Capital One Financial Corp (COF) 2015 Q2 法說會逐字稿

Welcome to the Capital One second 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, Nancy, and welcome, everybody, to Capital One's second quarter 2015 earnings conference call. As usual we are webcasting live over the Internet.

If you like to access us 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've included a presentation summarizing our second-quarter 2015 results.

With me this evening 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.

And for more information on these factors please see the section titled Forward-Looking Information in the earnings release presentation and the Risk Factors section in our annual and quarterly reports accessible at the Capital One website and filed with the SEC.

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

Thanks, Jeff. For the second quarter Capital One earned $830 million or $1.50 per share. And had a return on average tangible common equity of 11%. On a continuing operations basis we earned $1.48 per share.

Net income was down $285 million driven by lower linked quarter pre-provision earnings and higher provision expense. These provision earnings decreased by $233 million versus the prior quarter as higher revenue was more than offset by higher marketing and operating expenses.

Provision for credit losses increased on a linked-quarter business as lower charge-offs were offset by a larger allowance build. We had nonrecurring costs of $225 million in the quarter. We have included an appendix slide in our earnings presentation available on our website illustrating the impacts from these items to key line items and ratios in the quarter.

Nonrecurring charges include restructuring expense of $147 million related to the realignment of our workforce that we recently announced internally. We expect a modest amount of incremental nonrecurring charges later this year from site closures related to this activity. We also added $78 million to our UK PPI reserve of which $37 million was captured as a contra-revenue item and $41 million was captured in non-interest expense.

The increase in our UK PPI reserve is driven by complaint volumes declining more slowly than we had previously estimated. The refund of PPI fees and interest is an industry-wide issue and there continues to be uncertainty as to how these exposures will play out. Estimating future complaint levels is difficult and there is the potential that more complaints will be filed in the future then we are currently estimating.

As always, our 10-Q will provide further details on the factors we consider in estimating our reserve. Excluding the impact from the restructuring charges and the build in UK PPI reserve earnings per share in the quarter were $1.78 and our efficiency ratio was 54.6%.

Turning to another legal matter. In the quarter, we recorded a $36 million benefit from reducing our reserve for representation and warranty claims. This reduction was driven by our recent High Court ruling in New York regarding the application of Statute of Limitations. We also expect that the ruling will result in a decrease to our reasonably possible rep and warranty exposure by approximately $500 million from the level reported in March 2015. But that calculation will not be finalized until the 10-Q is filed next month.

As outlined on slide 4 reported NIM decreased 1 basis point in the second quarter to 6.56% as lower investment securities and earned yields were partially offset by lower cash balances and additional day to recognize revenue in the second quarter. We continue to be above the fully phased-in LCR requirements as of June 30, 2015.

On slide 5 you can see our common equity Tier-1 capital ratio on a Basel III standardized basis was 12.1%. On a fully phased-in basis we estimate this ratio would be approximately 11.8%. We reduced our net share count in the quarter by 5.5 million shares or 1%, primarily reflecting our share buyback actions. We entered parallel run for Basel III events to purchase on January 1. And we continue to estimate that we are above our 8% target.

Let me now turn the call over to Rich.

Thanks, Steve. I will begin on slide 7 with our domestic card business.

Strong loan growth continued in the quarter. Ending loans were up 11% year over year and average loans grew 9%. We continue to see attractive 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 20% year over year.

The success of our rewards programs increased new account originations and credit line increases continued to drive purchase volume growth. Revenue increased 8% year over year. On a linked-quarter basis revenue margin decreased 12 basis points driven by the change in our finance charge and fee reserve, which swung from a modest credit-driven release in the first quarter to a modest growth related build in the second quarter. The domestic card revenue margin remains healthy at 16.8%.

As you know, we stopped selling payment protection two new customers in the US in 2012, but we allowed existing customers to keep the product. Since then, our revenue margin has absorbed a small drag as the back book of payment protection has been gradually running off as a result of account attrition, charge-offs and cancellations. Payment protection is expected to contribute about 25 basis points to the full-year 2015 revenue margin and has been declining by an average of about 10 basis points a year.

As we continue to simplify our operations to focus on our core offerings, we believe it is the right time to fully exit the back book, which we expect to largely complete in the first quarter of 2016. We expect the contribution to revenue margin to essentially go to zero by the second quarter of 2016.

Year-over-year non-interest expense increased 7%, driven by higher marketing and growth related operating expenses, as well as continuing digital investments. Credit in the second quarter was driven by expected seasonal improvements. The charge-off rate improved 13 basis points to 3.42%. The delinquency rate improved eight basis points to 2.84%. Recall that last quarter, we experienced better than forecasted delinquency flow rates. As first-quarter delinquency favorability rolls through to charge-offs, we expect quarterly charge-off rate to be around 3% at the third-quarter seasonal low point.

Longer term, our credit expectations are unchanged and are driven by growth math. As new loan balances season they put upward pressure on losses. We still expect growth math to drive quarterly charge-off rate to be in the mid to high 3% range in the fourth quarter and higher from there in 2016.

Loan growth coupled with our expectations for rising charge-off rate drove an allowance build in the quarter and we expect these same factors to drive allowance additions going forward.

Slide 8 summarizes second-quarter results for our consumer banking business. Ending loans were flat compared to the prior year. Growth in auto loans was offset by expected mortgage runoff. Auto originations increased about 1% year over year and 5% from the linked quarter. Consumer banking revenue was up 2% year over year, driven by growth in auto loans.

Revenue continued to be pressured by persistently low interest rates on the deposit business, declining mortgage balances and margin compression in auto. Non-interest expense increased 6% year over year, driven by infrastructure and technology expenses in retail banking and growth in auto loans. Provision for credit losses grew $42 million year over year to $185 million.

Growth in auto loans and normalizing auto credit resulted in higher year-over-year charge-off expense. In our auto business, used vehicle values have softened although they remain near historically high levels. A decline in used-car prices would put pressure on our results.

We discussed increased competition and pricing and underwriting for some time. In the second quarter, we observed increasingly aggressive underwriting practices by some of our competitors particularly in subprime. We are losing some contracts to competitors who are making more aggressive underwriting choices. As a result, subprime originations declined modestly compared to the prior year. We will continue to pursue opportunities in auto lending that are consistent with our longstanding focus on resilience. Including adding new relationships with well-qualified dealers and gaining greater share of prime originations with existing dealers.

Our consumer banking businesses are delivering solid performance in the face of continuing headwinds. Persistently low interest rates will pressure returns in our deposit businesses even if rates begin to rise in 2015. Planned home loans runoff continues. And auto loan growth is slowing and margins are compressing from once-in-a-lifetime levels. We expect these trends will negatively effect revenues and efficiency ratio in the second half of 2015 and 2016.

Moving to slide 9, I'll discuss our commercial banking business. Ending loan balances increased 6% year over year and 1% from the linked quarter with most of the growth in specialized industry verticals in C&I. Average loan balances were up 8% year over year. As we've been signaling, our growth is slowing compared to prior years because of choices we're making in response to market conditions. While increasing competition, pressuring loan terms and pricing in CRE and plain vanilla C&I, we continue to see good growth opportunities in select specialty verticals in C&I.

Revenues increased 8% 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 24 basis points compared to the prior year driven by increased competition. Loan yields increased modestly from the linked quarter.

Provision for credit losses increased $37 million from the prior year to $49 million driven by allowance build. We've built allowance over the last three quarters in anticipation of increasing risk in oil and gas and taxi medallion loans. In the second quarter, criticize nonperforming loans were up $282 million from the prior year to $463 million and the NPL rate increased about 50 basis points to 0.90%. These trends were driven by downgrades of oil and gas loans and to a lesser extent downgrades of taxi medallion loans.

Second-quarter credit results include the final results of the shared national credits exam. 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. Of our approximately $3.4 billion portfolio of oil and gas loans, our largest exposure is in exploration and production and our second largest exposure is in oil field services. Our taxi medallion loan portfolio is less than $1 billion in loans. In the face of growing competition from Uber and other entrance taxi medallion values continue to decline and we are closely watching the sector.

I'll conclude tonight on slide 10. Capital One posted solid results in the second quarter, highlighted by strong growth in our domestic card business. We're delivering attractive risk-adjusted returns today and investing to sustain growth in returns over the long term.

We remain compelled by the opportunity, need, and urgency of digital transformation. We are entering a mobile on-demand realtime world. Digital is already disrupted many businesses and has created entirely new industries. The pace of disruption is sweeping, breathtaking, and accelerating.

Banking is inherently a digital business and is ripe for transformation. To win in the digital world we can't simply bolt digital onto the side of our existing business or port analog banking services to digital channels. Technology and information will fundamentally change how banking works and unlock new capabilities and the ability to deliver entirely new experiences.

To fully capture these benefits we're deeply embedding digital into our businesses. We're becoming a destination for great digital talent, product managers, designers, engineers, and data scientists. Were simplifying and modernizing our infrastructure to drive agility across the company. We're building foundational capabilities around software development, design, and information. And were transforming the way we work to unleash the power of modern technology and great talent to drive innovation.

We are making significant investments in our digital future. We don't build technology for technology's sake we are working backward from a future where the vast majority of interactions with our customers will be digital. We are already seeing the payoff. Our digital investments are creating a compelling customer experience delivering data-driven insights and are a key enabler of the strong growth we are delivering.

We continue to see strong growth opportunities across our domestic card business. We believe that the right choice to drive long-term value is to spend marketing and operating expense to capitalize on this window of opportunity. Taken together, digital transformation, domestic card growth opportunities, and rising industry regulatory requirements drive our investment levels. And we believe all three are strategic imperatives that are critical to long-term value creation.

Last quarter we indicated that full-year 2015 efficiency ratio could be modestly above 54.5% driven by incremental marketing and growth related operating expenses. With strong domestic card growth opportunities continuing we now expect full-year 2015 efficiency ratio to be around 55% excluding nonrecurring items.

While it's difficult to predict next year's efficiency ratio 18 months in advance, we can see a number of factors which will effect it. We expect the 2016 efficiency ratio will benefit from recent card growth and recent cost moves. But the continuing investments in growth, digital and regulatory, as well as the revenue pressures in auto and retail banking, are expected to put upward pressure on efficiency ratio.

Net net and excluding nonrecurring items, we don't expect much improvement in 2016 efficiency ratio relative to full-year 2015. We're managing expenses tightly with the goal of offsetting digital investment, growth, and regulatory expenditures as best we can with savings in other areas. One example in the second quarter is the choice we made to restructure our workforce as we become a more digital company.

Pulling up, Capital One is well-positioned to sustain attractive shareholder returns. Over the near-term we position Capital One to deliver financial performance with the following characteristics: strong revenue growth driven by growth in loans; pre-provision earnings growth, more or less in lines with revenue growth; higher provision for credit losses, creating headwinds for net income; and significant capital distribution, subject to regulatory approval, with share repurchases reducing share count and aiding earnings per share.

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

Thank you, Rich. We'll 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 question. If you have any follow-up questions after the Q&A session, Investor Relations team will be available after the call. Nancy, please, start the Q&A session.

Thank you.

(Operator instructions)

Ryan Nash, Goldman Sachs

Good evening.

Can you help us better understand the growth math. It seemed like the provision build was significantly higher than any of us had expected coming into the quarter. Steve, maybe you could just walk us through the outlook for charge-offs, expectations for growth, maybe help us understand the qualitative component and should we be thinking about a ramp in provisions from here? You know given the growth you generated? Or do you think we are finally getting to the point where provisions could be commensurate with the loan growth profile?

Yes, Ryan, hopefully this will be a repeat to what we've been talking about for a while, but I think, as you say, it continues to be a source of difference. Let me talk in particular, because most of this is driven by card and focused there.

As we've mentioned our allowance is built off of three components. The loan balances at the end of the period, our 12-month forecast going forward and qualitative factors for risks that are not covered in the models. As mentioned, and we've talked about this for a while, we're in a growth period for card. So that growth, all else equal, is going to be pushing up the allowance.

Even more precisely, we've given you a sense for what's going to happen to charge-offs. Our current allowance, right now, includes the, if you think about it, there's a rotation that happens every quarter. Our current allowance includes expectations for low NACo losses in the third quarter of 2015. We talked in our guidance of around 3%.

And, if you think about it, at the end of next quarter, we will replace the third quarter of 2015 with the third quarter of 2016. Remember, we have guided now consistently. There's not been a change in outlook for our loss content in card. We have guided consistently over the last couple of quarters that we're going to be in the mid to high 3% in the fourth quarter of FY15 and higher from there.

So all else equal, even before loan growth, just the quarter swap would mean an allowance build next quarter. And the same thing happened you could talk about this quarter. Now I always have to put a qualifier of all else equal.

Changes to our underlying loss expectations can have a real impact on allowance build. Because it happens over the next four quarters. So it's really the combination of growth and our outlook for charge-offs that's going to ultimately work its way into changes in allowance.

Sanjay Sakhrani with KBW

Thank you.

I guess you have been seeing some good growth in card. Could you talk about the types of growth you're seeing? What kind of competition you're seeing. What the loss content of that growth because that kind of ties into the allowance question.

And I will ask my second question up front. I guess there's some changes to the CCAR approach, as far the advanced approach is concerned. Maybe, Steve, you could just talk about how that might impact you? Thanks.

Do you want me to go first on the capital --

Sure.

Look, I think that the two things that apply to us are they're going to move away from the old Tier 1 common ratio, that's not a big impact for us on CCAR. The other thing is, at least for now, it feels like CCAR and advanced approaches have been delayed indefinitely and that added more uncertainty, which we've talked about. So those are the two things that will impact us.

There's still, obviously, it's not a model that we can control and we can't predict entirely what the changes are going to be year over year, but on balance the biggest change was probably knowing for some period of time there will not be a combination of CCAR and advanced approaches. Rich.

Yes, Sanjay, the growth in the card business is a very similar story to what we've been saying for some time now. We are seeing good opportunities in growth across the segments that we are growing and that we are investing in, in our card business.

The lost content is similar to originations we've been doing for quite some time. Those losses are higher. The losses of new originations are higher than our highly seasoned back book, just because that back book was profoundly seasoned by anybody who survived the Great Recession, in the very extended period of low originations for us and in many ways for the industry. Off of an unusually low loss back book, we are seeing very good origination opportunities and it's really more of the same that you've seen from us a for a long period of time.

Next question please?

Eric Wasserstrom, Guggenheim Securities.

Thanks, very much. I just wanted to clarify one question on provision and then I have a question about the net interest margin.

There was reserve build in the commercial segment, but is that also, given the dynamics that you just went through, Steve, as they relate to card, are they similar for commercial given what's going on there in terms of some of the credit stress?

And then my margin question is, can you just walk us through some of the puts and takes in terms of what's going on in yields across the different product areas and maybe what's going on in cost of funds? Thank you.

So the provision in commercial that's really the drivers of that are primarily the energy and taxi remarks that Richard made earlier. I'm sorry the next question was? What was a question on interest margin?

Just largely about if you could give us some insights into what's going on in terms of yield expectations and what's going on in terms of your cost of funds expectations?

Well there's pluses and minuses, and a lot of that obviously depends on which side of the balance sheet you're talking about. In general, on the positive side we've moved to a higher mix in card. That's probably been something that's been a help to that interest margin. I would say yields, more generally, across the portfolio have been going in the opposite direction.

Don Fandetti, Citigroup

Rich, you mentioned subprime auto competition again this quarter and I was curious if you're seeing -- is it an across the board pickup in terms of aggressive activity? Or is it more one player because we're, obviously, aware of one participant that had some strategic changes that's led them get more active.

If you could comment on that.

It's not across the board. It's a little more isolated, but it's a similar phenomenon we've been talking about for some time. We, of course, are making the choice to be very consistent with our own underwriting here.

And, lastly, are you seeing any impact at all from the online marketplace lenders? My sense is probably not, but I just wanted to check on that?

No. We are intrigued with, frankly, all of the startups in the financial services space, one category of which is the online lending and peer-to-peer lending and so on. The numbers involved are small relative to the magnitude of the balance sheets and originations. And most of us it would probably be hard to see that.

I also do want to point out that most of this lending on the consumer side is focused on installment lending and that's not an area we're doing a lot of origination in, so we certainly don't see any direct effect. It would be hard to measure indirect effect.

Even though we may not see much of an effect, we certainly have a real interest in watching what goes on in that space.

David Ho, Deutsche Bank.

Good afternoon. I wanted to talk about the 2016 efficiency ratio little more. I'm a little surprised that it would stay elevated relative to already increased levels of for 2015. Particularly in light of your asset sensitivity and, obviously, some growth in digital that should lower your cost of acquisition.

Do you see more flexibility in the event that revenue pressures persist on the cost side and maybe in retail banking? Or across other areas of the business?

Let me say a few things about the efficiency ratio. As you know, and probably looking at our own conversation over the course of this year, it's hard to precisely predict efficiency ratio, but what we want to give investors a sense of there really are tailwinds and headwinds that are competing pretty strongly with each other.

The recent growth that we've done in the card business, for example, is certainly a positive force. Offsetting that, of course, is what we will do in terms of investing in card growth. During the year, next year and a pretty big component is the digital investment, as well in some of the other things that I mentioned.

In terms of how these play out, the card growth will ultimately be beneficial to efficiency ratio as growth moderates and the investment in digital. A lot of banks are talking about digital in the language of how the investment in digital compares to the cost savings. We are not primarily motivated by cost saving with digital, because I think that's about fourth on the list of things that the power that digital provides. Right now it is still a net negative and probably for extended period of time measured purely by cost, digital will probably be a net negative.

But even then on the cost side we're seeing benefits already in statement and payment processing, telephone servicing costs, workforce restructuring that you saw, branch efficiency, data storage, a lot of things. But the bigger benefits are things beyond that and that show up in terms of better credit risk management, faster product development and ultimately the kind of growth that you're seeing.

The reason that we took the time here to lay out efficiency ratio guidance was just to give you a sense of the commitment that we have to investing on the digital side and the commitment that we have to seizing the opportunity on the card growth side. And I think both of those factors are going to be significant enough that we don't see a lot of opportunity for the efficiency ratio to go down in the near term.

During the same time we are working incredibly hard to save costs in one minus those two areas. I think today's announcement is a manifestation of some of those efforts.

Okay. Thanks. And going back to Ryan's question a little more on the card loan growth that you're doing. It's clear your business is below prime, how quickly is that growing relative to prime. Are you seeing a bit more migration into the segments as the economy improves?

Our mix is staying pretty steady. We're growing in all of the areas that we're investing in.

Next question please?

Bill Carcache, Nomura. Please check your mute function.

Hello, can you hear me?

Hi, Bill.

Can you talk about the IRR's on the new loans that you're originating today versus what those IRR's have looked at over the several years. And within that can you give us a sense for what's been happening with customer acquisition costs over time?

Bill, IRR's are probably on the higher end but still in the range of the IRR's we've seen going back for an extended number of years now on our originations.

The primary thing is the magnitude of origination opportunity that we see. But it is also the case that the octane measured in terms of pretty much any way we measure it that most importantly by ultimately the NPV, NPV per marketing dollar, IRR and various things, is on the higher end.

Is there a follow-up, Bill?

No. That's it. Thank you.

Next question, please.

Chris Brendler, Stifel.

Good evening. Thanks for taking my question. I want to ask two separate questions, but I will ask them together to make it easier.

First, on the card business your in such an impressive trajectory in your US card loan and volume growth, yet it's not seeing nearly the follow-through that we've come to expect on the revenue side. I know you called out some of payment protection plan as a negative, but I'm also looking at a pretty significant decline in interchange revenue and I didn't know if there's anything there? Is just a higher rewards rate?

Also, sequentially, it went from 12% to fifth percent interchange growth as volumes are accelerating. So if you can just talk to me about that and any other factors you're weighing on US card growth?

My second question is for Rich. On SMB lending, I noted your comments about the outlenders and can't help if I look at small business from some of these alternative lenders that seems to fit Capital One's core competencies and direct marketing and mining data and looking for mis-priced loan opportunities. Can you tell us your appetite for SMB loans that are nationally and directly originated? Thanks.

Okay, Chris, let me start with the interchange.

The net interchange metric can have quite a bit of quarter to quarter variability because it includes partnership contractual payments. It includes international card and we periodically adjust our rewards liabilities based on customer trends and redemption rates and things like that.

So as such, in any particular quarter, there tends to be a lot of noise around that. But if you pull up beyond the quarterly noise, you're absolutely right in pointing out that net interchange growth has generally lagged general-purpose credit card interchange growth, purchase volume growth. We would expect this trend to continue.

In many ways it's really a byproduct of the success that we're seeing. Our rewards programs have been and continue to be enjoying a lot of growth. We are making the choice to upgrade a lot of our customers to these products and we're also extending rewards products to existing customers who don't have rewards.

If you look at the effect of all of those together, that's why interchange growth lags purchase volume growth, and I think that while that will bounce around from quarter to quarter. I think over the longer run those two metrics will converge. I think it still will be some time before they fully converge.

And with respect to the alternative lenders for example, small business lender's. We're very intrigued with some of these startup companies. I think that they have demonstrated a lot of innovation from which I think we can learn a lot at Capital One.

The way that they do their underwriting, obviously, the digital capabilities that they have. In a number of cases they're using very sophisticated and interesting data analytics. The way that they do cash flow-based underwriting. The way that they do the daily collections thing. There's a lot of very creative activities going on in that particular space. We're watching it carefully and we'll continue to see and learn from the people that are leading in this space.

Next question please.

Matt Burnell, Wells Fargo.

Thanks for taking my question. Rich, maybe a question for you.

You mentioned earlier in the call that on the card side, the card portfolio mix has been pretty steady but if we take a look at some of your regulatory filings it appears that the sub 660 FICO co-cohort within US card is growing at a slightly faster rate in terms of the overall proportion of loans with that FICA score. So I'm just curious: given that you haven't really changed your outlook for credit losses over the next few quarters.

What do you need to see? What is the canary in the coal mine, particularly in the sub prime side of things, that might make you reassess what your loss content in that particular part of portfolio might be?

First of all, Matt, you are right. While overall, generally, the mix is about the same there has been a very small increase in the subprime mix. But overall when we look at our originations, when we look at the strategy that we have, there's a real consistency and the phrase I say, sometimes the more things change the more they stay the same in terms of how the opportunities we're pursuing and the nature of the growth that we're getting.

When you asked the question what is the canary in the coal mine with respect to this business? Obviously, we look incredibly carefully at the metrics that begin on the origination side. We look at the nature of the mix of applicants that we get and that tends to be an indicator of whether there's positive or negative selection. And then we track very closely every single month all of the metrics and early indicators of whether there are any issues.

At Capital One we predict outcomes before, during and after every single origination. We monitor this incredibly closely. You also know that in things like the subprime space, we have about more than 15, approaching 20 years experience in this particular space.

What I would say for it is what I would say for any part of the card business, we watch very carefully for adverse selection. We monitor the metrics extremely closely and we stay mobilized to move and also to let our investors know when things change relative to our own expectations.

All that said, we continue to see really across the card business a stability in the competitive environment, a stability in the origination environment, a stability in the consumer and their own behavior and really a stability in the vintages of our originations.

And, clearly, if we saw a canary in the coal mine I don't think you be seeing the type of growth that we are currently seeing in the card business.

If I could follow-up with another credit related question, I guess on the commercial side and specifically with the oil portfolio. It looks like your outstandings were down about 6% quarter over quarter from what you reported in the first quarter.

Can you give us a sense as to if the commitment trend is roughly similar in that portfolio quarter over quarter? And there's been some anecdotal evidence that there's been some increased focus from regulators on that portfolio. I'm just curious as you head into the fall re-determination sort of what you're thinking is in terms of the potential for provision pressure within that portfolio?

Obviously, that business we're very, very closely monitoring and on numerous calls recently we have been talking about that segment. One of the benefits of the upstream oil and gas business is the ability to do the borrowing base re-determination. So loan balances were down 6% from the prior quarter as a result of the spring borrowing base re-determination.

Our E&P borrowers decrease their balances to conform to the lower commodity prices and oil field services company's reduced their balance sheets. We've seen particularly -- what we've seen pretty much across the energy business, a pretty darn quick reaction by reducing expenses, particularly capital expenditures, and taking advantage of the receptive capital markets.

All of that said, obviously, you don't have to look very far to notice what's happening in oil prices and the volatility and risks there. The allowance builds that we have had for several quarters now have been significantly driven by energy, as well as in the taxi business as well. That one we'll really have to monitor carefully. But we do like some of the inherent resilience dynamics that exist particularly in the upstream part of the business as they move quickly to adapt to the oil pricing pressure.

Next question please.

Moshe Orenbuch, Credit Suisse.

Thinking about some of the comments you made about the revenue in the credit card business. Given that it seems like most of the incremental interchange revenue you're generating is going back to the consumer. Could you talk about whether there's increasing or decreasing percentage of the base that's actually revolving. And I have a follow-up.

Moshe, I do not have a metrics right in front of me, but, I think, there is a gradual migration away from a revolving toward the transacting side of the business. But I don't have the metric in front of me, nor do we report that. Just looking as you can see the pretty eye-popping growth in purchase volume that would be consistent with that.

And you made some comments about the fee and finance charge reserve. That, probably three years ago, was probably at least $100 million higher. So I'm assuming with the growth in the business that that's a number that probably could be rising over the next couple of quarters? Is that reasonable?

Yes. All else being equal, more growth would lead to more of a reserve there.

Thanks.

Next question please?

Chris Donat, Sandler O'Neill.

Good afternoon, thanks for taking my question. Steve, I wanted to come back to something you said about the allowance methodology and qualitative factors. I'm just wondering with the environment we're in where we have a 40-year low on jobless claims announced today and oil prices and gasoline prices remaining low.

Are those things you factor into your outlook? Do you have expectations there? Because it seems like there should be tailwinds, or have been tailwinds for credit quality, particular for subprime borrowers, for the last few months.

I think the thing that you should really focus on in trying to forecast the primary drivers of provision are, obviously, charge-offs and allowances. We've given you a little bit of help on charge-offs over the near-term, and the two things I really want you to spend your time on in terms of the allowance builds are really the loan growth expectations and the charge-off replacement phenomenon that I talked about.

Qualitative factors can be important from time to time in terms of adjust over the next 12 months, but I think if you focused on those two, that's going to be the most important factors.

Next question please?

Betsy Graseck, Morgan Stanley.

Hi. Just a question on payment protection. You indicated 25 BPS are going to be gone by 2Q FY16, I wanted to make sure understood that we should assume that they ratable decline over the next three quarters? And then the follow-up is what kind of offset should we be thinking about that could potentially come through?

Betsy, this has been a gradually running off revenue stream ever since we stopped originating new payment protection in 2012. And that will continue to just gradually run off until the event happens over the course of the first quarter, it won't be on a single day, it will happen over the course of the first quarter, where we basically shut down the back book business.

And so from a run rate point of view where you'll see that affect fully is starting with the second quarter. And what we're saying is relative to full-year 2015 this is a 25-basis point effect. We are not -- I wouldn't look for any specific thing to offset that. It's one of many, many things that effect revenue over time. Our point is, other things being equal, that would take down the revenue margin by 25 basis points.

We have a very healthy revenue margin. We have great things going on in the business, but we are not intervening to do something on the revenue side to offset this. What we're doing is really just accelerating and getting over with something that was going to happen anyway over the next couple of years.

Next question please?

Rick Shane, JPMorgan.

Thanks for taking my question. I'd like to just delve in a little bit to the 11% year-over-year card growth. One of the things we're wondering is how much of that's really being driven by average balance growth from seasoned accounts, so say over 12 months, and how much is really driven by net new adds over the last 12 months?

That's, as you can imagine, a very good question, Rick. Because, of course, this is many vintages and various effects all happening on top of each other. I think the best way to think of this is that the majority of our originations and growth is from new account acquisition.

As just a general observation, the majority is coming from new account origination and the very natural, early balance growth associated with that. A sizable minority is coming from credit line increases on more seasoned book. But we are approaching an equilibrium with respect to those effects.

I flagged several quarters ago that we had a bit of an outsized credit line increase going on because we had had a brownout for the period preceding that. And we are pretty close to an equilibrium now, maybe just a little bit still residual on that credit line increase side, but what you see is approaching an equilibrium with respect to the mechanics of how growth works.

Great. That's very helpful. Thank you, guys.

Next question, please.

Sameer Gokhale, Janney Montgomery Scott.

Thank you for taking my questions.

Rich, you talked about your incremental investments in digital, and as I look at the banks and you it seems like digital is clearly the Wild West to a certain extent. When you think about digital investments, how do you think about sizing how much of a budget you want to allocate to those investments?

How are you thinking about that in terms of investments over the next couple of years. Is there a specific earmarked amount, or is it just ideas that trickle up that you feel you can fund on a discretionary basis? It would be helpful to see how you're thinking about that. Thank you.

Thank you, Sameer. Digital is becoming so all-encompassing into how life works and how the business works. It's increasingly difficult to even, in a sense, technically answer your question.

But we don't start with a thing that says okay, we have $X million to spend on digital and that's it. What we do is, we start strategically with the environment and say where's the world going and what does winning entail as the world goes there. And we work backwards and then develop a strategy and we figure out where we need to go as a Company.

Along the way you can imagine that digital is a centerpiece of that entire strategic agenda. And so everybody from the bottom up builds the economics of their business working backwards from where they're trying to go as a business and all of that adds up to our overall economics. We see if it makes sense. We drive incredibly hard to wring costs that are not directly related to digital innovation and growth.

I know you can't necessarily see those effects but they are very significant. As are the digital investments on the other side. But I think that I'd just like to stop and reflect a little bit on what is it that we're investing in?

Because I think a lot of banks say, and I've heard several of them say it, we're going to self-fund this digital investment. You tell me how much you can save and that's how much we can invest. That is a really, really tough we to take any institution to where it needs to go because the marketplace isn't waiting for us to do that on those terms.

On the other hand, we're not just investing in science experiments or seeing what's new and shiny object. When we talk about digital investment it starts with talent. We're talking about of bringing in top engineers, product managers, designers, data science that's often tech companies and startups outside of financial services. This is a very important thing and, obviously, it costs money to do that but that's a foundational thing.

We're talking about providing the digital workspaces and the most modern tools for these folks. That's essential in terms of recruiting them and essential in terms of leveraging them.

So often I think banks when they think about digital, they think, I've got to go build apps. We have to get customer facing or associate facing apps. Most of the leverage is really in infrastructure, in terms of things like rationalized and simplified core infrastructure. Increasingly we're focusing on cloud computing and building the underlying capability such that product development will be faster and faster and more effective over time.

We're obviously investing in terms of product development itself and we're on an accelerating basis shipping product and you can go to the app store and take a look at some of the stuff, it's pretty highly rated. We're investing in cyber security. This is an incredibly important area and we are putting a lot of very top talent and a lot of energy and investment into that.

The key thing is this is not because we think this digital thing is cool and there's opportunity someday. These are delivering benefits right now on many fronts. While you can't necessarily see it in the numbers that you see, but the enhancements to productivity, the power of innovation, the dramatically growing customer experience benefits and it's inextricably linked to the growth that we're generating right now.

Pulling way up from that it doesn't really start with, this is the number. It's really increasingly who we are and how we think about the business. But the keys -- so pulling way up. What we are so focused on is making sure that we can generate very strong returns for our shareholders and continue to invest in a future that has very strong returns for our shareholders over time.

And right now we see right in front of us two very, very big opportunities. One of them is card growth and the other one is this digital opportunity. Both of them involve spending money to make more money later, but at the end of the day I go back to the thing that we focus on every single day. How can we create value for our shareholders today and ensure that we can create book value for them tomorrow.

And the way to do that is to generate well above hurdle rate returns, to make sure that our investments are very disciplined and driven by a net present value framework to the absolute most rigorous extent possible, and be sure that we are really obsessive guardians of capital and in the end distributing capital to our shareholders.

So that's the long answer to your question. But I'm glad you asked because increasingly digital is who we are and it's where the leverage is.

Terrific. Thanks, Richard, I appreciate the fulsome answer.

Thanks, Sameer, and thank you, everybody, for joining us on this conference call tonight. We thank you for your continuing interest in Capital One. Just a reminder the Investor Relations team will be here this evening to answer any questions you may have.

Have a great evening everybody. Thanks.

And that concludes today's presentation. Thank you for your participation.