Capital One Financial Corp (COF) 2013 Q2 法說會逐字稿

Welcome to the Capital One Second Quarter 2013 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 conference over to Mr. Jeff Norris, Senior Vice President of Global Finance. Sir, you may begin.

Thanks very much, Michael. Welcome everybody to tonight's 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 the financials, we've included a presentation that summarizes our second quarter 2013 results.

With me tonight are Mr. Richard Fairbank, Capital One's Chairman and Chief Executive Officer; and Mr. Steve Crawford, Capital One's Chief Financial Officer. Rich and Steve will walk you through this presentation. To access a copy of the presentation and 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 in any forward-looking statements contained in today's discussion and material speak only as of the particular date or dates indicated in the materials. Capital One does not take -- undertake any obligation to update or revise any of this information, whether as a result of new information, future events, or otherwise. Numerous factors could cause our actual results to differ materially from those described in forward-looking statements. For more information on these factors, please see the section titled Forward-Looking Information in the earnings press release presentation, and the Risk Factor section in our annual and quarterly reports, accessible at the Capital One website and filed with the SEC. Now I'll turn the call over to Mr. Crawford. Steve?

Thanks, Jeff. Let me start out on slide 3 with a quick review of earnings for the second quarter. We had net income of $1.1 billion, or $1.87 per share, which was up 4% in the first quarter. Pre-provision earnings before tax were $2.6 billion, up about 2% from the first quarter. I want to clear three items that are worth calling out in the quarter relative to operating trends. The first you will see on slide 3, provision expenses are lower by about $120 million. The change versus linked quarter is really driven by lower charge-offs. We also had nearly a $200-million allowance release in provision, which is consistent with what happened in the first quarter. Rich will spend more time on credit in his remarks.

We also had $183-million pre-tax charge in the quarter for rep and warranty. As we've disclosed last quarter, there was the effects of moving Best Buy to held for sale, which favorably impacts pre-tax earnings by about $123 million. To clear a question I'm sure will be asked later, I wanted to talk about prior guidance. We talked in the past about pre-provision earnings of approximately $10 billion, excluding extraordinary items. We still believe we will achieve that within a reasonable margin of error.

Finally, on slide three, I just want to talk for a second, consistent with feedback we've had from investors, we also have a new non-GAAP disclosure. It's income absent deal adjustments. You can see a reconciliation of that on Appendix A, but that would translate into about $1.3 billion of net income, or $2.18 a share.

Turning to slide 4 and spending a second on margins and the balance sheet, you can see total interest-earning assets were down 2% quarter over quarter. Total interest-bearing liabilities were down 3% quarter over quarter, driven by lower funding needs. The 12-basis-point increase in net interest margin you see over the quarter was driven by one additional day from the first quarter, and by the held for sale treatment we've discussed with respect to the Best Buy portfolio, primarily. As you've seen an our prior disclosures, our balance sheet is asset sensitive, so the increase in rates will result in an earnings benefit which will be realized over time. I want to add that's all other things being equal -- potential changes in mix, competitive dynamics in our business, credit trends, and more generally, macroeconomic trends, will also contribute to the evolution of our net interest margin.

We have expectations for portfolio run-off which are slightly updated from what we talked about in the first quarter. In 2013, we expect about $11.5 billion in run-off, $9.5 billion through mortgages and $2 billion in domestic cards; and $8 billion in 2014, with roughly $7 billion of that coming from mortgage, and $1 billion from card.

On slide 5 -- I'm sorry, on slide 4, let me talk about Basel I and capital. You can see that our Basel I Tier I common ratio was up 30 basis points in the quarter to 12.1%. Our Basel I Tier I -- Basel III Tier I capital was above our 8% target. There was approximately 8.5%. If you include, actually, the impact of OCI, which would be about 20 basis points, it would be down to about 8.3%. We are emphatically not changing our Basel III target of 8%, but we continue to assess the regulatory interpretation of the rules that were recently released.

I want to end on our plans for capital return. We have received, as you've seen, approval for a $1-billion buy-back, which we plan to execute in 2013. We announced last quarter our plan for a pay-out ratio in 2014 to be well above industry averages of around 50%. We are still consistent with those plans, of course, subject to regulatory approval. While we have not changed our forecast for capital return for 2013 and 2014, the uncertainty for the industry's long-term capital requirements has not declined. I want to reiterate the higher pay-out ratio we expect for next year will be largely, if not entirely, from stock repurchases. We believe our stock is attractive, and we feel that the flexibility in repurchases is consistent with the regulatory push for higher capital.

In all likelihood, the next major benchmark for us on the capital front will be March 2014. It's unlikely that any of our guidance will change in advance of receiving these results in March of 2014. Let me turn it over to Rich to go through some of the businesses.

Thanks, Steve. Good afternoon, everyone. I'll begin on slide seven with an overview of domestic card results in the second quarter. Ending loans were flat compared to the first quarter. Excluding the planned run-off of acquired card loans and installment loans, ending loans were up a little more than 1% in the quarter, in line with historical, seasonal patterns. Ending loans declined about 13% year-over-year. Excluding the planned run-off and the movement of the Best Buy loan portfolio to held for sale, the year-over-year decline was about 2%.

Looking below the surface, we're seeing strong loan growth and share gains in parts of the business where we are investing, particularly in the transactor segment. Underlying loan growth has been more than offset by shrinkage in the parts of the business we are avoiding, like high-balance revolvers, as well as planned run-off. We are seeing -- we are beginning to see more traction in originations, and we are seeing more line increase opportunities as we implement solutions to the regulatory rules online increases. These improvements will not move the needle on balances until sometime next year, and will be muted by the continued runoff of the less resilient parts of the card portfolio.

Purchase volume was up about 12% year over year. Excluding purchase volume on acquired card loans, purchase volume was up 9%. This growth remains above industry average, and we are gaining purchase volume share. The year-over-year trends in loans and purchase volumes reflect our strategic choices, which continue to focus on generating attractive, sustainable, and resilient returns. Revenue margin increased to 18.7% in the quarter, with a full-quarter impact in held for sale accounting impact. Excluding held for sale accounting impacts, revenue margin was 16.8%, a very healthy margin that's consistent with attractive and sustainable bottom-line returns.

Our card credit metrics improved in the second quarter. On a sequential-quarter basis, losses improved 15 basis points to 4.3%, and delinquencies improved 32 basis points to 3.05%. We generally see some seasonal improvement this time of year, although what we saw in the second quarter was better than what we would expect based on normal seasonality, particularly in delinquency rate. Strong credit performance has been benefited by the choices we have made and our strong underwriting. We have a highly seasoned back book, a front book of high-quality originations in highly resilient segments, and a focus on attracting a more disciplined consumer who is less likely to be over-stretched or over-indebted. As a result of our choices, as well as the cautious consumer and a recovering economy, the strong domestic card credit performance we are seeing is likely to continue.

Pulling up, our card business remains well positioned. It's delivering strong, sustainable, and resilient returns, consistent with historical levels, even with the inclusion of a lower-yielding partnerships portfolio. And it's generating capital on a strong trajectory, which strengthens our balance sheet and enables capital distribution. We expect these trends to continue as a result of the strategic choices we're making in the domestic card business.

Moving to slide 8, the consumer banking business delivered another quarter of solid results. Ending loans declined about $1.4 billion. About $1.4 billion of continuing growth in auto loans was more than offset by about $2.8 billion of expected mortgage runoff. Ending deposit balances declined by about $2.8 billion. We have ample deposit funding, and a period of relatively low overall loan growth, so we are throttling back on deposit growth. The brand conversion from ING Direct to Capital One 360 has gone very well, and we have continued to see growth in checking accounts across our digital and branch deposit franchises.

Consumer banking revenue was up modestly compared to the fourth quarter, driven by a modest increase in loan yields, and stable deposit interest expense. Non-interest expense increased $20 million in the quarter, driven by operating expense related to higher auto originations and loan volumes. Provision expense improved in the quarter, driven by the impact of home price improvements and a one-time refinement in our retail banking allowance processes. The overall consumer banking charge-off rate remains below 1%.

Before leaving the consumer banking segment, let's pull up and discuss the auto finance business. We've worked hard to put our auto finance business in a strong position. We've focused on careful and rigorous credit risk underwriting and on building deep relationships with our very best dealers. We emerged from the recession -- as we emerged from the recession, we were able to grow and take advantage of exceptional trends in competition, pricing, and credit quality. As the cycle plays out and competition continues to pick up, we expect the exceptional results of the past two years to moderate somewhat. We expect the pace of loan growth to decelerate as annual originations stabilize.

Second-quarter auto originations were up about $200 million year over year, and remain in the range of about $16 billion to $17 billion on an annualized basis. We expect charge-off rates will continue to increase as the industry continues to normalize to more business-as-usual underwriting, following significant tightening during the great recession. On a year-over-year basis, auto finance delinquency rate and charge-off rate both increased by about 15%, consistent with our internal expectations. As we've said before, we are now past the cyclical low point for auto credit, and we expect some softening in historically high used-car auction values, so we expect auto finance losses to continue to increase gradually from the historic lows of the past few years.

Delinquency and charge-off rates remain low by historical standards. We expect that continuing increases in competition will drive returns downward from current levels. This expected trend of unusually strong results regressing back toward more typical levels is sort of baking in the oven, if you will, in our portfolio, as each new origination vintage reflects returns that are modestly lower. Even as returns regress to more normal levels, we still see solid overall profitability and above-hurdle returns in new originations. Our consumer banking business is delivering solid results and remains well positioned for the future.

As you can see on slide nine, our commercial banking business delivered another quarter of solid growth and profitability. Loans grew 4% in the quarter and 13% year over year, driven by growth in CRE and middle-market CNI loans. Revenues were up about 2% from the first quarter, and about 8% compared to the second quarter of last year, driven by growth in loan and deposit balances. Revenues grew despite increased competition and pressure on margins. Our loan yield was down 43 basis points from the second quarter of 2012, which is largely due to the continuing movement of our portfolio to shorter-duration, floating-rate loans with better credit quality, as well as competitive impacts on pricing. Our charge-off rate in the quarter was four basis points. While the current very low charge-off levels are not necessarily sustainable, we continue to see improvements in non-performing loans and criticized loans, so we expect the strong credit performance of our commercial banking business to continue.

Our commercial banking businesses is in a strong position to continue to deliver growth and profitability. While increasing competition, particularly in the middle market lending space, may continue to impact the pricing and volume of new loan originations, we expect our focus and specialized approach to commercial banking will continue to derive solid growth and profitability. For example, we focus on multi-family housing, and have a deep expertise in New York City commercial real estate, and we've developed differentiated industry verticals in C&I lending. Across our commercial banking businesses, loan growth, credit, and profitability trends remain healthy.

I'll conclude my remarks this evening on slide 10. Our businesses continue to deliver solid results in the quarter. We have great businesses which generate strong revenues and attractive and resilient risk-adjusted returns. And, we remain focused on important levers that will sustain and improve profitability. On the cost front, we are on track for operating expenses of around $11 billion for 2013, and about $10.4 billion in 2014. Driving digital transformation in all of our businesses, and driving more efficient and effective procurement and third-party management provide sustainable opportunities to save operating costs.

Our outlook for marketing expense in 2013 remains about $1.5 billion. As always, we will make decisions about how and when to spend marketing dollars based on rigorous NPB-based assessment of expected returns on our marketing investment, and our current and expected view of opportunities in the marketplace. We are committed to tightly managing costs and operating more efficiently across our businesses. We don't view this as a one-off project. We've internalized that the industry has changed, and efficiency in cost management are very integral to how we run the business, and how we create value for our shareholders. It's a focus in all of our businesses, and in every budget cycle.

Our credit result our strong, driven by our long-standing discipline in underwriting across our businesses, and our continuing focus on resilience in the domestic card business, in particular. Growth remains a high priority for us, but in the context of a pre-emptive focus on generating attractive, sustainable, and resilient returns. Overall loan growth in the coming quarters is likely to be muted as planned run-off and other strategic choices we've made continue to mask stronger underlying growth in areas we've been emphasizing, including commercial banking, auto finance, and selected segments of the domestic card business, including transactors, partnerships, and revolvers -- other than very-high-balance revolvers.

Finally, capital management remains an important part of how we expect to deliver superior and sustainable returns to our investors. Steve affirmed our capital return commitments for 2013 and 2014. I want to add a few points of emphasis. Our capital and liquidity positions have never been stronger. Our businesses continues to deliver attractive and sustainable returns, and generate capital on a strong trajectory. We are comfortable with our strategic footprint. Planned run-off frees up capital. And our stock is at attractive current levels. All of these factors drive our planned capital distributions in 2013 and 2014.

As always, there are risks that are largely outside of our control which may impact our ability to return capital, but I want to be absolutely clear about our intent to return capital. We continue to believe that we will generate capital well in excess of our needs for growth and risk. So we continue to expect that capital generation and distribution will be important parts of how we deliver shareholder value over the next couple of years, and over the longer term. Now Steve 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 our other investors and analysts who may wish to ask a question, please limit yourself to one question plus a single follow-up question. If you have any follow-up questions after the Q&A session, the Investor Relations team will be available after the call. Michael, please start the Q&A session.

(Operator Instructions)

Sanjay Sakhrani, KBW.

Thank you. I had a couple of questions. First, I know this has been a tough one to answer, but, the US revenue margin seems to be doing better than expected when anticipating some of the impacts you gave us previously. Outside of seasoning going forward, do you feel these levels are sustainable? Second, just the tax rate, if you could help us with what the ongoing tax rate estimate is, that would be great? Thanks.

Okay Sanjay, so, let's talk a bit about the US card revenue margin. Using only held for investment loans as our denominator, revenue margin in the quarter was 18.7%, strikingly up from 17.6% in the first quarter. The increase was driven by the incremental Best Buy held for sale impacts of about 65 basis points, combined with seasonal margin increases and strong credit; and offset a bit by the franchise enhancements we've talked about in the prior quarters. The second quarter had a full quarter's impact of Best Buy held for sale. Adjusting for that, underlying revenue margin is 16.8%.

When we look out into the future about our revenue margin, there is some puts and takes, but you of course have seasonality and effects of purchase accounting. But kind of looking past those, let me just talk about the more fundamental puts and takes. There's really kind of one primary one in each direction. You have the franchise enhancement activities. This is where we are making choices to -- that end up reducing revenue by changing some of our practices or activities to help enhance our franchise and customer experience. We have made some forward-looking guidance about those and we are pretty much on track relative to those.

In the other direction, really, is the -- having Best Buy as it moves out of our portfolio. Best Buy has a revenue margin that's lower than the portfolio average. These two factors, generally, kind of offset each other in the medium term. While there are many other factors that can drive revenue margin, like industry pricing and credit performance and growth and adding partnership and things like that, the -- on an adjusted basis as we talked about this, the revenue margin that we are seeing is pretty consistent with historical ROAs, and is generally, I think, from a fundamental basis, pretty sustainable.

Taxes? So in taxes we were a little over 30% in the first quarter. The biggest factor which drove the quarter-over-quarter increase was an expectation for more income. There were some discrete items, as well. There is a catch-up adjustment that happens, also, to incorporate the higher expectations for earnings throughout the year. That's why the tax rate jumped up to 32% in the second quarter. I can't go out too far, but I would say for the year, it's probably going to be between what it was for the first and second quarter.

Next question, please.

Brian Foran with Autonomous.

Hi. I was wondering if you could help us think about expenses a little further out. At a recent presentation you gave some comments around third-party expenses being high relative to peers, and that needing three to four years to work its way through. Also, if you could put it in the context of how to think about expenses within the card business, specifically? I mean, I just always get hung up on the expenses running at around 9% to loans. I'm sure you kind of look at it more on a revenue basis. But 9% expense to loans seems like a very high number relative to history and relative to peers, still?

Right. Brian, let me in fact, take your point about the card business first. There are a number of metrics at Capital One that, because of our business mix and the way we manage the business, that are apples and oranges relative to competitors. Certainly, the cost per balance is a classic one of those. Costs are really driven by customers. Our average balance per customer tends to be lower. We have a different mix. We avoid the high-balance revolvers.

We are very focused on really driving to a more and more efficient place in the card business; but I think that our destination -- we always look at competitors for comparison, but I think that we see real opportunities to improve efficiency, but it's driven in the context of still a very different kind of business mix, particularly as manifested by that metric. Also, if you include in an expense calculation marketing, we've tended to avoid teasers. A lot of competitors are very heavy -- use teasers very extensively. In some ways, our marketing expenses are someone else's balance transfer teasers, for example.

But beyond those sort of calibration points, we have great energy and passion around the expenses. While we are driving efficiency in every single way that we manage the business, we have highlighted both third-party expenses and digital as particularly areas for opportunity. We -- over the years, we outsourced quite a few activities. I think, in many ways, it may be that relative to a number of players we have a higher percentage of things outsourced. I'm not totally sure of that.

But, we believe there is great leverage to really get best in class with respect to third-party expenses. One thing that we have done is to mobilize a lot more of the third-party expense and negotiating activities, to very central -- centralized, highly talented, really experienced team. We are already seeing, in that movement, some pretty significant saving opportunities. I think there's an opportunity there for some steady increases, improvements in expense over time.

The other kind of biggest one to highlight is in the areas of digital. I think it's not an exaggeration to say we are living through one of the most profound changes that's happened in the history of mankind, and banking is certainly no exception. Frankly, I think banking has been quite belated relative to many other industries with respect to the digital revolution. Most of the things that we're doing to drive leadership in digital are not motivated primarily to reduce cost. I think the benefits are so great with respect to the customer experience, the ability to be fast to market, the ability to drive information-based strategies in real time and so on.

But, I am certainly struck by the fact that most transactions, the significant majority of all transactions that happen outside of a digital channel -- in a bank, either a card business or in a bank, could be done digitally by customers. Now in the end, they are going to make their own choices. For us, the drive to digital is a multi-pronged effort to first of all create great digital capabilities, and give our customers a customer experience that can enable them to choose digital as a primary way of banking.

Secondly, if you build it they won't necessarily come, in the sense that driving customers to digital is a really key part of this thing. Thirdly, digital is not just about how we interface with our customers, but in a sense, digitizing the whole Company, and really running the Company, operating, and most importantly, take the mindset of digital. It really has tremendous leverage to it. This is not something that's going to transform economics overnight, but I think that both third-party and expense and the digital opportunity give us something that I think we can drive to for multi-year opportunities to in the end raise our game, and along the way get more efficient.

Next question, please?

Ryan Nash with Goldman Sachs.

Just a couple of quick questions. I guess first, Rich, can you give a little more clarity on your outlook for card loan growth? It seems like there's been some positive turns in the business, particularly in the transactor sector. You mentioned a pick-up in utilization in some of the parts that you're playing now. I know there's still run-off in parts of the portfolio, but what is your expectation when we actually see growth in the portfolio? A second question, just in terms of -- you said you saw seasonal improvement in credit that was better than expected? I know you were talking about stable credit trends year on year, but could we actually see credit improve year on year, given that slightly better than expected outlook?

Yes, Ryan. Look, I think -- I'm encouraged by the things that I see beneath the surface in our card business in the areas where we are investing. I see a bit -- I don't want to overstate the effect -- but, I see more attraction. I see things happen -- happening a little bit more response. I think that some of the new programs we've been putting in place are getting some nice traction. The line increase brown-out that we have experienced really since the beginning of 2012 when the regulatory rules changed on requiring a validation of income before doing a line increase, we are working our way through. We are pretty much there with respect to having the capabilities we need to now increase credit lines and so on.

I do want to say, so, though that the Capital One way of doing the card business is one where we book accounts and build balances on a gradually, kind of, increasing basis. So this is not a big change that you will see. In fact, I said that the needle on what I just talked about will really move more next year than this year.

The other thing that makes me still cautious to point to loan growth, is that when we talk about running off -- the two things that we're essentially running down -- one is the riskiest parts of the HSBC portfolio, and the least resilient parts of our own portfolio, really more focused around high-balance revolvers. That run-off involves a lot of balances, and that each year we kind of start behind the starting line in generating growth. When you see the bounce in my step in the excitement about the business is that I know those choices are going to really enhance the resilience of our business. You won't get paid for that in the good times, you get paid for that in the bad times. Meanwhile, everywhere we are investing, I really like our chances.

The other one I want to say is -- the other place where I think there is upside from here, but it's not upside that is like right around the corner, is in the partnership space on the organic side. In the last couple of years, really since we announced the HSBC deal, pretty much all of our energy has gone in -- with respect to that partnership business -- has gone into doing the integration and re-upping with partners.

I think what excites partners about Capital One is the opportunity to create innovative marketing programs and really build business over time. In that sense, I think some opportunities have been lying fallow, if you will, and can be capitalized over time as we kind of, in fact, really pretty much at the destination with respect to integration and partner sign-ups. That's why I've gotten a bit more bounce in my step, but I just don't think you are going to see the metrics really moving for a while in any dramatic way.

On the credit side, you've heard our comments over the last several years. We've tended to be -- we never like to book improvements that might come out in the future. It is certainly striking. It's extraordinary, really, what is happened over the last few years, as consumers have become more and more careful. Frankly, originators like Capital One and our competitors have also, I think, been particularly conservative in their originations. I think what we are seeing is that as this plays out in our portfolio, the kind of payoff of years of conservatism by us and by the consumer is manifesting even better credit performance than we probably would have expected -- maybe the flip side of why we lament about loan growth, sometime -- that de-levering consumer.

Our comments that -- I mean, I'm not sure I'm ready to declare that things could get better from here, but I think the trend in credit -- and when we look at things like roll rates and some of the underlying -- pretty much all the metrics associated with credit, continue to show two things -- one, the payoff from the conservative approach we've taken to originations, and all of our credit policy; second, a consumer that continues to be cautious.

Next question, please.

Donald Fandetti, Citi.

Rich, if you look around at some of the other large banks in the card issuing space, BMA has recently expressed more confidence on market share, Wells is talking about more cards, and there are other banks. I guess we've all become a little accustomed to just thinking cards are a great business with a sustainable ROA. I just want to get your sense on any risk around the competitive framework and yields as you look out the next one or two years?

Well, you remind me of back in my consulting days, when I showed one of my clients the sum total of the growth predictions of all the players in the industry and said unless there is a massive revolutionary growth shock to the system, I think we are all going to be disappointed in more ways than one. Now a thing that I would say on a -- so your question, Donald, is a very good one. If I cross-calibrate what's happened in the card business versus other places, I think the card -- in the businesses we operate in, I think the card industry has been the most rational, relative to the auto business and the commercial business, in terms of competition in the wake of the great recession.

You see a lot of folks kind of rushing into C&I lending. You see folks running into the auto business. In the credit card business, supply has kind of subsided here in the last couple of years, and pricing has been pretty stable. I would say what we are talking about here is probably the most rational of the markets. That said, all the players seem to have a bit more bounce in their step. I think that it's a good caution that we should keep an eye out for changes in supply and in pricing and other things that might happen.

Notice my own proclamations, here. I'm not saying anything about that you are going to see real growth out of Capital One's card business. We still have a conservative stance. We got a lot of things running off. I'm very focused on generating resilient returns, and letting the growth that the market has to give us come to us in the way that it will. But we are going to keep a conservative stance on that.

Next question, please?

Ken Bruce, Bank of America Merrill Lynch.

Thank you, good evening. Rich, could you possibly dimensionalize what you are seeing in the auto business? You had mentioned that things are, in a sense, tightening up there. I don't know if there's a way that you can describe how the ROAs are changing in the business or how you are seeing that shift, but that would be very helpful. That's my first question.

Yes Ken, the auto business had a confluence of things happen to it that I believe in our lifetime you are never going to see again, okay? In the period after the financial crisis, you had competitors head for the hill -- more exiting in that space than in the other businesses that we play in. You had the car companies run in to huge problems that cut back their supply. You had the consumer, in many ways, even walk away from their homes while they are making sure that -- I mean, it seems like the asset that they were most making sure they paid on was their car.

You had an extraordinary sustained increase in used-car prices that meant for all of us, every year when we did our originations. For us, of course, assuming that whatever we saw in used-car prices would regress toward the mean. The fact that we find on the recovery side so much more value than we had estimated -- you really had kind of the golden age, if you will, of the auto business.

What's happening now is that -- other than the fact we don't yet see evidence of used-car pricing subsiding -- although we would expect that, as well, you see pretty much more a return to normal on all the things that I just talked about. People have re-entered this space. Lenders have re-entered the space. It's not lost on them that there was some gold in them there hills. The car companies are getting their mojo back and stepping up volumes quite a bit. We are very careful to watch these markets carefully, and not pursue growth objectives at the sacrifice of good credit and all of that.

So where are we? This is not a red flag that I'm dropping on this business. It's really more of a return from an exceptional once-in-a-lifetime kind of period to something more normal. From an underwriting point of view, if you talk about -- if you look at pricing in the prime space, pricing is now at pre-recession levels. It's very competitive. In sub-prime, it's healthy but falling and approaching the -- approaching kind of more cycle average, but still above it. From a credit point of view, the LTV's are stable and healthy. FICO scores are holding pretty firm in the industry, but there is some lengthening of terms -- significant growth in the sort of 73-month and beyond kind of term period. We will keep an eye on that. But of the various metrics to be loosened, that one is a lot less alarming to us.

What we see, Ken, is a business that, at the margin -- if I described it, I think, at the margin, the originations we are doing now in prime are kind of, pretty much typical for what you'd see through the cycle, probably. In sub-prime, they are a bit above; but they are clearly well above hurdle, but not at the exceptional levels that we saw in the past. There's still a comfortable margin in our originations, relative to our cost of capital. We are comfortable with the underwriting that we are doing. That's why, at the pretty high level of originations we've been operating at, we hope to continue at levels pretty consistent with that.

But the main thing that we wanted to do was flag that -- well, at times, I will raise issues and say watch out for these various concerns out there. These changes in the auto business are -- it's absolute portfolio math as these new originations replace the old. We still love the business, and we are going to be very passionate in our pursuit of it. But there's going to be a little less gold in them there hills going forward.

I understand. Then as maybe an analogous event in terms of what may happen -- getting back to Don's question about competition -- do you see that possibly that could happen within the US card business? This is obviously a point in time where the returns in the US card business are extremely high, and clearly everybody is focused on it. I'm wondering if you are seeing any evidence of a shift, whether it be in the pricing or the underwriting, that would suggest that we are maybe on the early stages of seeing something similar in US card?

I think there's a real difference between the kind of exceptional -- the high returns in the card business, and the high returns in the auto business. In the auto business, when there is a gold rush like we've had in the past number of years, pretty much anybody out there can go out and partake in that. Almost anybody could have made a lot of money doing that business. You just need the right price for the right dealer at the right time, and you are pretty good to go.

What makes the card business exceptionally profitable on a sustainable basis, is the nature of -- in an incredibly sophisticated business, the nature of these relationships that are not just a one-off origination. These are customers that you manage over time, and the industry is down to a handful of players who are deeply experienced in the business. Every one of those players just went through the great recession. Several of them lost billions of dollars in the business.

Everybody, I think, saw the -- what happens to parts of their business when the stuff that they chased too aggressively -- Ken, I'm more hopeful that the -- I think the auto business -- the other thing is that the auto business, I think, has gotten to a place where the cost to acquire is really pretty high. Certainly, what we are doing is focusing mostly on profitability and taking what the market will give us. But I think it's a real difference versus what I've seen in auto, and especially what I see in the C&I business, of people sort of rushing into these spaces because they don't really have a lot of other places to go.

Next question, please.

Moshe Orenbuch, Credit Suisse.

Rich, you talked about $1.5 billion in marketing this year and you talked about having effective marketing use of that money to generate growth in some of the areas. As you kind of look at that and we think into 2014, are those opportunities getting better or worse? Do you think you are going to go for more growth in 2014 in those areas than you're seeing now, or dial back in the card business?

Moshe, I think that we see at the margin a bit of increase in opportunities. I'm not sure that's really going to translate into an increase in marketing, because I think it may be that the things we've been investing in we see some pretty good results from, and we would continue doing that. I believe that we already have good success in our business when you look past the things that we are running off. That's the result of many things, including our investment in marketing. I think we see continued success, and you should probably expect continued investment in marketing.

When people talk about growth, of course, growth is really driven by originations, account management, and choices to run off things. We've had a bit of this paradox that we are investing quite a bit in marketing at the same time that we are going sideways with returns respective to the portfolio. But again, we look at it down at the next level, and really look at what is that marketing actually generating? I think more, we just see a validation of the success of our marketing, but we are not really here to suggest any significant changes in that.

As a follow-up, you identified the earnings contribution for the Best Buy portfolio. If you annualize that, and kind of assume you buy back $1 billion worth of stock gets you about 2.5% of the shares. You annualize the Best Buy contributions -- $0.50 to $0.55 -- 2.5% of the shares kind of benefits you by -- in the neighborhood of $0.15. Is that math about right, that cost about $0.40 a share?

I'm not sure. Can you go through that again, please? We've got -- we're going to do the $1-billion repurchase, right? But that's all going to be back-end loaded in 2013, so you won't have the full impact of that until next year.

Right. I'm thinking about it -- both of them -- on a run-rate basis. But you had kind of identified an impact of $120 million some-odd pre-tax positive from Best Buy. If you kind of annualize that, it's in the neighborhood of $500 million bucks or after-tax somewhere in the neighborhood of $0.50, $0.55, and then kind of benefit on the other side of that from --

Multi-purchase. Actually, that's actually one quarter of held for sale. Last quarter, we actually gave a schedule quarter by quarter of what happens with respect to Best Buy. You really, for that run rate impact of Best Buy, need to look at the fourth quarter. Even that we suggested wasn't going to be necessarily the final picture, because we are still at work on the cost side. So this quarter, in terms of the impact, isn't really a good way to think about Best Buy on an annualized basis.

Next question, please.

David Hochstim, Buckingham Research.

Could you just clarify for us how much of the $73 million sequential reduction in reserves for estimated uncollectible finance charges and fees would have helped the margin at net interest income, and how much would have been in fees?

We couldn't hear you. Could you ask that question again?

Sure. I just wondered if you could give us the breakdown of the sequential decline of the uncollectible finance charges and fees? It was about $73 million lower in Q2. I guess, also, I was curious about seasonality, because it's down a lot more from a year ago in the second quarter. It's been moving around, as credit qualities improved?

Wasn't the second quarter of last year when we had the one-time increase in the finance charge and fee reserve from the acquisition? The decline is more the absence of that one-time effect.

Okay, but sequentially, from Q1 to Q2 is about $73 million. Could you give us a sense of how much of that is in net interest income and how much is in non-interest income?

No, we don't really break that out between non-interest income and net interest income. David, it's some of both, but we don't have a quantification with it.

I guess it's back to kind of trying to normalize what -- normalize the margin, if that's going to move around and that's a -- that kind of a benefit you have this quarter --

Part of that is, actually an impact of credit, and part of it is just lower fees. It's consistent with what you've heard from Rich on the credit side. We are not anticipating huge improvements from here on that. I think you'll probably see more overall stability in the item going forward.

Next question, please.

Bill Carcache with Nomura.

Rich, I was hoping you could give us your current thoughts on where you see the rewards environment currently? In particular, whether you're seeing any signs of industry rewards being scaled back a little bit, given the focus on controlling expenses. For Capital One, specifically, what's been happening directionally with your rewards ratio?

Bill, we have -- ours is more of a stable story in our case. We've been investing in this business for years. Our value proposition is pretty attractive for consumers, and one of the key characteristics of what we offer is what you see is more what you get. There are not lots of fine print and complexity in terms of ultimately how much the customer gets. We are finding pretty high levels of redemption, which is consistent with customers really getting what they thought they would get.

We've been investing in this for years. We like what we see. For us, it's a very stable kind of story from here. I've not seen really much change from competitors on this dimension, either. I think, frankly, it's a very competitive space and if people are looking for cost saves, I don't see our competitors really finding them in the rewards space.

Okay. Finally, can you talk about -- just looking at the reported 19% year-over-year increase in net interchange for your revenues this quarter, and comparing that to the purchase volume growth, which for your card business was up about 12% over the same period? I know there were some US card acquisition, and there was an impact that that had. I guess I was just hoping you could maybe help us understand what the difference is between the growth rates in your net interchange for your revenues and you purchase volume growth? That's it, thanks.

Thanks, Bill. Purchase volume grew, I think, 13% year over year, or around 9% when you exclude the HSBC portfolio. One thing that -- this always gets a little complicated on our net interchange disclosure. That represents all of our card business, including international credit card and our bank debit business, and the impact of some partnership payments -- those payments which are related to purchase activity.

If we separate out partner payments, and focus on the trends in our domestic general-purpose credit card portfolio, our purchase volume growth has been higher, generally, over the last few years, higher than our net interchange revenue growth, because we have been growing in the attractive products. We've been marketing, as you've seen them on TV and elsewhere, and the percentage of purchases in our card portfolio, driven by people with reward cards -- as opposed to without reward cards -- that has been a sustained mix change over time. That will continue over the course of the next year or so.

We actually got to the -- these things bounce around a little bit, and we got -- in this particular quarter -- when things net out, you actually had the interchange growth, kind of on a net adjusted basis, beyond the things I talked about, grow pretty much at the same level as purchase volume growth. I think over time, you will see some -- still some lagging of the interchange growth rate relative to the purchase volume growth rate, only because we continue to migrate more of our portfolio to rewards. It's the by-product of actually a movement to bringing better products and experiences to our customers.

Where we get rewarded with that over time, no pun intended, is with better customer experience, lower attrition, and the more sustainable franchise metrics that are really what this journey is about. What I'm happy about is, for some years, actually, the interchange was lagging the purchase volume growth by a lot. Now, the rate has become much closer.

Okay. Thanks, Michael. Thank you everybody for joining us on the conference call today, and thank you for your interest in Capital One. Remember, the Investor Relations team will be here this evening to answer any further questions you may have. Thanks and have a great evening.

Ladies and gentlemen, that does conclude today's conference. We thank you for your participation.