Capital One Financial Corp (COF) 2019 Q2 法說會逐字稿

Welcome to the Capital One Second Quarter 2019 Earnings Conference Call. (Operator Instructions) Thank you. I would now like to turn the call over to Mr. Jeff Norris, Senior Vice President of Finance. Sir, you may begin.

Thanks very much, Leanne, and welcome, everyone, to Capital One's Second Quarter 2019 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 financials, we have included a presentation summarizing our second quarter 2019 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 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 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 in 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, which are 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 $1.6 billion or $3.24 per share in the second quarter. Net of adjusting items, earnings per share were $3.37. Adjusting items in the quarter included $54 million of launch and integration costs associated with our Walmart partnership and $28 million of restructuring charges associated with the exit of certain investing businesses. Slide 13 of our earnings presentation outlines the financial impact of these costs.

In addition to these adjusting items, we sold several small partnership portfolios in the quarter totaling approximately $1 billion of outstandings, which resulted in a pretax impact of $128 million or $0.21 per share and included a gain on sale of $49 million and an allowance release of $68 million. This collection of partnerships generated about $160 million in annual revenue.

Relative to a year ago, adjusted preprovision earnings declined 1% with revenue growing 4% offset by noninterest expense growing 9%, which was driven by higher marketing expense and the absence of a nonrecurring adjustment to a vendor agreement this time last year. Provision for credit losses increased 5% driven by a modest increase in charge-offs, coupled with a smaller allowance release in the current quarter compared to the prior year quarter.

Let me take a moment to discuss the quarterly movements in our allowance for each of our businesses, which are detailed in Table 8 of the earnings supplement. Our card business saw an allowance release of $225 million. The release was driven by the strong economy and stable underlying credit performance as well as the partnership sale I discussed earlier. In our consumer business, there was a slight release of $7 million driven by our auto portfolio. Reserves in our commercial business increased by $68 million -- $66 million primarily related to a handful of credits.

Turning to Slide 4. Net interest margin was 6.8% in the quarter -- 6.80% in the quarter, 14 basis points higher than the prior year quarter. The year-over-year increase is largely driven by the lack of a couple of discrete events that occurred a year ago, including a build to our U.K. PPI reserve and the net impact of the sale of our mortgage business, which collectively were a 17 basis point drag on NIM this time last year. These factors were partially offset by higher average deposit costs as we continue to see strong growth in and mix shift towards our Capital One 360 deposit products. Going forward, we continue to expect deposit mix to be a headwind to NIM throughout 2019.

Turning to Slide 5, I will cover capital. As previously announced, following the Federal Reserve's nonobjection of our adjusted CCAR plan, our Board authorized repurchases of up to $2.2 billion of common stock through the end of the second quarter of 2020, and we expect to maintain our quarterly dividend of $0.40 per share, which is subject to Board approval. Our common equity Tier 1 capital ratio on a Basel III standardized basis was 12.3%. In the near term, we are well positioned to support the Walmart portfolio acquisition, organic loan growth, the phase and impacts of CECL and capital distribution.

Based on company performance and the evolution of capital regimes, we continue to believe that our long-term capital need is around 11% CET1. However, we will keep an eye on the impact and timing of the Fed's tailoring and stress capital buffer proposals, CECL and the evolution of CCAR.

We are well along in preparing to adopt CECL on January 1, 2020. We have been running CECL models quarterly and working through accounting elections that we continue to refine. We expect to provide details on the impacts of adopting CECL in our Q3 call.

With that, I will turn the call over to Rich. Rich?

Thank you, Scott. Slide 8 summarizes second quarter results for our credit card business. Pretax income was relatively flat compared to the second quarter of 2018. Year-over-year growth in loans and purchase volume drove higher revenue, which was offset by higher noninterest expense. Credit card segment results and trends are largely driven by the performance of our Domestic Card business, which is shown on Slide 9.

Second quarter Domestic Card results include the impacts of our choice to exit several small partnerships that Scott mentioned. The exits and portfolio sales affected the optics of second quarter Domestic Card loan growth, revenue and allowance.

Ending loan balances in our Domestic Card business were up $2.2 billion or about 2% compared to the second quarter of last year. Excluding the impact of the partnership exits, ending loans increased about 3%. The growth of Branded Card loans, which exclude all private label and co-brand cards, continues to accelerate. In the second quarter, Branded Card loans grew 4.7% from the prior year quarter.

Year-over-year growth in new accounts and purchase volume was well above the growth in loans in the quarter. New account originations were very strong in Branded Cards, particularly at the highest end of the marketplace as we continue to gain traction in our heavy spender franchise. Led by heavy spenders, Domestic Card purchase volume growth was 10% from the prior year quarter. Total company net interchange growth was 13%. Notably, we have been able to grow our spender franchise without sacrificing revenue margin.

Revenue increased 7% from the second quarter of 2018 aided by a gain on sale of the partnership loans. Excluding the gain on sale, revenue increased by about 5%. Growth in purchase volume and average loans drove the underlying increase. Revenue margin increased 57 basis points to 16.45% for the quarter with 21 basis points of the increase from the gain on sale.

Noninterest expense was up about 21% compared to the prior year quarter. Operating expenses increased as we continue to ramp up operational capabilities for a smooth Walmart conversion and launch later this year and because the second quarter of 2018 benefited from a nonrecurring vendor accrual adjustment. Marketing increased year-over-year as we continue to see attractive market opportunities.

Credit performance remained stable. The charge-off rate for the quarter was 4.86%, up 14 basis points from the second quarter of 2018, and the 30-plus delinquency rate was up 8 basis points. Pulling up, in the second quarter, our Domestic Card business delivered strong results and continued to gain momentum.

Slide 10 summarizes second quarter results for our Consumer Banking business. Ending loans increased about 3% compared to the prior year quarter driven by growth in auto loans. Average loans decreased by about 10%, reflecting the trailing impact of the home loans portfolio sale in 2018. Second quarter auto originations increased 5% year-over-year after several quarters of year-over-year decreases. The return to growth in originations is, in fact, a direct benefit of our investments in -- is in part a direct benefit of our investments in differentiated digital customer experiences.

Ending deposits in the consumer bank were up 5% versus the prior year quarter with a 38 basis point increase in average deposit interest rate. Powered by the rollout of our national banking strategy, our strongest deposit growth is in Capital One 360 products, driving a product mix shift toward high-rate deposit products.

Over the past year, the changing product mix, rising market interest rates and intensifying competition drove the increase in our average deposit rate. From here, we expect that faster growth in high-rate deposit products will continue to change our product mix. Our average deposit interest rate will depend on several factors, including our deposit mix, the market interest rate environment and competitive dynamics.

Consumer Banking revenue increased about 5% from the second quarter of last year. Growth in auto loans and retail deposits was partially offset by the revenue reduction from the home loans portfolio sale in 2018. Noninterest expense was up about 4% compared to the second quarter of 2018 driven by marketing for our national banking strategy. Provision for credit losses increased $47 million from the prior year quarter driven by a modest allowance release in 2019 versus a larger allowance release in the second quarter in 2018.

The auto charge-off rate improved compared to the prior year quarter to 1.09%, which is a large improvement to an unusually low level. Better-than-expected auction values and a benign economy continue to support strong auto credit. We continue to expect that the annual auto charge-off rate will increase gradually as the cycle plays out.

Moving to Slide 11. I'll discuss our Commercial Banking business. Second quarter ending loan balances were up 6% year-over-year. Growth in average loans was 8%. Linked quarter growth was more modest with ending and average loans both up about 1%. Commercial bank ending deposits were down 1% from the prior year. Average deposits were down 5%. Over the past year, commercial deposit customers have rotated out of deposits and into higher yielding investments in the rising interest rate environment.

Second quarter revenue was down 2% from the prior year quarter. Lower average deposit balances contributed to the decrease, and the revenue benefit of higher average loan balances was offset by lower loan margins.

Noninterest expense was up 4% compared to the prior year quarter as we continued to invest in technology and other business initiatives. Provision for credit losses increased compared to the second quarter of 2018. The largest driver of the increase was an allowance build driven by downgrades to a handful of credits.

Commercial Banking credit performance remained strong. The charge-off rate for the quarter was 0.09%, and criticized loan rates were relatively stable compared to both the prior year and sequential quarters. The criticized performing loan rate for the second quarter was 3.1%, and the criticized nonperforming loan rate was 0.5%.

Pulling up, increasing competition from nonbanks continues to drive less favorable terms in the commercial lending marketplace. We're keeping a watchful eye on market conditions and staying disciplined in our underwriting and origination choices.

In the second quarter, Capital One continued to post solid results as we invest to grow and to drive our digital transformation. Our marketing investments are building our momentum and creating great value. Our Domestic Card business posted strong year-over-year growth in new accounts, purchase volume and net interchange revenue as we continued to gain traction with branded cards and heavy spenders. In our Consumer Banking business, our national advertising, brand and compelling digital experience enable us to post strong year-over-year growth in retail deposits without being the industry price leader.

With the momentum we have in domestic cards and retail deposits, we continue to expect full year marketing for 2019 to be modestly higher than in full year 2018 with more normal seasonal patterns than the exaggerated patterns we saw last year. As always, marketing will depend on our continuous assessment of opportunities in the competitive marketplace.

And as I discussed last quarter, we are now in the seventh year of our technology transformation. We're building a technology company that does banking instead of a bank that just uses technology, and our progress is accelerating. Our technology transformation is motivated by many benefits: faster to market, better products, better customer experience, better risk management, more effective operations, more growth, better efficiency. We are already seeing significant benefits across the company.

For example, digital productivity gains are driving operating leverage. Since our journey began, operating efficiency ratio has improved by 400 basis points even as we have continued to invest in our transformation. We are operating today with one foot in the legacy data center environment and one foot in the cloud as we continue to complete our cloud journey. As we migrate an increasing percentage of our applications and data to the cloud, we have all those costs. And at the same time, until we fully exit our data centers, we also bear the significant legacy costs as well.

We continue to expect that we'll complete the exit of our data centers by the end of 2020, which should generate significant costs and efficiency improvement opportunities beginning in 2021. Until then, we'll continue to drive for operating efficiency improvement even with the elevated costs of straddling both the data center and cloud environment. We expect to achieve modest improvements in full year operating efficiency ratio net of adjustments in both 2019 and 2020.

We continue to expect full year operating efficiency ratio net of adjustments to improve to 42% in 2021, powered by the exit of our data centers, continuing technology innovation and Walmart. And we expect this operating efficiency improvement to drive significant improvement in total efficiency ratio by 2021 as well.

As the many benefits from our technology transformation continue and increase, we are well positioned to succeed in a rapidly changing marketplace and create long-term shareholder value.

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

Thanks, Rich. We'll now start the Q&A session. (Operator Instructions) Leanne, please start the Q&A.

(Operator Instructions) And we'll take our first question from Sanjay Sakhrani with KBW.

First question's on the interest rate environment and the broader market expectations of rate cuts. Scott, could you just talk about how we should think about the NIM trajectory in that backdrop? I know Rich spoke to the pressure from higher deposit funding costs but just how you guys expect to manage through that?

Yes. Thanks, Sanjay. So as a reminder, I think we've said this many times that we really don't seek to bet on interest rate movements, and we try to maintain a pretty neutral rate position relative to implied forwards. So from here, I would say that a flatter or inverted yield curve is going to be a modest headwind to our NIM. On flip side of side, a steeper yield curve is going to be a modest tailwind.

As you know, the yield curve flattened in Q2, and long-term swap rates are now down to around 2%. And at that level of long-term rates, the flatter yield curve has created probably a few basis points of headwinds to -- of headwind to NIM in our full year 2019 net interest margin. So that's a little bit of where I see the interest rate's impacting us.

Okay. And then my follow-up question on that partnership loss. Was it a matter of misalignment between yourselves and the partner? Or is it sort of a reflection of a more heightened competitive environment? And maybe, Rich, you can just speak to the broader competitive environment while you're at it.

So I don't think there's any big significance to read into this. What I would say is with our digital transformation and where we're going in our card business, we are focusing more on partners that are industry leaders and scale players. And we continue to be very excited about the card partnership business. And of course with Walmart coming on, we have a lot of momentum. We are continuing to build capabilities that differentiate Capital One from other players at auction so that we can build a growingly valuable partnership business, both for ourselves and for the partners who team with us to build their franchise.

And our next question comes from Don Fandetti with Wells Fargo.

Rich, could you talk a little bit about the auto business? Looks like the yields moved up, and I know some of the peers that have been reporting recently that are big players in auto lending are talking about rates on new originations being higher than the current portfolio and having arguably some pricing power. Can you talk a bit about that?

I don't think we're struck by any significant movement in pricing power. I think we're at a pretty good place competitively in the marketplace. As you watched our business and the conversation we have on all of these calls where we'll really see a bigger opportunity and there'll be pretty sizable growth in originations, then the competition comes in either in magnitude and/or in some of their practices and we kind of pull back a little bit, I think we're in a fairly balanced place right now. I'm not struck by a change in the margin opportunity, but we -- if you -- but just sort of the feel of the marketplace, I think there is a -- there is some growth opportunity. And I think the other thing that we're struck by in Capital One's case at least is the strength of some of the credit results that we have been seeing, and we're pleased by that.

Okay. And just real quick follow-up. The Fed looks like they're going to cut rates. Do you think that'll have any impact on the card business from a focus on revolver versus transactors? I know that when rates moved up, you did see some change in behavior.

I don't think -- are you talking about the change in behavior in our customers or in terms of the focus that we have in our...

Yes, just a change in the focus on revolvers versus transactors. I know when rates moved up, there was a little bit of a shift over to revolvers. I didn't know if you thought there was any change from that perspective.

Yes. Over the whole range of interest rates that we've -- the range of interest rates that we've had for the last significant number of years, I don't think it's led to real pivots by us relative to transactors or revolvers. I think we are very -- as you can -- as you know, we're leaning into the opportunity at the high end of the marketplace where we're getting a lot of momentum with the franchise that we're building, and these are long-term, stable, very low attrition, very valuable annuities, and we're capitalizing on that opportunity.

And sometimes in our conversations, we talk more about that; but meanwhile, on little cat feet, if you will, we continue to just keep plowing ahead very consistently on the revolver side of the business. And frankly, the growth of -- the continued really strong performance in new originations is not only a top-of-the-market phenomenon. We continue to have strength across our -- across the transactor and revolver side of the business. And this gives rise to growth opportunities as we -- on the revolver side as we grow the -- as customers grow their balances and as we extend higher lines over time.

And we'll take our next question from Rick Shane with JPMorgan.

Rich, you spoke about the traction in this spender market. I am curious given the strength in labor and wage growth and frankly, low gas prices how you feel about the middle-income consumer. And is that an opportunity that perhaps you should have leaned into a little bit harder over the last year? And will you -- is that something -- is it appropriate to lean in now?

Yes. I think that our -- we've had a very consistent strategy for an extended period -- for a long time relative to the revolver part of the marketplace, which is one, where in this extended recovery is one that I think continues to post strong credit results. We -- if I pull up about what we -- how things have varied in the last few years, so we had a significant growth surge in 2014 through 2016. And we all watched. A lot of the metrics at Capital One change significantly. We saw that -- we saw signs of -- some signs of concern in the industry vintage curves gapping out a bit in 2016, and our own results were consistent with what we saw in the industry. We pulled back on our originations and certainly launched a more conservative approach toward credit lines. Since then, Rick, we have seen -- we're very pleased with the vintage results that we have seen in 2017, what it looks like 2018. So there is certainly a strength there that we note, and it is that, that is leading us to open up a little bit more gradually on the credit line side, which is a contributor to the gradually increasing loan growth. But along the way, we have continued to really go for the opportunity in growing new accounts. It's been the -- sort of the -- our lever of -- the lever that we have dialed is how significantly to open the credit lines and how quickly to move them. The actual origination machine has stayed at a -- sort of wide-open over that period of time, and we're getting particularly strong results in the last 12 months in that.

Got it. Yes. Look, I understand hindsight 2020, and it's easy from my seat to say that. And objectively, we thought the growth surge that you guys experienced in '14 and '15 was a big catalyst. It is interesting to sort of think about it moving forward as well.

Yes. The other thing, Rick, is there -- I think if you stand back and look on an absolute like-for-like normalized basis, while 2016 had -- we saw the most impact across the industry in terms of things gapping out, on an actual like-for-like basis, originations keep normalizing a little bit and exact -- on a like-for-like basis, the credit losses are a little bit higher. Now at Capital, we are very pleased with our vintage -- the vintages of our originations and the choices we made on line increases. But part of that strength comes from the dialing back around the edges that we've had.

And the other thing I want to say is that it's not lost on us. We just -- we -- America just broke the record for the longest sustained recovery. We are deep into the cycle, and so our biggest focus is on underwriting for resilience. And -- but in the meantime, we're really pleased with the strength of the originations, and we continue to unleash some of that in terms of loan growth on the credit line side.

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

I just wanted to circle back on the provision explanation for a moment if I could. I was just looking at the past several quarters' worth of credit loss and provision coverage history, and the losses have gone up at a very moderate pace, a few basis points over the past 5, 6 quarters. But it looks like the coverage has come in a bit with this release in this period. And I was hoping you can give us a little more color on what drove that change and forward expectation in light of that very moderate decline in asset quality over the same time frame.

Yes. The -- well, a couple things. So in my comments, I mentioned that we've seen very stable credit performance in an economy that just has continued to really roll forward, and it's just the combination of those things. Honestly, as you know in our portfolio, given its size, small moves there can generate $100 million release. So if you think about the release in card, a good portion of that was related to the sale of the -- several of the small partnerships that we talked about, and the remainder was just driven by the ongoing strength of credit and the economy.

Okay. And if I can just follow up on that point. Does the -- does that imply some sort of -- I mean the ongoing strength -- I guess I'm trying to understand whether that ongoing strength implies to you that you think credit losses will improve from here or just continue at this sustained pace of small incremental deterioration.

So our viewpoint that is that credit performance that we see is basically flattish. And there are a number of kind of small effects, offsetting effects, different things that are idiosyncratic about the drivers that make variation off of flat -- but on a seasonally adjusted basis, things look pretty flattish for us.

As we look at other metrics like delinquency flow rates, they look strong. They look stable. We, of course, do have some continued benefits from Growth Math being a good guy quietly in the background. And I think overlaid on top of all of that, it's probably underlying a little bit of normalization in the card business, and I think in our case, they're kind of -- these moderate effects are offsetting pretty much to a draw. So I think things are pretty stable. And of course, we always have to remind ourselves where we are in the cycle.

And we'll take our next question from Moshe Orenbuch with Crédit Suisse.

I was wondering, you mentioned -- I think for the first time, you talked about the growth rate of your Branded Card portfolio at 4.7%. And what had that been growing at? And you alluded to the process that you've talked about a few times in terms of kind of seasoning the accounts a little longer before increasing their credit lines. And maybe if you could kind of just talk a little more about -- because we're kind of approaching about a year since you started adding those accounts. And so I mean is it reasonable to assume that, that 4.7% would be accelerating from here?

So we pointed out the branded metric because, partly, there has been some things that have been modestly affecting the metrics in the other direction on the partnership side. And also, of course, a lot of the marketing we're spending, the franchise we're building, that directly is in service of the Branded Card business that we're building. So you can see -- well, basically, while we're not giving historical metrics on those thing, that Branded Card metric is also picking up, and it is the primary area that is getting the benefit of the significant surge in account originations. So I think with every passing quarter, we're opening up a little bit more on the credit lines, and hopefully, we'll continue to have strong account originations. And the combination of those 2 can be a good guy for the growth in our Branded Card business.

Got it. But could you -- I mean, was that number 100 basis points lower or -- if you went back 6 months?

Yes. I don't -- we're not going to give the retro numbers, but it is -- it has tended to be stronger than the 1 minus the Branded Card in recent periods, and it is growing nicely.

Yes. Moshe, I believe last quarter we gave the metric on the call at just a little over 4.

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

Rich, the industry was able to significantly lag on the way up on deposit pricing, but you've had a lot of banks building out all sorts of digital deposit taking capabilities. So outside of the negative mix shift that Scott talked about, what are your thoughts on banks like Capital One and the industry's ability to reduce deposit pricing on the way down? And I have a follow-up question.

I think it is a great question. I'm not going to -- often, I'll stick my neck out and make predictions. I think here, there's certainly an industrial logic for it. We've seen a few of the direct players, 3 of the big kind of 9 direct players have made a move downward, which is noteworthy. And I think the choices that are made by each company is going to be very much dependent on their particular situation, what is their need for deposit growth and what other kind of pressures are they facing. But I certainly -- I've always thought it's ironic that people talk about deposit betas as if beta is the number that's the same size on the way up and the way down, and a lot of people model things where they number cough the deposit beta. But the first thing most intuitively is the betas have to be different on the way up and the way down, and they're going to probably be different for direct players than they will be for regular players.

But I'm heartened, Ryan, by some of the dynamic moves that we're seeing in the marketplace, but I'm not ready to predict that players will have much movement downward. I think it's going to be harder for -- well, certainly, the biggest banks don't have anywhere to go because they really didn't chase the rates up. Regional banks maybe are kind of in between relative to the direct banks and the big banks. But we'll have to monitor this closely, and your question is a good one.

If I could ask just one follow-up, so the stock's trading just above 1.15x tangible book value for a company that's putting up a high teens return on equity. What do you think the market is missing about the resilience of the business model or the efficiency opportunity from the digital transformation in -- over the next couple years?

Well, thank you, Ryan. I think that Capital One is in a very great place in terms of the opportunities that we see headlined by the digital opportunity. And it is very clear inside our company, and you're starting to see some manifestations externally that our tech progress is accelerating and the benefits, which extend across a lot of different aspects of the business from speed to market, to product quality, customer experience, risk management, operational effectiveness, growth, efficiency, there's a lot of different aspects of it. And it's all not going to manifest itself in a Big Bang, but we feel we can see traction accelerating in many places.

Now how that translates into valuation is very much probably related to also how investors feel about a consumer stock and a consumer lending stock at this time in the cycle as well. So with respect to that side of the business, Ryan, we -- the #1 thing that drives our underwriting is not reaching for growth opportunities. It's a focus on resilience, and I think this served us very well in the last recession. We underwrite as if a recession is upon us. And I very much like the resilience of the business that we're booking, but I think investors still carry concerns about that, and I think that affects valuation.

But if you see a bounce in my step, if you see some -- the -- hear the energy in the sort of spit flying passion with which I described this thing, I've been building this company for -- this is the 25th anniversary this year of our IPO in 1994. And I must say that the period we're in reminds me, in many ways, of the early days of Capital One with the -- just some really nice opportunities to differentiate ourselves in the marketplace and to make a real impact on customers and build a franchise. And how that makes its way into valuation is one thing we'll all have to look at. But the thing that we focus most importantly is on getting it to make its way into the metrics of earnings and growth and returns themselves.

And we'll take our next question from Kevin St. Pierre with KSP Research.

Rich, I believe you'd mentioned that the majority of the deposit growth was coming through the Capital One 360 products. Some of the other large banks have incorporated mobile and digital slides into their presentations, where they give us statistics on mobile users and transaction. Was wondering if there were some successes, some numbers that you could share with us both on the mobile front, on the Capital One Cafés and even some numbers behind the Capital One 360 products.

Kevin, we -- there's a lot of traction in all the metrics that you mentioned. We haven't -- I think, for certain competitive reasons, have not chosen necessarily to lay all of that out. But directionally, the growth in mobile users, the metrics I've seen at Capital One at the top of the league tables in terms of growth rate of mobile users and dangerously close to the top of the league table in terms of total mobile users, which growth rate and magnitude, if they're both at the top, that augurs pretty well.

So on the 360 side, of course, there is -- what's sort of unique about Capital One is that we really have sort of 2 different banks. We're a combination of a local bank and a direct bank. And we've built, over time, a strategy that's more of a -- instead of running around with 2 businesses, it's more of a fusion of the 2. That said, our metrics continue to be sort of a blend of the performance of the 2, but what we're really excited about is the power that comes from building a single phase and a single brand and a single franchise that tries to combine the best of what local banking has but -- and the best of what a more pure digital bank would have. And we are very pleased with the early results, and we continue to be bullish about the opportunity there.

Just following up on that and maybe also following up on Ryan's question and commentary. I think if you are at the top of the league tables in terms of mobile users, mobile growth and you could potentially show us that, I'd respectfully say that, that might solve a little bit of a valuation issue. If you can show that you are slugging it out with the big boys, punching above your weight on the mobile digital front, I think that could only help. Just a quick follow-up. Maybe -- if you could speak to the preparations for onboarding Walmart both in terms of servicing -- preparing for servicing the customers as well as any changes you're planning to the structure of the product.

So we remain excited and on track with respect to the launch of the Walmart partnership and the conversion of the back book, both of which are slated for late third quarter, early fourth quarter. We are working closely with both Walmart and Synchrony in this complex conversion. Both are being good partners in this conversion.

With respect to products and marketing plans, we're going -- we have nothing to announce on that. But as you can imagine, we're working very hard, and we look forward to our launch date.

And our next question comes from Betsy Graseck with Morgan Stanley.

Two questions. One, a little more of a modeling question, but I just wanted to confirm. The portfolios that you sold, was that at the end of quarter? I'm just wondering, and I think, Scott, you mentioned $160 million of annual revenues associated with the portfolio. And is that in -- is that out of the 2Q run rate? Or do we start that from 3Q? And maybe you could give us a sense of the expense ratio we should align with that.

Yes. That was at the end of the quarter, so that run rate is going to start in Q3. And in terms of efficiency, I don't expect that it's going to have any meaningful impact to the overall efficiency ratio.

Okay. So same efficiency. Okay. And then just wanted to hear what your thoughts were with regard to some of the new competitors that are going to be coming in. We've got Goldman and Apple that are planning on launching a card in the next couple of months. And they've been very vocal about looking to go with a low-cost to the consumer solution, no fee and low interest rate. I mean we'll see what those rates look like when it gets launched because, clearly, it's a marketing pitch right now. We don't have any data to back that up. But that's the plan. So Rich, I was just wondering how you think about that type of new entrant coming in. And if there was anybody other than Apple, maybe -- or I don't know, maybe it doesn't matter that it's Apple, but just wondering how you think about that. And you mentioned earlier how you're really underwriting as if a recession is upon us at all points, which makes a lot of sense, and it serves you well. I'm just wondering, do you think that there's any challenge or risk that, that could get upended in a new competitor coming into the market like this?

Yes, Betsy. It certainly gets our attention when pretty much anything that -- let me start with Apple -- anything that Apple does gets our attention because they and the other big 4 consumer tech companies are -- whether they say it or not, are certainly focused on the -- by the way, they don't want to become banks. They are plenty happy, I think, to let banks be banks. They're interested in really controlling the front end of banking, which is really the customer interface, the customer experience. That's where the eyeballs are. That's where the interaction is. That's where the data is, and that's where -- that's the less regulated side of the business as well. So that certainly, as the general point, always has our attention. And I think the tech companies bring a lot of natural assets to the table, and they're certainly -- have good technology.

It also gets our attention when players like Goldman Sachs build a consumer business because I think Goldman's a great company, and they -- starting from scratch, building a consumer business. I think they've done a nice job with what they've done. So I think -- I don't have any predictions to make about this. I think it's nicely put together with nice marketing. And I would expect Apple and Goldman to be successful with what they're doing.

As far as we're concerned, we continue to go all in transforming our company from a tech point of view, and that puts us in a position to have great digital customer experience. And I'm very bullish about our opportunity even as others step up their offerings and their competition.

And we'll take our next question from John Hecht with Jefferies.

You guys spoke about being somewhat neutral from a rate environment perspective in terms of the NIM, but then you did highlight that your deposits might reflect a headwind for the remainder of the year. I wonder, can you give us, I guess, some color around what type of NIM pressure that might reflect and the cadence of that?

Yes. John, we've been signaling that deposit mix and -- at least during the period where we were seeing rates rise, even some of the deposit rates were putting some pressure on NIM. As you can look at our -- kind of the movement of our NIM quarter over quarter over quarter for a while, you can see that it's been drifting down just a little bit each quarter. And so that's a little -- just to give you a sense of the trajectory there, I think that these aren't really significant headwinds, but it's just a pretty much a consistent few basis points every single quarter that we're seeing as pressure.

Okay. And then just, I guess, a follow-up tied to that is how do we think -- you had a pretty big growth in deposits during the quarter. How do we think about the overall deposit strategy? What's kind of the maximum in terms of the composition of deposits you'd want for liabilities? And how much mix do we -- should we expect in the 360 product?

When you think about deposits, we have a relatively high ratio of loan to deposits, so we would love to be able to continue to grow our deposit base. We try to make sure that we have access to all of the wholesale funding channels that we can. We also take advantage of commercial deposits where they are appropriate for our liquidity profile.

So when it comes to just where we hope to be on our direct bank deposits and our local bank deposits, and we think that's an opportunity for us to continue to grow, we think we're really well positioned with the products and the digital tools that we have out there in the market. And so I would expect that we'll be able to continue to see growth in that area of funding of the bank.

And our final question this evening comes from John Pancari with Evercore.

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On the -- on your operating efficiency ratio expectation, Rich, 42% by 2021, I know that excludes marketing spend. Can you talk about, over that period, how you think about the trajectory of marketing spend just given the competitive dynamics in the business? Or I guess another way to ask it, you expect that improvement to 42% to improve the total efficiency ratio for the company. Maybe can you give us an idea, the magnitude of improvement in the total ratio that you expect?

Yes. John, the reason that we gave our long-term guidance on operating efficiency ratio and not total -- I mean we did give one in -- on total efficiency ratio, but it was less specific than the operating efficiency ratio, is because the operating efficiency ratio is -- there are a lot of dynamics happening in our business and in our quest to keep driving down operating efficiency ratio that -- and these effects are, colloquially put, baking in the oven. And we -- the -- what's happening with Walmart and the move to the full revenue share at the end of 2020, for example, that -- there's an economic change that happens. And also, that's when we're going to be fully kind of in ramping on the fund book of Walmart as well.

Then we've got the data center exit, and the timing of that continues to be relatively certain. And we can see the economics that, by the way, don't just happen automatically, the economic benefits. But with tremendous efforts to make sure that they happen, we can see that baking in the oven. And there is some other technology innovation that is in the works that collectively happened to line up around that time period. And given that, we have been spending a bunch of money on technology. Our investors have had a lot of questions about technology, and one of the many benefits of the tech transformation is the opportunity to really significantly improve operating efficiency. We shingled ourselves to that.

The marketing is not something that we would lay out our shingle about what it's going to be 1 and 2 and 3 years from now. That's very much going to be based on what we see in the market at that time and the opportunities we have to build a franchise, how much traction that we are having in the upper end of the marketplace where a lot of the marketing is directly focused. And -- but we also didn't want to just exclude that from the conversation because obviously to investors, in the end, total efficiency is the thing that drives the bottom line. And that's why even with the kind of range of outcomes that can have on the marketing side, our point was that we think total efficiency ratio can significantly improve by 2021.

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

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