Capital One Financial Corp (COF) 2018 Q1 法說會逐字稿

Welcome to the Capital One Q1 2018 Earnings Conference Call. (Operator Instructions) I would now like to turn the call over to Mr. Jeff Norris, Senior Vice President, Finance. Sir, you may begin.

Thanks very much, Leeann, and welcome, everyone, to Capital One's First Quarter 2018 Earnings Conference Call. As usual, we are webcasting live over the Internet. To access the call on the Internet, please log on to Capital One's website at capitalone.com and follow the links from there. In addition to the press release and the financials, we've included a presentation summarizing our first quarter 2018 results.

With me this evening are Mr. Richard Fairbank, Capital One's Chairman and Chief Executive Officer; and Mr. Scott Blackley, Capital One's Chief Financial Officer. Rich and Scott will walk you through this presentation. To access a copy of the presentation and press release, please go to Capital One's website, click on Investors, then click on Quarterly Earnings Release.

Please note that the 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.

Now I'll turn the call over to Scott.

Thanks, Jeff. I'll begin tonight with Slide 3.

Capital One earned $1.3 billion or $2.62 per share in the first quarter. We had one adjusting item in the quarter, which was $19 million of restructuring costs. Net of this item, earnings per share were $2.65. A slide outlining adjusting items can be found on Page 13 of the slide deck.

Pre-provision GAAP earnings increased 3% on a linked-quarter basis and 8% on a year-over-year basis to $3.3 billion. Provision for credit losses decreased 13% on a linked-quarter basis and 16% year-over-year, primarily driven by smaller allowance builds in our Domestic Card business. Let me take a moment to explain the movements in allowance across our businesses, which are detailed in Table 8 of our earnings supplement.

In our Domestic Card business, we built $59 million of allowance in the quarter, reflecting seasonally adjusted growth and the moderating impacts of Growth Math. The allowance in our Consumer Banking segment increased $11 million, driven by growth in our auto business, and net reserves in our Commercial Banking segment decreased $33 million, primarily due to paydowns and an improved risk profile. Our effective tax rate in the quarter was 19.2%. We have refined our estimate of the impact of the new tax law, and we now expect our 2018 corporate annual effective tax rate to be around 20%.

Turning to Slide 4. You can see that reported net interest margin decreased 10 basis points from the fourth quarter, primarily driven by day count and an increase in rate paid for deposits, which was only partially offset by higher asset yields and mix. Net interest margin was up 5 basis points on a year-over-year basis, resulting from a higher mix of card assets on the balance sheet. As of the end of the quarter, our net interest income was modestly liability-sensitive to implied forwards, and a flatter yield curve would create a modest headwind to earnings.

Turning to Slide 5. Our common equity Tier 1 capital ratio on a Basel III standardized basis was 10.5%. Last quarter, I shared that we expected our CET1 ratio, which is our binding capital constraint, to trend back towards the mid-10% range. Since then, there have been several developments that have affected our capital requirements. These developments include: more severe 2018 CCAR assumptions that were provided by the Federal Reserve in its stress scenarios; more severe Federal Reserve CCAR loss models are coming for card and subprime auto; and of course, the impacts of both of these developments are compounded by the associated incremental disallowed DTA resulting from the loss of the NOL carryback.

Given these developments, we now believe that our CET1 ratio will trend up to around 11%. In the first quarter, we repurchased approximately 200 million of common stock, and in light of our updated view of capital, we do not expect to use any of the remaining authorization for the 2017 CCAR approval window, which ends June 30, 2018.

Importantly, this view does not incorporate any of the potential impacts from CECL implementation in 2020. With respect to CECL, we were pleased to see bank regulators acknowledge in their MPR that the initial challenges of -- the initial challenges of CECL implementation, but they didn't go far enough. Our current capital regime was built around an incurred loss allowance model, and under CECL, we will shift to a lifetime loss allowance but we've seen no commensurate shift in capital frameworks. We view the potential increase in allowance from CECL as simply capital in another form, and since the MPR doesn't allow for Tier 1 capital relief, it will, all else equal, simply cause banks to hold more capital.

In addition, CECL has the potential to be very procyclical and will discourage loan growth, especially in recessionary periods, and it will make financial statements less comparable and less useful. We will continue to advocate to bank regulators and the FASB to carefully consider all of the impacts of CECL.

So with that, I'm going to be turning the call over to Rich. Rich?

Thank you, Scott. I'll begin on Slide 8 with our credit card business.

We posted strong year-over-year growth in both revenue and pretax income, driven by the performance of both our Domestic and International Card businesses. Credit card results also benefit from the absence of any additions to our U.K. PPI reserves in the quarter, which adversely impacted the first quarter last year.

On Slide 9, you can see the first quarter results for our Domestic Card business. As a reminder, Domestic Card results and metrics now include the impacts of the Cabela's portfolio, which are playing out as expected. Ending loan balances were up $7.4 billion or about 8% compared to the first quarter of last year. First quarter purchase volume increased 18% from the prior year.

Revenue for the quarter increased 6% from the prior year. Revenue margin for the quarter was 15.9%, down 36 basis points from the first quarter of 2017. Strong net interchange revenue partially offset the expected margin pressure from Cabela's. Noninterest expense increased 7% compared to the prior year quarter.

The charge-off rate for the quarter was 5.26%, up 12 basis points year-over-year. The 30-plus delinquency rate at quarter-end was 3.57%, down 14 basis points from the prior year. Both metrics include the benefit from adding the Cabela's portfolio.

The competitive marketplace remains intense but generally rational. Supply of card credit is on the high side, although it has settled out a bit. We continue to see good opportunities to grow card loans and purchase volumes with a watchful eye on the marketplace.

Slide 10 summarizes first quarter results for our Consumer Banking business. Ending loans grew about 1% compared to the prior year, while average loans were up about 2%. Growth in auto loans was partially offset by planned mortgage runoff. Ending deposits were up 3% versus the prior year, with a 23 basis point increase in average deposit interest rate compared to the first quarter of 2017. We expect further increases in average deposit interest rate, driven by higher market rates and increasing competition for deposits.

The auto business continues to grow. First quarter auto originations were strong, and ending loans were up 10% year-over-year. Competitive intensity in auto is increasing, but we still see attractive opportunities to grow.

Consumer Banking revenue for the quarter increased about 4% from the first quarter of last year, driven by growth in auto loans and deposits. Noninterest expense for the quarter decreased 4% compared to the prior year quarter, driven by our ongoing efforts to tightly manage costs and the exit of the mortgage origination business last quarter, partially offset by continuing growth in auto.

Provision for credit losses was down from the first quarter of 2017, primarily as a result of lower auto charge-off rate and a smaller allowance build. In auto, we remain cautious about used car prices and our underwriting assumes that prices decline. As the cycle plays out, we continue to expect that the auto charge-off rate will increase gradually.

Moving to Slide 11, I'll discuss our Commercial Banking business. First quarter ending loan balances decreased about 2% year-over-year, and average loans decreased 3%. Both trends were driven by our choice to pull back in several less attractive business segments in the second half of 2017. With many of these choices behind us, ending loan balances increased about 2% from the sequential quarter.

First quarter revenue was roughly flat year-over-year as strong noninterest income in capital markets and agency offset the decline in average loans and the effect of the lower tax rate on tax-equivalent yields. Excluding the net impacts of the new tax law, revenue would have grown about 4%.

Noninterest expense was up 3%, primarily as the result of technology investments and other business initiatives. Provision for credit losses was actually a benefit of $14 million in the quarter, driven by lower charge-offs and a larger allowance release as compared to the first quarter of last year. The charge-off rate for the quarter improved to 11 basis points. The Commercial Bank criticized performing loan rate for the quarter was 3.7%, down 40 basis points from the fourth quarter. The criticized nonperforming loan rate was 0.5%, up 10 basis points from the fourth quarter.

Last quarter, we shared with you that we had moved the vast majority of our Taxi Medallion portfolio to held-for-sale, which drove most of our fourth quarter commercial provision expense. During the first quarter, we sold most of this portfolio and realized a small gain. We have just over $40 million in remaining Taxi Medallion loans and assets on the balance sheet, which are carried at a valuation comparable to the recently completed portfolio sale.

In the first quarter, Capital One delivered year-over-year growth in loans, deposits, revenues and pre-provision earnings. We tightly managed costs even as we continued to invest to grow and to drive our digital transformation. Total company ending loan balances grew 3% year-over-year, and we still see opportunities to book attractive and resilient loans in our card, auto and Commercial Banking businesses. We expect marketing in 2018 will be higher than 2017.

First quarter efficiency ratio improved year-over-year as revenue growth outpaced the growth in noninterest expense. While efficiency ratio can vary in any given year, over the long term, we continue to believe that we will be able to achieve gradual efficiency improvement, driven by growth and digital productivity gains. As always, marketing expense will continue to be driven by the opportunities and requirements of the competitive marketplace. We expect long-term improvements in total efficiency ratio will mostly come from improving operating efficiency ratio.

We continue to expect a majority of the tax benefit will fall to the bottom line this year. While it's still early to have definitive observations and conclusions, we continue to believe markets behave in predictable ways. A surge in tax benefits has a way of working its way into the marketplace through increasing competition, including higher levels of marketing and lower prices. Responding to these actions will likely consume a growing portion of the tax benefit over time.

In addition, we will also continue to lean into our investments in talent, technology, innovation, brand and growth. We are bullish about the long-term benefits of our investments. Taking all of this into account, we continue to expect that our current trajectory, coupled with the new tax law, will enable us to accelerate full year 2018 EPS growth compared to full year 2017 EPS growth, net of adjustments and assuming no substantial adverse change in the broader economic or credit cycles.

Pulling up, we continue to build an enduringly great franchise with the scale, brand, capabilities and infrastructure to succeed as the digital revolution transforms our industry and our society. Our digital and technology transformation is accelerating. We're growing new customer relationships and deepening engagement with new and existing customers. And we're strengthening our position to succeed in a rapidly changing marketplace and create long-term shareholder value.

Now Scott and I will be happy to answer your questions.

Thank you, Rich. We'll now start the Q&A session. (Operator Instructions) Leeann, please start the Q&A.

(Operator Instructions) And we'll take our first question from Moshe Orenbuch with Crédit Suisse.

Rich, I was hoping that you could -- I mean, you alluded to this in your prepared remarks. You talked a little bit about seeing opportunities for growth in a market that you kind of defined as still rational. Maybe if you could kind of flesh that out a little bit, where -- kind of where within the credit spectrum. What have you seen in terms of both supply of credit and the ability to -- for your borrowers to support it in the market? And how has that influenced your thought process?

Okay. Thanks, Moshe. So if I calibrate, so we had a big surge of growth in 2014 through 2016. And as you know, Moshe, we are very sensitive about what is the supply-demand situation in the marketplace, being so cautious about oversupply. And we saw a window that we said, at the time, it gave us, I think, an exceptional opportunity to grow and get the kind of performance that we wanted, and we went all in on that. In -- starting in 2016 and sort of into 2017, we saw a big -- a surge in industry supply. Well, it actually started before that, but there was a big surge in industry supply. In early '16, we started making our cautionary sounds about, look, that will probably have ripple effects on some of the performance metrics in the business, the credit performance metrics in the business. And sure enough, those performance changes -- I mean, that's nothing overly alarming, those performance changes we saw in our own and in industry metrics in 2016. And so we dialed back to a more moderate growth rate, dialed back basically around the edges across our revolver programs. And you see the slower growth in '16, and you can see growth has been pretty slow at this -- to this quarter that we're reporting today. I think I would describe that, generally, things have kind of settled out in the environment, not in a huge way, but just in a moderate way. You can see supply is a little bit settled out, even though supply is still on the high side. And clearly, the supply -- the growth of revolving credit is well above the growth of the economy, et cetera. So certainly, we'll call that one on the high side but kind of settling out. If you look at industry practices, pricing and various things, I think there is a rationality and a stability to things. Competition is fairly intense, especially on the very high end of the marketplace. But I would call it kind of a settling-out period. I think we see an opportunity for attractive growth in this environment, not like a big surge like before. But I think that we still feel optimistic about the ability to have appropriate attractive growth in this environment. You talked about where across the credit spectrum do we see this. I would really say that across the areas that we tend to invest in, we see some attractive growth opportunities. We continue to be going very hard at the top of the marketplace. That's very competitive there. I think that the people who will succeed and are succeeding there are those who invest for years in building a brand and sort of benefits of staying power in that particular area, but we continue to like our results there. And you can see we printed some pretty good purchase volume growth metrics. In the revolver space, across the credit spectrum, I think there's an opportunity, a kind of medium-sized opportunity there. So we'll be very vigilant along the way as we read the market conditions and act appropriately. But I think that we do see some opportunity for growth.

And just the last part of that was whether you kind of are seeing anything in the kind of customer base from an employment or income standpoint that would make you kind of more or less enthused.

Yes, I think for the consumer, things look pretty strong over -- in the near term. I think they're benefiting from job growth and wage increases, maybe a bit from tax cuts. And so I think that the consumer and the economy, sort of in which the consumer is a big part, is in the near term in a pretty strong and stable place. Now when you look out a little bit farther, there are a number of things that are still concerning like growing consumer indebtedness, growing the government deficits and a number of issues, but almost all the issues are a bit farther out. So all of that adds up to a view, in our case, that there is a kind of middle-of-the-cycle field to where we are right now. I think that we have some attractive opportunities to grow. But one has to, I think, bring a very careful and wary eye to work every day because there are a number of factors out there that could get a lot worse from here.

And our next question comes from Sanjay Sakhrani with KBW.

When I look at the monthly progression of the U.S. card credit metrics, they paint a pretty positive story. Delinquencies are down year-over-year. The charge-off rates seem to be trending down year-over-year now. Could you maybe help us reconcile your expectations for the charge-off rate to be up this year given this phenomenon?

Look, Sanjay, first, I don't think we've given any guidance about the 2018 full year charge-off rate. I think that we've historically been telling you that we expected that the increasing pressure on a year-over-year basis from Growth Math was moderating, and that's what we've talked about. I mentioned that, that is having a modest impact on the allowances. We've seen that thing come down. But Rich, I don't know if you want to make any other comments about that.

Well, and maybe it's appropriate to kind of just seize the moment and just talk about Growth Math and where we are on that. If we kind of pull back over our journey of the last several years, the reason we talked about Growth Math was to highlight the impacts of our outsized growth relative to the rest of the card industry. And that surge turned out to be from 2014 through 2016. And since then, our growth has been moderate. If you combine our vintages of outsized growth, 2014, 2015 and 2016, their losses have stabilized and now actually started to improve. And our newer vintages, 2017 and forward, are in the early seasoning phase with increasing losses. And this is a natural way that seasoning works in the card business. When you net these 2 effects, the result is the small tail of Growth Math we have spoken of. But pulling way up, we're near the end of the Growth Math story. And from here, we expect our credit will be impacted more by the economy, the competitive cycle and other industry effects. And these factors are more likely upward than downward. And they will, in our portfolio, will ultimately be a blend of all of these effects. But I think the thing we wanted to point out is that the surge, if you will, from 2014, 2015 and 2016, those vintages actually have turned to the positive.

I mean, I guess just a follow-up on that. I mean, do we think that now the charge-off rate could then come down for the year relative to last year? And then just one question on the CCAR comment, Scott. Could you maybe just talk about how the more onerous expectations affect your ask this time around, I mean, in terms of just dimensionalizing that?

Sanjay, we're not -- it's been our norm over the 20-some years we've been a public company not to give specific credit guidance. And I think our view is since now we're kind of beyond the Growth Math story and our credit is going to be driven mostly by industry factors, we give you a little bit of a window into what's happening along the way with that thing I'll call the surge over the 3-year period. But I think we're now -- it's probably less of a Capital One-specific story and more about industry factors. But we will have a bit of the beneficial impact of that -- of the surge being very gradual. All other things being equal, a very gradually beneficial. And again, everything being precisely equal, something that is, over the rest of its life, sort of having -- being a modest good guy as opposed to the "bad guy" it has been for several years as the losses have been so front-loaded.

Sanjay, on CCAR, so I obviously can't give you much information about our 2018 CCAR submission. I will kind of just pull up and first talk about the white paper that the Fed released on its modeling. We don't have any more information about how that's going to impact us than you do. We've made assumptions about that in terms of dimensioning the 11% that I'm -- that I've told you that we're going to be trending towards. So I'll just make a couple of comments about what I think looking ahead for capital. I think that we're going to be trending up towards 11%. I would think that we'll get there over the next 12 months or so, for sure. I would think that when I look at our earnings capacity, I think that we have the earnings capacity to have -- support growth, to support our capital trending up and for the opportunity for some continued capital distribution along the way. So we're looking at all components of that as part of our dynamic management of our capital levels.

And we'll take our next question from Don Fandetti with Wells Fargo.

Rich, I was wondering if you could talk a little bit about sort of your view on industry card loan growth. If you look around, a lot of the issuers are tightening up underwriting on the edges, yet the consumer is in very good shape. Can you talk a little bit about the outlook there and also the competitive dynamic? You've got the Fed continuing to raise rates, yet you've got corporate tax rates that have been cut. Are you seeing any changes in the competitive behavior from some of the banks?

Right. Don, the -- I wouldn't -- I'm not sure that the industry is pulling back as much as it's kind of settling out. It was clear that the growth of -- in the card business, the growth of supply was surging over the last couple of years. It is -- seems to have settled out around 6% subprime growth rate, surged quite a bit higher than that and has now come down, but it is still a little bit higher than the prime rate. So again, my characterization of that would be supply is on the high side but kind of settling out relative to the pace it was going 1 and 2 years ago when we were raising some alarm bells. The -- on the -- at the top of the market, there's a tremendous competition at the top of the market. And the top competition shows up in rewards offerings that not only are card players actively putting some pretty aggressive things out there, but retailers are kind of jumping into the fray. There's been a lot of competition on rewards themselves, intense marketing associated with those. And I -- my expectation is that, that will continue. I see nothing abating about that. You asked the question about the impact of taxes. The -- both intuitively and in any retro studying we have done, when a windfall happens to come to companies, intuitively and empirically, it seems those windfalls end up making their way into the marketplace. Now one of the frustrating things will be, I'll say it in advance now, we won't be able to measure it and we won't be able to ever attribute any particular thing to that in the same way when the windfall from bankruptcy reform that happened in the '00s ended up making its way, I would argue, into a pretty unhealthy way into the credit card marketplace. Again, who can attribute cause to all of these things? But the striking thing in the wake of that, sort of the industry got a little bit overheated and competitive in some unnatural ways. So -- but my points are even kind of larger than a card industry point. I think as a corporate America point, with a big windfall is my expectation over the course of, say, the first year, most of that, I'll certainly speak for Capital One when I look at our own actions, I think that this thing looks like it's headed to fall to the bottom line. But I think my cautionary words to all of us is, I would expect, in little ways here and little ways there, this will make its way into the marketplace in the form of more investment, more spending, pricing in various ways such that it kind of gets competed away, which is probably -- which is a good thing from a societal point of view, and how in the end, giving a break to corporations has a way of making itself broadly available into the marketplace. But to -- so although we won't be able to measure it, we are assuming, over time, in our own planning, that the marketplace will get more competitive, and those are my cautionary comments. And in the end, the one thing we'll know is we won't really be able to measure that effect. So if I pull way up though, I still am pretty bullish about the opportunity in the credit card business. I think it's a reasonably stable time in the industry. We know which direction in the credit cycle things are moving, but I think there's a window of opportunity to still have some good growth.

And just a quick clarification. If I look at your funding costs on securitized debt in senior and subordinate notes, it looks like they went up a lot, the yield quarter-over-quarter. Is there anything to call out there, or was that just sort of normal progression?

Yes, most of our wholesale funding is actually swapped out to 3-month LIBOR, so that's just really reflective of kind of the rate moves. And we saw a little bit of a disconnect in the 3-month LIBOR, which runs through that for most of those items.

And our next question comes from Rick Shane with JPMorgan.

I just want to talk a little bit about the impact of higher deposit costs and higher rates on funds transfer pricing. I realize it's a net -- or it's a zero-sum between corporate and the consumer bank. But I am assuming that as rates rise, the bank will be more profitable at the expense of the corporate and other line. I would just like to go through that a little bit.

I think as a really broad principle, I think you're right. I think that the -- we transfer funding costs from the other segment into the retail bank, and as rates rise, that spread's going to be more beneficial. And so all things being equal, I think that's likely going to be true.

Scott, and how often do you reprice that, just so we understand -- think about the dynamic in the right way?

Yes, we do that on more or less a monthly basis is the process that we follow.

And we'll take our next question from Ryan Nash with Goldman Sachs.

So I just wanted to ask a follow-up to one of the questions that was asked earlier regarding credit. Now we've obviously seen 2 straight months of improving charge-offs and delinquencies. Rich, you talked about the '14 through '16 vintage. Vintages are starting to have some gradual improvements. So given that we're now a couple of months into the year with both losses and delinquencies down on a year-over-year basis and seemingly, we should have more tailwinds from this, I guess, what would we need to see from -- if I'm assuming the environment is going to be stable, what would we need to see for losses and delinquencies to actually start going up over the course of the year? I take the point that there's no full year guidance, but I'm just trying to understand, unless there's a big change in the operating environment, why would losses start to go up?

So I think small changes in the environment can very easily happen. They can come on little cat feet. I'll give you an example of just what happened in 2016. Now in 2016, we were just beginning to -- well, we were in the last year of our growth surge. But we started raising alarm bells about some of the supply things we saw going on. And sure enough, when we -- when you look back -- and by the way, at the time, one can't really see things, particularly on origination programs and things like that. But if you look back at the period where I would say the card industry worsened a bit, starting in the second quarter of 2016, particularly on the origination side, where the industry vintages from that period started gapping out, you -- there was a worsening there. And then we also saw that over the 2016 and 2017 period, that the good guy the back book had been for so many years we'd almost all forgotten, where the back book not only was stable, it actually was getting better and better, that moved to stable and then actually, for several quarters, and you can see this as an industry phenomenon, it was Capital One and you can see it in the securitization trust for the industry, actually worsened. Now both that origination effect that we noticed in the second quarter of 2016 and this back-book effect that went from good guy to neutral, to even a worsening, that seems to have settled out a little bit. But those are things that can happen very easily. And while there always can be economic effects that cause them, the thing that I'm most focused on, those things can happen very easily by competitor actions in the marketplace, extra supply, changes in underwriting or various things. So I -- my only point is that this is why we're not really in the credit guidance business because what we want to do is be in the credit guidance business when we have unique things to talk about, about our portfolio that wouldn't just follow the industry things. So look, I think the most important thing that I have to share with you is that our 2014 to '16 surge has turned into a gradual good guy. And that -- and so whatever thing that happens from there, whether the industry gets worse or better or whatever, we will have that little benefit on our own portfolio, and it may be beneficial relative to other card players. And put another way, as we've talked about, is we're farther along in the later innings kind of in Growth Math than some of the other players. So I think Capital One will carry that particular benefit. Whether losses go up or not for us and the industry, I think is something we'll have to see.

Got it. And I guess, if I could ask one follow-up. Rich, you've been spending heavy on tech for the past 5 years, but we still managed to see 330 basis points of efficiency improvement in the last 2 years. However, I think over half came from lower marketing and lower amortization. So as you continue to get more benefits from these analog cost-saves and maybe we start to see some of the investments sunsetting, could we actually start to see the savings that you're seeing coming through on the expense side accelerate and maybe we could see a little bit lower expense growth going forward?

I think the -- I think we have one growing benefit and one less benefit than we had on something like efficiency ratio relative to the last few years, and not even counting, by the way, your point on amortization. But I think the benefit that will grow over time is the relative meter between the increased investment in technology, which has been going on for years, and the meter of the savings that we get because we're investing in technology. And what I've been saying for a long time is Capital One was way out there from the beginning, saying, while some banks are saying they're going to self-fund their tech investment, I want to make one thing clear: We're not self-funding this thing. It's going to cost more before it costs less. So we have continued to invest heavily in technology, and we will continue to invest heavily in technology. And there are many benefits that come from that, and cost to me isn't even at the top of the list and we're not doing it primarily for cost benefits. However, with respect to cost, there are 2 growing good guys to offset the continued investment in technology. One is tech savings on tech spend. And so a bunch of the -- we're spending a lot in technology, and it's starting to actually create some tech savings. The other thing is the -- really helping to grow the meter of sort of 1 minus tech spend across the company. And this is a gift that will keep on giving over time. And so what I've always said is I'm not ready to predict what -- it could be that tech spend will grow as far out as we can see because at some point, we all become just tech companies. That's all we are. But the thing that is clearly going on is our -- that tech is starting to save on itself and 1 minus tech spend is that the savings meter is starting to grow, and I think that's going to be a gift that gives for a bunch of years. Now the one thing that's not as helpful to us over the next few years relative to what we had as our efficiency ratio has pretty steadily marched down over the last few years is the, basically, the growth rate of the company. We were able to have the -- it was really nice to have a pretty rapid growth rate and just not grow cost as much. So we got our work cut out for us more with more moderate growth rates. That's going to be a bit harder work, but we believe that -- and a very important way our investors will be paid and an important manifestation of the benefits of really transforming the company into a tech company that does banking instead of a bank that, like I think so many in the industry, a bank that uses technology, is that we should be able to have the benefit in the operating cost over time. In any particular year, we're not really into the near-term guidance on that. And the only other thing that I wanted to say just about efficiency ratio -- and you may have noticed the distinction that I made, that what we believe over the longer term, overall efficiency ratio will be a good guy over time. I think that marketing, we've already said we expect to increase marketing over time. We had earlier questions on this call about the very competitive card marketplace, et cetera, as we look around. We expect to continue to invest heavily in marketing. I think it's really important to the growth opportunities of the company and for the brand and ultimately, where we need to go as a company. But even in spite of higher marketing spend, we are very hopeful for the continuing benefit of operating cost through technology savings to carry the day.

And we'll take our next question from Betsy Graseck with Morgan Stanley.

A couple of questions. One, I just want to understand -- make sure I understand what you said about the CET1 ratio, the capital ratio. So I think you said that over the course of the next 3, 4 quarters, you expect you can get it back -- you can get it to around 11%. Do I take that to mean that from there, you would anticipate holding it at 11%? I just want to make sure I understand the drivers behind why you feel the need to go there and how we should expect it trajecting and what kind of levers you're planning on pulling to either maintain or to get there.

Yes, hey, Betsy. Thanks for the question. So I did say that I would expect that we would get to around 11% over the next 12 months or so from here. I think that we've got the earnings power that's going to allow us to accrete to those levels, and at the same time, support growth and the potential for some capital distribution as well. As we think about kind of where we need to be, I think 11% is kind of where I see the company needing to be with our current mix of business. The one thing that is out there that we're going to need to keep a close eye on is CECL. And as kind of the way CECL and its implementation comes out, we're likely to, at some point, going to have to take and adjust that 11% for what we see and what we learn about kind of how CECL is going to be implemented in stress testing and the day-1 effect of CECL. So those are all the things that I think that I have to say on that topic.

Okay. Just because the timing, does it have to do in part with what the CCAR test was like this quarter? Is it at all around a Fed parallel run on Basel II? Is it a function of what your outlook is for credit losses? I'm just trying to understand the timing of this comment around 11%.

Yes, well, the timing is mainly -- I previously mentioned that we thought we need to be around 10.5%. And since then, we've gotten additional information from the Fed about them incorporating updated models in card and in subprime auto, which are 2 big businesses for us. So we're trying to make sure that we don't get caught behind the 8 ball on any of those items.

And we'll take our next question from Eric Wasserstrom with UBS.

Rich, if I may, I'm just trying to just sort of aggregate the responses to several of the questions that have come before so that I can sort of understand where the real pivot points in the income statement exist. So is it -- is this a fair characterization? I mean, what we're going to see is sustained but relatively low growth, a little bit of margin benefit as yield -- asset yields outpace changes in cost of funds and operating and provision benefits relative to the prior year as the primary drivers of EPS growth. Is that basically correct?

Hey, Eric, I think that when it comes to margin, I think that what I would say is if you look at our sensitivities to further rate changes, we're basically neutral to implied forwards. So I don't anticipate that you should expect a benefit with Capital One from further rates. In fact, we're slightly liability-sensitive. And so that can be -- that's against -- that's in a shock scenario, so we're slightly liability-sensitive there. And then I would also add that we are sensitive to the shape of the curve. So if we were to see a slightly flatter curve, that also can create a headwind for us to net interest margin. And then I think when it comes to operating efficiency, as Rich just said, that's something that we've given guidance, that we believe over time that that's a metric that we will see trend down. We've mentioned that we anticipate increasing our marketing spend versus 2017. And then on the growth side, I think I would just characterize that as we think that we've got a pretty good competitive environment to compete. And so we're not going to see kind of the same growth rates that we were able to see kind of in the '14, '15, '16. We think that there's an opportunity for us to have healthy and reasonable growth.

And if I can just follow up on one point. The -- I was trying to calculate the marginal cost of deposits, and it looks like the delta there in cost was about 33 basis points and the Fed funds were up about 34 over the course of the quarter. Is that -- is my math in the ballpark?

I think that you're in the ballpark in terms of total costs. Certainly, we had a number of -- we talked a little bit about wholesale funding going -- as being indexed to the short end of the curve, 3-month LIBOR, so that picked up all of the change there, so basically, a beta of 1. And then we also had some higher rates moving up in our commercial business as well as some of the more competitive aspects of savings and CDs. So those were all the things that contributed to that move-up in average deposit pricing.

And our next question comes from Ken Bruce with Bank of America Merrill Lynch.

I'd like to ask a question on credit. And look, I understand you're trying to get out of giving any direct guidance, and so I won't ask for that. But if we look back at the last couple of years of growth, and you've pointed out that there was inflated growth through '16, there was also a pretty significant shift in the mix of Capital One's business towards sub-660 FICOs. And that has come off pretty dramatically over the last few quarters. So is it fair to assume that as we look forward, that the -- that slower growth in that subprime portfolio should begin to accelerate the, if you will, the improvement or the downward pressure from the kind of reverse Growth Math over the next, call it, 18 months?

Ken, I probably -- I mean, mechanically, what you say would be the way things would work if the subprime mix goes down. And we have seen the subprime mix has declined recently. I do want to say Cabela's is a pretty significant contributor to that impact. These are also numbers that are like rounded off to the nearest integer kind of thing. And I wouldn't want you to take away that things have changed relative to the mix of Capital One business. I think things are very similar to how they've been for a long period of time. Most of our pullback around the edges was like through all our revolver businesses, in a way, just trying to be cautious in the context and the industry getting a little bit carried away, while continuing to pretty intensely go after the top of the marketplace. So I think things are going to be pretty consistent from a mix point of view as a general observation, but that number will bounce around, and Cabela's has brought it down relative to the highs from a couple of quarters ago.

Great. And our own math would support that just the growth that you had in '16, in particular, is going to actually start to give you some downward pressure on loss rates into '18, so we're a bit more optimistic about that than maybe you. My follow-up question is on...

Can I -- Ken, I'm sorry, can I -- the one thing I wouldn't take to the bank, because I don't take it to our bank, is the vintage -- vintages, in general. I think the way to think about vintages is that for a couple of years, they're very clearly sort of bad guys. And then there's kind of a stabilization and then there's this kind of, over the rest of its life, all other things being equal, a very gradual kind of positive, right? So I -- and one thing that I've always been struck by is each vintage has a different personality that -- where it actually peaks, the exact timing of when they turn. So I wouldn't lean in too hard to any particular vintage and count on that being a big contributor. But all of that said, the physics -- remember, when I've come out with this Growth Math term, I said, "Look, I can't be precise about the exact timing and magnitude of things, but it's sort of physics." The physics works as you're saying. I just wouldn't lean in too hard on any one vintage really being a significant contributor to this year's performance, particularly '16, which is the youngest of the 3 that I talked about in the surge. Anyway, sorry, go ahead. I interrupted you.

Yes. Caution noted. I guess the -- my follow-up is just if CECL is going to create this potential capital event, would you think about changing the mix of business that you were willing to do based on the potential life-of-loan loss expectations that had to go into that math?

Ken, the one thing I would just say about CECL, I think CECL is going to have an impact on a number of different asset classes. I don't think this is just something to be worried about with, whether it's card or auto, for us. When I look at -- it's really going to have an impact on any type of asset that has a long life, where you're going to have to extend your coverage from what's a 1- or 2-year coverage window to a lifetime window. I think with card, one of the challenges with card is because it's a revolving asset, and with CECL, you're setting an allowance based on the outstanding balance, we may see that card isn't the asset class that's most impacted by CECL. But I think that the biggest challenges for CECL that I see are as you're going in and out of a cycle, it's really going to be procyclical and it's going to really put a challenge for all banks, not just Capital One, for all banks, I think. It's going to disincentivize loan growth in tough times. So that's -- sorry to carry on there, but I think those are -- there are broader impacts than just in Capital One.

But Ken, I actually want to follow up on the strategic spirit of your question. Look, if you pull up on, frankly, the credit card business in general, subprime cards in particular, the tax on them, if you will, over time, is pretty striking. The capital requirements that have continued to build the stress test modeling about that business, the -- because it's a higher-loss business, the front-loading, and then with FAS 166/167, bringing all that into front-loading, the impact of a -- of rapid growth in the business, then you bring the CECL effect, this is a lot of tax on the business. What is clear to us is we have to make sure that we -- our risk-adjusted return in a business like this is robust and resilient to all of this. I'm hopeful, over time, that a rational industry incorporates these things. I mean, these things should show up in the form of higher required returns, higher pricing for the risk and things like that. One thing it does do is scare off a lot of players who dabble in this space. And so I think it's pretty clear that people are going to have to really -- I think that people are going to have to really be good at this in order to do it and be very successful. But I think it is worth taking note on how much the tax on really most consumer lending, in general, has gone up in the banking business. And now look, in the end, as markets equilibrate over time, I feel that the nature of our potential competitive advantage is the same. But we can't get there by just going in and doing the same thing and making the same assumptions we've done that we used to do, and we ourselves have to ask it to deliver even more, given the tax on it.

And our final question tonight comes from Chris Brendler with The Buckingham Research Group.

I think to just focus on the noninterest income in the card business for a moment. I think you mentioned the strong net interchange growth, but I think we've had some head fakes in this line item before. Anything to call out in that strong double-digit growth in net interchange, either on the interchange or reward side that's driving that? And as well, that the service line, service fees in that statement as well, service fees were up for the first time in a long time. And I think you've been pulling back on some of those credit products that are sort of nonlending-related fees in the card business, and it looks like that may have inflected as well. If you just had any insights on those 2, that would be great.

Yes, why don't I just start off on service charges? The service charges, when you're looking at that on a year-over-year basis, just remember that last year, we had a U.K. PPI charge that was around $37 million that impacted Q1 '17. So that's impacting the period-over-period. And I'd just also mention that as part of the new accounting standard that we adopted, we reclassified about $18 million of FX-related fees that used to run as a contra to service and got moved down into operating expenses. And so that's impacting Q1 but not any of the prior periods. So that's -- it's really just some of the mechanical things that are impacting that trend line as opposed to core business things.

Chris, on the interchange side, we -- as you've seen for years really, the growth in purchase volume has well outstripped the growth in interchange revenue. Second thing I think has been very striking, and it's what's behind your question, is this number bounces all over the place and it's almost in any 1 quarter, and especially if you're looking at growth rates in any 1 quarter, not only does that quarter bounce, but we're comparing it to a year-ago quarter that had its own bouncing dynamics to it. So I think it's kind of structural in the marketplace that the interchange growth is less than the growth in purchase volume because of the growing competitiveness of the marketplace, the -- and the growing penetration of great rewards products to all the players, including Capital One's broad -- broader customer bases. But I also am pleased to see though, that even in the tremendously intense interchange race that we all -- I mean, the rewards competition that we see, that it is the case if you pull way up from this bouncing ball, you see that year after year, Capital One's been posting pretty solid net interchange growth in the face of all of this competition and all the moves to extend it to broader parts of our customer base. And I think that that's a manifestation of the fact that while we're competing very intensely, we keep our pencils very sharpened to make sure that the collective economics of what we're booking is something that can really reward us over time. And we continue to believe in the economics of this franchise we're investing so heavily in, this top-of-the-market spender business. And I think that while this is a particularly high quarter, and I wouldn't take that one to the bank, I think that the fact that there is real interchange growth is real.

Great. And if I could ask a follow-up on credit maybe in a different way, instead of looking at the loss rate, looking at the provision expense and reserve building. Subprime loans in the mix you mentioned is actually directionally down on a dollar basis. So sort of excluding the Cabela's effect, subprime's gone negative. Delinquencies are negative, loss rates are improving, and growth has slowed. Any reason why reserve building shouldn't continue to slow from here in the card business?

Chris, thanks for the question. Look, I would just say that when it comes to the reserve, that's a really dynamic process. You know that. It's small changes in expectations. Given that we've got a $100 billion card portfolio, a 10 basis point move there is $100 million of allowance. And so I think that there are a number of forces. Rich talked about all the dynamics that will impact our overall loss rate, and those are really the things that I think we'll be looking for to drive the allowance going forward, as well as just the amount of growth that we're putting on the balance sheet.

So that concludes our call and our Q&A session for this evening. Thank you very much for joining us on this conference call today, and thank you for your continuing interest in Capital One. Remember, if you have further questions, the Investor Relations team will be here after the call. Have a great night.

And that does conclude today's conference. Thank you for your participation. You may now disconnect.