Capital One Financial Corp (COF) 2014 Q3 法說會逐字稿

Welcome to the Capital One third-quarter 2014 earnings conference call.

(Operator Instructions)

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, Lauren. And welcome, everyone, to Capital One's third-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 at capitalone.com and follow the links from there. In addition to the press release and financials we have included a presentation summarizing our third-quarter 2014 results.

With me today 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 the 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 and any forward-looking statements contained in today's discussion and the materials speak only as of the particular date or dates indicated in the materials. Capital One does not undertake any obligation to update or revise any of this information, whether as a result of new information, future events, or otherwise. Numerous factors could cause our actual results to differ materially from those described in forward-looking statements. For more information on these factors, please see the section title 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.

With that, I'll turn the call over to Mr. Crawford. Steve?

Thanks, Jeff. I'll begin tonight with slide 3. Capital One earned $1.1 billion or $1.86 per share in the third quarter. On a continuing operations basis, we earned $1.94 per share, and had a return on average tangible common equity of 15.7%. Included in continuing operation results this quarter were higher linked quarter revenue, flat linked quarter noninterest expenses, higher provision for loan losses driven by a $214 million allowance build, partially offset by lower charge-offs.

There were a few nonrecurring legal reserve changes in the quarter I would like to highlight. First, a $27 million contra revenue impact. Second, we had charges in noninterest expense of which were offset by a $28 million benefit in our Domestic Card business. And last, we had a $70 million charge from rep and warranty expense and discontinued operations.

Turning to slide 4, net interest margin increased 14 basis point in the third quarter to 6.69%, primarily driven by higher average balances in our Domestic Card business and the third quarter having one more day worth of recognized income. Average interest-earning assets were up quarter over quarter, driven by higher average loan balances in our Domestic Card, Auto Finance, and Commercial Banking businesses.

Turning to slide 5, let me cover capital trends. Our common equity Tier 1 capital ratio, on a Basel III standardized fully phased-in basis, was 11.8% in the third quarter compared to 11.6% in the second quarter of this year. With the benefit of phase in, our common equity Tier 1 capital ratio on a Basel III standardized basis was 12.7%. And while we have yet to enter parallel run for Basel III advanced approaches we continue to estimate we are above our target of 8%.

We reduced our net share count by 3 million shares in the quarter, primarily reflecting our share buyback actions. We completed approximately $500 million of our share buy back program in the third quarter. And we expect to buy an additional $1 billion over the next two quarters.

Let me close tonight with a brief update of our 2014 expectations. We continue to expect pre-provision earnings to be about $10 billion excluding nonrecurring items. Traditionally our marketing expenses are seasonally higher in the fourth quarter. That seasonal increase in marketing, as well as our operating expense investments in growth, which Rich will review in more detail, will drive an increase in noninterest expense in the fourth quarter of this year, which will carry into 2015.

We highlighted for you last quarter that allowance releases were less likely going forward. In the third quarter, we built allowances as we grew our card loans, and expectations for future card growth will likely drive allowance builds in coming quarters.

With that, let me turn the call over to Rich.

Thanks, Steve. I'll begin on slide 7 with our Domestic Card business, which delivered another quarter of strong results. Ending loans were up about 5% year over year and about 3% from the linked quarter, stronger than typical seasonal growth in the third quarter. Continuing momentum and new account originations and credit line increase programs drove loan growth in the quarter.

Purchase volume on general-purpose credit cards, which excludes private label cards that don't produce interchange revenue, grew 17.5% year over year. Revenue margin for the quarter increased 34 basis points to about 17.4%, consistent with normal seasonality. Revenue dollars grew about 6% from the linked quarter, driven by growth in average loans and the seasonal increase in revenue margin. Year-over-year revenue dollars were down about 4% as the revenue impact of our choice to sell the Best Buy portfolio was partially offset by strong underlying growth in average loans.

Noninterest expenses increased $17 million from the prior quarter, driven by higher marketing expense. We expect both operating expenses and marketing to increase in the fourth quarter driven by loan growth, the expected seasonal ramp in marketing, and continuing opportunities we see to grow customer relationships, purchase volume and loans. Domestic charge-off rate improved 69 basis points on a sequential quarter basis to 2.83%. We believe the sharp improvement in the quarter is temporary.

The third quarter is usually the seasonal low point for card losses but we think seasonality drove only about half of the improvement that we saw in the quarter. Most of the remaining improvement was the result of better-than-seasonal delinquency rates we experienced in the first half of the year flowing through to charge-offs in the quarter. We've already seen this short-term delinquency benefit reverse itself.

We think the 2.83% charge-off rate is an unsustainable low point and that losses are headed up from here. In the short term we expect normal seasonal increases in the charge-off rate in the fourth quarter and the first quarter of 2015. Beyond seasonality, the temporary delinquency benefit I just described has run its course which will add to the upward change in the charge-off rate in the fourth quarter.

Longer term, loan growth will start to impact the charge-off rate in 2015. As new loan balances season they will start putting upward pressure on losses. While the impact on the charge-off rate will be modest at first, we expect that the impact will grow throughout 2015 and beyond.

Pulling together both the short-term and long-term factors, including seasonal variability, we expect the quarterly domestic charge-off rate throughout 2015 to be in the mid to high 3% range. In addition to rising charge-offs, we expect allowance additions resulting from loan growth. We aren't counting on further economic improvement helping our credit loss nor are we projecting renewed economic weakness. Of course, changes in this still tenuous economic recovery could substantially impact our current loss expectations.

Our card business remains well-positioned. Loans, purchase volumes and revenues are growing and we are delivering strong and resilient returns.

Moving to slide 8, the Consumer Banking business delivered another quarter of solid results. Ending loans were flat compared to the linked quarter and declined modestly from the prior year. Growth in auto loans continues to be offset by expected mortgage runoff.

Auto originations increased 14% year over year. Most of the growth came from prime originations as we continue to capture additional prime share from our existing dealers. On a linked quarter basis auto originations were essentially flat.

Ending deposit balances declined by about $1.5 billion or 1% in the quarter. Year-over-year deposit balances declined about $800 million. We've had an abundance of deposits since the ING Direct acquisition, and we've been allowing the least attractive deposits from Capital One's legacy direct bank to runoff.

Consumer Banking revenue was flat compared to the second quarter. Year-over-year revenue declined by $61 million or 4%, driven by the impact of persistently low interest rates on the deposit business, declining mortgage balances and margin compression in auto. Auto loan growth partially offset these negative revenue impacts.

Noninterest expense increased $29 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 $55 million from the linked quarter driven by expected seasonal trends in auto charge-offs.

Home loans credit trends remain favorable and continued to perform well inside the assumptions we made when we acquired the mortgage portfolio. Our Consumer Banking businesses are delivering solid performance in the face of continuing challenges.

While we expect that auto returns will continue to be resilient and well above hurdle we expect that they will continue to decline as we move from exceptional levels to more cycle average performance. And 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 2015.

As you can see on slide 9, our Commercial Banking business delivered another quarter of profitable growth. Loan balances increased about 3% in the quarter and 17% year over year. Most of this growth is in specialized industry verticals in C&I lending and CRE. Loan yields declined 11 basis points in the quarter and 48 basis points compared to the prior year, driven by increased competition and our choice to originate more variable-rate loans.

Revenues increased 3% from the second 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, offset by declining loan yields. The stronger increase in noninterest income was driven by the Beech Street acquisition and growth of fee-generating business.

Noninterest expenses were up 18% from the prior year as a result of growth, including the Beech Street acquisition, and continuing infrastructure investments to drive future growth. In the quarter noninterest expense was flat.

We continue to closely manage credit risk. Charge-offs, nonperforming loans and criticized loans all improved in the quarter and remain at exceptionally low levels. While commercial credit results remain very strong, the current levels are not sustainable through the cycle.

Commercial Banking competition continues to increase, pressuring margins in returns. As competition continues to increase it's likely that the pace of our commercial loan growth will be slower in 2015 and closer to overall industry growth rates. But we expect our focus and specialized approach will continue to deliver strong returns in the commercial bank.

I'll conclude my remarks this evening on slide 10. We posted another quarter of solid results for the Company and across our businesses, and we continue to return capital to our shareholders as we execute our announced $2.5 billion share repurchase program.

As Steve mentioned we're on track to deliver 2014 pre-provision earnings of about $10 billion. We expect growth in full-year revenues in 2015 driven by strong growth in average loans. 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 nonrecurring items.

Our expectations for both the remainder of 2014 and 2015 include the impact of investments to drive future growth, be a leader in digital banking, and to continue to meet rising industry regulatory requirements. Continuing opportunities to grow our Domestic Card business are expected to drive higher marketing expense in the fourth quarter and in 2015. Marketing efficiency, cost to acquire new accounts, and the NPV of our marketing investments, are strong.

We're also making significant investments in digital and technology. Banking, inherently, is a digital product and digital will transform banking over time. The momentum around digital is building across financial services. Consumers increasingly expect elegant and robust digital experiences from all companies, including banks. Software is the predominant way consumers interact with their banks even today, and that engagement will only go up.

Activity in the payment space from financial services companies and nonbanks is accelerating. The ability to efficiently store and use vast amounts of data will unlock new opportunities. Capital One is well-positioned to succeed in the digital world and we're investing in the foundational infrastructure and capabilities to be a digital leader.

We're continuing to expand Capital One 360 as a national digital banking platform. We're bringing in significant native digital talent: engineers, product developers, designers, and data scientists. We're very active in mobile and in payments. For example we are one of only a handful of banks included in Apple's launch of Apple Pay in September, and shortly thereafter launched our Capital One digital wallet.

We're focused on delivering an exceptional user experience to our customers, and recently acquired a leading design firm in San Francisco called Adaptive Path. While the financial cost was modest, Adaptive Path has been a pioneer in the UX field and they will make a big impact on our customer experience.

Also, Capital One has a deep heritage as an information-based company, and big data is tailor-made for us. We're investing in our big data infrastructure to enable rapid cycle analysis and the generation of even more powerful insights and new services.

As we're reminded of almost daily in the media, there are significant threats to information security across all industries, including financial services. At Capital One protecting customer information is paramount and requires that we are ever vigilant in our defenses. We've made significant investments in this area over the years and will continue to invest aggressively.

Ultimately the winners in banking will have the capabilities of a world-class software company. Most of the leverage and most of our investment is in building the foundational underpinnings and talent model of a great digital company. To succeed in a digital world the Company can't just bolt digital capabilities onto the side of an analog business.

At Capital One we're embedding technology, data, and software development deeply into our business model and how we work. For example, we're focused on building reusable plug-and-play middleware using RESTful APIs, modern software development and design, integrating our platforms and making them scalable in real-time, and building a powerful and flexible data infrastructure. These foundational investments, while not always the most visible or glamorous aspect of our digital journey, creates sustainable competitive advantages and position us to continue to thrive as banking goes even more digital.

We're also investing to continue to meet rising industry regulatory requirements. We are enhancing our capabilities, infrastructure, and talent to meet heightened expectations for risk management and regulatory reporting.

We're continuously improving processes for capital and liquidity management, including CCAR and the new LCR requirements. And we're investing to deliver on the broad set of emerging regulatory requirements. The expectations for large financial institutions continue to rise and we'll continue to invest to keep pace with these requirements.

Pulling up, Capital One is delivering attractive risk-adjusted returns today and we expect that will continue. We have the financial strength to invest in our future without compromising current financial results. We remain focused on the levers that create and sustain high performance.

We'll continue to pursue growth opportunities in Card, Auto, and Commercial Banking. We'll maintain our long-standing discipline in underwriting across our businesses and our preemptive focus on resilience. And we'll actively work to return capital to shareholders as capital distribution remains an important part of how we expect to deliver value to our investors.

Now, Steve and I will be happy to answer your questions. Jeff?

Thank you, Rich. We'll now start our 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 further follow-up questions after the Q&A session the investor relations team will be available after the call. Lauren, please start the Q&A session.

(Operator Instructions)

Sanjay Sakhrani, KBW.

Good evening. The first question just on your expectations for charge-offs. I appreciate the color.

Is it fair to assume the ramp in the reserves was related to that as well as the growth? And maybe you could just remind us of the methodology you used to determine reserve adequacy.

And the second question, I'll ask up front, just a growth in the balances. It's pretty encouraging. What are you seeing that's different from maybe a year ago that's driving that growth in balances in card? Thank you.

I'll take the first and I think Rich will take the second. You're spot on in your observation about what drives the allowance. It's really two factors -- loan growth, which we've been talking about returning in the second half for a while, and then also the higher delinquencies which translates into higher NACO likely in the future.

And basically we have an extremely low quarter of NACO this quarter. As Rich talked about, we expect that to normalize. And that replacement effect also has an impact on allowances.

So, going forward you should absolutely be focused on loan growth. And then to the extent that you believe delinquencies and NACOs are headed up, and that's going to have an impact on allowance. And obviously if you thought the opposite, the opposite would be true. But it's really both factors.

And Sanjay, what we are seeing is a continuation of what I have been, in a sense, talking about what we're working on for a number of years, and talking about the traction the last several quarters -- the traction that we're getting. It's really in both originations and in line increases.

In originations, in the areas that we have really chosen to focus on, including the top of the market with the heavy spender segment and in revolvers other than high balance revolvers. We have seen really growing traction in those areas, and that's a good thing to see.

The other big effect is line increases. Line increase is something is always a central part of how we manage our business. As you know, we experienced a line increase brown-out, starting, really, in some sense, back in the throes of the Great Recession. We were very conservative and, of course, we had the CARD Act and the rules associated with proof of income before we could do line increases.

So, in some sense, what you see now is moving from a browned out line increase situation to now where we're back into equilibrium in doing that. And also catching up with some deferred line increases along the way. So, there's a lot of strength in both areas. And I think we're encouraged not only by the traction but by the prospects for continuing traction.

Betsy Graseck, Morgan Stanley.

Hi. A couple of follow-ups.

One is just on the ALLR ratio itself, your point expecting NCOs to come back up. Are you using a forward look of, say, 12 months, 18 months? And I also just wanted to understand how you're assessing what ratio to get that ALLR up to today.

Yes. It's actually different, Betsy, based on product. But the big driver is card. In card the most important timeframe is the next 12 months.

So, it's really the view of what's going to happen to the loss rate over the next 12 months that's going to be the principal driver. In addition to that you've also got to factor in what the growth will be.

Ryan Nash, Goldman Sachs.

Good evening. Steve, when you think about the 53% to 54% efficiency ratio for 2015, can you give us a sense of what type of PP&R would be associated with that? I know you noted, Rich noted that you expect growth in revenues for the coming year. But Rich also gave a long list of things that you needed to invest in.

So, if we do continue to see balance sheet growth at the pace that we are seeing, can you just help us understand what might be a good base level to anchor to? Thanks.

Yes. I think Rich did a couple of things. He reconfirmed the 53% to 54%. He also said we expect loan growth to really drive the revenue outlook.

So, I think we'll leave it up to you to really figure out what you think a reasonable rate of loan growth is. And that's probably as far as we're prepared to go in 2015 in terms of forecasting PP&R.

And then if I could ask one follow-up question. Rich, you talked a lot about digital investments, Steve spoke about opportunities to make the business more efficient in the past. I know you guys are talking about a 53% to 54% next year, which is essentially flat on a core basis. But as we look out over the next few years do you think there's enough leverage in the investments that you're making now that we should see continued efficiency improvement over time?

Ryan, I think digital, there are many benefits to digital investment. And the economics ultimately of going digital are pretty dramatic. The marginal cost of a digital interaction is virtually zero, and we are far from that in the analog activities that we do.

A couple things I want to say about that. First of all, I don't even think the biggest benefit, or the most compelling case, for digital is just to lower cost, even though I do believe that is the end game.

This is one of those few things in life where it's pretty much everything gets better. But we're talking about being able to be faster, more efficient, a better customer experience, better controlled in an intense regulatory environment, much more able to innovate, a better associate experience. So, there's a lot of things that come on this journey.

From an economic point of view we have tracked digital investment and also the clear savings that come from that, most importantly from driving customers to digital. Just because you build it, they don't necessarily come. We have a lot of efforts on that and we're making a lot of progress.

That said, the tally right now for the measurable part is we're spending more than the manifest savings are. And I think actually that differential will continue because there's a lot to invest in. But it's very clear to me that we can see savings and we can see a lot of other benefits happening.

But the thing I want to leave with you is this is not a program, this is not a project, this is not a one-year kind of thing. We're essentially talking about we happen to be living through probably one of the biggest revelations in the history of the world, up there with possibly fire and the wheel. That said, I think there's a lot of transformation to go on in banking.

So, I think the impact of digital investment will put upward pressure on efficiency ratios as opposed to downward in the near and medium term. Longer run, its direction is clearly downward. But I just wanted to leave you with that.

Ken Bruce, Bank of America, Merrill Lynch.

Thanks, good evening. I would like to delve into what you're seeing within either the portfolio or just generally that's leaving you to believe that delinquencies are heading higher. It seems, just looking at some of the trust data, that you see a little bit of a seasonal effect. But I'm wondering if there's something specific that you're focused on or what's leading you to believe we're past the best in delinquencies?

Let me separate out the comments I often make about where we are in the cycle versus things related to Capital One and the strategies that we have. I don't have a changed point of view about where we are in the cycle. We're in an extraordinary time.

It's hard to imagine as an industry losses getting much better than this. I've been wrong before on that over the last few years. It's really quite extraordinary where we have come to.

But this is not -- when we're talking about delinquencies and charge offs going up, this is not calling a turn, in a sense, of, finally the credit card industry has gotten beyond its lowest point. At some point that's going to happen. What we have going on here is much more, is partly just mechanics that we want to share with you. And then, most importantly, it's the growth story.

The mechanics are that we had unusually low third quarter. Coming back off an unusually low third quarter is part of the math that we want to make sure that everybody understands. And within that, of course, you have the seasonal effects.

But, also, we've seen in our history, we watch very carefully for changes in flow rates that we see across the business. There was a particularly positive good surge in flow rates in the first half of this year that, just looking at the mechanics of that, that has reversed itself -- not into something bad but more of a just reversing of that particular surge. That is one affect that is going on here.

As we look forward, first of all, we're reversing out of the unusual momentary low of this quarter. And then you pretty much from there you're looking at seasonality. And we're heading into the seasonal ramping part of the year. And then you have the growth, the dynamics of growth taking over from there.

So, this isn't really about the credit card industry, it's really about Capital One and the effects of the very positive story that we see developing in terms of our growth. But we want to make sure people understand that what comes with that territory is increasing losses, particularly compared with our environment of not much growth, and even shrinking over the last few years. And we want to make sure investors just understand the charge-off math associated with that.

And everybody is focused on credit card growth, it seems. The success that you all have had is being looked at by others jealously. And I'm wondering if you've seen any change in the competitive landscape based on others' behavior?

I think the competitive landscape in card continues to be intense but strikingly stable. And, again, I would compare -- you've often heard me talk about, I think, both the commercial business and the auto business are getting into a degrading of competition, as they regress toward the mean and so on.

But the card business, pricing is relatively stable. You've had mail volumes increase by about 16% over the last year, so we've got to keep an eye on that.

And, by the way, that's mail volumes increasing in the context of where the world 's increasingly going to digital, so that the total amount of marketing is even greater than what you see in mail volumes. Certainly there is competitive intensity there.

But I think the real thing that's going on is the surviving and successful players in the card business have looked back in their rear view mirror at their trip through the Great Recession. And they have figured out where they're good and where they're not so good. And they have staked out, in most cases, strikingly different strategies.

And I think each of those strategies makes a lot of sense for the particular issuer, and it's playing to the strength of the particular issuer. But I think it helps contribute to a rational competitive environment in which, in its own way, we can all succeed.

One thing helping us a little bit after all these years of the card industry and total growth going nowhere, you have seen in the last few months, just looking at revolving credit data, things inching up from near zero to in March 1.5%, April 2.6%, May 2.5%, June 2.9%, July 3.4%, August 3.3%. So just a little bit of rising of the tide, as well.

So, these alleged jealous competitors I think are feeling very good about how they're doing. It's a pretty stable industry.

Bill Carcache, Nomura Securities.

Thank you, good evening. There's a lot of focus on auto, so I had a couple questions that I'll ask up front. Rich, can you give some perspective around how the auto business at Capital One has transformed from its early years to where it is today? And the extent to which during that time there's been a remixing away from what was then maybe a bit more of a focus on sub-prime customers to perhaps a bit more of a focus on prime today?

And just bring us to where your mix of prime versus sub-prime is currently. And maybe talk about the relative attractiveness of each of those segments in the current market.

And then, finally, maybe it just doesn't necessarily have to follow that the risk of loss is greater in sub-prime given collateral quality and the extent to which used car prices still remain pretty strong. I know there's a lot there but I would appreciate any color on that.

When you say is the loss of risk greater and sub-prime greater than what? Greater that it was before, greater than prime? What are you --?

Maybe just talk about risk-adjusted margins and how they have changed in both prime and sub-prime and how collateral plays into that.

Okay. Thank you, Bill.

Capital One, in 1998 we entered the auto finance business with the belief that this highly fragmented industry was going to go national. And we wanted to bring information-based strategies and a national strategy to that business. We bought a sub-prime credit card company, Summit Acceptance Corporation.

Our initial foundation came out of the sub-prime side. And over the decade and a half that we've been doing it since we have migrated to a pretty much full credit spectrum perspective. This is not only to leverage scale economies. But what's very clear is that the real leverage is in deep dealer relationships.

There is economic benefit in that. And I think in terms of the quality of the kind of loans that come out of that, it's a win-win to build deep dealer relationship. And also it is our nature. If you look across the businesses that we do, that we tend to try to play across the credit spectrum, and tend not to specialize just in one particular place.

This has been a long journey over this period of time but you can see the continuing move toward not only near prime but so much growth in prime. And most of this is a matter of solidifying and deepening the existing dealer relationships that we already have. So, I think it's a win-win as we do that.

Now, when you think about the economics of the business, sub-prime has high margins and higher losses. And it's all about how well one can play the credit risk management game. I think this is not for the faint of heart. This is for companies that deeply invest in that.

We have 15 years experience in auto and a couple of decades experience in the card business, at underwriting in that particular segment. And we feel very good about the risk-adjusted through cycle returns that we experience there. And I think our rear view mirror experience in the Great Recession is confirmatory, as well.

The prime business -- near prime, by the way, is just in between everything that I'm going to say about prime and sub-prime. On the prime side this is very thin margins and very low credit losses. That is a business where scale matters and every expense dollar is really important and so on. But I think we've managed to build one of the top positions in that business.

And while the returns are much lower, we are comfortable with those returns. They're much lower than sub-prime. We're comfortable with the returns and we're very comfortable with the integrated economics we're getting in this business.

Just one comment about the cycle for a second. The extraordinary returns of a few years ago in the auto business, as competition headed for the hills, have now pretty much regressed very close to the mean.

Sub-prime remains a little bit above in terms of returns at this point. And the prime business is really right there at the intense point in the cycle from a margin point of view. But overall things are -- we feel, good.

Also look for additional information on the mix of our auto portfolio in our upcoming 10-Q.

Don Fandetti, Citigroup.

Rich, I had a question around Apple Pay. It seems like the banks may be paying some type of fee to Apple. Obviously you can't talk about specifics. I was curious if you can offset that, outside of fraud?

And then, secondarily, I know the networks are creating a vault in charging the banks, and there's been some talk that the banks might create a vault. I was wondering if you've considered that, as well?

Don, we don't get into the economics of our contract with Apple. But the decisions that we make come with the belief that this is an important thing for us to do and I think offers a good opportunity and upside for us.

The vault that Bill is referring to, let me just comment for a second. One of the key elements in security that's a very important breakthrough is that card numbers are not going to be embedded inside the secure element on a phone. Instead, one-time single-use or a few times use tokens will be, in a sense, sent to the phone so that the risk of extended fraud is massively reduced.

Visa and MasterCard are creating a vault. And there is other activity that is going on, some alternative approaches, as well, just in the nature of an evolving industry.

I think people aren't leaving single solutions as the only way to go. But whether it is coming from Visa and MasterCard or from a banking industry vault or really actually from individual issuer's vault, there is work going on all three of those dimensions. But the big story there is this tokenization is a game changer in terms of security.

Thank you.

Bob Napoli, William Blair.

Thank you. Good afternoon. Just on the credit card business.

Rich, your growth just over the last few months has just really accelerated. Are we getting to high single-digit growth or double-digit growth in the credit card business? Or is it just a one-time catch-up in bringing the credit lines catching up with the increases in credit lines that you had delayed for several years? Pretty stark increase in loan growth from 0% to 5% in the last three months or four months.

It's funny given the heritage of the Company that we would think numbers like this are so big. But all jokes aside, of course we did live through the period where not only -- we're going from an environment where we had a very cautious consumer. And we ourselves had certain challenges that we had to deal with that I talked about earlier.

And then we also had the running off of some of the HSBC highest risk things. And then our multi-year still going on avoidance and running off of high balance revolvers.

So, that's a lot of things that conspired to generate some anemic and, frankly, negative numbers in terms of our growth. What's going on here, Bob is not really a one-time effect. There is on-the-line increases. There is some element of catch up with that.

But I would more leave you with this is really the product of the steady work we have done for a number of years, both in the line increase innovation side and on originating in the segments we know so well. It's actually continued traction there. You know us well enough to know that we're not going to make a forecast of growth. But you can also tell that we feel pretty good about the traction we have right now, and we do look forward to seeing continued growth.

The last question is just on the commercial business. You've had very good growth there, your loan yield -- credit is phenomenal, your yield has dropped almost 50 basis points and deposit costs are relatively flat year-over-year. And you talked about very intense competition.

Do the loan yields flatten out here? Does the growth really slow down because it's too competitive? Can you really generate the returns you are looking for with the trends that I'm looking at?

I think that the nature -- let me comment for a second about the nature of how I think credit cycles work. When you're in the good part of the credit cycle, which has been the last few years where borrowers are more careful and lenders are more careful and maybe a little more scarce. As you go on in the cycle, I think there is a very classic pattern that occurs.

As competition increases, lenders, particularly those who have strong memories of a recent recession, like we all do here -- what happens is the competition becomes almost singularly focused on price. And I think that prices fall until you get down to that point where there is not a lot of room there. And then you move to phase two in the cycle evolution, where people start compromising various underwriting terms.

I think most of, how I would describe commercial, this battle has been played out on the pricing side. But also there is certainly other things going on.

On the C&I side, the impact of the CLO market and the covenant-light loans has put a lot of pressure on the lower end of the marketplace. But it is not impacting banks that much at this point. But we have a wary eye on that.

Just the percentage of loans in the institutional market that are covenant-light is substantially higher than before the Great Recession. So, we certainly have to keep an eye on this.

In other areas, individual areas, you start to see some loosening of some underwriting standards in the industry. But I think all in all things aren't in a bad place yet. The key thing we're doing is focusing on segments where we are comfortable with the segments. And for us that's mostly the specialty lending segments that are not as subject to 8,000 banks looking for assets trying to go out and see if they can generate business.

This is like the card business where highly sophisticated, limited number of players who know what they're doing, are competing in these spaces. So, the net effect of all of that is, I'm going to leave you with we still feel that there is good business to be had in commercial, but you should be thinking that as this regresses to the mean our own growth is going to do the same.

Chris Donat, Sandler O'Neill.

Good afternoon. Thanks for taking the question.

I wanted ask about the marketing spend in the third quarter, which typically, or at least for the last few years, has been down from the second quarter but it upticked this year. I'm just wondering if that's reflective of opportunities you're seeing that are then translating into new account growth? Or is it more tied to other campaigns or something like Quicksilver? Just a little explanation about where we are in the third quarter, also with your comments of expecting an increase in the fourth quarter.

It's a very natural thing for everybody, when they think marketing, to think of TV ads because that's what you all see unless you are blessed by having your mailbox full of some of our solicitations and so on. I want to say that, just as a reminder, the amount of money we spend on television advertising is a modest portion of the entire expenditures that we do in marketing.

So, my short answer is that you've seen the seasonality of marketing spend and a bunch of that comes from campaign seasonality. Things like our sponsorship of a lot of things in the NFL and college football and things like that, there's a whole seasonality there. Campaigns you see like Quicksilver and various things, there's a lot of hard wiring in advance of some of that stuff.

But the increases that you see beyond the normal seasonality really are a reflection of real-time seizing of the opportunity that is going on at Capital One as we see growth opportunities. So, there's a fixed component in the near term and there's a variable component. And we've always said that in the end that variable component is pretty sizable, as well, and you're just seeing the manifestation of seizing the moment and taking advantage of that.

Rick Shane, JPMorgan.

Thanks, guys for taking my question. I actually want to circle back a little bit on the question that Bob Napoli raised.

When we look at margins, particularly on the card segment, when we strip out the impact of the HSBC portfolio and the runoff there, it actually looks like your margins have been pretty stable. Rich, I know you have given a lot of metrics related to 2015 outlook in terms of credit expenses. And I don't want to push too hard in terms of getting you to give us one more, but give us a sense. Do you think that we are -- and, again, you guys have talked for a long time about margin erosion and then backed away from it -- do you think that we're at that inflection point now?

You're talking, Rick, about the card business?

I am talking about the card business, yes.

I don't see evidence that we are. Look, I'm the last guy you'll ever see saying -- read my lips, no price reductions from here -- kind of thing. But, no. I see people intensely competing in the segments where they see their strength. All of them are sophisticated, they all have fresh memories from the Great Recession.

Yes, we have been one that has been predicting margin decline for a number of years. So, first of all, you probably shouldn't be asking me, given my credibility that has been lost over that subject.

But I see, again, a very competitive but stable, rational environment. Probably in the longer run there will be pressure on that, but it sure has a different feel to me, again, than the other segments we play in where things are only going in one direction.

Got it. I think of it as that several years ago you talked about margin compression following CARD Act, and eventually threw your hands up and said -- hey, we're just not seeing it. It feels that way still.

Yes. Again, a lot of my predictions about the margin compression back in the post CARD Act days really was thinking through the mechanics of all the aspects of the CARD Act and how that would play out. And some of that stuff didn't play out exactly as we had predicted.

The other thing that is going on -- I really want to draw another thing into this conversation -- in both the commercial and the auto space, if I were to calibrate that compared with the card business. In the commercial and auto space you literally had people heading for the hills for a whole period of time as the Great Recession was raging. A lot of auto players literally bailed out of the business. You had a lot of particularly European players bail out of the business, so much capital markets money and so on leaving the commercial space. And, so, supply itself has really changed over this period of time and it has led to margins to really go up and then to really go down.

In contrast, in the card business all of the players who pretty much entered the Great Recession are still the same list of players on the other side of it. We're all a little wiser now but we're all very committed to the card business, and pretty much doing all the things to continue to make us successful. So, the card business never had the spike in margins that occurred in the other businesses. Nor does it have the regressions in the mean therefore that occurred in the other businesses.

Brian Foran, Autonomous.

Hi, good evening. I know you said you don't want to give revenue guidance.

The question I have is, you're being fairly explicit about expenses going up, and we are at a $12 billion annualized run rate. So, it feels like - the current consensus is 12.3% -- it feels like up is something more than that. And you're still talking about a 53% to 54% efficiency ratio. Just to make those two tie out, wouldn't revenue growth have to be in the high single digits just to make the math work?

Brian, if we had wanted to get that specific by line item we really would. There's a lot of moving pieces in the environment. We're trying to do a lot of the same things, a lot of things at the same time -- keep our customers, our regulators and our shareholders delighted. And particularly in this interest-rate environment that's a handful.

We feel comfortable with our guidance of 53% to 54%. We've tried to give you a sense as to what's going to drive the top-line growth next year, which is really loan growth. Rich has talked a little bit about how we feel about loan growth. I think, given where we are, that's probably as far as we're prepared to go.

Fair enough. Maybe a follow-up on a separate tack is marketplace lending or peer-to-peer, whichever term you prefer. How do you think about it, both as a competitive threat and as an opportunity for Capital One?

We have a great interest in all of the innovations that are coming out of the digital space. I think one thing that is a classic thing that banks do, and I always worry that we resemble that description, is to focus on things the way that we do it, and miss the fact that there are really breakthrough things going on.

The peer-to-peer lending, which is a pretty much non-existent activity on the banking side, is clearly picking up quite a bit of steam in the startups and in the digital space. It is our view that of all of the opportunities in the digital space -- and we pretty obsessively study those, including a bunch of lending ones -- the peer-to-peer lending opportunity is not one that is at the top of our list in terms of the opportunities. We're going to be very close students of what's going on, but I think there are a number of other really clever things that are happening with startups that we're a lot more interested in.

When you think about peer-to-peer lending and all the risk issues associated with that, and all the regulatory environment we live in, and the things that we have learned, that I personally, for example, have learned over two decades of building a consumer lending company, there is a lot of challenges and a lot of risks in there. So, what we're going to do is probably be a very eager observer and we'll go from there.

Matt Burnell, Wells Fargo Securities.

Thanks for taking my question. A bigger picture question, then a fairly focused one. Rich, given all the commentary you gave us in terms of your focus on improving the digital offerings, and at a time when a lot of the traditional commercial banks are spending a lot of time and effort on doing the same thing. Can you give us a sense as to the trend and your level of comfort in your ability to keep deposits and maintain deposit pricing relative to maybe how you were thinking about that a couple of years ago?

Are you talking about asset liability sensitivity or --?

I'm really talking about deposit beta. One of the questions we get most often from investors is -- Capital One spends a lot of time talking about their digital offerings -- and I think that in some cases gets investors worried about the potential for outflow of deposits faster at Capital One than at a quote/unquote, traditional bank, even though those traditional banks are now following down the path of Capital One trying to focus on digital acquisition of deposits.

First of all, when I gave my spit-flying little passionate speech about digital a few minutes ago, one thing I want to say is the way digital is transforming banking goes far beyond what I think the thing people most think about, which is today there are branches and tomorrow there is a branch in people's pocket. And, look, that is a very important component of that whole thing.

By having bought ING Direct, by having before that already built a digital bank of our own, and having a big commitment to digital innovation, and having a heritage of 20-some years being a direct marketing company, I certainly am very interested in the opportunities there. The bulk of our digital investment itself and capabilities is really for things that extend beyond some of the narrowest view about just moving to a bank in your pocket kind of thing.

Let me comment on deposit stickiness, and I really appreciate that you asked the question. The conventional wisdom out there is -- gosh, the only way that some of these online banks -- they've used price as a way to generate their business. And, again, having ten years experience ourselves in building an online direct bank and then having bought ING, we have a window that shows how very different the actual world that we live in is versus some of those perceptions. And it really pivots around what is it that is drawing customers into a bank like ING Direct, for example, and now Capital One 360.

Many years ago, at its very beginning, ING offered one of the highest rates paid. And over the years it had a very explicit goal that we are going to move into building a franchise and building a brand. And the benefit of that is we're going to get people to come to us for something other than just being number one in the league tables with respect to rate.

Over time the ING franchise, now Capital One 360, has moved way off the frontier of where the hot money goes. And, in fact, we now have well more than a decade of experience of just seeing how long-lived these customers are, and also how beloved this franchise is. The customer loyalty is really extraordinary.

And, so, while I would say that relative to the branch on the corner, we in our own planning are assuming a deposit beta that is higher than those most sticky of deposits. I think that people are going to be pleasantly surprised by the resilience of these deposits.

You make the other point, which is really important, too, which is that there is a blurring of the lines here over time as more and more of banking becomes digital. And I think, especially with Capital One strategy ourselves to create the fusion of the truly ING-oriented digital bank and the physical distribution Capital One that we are. And I think that as our own lines blur, also you are going to see the industry lines blur. And I think that over time it is a franchise with surprising striking resilience.

And, Rich, just add, extending that beyond just how online versus end branch deposits respond, I think the way your whole liability mix responds to changes in environment is a much bigger question. It's a function of your wholesale-retail mix, what's insured, what is not ensured, the size and duration of your deposit relationships. And as we look at it, we don't feel disadvantaged relative to peers. And I think if you looked at our asset sensitivity you'd find it lines up pretty closely with the average peer bank.

Thanks, Steve. And then a quick question for you, perhaps.

You mentioned the LCR requirement. How far along are you on that? And was the decline in the yield on investment securities this quarter versus the second quarter driven by some of the actions you've taken over the past three months?

We have been rotating. There will probably be a little bit more but that's not a big impact on margin. We're going to be fine in terms of meeting the transitional requirements.

LCR isn't a huge issue for us except there is a little bit of margin compression, and obviously there's some OpEx getting our systems into a place where we'll be able to calculate all this stuff on a daily basis. It's a good example of the regulatory costs Rich was mentioning.

Thank you, everyone, for joining us on the call tonight. Thank you for your continued interest in Capital One. And, remember, the Investor Relations team will be here this evening to answer any further questions you may have. Have a great night.

Thank you. And that does conclude today's conference. we thank you for your participation.