Capital One Financial Corp (COF) 2011 Q1 法說會逐字稿

Welcome to the Capital One first-quarter 2011 earnings conference call. (Operator Instructions). Thank you. I would now like to turn the conference over to Mr. Jeff Norris, Managing Vice President of Investor Relations. Sir, you may begin.

Thank you very much. Good morning, everyone, and welcome to Capital One's first-quarter 2011 earnings conference call. As usual, we are webcasting live over the Internet. To access the call on the Internet, please log onto 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 first-quarter 2011 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. Rich and Gary will walk you through this presentation. To access a copy of the presentation and the press release, please go to Capital One's website, click on Investors, 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. And 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 that are accessible at Capital One website and filed with the SEC.

Now I will turn it over to Mr. Perlin. Gary?

Thanks, Jeff, and good morning to everyone listening to the call. I will begin on slide three.

In the first quarter of 2011, Capital One earned $1.02 billion or $2.21 per share, up from $697 million or $1.52 per share from the prior quarter. The biggest quarterly driver of the 46% improvement in income came from a $305 million decline in our provision expense, largely accounted for by a $249 million decline in charge-offs. Total Company charge-offs fell 78 basis points from the prior quarter to 3.66%, the lowest level since 2007. Even factoring in the $105 million allowance build associated with the Hudson Bay portfolio, better credit performance across all of our businesses drove a $561 million release in the allowance, and our total coverage ratio now stands at 4.08%. Non-interest expenses were up 3% in the quarter. The seasonal decline in marketing spend was more than offset by a $103 million increase in operating expenses driven mostly by $60 million of legal expenses in our card business and the costs associated with the addition of the Hudson Bay portfolio.

Looking ahead, it is reasonable to assume that non-interest expenses will rise modestly in line with marketing opportunities. Revenue in the quarter was up 3%, even as average loans were virtually flat. I will discuss the drivers of this margin improvement as we turn to slide four.

The 29 basis point expansion of net interest margin in the quarter was primarily due to higher asset yields in our card and auto finance businesses and a 9 basis point decrease in our cost of funds. The higher asset yields in card were a result of the continuation of favorable credit trends, the mix of balances, and a modest increase in fee revenues.

Strong credit trends drove first-quarter suppression down to $105 million from $144 million in the prior quarter as reversals declined by $25 million and recoveries rose modestly. Consistent with the prior quarter, we released $49 million from the finance charge and fee reserve, which now stands at $163 million.

The credit-related benefits to revenue have proven to be more persistent than we had expected, but we believe that credit impacts on revenue will stabilize once we reach more normalized charge-off and delinquency rates.

In addition to the favorable credit impacts, first-quarter margin in the card business also benefited from continuing runoff of lower margin installment loans and a continued low level of new balances on promotional rates.

Looking ahead, total Company margins will continue to be impacted by credit trends, competitive dynamics in pricing, and the timing and pace of loan growth. All else being equal, the addition of the Kohl's partnership assets will lower margins in the domestic card segment, beginning in the second quarter. However, we expect that the impact from Kohl's on total Company margins will be offset by a reduction in cash.

I will now discuss capital as we turn to slide five. Our Tier 1 common ratio remains strong at 8.4% under Basel I or 8.7% using known Basel III definitions. The nearly $1 billion increase in retained earnings caused our tangible capital ratio to rise 45 basis points this quarter. However, anticipated impacts to the numerator and denominator of our regulatory capital ratios caused a dip in those ratios this quarter.

Let's start with the Tier 1 denominator. The first quarter marked the final regulatory phase-in of the implementation of FAS 166/167, and as a result, the denominator of our regulatory ratios increased to account for the addition of $15 billion of risk-weighted assets, even as end of period loans declined by $2 billion.

Moving on to the Tier 1 numerator. Our regulatory ratios were also impacted by a modest increase in the level of deferred tax assets disallowed for regulatory capital calculations. With the carryback period now including the hardest hit recession years, we had earlier believed that the level of disallowed DTA might rise by as much as $1 billion this quarter, which led us to believe that our Tier 1 common ratio could fall closer to 8%. As it turns out, business performance and favorable tax settlements late in the quarter drove down the overall level of deferred tax assets, and consistently strong earnings means less of that DTA is disallowed. The net result is that disallowed DTA was up by only $300 million.

In summary, strong earnings, a smaller than anticipated increase in our disallowed DTA, and the expected increase in risk weighted assets caused our Tier 1 common ratio to dip by only 40 basis points of this quarter. We continue to be very comfortable with our strong capital levels and their expected trajectory from here.

In addition to our ability to generate strong retained earnings, we expect our regulatory capital ratios will benefit from the recapture of the remaining disallowed DTA over the coming quarters.

With that, I will turn it over to Rich to discuss our balance sheet in greater detail. Rich?

Thanks, Gary. I will begin on slide six with loan and deposit volumes. Period-end loans declined about $1.9 billion in the first quarter. Our mortgage, installment loan and small ticket CRE runoff portfolios declined a little more than $1 billion in the quarter. So excluding the runoff portfolios, period-end loans declined about $800 million, which is in line with historical seasonal patterns for loan volumes in the first quarter.

Looking at average loan balances, the first-quarter decline was a more modest $400 million as about $1.2 billion of loan growth occurred early in the quarter with the addition of the Hudson's Bay Company card portfolio in our international card business.

Domestic card loans declined in the first quarter as a result of expected seasonal paydowns and continuing runoff of installment loans. Despite declining loans, we are gaining traction in our domestic card businesses.

First-quarter purchase volume increased 14% compared to the first quarter of 2010. New account originations in March were the highest since November of 2007, and new account originations in the first quarter of 2011 were double the originations in the first quarter of last year. We expect that the first quarter is below point for domestic card loans.

With the addition of the Kohl's portfolio on April 1, we expect that second-quarter loan growth will largely offset the loan declines we have seen in the first quarter. We are thrilled to be partners with Kohl's, a growing retailer with a great brand, great customer value and loyal customers. We expect modest loan growth to continue in the second half of 2011 as the headwinds of elevated charge-offs and installment loan runoff continue to diminish.

We are also well-positioned to gain share in the newly leveled playing field created by the Card Act.

In Consumer Banking, loan balances were relatively stable as continuing runoff of the mortgage portfolio offset growth in auto loans. Auto finance originations were $2.6 billion, up 16% from the fourth quarter and 91% from the first quarter of last year. We expect that auto originations will remain strong and drive modest growth in auto loans. We expect that continuing mortgage portfolio runoff will largely offset the growth in auto loans.

Our Commercial Banking business delivered modest loan growth in the first quarter. Growth in loan commitments, an early indicator of future loan growth, was somewhat stronger. Our C&I business experienced the strongest growth in both loans and loan commitments. Growth in treasury management and Capital Markets services is driving higher fee revenues and deepening relationships with our Commercial customers. New commercial loan originations remain strong, and loan demand is beginning to shift away from refinancing toward financing new growth for our Commercial customers.

Looking at the whole Company, we believe that the period of shrinking loans through the great recession has come to an end in the first quarter, and that we will return to modest growth beginning in the second quarter. We expect modest year-over-year growth in ending loan balances in 2011. Given the lower starting point for loan balances, we expect that average loans for 2011 will be comparable to average loans for 2010, even as period-end balances grow.

Total deposits grew by $3.2 billion in the first quarter, continuing the strong growth we experienced throughout 2010. Commercial and Consumer Banking deposit growth of $5 billion was partially offset by the expected runoff in brokered deposits. Deposit interest expense and total cost of funds continued to decline modestly in the quarter as a result of a mix shift toward lower-cost deposits in our banking business.

Slide seven shows improving credit results across all of our Consumer businesses. Domestic card charge-off rate improved in the quarter. Strong underlying credit improvement trends, lower bankruptcy losses, and higher recoveries were more than enough to offset expected seasonal headwinds. Delinquency rate also improved as a result of improvements in flow rates and delinquency inventories and expected seasonal tailwinds.

Charge-off and delinquency rates in our international card business improved as the result of continuing economic improvement and seasonal tailwinds. Net income for this business was pressured by the one-time allowance build associated with the addition of the Hudson's Bay Company portfolio in the first quarter. Hudson's Bay Company is a great partnership for our international card business. It is one of the largest retailers in Canada with an iconic brand, loyal customers and a great private label card program. We are excited to add this portfolio and growth platform to our international card business.

In our Consumer Banking business, charge-off and delinquency rates improved in the home loans portfolio and the auto finance business. Improving auto finance charge-off and delinquency trends are consistent with expected seasonal patterns. Auto finance credit performance remains strong, particularly the performance of newer originations. While we expect our auto finance business will continue to deliver strong credit performance and economic results, it is likely that we are approaching a low point for the auto finance charge-off rate. We expect that the charge-off rate will increase for the second-half of 2011, driven by seasonal patterns and competitive factors. And auction prices for used vehicles are approaching all-time highs and are likely to moderate or decline over time.

Credit improvements in our card and auto finance businesses have continued to outpace the modest and fragile economic recovery. While overall unemployment rate is expected to remain elevated for an extended period of time, almost half of today's unemployed workers have been out of work for six months or more and have likely already charged off. We continue to see a higher correlation between our delinquency rates and short-term unemployment rate, which counts workers who have been unemployed for less than six months. Short-term unemployment rate is well off its 2009 peak, and the pace of new job losses has come down sharply.

The choices we made in underwriting and managing our businesses through the great recession are a growing driver of favorable credit performance. We made tough choices to tighten underwriting, focus only on the most resilient businesses, and aggressively manage and mitigate credit losses. As a result, we are seeing strong credit performance of recent loan vintages across our consumer lending businesses. We expect continuing strength in card and auto credit performance despite an extended period of elevated unemployment.

Slide eight shows credit results for our Commercial Banking businesses. Nonperforming asset rates improved in middle market C&I and specialty lending, but worsened in commercial and multifamily real estate and in the runoff small ticket CRE loan portfolio. For the Commercial Banking business as a whole, lower charge-offs and loss severities were the primary driver of the increases in nonperforming asset rates.

Because appraisal values continued to recover in the first quarter, the initial amount charged off on new nonperforming loans decreased, leaving more of the loan balances in the nonperforming asset rate.

Charge-off rates improved in the quarter for all of our Commercial businesses, in part because of the lower loss severities I just described. The improvements we have seen in the commercial real estate market in New York where we have our largest CRE exposure continued, and gradual economic improvements in all our Commercial Banking markets also drove lower charge-offs in the quarter.

Commercial Banking credit metrics have stabilized and improved modestly over the last four quarters. We believe that the worst of the commercial credit cycle is behind us, but we continue to expect some quarterly uncertainty and choppiness in Commercial charge-offs and nonperformers.

I will close this morning on slide nine. Strong first-quarter results across our businesses demonstrate that we are emerging from the great recession in a strong position to win in the marketplace and to continue to deliver shareholder value. Our domestic card business delivered another quarter of improving credit results and strong returns. The headwinds of installment loan runoff and elevated charge-offs continue to subside. New account originations and purchase volumes are growing.

Our new products, our new partnerships and great customer service are winning in the marketplace. We are well positioned to gain share in the new level playing field created by the Card Act, and credit continues to improve.

In Consumer Banking, our auto finance business continued to deliver loan growth with improving credit and strong returns in the first quarter. We expect that auto finance origination volumes and returns will remain strong in 2011, and we are delivering strong growth in low-cost deposits and retail banking customer relationships.

Our Commercial Banking business is demonstrating positive trajectory. With the worst of the Commercial credit cycle behind us, we are growing low-risk commercial loans and expect further modest growth to continue in 2011. Treasury management and Capital Markets services are producing growth in fee revenues, and Commercial deposits and Commercial customer relationships continue to grow.

We are gaining traction all across our Company. Much of the growth we are delivering today is focused on franchise-building customer relationships such as transactor customers and new partnerships in our domestic card business, Commercial Banking customers with an emphasis on primary banking relationships, and deposit customers in our Consumer Banking business. While loan balances and revenues from these customers ramp up gradually over time, we expect the growth of these franchise-building customer relationships to drive strong and sustained bottom-line earnings and capital generated through sustainably lower charge-off levels, low attrition and long annuity-like revenue streams that build gradually but stick around for years.

We had become one of the leading banks in the United States by combining the best aspects of national scale and local banking supported by a strong and resilient balance sheet. We have top five scale positions in attractive local banking markets. But unlike other local and regional banks, we are not constrained by geography because we have national access to consumer assets and a national brand.

As a result, we are in an advantaged position to deliver attractive and sustainable results, including modest loan growth, moderate deposit growth and strong returns in capital generation. 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 in multiple ways, including investing capital in organic growth, pursuing attractive acquisitions across our businesses, and returning capital to our shareholders. We believe that returning capital to our shareholders will be an increasingly important part of how we deliver value.

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

Thank you, Rich. We will now start the Q&A session. As a courtesy to other investors and analysts who may want to ask a question, please limit yourself to one question plus a single follow-up. If you have any follow-up questions after the Q&A session, the Investor Relations team will be available after the call.

Alan, please start the Q&A session.

(Operator Instructions). Don Fandetti, Citi.

Rich, I was wondering if you could talk a little bit about your new card business in the quarter in terms of acquisitions. I mean where in the credit spectrum are they compared to where you have been historically, and can you talk a little bit about rates and competition in the business as you see it emerging?

Okay. I'm really pleased that the card business is starting to see more traction. One thing that we said all through the Card Act as it was unfolding and being implemented is that our business model is going to remain intact, not only in terms of the revenue margin of the business, but actually the business model that we have. So the more things change in some ways, the more they stay the same.

While there has been a redistribution of the revenue model for all players and more move toward very upfront pricing and a return toward a greater emphasis for the industry, which we are so pleased with on the leverage is really in sustainable upfront underwriting. The businesses that we have spent so many years developing are now thriving again.

So similar places along the credit spectrum, and for us it is a matter of taking all the sub segments of the business and looking at the market clearing price and comparing that with what we need on a sustainable basis, and sensitive to some of the limitations with respect to dynamic pricing over time that is going to be allowable in the business.

And what has happened with -- let me talk about the marketplace for a second. It is very clear that supply has continued to rebound in the marketplace. Mail volumes are now back to 2007 levels. They are still at about 60% of the all time high levels in the business, but don't necessarily be fooled by that because there is much more marketing now on the Internet and things beyond what is captured by the mail volume. So my feel of the business is we are close to the competitive levels from the heyday of the card business.

For us we find some subsets of the card business, the pricing is still below where it needs to be for resilience, and we are staying back in those areas and in quite a number of places. So the price levels are such that we can generate attractive returns.

So what I'm finding when I meet with my card people, every time we meet with them, you can just feel a little more traction, a little bit more balance in their step, and a little bit more validation that the consumer is stepping up and buying these products.

Craig Mauer, CLSA.

Regarding the marketing, we saw it down less than what normal seasonality pre-recession would dictate. Is this a -- first of all, are we seeing a direct indicator that opportunity is increasing as you just said?

Secondly, is this a move toward the former pre-recession highs and marketing spend, or is there no reason to get back to those levels based on market demand right now?

Yes, I mean I think the fact that marketing did not drop as much as perhaps the seasonal usual is a reflection of the fact that we see good opportunities out there. The kind of things that we are going after are pretty expensive in terms of new account origination. I mean the one kind of universal description I would lead you to on our card business is that we are not focusing nearly as much on business that generates balance transfers and kind of immediate loan growth.

What is all across our card business, it is very focusing on the things that are the longer-term, lower attrition, really highest-quality annuities. In almost every case, that tends to take us toward the higher cost to acquire and relative to some of our historical norms, and that is very advertising and marketing sensitive. So I think you should expect that our investment in marketing will continue to be pretty robust. The actual levels, of course, will depend on the opportunity, the magnitude of the opportunity as it continues to unfold.

Brian Foran, Nomura.

I guess you have been linked or speculated to be looking at a lot of deals in the press over the past couple of months. Maybe if you could just talk about acquisition ambitions overall and maybe specifically address three different categories of traditional branch-based banks, Internet deposits, and it seems like there might be a few US credit card properties for sale. Would you ever be interested in buying another US credit card business?

Okay, Brian. Well, our long-standing policy, of course, is we don't talk about specific potential targets. Let me just talk generally about our philosophy of acquisition.

I have been saying for a long time internally and externally that a recession is a bad thing to waste in a sense, and there is no doubt the great recession will give rise to a lot of properties that would otherwise not have been for sale and also create many of these opportunities at prices that are dramatically lower than they would have otherwise been.

So, as a general strategic premise, we have had an interest in capitalizing on that given the strength of our position as we go through the great recession.

As we have commented to investors, we tend to look more broadly than a lot of players. A lot of banks are focused only on banks, and we certainly look at banks. We have looked at lending companies and asset portfolios, partnerships.

We are very focused on growth platforms and very strong financial plays, and we have been through quite a few of the processes associated with these things. You know that we don't have much to show for it, and hopefully that is inspiring to our investors in the sense that we have been very financially disciplined. And, in fact, the only acquisitions that we have done since Chevy Chase have been on the partnership side, you know Kohl's, Sony, Hudson's Bay type of thing.

So we will continue to look. We will continue to be financially disciplined, and I would reiterate that I do think over the next 18 to 24 months the great recession will continue to give rise to acquisitions that otherwise really would not have happened.

And then just as a follow-up, just to be clear, so I think the growth guidance on US card is exactly the same as what you said last quarter, so just to clarify that. And then also what underlying -- you mentioned some of the points of underlying evidence, but maybe if you could just go into more detail. It seems like the spend volume is accelerating. I don't know if that is part of the confidence, but what other data points are you seeing when you look through your book that give you the confidence that loans will stop shrinking and grow modestly over the rest of the year?

Brian, our confidence about growth is mostly from just looking at internally saying internal things that are happening in our business, if you start conceptually from the outside thinking about growth -- before I talk about inside and our own results -- I think it is an unclear picture about the growth trajectory of the card business. The consumer has been de-leveraging, although the consumer's extent of de-leveraging is now kind of stabilizing. And, of course, we have enjoyed the benefits of consumer de-leveraging as a contributor to great credit.

The card business, it is a bit of a different card business now. The industry has been battered. The consumers -- you know, I don't think the consumers fully demonstrated how much collectively they are going to step up and be the same consumers they were before with respect to cards. We will have to take a look at that.

One thing I do want to say, though, is a kind of quiet effect that I really think is a big one that is going to be in favor of card. And that is that I think one of the biggest things that took a chunk out of the really high quality credit card market in the past decade has been this meteoric rise of home equity, and obviously that competition is going to be a shadow of its former self.

So I think conceptually we are bullish -- you know, we are cautiously optimistic about some return to modest growth for the card industry. We are not really planning on it are counting on it. The thing that gives me a bounce in my step are the things that I see internally. As we go segment and subsegment in our business, we are just seeing based on, of course, the testing that we do pretty consistently a pattern of steady, moderate improvement in response rates, coupled with very strong performance of the actual origination programs. So we are pretty bullish about the return to moderate growth in the card business.

But the thing I want to point you to as much, I don't think that the full bounce in our step that we have about this will not immediately manifest itself in the metrics that you see necessarily. Because this time a lot of the things we are doing does have the slower ramp, the longer-term -- I mean a little bit longer paybacks, and it is really longer, very high quality annuities.

Where I think you will see this show up over time, yes, it will include loan and revenue growth, but a little bit slower for each vintage than before. You already see the significant growth in purchase volume, and that is very indicative of some of the emphasis we have had on the top end of the marketplace. But also, I think what you will find over time is that the enduring strength on credit is going to be increasingly driven by the performance of recent vintages as they become the majority of the portfolio. So collectively we feel quite optimistic about the opportunity to really create value in this business.

Chris Brendler, Stifel Nicolaus.

I'm just a little bit surprised to not see any more detail. Maybe you could just give us an update on where you stand on the rep and warranty situation, any material changes in the key rates there, or the claims you are seeing or anything paid out? Can you give us an update there?

And then sort of a broader question. I think your results certainly have been pretty remarkable given the improvement in credit quality. Obviously we are still concerned about the turn in the portfolio, and it sounds like we are getting some traction there.

What do you think, I guess, from a strategic standpoint, you talk about the bank and the local deposit gathering at the national lending scale. It is, I think, starting to come together. When do you think that we will hear more from Capital One either through an Investor Day or a broader investor relations approach to get this message out there? I think your numbers really have not been fully reflected in the stock price, and I think it is a lot of sort of the legacy issues are falling away, and I think the opportunity here, as you look ahead, seems to be pretty compelling. I'm just wondering if you're planning on telling that message a little more forcefully in the future.

Let me take your first question on rep and warranty. I guess the news here is that there was not much news, which is why we have not focused too much on it. Overall rep and warranty expense in the quarter was about $40 million, of which about $30 million was an increase in the rep and warranty reserve. It is a small increase. We are now up from $816 million to $846 million, and most of the increase was driven by a moderate uptick in intensity among a subset of whole loan investors. So you will see it show up in the Q in the reserve related to non-GSE non-insured securitization. That is the biggest news.

Otherwise, there has not been much change in what we have seen in terms of either claims or activity. And so without much of a change in the outlook, there is not much else to add.

Chris, I appreciate your comments about how slowly but surely and sometimes maybe a little too quietly our results have shown through, and we are certainly well positioned for opportunities from here.

I think it is not necessarily our style to go out to the highest mountaintop and trumpet look at this and look at that. Particularly you can hear a little bit of my caution this time that so much of what I am most excited about is stuff that more gradually makes its way into the metrics as opposed to very dramatically doing that. But I will certainly take your feedback to heart, and Gary and I are very committed to making sure that we get our message out there to all of our investors in a variety of different forums. I certainly think we will have a lot to tell, and I'm -- (multiple speakers) yes, go ahead.

I just think some of this has been coming for a long time. I remember that you really have a very strong bench behind you in terms of the people who run these businesses and a very compelling story to tell. And for years and years and years, you had an Annual investor Day, and you really got a good sense of the people behind the scenes and the franchise you have underneath the surface rather than looking at the top down. And back then, it was just mostly the card business. But you have still got an opportunity to talk about auto and other things you are doing back in those days.

Today this Company has been under a significant transformation with the banking businesses. We have also had obviously a lot to talk about what's happening on the regulatory front and the changes that have taken place in your lending business. But yet it has been a long time since we have had the opportunity to really go into the details.

You know, as I go out and talk to investors on Capital One, a lot of people don't -- even people who are supposedly close to the name don't really understand what you bring to the table as a Company because it has been so long that you have really been able to go in there and do a deep dive.

So I just get that feedback consistently. I think time is getting closer where the recession issues that may have been so distracting and made it difficult to have an event like that are behind us, and now I think there really is a compelling story to tell, certainly the numbers this morning. I mean these numbers suggest that you are delivering excellent returns and excellent results, and I think there is a bright future ahead on the earnings front, and I think we should be closer to getting that message out to investors in a more comprehensive way.

Thank you, Chris. We hear you.

Rich Shane, JPMorgan.

When we look back at what was causing industry runoff, it was a combination of lower supply of credit and lower demand from consumers. Rich, what I think you highlighted was that the supply of available credit is increasing, but demand has not.

When you look at the tools and strategies available whether it is promotional rates or higher line limits or whatever is out there, what do you think you guys are going to do to stimulate consumer demand?

You know, I'm not sure that we have any magic answers to stimulate consumer demand. The one thing I would say, but I want to just comment for a second that I think all of us internally and externally can sometimes be measuring our standard of the ability of the Company to grow value is really kind of driven by how much can we grow the loan book. And I think that the consumer is paying us in value creation in pretty profound ways by their current behavior, and we need to be pretty careful what we wish for.

So, for starters, the absolutely just astonishing, and I have been doing this for 22 years, the astonishing divergence of credit performance from the economy is really extraordinary and an important factor in that I think is the consumers deleveraging and just being so careful.

The second way, and it is a sibling of this, but a way that we find value can be so dramatically created, frankly, in this ostensibly weak environment is through the very, very strong credit performance actually of the people who are stepping up to get credit cards. I think that we have been very, very pleased with the performance of some of our recent vintages, and I think that what is emerging is a healthier and more savvy maybe and discriminating user of credit cards. And I think that in terms of the opportunity at the end of the day to me and to Gary and all of our team, it is really not about how much we can grow loans; it is really about how much can we create value. And when we compare the pound for pound ability to really create value on this side of the downturn versus before, we are finding just total value creation per year as we measure, kind of add up all the NPV and so on. Even with the sort of weaker overall volume levels, we are pretty much getting to the, in our card business, the places that we were years ago -- over the heyday of the Company. And there is a lot of value to be created there. It will show up a little slower and manifest a little bit differently with the metrics.

And then, of course, on top of that, we have the auto business that is performing at a very high level. The Commercial business where we have been -- had among the lowest charge-offs in the nation for the major players, quietly that is picking up traction as well.

So I think there is a lot of opportunity to, even if it is in the context of a little less loan growth, to really create value at the kind of levels that you were used to us doing year after year in the middle of this past decade.

Well, I guess ultimately it is a lot easier to give money away than to get it back is what you are really saying?

That has been the haunt. Ever since I got into banking 22 years ago, this whole -- this odd thing that the industry for many years actually and especially now like the hardest thing for banks is to create assets. And I always said, is it just -- is it really -- can't people find a way to give away money? But you really get to the heart of the thing that it is really about getting it back.

And so I would any day, I would any day choose an environment where customers are more discriminating and more challenging, but their behavior surprises us on the upside with respect to the strength and the quality of those customers.

So what I find is, part of what is exciting me is a combination of a consumer that is in a very, very good place to surprise us to the upside on the credit side, combined with a competitive playing field that is dramatically leveled. And it really enables our Company who at times felt we were playing a bit with one hand tied behind our back, able to go out there and play with all of our limbs using it competitively.

The combination of those two things creates a very, very sound environment to create value for the Company, even though paradoxically it is in the context of sort of lower nominal growth.

Bruce Harting, Barclays Capital.

On your average balances and net interest income and net interest margin table, am I interpreting this the right way, or Gary, are you both asset and liability sensitive? In other words, it looks like -- how are you managing to keep your net interest margin actually a little bit higher on a linked-quarter basis in this environment? So are you one of the few companies that have ever seen over a long period of time where you're both asset and liability sensitive? In other words, you are benefiting from lower rates, and when rates go higher, I would think given the components of this table, you might actually have margin expansion.

And then good win last night, Rich. I don't know if you stayed up for the double over time, that winning goal was a little bit questionable, but a good game, a good comeback.

Well, I appreciate that. One thing that I have always come to appreciate, I went to the game in New York on -- and this is not a joke. All jokes aside, we were so struck by how nice all the folks were in Madison Square Garden. The fact that we lost made it -- they were particularly nice to us, but anyway that was one of the most amazing hockey games. It will go down in history, probably a little more in the Caps history than the Rangers. But, anyway, I appreciate your comment, Bruce.

And I guess I will take the other part of that one. Look, going forward I think the outlook would be for the net interest margin to be pretty stable. With respect to this quarter, let's recall that what we have been saying for a while is still true, which is our balance sheet has become naturally more asset-sensitive because we have more floating-rate assets both card and commercial loans and with an increasing share of indeterminate maturity deposits on the balance sheet that kind of lengthens out the liability.

So naturally we are more asset-sensitive, but given the current rate environment, we have adjusted the balance sheet to be somewhat liability sensitive to take advantage of the circumstances. So I think that is the overall explanation on the deposit side.

On the funding side, again, you did see a decline of about 9 basis points in our cost of funds. We are continuing to swap out of older, longer dated capital market type maturities and brokered deposits and CDs into deposits. So there is still an opportunity, though a substantially decreased opportunity, going forward given where we stand in terms of our deposit share of funding and where rates are.

And I think on the asset side, it is important to remember that although there has been good fundamental strength in the asset yields, particularly, say, in the auto finance business. In card there could be just a little more drifts given the fact that the favorable credit trends that have positively affected our asset yields in card will stabilize at some point and perhaps with growth even go a little bit the other way. We will have to see what happens with the mix of balances and so forth. But I do believe you should take away pretty good stability overall in net interest margin, and given the overall environment, I think we are pretty happy with that.

John Stilmar, SunTrust.

Rich, you have talked about credit in a lot of detail this quarter, and I appreciate it. Then you talked about it being sustainably low relative to history. How much of that is because the quality of the individual customer has changed for the same segment versus the market? Everybody has kind of moved up market. Is it just that you're getting better risk-adjusted returns by moving up market, or is it that the quality of the customers for that same segment has dramatically changed in your perspective of sustainably low?

And then my follow-up question is, specifically with Kohl's, it seems if I understand it correctly, Kohl's is going to be managing the card portfolio. What is it about the Kohl's business that allows you to let another person manage that business, and what is it that strategically important that you can learn from it, or is there a platform? Can you walk me through a little bit of the rationale because Capital One has always done such a good job of managing its customer base. Thank you.

Okay. So I think that the quality -- the credit quality -- look, I don't want to overdose on this point, but I do want to, say, credit quality I will comment at two levels.

First of all, credit quality overall that shows up in our portfolio and our competitor's portfolio is a phenomenon I call divergence because our card losses have declined 480 basis points since the first quarter of 2010, while unemployment rate has dropped only 90 basis points. That is a pretty dramatic effect.

You know, probably in order of importance, I think the biggest factor is the unemployment is different this time, and what I talked about earlier that longer-term unemployment, while a very serious issue for the economy, is less of a driver really of what is going on on credit portfolios. And shorter-term unemployment is well off its peak, so that creates a positive performance.

Secondly, the portfolio replacement effect is starting to get bigger. It is a very big deal in the auto business, and I will come back to the performance of our own little vintages to your question. But that one is driving things. Portfolio seasoning related to being on a lot of our book is aged past the peak loss period and the consumer behavior with lower debt burden. So the first kind of headline about the card business is the portfolio of ours and our competitors performs better.

A lot of the drivers of that are the same thing that cause originations, even in the context sometimes of not a lot of demand out there to perform better. And yes, to your point, sometimes you can get a little bit better performance pound for pound from the same kind of underlying credit metrics then you could at other times during the cycle. And that is really almost definitionally what positive or negative selection is about. I'm not saying there is dramatic positive selection right now, but we have had a lot of negative selection in some of -- in the time leading up to the great recession.

Finally, let me just talk about Kohl's and partnerships. You have seen a lot of movement in Capital One with respect to partnerships like Kohl's, and you see it in Hudson's Bay and Sony and Delta in Canada, for example.

You know, it is interesting. This really isn't a change in strategy for Capital One. We have always liked the partnership business. Similar to what we do with acquisitions in general, though, it really depends on price, and the pricing used to be almost insane in this business. It has become a lot more rationalized, and I'm talking about the bid price to get these portfolios.

Many or most partnerships are uneconomic and not really a great thing. So the key is it is all about which ones. What we are doing is going after businesses like Kohl's that are premier partners with great customer base, great customer loyalty, a real commitment to a card business that is not just for the retailer to be a big money maker, but really a way to drive better loyalty with their best customers.

And so in being selective, we have stepped up to the plate, and a company like Kohl's is really to me Exhibit A in this. They are very, very committed to doing all the things that build a long-term great customer relationship. And I find that we are essentially soulmates with respect to that long-term focus, and therefore, we find as we sit down to make joint decisions on things like credit and how to build the franchise, we are completing each other's sentences. And I think that bodes very well. It is reflective of the whole focus of Capital One across everything we are doing, do the things that build the long-term franchise, and that is what we are doing. Thank you.

Moshe Orenbuch, Credit Suisse.

Rich, given all the discussion you had about the leveling of the playing field, I'm curious to know how you view what your competitors are doing in this environment. Because it just seems to me that they have probably even to a greater extent than you narrowed their focus to a more persistent and regular cardmember, which means that they have likely got to be going to people that already have a credit history and already have a card somewhere. Doesn't that mean that kind of attrition amongst the major card issuers is going to be the norm rather than the exception? And how are you thinking about -- forget acquisition for a second -- but retention in the next year or so and how that might impact the results?

I think it is a really good point. You know, one of our real friends, and I know I speak for the industry here, I would guess, one of our friends quietly during the downturn has been retention. I mean there is no doubt that attrition rates for us, in addition to kind of the macro trend of Capital One to continue to build, focus more and more on those long-term franchise things. In addition, we have had the wind at our back with respect to retention. Because I think people during the great recession kind of wanted to hang on to what they have.

We are expecting significant increases in attrition. From here, I think that is very, very logical. I think that we can expect the costs to originate. Accounts is going to be high. And it is not lost on me that so many players are going right at, for example, the top end of the market, the heavy spender transactor part of the market. Obviously you have seen Capital One with our investment in businesses like Venture and so on.

So -- and you can see it manifests itself in the pricing, not only the amount of marketing, but you see it in reports that you feature every month. But we see in those markets teasers are lengthening. First, purchase spend incentives, related incentives are rising. The amount of rewards given at the time of sign-up are going up, foreign exchange fees going down, and so on. These are all the manifestations of things that we have seen and the ebb and flow of competition for 20-some years.

So to us, it is we start with the assumptions that the environment will be just as you described, and then to us it is a matter of testing and validating that we can create real value in this context. And because of the effect that you're talking about, we find that whole parts of the card business we have to stay back from because the market-clearing price just is not good enough.

Part of my message here today, though, is on a micro-segmented basis. There are lot of pockets of the market that still, despite intense competition, I think are generating very consistent kind of NPV per marketing dollar and NPV on any metric as we have seen during the heydays and powered again by strong credit quality and long-term annuities.

Well, that concludes our call for today. Thank you all for joining us on the conference call, and thank you for your interest in Capital One. Have a great day.

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