Capital One Financial Corp (COF) 2014 Q2 法說會逐字稿

Welcome to the second quarter 2014 earnings conference call. All lines have been placed on mute to prevent any background noise.

(Operator Instructions)

Thank you. I would now like to turn the call over to Mr. Jeff Norris, Senior Vice President of Global Finance. Sir, you may begin.

Thanks very much, Justin and welcome everybody to Capital One's second quarter 2014 earnings conference call. As usual, we are webcasting live over the internet. To access the call on the internet, please log onto Capital One's website, capitalone.com and follow the links from there. In addition to the press release and the financials we have included a presentation summarizing our second quarter 2014 results.

With me today is 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 and 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 as of the particular date or dates indicated in the materials. Capital One does not undertake any obligation to update or revise any of this information, whether as a result of new information, future events or otherwise.

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

Thanks, Jeff. I'll begin tonight with slide 3. Capital One earned $1.2 billion or $2.04 a share in the second quarter and had a return on average tangible common equity of 17.5%. We reduced our net share count by 11.1 million shares in the quarter, reflecting our share buyback actions.

Included in continuing operations results for this quarter were higher link revenues, higher link quarter revenues, flat linked quarter non-interest expenses, a lower provision for loan losses driven by lower charge-offs and a $100 million allowance release. A $37 million addition to our reserves regarding UK cross-sell which was split almost evenly between non-interest expense and non-interest income.

In the UK, refunds to customers who bought payment protection insurance is an industry wide issue and continues to be in the headlines. Our reserve build reflects the fact that while the number of customer claims we receive is continuing to fall, it hasn't fallen as quickly as forecasted. The reserve build does not reflect any change in how we calculate customer refunds.

It is possible that we may further add to reserves if we determine that we need to change the calculation of customer refunds. Finally, we had an $18 million benefit related to mortgage rep and warranty which includes a provision of $11 million before taxes and discontinued operations and a benefit of $29 million before taxes and continuing operations.

Turning to slide 4, I'll touch briefly on that interest margin. Reported NIM decreased 7 basis points in the second quarter to 6.55% primarily driven by lower yields and average balances in our domestic card business partially offset by the second quarter having one more day worth of recognized income. Average interest earning assets were up modestly quarter over quarterly primarily driven by higher average loan balances in our auto finance and commercial banking segments. We are updating our expectation for mortgage run-off in 2014 to about $6 billion, based on our current view of rates.

Moving to slide 5, I'll briefly cover capital trends. Our common equity tier 1 capital ratio on a Basel 3 standardized fully phased-in basis was 11.6% in the second quarter of 2014 compared to a Basal 3 standardized fully phased-in equivalent ratio of 11.7% in the first quarter of this year. With the benefit of phase-in, our common equity tier 1 capital ratio was 12.7%, down 30 basis points in the Basel 3 standardized equivalent of 13% in the first quarter of this year. And while we have yet to enter parallel run for Basel 3 advanced approaches, we continue to estimate we are above our target of 8%.

Last, we reduced our net share count by 11.1 million shares in the quarter, reflecting our share buyback actions. We completed approximately $1 billion of our share buyback program in the second quarter and we expect to buy an additional $1.5 billion over the next three quarters. We have demonstrated our commitment to return capital and understand it remains an important part of the return equation for our shareholders.

I'll close tonight with a brief update of our 2014 expectations. We continue to expect pre-provision earnings to be about $10 billion within a reasonable margin of error and we continue to expect some modest, but principally offsetting changes with higher revenues offsetting higher expenses relative to our expectations earlier this year.

While we had a release of allowance in the quarter, going forward, as we return to growth, and considering the charge-offs remained below historical averages, we are less likely to see releases going forward. With that, let me turn the call over to Rich.

Thanks, Steve. I'll begin on slide 7 which shows another strong quarter posted by our domestic card business highlighted by a return to year-over-year growth. The year-over-year trends in loans and purchase volume continue to reflect our strategic choices which focused on generating attractive, sustainable and resilient returns. Ending loans were up about 4% from the first quarter and about 1% year-over-year.

We had expected year-over-year growth to resume sometime in the second half of 2014. The early return to year-over-year loan growth resulted from increasing traction in the segments we're emphasizing including rewards customers and revolvers other than high balance revolvers as well as the success of credit line increase programs. The collective impact of these factors was greater than the continuing impact of our choice to avoid high balance revolvers.

Purchase volume on general-purpose credit cards which excludes private label cards that don't produce interchange revenue grew about 16% year-over-year. Revenue margin for the quarter increased 13 basis points to about 17.1%. The increase resulted from expected seasonality and higher non-interest income, partially offset by a decline in loan yields. Revenue dollars were down about 10% year-over-year, driven primarily by our choice to sell the Best Buy portfolio.

Non-interest expenses improved by $32 million from the prior quarter driven by operating efficiencies, partially offset by a modest increase in marketing. We expect an increase in marketing in the second half of 2014 driven by both the expected seasonal ramp and because of this success in continuing opportunities we see in growing customer relationships, purchase volumes and loans.

On a linked-quarter basis, charge-offs and delinquencies were in-line and continued strong underlying credit performance and better than seasonal expectations. The charge-off rate improved 49 basis points to 3.52% driven by seasonality as well as the diminishing impact of aligning HSBC branded card customer practices with Capital One practices. The 30 plus delinquency rate improved 19 basis points to 2.83%.

Our card business remains well-positioned. We returned to year-over-year loan growth a bit earlier than expected despite continuing runoff and our choice to avoid high balance revolvers. We're delivering strong, sustainable and resilient returns and we continue to generate capital and solidify our customer franchise.

Moving to slide 8, the consumer banking business delivered another quarter of solid results. Ending loans grew about $335 million from the first quarter and declined about $1.2 billion from the second quarter of last year.

On a year-over-year basis, continued growth in auto loans was more than offset by mortgage runoff. Auto originations increased from the first quarter and remain on strong growth trajectory. Sub-prime originations were relatively stable while prime originations grew as we continue to capture additional prime share from our existing dealers. Ending deposit balances declined by about $2.4 billion in the quarter, consistent with normal seasonal patterns.

Year-over-year deposit balances declined about $640 million. We had an abundance of deposits since the ING Direct acquisition and we've been allowing the least attractive deposits to runoff.

Consumer banking revenue increased about $18 million or 1% compared to the first quarter. Year-over-year revenues declined by about $66 million or 4%, driven by the impact of persistently low interest rate on the deposit business, declining mortgage balances and margin compression in auto. Auto loan growth partially offset these negative revenue impacts.

Non-interest expense increased $28 million or 3% from the prior year. The increase resulted from growth in auto loans as well as a change in the geography of where we recognize auto repossession expenses, which are now included in operating expense rather than in net charge-offs.

Provision for credit losses increased modestly in the quarter at about $76 million from the prior year. The year-over-year change resulted from a swing in the allowance from a release in the second quarter of 2013 to a modest build this quarter related to auto loan growth. Auto charge-off rate improved in the second quarter driven by expected seasonal patterns in the higher proportion of prime loans in the portfolio.

Home loans credit trends remain favorable and continue to perform well inside of the assumptions we made when we acquired the mortgage portfolios. The overall consumer banking charge-off rate remains below 1%.

Our consumer banking businesses are delivering solid performance in the face of continuing challenges. In auto, second quarter growth and performance were very strong but we expect that auto margins and returns will continue to decline as we move from exceptional levels to more cycle average performance. We expect that auto returns will continue to be resilient and well above hurdle. In our retail deposit business we expect that the inexorable impacts of the prolonged low rate environment will continue to pressure returns even if rates rise in 2014.

As you can see on slide 9, our commercial banking business delivered another quarter of profitable growth. Loan balances increased about 5% in the quarter and 18% year-over-year, driven by growth in specialized industry verticals and C& I lending and CRE. As competition continues to increase, it is likely that the pace of our commercial loan growth will moderate over time. Loan yields were stable in the quarter, but declined 34 basis points compared to the prior year driven by lower market pricing from increased competition and our choice to originate more variable rate loans.

Revenues increased 7% from the first quarter and about 10% from the prior year. The year-over-year increase was the result of growth in loan and deposit balances across the franchise, partially offset by declining loan yields. The stronger increase in non-interest income was driven by the Beech Street acquisition and growth of fee generating businesses.

Non-interest expense was up 17% from the prior year as a result of growth in loan balances and continuing infrastructure investments to drive future growth. In the quarter, non-interest expense was up about 5%. We continue to closely manage commercial credit risk and commercial credit results remain very strong. Charge-offs, non-performing loans, and criticized loans remain at exceptionally low levels that are not sustainable through the cycle.

Commercial banking competition continues to increase, but we expect our focused and specialized approach to deliver strong results in the commercial bank.

I'll conclude my remarks this evening on slide 10. In the second quarter of 2014, we posted another quarter of solid results for the Company and across our businesses and we continued to return capital to our shareholders as we execute our announced $2.5 billion share repurchase program. We're delivering these results in an operating environment that has both encouraging trends and continuing challenges. Credit remains relatively benign and our domestic card business is growing. On the other hand, the interest rate environment remains challenging and competition is picking up, particularly in auto and commercial.

Capital one is earning very attractive risk adjusted returns and we continue to focus on multiple levers to sustain our profitability. We'll continue to pursue growth opportunities in card, auto and commercial banking as growth remains a high priority. We'll maintain our long-standing discipline in underwriting across our businesses and our pre-emptive focus on resilience.

We will continue to manage expenses tightly in the context of investing to drive future growth, be a leader in digital banking and continue to meet rising industry regulatory requirements. We're on track to deliver 2014 pre-provision earnings of about $10 billion.

We expect that 2015 pre-provision earnings will rise with growth in average loans driving increased revenues partially offset by a higher non-interest expense as we continue to invest to sustain growth and returns. While the efficiency ratio will vary from quarter to quarter, we expect the full year 2015 efficiency ratio to be between 53% and 54% excluding non-recurring items.

Capital distribution remains an important part of how we expect to deliver superior and sustainable value to our investors. We continue to generate strong earnings and work actively to return capital to shareholders. 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 other investors and analysts who may wish to ask a question, please limit yourself to one question plus a single follow-up. If you have any follow-up questions after the Q&A session, Investor Relations team will be available after the call. Justin, please start the Q&A.

(Operator Instructions)

Ryan Nash, Goldman Sachs.

Hi. Good evening, guys.

On the 2015 efficiency, the 53% to 54%, can you just give us some help understanding what type of backdrop you're assuming? Are there expectations for rising interest rates or any sort of acceleration in growth either in your loan portfolio or in the economy from the current levels?

Ryan, I think we gave guidance on 2015 on efficiency ratio and only gave guidance on that because we largely want to avoid forecasting other items. I do think it was important for us to express what we think the potential is to drop additional revenues to the bottom line as we move into 2015. But also to give you a real sense of what we think some of the investments are that we're making to ensure that we can sustain the returns we have which we think are very good and also grow going forward. So you can see what's happening in general on loan growth around the industry and I think we'll leave it up to you to try and figure out where you think that's going to go over the next 18 months.

Do you have a follow-up, Ryan?

Thanks, Jeff. You've obviously had some of the strongest growth that you've seen in quite some time and I take your point that we're likely not to see much in terms of reserve releases going forward, but how should we think about provisioning for growth? Should we think about charge-offs matching provisions from here? Or do you feel the reserve is at a good place and it can likely stay at the current levels?

Well, I think most people who have been in the card industry have consistently assumed that we're at the end of a period of improvement and they've been consistently wrong for a long period of time. We just felt like it was important to say, with where charge-offs are, which is pretty historic levels, that we would bet against additional reserve releases going forward. I think a lot of people have continued to make that assumption over the last couple years and they've been wrong.

Next question please.

Sanjay Sakhrani, Keith, Bruyette & Woods.

Thank you. Rich, you mentioned that loan yields were a headwind to other positives for the card revenue margin. I was wondering if you could help us think about loan yields on the new loans that are coming on relative to those that might be running off and maybe those that you were originating pre-recession or card act? I just want to get a sense of how that's progressing.

Well, I think, Ryan, first of all I do want to say, just a contextual thing and your question may or may not have been stimulated by that. Average loan yield, it sort of has had some funny dynamics over the past several quarters. And year-over-year it's artificially heightened because of the Best Buy held for sale -- in 2013, by the Best Buy held for sale accounting and so on. But if you get beyond some of the noise in the current movement and perhaps it's really better for me to speak in terms of revenue margin.

I think there is a striking stability in revenue margin that really goes back a number of years when you think back to revenue margin in 2011 was around 17%. Then 2012 we added HSBC and adjusted for purchase accounting. Purchase accounting margin was also around 17%.

And then in 2013 if you really normalize for the Best Buy impacts and deal related items, revenue margin was kind of in the low 17% range. And we had some offsetting things that were going on there from the removal of Best Buy's low margin business roughly offset by a bunch of moves we made on things like payment protection, stopping the origination of that and some other kind of franchise enhancements.

We've also said that, I think on a calibration across all the businesses that we operate in, I think the most stable business in terms of the yields and the margins in the business overall is the card business. So unlike, say on the other end of the continuum, the auto business where we say the new originations are definitely at a lot lower yield and margin than what the back book has. I think the best way to think about it, Ryan is that -- I mean Sanjay, is that the front book has pretty strikingly similar kind of revenue dynamics to the back book. And I think that's really in many ways a reflection of the stability of our own business model and a reflection of the relative stability of pricing in the card market.

When you think about sub-prime as a function of the total, has that mix moved up in sub-prime? Are there opportunities in sub-prime that might not have been there a little while ago?

In some ways the more things change, the more they stay the same. Pretty similar to the revenue margin story, the sub-prime mix in our portfolio has stayed pretty similar as the FICO under 660 has been about a third of our outstandings in terms of currently measured FICOs. And that metric has been stable for an extended period of time.

Next question please.

Bill Carcache, Nomura.

Thank you. Good evening, guys.

Rich, last quarter we saw a relatively slower interchange revenue growth relative to your purchase volume growth. But this quarter we saw a very strong net interchange growth of 22% sequentially and 10% year-over-year. Can you give some color around that dynamic that's at play here and talk about the sustainability of those trends?

Yes. In the same way I cautioned when it was very paltry last quarter and then it surges this quarter, I really kind of give you the same caution. In any individual quarter, the net interchange metric is -- I wouldn't put too much reliance on trend reading, based on that.

The net interchange metric, first of all, it includes a bunch of things. It's got partnership, contractual payments in it. It's got international card in it and we periodically adjust our rewards liabilities based on what we're seeing in terms of customer trends, redemption rates and things like that.

Over the last few quarters, as you say, net interchange growth has generally lagged general-purpose credit card interchange growth significantly. But overall what we have said is that we expect the trend to have interchange growth lag general-purpose credit card growth. You'd expect this -- a lag with some volatility quarter-to-quarter to continue. Let me explain just a little bit what's behind that.

Our rewards programs have been and continue to be very successful. We are also though, in addition to aggressively marketing new rewards originations, we are also working to build our long-term franchise by upgrading rewards products for our existing rewards customers and extending rewards products through some existing customers who don't have rewards. All of that means some near-term cannibalization but overall I think it really helps deepen the customer franchise.

Those effects I think will last for an extended period of time so again, we feel very bullish about the ability to grow general-purpose purchase volume. Interchange should lag that with some quarterly volatility, but overall the economics of our rewards products, we feel very good about them and what we're doing there is over time we are building a growing net interchange revenue.

Additionally, what comes with the territory of this business is the spenders build balances over time and they build finance charge revenues gradually over time. And then you get the great charge-offs, the low attrition and kind of the long-term franchise dynamics of the whole thing. So I appreciate the call because I think it's important to understand why the interchange does have a lag there relative to the purchase volume, but it's all part of something we are investing in and feel very good about.

Thank you for that detailed explanation of the dynamic. That's really helpful.

If I could as a follow-up, do you believe that we're at a point in the recovery where perhaps the near prime revolver is finally starting to feel the benefits of what today many would argue has been a rather lopsided recovery favoring the affluent?

I think that I'm always a little cautious about using the recovery word. I mean this thing is -- we're talking about recovery with a small R, I think, in general.

Certainly, I think the recovery has been more manifest at the top of the market. But yes, I would support the notion that I think we see across our business some modest signs of some strengthening across the broader spectrum of the mass-market. But I think these are all in the context of fairly modest effects at this point.

Next question please.

Eric Wasserstrom, SunTrust Robinson Humphrey.

Thanks very much. I just wanted to follow-up on the PP&R guidance and the OpEx guidance and just understand -- does this suggest that there's going to be some degree of incremental operating leverage heading out into next year? Or are revenues and expenses moving up more or less in lock step?

I think -- go ahead, Steve.

I guess it depends upon what your frame of reference is. I think our GAAP efficiency ratio in 2013 was a little over 55%. The first two quarters of this year we've been operating around 54%, 54.5% and next year we're talking about somewhere between 53% and 54%. So if you're defining operating leverage solely with respect to efficiency ratio, that number is going down over time.

Thanks for the clarity. And just a follow-up on the customer refunds issue.

I think Steve, you said that it's playing out a little bit differently than you had anticipated. I was curious as to why you think that is.

It's just the submissions in terms of -- they've been coming down. They just haven't been coming down at the rate that we expected. There is a little bit different of a trendline which is why we increased the number by $37 million.

A big part of that could be that there's been a fair amount of media about PPI recently. That could be one of the things that kind of drove the increase.

Next question please.

Brad Ball, Evercore.

Rich, in talking about the growth that we saw this quarter you mentioned three drivers. You said rewards, non-high-balance revolvers and credit line increases. Can you give us a sense as to which of those is driving the most receivable growth? And are those the same drivers that you expect to drive US card balance growth in the second half or will you be perhaps expanding the market to grow in the second half?

Yes. I mean, all three are important factors. I think that the investment in originating new account -- all the efforts on originating new accounts, be they on the top of the market side or in revolver other than high balance revolver, that has been a very steady kind of growing thing that is increasingly picking up traction and we feel good about that.

The credit line increase thing has been a little bit more volatile as you recall really going back to the beginning of 2012. There is a bit of a brownout related to that as we retooled our capabilities in the context of some regulatory guidance that came down about the need for having that income before we did a credit line increase. The pattern of that is the problem-solving to get solutions for that -- we kind of got to a good place in the latter part of last year and then so we started initiating credit line increases on a growing basis around that time.

So part of the surge that you see this quarter reflects that effect. It is not entirely -- it's not a one quarter little blip. There is actually continuity and continued momentum in that one as well. But that one is a little bit more of a surge than the other two effects that are just very steady kind of growing effects.

Great. And then separately on auto finance, you mentioned that prime grew this quarter from capturing share. I think you had said in prior quarters that you were seeing some increased pricing pressure around prime. What's the dynamic there? What's your outlook for auto finance growth in the second half?

Yes. So it's a little -- you're a careful student of what we say because we have said, as we have talked about the marketplace, that the most competitive part of the credit spectrum is prime and that's really in fact, in terms of margins, at a near cycle low in many ways. Although the underwriting is generally healthy, but the pricing is really tight.

In the sub-prime space, things are compressing, but are still at a healthier place. So it's been kind of -- the question is so why are we holding -- why are we flat in sub-prime and growing prime?

What we're doing is deepening our dealer relationships. In our dealers where we have a very strong position in sub-prime, we have a lot of opportunity to grow in prime.

And it's really -- there's two things going on. One is, I think we feel good on a standalone basis about the economics of the prime business although it's certainly on the lower end of returns and by the way, of losses, of the various things that we do.

But I think the biggest benefit is the deepening of the dealer relationships and the benefits that come across the credit spectrum in terms of the quantity and quality of the deal flow that we get. So we feel -- even as one-time we've got a cautious eye on the pricing side on prime, we feel good about this expansion. But we just wanted to flag that most of the growth is coming -- most of the incremental growth is coming on the prime side.

Next question please.

Don Fandetti, Citigroup.

Rich, I know you've made some comments about card loan growth. I just wanted to follow-up. Is your sense that we'd be more likely to peak out here in terms of industry card loan growth or do you think that we are potentially in an earlier part of the stage here? And then secondarily, are you seeing any differential in terms of the health of the consumer on the low or high end?

So it's always hard -- it's probably definitionally hard for anybody in the middle of these businesses to tease out the effects of industry growth versus one -- the growth that we ourselves are generating through our good innovation and marketing and so on. You can see we've had some pretty striking sort of step forward here in the sense that in going from -- I can't remember something like a minus 3% year-over-year to a low single -- now a positive growth number in card despite all the stuff that we are running off.

As I look at it from our more narrow perspective, I see across all the things that we are investing in. We went out and spent a lot of time testing and we're rolling out on things that we're testing and we've had a growing amount of innovation and we're rolling that stuff out. And it feels -- it doesn't feel like we're just riding an industry tied up. I think this really feels very much like what we expected from the tests that we did and the rollouts are performing very well and consistent with that and they're expanding in that sense.

I am really pretty cautious to declare any kind of industry effect. I've seen for such a long period of time the virtually zero and for a long time, kind of negative growth in terms of revolving debt. And of course I do want to say too, is we continue to just stare so at the astounding performance on the credit side.

We should all remember that this effect that has kind of exceeded the expectations of virtually anybody out there, I think, is certainly one of the important factors there is the flip side of the consumer cautiousness that's holding back the growth. So I don't think as an industry we'll get a package of a bunch more growth and still just like record low credit. What I do feel is, I feel very good about our own growth programs that we've steadily invested in and I think we've got good traction there and we hope to continue.

Next question please.

Bob Napoli, William Blair.

Thank you. Good afternoon.

The private label card business, I would just like some updated thoughts on that and what you're thinking about as far, Rich, about opportunities. Are you see more opportunities?

Obviously Nordstrom, you can have a big file coming onto the market. You have a big competitor that is going public, the GE Capital spinoff, Synchrony, I guess. Just some updated thoughts on your opportunities, if you're seeing more or less and excitement about that business.

Well, gosh, we certainly like the business. Probably four years ago we didn't have any partnerships.

So in some sense we've come a long way since then with over 20 partners and $15 billion of outstandings. Of course, the biggest single effect of that was the purchase of the HSBC business. But also before that we had pretty actively entered the market and going after top-of-the-line players, Kohl's being the flagship partner there.

Our view of this business is it is a real natural for Capital One because we are already a big player in the card business. I think this business is also crying out for innovation, whatever digital innovation any of us are thinking about in banking, if you want an industry that is in incredibly big need of digital innovation, it is the retailing business. And I think that an opportunity to leverage our own digital innovation in that space is very exciting to us.

What we're trying to do in that space is not -- even though scale matters a lot and it definitely matters a lot and all you have to do is look at the loss of scale that came from our walking away from Best Buy to see some of those marginal economics. Scale really matters and so that's why we're very focused on growing.

But I think each of the different players sort of has their different strategy. We're certainly trying to go more toward the higher end of the market in terms of the real quality retailers who are focused on building a franchise, deepening their customer relationships through the card as kind of the flagship and central nervous system of that transformation.

That's really our sweet spot and I think where we can create a very unique positioning. You may have noticed that in an unusual move, Kohl's, with whom we already had a contract for many years still, proactively went out and sought to extend that by another five years because they were so -- and again you have to look at their own words on this, but very happy with the relationship we were building. And said that in order to really invest to build a long-term franchise with us they wanted an even longer commitment because they felt we were soul mates about leveraging the card to really build the franchise.

We see great promise in that business. In the near term, we have the challenge of that scale really matters and we're kind of sub-scale. Yes, there are a lot of -- well, there are several things that are floating around in the market right now.

And we'll have to see how that thing turns out, but I really want to say that we still -- I still go back to the core principles that while growth really matters. What matters more than that is that we have quality partners who are motivated to do this for the right reason and a contract that really works. Where we find that, I think we want to be in a pole position to get those deals and I think over time I like our chances.

Next question please.

Moshe Orenbuch, Credit Suisse.

Great. Thanks.

Rich, I thought I heard you say something about the deposit margins coming down even if interest rates rise. Could you kind of go over that because I wasn't sure I caught that?

Yes. I'm not sure that that was in the comments. What I think he said, which is not inconsistent with what I think the rest of our peers are saying, is that even if we have a near-term rise in interest rates, that doesn't mean that you will be showing better spreads in the consumer banking business.

Got you. Would you say that the terms of the Kohl's contract are comparable to what they've been? Because in the past, your disclosures showed that you kind of remitted 90% of the revenues over to them. And it's not clear what -- maybe you could talk a little bit about what that partnership actually does for Capital One.

Moshe, I don't know if we want to get into the details of the Kohl's contract. I think both we and Kohl's have felt that economically, this is a good program for both sides. In fact I think an acid test of a partnership is it really works economically for both sides.

And some of the elements of this are structured a little differently from some of the other programs that are out there, but not in a way to have adverse economics for us. It's just if you compare that structure to some others, it's just a different way that the revenues flow and the payments work. But underlying it, it's a good program with attractive economic opportunity for us. And the renewal was, while there were some changes in the terms, it was directionally along similar lines.

Next question please.

Betsy Graseck, Morgan Stanley.

Hi. Good evening. A question on the purchase volume.

You had a nice increase there obviously. Year-on-year up 11% and up significantly from last quarter. You talked through earlier about the drivers to the increase in the loan balances. I'm just wondering if you could parse out the different drivers to the purchase volume increase by the different products and client types that you have.

So the purchase volume, Betsy, is -- and here I'll really speak about the general purpose card. Obviously there is purchase volume growth going on on the private label side. But we've more called your attention to the general purpose side since, of course that's where interchange and the branded card business is for us.

So we've talked about year-over-year growth of 16% which is even up on what we've seen recently. The two effects that are going on is continued growth in the spender side of the business, both in consumer and small-business, as a result of a lot of the marketing and customer experience work that we've been doing.

And then also though, Betsy, another factor that has boosted this is credit line increases. Because of course what's happening is, as people are filling their new credit lines, they are doing it through purchases as well. So that certainly added to this significant growth number.

I know the credit line increases -- typically with the barbell strategy, you've got credit line increases primarily targeted towards the lower end of the customer -- the near prime customer as opposed to the prime customer. Is that the way the credit line increases have been going recently? I mean given the fact that you had the brownout, I'm just wondering if credit line increases are across the board in terms of the quality set of the customer, are they still more likely to be skewed towards the near-prime than the super-prime?

Our credit line -- I'm going to go back to what led us to have a bit of a brownout in line increases and that was this regulatory requirement that one needed a validation of income before one did a line increase. So our line programs work across our entire portfolio.

There was more impact on the lower end because we tend to start with lower lines and then the mechanism -- then there are more line increases to get to a destination than say were you to get a venture card. You'd be starting with a pretty high line. So the differential impact was more on the lower side of the market of our portfolio, but really the effect and our rollout now of full capabilities and line increases is targeted across our whole portfolio.

Next question please.

Matt Howlett, UBS.

Thanks for taking my question. On the expense guidance again, going back to last year the original guidance was for just up under a $600 million decline or improving efficiency. What's changed that? Is it more opportunities you're seeing to take share or is there some other competitive dynamic that would suggest otherwise?

Were you talking about -- I thought I heard you say expense efficiency?

The operating expense, the previous guidance for the fall -- last issue

So if it's operating -- we really haven't changed our guidance for 2014. What we did tonight was add a bogey for 2015. With respect to our original guidance for 2014, all we've said is that we expect higher revenues and higher expenses relative to our original estimate.

Okay. In terms of the pre-provision guidance I thought you said sort of higher -- $10 billion but higher revenue offset by higher expenses. I just didn't know why the guidance for it to fall year-over-year, why that would have changed?

Guidance for the efficiency ratio to fall?

For the overall operating expense number.

I'm not sure I'm following.

I'll follow-up online. Thanks.

Next question please.

Matt Burnell, Wells Fargo Securities.

Good afternoon. Thanks for taking my question. Just one question, Rich, you mentioned in terms of the commercial loans, a little bit of slowing in the loan growth there and I saw specifically in commercial real estate and the multi-family portfolio that that was growing an annualized rate a little bit about half the rate of what you've done year-over-year.

Is that from your being tighter on underwriting? Or is that just a drop in demand across your markets?

It's probably not technically either. We haven't tightened our underwriting. Nor have we loosened it and I don't think demand is going down. If anything, I think demand is going up a little bit.

I think -- but maybe I'm parsing words here. I think what's happening in some of these markets is that the markets are heating up in terms of competitive activity and some of the pricing in these spaces.

So what we have done and multi-family is a good example of that -- we are working hard to grow, but not by a lowering our underwriting standards. We work really hard within the context of our standards to get all the business that we can and one of the things that we've said, in parts of the commercial business, probably even more so on the C&I side, there are increasing evidence of some underwriting and pricing softening in the marketplace on the C&I side.

Certainly I think the impact of -- on the institutional investor side of covenant light loans and things like this. This is slowly kind of spreading into different parts of the commercial marketplace. And that is the biggest reason that we're saying over time this very significant growth rate that we have. We expect it to moderate just because we are holding pretty firm on the standards that we will accept for these loans.

Okay. Rich, and then I just want to follow-up on a comment you made at a conference recently about selectively placing branches across your platform. Obviously you have a number of markets where you already have reasonable ranch density.

I'm just curious at this point, given your comments about thinking about branches, if you are more interested now than you might have been in the recent past about making very targeted acquisitions of branches in and or around where your branches currently sit?

I think we are big believers, frankly in being on the forefront of the digital revolution in banking. And it is clearly sweeping the banking industry and we're not just idly interested in it. You may have noticed that we bought ING Direct that had a very big investment in digital banking.

What we have often said though, as my perspective from one who's started out over 20 years ago to build a company that I thought would be a direct only company. Over time, I've really come to appreciate the benefits of physical distribution and face-to-face contact.

What we're trying to do is work backwards from where that market is going as opposed to just try to go re-create what others have done in classic banking. Therefore, I think putting in some light physical distribution in key metro areas is part of our future. But I think we're going to go about this trying to go where the market is going and not through the classic go acquire across the country kind of thing.

Next question please.

Brian Foran, Autonomous Research.

Good evening. Back to the efficiency guide for 2015, if I think back over the past few years we've been on this kind of transitional period where there was the top bank initiative and the scaling up to be one of the top five banks and the infrastructure that goes along with that. There's been the merger charges increasing the tangible amortization which is now running down.

So I guess as I think about 53% to 54% in 2015, recognizing that no environment is ever really normal or the end game. But would you view 53% to 54% as a roughly normalized level of efficiency for the company or would you still view it as a transitional year to some ultimately lower level?

Look, I think if we were going to talk about something through the cycle, we probably wouldn't pick efficiency ratio because you can't pay dividends and return capital out of what your efficiency ratio is. So I think it's reasonable and we think about what the right through the cycle level of profitability is. There may be a point where that's a discussion we have, but if we do that it certainly wouldn't be around efficiency guidance.

Fair enough. As a follow-up and just a small thing, the jump in occupancy expense this quarter, is that a new run rate or was that something that happened that was idiosyncratic to this quarter?

That's probably closer to a new run rate. Nothing idiosyncratic there.

Thank you.

Well, thank you very much to everyone for joining us on the conference call today and thank you for your continuing interest in Capital One. Remember, if you have further questions the investor relations team will be here this evening to answer any questions you may have. Thanks again. Have a good evening.

Thank you and that does conclude today's conference call. We do thank you for your participation today.