as portfolio runoffs and charge-offs continue to abate. Our banking infrastructure has matured and become scalable. Thus, we expect over the course of coming quarters to see evidence of the path to solid and sustained performance beyond 2011.

Before I turn the call over to Rich, I'd like to focus on the Company's capital generation. Slide five shows that our Tier 1 common ratio increased 60 basis points to 8.8% in the fourth quarter of 2010. We continue to be very comfortable with our capital and its expected trajectory. TCE has improved consistently, and regulatory ratios should rise steadily after a temporary decline in the first quarter of 2011, resulting from the final phase-in of risk-weighted assets dictated by the regulatory transition to FAS 166/167 and an increase in disallowed DTA caused by the turn of the calendar year, such that the regulatory lookback period for DTA now includes the most recession-affected years.

While we are highly confident the level and trajectory of our Basel I ratios, I should also note that Basel III will have only minor effects on Capital One. In fact, we expect to exceed Basel III required minimums, plus conservation buffers, throughout 2011.

Capital One is, of course, one of the 19 banks participating in the Fed's current capital plan review. We submitted our capital plan, including stress scenarios, on January 7, and while we don't know precisely when we will hear back from the Fed, we expect that it will be during the first quarter. We've been using stress tests as a way to assess our risks and manage our capital for years, and continue to maintain substantial buffers over a full range of stress scenarios.

As for our fundamental capital trend, strong business performance, coupled with the abatement of headwinds from 2010, positions our Company to be highly capital generative over the coming years. Many of the headwinds we face in our regulatory ratios will shortly turn to tail winds. Even with an increasing loan book, the completion of regulatory consolidation will lead to slower growth in the denominator of our regulatory capital ratios over the next couple of years, as compared to the recent past. And the numerator of these ratios will rise, not only in line with earnings retention, but also with the steady decline in disallowed GTA, which we expect will be around $2 billion at the end of the first quarter and will largely disappear over the next couple of years.

We expect that our strong capital position and generation will enable us to deploy capital in the service of shareholders to generate attractive returns in 2011 and beyond.

With that, I'll turn it over to Rich to discuss the performance of our businesses in greater detail.

Thanks, Gary. I'll also focus tonight on some of the underlying trends that have shaped our results in 2010 and how these trends are likely to play out in the future.

I'll begin with loan and deposit volumes on slide six. For the year, loans declined by $11 billion, with about $6 billion of that decline from the expected runoff of mortgages, installment loans, and small-ticket commercial real estate. In the fourth quarter, loans declined about $400 million. Our mortgage, installment loan, and small-ticket CRE runoff portfolios declined about $1.4 billion in the quarter. So, excluding runoff portfolios, loans grew by about $1 billion across our businesses.

In the second half of the year, we've started to see some stabilization in loan volumes and early signs of a return to loan growth in 2011. When we retrenched and repositioned our auto finance business early in the recession, our quarterly originations dropped to a run rate equivalent to about $5.5 billion a year. In the last two quarters of 2010, the quarterly originations have grown to a run rate of about $9 billion a year. Auto finance loan balances hit their trough in the second quarter and grew modestly in the second half of 2010.

We've also seen modest growth in our commercial banking loans in the second half of 2010, despite the expected runoff in small-ticket CRE.

In our domestic card business, we restarted the engine for future growth in 2010. We increased marketing investments and acquired new partnerships. We laid the groundwork for future organic growth with improvements in customer service and great new products like the Venture card.

We are gaining traction in our domestic card business. Fourth-quarter domestic card purchase volumes grew 10%, compared to the fourth quarter of 2009. Purchase volumes have grown even as overall loan balances have declined. This reflects an ongoing change in the mix of our domestic card loans toward rewards products with higher spending levels, lower revolving balances, and lower loss rates.

New account originations in the fourth quarter of 2010 were more than double the originations in the fourth quarter of 2009. Excluding the installment loan runoff, domestic card balances grew by $700 million in the quarter. It is likely that normal seasonal patterns will drive a first-quarter decline in domestic card loans and that the first quarter will be the bottom for domestic card loan balances.

We expect that loans will grow after the first quarter. By the end of the second quarter of 2011, we expect domestic card loan balances to be higher than they are or were at the end of 2010, with further growth expected in the second half of 2010 -- excuse me, in the second half of 2011.

We expect the headwinds of elevated charge-offs and installment loan runoff will subside somewhat. We are well positioned to gain share in the new level playing field created by the Card Act, and we expect to add partnership loan portfolios and growth platforms, including the Kohl's partnership early in the second quarter. Compared to our existing domestic card loans, we expect that the Kohl's portfolio will have lower revenue margin and lower charge-offs, resulting in strong risk-adjusted returns.

Deposits in our consumer and commercial banking businesses grew by about $4.5 billion in the fourth quarter, continuing the strong growth we've experienced throughout 2010. The growth in bank deposits enabled us to bring down higher-cost wholesale funding. Our total cost of funds improved in the fourth quarter as a result of mix shift toward deposits and away from wholesale funding, as well as continued deposit price discipline. Our loan-to-deposit ratio now stands at 1.03.

Slide seven shows margin trends throughout 2010. Net interest margin declined modestly in the quarter. In our domestic card business, loan yields declined as a result of two factors. Although the improving credit performance and outlook continued to favor margins in the quarter, the magnitude of this benefit was slightly lower than in prior quarters.

And the full-quarter effect of lower late fees resulting from the Card Act also pressured domestic card loan yields and margins in the quarter. We now believe that substantially all of the impacts of the Card Act are fully reflected in the domestic card net interest margin and revenue margin.

Stronger-than-expected deposit growth in the quarter drove a mix shift of earning assets from loans to the lower-yielding investment portfolio, and the yields on investments declined modestly in the quarter. These trends were partially offset by the improvement in funding costs.

Revenue margin declined in the quarter, driven by the same factors that impacted net interest margin. In 2011, we expect margins to remain at strong levels, though they may drift downward modestly depending on pricing and the competitive environment, and the timing and pace of loan growth. We expect a continued funding mix shift toward deposits in 2011, which should provide modest funding cost benefit to the net interest margin.

Slide eight shows credit results for our consumer businesses. Improving consumer credit results continue to be a key driver of strong profitability across our businesses. Domestic and international card charge-off and delinquency rates improved in the quarter, despite seasonal pressure. Mortgage portfolio charge-offs increased in the quarter. Loss severities were higher as a result of continuing weakness in collateral values. Delinquency trends were stable.

Seasonal pressure drove a modest worsening of auto finance delinquencies in the quarter. Auto finance charge-offs were flat.

The credit performance in newer originations remains very strong. Credit improvements in our consumer businesses continued to outpace the modest and fragile economic recovery. This favorable divergence continued and even increased in the fourth quarter. While overall unemployment rate is expected to remain elevated for an extended period of time, we are seeing higher correlation between short-term unemployment rates and our delinquency rates.

In addition, we are seeing the benefits of seasoning loan portfolios and strong performance of recent loan vintages across our consumer-lending businesses. We expect that credit improvement in our consumer-lending businesses will continue to outpace the economic recovery.

Slide nine shows credit results for our commercial banking business. Commercial banking credit metrics showed signs of improvement for the third consecutive quarter. Nonperforming asset rates were stable in the middle-market C&I business and improved across the rest of our commercial-lending businesses.

In addition to the improvement in nonperforming asset rates, we experienced a third consecutive quarter-over-quarter decline in the dollar amount of criticized loans, reflecting stabilization across our commercial banking businesses.

During the quarter, we saw continuing improvement in the commercial real estate market. For the third quarter in a row, leasing activity and vacancy trends remained strong in New York, where we have our largest CRE exposure. Traditional CRE investors continued to reenter the market, providing needed liquidity, and sponsors continue to invest new equity into troubled transactions, enabling us to right-size many of our troubled loans. We expect that the worst of the commercial credit cycle is behind us, but we expect a few more quarters of uncertainty and choppiness in commercial charge-offs and nonperformers.

I'll close tonight on slide 10. Throughout the great recession and the most sweeping regulatory reforms in generations, we've made tough choices and bold moves that have helped us to weather this storm relatively well and put us in a strong position to deliver shareholder value today and in the future. We've emerged from the recession as one of the nation's leading banks by combining the advantages of national lending and local banking.

In 2011, we believe that our businesses will demonstrate line of sight to a very attractive destination. While we won't get all the way to the destination in our domestic card business in 2011, we expect to make significant progress. Excluding the runoff installment loan portfolio, domestic card loans are growing now. We expect further growth in 2011 as the headwinds of installment loan runoff and elevated charge-offs subside.

New account originations are growing. Purchased volume growth is strong. Our new products and great customer service are winning in the marketplace. We are well positioned to gain share. We're bringing new partnerships on board, and of course, credit continues to improve. We expect that our domestic card business will continue to deliver industry-leading returns in 2011 and beyond.

Our auto finance business delivered modest growth with improving credit and strong returns in 2010. We expect that auto finance origination volumes and returns will remain strong in 2011.

Elsewhere in consumer banking, our retail banking business is delivering strong growth in low-cost deposits and customer relationships. Our commercial business is demonstrating positive trajectory. With the worst of the commercial credit cycle behind us, we expect to grow low-risk commercial loans in 2011. Increased emphasis on Treasury management services and deeper relationships with our commercial customers enabled the strong growth in fourth quarter non-interest income, and it provides revenue growth opportunities in 2011.

And we are delivering strong commercial deposit growth at attractive spreads.

Transactional services bring new commercial customer relationships and, of course, deepen existing relationships. We can generate future loan revenue growth by expanding these relationships in 2011 and beyond.

Pulling up, we built a bank that is in a strong position to deliver attractive and sustainable results, including moderate growth in card and auto loans with high risk-adjusted ROAs, moderate growth in low-risk commercial banking loans, strong growth in low-cost deposits and high-quality commercial and retail customer relationships, and potential growth upside, depending on consumer demand.

We expect that our strong capital and capital generation will enable us to deploy substantial capital for the benefit of our shareholders. We expect to deploy capital for the benefit of our shareholders in multiple ways, including investing capital in organic growth, attractive acquisitions across our businesses, and returning capital to shareholders.

We've become one of the leading banks in the United States by combining the best aspects of national-scale lending and local-scale consumer and commercial banking, powered by a leading brand and a strong and growing balance sheet. In 2011, we expect that we'll continue to demonstrate significant progress toward an attractive destination for our customers, our associates, our communities, and our shareholders.

With that, Gary and I will be happy to take your questions. Jeff?

Thank you, Rich. We'll 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 Relations staff will be available after the call. Please start the Q&A session.

(Operator Instructions). Brian Foran, Nomura Securities International.

I guess when you referenced the vintages, we try to look at vintages in the master trust data, so we're limited at what we can see, but it just strikes me, the 2009 vintage in particular, now I'm guessing the 2010 has very high payment rates but also very low delinquency rates, like much lower even than back in 2005. And I wonder if you look at the whole data set you have, are you seeing the same thing? And what does that tell us about, A, the ability to grow through those higher payment rates, and then, B, the credit performance with the structurally lower delinquencies? Because it's just -- the data for the 2009 vintage actually looks something like the Canada card market more than the U.S. market that we're used to looking at historically.

So, Brian, I think what you're seeing there is -- you are correct in your observation that recent vintages have -- frankly, this is a general observation across most of our Company, but certainly in the card business, recent vintages are performing very strong with respect to credit.

And they -- it's a natural thing that they would have higher payment rates and lower delinquencies. And let's say there's probably three reasons for this. We have been certainly very, very strict in our credit requirements going through this downturn. We also, as you've seen on national television, put a lot of emphasis on going after the very top of the credit card market, and we're happy with our success there and that certainly -- almost definitionally gets folks very high payment rates and low delinquencies.

And the other thing I think that during this period of time as consumers are delevering, there is sort of a temporary period of what you might call positive selection, paradoxically, in this part of the great recession, and all of that leads to stronger vintages. So, we see very good vintages, and of course, the big issue is how quickly can we grow these. With each passing quarter, we feel -- we see more evidence of traction across all the parts of our origination business, and I think we should therefore be able to get a larger scale of the effect that you're observing.

And if I could follow up on the marketing budget, I guess the question I get a lot, when we see a marketing budget like $300 million, is that -- you see opportunities and you have the credit tail winds, so you are spending it offensively because you can, or is it defensive? You have to spend $300 million just to stabilize the loan book because it's a structurally tougher market to attract consumers.

No, I mean to us this is very much offensive, Brian. We are very committed in this Company to, well, frankly, 22 years of building a marketing and brand-oriented growth machine, if you will, and a cornerstone of that is a sustained and heavy investment in marketing.

So, there is a couple of components on the marketing side. Of course, we've got our actual origination programs that show up in direct mail and other Internet-based marketing that is, one rollout at a time, is a very -- is an NPB-based decision at the micro-segment level. And then, you also have a sustained investment by Capital One at the top of the house in terms of building brand and marketing some of our flagship products.

The striking thing to us is that, at a time like this when you see such weak demand generally and, frankly, quite a bit of intensity in competitor marketing, we still are finding that our returns per marketing dollar spent, they sort of measured like NPV per marketing dollar spent, is very strong and consistent with the strong days in our past.

Ken Bruce, Bank of America Merrill Lynch.

I guess the first question I have is really -- maybe dovetails into your last comment there. From a competitive position, it looks like you're focused much more on transactor business, and some of your competitors, on the other hand, are focused more on balance transfer type promotions. And I was wondering, is that market any more attractive to you at this point or does that -- is the pricing and term dynamic within the teaser arena still not an area that you think is best served by having Capital One investment dollars put at it?

Yes, so Ken, let me make several comments on that. First of all, let me talk about the transactor marketplace.

The transactor marketplace has been extremely competitive for the last two decades that I've been working in this business, and, frankly, that's because it's a great business. And all of the challenge is, how do you get business? We all love the business that we get. It is amazingly low attrition and wonderful economics and it's blue-chip customer base.

So, there's a lot of competitive activity there. Each of us stakes out a bit of a different position there. We are very committed to that space. We like the success that we're having, and we are going to continue to be very committed there.

With respect to the revolver space, and you know, there are a lot of different segments within revolver, but let me say a few things about that. First of all, the revolver -- a lot of the card industry has suffered very disappointing results on a relative basis with respect to the revolver space, particularly the pretty heavy-indebted revolvers that kind of showed good performance sort of until they got whacked in the great recession. So I think all of us in the industry are pulling back a little bit with respect to the zeal of pursuing some of this intense revolver space.

But here are the key things that we look at because, again, we subdivide this into micro-segments, of course, as you know, Ken, but as we look at this business, we have some high standards that we've been pointing out that sort of need to exist in order to pursue a particular revolver segment, and the stakes are higher now than sort of they were in the past with respect to this, and that's because in the wake of the Card Act, the go-to rate that we pick now is one that -- while there is some modest ability to do some repricing, this is really -- what we get is what we're going to have, and the industry's old habits of believing that there is a lot of sort of secondary pricing and repricing opportunities have to be very much corrected.

So we've been looking at what are the destination go-to rates that can sustain not only current performance, but in fact weather another significant recession. And the -- if you look at the industry go-to rates, Ken, they have gone up by -- since the great recession began, they have gone up by about 200 basis points and they are sort of leveled off at this point. That understates the margin improvement that's gone on because, of course, the cost of funds have declined during this period of time. So add a few more hundred basis points, and what has happened is that -- that price level has put a number of the micro-segments when we look at the business into an appropriate risk-adjusted kind of market clearing price.

Whole other parts of the revolver business are not at that level, and we are still, therefore, sitting on the sidelines with respect to this business.

So, there's definitely enough to work with here, but again, I caution that we all have to be very careful about the prices that -- the prices we've set at this point, we are going to be living with, and I think you're going to see some caution in some segments as a result of that for Capital One.

Okay. And as a follow-up, you touched on this a bit, but obviously the cost of funds has been the real benefit to the business over the last year or so. How much more improvement do you think that you can ultimately achieve in terms of a mix shift into deposits and essentially getting towards the front end of the yield curve? How much more benefit do you think that has altogether?

And separately, within the context of fee suppression, could Gary provide what the reserve level is for fee suppression, or give us some sense as to how to think about that number going forward? It's obviously been a big help here in the last year.

Sure, Ken. It's two questions, and I'll be happy to deal with both of them pretty quickly.

On the cost of funds, I think you have seen a very substantial decline over the course of the last year. I think you will see a continued improvement. I would be surprised if it were as dramatically good as it was over the course of the last year, just given the fact that a lot of our swapout for older fixed-rate wholesale funds were being replaced by deposits is kind of working its way through.

As Rich said, our deposit-to-loan ratio is pretty close to one at this point. So, I think there will be some room for improvement, probably not as dramatic as we have seen. Obviously, we are at a particular point in the rate cycle. As we go through that rate cycle, I think the potential for improvement in margins coming from better performance on the cost of funds aside coming from deposits in the long run is going to be extremely helpful. So, I think that's what you can look forward to there.

On the revenue side, as you know, we saw a substantial decrease in the amount of suppression over the course of 2010. That came from two sources. We were assessing fewer fees in the wake of some of the changes that took place post the implementation of the Card Act, and the collectibility of those fees went up, both with the performance of consumers in terms of credit and also just collectibility of fees when we were charging fewer fees. Given the fact that suppression was at only $144 million in this past quarter, that's at fairly low levels, and we kind of have gone through now the implementation of the Card Act, I wouldn't expect much movement off of current levels going forward.

Mike Taiano, Sandler O'Neill & Partners.

I guess, first, I was just curious if you could maybe give us some color on response rates that you've seen over the last few months relative to maybe earlier in the year. And one of your competitors last month had said that they were seeing a change, an uptick in the spending that was being done on cardholders that were traditionally revolvers versus the traditional transactors. I was curious if you were seeing a similar trend.

Mike, response rates, you know, if you look at overall the industry reports, response rates appear to be at their kind of record low at this point, because frankly industry mailings, for example, have gone -- have returned to 70% of their prior highs.

And you know, the amount of demand, shall we say, out there probably isn't commensurate with that. So I think overall the industry is challenged with respect to response rates.

Response rates are a measure that's getting harder to interpret nowadays when you look at any of the external data because more and more stuff is moving to the Internet. So, I think, and particularly for so many of us that are doing a lot of originations, whenever you go at the upper end of the marketplace, that's particularly -- it's pretty high cost to originate a particular account. That's why to us it's not about the response rates, per se. It's about the overall economics of the business, and I go back to the point that we're really pleased with the net present values that we're generating now. Despite a really pretty competitive marketplace and consumer demand being relatively weak, but pound for pound, we are seeing it as strong as we've seen in the past and we just are looking forward to getting a few more pounds of it as demand picks up a bit.

With respect to the -- I don't have a specific observation to add. It's intuitive -- I'd say intuitively plausible, your observation on the uptick of spending on revolvers. I don't have a particular data point on that.

Just a follow-up on just capital deployment. Just -- I think several months back, you had said the acquisition market, particularly for portfolios, seemed relatively attractive for you guys. Just given the M&A activity we've seen, and obviously it's been more tilted toward the bank side the last month or so, I think most people are surprised at some of the premiums that are being paid, and I just wonder if your view of the attractiveness for acquisitions has changed at all in the last month or two?

I certainly think that we're well positioned to be looking at acquisitions, as I've said it, ranging from the performance of our business and -- the triple whammy for us really has been the great recession, the Card Act, and FAS 166/167, and really all of that is basically moving into our review mirror, and we find ourselves with heavy concentration of the two businesses that are turning much faster in the recession than others.

So we certainly like our positioning and we have looked, as you mention, we have really not taken just a focus on bank acquisition, but really look across asset portfolios, asset origination deals, and things on the banking side as well. And we have gone into a number of these auction-type situations and have -- certainly on the banking side, we are certainly struck by how high the prices are. So, we're not discouraged from that. It doesn't cause us to not take a look.

But the fact that we have nothing to show for these efforts, certainly on the banking side since Chevy Chase a few years ago, shows that we are still staying very disciplined.

So in summary, what we -- we continue to believe the great recession will cause a lot of properties to become available, and properties that otherwise wouldn't have come available across the different businesses that we are in. We are going to actively take a look. We're going to be very disciplined about it, and meanwhile, we're putting a lot of effort into re-starting the origination machine and we feel very bullish about those opportunities.

The only other thing I want to say on acquisitions, and that is, of course, we have done a number of credit card partnerships that involve not only getting a partnership, but typically acquiring a portfolio there. And there is a case where we've always kind of fancied the partnership business. We'd go to auctions and we just couldn't believe how high the prices were years ago. Price levels have come down a lot, and we're selectively going after some of the very best partnerships, and there is an example of something we've done for a long time, but waiting for a pricing to get where it's right, and then we pounce.

Sanjay Sakhrani, Keefe, Bruyette & Woods.

I have two questions, so I'll just ask them all up front. I guess one question for Rich, following on that acquisition question before. If we were to see you guys do acquisitions this year, where would they come from specifically? Is there kind of a priority level in where you'd look to add inorganically?

And I guess the second question, for Gary, is just on the revenue margin for cards. You guys mentioned that since all the Card Act impacts in the fourth quarter, should we expect some kind of stabilization going forward in the U.S. card revenue margin, or could there still be some impact from the partnerships that come on, as well as Card Act? I don't know if there is any more impact from on the Card Act.

And then, maybe just one more, Gary. Can you just talk about the impact related to FAS 166/167 on the Tier 1 capital ratios again? Thank you.

Sanjay, on the acquisition side, we have -- I think we've taken a much broader kind of scope into this than a lot of players.

So, literally during this acquisition, we've looked actively in the card space. We have looked actively in the auto space. And we have even taken a look at a few growth platforms on the national lending side, where we have not been in that particular business, and then we've been looking on the banking side as well.

With respect to banking, our -- certainly, our top priority is things that are -- can enhance the footprint that we're in. We always keep an eye on attractive markets and opportunities in a market we're not in, but it would be with a very careful eye about how we could get to this kind of scale that we would want in a particular market.

Okay, your two other questions, Sanjay, very quickly. On the revenue margin, particularly in the card business, again as we've said, both Rich and I, with most of the Card Act implementation in our rearview mirror, I think the big effects that you're going to see over the course of the next year or so, certainly there will be a downward impact on the revenue margin coming from the completion of some of our partnership deals. Those are both lower yielding and lower loss assets, and as Rich described, in particular the Kohl's portfolio in the second quarter is a $3 billion to $4 billion portfolio with both a revenue and loss-sharing arrangement, so that will have a material impact on the reported revenue margin in card.

The other thing, of course, is that to the extent we see a pickup in volume, that often comes at a promotional rate, so that will have an effect on the revenue margin.

And then, lastly, as we see loss rates coming down and to the extent those appear to be something that we are going to experience for a period of time, one might expect in the competitive marketplace that margins will drift down to recognize the lower losses that we're seeing. So again, we don't see a particular change from the outlook that Rich and I have been sharing for the last year or so on where that margin goes, and those are the sources of the change.

Your other question, Sanjay, on the impact of FAS 167 consolidation on Tier 1 common. So, listen up. You're only going to hear this for one more quarter, and then we can pretty much stop talking about it, and I know we're all looking forward to that.

So, TCE has no more effect from FAS 167. That all hit in the first quarter of 2010 when we built the allowance. The -- in the regulatory capital ratios, the risk-weighted assets have not yet shown the full effect of FAS 167. You'll see the last dose of that in the first quarter of 2011, at which point in time that will be complete, and that will add a considerable amount of risk-weighted assets to the denominator of the Tier 1 common ratio, but, still, nothing that we haven't expected all along, and we've been giving you a sense of that trajectory, which effectively hasn't changed.

Remember that the other item that affects our Tier 1 common, or all of our regulatory ratios, that doesn't affect TCE is the disallowance formula for DTA. That is at least as big an impact on our Tier 1 common in the first quarter of 2011 because, as I said earlier, we are turning the page on the calendar when we come in to 2011. Our look back period is limited to two years for regulatory capital purposes. So now we're looking at 2009, 2010, which were the deep recession years, so disallowed DTA will go up.

The net result of that is that Tier 1 common will come down in the first quarter, probably to maybe where we were a couple of quarters ago, maybe between the Q2 2010 and the Q3 2010 levels, but thereafter not only will you see the fundamentally positive trajectory in our TCE flow through into our regulatory ratios, but you'll actually see an acceleration of accretion of regulatory capital. As that DTA rolls off, it's going to add capital to our numerator, and even with loan growth, we're not going to be adding to the denominator nearly as much in the next two years as we added in the last year because of 167.

So, hopefully that gives you kind of most of the moving parts and pieces, and explains our comfort level with all of our capital ratio trajectories.

Bruce Harting, Barclays Capital.

Running at the ROE that you're achieving right now, and your return on tangible comment reminds me of earlier days when you were at the earlier part of your sort of younger stages of growth when you used to talk about 20% EPS growth, 20% EPS -- or ROE, and you're there on the ROE on tangible. And I guess some people would say that you're not getting a higher multiple because of reserve release, by our estimate. Provision and charge-off converged by the end of this year. So, $6.00 seems like the right normalized number, and with more deposits and -- far more deposits compared to 10 years ago, when those were the applicable numbers, the valuation is much, much lower.

So I just wanted to see if you could comment on that, and what your thoughts are on what else you could do. It doesn't seem like -- I think the ROE, if I'm not mistaken, in those higher growth days was in the [one five] to [one six] range, and you're operating there now.

I guess the question I would have, Rich, is I heard you talk about the loan growth for the cards, and I just wonder, could -- where would you like to have the card portfolio as a percentage of the total? And I didn't hear you comment on growth, or I might've missed it, on some of the other portfolios, if you could just fill that in. And then, any thoughts on anything that can be -- you're doing all you can. I just wonder why the valuation isn't higher, given these returns. Thanks.

You've got some real fans here in this room for the observations that you made.

But I -- it -- the -- our quest in this Company is to build a franchise that can generate a very attractive, value-creating blend of exceptional returns and strong growth. And obviously, the issue these days has been growth, and I'm going to come back and talk about that for a second, but let's start with just the power of the profit model of our Company here. And in the card business, I think your back-of-the-envelope calculations are reasonable there.

I mean, in the card business, we are sort of settling in on a -- we're kind of settling in on a return, and frankly, we've made a lot of return through the great recession in this business, but we can kind of reach out and sort of just about touch sort of normalized, as you get back into this business. And of course, I've been saying for a long time, the revenue margin normalized -- the revenue margin is 15%, and I keep looking like a liar because it keeps staying stubbornly higher than that, but doggone it, I'm still sticking with my points here that I think the revenue margin is headed for the 15s. And -- you know, with the Kohl's portfolio, with the higher percentage of the portfolio at teaser rates, as we stoke up the growth a little bit more, and as the market gets a little bit more competitive.

But if you kind of think about destination economics, if you will, in the card business, that kind of revenue that I talked about and non-interest expense sort of in the 6% neighborhood as we step up marketing a little more from where we are as opportunities get better, credit going to normalized levels kind of in the 5% range, and frankly, they are going to get there probably a lot sooner than the economy really recovers, and you know, you're looking at normalized pretax ROAs in the 4% kind of range and after-tax in the high 2s and maybe a little to work with around the edges there as well.

And so, what -- it's a manifestation, I think, of the power of the profit model that we've kind of built in the card business, but of course, we have a 22-year heritage of really trying to create growth opportunities in this business, and we're really, Bruce, pretty darn bullish about growth.

Certainly bullish especially about market share growth in the card business because we just love the new level playing field. It's been unlevel for -- and getting increasingly unlevel for the last 10 years with some of the card practices. We love the level playing field, and while others may be retooling their business model and card, ours has really made it in stride through the Card Act and is really ready for business and, I think, in strong shape here.

With respect to that, and as we said, we're already really seeing growth in that business, and net of runoff portfolios, there's more growth than meets the eye. And we look forward to growth in that business starting to pick up after the dip in the first quarter.

In other businesses, let me talk about other businesses. So, take the auto business. The auto business, that also is a business that we're very happy with our returns in the auto business. It's very information-based strategy. We spent many years building that.

After a bit of a rough start at the beginning of the great recession, that thing is -- really generated strong returns, and the -- there's -- to everybody in the business, it feels like a high-growth business right now because it doesn't to you look like it because what we are having is the runoff, the portfolio back when we were yet larger, has been sort of the overall -- been holding back the kind of growth optics of the whole thing.

But when we talk about auto originations going from five -- in the fives to now a running rate of nine, this is pretty darn rapid growth, and I like our upside in the auto business. The competition has been -- has backed off a bit, and where we're getting the growth, Bruce, is in deepening dealer relationships.

So, what we did with our dialback is we're a lot less all things to all people, and we've really focused on the deep dealer relationships and built, as we generate the benefits of that and then expand from there, I think it's very solid line of sight to continued growth opportunities in the auto business.

On the commercial side, commercial banking is a pretty solid business. We've had a strong credit foundation. We've been spending quite a bit of time to sort of build some of the infrastructural components consistent with a top 10 bank that weren't necessarily there in some of the regionals that we bought. But that business, frankly all you have to do is squint your eyes a little bit and look sort of to a normalization of credit, and you're looking at a business with return on allocated capital in the 20s type of thing, and that certainly looks attractive to us, very line of sight.

And finally, we have the retail bank, which I think represents -- one of the things that, Bruce, that is very differentiated that we do with our local bank, possibly the biggest gift we give our local banks, is the ability to be unbalanced and not to have to push too hard for assets and, frankly, be able to -- in being unbalanced, not only does that lead to mitigating credit pressures, it also enables the opportunity to grow deposits at a higher rate than a lot of other banks do. So we see good growth opportunities in that.

Now, to get to a higher P/E, -- so wait, so where does card as a percentage of the total come out in all of that? We don't have a particular target, Bruce, but the net effect of all of this, I think card will grow and I think the rest of the Company, you know, will probably grow a little bit faster, so over time, the mix will mitigate a little bit. And to get to a higher P/E, I think the -- as we really put the -- in the rearview mirror the trilogy of things that have spooked investors, understandably, the great recession, the Card Act, and FAS 166/167, I think that we're going to be able to demonstrate to our shareholders the sustained results, the confidence that -- from a risk point of view, we just risk-managed quite successfully through an amazing black swan event, and now we are generating capital, high returns, and in fact growth that is, I think, higher than a lot of our competitors, so I'm very bullish about it, Bruce, and we look forward to seeing this happen.

Moshe Orenbuch, Credit Suisse.

Rich, I was wondering if you could talk a little bit about competition in the auto business? Some of the regional banks that are large in the business have already said they are seeing too much competition on yields and are pulling back. Two of the big standalone providers have been acquired in the last several months, and probably gives them a little more firepower as time goes on. Yet you talked about that as a growth engine. Can you talk about the competitive environment and how you see that developing? And I'm just wondering if you would be considering breaking out the mix of yields on the loans within the consumer banking business now that you've got several categories in there.

Moshe, the auto business is absolutely destined to become more competitive. It was always a competitive business. I think it got less competitive during the great recession. A lot of people backed off of -- a number of people, literally, exited the business, and the auto companies and their captives went through a number of issues.

So you're absolutely right. All signs point to more competitiveness.

Now with respect to the regional banks, I think what you're seeing there is less a comment on the market and more of a symptom of another issue, which is something that we believed strategically 13 years ago when we got into this business, and that is that this is a national scale business. This is a thin margin, tight business, and scale, the scale of operating costs and the scale of information management in this business is going to make it make it increasingly difficult for regional banks to compete, and that's been a macro trend for a long time and I really strongly predict that will continue.

So, what we see is tighter pricing across the board, but for us right now, the credit quality of what we've been booking, Moshe, is still enabling us, even with tighter competition, to generate exceptionally good returns right at the moment, but we are planning for a tougher environment. I don't think that's going to cause us to not be able to grow the way we want to in the business, but I just think that it's a very valid reminder from you that these businesses get competitive. I just think we are very well positioned in it.

We don't have any plans at this point to break out the yields with respect to the consumer portfolio, but I appreciate it is a little complex looking at the different pieces inside that business. We'll try to do our best to give you a window into that.

Betsy Graseck, Morgan Stanley.

I had a question on how you're thinking about the duration of the new customers that you're going after. When I hear that the hits for the response rates on the marketing are at all-time lows, but the marketing dollars are up, I'd just like to understand what type of duration you are expecting your new customers to be, relative to the portfolio that's on your balance sheet today.

First of all, Betsy, I'm not necessarily saying that our response rates are at all-time lows. That was an industry observation.

And again, these days the Internet is such an important part of the origination thing. Response rate metric is a little bit an odd one. But it is a fair comment that the cost of acquisition is pretty high these days.

Now, we have been explicitly going after very high-value customers in the various segments that we go after. So, it may cost a little bit more to get them, but we certainly like what we're getting.

Let me make a comment on duration. First of all, attrition rates. I bet I speak for the whole industry. I certainly speak for Capital One. Attrition rates have gone -- well, at Capital One, our attrition rates have plummeted, frankly, over the years, and that's a blend of some of the change in the mix of business that we've done. It's a reflection of the huge investment in franchise that we're doing, and I think it's frankly also a manifestation of a more temporary phenomenon, which is the recession and everybody just kind of sticking with what they have.

So, we -- but we are finding that even with the -- all the evidence is the business that we're going after, Betsy, I think is going to have some of the best retention characteristics in the history of the 22 years I've been doing this business. And it's not -- it's really -- I want to underscore how much our Company is focused on building a franchise, building customers that where we can dynamically manage that customer through all of their life stages and so on, and all of this is kind of paying off in a kind of record levels of low attrition, most of which, I think, will sustain, some of it which will pick up after the recession rounds the corner.

Okay, so the follow-up is, when you are thinking about that new customer and the marketing expense associated with it, to get to the ROA hurdles that you have for the customer, are you layering in anything other than credit card? Are you layering in cross-sell on other products that you have?

We actually take a very conservative approach to our NPV modeling. So, we -- most of the kind of deep relationship upside, we do not model into the original thing.

So, we of course make attrition estimates, but things like cross-sells, we don't really include them. Even a bunch of the balance build and other account management things that we do, we tend to take a very conservative approach on that because I've just grown to be a skeptic about modeling in all the kind of upside that's going to come, even though we believe deeply in it as a discipline. In the same way, Betsy, that we have always essentially put recessions right into our -- hardwired them right into our credit forecasts, we have a very rigorous kind of methodology of how do we quantify where upside exists, but make sure that we don't actually put it into our core assumptions lest we get addicted to it in a way that could -- we could regret.

Chris Kotowski, Oppenheimer & Co..

Most of my questions have been asked, but just on the non-card charge-offs were slightly up this quarter, and it was actually second quarter in a row, and just is that year-end cleaning up or are there some countertrend elements in that, or is there an explanation?

Yes. So the -- in auto, the -- you're basically are -- any credit effect we are seeing in auto is a seasonal effect. So seasonally, this is a time that -- charge-offs and delinquencies are rising during this period of time.

Frankly, in our own observations, if anything, the seasonal effects, the quality of the credit performance has even sometimes exceeded the seasonal effects that one would expect. But nonetheless, auto, anything there is just seasonal. The credit performance has been very, very strong.

In the mortgage business, actually the charge-off in our home loans business more than doubled, actually, from the third quarter to the fourth, from 41 basis points to 89 basis points. So I appreciate your asking that question. This was really driven by two one-time effects. First, back in the third quarter, we made a change in charge-off policy in parts of our home loan -- excuse me, our home-equity portfolios to align them all around the same charge-off policy because some of these had come from different acquisitions and things.

And this had the effect of suppressing third-quarter charge-offs for home loans by 15 basis points. So, the fourth quarter represents more of the normal equilibrium, but -- so it was more of a distortion in the third quarter.

Secondly, we received -- as we do from time to time, we get updated home value estimates, and we received updated home value estimates for 1,300 properties that were delinquent more than 180 days and that are being serviced externally, and these updated valuations led to a one-time, one-off write-down on the loans, and that was a 25 basis-point whack. So sort of adjusting for these one-time effects, you really had an eight basis-point move in the third quarter.

In general, the home loan metrics, we feel pretty good about the stabilization of those metrics.

And commercial, by the way, is a lumpy business. And that is -- things -- if you look beyond the lumpiness, we definitely see a rounding of the corner in commercial. And I think you're going to see commercial credit get a little bit better for next year.

Okay. Then just another little nit, kind of both on a consolidated basis and looking at your consumer banking franchise, the income. It's held rock steady for the last couple of quarters, and it just -- it doesn't seem like your experiencing the same drag on deposit service charges that some of the other banks are doing. So I'm curious what your secret is.

I really wouldn't tout any kind of great secret there. I -- on the -- so, let me comment for a second on the things that are whacking the revenue model of consumer banking, and just give you some of our numbers on that NSF/OD front.

We see a $75 million to $100 million annual effect, and of course, this has already gone into effect, so you really see that in the numbers. The -- on the Durbin side, like many banks, we were certainly struck at the Federal Reserve's interpretation of an already harsh law there, but we estimate $75 million to $125 million pretax impact of that.

Now, all of these estimates I'm giving you are before any clawbacks that come from revenue choices that we make. And we're -- we have nothing to announce at this point. We're certainly spending a lot of time analyzing that.

So, I think our retail bank has kind of hung in there, but it -- and I think the reason -- for Capital One overall, these effects percentagewise are not that big because we get so much of our earnings and revenue from other places, but, so, we would look -- we're going to be working hard to make sure that we can replace the earnings in another way.

Bill Carcache, Macquarie Research Equities.

Rich, so since you are not being directly impacted by the debit interchange changes, I guess a bit of a follow-up on the last comment that you just made. I guess my initial thinking was is it fair to conclude that you're not thinking about modifying your rewards programs or adjusting your fees, but it sounds like you may still be open to it and no final determination has been made, from your last comment. If you could just clarify on that.

Yes, I mean, you know. We, of course, feel that we are directly impacted by the debit interchange, and I think pound for pound we are like other banks. We just don't have as much -- as many pounds of that business.

But, you know, I think that -- we're looking very closely at what choices we want to make there. But I think all of our choices, because this is a business that is a smaller part of our whole, will be done not only in the context of the local bank, but also in the context of where we are trying to go as a Company. Now that's a vague statement. That doesn't really -- don't read too much into it. It's more of a way of saying we are still working on it, Bill.

Okay. And as a follow-up still on the topic of debit and everything that's been happening there, as we look ahead, do you see a shift away from debit and does that potentially present any kind of opportunity for Capital One? Thanks.

You know, I -- it's certainly been striking, the success that debit has had. It's the most dramatic, probably, growth vehicle in all of financial services over the last number of years.

Debit, while it's been pretty breathtaking growth relative to credit cards, I believe most of its growth has really come at the expense of cash and check, less so in terms of substitution with credit card, but we certainly had an eye on that.

You know, it's -- to the extent -- I think you kind of have to look at, Bill, how much in the banks' repricing of things, sorry, let me make the case on either side. You, of course, can have -- with the various steering kind of things going on with the lower debit interchange costs, you certainly can have merchants be more activist relative to driving more debit card use. I'm going to take the under on that. Because there's already been lots of reasons merchants can already drive volume to lower cost things and create discounts, but consumers end up feeling their surcharges, and I guess I'm probably going to take the under on that particular thing.

Now with respect, on the other side of it, to your point that might these price changes cause a move away from debit, I think the key thing to look for there is how much are banks changing the price of deposits and deposit banking relationships overall as opposed to charging for debit cards. So, in the limit, if they, given that there's a lot of money that's got to be recouped, the more that they put that into the price of the debit card, either on a transactional basis or in terms of having one, that actually could create a mix shift toward credit cards. If it's more about just making deposit relationships cost more, I'm not sure that the credit card is going to stand to gain that much in all of this.

Okay. Thank you very much to everyone for joining us on the conference call tonight. And thank you for your interest in Capital One. If you have further questions, the Investor Relations team will be here this evening to answer them, and wish everybody a good night. Thanks.

Thank you.

That concludes today's conference. Thank you for your participation.