Capital One Financial Corp (COF) 2015 Q1 法說會逐字稿

Welcome to the Capital One first-quarter 2015 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, Jennifer, and welcome everyone to Capital One's first-quarter 2015 earnings conference call. As usual, we are webcasting live over the Internet. To access the call on the Internet, please log on to Capital One's website at www.CapitalOne.com and follow the links from there. In addition to the press release and financials, we've included a presentation summarizing our first-quarter 2015 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 this presentation. To access a copy of the presentation and the press release, please go to Capital One's website, click on Investors then click on Quarterly Earnings Release.

Please note that this presentation may contain forward-looking statements. Information regarding Capital One's financial performance and any forward-looking statements contained in today's discussion and the materials speak only as of the particular date or dates indicated in the materials. Capital One does not undertake any obligation to update or revise any of this information, whether as a result of new information, future events or otherwise.

Numerous factors can cause our actual results to differ materially from those described in forward-looking statements. For more information on these factors, please see the section entitled Forward-looking Information in the earnings release presentation and the Risk Factors section in our annual and quarterly reports which are accessible at the Capital One website and filed with the SEC. With that, I will turn the call over to Steve Crawford.

Thanks Jeff. For the first quarter, Capital One earned $1.2 billion or $2 per share and had an average return on tangible common equity of 15%. On a continuing operations basis, we earned $1.97 per share.

Net income was up $154 million, driven by higher pre-provision earnings and lower provision expense versus the prior quarter. Pre-provision earnings increased by $69 million versus the prior quarter as lower revenue was more than offset by lower marketing and operational expenses. Provision for credit losses decreased on a link quarter basis driven by a smaller allowance build and lower charge-offs versus the previous quarter.

Turning to slide 4, I will briefly touch on net interest margin. Reported NIM decreased 24 basis points of the first quarter to 6.57%. The quarter-over-quarter decrease was primarily driven by two fewer days to recognize income and temporarily higher cash balances. We don't expect any incremental margin pressure to meet the LCR since we're already above the fully phased-in LCR requirements as of March 31, 2015.

Turning to slide 5, let me cover capital trends. Our common equity Tier 1 capital ratio on a Basel III standardized basis was 12.5%, as of March 31. On a fully phased-in basis, we estimate this ratio would be approximately 12.1%.

We reduced our net share count in the quarter by 5.4 million shares or 1%, primarily reflecting our share buyback actions that began last April. Over the past year, we have reduced shares outstanding by 24.9 million, or 4%.

We entered parallel run for Basel III advanced to purchase on January 1, and we continue to estimate that we are above our 8% target. We were pleased with our 2015 CCAR results and believe they continue to demonstrate our strong commitment to return capital to shareholders.

Our approved submission included a plan to increase in our quarterly dividend from $0.30 to $0.40 per share. In addition, our plan authorizes the reauthorization of up to $3.125 billion of common stock through the end of the second quarter of 2016.

Our long-stated preference for the focus of capital return continues to be in the form of share repurchases. While investors can expect an ongoing ability to generate strong returns and a commitment to return excess capital subject to regulatory approval, investors should not infer a long-term commitment from our recent payout ratios. With that, let me turn it over to Rich.

Thanks, Steve. I will begin on slide 7 with our domestic card business. Loan growth accelerated in the quarter. Ending loans were up about 9% year over year, and average loans grew about 7%.

We continue to post strong growth and see good opportunities in the parts of the market we've been focused on for some time. Purchase volume on general purpose credit cards, which excludes private label cards that don't produce interchange revenue, grew about 19% year over year. This growth was driven by the success of our rewards programs, increased new account originations across our current business, and credit line increases.

Compared to the first quarter of 2014, revenues were up 7%, in line with average loan growth as revenue margin was stable. On a linked quarter basis, revenue margin decreased seasonally to 16.9%.

Year over year, noninterest expenses increased 2% driven by higher marketing consistent with our return to loan growth. As expected, noninterest expenses decreased about 6% from the linked quarter with seasonal declines in marketing.

Credit in the first quarter was stronger-than-expected. We experienced better-than-forecasted delinquency flow rates. The charge-off rate increased 16 basis points to 3.55%.

The delinquency rate improved 35 basis points to 2.92%. As first-quarter delinquency favorability rolls through to charge-offs, we expect quarterly charge-off rates in the lower end of our previously communicated mid to high 3% range, perhaps even getting into the low 3% range at the third-quarter seasonal low point.

The improvement in our outlook for domestic card credit drove a modest allowance release in the quarter. We also expect favorable credit to drive lower-than-expected past-due fees, putting modest pressure on revenue.

Longer-term, our credit expectations are unchanged and are driven by growth math. As new loan balances season, they put upward pressure on losses. While this impact on the charge-off rate is modest at first, we expect that the impact will grow throughout 2015 and beyond.

We still expect growth math to drive quarterly charge-off rates to be in the mid to high 3% range in the fourth quarter, and higher from there in 2016. In addition, while this quarter shows that we may not have allowance builds every quarter, we expect growth to drive allowance additions going forward. Our card business remains well positioned to deliver growth with attractive and resilient returns.

Slide 8 summarizes first-quarter results for our Consumer Banking business. Ending loans were up about 1% from the prior year. Growth in auto loans continues to be offset by expected mortgage runoff.

Auto originations increased about 10% year over year, driven by strong auto sales and deepening relationships with our dealers -- with our existing dealers. Consumer Banking revenue was up 1% year over year, driven by growth in auto loans. Revenue continues to be pressured by persistently low interest rates on the deposit business, declining mortgage balances and margin compression in auto.

Provision for credit losses grew $66 million to $207 million, driven by a change in allowance. In the first quarter of last year, we had a modest allowance release. The first quarter of this year, growth in auto loans and normalizing auto credit drove an allowance build.

Our Consumer Banking businesses are delivering solid performance in the face of continuing industry headwinds. Persistently low interest rates will continue to pressure returns in our deposit businesses, even if rates begin to rise in 2015.

In our auto business, we've been experiencing normalization of both credit and returns from once-in-a-lifetime levels coming out of the great recession. Credit performance is gradually worsening in the industry, and we see slightly higher losses on newer originations.

We've been cautious on industry underwriting and competitor practices for some time. As a result, our subprime originations have been essentially flat for nearly two years.

In the first quarter, we observed increasingly aggressive underwriting practices by some competitors, particularly in subprime. We are losing some contracts to competitors who are making more aggressive underwriting choices.

And, used vehicle values remain at historically high levels. A decline in used-car prices would put pressure on our results, but we assume lower prices in our underwriting, so we remain comfortable with the resilience of the business. Despite our heightened caution, we will continue to pursue opportunities in auto lending that are consistent with our long-standing focus on resilience, including adding new relationships with well-qualified dealers and gaining greater share of prime originations with existing dealers.

Moving to slide 9, I will discuss our Commercial Banking business. Ending loan balances increased about 10% year over year, with most of the growth in specialized industry verticals and C&I and CRE.

As we've been signaling, our year-over-year growth is slowing compared to prior years in response to market conditions. Loan balances declined modestly from the linked quarter as we've seen some slippage in industry underwriting standards in pockets of the market.

Revenues increased 13% from the prior year, driven by growth in average loans as well as increased fee income from agency multifamily originations. These factors were partially offset by loan yields which declined 25 basis points compared to the prior year, driven by increased competition.

Noninterest expenses were up 7% from the prior year, as a result of growth in our portfolio and continuing infrastructure investments. Provision for credit losses increased $28 million in the quarter to $60 million. The provision in the quarter was primarily driven by an allowance builds for our $3.6 billion of loans to the oil and gas industry, driven by the impact of lower oil prices.

We remain highly focused on managing credit risk and working with our oil and gas customers. Through Hibernia, we've been in this business for more than 50 years, through multiple cycles. 96% of our loans are secured and 73% are shared national credits.

Our largest exposure is in exploration and production, in which we benefit from holding loans at the top of the capital structure and discounted collateral values. Many of our borrowers are at least partially hedged against falling oil and gas prices.

The second largest exposure is in oilfield services, in which our customers face greater downstream challenges as the E&P companies cut back in response to low asset prices. We're working through these issues on a customer-by-customer basis.

We are also a lender in the taxi medallion finance industry with a small portfolio of less than $1 billion in loans. Medallion values have softened because of increased competition from new entrants like Uber. We continue to closely watch this sector.

Overall, commercial charge-offs, nonperforming loans and criticized loans remain strong. While we continue to closely manage credit risks, we don't expect these levels to be sustainable through the cycle. Our Commercial Banking business remains well positioned to navigate a challenging environment in which intense competition continues to put pressure on growth, margin and returns.

I will conclude my remarks this evening on slide 10. Capital One posted strong results in the first quarter. We are delivering attractive risk-adjusted returns today, and we expect that will continue. For the full year 2015, we expect growth in revenues driven by growth in average loans.

As you can see in our domestic card business, we are experiencing very strong growth. In this window, we are likely to increase marketing to take advantage of the opportunities we see to help sustain the current trajectory.

While growth opportunities would drive long-term value creation, the higher marketing and the higher operating expense of additional volumes will pressure -- will put pressure on efficiency ratio. As the result, we're likely to be in the higher end or possibly modestly above the 53.5% to 54.5% efficiency ratio range excluding nonrecurring items. We are managing costs very tightly across our businesses to stay within the range, but we will also strive to make the right business choices to drive long-term value as growth opportunities unfold through the year.

Pulling up, our strategic priorities for 2015 have not changed. We remain focused on the levers to create value and sustained strong performance. We will continue to pursue growth opportunities. We will maintain our long-standing discipline and underwriting across our businesses and our preemptive focus on resilience.

We will manage costs tightly while we invest to grow, be a digital leader and continue to meet rising industry regulatory requirements. And, we will 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 take your questions.

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 that Q&A session, the Investor Relations team will be available after the call. Jennifer, please start the Q&A session.

(Operator Instructions)

Ryan Nash from Goldman Sachs.

Just wanted to follow up on the update to the efficiency. I think you guys came in at roughly in the middle of this quarter.

And I was just wondering, Rich, can you give us a little more clarity on how we should think about the incremental costs that you need to spend on marketing and how it flows through to loan growth? How long of a lag should we see on growth, and then I have a follow-up.

Ryan, our initial guidance on efficiency ratio, we did three quarters ago, we updated it for the dramatic changes in interest rates. Over this period of time, there have been -- we have constantly responded to the growth opportunities we see in the marketplace.

We continue to invest, to capitalize on those opportunities, and we continue to refine our forecast, if you will, of what are the actual growth numbers that we think will come in the near term. And the byproduct of all those moving pieces has been -- leads to my commentary on the efficiency ratio.

The bottom line is, to grow, we need to spend money. We believe this is a very, very important window of opportunity, and we are taking action to capitalize on that, and along the way, working very hard to manage short of one minus the cost of that and keeping our investors posted along the way.

Got it. Just following up on your outlook on credit, you talked about mid 3%s charge-off with the exit run rate closer to the mid to high 3%s. How should we think about the impact on the provision?

If loan growth is sustained at these levels, should we expect the provision to track charge-offs and then build for and have a subsequent build for loan growth? Just related to that, Rich, you commented that it continues to increase as we move into 2016. At what point do we actually start to see the charge-offs leveling off?

Let me take the provision. There's obviously two parts of provision. There's a charge-off component, and then there's what happens in your allowance.

You have one piece of that already in the charge-off guidance. That charge-off guidance, in and of itself, is also a contributor to what's likely to happen to allowances.

So, let me back up for a second. I know this is a continuing question and just try to give a little bit more help. At the highest level, we build our card allowance, and actually, it's not too different anywhere. Let's talk about our card allowance of three different things.

What the loan balance is at the end of the period, what our charge-off forecast would be the over the next 12 months, and then there are qualitative factors which really cover the risks that are not captured by models. So, if you're really trying to model the allowance in future quarters, you're going to need to make assumptions on all of those -- the growth rate, the assumptions, the loans. Remember, if you are not doing a year-over-year growth rate, you've got to think about the seasonality, because they can run off in different ways.

Next, you also would need to -- whenever you want to forecast that for, the balance is look at what charge-offs are over the next four quarters after that. Then with regard to our qualitative factors, they've been about 10% to 15% in benign periods, but they can very pretty significantly if you are entering or exiting a credit cycle.

I'm trying to give you a little bit of a picture of why small movements and assumptions can create swings in a quarter which end up being meaningful. The most impactful of the three assumptions is really the net charge-off rate. Just looking at this on a static basis with our current loan balances of $74 billion, a 15 basis point change in loss rate in the quarter, all other things being equal, would drive a $100 million change in allowance.

As Rich talked about in the first quarter, we experienced better-than-expected delinquencies in flowrates, so the starting point for our next 12 months loss forecast has shifted down. And as a result, we had allowance releases. Had that not happened, growth would have actually probably driven allowance builds.

So, going forward, it's a combination of growth and our expectations for loss that suggests we are going to need allowance builds. It's really hard to go a lot further than that, given all the factors that I've been through. Hopefully that helps, Ryan, in the way you think about constructing what could happen to allowance.

Ryan, then, in terms of the trajectory of losses, it's interesting. You may remember last year, we flagged at this time a similar phenomenon that we saw this year. Better-than-expected flowrates, and seeing those flowrates mechanically, we put -- given the six-month window that we have, that we can watch delinquencies flow into charge-offs, you can see that we've adjusted our projections for that six-month window.

You may remember last year that this phenomenon that we saw around this time last year, in the latter part of the year, we said we saw most of it dissipate. We are not assuming that this changes the outlook for the end of the year or beyond. If that changes, obviously -- if this phenomenon sustains itself, obviously, we would adjust that.

So, we are here today with the same outlook that we had last time we were talking to you, and it is just very clear that the growth math -- and you can see the pretty dramatic growth numbers. We have the growth math pretty much has to carry the day. That's why we are looking to the fourth quarter as still the mid to high 3% range.

Then, we are saying --and then 2016 would be up from there. We are saying up from there, just again, by the vintage math of growth.

All of this is in the context of a unique time in the industry and for Capital One where most of our customers that we have right now in our book, they weathered the great recession and are very low risk and I think exceptionally resilient. Pretty much anything we book moves the numbers up from here.

We feel great about the credit quality of what we're booking, but the growth math is just very inexorable in that sense. You asked the question when will this level off.

We are reluctant to be predicting something that's going to be -- have a lot of factors driving that when we get there. But, I think our point is that 2016 will be a year of rising charge-offs off of the trajectory with which we leave 2015 just because, again, the accumulated math of the vintages of the new business that we're booking.

Next question, please.

Bill Carcache from Nomura.

Rich, I was hoping that you could update us with your current thinking on the strategic importance of the international credit card business and, perhaps, talk about its growth outlook. Maybe tie in reports this quarter that Capital One was cutting its credit card rewards in the UK and how that may influence how you're thinking about it.

Okay. Bill, first of all, I want to say that most of you may be aware that in both the UK and in Canada, there have been regulatory based moves to lower interchange. Neither of our businesses, particularly our UK business, are highly dependent on purchase volume for the economics of the business.

So, I don't think this will have a big impact on our particular overall economics, even though it's an important move in the marketplace. They already -- a number of issuers have come out in response to the lower interchange rates in the UK and have notified their customers that future reward -- future rewards will be at a lower rate.

I think that's pretty natural in a tight margin business, and the rewards business is a very tight margin business with the interchange and the high payment of reward benefits. That's pretty natural market phenomenon, and we already see that going on in the UK.

Interestingly, there's been some pushback and noise on the consumer side. Consumers really do like their rewards, and I think we should all take note that even in a country where the rewards rates are lower, there is some pushback there. And I think it's a reminder that in the US, consumers who are enjoying higher rates of rewards are pretty vocal for us for the preservation of these benefits.

Thank you. Rich, that's very helpful. I appreciate that commentary. If I may ask a bit of a high-level question on what we're seeing in the partnership business, the view I believe I've heard you express in the past is that you like the partnership business but that your optimism is somewhat tempered by the fact that contracts come up for renewal every five years or so and the potential exists for outsized profits to get competed away in that process.

I know I'm paraphrasing. That's the sense I've gotten from your commentary. But, there are others in the space who are expressing a bit more of an optimistic view on partnership businesses and talking about how the thing that they are most focused on is how their merchant partners are looking for them to help them drive incremental sales growth, and they talk about how their pipelines are very strong.

I guess the question, then, is what do you think is driving these differences in views that some folks in the partnership business are a little bit more optimistic in their outlook? And that's it. Thank you very much.

First of all, I think in many ways, it's all relative, and relative to what? As one who built this Company, initially on a direct-to-consumer model, one customer at a time, you have seen the long history and current performance of that business. And it a little bit spoils me relative to pretty much everything else in the banking business and I start from there for my calibration.

Frankly, the big difference between -- as you said -- between the regular direct-to-consumer credit card business and the partnership business, is the holding of auctions that happens on average every five years. That tends to -- all other things being equal -- be quite a mitigator, in terms of some of the upside potential. So, many of my comments have been just that calibration.

The partnership business is a very interesting and intriguing one to me and for a lot of the reasons that you cited, others are talking about. As you know, the retailing business, for example, is in massive strategic turmoil.

The impact of digital and the need for retailers to reinvent themselves is an extraordinary and, in many ways, existential imperative. I think than companies like Capital One that are doing very significant investments in digital and in mobile and not just the customer experience associated with that, but all the underlying infrastructure that is behind what it takes to actually innovate in digital.

Companies like ours, I think, are in a very good position to partner with retailers and help them strategically and actually, in terms of real product and innovation and execution in that transformation. We are also investing in that opportunity, and we have partners with whom we're working right now on some pretty cool digital innovations.

Look, that's one reason I like this space a lot. It's also such a natural sibling to our regular branded business, and what we are doing is, how do we deal with this overhang of the auctions?

We just make sure that we never say we have to win no matter what. We go out there. We're selective relative to making sure these are great companies we're working with.

Companies that are in the partnership business with us for the right reason, where it's really motivated to build the franchise and not just for the making of near-term money that sometimes comes with the sacrifice of customer practices. Finally, selectively where the ultimately the price of the deal is something where both parties can win.

Thank you.

Next question, please.

Sanjay Sakhrani from KBW.

I've got a question on credit quality, again. The seasoning map was supposed to impact 2015, and now it's not. What's really driving that better performance? Is it fuel prices or something else? I have one follow up after that.

Sanjay, I think in the very near term, as we grow, there is some what we call speed boat effect that growth in the near term has a depressive effect a little bit before it inexorably raises the charge-offs some months down the road. But, that's really a small effect.

Mostly, essentially what we are talking about here is something that we've seen not infrequently over -- for me -- the 20-year history of being in this business, is that from time to time, we notice that all our flow rates, our delinquency flowrates, move in a similar direction, all at one time. Usually, when this happens, there's not necessarily an explanation for it. Often, we are able to go back later and tie it back to economic data that comes out later and so on.

This is not a huge effect. I don't want to get carried away. I've seen much bigger effects at other times.

Because we have actually gone out to give quarterly guidance, all we're saying is coming in better than the quarterly guidance in the relatively near term, relative to when we did it, just relates to better-than-expected flowrates without having a perfect explanation, there's probably some general economic affect that is going on. But, then, our most important point is that we don't necessarily see any evidence that this should change our longer-term view about the trajectory and magnitude of the charge-offs we're talking about.

Okay. Understood. Follow-up question, I want to make sure the expense take-up on the guidance, that's just more opportunistic spending, right? To the extent that you are being opportunistic, can you just talk about where those opportunities are? Thanks.

The opportunities -- gosh -- the more things change, the more they stay the same. For a long period of time, Capital One -- pretty much always in our history -- we have always been one to invest in growth opportunities.

The investment begins by investing in innovation, in testing, in brand building and in creating and looking for opportunities where real students of the windows of opportunity. When we see them, we tend to seize them because we've also learned markets continue to move. That's the phenomenon that's going on, here.

Where we are thing the growth opportunity is pretty much in our branded book across the board where we are investing. We pretty much are investing in all places other -- as we talked about -- other than high balance revolvers, pretty much one minus that is where the opportunities are happening there.

And they are a byproduct, again, of a lot of work over the years behind the scenes in investing in things to be in this position. But, there's something that still requires us to invest quite a bit in marketing and the associated cost of growth as the opportunities continue.

Next question, please.

Rick James from JPMorgan.

You talked a fair amount about the provision on the credit card side. I'd like to talk a little bit more about the provision on the commercial side.

Rich, you talked about some of the qualitative factors that drove the increase of provision. But, I'd like to relate it back to Steve's comment about how you think about reserve levels.

Obviously, this quarter we saw a pickup in provision, pretty substantial, without any deterioration in credit. Obviously, that's forward-looking relating to what you see going on in the oil patch. I'm curious if there is specific credits within the portfolio that you've already identified as particularly at risk, or is this just a generic reserve related to the qualitative factors Steve talked about?

The comments I was making were really directly off of card. But, let me address commercial.

As Rich said, that was really driven principally by energy. If you think about that, it's a little bit of both. It's a little bit of specific credit observations.

It's a little bit of trying to get ahead of what we see in the marketplace using our historical experience developing a scenario and making sure that that's reflected in our provision and allowance, as well. Those are the things that are really driving the number in the quarter. One of the things I would say, we are early in the cycle, but we are obviously trying to use the experience we have and energy to forecast what could happen.

Got it. I will bootstrap a follow-up question a little bit. Are you seeing anything on the consumer side in the oil patch that has you concerned at this point, as well?

No. When we look at geographical segmentations of where there is the greatest oil-related activity in those more local markets, we do see a tick up in some of the consumer credit metrics that you would expect. Nothing dramatic at this point. But, it is visible in the markets that are most highly concentrated with respect to oilfield activity.

Next question, please.

Don Fandetti with Citi.

Rich, you've been pretty cautious on subprime auto for awhile now. It seems like your comments today are perhaps a little more cautious. What do you think is driving the more aggressive lending let's say this quarter?

It's interesting. Credit looks like it's actually gotten a little better in subprime, and is it the smaller players? Can you talk a bit about that?

Don, it is -- there are a lot of different practices people use in the industry in the underwriting practices. We all use them on a sloped basis. It's not like, well, there is a practice. We don't use that one or when do we require this collateral or this information for a particular loan.

It is the intersection of the particular practices as it relates to a particular customer and the credit risk of that customer that has moved for some players. It's not a universal thing. Some players have been more aggressive than others.

We've just been around long enough to know the key thing is we very much have a culture around here. People don't live with growth targets at Capital One. We forecast growth when we think it's going to come. But, people all know that job one is to raise your hand and flag when you see opportunities, and the most important thing is that we go after resilient business.

We are flagging some of -- yes, we've picked up a little bit. Our commentary on this -- although we have been talking for quite awhile about it, we talked -- in many ways, taken two different perspectives.

Partly what we've said over time, is just understand coming off the once-in-a-lifetime unique situation of incredibly tight credit and incredibly conservative borrowers, some of the loosening that's going out there would be in the category of normal reversion to the mean. Some of the stuff that we are flagging here, would, I think, be on the other side of that.

But, on the other hand, this is not something where we're saying -- oh my gosh, you're going to see us just pull out of this thing. We still believe there is selectively very good opportunity for Capital One to go get the assets that we want and -- continue to build and even expand the number of dealer relationships that we have.

We wanted to just put the Street on the increasingly -- on notice in a sense, that we are very carefully watching the practices, and we're going to make the choices that we make for resilience. We hope -- there are really, in many ways, two offsetting forces, with respect to growth. We are clearly losing deals one customer at a time, sometimes, that we might have won in the past because others have moved farther in their underwriting.

On the other hand, some of the innovations we have and the really sustained success in building deeper dealer relationships moving up through their prime relationships and expanding dealer relationships is a force in the opposite direction that still generates growth. The net effect of those two things will drive our results.

You can see that, in general, subprime is where we have -- you don't see that much growth going on anymore. Most of that really has been in prime lately.

What is the percentage mix of your recent card loan growth between existing and new accounts? In terms of the seasoning, I guess you see more of the seasoning impact on new accounts. Is that a fair assumption?

Yes. The only seasoning that one would have on existing accounts -- first of all -- existing accounts, the outstandings ebb and flow with people's spending and borrowing and just general ambient activity. The only big mover on the existing file would be line increases. And having been in a brownout period for a couple years with respect to line increases, as we've said, getting back into line increases lead to -- if you will -- a surge of catching up for a second.

We're on the slightly higher side of equilibrium probably at the moment, I would say there. The seasoning of those is a different seasoning dynamic with respect to new business.

The line increases tend to -- all the economics of line increases have upfront very good things. It doesn't cost much to get them. There is no spike of diabolical behaviors or anything.

What you tend to have -- and for while, people used their line to pay any obligations, and so on. What you have there is more of a study delayed rise in charge-offs over time with that vintage. That is an important but minority part of the overall growth right now. It's an important minority, shall we say.

The majority of the growth is coming from the origination side of the business or from recent originations and the very immediate credit line moves we might make relative to those. But I put that all in the category of originations.

The vintage dynamics for that are very different. First of all, all the economics are upfront. You take all your pain, you've got your high cost to originate.

The big allowance build, there is even the peak of charge-offs comes pretty early and then moderates over time. So, all the good news aspect of that thing happens over time. The majority of our growth is coming on the origination side, but there is a sizable minority that is on the line increase side, and that's approaching an equilibrium, now it's on the high side of equilibrium.

Next question, please.

Moshe Orenbuch from Credit Suisse.

Rich, you talked a little bit about the rewards in the UK coming down a little bit on tight interchange in the market. Can you talk a little bit about your outlook for the US where rewards have generally gotten more aggressive and the like in the prospect of perhaps at some point, seeing a higher interest rate environment and whether that will have any impact on the industry?

Sorry, Moshe. Repeat your question?

Basically, you had aggressive rewards competition. It's been increasing both on a cobranded and also even on a cash back and mileage type programs.

The question is, does that turn around? Does it turn around if interest rates start to move up when profitability on a customer who is basically using the card like a charge card would go down?

Moshe, you are talking about a sector that as long as I've been around it, has been pretty intensely competitive. Now, it tends to be lopsided relative to a lot of competition from a small number of players and modest involvement from everybody in the business.

This rewards space is -- certainly is still very competitive, and the recent manifestation of extra competition there has been early spend bonuses have continued to rise. That's probably the most noteworthy thing.

I think others, in general, have come out with products that are a little better than what they have for the existing books. There is a little movement on product value and continued competition on early spend bonuses. So, we have our eye on that.

Of course, the other place for the competition, of course, is just in the amount of marketing. People are stepping up the amount of marketing, as well. Overall, I would say there has been modest, pretty modest -- in the overall scheme of things, an increase in the intensity of competition, there.

Now, talk about -- in the context of all of that -- as rates go up, at some point, I think sizable increase in interest rates will probably have a fair amount of impact on that. I wouldn't expect modest interest rate changes to impact that too much.

Steve, I know you spent a lot of time thinking about this. What were you going to say?

With respect to interest rates, three observations. First, when we book new accounts, we fund the balance -- what we assume the balance is going to be going forward.

So, there's not rate risk as you would say on the existing book. The rewards that we have are obviously were accumulated in our expense.

As Rich that, the underwriting that we do on the accounts does assumes some stress level in the rate environment, so it's not booked based on current spot rates. So, there's a lot of thought into the interest rate risk associated with the business.

Just as a follow-up, any update on what you're seeing in your relationship with Costco and Canada. If not now, when do think we'd hear about that?

Yes. We are excited about our new agreement with Costco. This was launched in September of last year.

Of course, we are the exclusive credit card issuer for the retail brand in Canada. This didn't -- it by the way -- it didn't come with a portfolio acquisition. So, this is really one that we're from scratch working to build the customer is. In the first six months since the partnership launched, we are seeing pretty strong demand, as Canadian consumers appear to be certainly very willing to take up what is a quite attractive MasterCard product.

Next question please.

Eric Wasserstrom from Guggenheim Securities.

Steve, if you wouldn't mind, could you just clarify what you meant in your comment about the payout ratio going forward just so I understand it in the context of what Rich concluded with in terms of the payout outlook?

We'd ask you to look more at our actions and our commitment to return capital over the last two years. I don't think you will ever see us -- certainly not in the near term -- but my guess is probably ever, committing to a payout ratio. The business is just -- we like to retain the flexibility, and obviously, if opportunities arise or the economy changes, there can be a whole bunch of things that change.

In the near term, we saw that this year, our test improved a fair amount in terms of how the Fed looked at us, which is good news. We hope things continue to move in that direction, but we can't be assured that's the case.

The other big uncertainty we've talked about and continue to have going forward is how CCAR and advanced to purchase will come together. So, there's just a whole bunch of reasons why we don't want people to lock into what we have done over the last two years and just assume that's the minimum going forward.

Got it. You're really just underscoring the need to maintain capital flexibility in light of competitive conditions and a continuously evolving regulatory environment?

Absolutely.

Great. Thanks very much.

Next question, please.

Bob Napoli from William Blair.

Just a question on growth and a follow-up on regulation. Rich, what do you expect -- what are your thoughts on the growth rate of your credit card business?

You've had very strong growth, accelerating growth, as you said, helped by credit line increases, as well as your branded product. Are we done with the credit line increases? Are we going to continue to see an acceleration in that business?

Your spend growth in the US is pretty amazing compared to the industry. I guess that's credit line driven, as well? Outlook for growth -- which products, and are you near the end of the credit line increases?

Bob, let me talk about the outstanding growth to start with. That is being driven by -- somewhat by line increases. Also, by the success of origination programs across the various parts -- across all of the parts of the business that we are investing in.

So, the line increases -- I guess my description was -- we are on the higher side of equilibrium. But, there's approaching an equilibrium level. But, we are a bit on the higher side of equilibrium, there.

On the spend side, that is -- that's driven by -- you are right where you are going, in a sense. The spend is -- partly, the success we have in the rewards programs we have, it's also people filling up their lines, in a sense, either coming from line increases or a lot of new originations where people are starting to ramp up their spending there.

So, there's a number of things that have come together to make really quite extraordinary spend growth. And all of that, I think, is reflective of -- if I pull way up and just talk about our growth here for a second, the growth that you see here -- Bob, you've known Capital One for a long, long time. Our strong growth is really driven by the investments we've made in the last few years and the current market dynamics that represent a window of opportunity.

We're continuing to invest to try to sustain this trajectory, and you've been around long enough to know that life's about windows of opportunity. The way Capital One works is, when we see windows, we really do go for it.

We also, interestingly, if there is a reverse window, if you will, when we think market dynamics get in any negative sense, we, a lot of times, exceed the market in the other directions, sometimes, in pulling back. This is one of those things where a number of things have come together and the byproduct of a lot of investment in opportunities, some digital innovation that's going on, and we will capitalize on it as long as it lasts.

We are reluctant to give a growth outlook because almost by definition, when you are growing at some of the rates you've seen here, it's just hard to predict where things go from here. We certainly are continuing to invest, and that's reflective in some of our comments on the cost side.

Just on regulation, are you seeing -- are we getting near the end of the increase in regulatory costs? Do you have any sense that things are settling down?

You hired 5,000 people over the last year, and there's a lot of investment. I don't know. How much has regulation pressured your business from an operating expense and operating perspective, and do you feel like maybe you could see the light at the end of the tunnel, or not?

Well, I don't think you could probably find a bank executive in the entire United States that would predict that the increase in regulatory costs has come to an end. So, Bob, I think there are some companies who have gotten themselves in a very complicated situation and are trying to rectify some big very public problems and things like that.

I think for us, the philosophy we take, look, the regulatory bar dramatically increases every year. I mean every year including even -- the other day I was giving a presentation to our associates and listing within the last 12 years, a long list of things that have raised the bar in the past year.

The approach that we are taking is to say let's try to seize this opportunity, seize the regulatory moment, not just fill out a checklist and get all of our to-do requirements done, but to work backwards from what it takes to build a really dynamic, well-controlled company in the modern era, if you will. And, work backwards from that and make sure that what we're putting in is consistent with a dynamic company that can innovate and do a lot of things.

Also, embrace the spirit behind some of these regulatory requirements that the world is really expecting and demanding a very high level of execution, and we're going to try to step up to that bar. Along the way, the costs, frankly, keep going up, Bob.

Next question, please.

Betsy Graseck from Morgan Stanley.

Just had a question on some of the new partnerships that you've been announcing. I think you've done some work with innovative companies like some of the firms out there in the West Coast.

And, wanted to get a sense of how much your technology investment spend has helped you to be a leader and helped you to announce these partnerships early on? I'm talking about what you recently announced with Uber.

Betsy, first of all, with respect to external digital parties, there's a lot of manifestations of Capital One's commitment to digital. We've done a number of partnerships.

We've done a number of acquisitions like Adaptive Path, Level Money and things like that. We've done a number of -- very large number of recruiting successes including some pretty high-profile folks that we brought in.

One thing is absolutely clear, and we believe this from the beginning. Every bank is going to need to transform itself. The digital revolution is changing banking on just about every dimension that you can imagine, basically.

It's changing what it takes to win in payments, in distribution, in marketing, in brand, foundational infrastructure, experienced design, if you will, the way information is used. And in the end, that really means the role of talent is central to that transformation.

So, in the talent marketplace, in the partnership marketplace, I think these folks -- you can't just go out there with a checkbook and say -- here we are, we are here to bring you into the fold. I think these folks look to see and they come in and kick the tires to say -- is this a company that is bolting digital on to the side of a traditional bank? Or, is this a company that is really -- like in our case -- really trying to build a really leading information-based technology company, in a sense?

The key manifestations of that are inside the company. Are the leaders committed? Are they digitally fluent? Have they digitally reimagined their business? Are they bringing technology talent, not just into some place in IT in a sense, but is it being brought right into the heart of the business and become who you are?

When you heard me talk a lot about digital, it's just this reminds me a lot of 20 years ago building an information-based company. I'm incredibly excited and sobered by what it takes to actually really build an information-based technology company, and I really like our chances.

Along the way, as we go on that journey, the more success we have there will correlate, also, with a lot of people from the outside saying, you know what? That is the company that I think speaks our language and is one of us, and you will see more of the partnerships and successes that you alluded to.

That's great. Just a follow-up on that on the impact on realtime payments. I know there's obviously a lot of work streams going on at the fed regarding trying to move the payment systems to be realtime settlement.

I'm sure you've thought a lot about that and are working on that, as well. Just wondering what opportunities does that potentially give to you as realtime payments come to fruition?

Gosh, that is -- there's a lot of dimensions to that particular thing. It is ironic that the banking system is from stem to stern built on a batch basis. You pretty much look at anything. From the old direct-mail stuff that Capital One and so many of us have done over the years, the whole way clearing works.

And so, really, while there are many, many aspects to the batch nature of this thing, right at the center is this irony that in a world that increasingly is going toward pure electronic payments, there is a massive lag in the end to make those things fully happen. Most banks -- pretty much all of us banks have built middleware layered to, in a sense, simulate realtime, even in the context of the reality that's very much batch based.

I'm not sure that realtime payments will actually transform banking as much as a lot of people think it will. But, the reality of when the world moves -- if we pull up from realtime payments and clearing technically to the larger point of the world moving to such immediate interactivity and such a mobile world, the really dramatic transformation that's going to happen to banking, is it's going to become realtime far beyond realtime payments. I think banks are so -- in a way -- ill-suited to drive to that destination, yet the world will drive us banks there.

I think you put your finger on something from a broader point of view, that I think is at the heart of the whole reinvention of banking that is coming. It's just that for banks to get there, the banking system and for banks, individually, there's a lot that that entails. We're going to need to think more like technology companies and maybe a little less like banks.

Next question, please.

Our final question today is from David Hochstim with Buckingham Research.

Just following up on that, what do you think it would cost in time and money to transform the Company into a realtime entity?

Capital One?

Yes.

In some ways, it's a lifelong forever journey. This is not like we're going to say by next year, we are going to be realtime. I'm just saying, from a journey for me that started 20 years ago and looking at the banking industry and saying in many ways, this is really the information business, not necessarily just the traditional banking business.

I'm saying the world -- it's very clear at the accelerating rate that the world is moving, the ability -- the dimensions of how information is leveraged, the realtime nature of information, and the software revolution that has changed everything, the connected revolution, here -- working backwards from that will be a lifelong journey. But, I think that the companies that -- for all of us, it will be gradual.

As we continue to leverage those opportunities, I think the difference between companies that are really taking advantage of that versus companies that are following the more traditional model, there will -- in the end, this is going to translate into growth opportunities and economic differences and a number of things that are pretty significant. This is something, in a sense, that is going to be a lifelong effort for banks like ours.

You think it will take a long time.

In some sense, it will probably take forever because, the world is going to keep moving that fast. The main thing is that we already see the benefits of some of the things we've been investing in, and one of the important drivers of some of the growth opportunities we have right now, is coming from the digital innovation that we have spent a number of years doing.

Thank you very much, everyone, for joining us on the conference call this evening, and thank you for your continuing interest in Capital One. The Investor Relations team will be here this evening to answer any further questions you may have. Have a great evening.

That does conclude today's conference. Thank you for your participation.