Capital One Financial Corp (COF) 2011 Q4 法說會逐字稿

Welcome to the Capital One fourth-quarter 2011 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer period.

(Operator Instructions).

Thank you. I would now like to turn the call over to Mr. Jeff Norris, Senior Vice President of Global Finance. Please go ahead, sir.

Thanks very much, Dana. And welcome, everybody, to Capital One's fourth-quarter 2011 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 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 and Principal Accounting Officer. Rich and Gary will walk you through this presentation. To access a copy of the presentation and the press release, please go to Capital One's website. Click on investors, 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 materials, speak only of the particular date or dates indicated in the materials. Capital One does not undertake any obligations to update or revise any of this information, whether as the 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. And with that, I will turn the call over to Mr. Perlin. Gary?

Thanks, Jeff, and good afternoon to everyone listening to the call. Let me provide a few highlights from the quarter and full-year on slide 3. Capital One earned $407 million or $0.88 per share in the fourth quarter of 2011. We saw strength in loan growth, and stable revenue. Earnings declined, however, due to increases in non-interest and provision expense, the latter reflecting stabilizing credit trends. There were an unusual number of unique items, impacting revenue and operating expense, which I will review in a moment.

While full-year 2011 results also had some noise, they provide a somewhat clearer picture of where we stand as we approach the integration of ING Direct, and the US credit card business of HSBC in the first part of 2012. After falling in 2010, Capital One loan balances grew by some 8% over the course of 2011, resulting in a constant level of average loans. Interest expense fell by about 30 basis points, and margins remain stable. As credit improved, a substantial reduction in provision expense more than offset a significantly increased level of investment in marketing and operations to restart our loan growth engine.

We also accelerated our build-out of top bank infrastructure, especially in the second half of 2011 to ensure our readiness to execute on very attractive acquisition opportunities. Although we expect considerable noise in our 2012 financials, from the purchase accounting effects, integration expenses and partial year impacts of these acquisitions, the economics of the deals are compelling and we remain excited about the sustained value creation they will enable. When the deals close, I will be able to provide you with a detailed view of how they are likely to affect our financials this year and beyond.

Now let's turn to slide 4, and I will focus on the fourth quarter. Capital One earnings per share were $0.88 or $407 million in the fourth quarter, compared to $1.77 or $813 million in the third quarter of 2011. The decline in linked quarter earnings was driven by lower pre-provision earnings, and increasing provision expense. Revenue in the quarter was down about $100 million or 2%, owing to a few unique items. Linked quarter revenue was negatively impacted as we recorded a very modest increase in our finance charge and fee reserve, after an unusually large $83 million release in the FCFR in Q3 of 2011.

Q4 revenue was also hit by a further build in reserves to cover higher expected expenses related to past sales of Payment Protection Insurance or PPI in our UK business. This resulted in a contra revenue of approximately $81 million. In addition, non-interest income in Q4 was negatively impacted by a representation of warranty expense of $38 million. Stripping out these impacts, revenue increased over the third quarter by about 2.5%, in line with average loan growth.

Moving to non-interest expenses, they were up quarter-over-quarter due to a seasonal ramp in marketing spend, and an increase in operating expenses. The $213 million increase in operating expense recorded in Q4 included $92 million in litigation expenses, two-thirds of which relates to our US card business. We also had approximately $40 million in asset write-downs and other costs, as we rationalized some facilities and equipment, principally related to acquired banking businesses.

The remaining increase in operating expense reflects, in large part, continued investment in growing our businesses, and an acceleration in building our top bank infrastructure as we prepare to integrate ING Direct and the US credit card business of HSBC. In view of our considerable progress on both these fronts, we expect our run rate operating expenses to remain at a level similar to the run rate of Q4. Provision expense increased in the quarter while our outlook for credit performance improved modestly, the growth in loan balances and seasonal effects led to both a lower allowance release than in Q3 and a tick up in charge-off dollars.

Turning to slide 5, let's take a quick look at balances and margin highlights. End of period loan balances grew in the quarter by almost $6 billion or 5%, reflecting growth in our Domestic Card, commercial lending, and Auto Finance businesses. Average loans were up by $2.5 billion, as much of that quarterly balance growth was concentrated in the last few weeks of the year. Net interest margin declined 17 basis points in the quarter to 7.22%. Benefiting the NIM, was a shift from cash to loans, and a reduction in funding costs attributable to lower deposit rates. However, these benefits were more than offset by a decline in loan yields, driven largely by one-time effects, such as the absence of a large finance charge and fee reserve release which benefited in Q3 interest income.

Turning to slide 6, let's take a closer look at year-over-year performance. Strong and stable margin performance and a significant credit improvement led to a 7% increase in net income from continuing operations between 2010 and 2011. On a total Company basis, earnings rose by 15%. Pre-provision earnings decreased in 2011, as non-interest expenses grew. Emerging from the recession, we invested in additional marketing in the rollout of new product offerings across our businesses. We also made significant progress in the build-out of our top bank infrastructure.

A substantial improvement in credit led to a 40% decline in provision expense in 2011. Charge-offs fell dramatically, the effect of which was somewhat offset by the lower level of allowance release as we see credit stabilize at historically strong levels. And we returned to loan growth in 2011, with an 8% increase in end of period loans. As expected, a majority of that loan growth came in the back half of 2011, which resulted in average loans being largely flat year-over-year.

Moving to slide 7. The strong loan growth at the end of the fourth quarter also had an impact on risk weighted assets and related capital ratios. Despite an increase of $500 million in Tier 1 common equity, our Tier 1 common ratio decreased 30 basis points in the quarter to 9.7%, using Basel I definitions. Using known Basel III definitions, our Tier 1 common ratio would be approximately 10 basis points higher than that. Over the course of 2011, we generated substantial amounts of capital, by retaining $3.2 billion of earnings, and recapturing $700 million of deferred tax assets previously disallowed in the calculation of regulatory capital. Our Tier 1 common ratio rose 90 basis points in 2011, despite a 22% increase in risk weighted assets.

We continue to be comfortable with our strong capital levels, and our capacity to generate healthy amounts of capital going forward. In the near term, closing the ING Direct acquisition and related capital transactions, will cause our Tier 1 common ratio to rise. We still expect that our Tier 1 common ratio will be in the mid 9% range in the quarter we close on HSBC, and complete the necessary capital actions. With that, I will hand the call over to Rich. Rich?

Thanks, Gary. I will begin on slide 8, with a look at loan volumes. Domestic Card loan balances grew just under $3 billion or 5% in the quarter and for the full-year. Fourth quarter growth was driven by seasonal spending and balance building on our growing account base. Growth for the year resulted largely from the addition of the Kohl's private label partnership, as well as the return to modest growth, with normal seasonal patterns in our general purpose card business in the second half of the year. The expected run-off of installment loans was a drag on Domestic Card loan growth of about $400 million per quarter in 2011. Excluding the installment loan run-off, our domestic credit card loans grew by a more robust $4.7 billion, or about 9% for the full-year.

Beyond loan growth, there are continuing signs of traction in our Domestic Card business. New accounts booked in the fourth quarter of 2011 were more than double the new accounts booked in the fourth quarter of 2010, and growth in our purchase volume outpaced the industry in 2011. Fourth quarter 2011 purchase volume grew 15% from the fourth quarter of 2010, excluding purchase volumes in the Kohl's portfolio. Fourth quarter Domestic Card revenue grew 5% from the fourth quarter of 2010, driven by seasonal growth in loans, strong purchase volumes and stable margins. The Domestic Card business posted $2.3 billion in net income in 2011, driven by significant credit improvement, the return to modest loan growth, and stable margins.

In addition to the continuing traction in our current card business, we expect to close the acquisition of the HSBC US card business in the second quarter. We expect to acquire HSBC's portfolio of resilient card loans with strong returns, and the acquisition will also greatly enhance our partnership's business and capabilities. After the initial increase in loan volumes, the acquisition may mute our Domestic Card growth trajectory somewhat, because of the expected run-off of portions of the HSBC portfolio.

In Consumer Banking, loan balances were up modestly as strong growth in auto loans was partially offset by expected run-off of the mortgage portfolio. Auto Finance originations were $3.6 billion, up 5% from the third quarter, and 62% from the fourth quarter of 2010. Auto loan balances at the end of 2011 were $22 billion, up 22% from the prior year. We expect that auto originations will remain strong, and drive continuing growth in auto loans. We continue to gain traction in consumer deposits as well. Deposits grew 7% from the prior year, while interest expense improved by 29 basis points. Deposit growth in the fourth quarter was essentially flat. The Consumer Banking business delivered $810 million in net income in 2011, driven by the strong performance of the Auto Finance business and growth in deposits with improving interest expense rates.

We expect to complete the ING Direct acquisition in the first quarter. This acquisition will have a significant impact on Consumer Banking, loan and deposit growth trajectories. We expect that sizable run-off of the ING mortgage portfolio, and the continuing run-off of our legacy mortgage portfolio, will more than offset the growth in auto loans, driving a declining trend in Consumer Banking loan volumes. Mortgage portfolio run-off is expected to mute total Company loan growth rates as well. With the acquisition expected to add $80 billion in deposits, with attractive all-in costs, our consumer deposit businesses are shifting their emphasis towards solidifying franchise-building customer relationships, and realizing the financial benefits of the ING Direct acquisition. The deposit volume trends in the fourth quarter of 2011 reflect this evolution in our deposit strategy in anticipation of the ING Direct acquisition.

Our Commercial Banking business delivered another quarter of steady loan growth. Ending loans were up 5% from the prior quarter, and up 14% from the fourth quarter of 2010. Growth in loan commitments, an early indicator of future loan growth, was even stronger. We are targeting and achieving the strongest growth in those areas in which we built specialized expertise in capabilities, including rent-controlled multi-family real estate in metro New York City, and selected middle market industry segments, such as energy and commercial finance. Commercial deposits grew 5% in the quarter, and 17% year-over-year, with modest improvements in interest expense. The combination of improving credit, and growth in loan and deposit volumes drove 2011 net income of $533 million in our Commercial Banking business.

The growth we are delivering today continues to focus on franchise building customer relationships and accounts all over Capital One. These include rewards customers and new partnerships in our Domestic Card business, Commercial Banking customers, and deposit customers, and auto dealer relationships 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 generation, through sustainably lower charge-off levels, low attrition, and long annuity-like revenue streams that build gradually, but stick around for years.

Slide 9 shows the credit results across our consumer businesses are stabilizing at relatively strong levels and exhibiting expected seasonal patterns. Domestic Card charge-off rate increased 15 basis points in the quarter, consistent with expected seasonal patterns. Compared to the fourth quarter of 2010, charge-off rate improved by over 300 basis points resulting from the significant cyclical credit improvements we experienced in 2011. The delinquency rate, as of December 31 was essentially flat from the prior quarter at 3.66%. The delinquency rate improved 43 basis points from the end of 2010. We expect the Domestic Card credit metrics will continue to follow normal seasonal patterns in 2012.

In our Consumer Banking business, the charge-off rate in the Home Loans portfolio increased 37 basis points in the quarter. As we discussed last quarter, we moved a portion of our mortgage loans from third-party servicers on to our own platforms. The quarterly increase in charge-off rate resulted from updated property values on these loans. This is a one-time impact that is not expected to impact charge-off rates going forward. Compared to the prior year quarter, the Home Loans charge-off rate was flat. Home Loan delinquency rate increased modestly in the quarter and year-over-year, but remains very low at just under 1%.

For the approximately $5 billion of Home Loans that were marked at acquisition, actual credit performance since the acquisition has been better than the assumptions in the original credit marks, keeping our reported credit metrics very low. In the Auto Finance business, charge-off rate and delinquency rate increased in the quarter, consistent with expected seasonal patterns. As you can see in the year-over-year improvements in both charge-offs and delinquencies, Auto Finance credit performance remain strong, with the most recent originations continuing to perform better than originations from 2007 and 2008.

Strong credit performance continues to reflect the actions we took to retrench and reposition the business, tighten underwriting and loss mitigation actions through the recession, and continued strength in used car auction prices. We believe we reached a cyclical low point for Auto Finance charge-offs and seasonal patterns will drive quarterly credit trends in 2012. The choices we made in underwriting and managing our businesses through the Great Recession, continue to drive strong 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, our internal portfolio credit metrics remains strong with normal seasonality re-emerging after a long period of cyclical improvement.

Slide 10 shows credit results for our Commercial Banking business. The nonperforming asset rate for the Commercial Banking segment improved in the quarter, despite an uptick in the NPA rate in our run-off Small Ticket CRE portfolio. The Commercial Banking NPA rate improved 38 basis points in the quarter, and 63 basis points year-over-year. Excluding Small Ticket CRE, nonperforming asset rates improved across our commercial lending businesses, as we continued to see a slower flow rate in to nonperforming loans. The charge-off rate for the Commercial Banking segment was 63 basis points, down 80 basis points from the same quarter last year. Excluding the run-off Small Ticket CRE portfolio, the charge-off rate in our core commercial lending businesses was 47 basis points in the quarter, an improvement of 53 basis points from the prior year.

Commercial lending charge-offs were up 20 basis points from the third quarter, driven by a small number of impaired CRE loans related to a single troubled relationship. We had reserved for these loans in the prior quarters, so these charges did not have a significant P&L impact in the fourth quarter. The slower flow rate into NPL and stable property values are driving lower charge-offs. Commercial Banking credit metrics have stabilized and improved over the last six quarters. We expect continuing strength in commercial credit, with some quarterly choppiness in commercial charge-offs and nonperformers.

I will close tonight on slide 11. In 2011, Capital One delivered strong and stable margins and revenues. The bottom line benefit of significant credit improvement, offset an increase in non-interest expenses. We gained strong momentum in loan growth in our Auto Finance and Commercial Banking businesses. And in our Domestic Card business, we returned to a modest growth trajectory with more normal seasonal patterns. We grew deposits with improved interest expense rates. Taken together, these trends produced strong underlying profitability across each of our 3 business segments, and for Capital One as a whole. And we sustained and improved the strength and resilience of our balance sheet. We put ourselves in a strong position to act on two game-changing acquisitions, with significant strategic upside and attractive economics.

Fourth quarter results were somewhat noisy, with several unique items and continuing growth in non-interest expenses, even after adjusting for unique items. Let's pull up and talk for a moment about the growth in expenses, what we are getting in return, and why we believe that the growth trend in expenses will not continue. The increasing trend in non-interest expenses in 2011 resulted from choices we made to build our infrastructure, ensure that we are ready to integrate significant acquisitions, and to prime the pump to restart growth.

We made significant investments in our infrastructure in 2011. We became a top 10 bank by inquiring -- acquiring and integrating three great local banking franchises. But none of the franchises we acquired had an infrastructure appropriate for a top 10 bank, let alone the top 5 bank we are set to become with the expected completion of our announced acquisitions. Therefore, we have been investing to build an infrastructure that's commensurate with the size, complexity and growth potential of the top 5 bank we'll soon become.

In 2011, we also made significant investments to restart growth across our lending businesses after a long period of cyclical declines in loan volumes. In our card business, the natural cyclical decline in loans provided significant resilience through the downturn, but also now requires investments to prime the pump to restart growth coming out of the downturn. We ramped up marketing and bolstered operating infrastructure for new private label and partnership growth platforms in our card business. We rolled out several successful new products, including Venture, Cash and Spark cards.

And we launched and ramped up new partnerships with Kohl's and Sony in the US, and Hudson Bay Company and Delta Airlines in Canada. In our Auto Finance business, we grew our sales force and enhanced our capabilities to build deep relationships with auto dealers. And we invested in infrastructure to attract and serve primary banking relationships in our Commercial Banking business. We are seeing these investments gain traction in the growth and franchise building customer relationships across our businesses.

In Domestic Card, we returned to modest growth with expected seasonal patterns in the second half of 2011. Growth trends and purchase volumes and new accounts are even stronger. New account growth is a leading indicator of future growth in loans and revenues as spending and balances build on these accounts over time. Our auto loan originations are at a run rate of about $14 billion annually, and auto loans and revenues are growing as well. And our Commercial Banking business continues to grow loans, deposits, and revenues as we attract new customers and deepen relationships with existing customers. For the full-year, we posted growth in ending loan balances of 9% in domestic credit cards, excluding installment loan run-off, 22% in our Auto Finance business, and 14% in Commercial Banking.

As we enter 2012, we expect noise in our results, driven by significant purchase accounting impacts, ramp up of integration expenses, and partial year impacts on nearly all P&L line items, as we complete our announced acquisitions. Looking beyond the noise, we expect continuing strength in our legacy businesses. We expect that our Domestic Card business will continue to post strong returns and modest underlying growth with seasonal patterns. In our Auto Finance business, we expect the strong 2011 trajectory in loans and revenues will continue, and we expect our commercial business to continue the strong and steady performance trends it delivered throughout 2011.

Even as these businesses grow, we expect to hold run rate operating expenses to a level similar to the fourth quarter of 2011 because we've made significant progress on our infrastructure build, and we are ready to begin the sure-footed integrations of two highly attractive acquisitions. We believe 2011 annual marketing expense is roughly in equilibrium, given the opportunities we see today in our legacy business. The growth trends we've seen in 2011 show that priming the pump has already taken hold. While these legacy trends will not be visible as a result of the expected acquisitions, they will remain an important part of how we deliver value in 2012 and over the long term.

In addition to the legacy trends, we expect to add significant new customer relationships, loans and deposits when we close our announced acquisitions. We expect to close the ING Direct acquisition in the fourth quarter, and to close the acquisition of HSBC US card business in the second quarter. We continue to expect that the combination of both acquisitions will deliver compelling financial performance in the near term and over time.

We remain on track to achieve the expected acquisition synergies and earnings accretion in 2013. And we expect that the acquisitions will be accretive to Capital One's long-term returns and capital generation as well. The choices we made, and the results we delivered in 2011, put us in an even stronger position to deliver and sustain share holder value through growth potential, strong returns and strong capital generation. 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 wish to ask a question, we ask that you 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 Relation staff will be available after the call. Dana, please start the Q&A session.

Thank you.

(Operator Instructions).

And we will go first to Sanjay Sakhrani with KBW.

Hi, thank you. I had two questions. I think I will try to hit them first, and then you can answer them. I just wanted to drill down on that expense discussion a little bit more. And I just wanted to be clear on some of the numbers. When you talk about the fourth quarter run rate, being the approximation of what we will see in 2012, you are probably talking about that, ex the one-time items. So when we think about operating expense, it's somewhere in the neighborhood of $2 billion. And then on the marketing dollar spent this year, I mean, basically you are saying it's equivalent in 2012, relative to 2011? And then maybe if you could talk about how, we should consider it out to 2013, with the combined entities in place. And then just on some of the one-time items. I wasn't clear, is that PPI -- I'm sorry the Protection Insurance charge kind of one-time, all else equal, if nothing changes from a collections standpoint? And then just on the uncollectible fees and finance charges, I recall we talked about this last time. And it would -- I thought it would be that, it would trend with credit quality. And it seemed to have gone up, despite the fact that the credit improved. So I just wanted some clarity on that. Thank you.

Okay, Sanjay, it's Gary. Why don't I just clarify some of the numbers for you. And then I will hand it over to Rich, to perhaps take up the marketing question, and anything else he may want to follow up on. So specifically, with respect to fourth quarter run rate, you are correct. We would simply back out the one-timers.

And with a total operating expense in the quarter of about $2.2 billion, I described about $150 million of unique items in the expense line. Not exactly that number, but good enough -- about $92 million in litigation expense, about $40 million in some asset write downs and other costs. And in fact, some the UK PPI even hit the expense line item as well. So I think if you were in the, say $2 billion, $2.05 billion kind of ballpark, I think that would be an appropriate understanding of what we can consider to be run rate.

As long as I'm on the topic of the one-timers, let me just speak quickly to the UK PPI, and what happened in our finance charge and fee reserves. With respect to the UK PPI, you may remember this from the second quarter of last year, where some new retrospective regulatory requirements had come in, that enables consumers to seek compensation for PPI that was sold in certain years, with respect to certain products, that included both ILs that were originated by Capital One in the UK, as well as a company that we acquired, as well as credit card products as well. We built a reserve back when those requirements came in, based on our estimate of what our claims experience and redress costs would be.

Now that it's been a couple of quarters, we have had increased volumes of complaints, driven by I guess what we would consider being both media and regulator comment in the area. And so, we had to increase our reserve, based on the fact that we now believe it's probable that we will have a higher rate of claims. So I can't say exactly what is going to happen. It's obviously, like all of our estimates, our best view of what is probable and estimable. But it is certainly consistent with the experience that we have seen to date. Most of that shows up as a contra revenue., either in net interest income or non-interest income, depending on the nature of the refunds. There is also a small amount that hits operating expense. But what we've done now is kind of bring it up to the level that we think is appropriate.

And finally, on the finance charge and fee reserve levels, where the level of suppression, Sanjay, I would say the change in the quarter was effectively nil. It was $3 million or $4 million increase to the reserve. As I indicated last time, when we made the one time change, about $80 million-odd in Q3, that was to get us to what we thought was more appropriate estimate of uncollectible fees and finance charges. A couple million either way, in any given quarter, I wouldn't read a -- any trend in that. So I think what we said was, you will basically see suppression be -- reflecting the actual reversals and recoveries, without much change in the reserve. And that's just what happened.

And Sanjay, this is Rich, just to comment to your question about marketing. We always manage marketing, really to the size of the opportunities that we see available. And that will be no different going forward. The reason for my comment here was to draw distinction between what I've said over the past year or two, where I said as we go from the significantly retracted state that we were through the Great Recession, and start to now invest in testing, and over time rolling out programs there, we -- you will see continual build of marketing. And that build will often -- will inherently be in advance of some of the benefits that come from that.

My point is really that, we've kind of -- we were now kind of rolling out those programs. I think the level of marketing represents kind of an equilibrium. Now if we see more opportunity out there going forward, or if we see less, we will adjust accordingly. But it's just the real sense -- is in a sense, I mean, the pump is in many ways kind of primed, after quite a lot of quarters at work in this, in a sense. You can feel the -- we are pretty optimistic about the traction we are getting in our programs, across the company certainly. But my point here, on marketing, is especially credit card related. But I think we are kind of in our stride at this point, and I think that will continue.

Next question, please.

We'll go next to Brian Foran with Nomura.

Hi. I think people are still struggling with the expenses, just solely, I guess, at least, based on the number of questions I'm getting. And maybe if you could just clarify again this $2.05 billion base. One would be the comment in the press release that you are ensuring readiness to execute on attractive acquisition opportunities. Is that referencing ING and HSBC, or are you talking about further acquisitions? And then two, how does that $2.05 billion base, change as the deals fold in? I think people are struggling to figure out -- is some of this kind of pulling forward expenses for those deals? Or do we still take the expense base of HSBC and ING, and add them on top of the $2.05 billion?

Hi, Brian, this is Gary. I appreciate the question, and the opportunity to go a little deeper. So as I said to Sanjay, first thing we need to do is take out the one-timers. I mean, over the course of 2011, we had a bunch of unique items in expense. And it was unusually high in the quarter. So that's why, I kind of took those off the top. The increase in expenses that has occurred -- and again if you kind of take away a lot of these other expenses, the unique ones, what you will see is we've had a steady growth in our salaries and benefits. You will see in the results this quarter, that we had about a some $60 million-odd increase there. And as Rich and I have said, those investments are of two kinds. One, certainly is supporting the roll-out of new products, and the growth of our businesses, which, of course, also carries marketing expense.

On the infrastructure side, Brian, let me kind of clarify the kinds of things we are talking about there. So for example, we were long on our way to becoming a mandatory Basel II bank. With ING Direct, we will trigger that, and so we need to move quickly to make sure that Capital One is ready for that. Just in terms of the size, and greater diversification of our balance sheet, which brings both some risk management responsibilities, but also some opportunities, quite frankly, to generate more returns by good balance sheet management. So we are bulking up on that. And of course, we are already positioning ourselves for the acquisitions as a result of that.

The third area, probably bigger than the other two, in terms of dollars. If you think about the IT and sales and servicing infrastructure that we need to have as a Company. Not for individual products, but with the two acquisitions we are talking about. And, yes, the point in the press release was referring to these two large transactions. We are going to be adding tens of millions of new customers, increasing our overall customer account base by more than a third. The infrastructure required for something that big and that complex, is something that we would have been building over time.

We've accelerated some of these efforts, simply to make sure that we are ready. Not only to be able to integrate well, but also to make sure we generate the opportunities that both of these acquisitions bring with them. I would not at this moment suggest that, the integration expenses or synergies that we expected out of the two deals will have changed dramatically, because so many of those are unique to the franchises that we are buying. I wouldn't consider this to be a pull-forward, of some of those expenses. What I'd say, it's an acceleration of, where we as a top 5 bank as Rich described, simply need to be, and we would have been there anyway. We've just moved a little faster. And so, we certainly are raring to go, and looking forward to integrating these acquisitions. And we are just going to have a more robust infrastructure, which is something that we and all big banks are going to need going forward.

Next question, please.

We will go next with Betsy Graseck with Morgan Stanley.

Hi, good evening. Can you hear me?

Yes, Betsy.

Hi, can you hear me?

Yes, we can.

Okay, great, thanks. So a little bit of follow-up on the last question. You are readying for the integration. And the first question is, how far through the preparedness, would you say you are at this stage? How many more quarters of investment spend, should we -- do -- should we expect to be fully ready to bring on the deals?

Betsy, I think -- kind of the point of our comment that the run rate that you see in the fourth quarter, is reflective of the run rate that we see out in '12 and '13 on legacy Capital One. It sort of definitionally implies that we are not building off that run rate from here. So, of course, soon there will be noise on those numbers, as we bring forward the acquisitions into the Company. But it is -- that is exactly our point that this build has been very sizable, frankly in the quarter but for this, and this quarter, and we are at a level that, that's going to be our run rate for an extended period of time.

Okay. And then are the regulators waiting for any of this build-up to occur in order to approve the deals? Is there any checklist with regard to Basal II readiness that you have to supply to them?

No. This is just our own preparedness.

Next question, please.

We will go next to John Stilmar with SunTrust.

Good after -- good evening. Just a real quick question, and I hate to go back on expenses. Gary, if I could be crystal clear with my understanding, 2.050 in expenses, -- plus the dollar expenses from two acquisitions, also then taking into account, the synergies that you expect to have, that's what you guiding us towards, in terms of an expense base of, Capital One legacy, plus the two acquisitions together, ultimately when we kind of get through the other side? Is that really the message you are trying to send?

That's the message, John. Effectively, we are talking about the condition of Capital One as we enter a period of time of obviously, intense integration activity. And so, needless to say, we are going to be looking to do some sure-footed integration. There will be integration expenses. I'm sure those estimates will change. As we get into the process, we will bring you up to speed on those. It seems premature for us to assume any changes there. And then we believe there is going to be some synergy opportunities to take run rate expense out of the combined companies going forward, and especially, given our knowledge and experience in both of these businesses. So I think you got the message exactly right.

Perfect. And then just a follow-up, RIch, in terms of the comments that you made around the Consumer Banking segment itself, in which the run-off of mortgages was going to be offset a little bit by the growth in auto. But you guided us towards, I believe a lower overall balance for 2012. One, can you confirm that, and go over that again? And two, how should we be thinking about the yield in that segment? Because I would imagine that some of those mortgages have a pretty high yield, given where you bought them and took the mark. And how should we think about the transition and the mix of those businesses together, both on a balance and a revenue perspective? Thank you.

John, yes, I mean, we really -- the segment interestingly is a blend of something that's in pretty ferocious run-off mode, and another that's in pretty ferocious building mode. So I think that -- I -- we just wanted to point out that, while some of the core businesses we were investing in are -- have a lot of growth trajectory. Just mortgage run-off is going to be a word, we're going to be spend a lot of time talking about, because we have this run-off, in this segment, now added to the -- some very big run-off portfolio that we are going to picking up on the ING side. So, Gary, you want to comment on the yield dynamics, including the mark?

Gary, before you go there. Rich, just to -- I think, John to clarify, Rich was talking about the growth trajectory, not those sort of balances. So think about it as the legacy mortgage portfolio and run-off, partially offsetting the growth in auto -- that's the trend we seen in '11. That trend probably will continue. Then we will add, ING mortgages with the acquisition. And that will be a much bigger portfolio, but then the trajectory will be modestly downward, because that will sort of double down on the run-off piece, so that the auto growth won't fully offset that.

And with respect to the future yield dynamics there, John, needless to say there will be a significant purchase accounting impact on those mortgage loans. We will be getting it -- into greater detail, as we close and know the fair value, and so forth. But there will be the impact of some accretable yield in those ING mortgage loans. They will get accounted for in --under SOP 03-3. So there will be some yield impact going forward. The other thing to remember about the ING mortgage portfolio, like a large percentage of our existing mortgage portfolio that was also acquired from our previous transactions, we will take a credit mark, so there should be relatively little charge-offs there. So the dynamics of the segment and of the product will change. To the extent these numbers are big and material. We will spell them out for you as we go.

Next question, please.

We will go next to Chris Brendler with Stifel Nicolaus.

Thanks. Good afternoon. The question on expenses -- I know it's been beaten up a little bit here -- but last quarter, I believe you were pretty clear, that expenses would be flat sequentially. And I was wondering, was some the investments you did in the fourth quarter, above and beyond some of the one-timers, just opportunities in the market? And can you -- you seem to be on TV a lot. Has that been a big part of the growth and expenses in your marketing budget? On a related question, can you talk at all about some of the market share gains? And it seems like you are moving up market, and your brand message for the double miles, and really, trying to target the transactors. Is that really I think, part and parcel to the increase in purchase volume you are seeing? Do you feel like you are getting follow through in that spending? Thanks.

Yes, Chris, Gary again. And so, indeed, we were at just under $2 billion in operating expense at the end of -- or in Q3, at around 2.2 in Q4 -- I have identified $150 million or thereabouts of unique items. Fourth quarter, sometimes we get a little extra boost to expense, as a lot of things find their way to the expenses as well. Is it slightly faster growth in expense than we might have anticipated? Perhaps. But again, we had better business growth opportunities, and we are trying to get ahead of what's coming, not just because of the acquisitions, but the higher regulatory expectations all around.

So I don't think we were far off of what we were expecting, at least on the operating expense line. If you go back to the marketing line, there was $100 million or about a third increase from Q3 to Q4. We don't -- I certainly wouldn't consider that to be an unusual quarter-to-quarter move based on the opportunities, especially knowing the historical trend towards higher marketing expense in the fourth quarter. But as far as what that means going forward, Rich?

Yes, Chris, on the market share -- a gain first of all I think, as we look across our big businesses, I think we are gaining share in commercial, we're significantly gaining share in auto. And by our tally, we are gaining share in the card business as well. And I think we were gaining share in the card business across several categories, including purchase volume, originations, and loan growth. Some of this the metrics are a little soft. So it's a little bit of -- imagination required in interpreting some of the numbers that we collect. But I mean, you can see the very strong numbers that are coming on the purchase side.

Purchase volume side, and, Chris, you are correct. This is pretty directly coming from the big push that we have been making for sometime, in the heavy spender, really top of the market in credit cards. It's a very competitive space, obviously. But we believe that our products and our marketing approach, can and in fact can be, and in fact is being, very successful in that space. And you've seen that, we now got three launches out there with -- in addition to the Venture card, we also now have our Cash card. And we just recently launched a small business card as well.

So all of these -- I mean, some of this is kind of early days still, but there is good response there, and the needle is really moving on purchase volume. And our -- and of all of the purchases going on in our portfolio, because there is kind of a migration toward transactor, and gradually -- and a little away from the heavy revolving, that is a greater share of that purchase volume is coming on the rewards. I -- the best way to think though about Capital One and our marketing, is a little bit to phrase, the more things change, the more they stay the same.

We -- because we have -- had a pretty resilient experience through the recession. We -- we are pretty much doing what we did before. Now it's obviously informed and enhanced by everything that we've learned in the recession. And the competitive dynamics in each of the segments have also been kind of changing as well. And, of course, you had the overlay of the Card Act. But with respect to Capital One, I think the real word is really, continuity. And pretty much all of the segments where we were playing before, and gaining share before, we are doing pretty much the same thing now with very similar approaches.

Some of the places where we have been cautious, and especially in the big line, heavy revolving, prime revolver space we continue to probably lose share at the margin in that space, because we worry about resilience in some of those segments. But overall, I think what is clear to us is that -- and I have been saying this quarter after quarter -- you kind of probably could detect the -- I would say, each quarter look -- that is, not too much to write home yet about, but I can just feel the traction growing in the card business, And we certainly see that this quarter as well.

Next question, please.

We will go next to Don Fandetti with Citi.

Rich, I was wondering if you could talk a little bit about recoveries, and the card business, in terms of the outlook. I mean, obviously, the pool shrinks as you come out of the downturn. But there has been some talk about, whether it's legal or regulatory issues. Do you foresee any problems in industry around that?

So with -- you make a good point on recoveries, by the way. Just, first of all, the recovery numbers. Recovery dollars have been coming down at Capital One, and it's a cyclical thing. It's just the math of a shrinking inventory of fresh charge-offs, against which to recover. And we still -- our recovery rates still, are coming in strong, but it's on a smaller base. And so in a way, it's a flip side of the good news, that is going on out there. There is a lot of noise in every credit product, an incredible amount of noise about the collections area, and certainly the scrutiny of credit card -- credit card is certainly in that category.

And we have put a huge amount of work over the years, to make sure that we have very rigorous and buttoned-down disciplined collections processes. And I feel -- I think we feel good about where we are. We have seen some changes out there. I know that it appears that one of our competitors, changed their practices in how they do -- how they prosecute collections and so on. I'm not sure what was behind that one. We are continuing to use the same collections practices that we have. And just work to be very sure that we are very, very buttoned-down in every aspect of what we do.

Thank you.

Next question, please.

We will go next to Joel Houck with Wells Fargo.

Thanks. It looks like the last couple of years, your return on tangible equities has been close to 20%. And obviously, there is a lot of reserve release in those numbers. So if you can kind of look forward, I mean, how you look at the business, obviously assuming there is not another recession, with normalized reserves, is it closer to 15% return on tangible equity? Or do you think with the synergies you are getting from these two large acquisitions, that you can get close to the 20% area?

Well, Joel, I mean, I'm pretty optimistic about what we -- what I think we can produce, when all of the dust settles from all of the dust storms that we live through. But the way I look at Capital One is, that we have worked very hard to put ourselves in a position -- to have very competitive scale positions in the key businesses that we were in. And -- and when I put -- and to, massively build as we have done for 23 years, a very rigorous net present value, a discipline that frankly, looks for well above, hurdle rate returns.

When I pull up on this, and look at our card business -- while it's an industry that certainly had a lot of pressure on it, I think we feel very good about the ability to continue to generate significantly above -- well, well above hurdle rate returns in that business. Even though I often said look, I think net-net from all of the effects that are going on there, a little down, probably off some of our historical levels, but still well above hurdle rate. In the auto business, we have generated a very profitable, successful operation there. And in the commercial business, you've kind of seen some the numbers that we have here.

So when I pull it all together, and then Joel, look at the acquisitions that -- and the value creation opportunity here, I believe that our positioning in the marketplace, should be the Company that can generate at the high end of industry return levels. And even as profit pressures are pulling down returns in banking overall, I like our chances to be at the high end of the return on tangible equity metrics, when the dust settles for this Company.

Next question, please.

We will go next to David Hochstim with Buckingham Research.

Yes, thanks. I was wondering, Gary, could you just update us on what you expect to need, in the way of additional capital for HSBC? Is that now smaller than you thought before? And then, sort of a follow up to Joel's question. Could Rich speak a little more to your comments on slide 11? Just how we should, or how you will be measuring the strong returns quantitatively? And you're investing for higher returns, but when do those show up in reported earnings as you keep investing?

Sure, David. Very quickly, I really don't have much of a change to our outlook for the capital that we would add for the purposes of capitalizing the HSBC portfolio. We have the same target that we've had since we announced the deal, which is to be in the mid 9% range of Tier 1 common in the quarter that we close. I have no reason at this point, to suggest any change in the previously announced estimate of a $1.25 billion of capital, but there is lots of moving pieces.

One of them that will be able to fix over the coming period of time here, is any effect from closing ING, to purchase accounting related to ING, the capital transactions, the balance sheet management actions that we have taken. And so, we will have to keep you posted on what that final outcome will be. But I will go back to where we started on the deals, which is there is a wide range of capital required for these deals, under which we would find both of them to be, and together to be very attractive. So we will be able to get to that.

And as I hand it over to Rich, just thinking about this question about returns, I think if you survey all of the banks, as to what kind of equity requirements are going to be out there, I think is going to be a pretty big part of the equation, in terms of what that return on equity will be. But we will obviously be learning about that, over the course of the next couple of years. The key here is the returns will be good, and that's what Rich was talking about.

David, we are very focused on delivering -- what the term I use is destination economics. And, we have worked very hard to get our Company to competitively, a very good state. And I think strategically, are in a place where we don't need to, go to a different place to be able to compete, and generate the returns that we need. So we are working -- we are very focused on generating destination economics. We have had a build. There has been pump priming over the last year, to year and a half. And we're more -- we now are kind of hitting our stride, in terms of the growth opportunities.

There is still a coiled spring, in terms of the balance build on some the accounts we were building. But we are pretty much hitting our stride there. Our point about expenses here is, even as you look at the sizable run rate, kind of expense after one-timers expense build in the last couple of quarters, our point is really to say that, don't take that line, and go extrapolate that thing upward. That is really a -- there is a story behind that expense build, but think much more, that a -- sustainable from where we are. So the other thing that is a little delayed gratification, of course, is the two big acquisitions that we have done. And that is going to create a lot of noise.

But we are very focused on -- on as soon as we can to -- work to drive great financial return out of these acquisitions, because that value creation is there. And we are committed to delivering on it. Now along the way, we will keep our eye out for unique situations that could come along. But frankly, on the acquisition front, we are not really trying to go anywhere. And frankly, our focus is really on the deals that we have, not on the deals that could be. So we are very focused on destination economics. And we are -- and we believe strategically we are in a great place in order to deliver that.

Next question, please.

We'll go next to Chris Kotowski with Oppenheimer & Company.

Hi. Two little things. One is the auto delinquency rate on page 9 of the handout. I mean it looks like it's gone up a lot this quarter. And that's also been the most rapidly growing portfolio. So I just wanted to confirm, that you said basically, this is just the seasonal impact you see. This is not -- is this -- is the delinquency experience, in anyway out of the bands of what you would normally expect, after you have grown the portfolio the way you had?

The auto delinquency -- first of all, I want to say auto delinquency itself is a poor -- we have learned to not -- that it's not a very good predictor, frankly, of losses in general, but unlike the credit card business. But that said, all of the credit performance you see in our auto business is entirely seasonal. We are at an extraordinarily kind of low point, in the kind of long, long view of auto, in terms of how good this industry's credit performance is. And I think it's a reasonable thing to do, to expect industry losses to probably to migrate up a bit from here.

That's partially offset by some of the growth opportunities that we have at Capital One. And we are doing quite a bit of growth in the prime space with -- and that's helping pull down the losses. But overall, we are seeing very good results from our recent vintages, really from the whole portfolio now, that it's at such an extraordinarily strong -- thing from a credit point of view. We are at a point now, that given the average life in autos is like 2.5 years. You are looking at the last couple of years of auto originations. And they are extremely strong credit performance, and the credit results are really, at this point just seasonal effects that you are observing.

Next question, please.

We will go next to Moshe Orenbuch with Credit Suisse.

Yes, thanks. I hate to go back to the expenses, but it sort of looks like you a little under $2 billion in the third quarter, before marketing, if you are saying $2.050 billion. I guess that seems like there is about $65 million a quarter, about $250 million kind of round numbers, at a run rate of annualized expenses, that relate to the -- this set of new projects that we didn't really know about before. Is it fair to say that, that's kind of in the neighborhood of 5% or 6%, kind of off the accretion of those deals, if that's what caused you to need to make those investments? I mean, am I interpreting that right? Or is there something else -- that we -- some other way to think about that?

Moshe, it's Gary. I mean, again, if you take a look at what's been underlying some of the expense growth, you will see that we have had considerable growth in our level of employment. Some of that is just -- some acquisitions like the Hudson Bay Company. Some of them are insourcing and onshoring, some other roles as well. But we had a significant increase in the third quarter, in our hiring of net jobs. And obviously, that kind of goes into Q4 as well. I think the issue, just to be clear, not to try and focus on the semantics, but to make sure that the understanding is absolutely clear.

Again, I think if you would look at any bank that is growing, you know in the way that we are -- Rich described it kind of as going from top 10 to top 5 -- the bar is being raised, in terms of expectations on the controls, and management, and regulatory interactions that take place. We think these are things that would have happened, even with organic growth. They may be happening a little faster than that, because of the growth and the size of our balance sheet, along with the acquisitions. We were not in a position when looking at those deals, to include in those deal numbers, things that are really all about infrastructure of a Company.

So again, what I'd say is, we are accelerating a little bit of the expense. But rather than thinking about it as specifically deal related, I would think about it as -- what does it take to be well-positioned, well-controlled, prepared for opportunities when you are going to have tens of millions of additional customers, and what kind of support you need for that. That is something that we would have been building over time. We're building it a little faster. So that's why it's hard to link, some of our preparatory work here, which is really just about being a bigger and better bank, and attribute that to individual deals other than the timing.

And I think that the timing of this, has been accelerated from what it might have been, which is why you have seen it a couple of quarters in a row. But what you've heard Rich and me saying, is that, we have made really good progress. Certainly, we will look for better synergies as we go forward? Absolutely. But I think if you take a look at what's going to be required of any top 5 bank, we intend to be there. We are getting there a little faster, and that's where it's coming from.

Next question, please.

And we will take our final question today from Bob Napoli with William Blair & Company.

Thank you, and good afternoon. Just a follow up on the auto business. Some of your big competitors, Wells and JPMorgan have -- their growth in auto, and Wells pointed out, a lot more competition coming in -- on-line in the fourth quarter. I think we have seen a fair amount private equity come into the auto business over the past year. Should we expect to see that business, the growth rate for auto slow down? And I mean, are you seeing the same competitive pressures that Wells, in particular, was talking about.

Bob, I -- there is no doubt that competition is intensifying. What happened in the auto business is a lot of players headed for the hills. And the auto business was sort of the first into the Great Recession to be worsening, and it was the first one to sort of come out the other side. And I think -- so the competitive dynamics have been positive over this period of time. And there -- I support your point that competition is increasing, and it's a very natural thing, and we completely plan for that.

The Capital One growth is -- there is a growth strategy that's happening at Capital One that's -- may be not -- well, this may be differentiated from the competitors, in that we are doing a significant -- still geographical expansion in the Company. The exact thing we do in some geographies, we have been expanding across the nation. The most sure -- I found in all of my years of experience, the most sure-footed sort of business growth opportunity is to take something you've proven in certain geographies, test it in the next geographies, and then, roll them out from there. So the growth play at Capital One is a blend of geographical expansion and more prime, to supplement the -- a lot of the sub prime that we already have in that space.

So it's something that we have been actually doing for years. You see it picking up momentum because, we have done a lot of testing, and we are in roll-out mode now. So the confidence that I have about growth in the auto business is more, Bob, driven by continuing that sort of Capital One growth strategy. I think on top of that, I think that even normalized for that, I think there is some continuing success we are seeing in penetrating our dealers. And so I think it's a good story at Capital One. But I think all of you would be well-served, to take a more cautious outlook about where pricing and competition will take this auto business over the next 12 months.

Okay. Well, I would like to say thank you to everyone for joining us on the conference call today, and thank you for your continuing interest in Capital One. The Investor Relations staff will be here this evening, to answer any further questions you may have. Have great evening.

Again, that does conclude today's presentation. We thank you for your participation.