Q4 2024 Earnings Call Transcript

Good day, and thank you for standing by. Welcome to the Capital One Q4 2024 Earnings Call. Please be advised that today's conference is being recorded. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] I would now like to hand the conference over to your speaker today, Jeff Norris, Senior Vice President of Finance. Please go ahead.

Thanks, Josh, and welcome, everyone. And just as a reminder, as always, we are webcasting live over the Internet and to access the call on the Internet, please log on to Capital One's website, capitalone.com and follow the links from there. In addition to the press release and financials, we've included a presentation summarizing our fourth-quarter 2024 results. With me this evening are Mr.

Richard Fairbank, Capital One's Chairman and Chief Executive Officer; and Mr. Andrew Young, Capital One's Chief Financial Officer. Rich and Andrew are going to 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 and click on financials and then click on quarterly earnings release.

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

And for more information on these factors, please see the section titled forward looking Information in the earnings release presentation and the Risk Factors section in our Annual and Quarterly reports that are accessible at Capital One's website filed with the SEC. Now, I'll turn the call over to Mr. Young. Andrew?

Thanks, Jeff, and good afternoon, everyone. I will start on slide three of tonight's presentation. In the fourth quarter, Capital One earned $1.1 billion or $2.67 per diluted common share. For the full year, Capital One earned $4.8 billion or $11.59 per share.

Included in the results for the fourth quarter were adjusting items related to discover integration costs and a legal reserve build. Net of these adjusting items, fourth-quarter earnings per share were $3.09. Full-year adjusted earnings per share were $13.96. We also had one notable item in the quarter, which was $100 million of accelerated philanthropy contributions. Pre-provision earnings of $4.1 billion in the fourth quarter were down 13% from the third quarter, driven by higher non-interest expense. The linked quarter increase in non-interest expense was driven by increases in both operating expense and marketing spend.

Revenue in the linked quarter increased 2%, driven by higher non-interest income. Provision for credit losses was $2.6 billion in the quarter, up about $160 million relative to the prior quarter. The quarterly increase in provision was driven by higher net charge-offs, partially offset by a larger allowance release. Turning to slide four, I will cover the allowance in greater detail.

We released $245 million in allowance this quarter, and our allowance balance now stands at $16.3 billion. The decrease in this quarter's allowance was driven by releases in our Commercial Banking and Commercial segments. Our total portfolio coverage ratio decreased 20 basis points to 4.96%. I'll cover the drivers of the changes in allowance and coverage ratio by segment on slide five.

The allowance balance in our domestic card business was flat. The coverage ratio declined 33 basis points, primarily driven by seasonal balances as well as favorable near-term credit trends. In our Consumer Banking segment, we released $131 million in allowance, resulting in a 22 basis point decrease to the coverage ratio. Vehicle values were stable in the quarter, resulting in an improvement -- improved recoveries outlook, which drove the release.

And finally, our Commercial Banking allowance decreased by $130 million, resulting in a 15 basis point decrease to the coverage ratio. The release was primarily driven by the reduction in criticized loans and to a lesser extent by charge-offs in the quarter. Turning to page six, I'll now discuss liquidity. Total liquidity reserves in the quarter decreased by about $8 billion to approximately $124 billion.

Our cash position ended the quarter at approximately $43 billion, down about $6 billion from the prior quarter. The decline in cash was largely driven by seasonally higher card loans and funding maturities, which were partially offset by continued strong growth in our Consumer Banking business deposits. Our preliminary average liquidity coverage ratio during the fourth quarter was 155%. Turning to page seven, I'll cover our net interest margin.

Our fourth quarter net interest margin was 7.03%, 8 basis points lower than last quarter and 30 basis points higher than the year-ago quarter. The linked quarter decrease in NIM was primarily driven by lower asset yields, which were only partially offset by lower deposit and wholesale funding costs. Turning to slide eight, I will end by discussing our capital position. Our common equity Tier-1 capital ratio ended the quarter at 13.5%, 10 basis points lower than the prior quarter.

Net income in the quarter was more than offset by the impact of loan growth, dividends and $150 million of share repurchases. As a reminder, the announcement of the acquisition of Discover constituted a material business change. Therefore, we continue to be subject to the Federal Reserve's pre-approval of our capital actions until the merger approval process has concluded. With that, I will turn the call over to Rich.

Rich?

Thanks, Andrew, and good evening, everyone. Slide 10 shows fourth quarter results in our Credit Card business. Credit Card segment results are largely a function of our domestic card results and trends, which are shown on slide 11. In the fourth quarter, our Domestic Card business delivered another quarter of steady top-line growth, strong margins, and stable credit. Year-over-year purchase volume growth for the quarter was 7%.

Ending loan balances increased $8 billion or about 5% year-over-year. Average loans increased about 6% and fourth-quarter revenue was up 9% from the fourth quarter of 2023, driven by the growth in purchase volume and loans. Revenue margin for the quarter increased 55 basis points from the prior year quarter to 18.6%, largely driven by the impact of the end of the Walmart revenue sharing agreement. The charge-off rate for the quarter was 6.06%.

The impact of the end of the Walmart loss-sharing agreement increased the fourth-quarter charge-off rate by roughly 40 basis points. Excluding this impact, the charge-off rate for the quarter would have been 5.66%, up 31 basis points year-over-year. And after 20 consecutive months of second derivative improvement, the 30-plus delinquency rate crossed into actual year-over-year improvement. The 30-plus delinquency rate at the end of December was 4.53%, down 8 basis points from the prior year.

As a reminder, the end of the Walmart loss-sharing agreement did not have a meaningful impact on delinquency rate. On a sequential-quarter basis, the charge-off rate was up 45 basis points. The 30-plus delinquency rate was flat compared to the linked quarter. Domestic Card non-interest expense was up 13% compared to the fourth quarter of 2023. Operating expense and marketing both increased year-over-year.

Total company marketing expense in the quarter was $1.4 billion, up 10% year-over-year. Our choices in Domestic Card are the biggest driver of total company marketing. We continue to see compelling growth opportunities in our Domestic Card business. Our marketing continues to deliver strong new account growth across the Domestic Card business.

Compared to the fourth quarter of 2023, Domestic Card marketing in the quarter included higher media spend and increased investment in premium benefits and differentiated customer experiences like our travel portal, airport lounges, and Capital One Shopping. Slide 12 shows fourth-quarter results in our Consumer Banking business. Auto originations were up 53% from the prior-year quarter. A portion of this growth can be attributed to overall market growth, while the remainder is the result of our strong position to pursue resilient growth in the current marketplace.

As a reminder, our choices to tighten credit and pull back in anticipation of credit score inflation and declining vehicle values were still in effect in the fourth quarter of 2023, resulting in relatively low originations. These choices also drove out really basically they drove strong and stable credit performance that positioned us to lean into current marketplace opportunities and return to originations growth in 2024. With four consecutive quarters of origination growth in 2024, Consumer Banking loan balances returned to growth in the fourth quarter. Ending loans increased $2.7 billion or about 4% year-over-year and average loans were up 1%.

On a linked-quarter basis, ending loans were up 2% and average loans were up 1%. Compared to the year-ago quarter, ending consumer deposits grew about 7% and average consumer deposits were up about 8%. Consumer Banking revenue for the quarter was up about 1% year-over-year. Growth in loans and deposits was partially offset by a higher year-over-year average deposit interest rate.

Non-interest expense was up about 10% compared to the fourth quarter of 2023, driven largely by the unique fourth-quarter items Andrew discussed, as well as increased auto originations and continued technology investments. The auto charge-off rate for the quarter was 2.32%, up 13 basis points year-over-year. The 30-plus delinquency rate was 5.95%, down 39 basis points year-over-year, largely as a result of our choice to tighten credit and pull back in 2022, auto charge-offs have been strong and stable on a seasonally adjusted basis. Slide 13 shows fourth-quarter results for our Commercial Banking business.

Compared to the linked quarter, ending loan balances were essentially flat. Average loans were down about 1%. Both ending and average deposits were up about 4% from the linked quarter. Fourth-quarter revenue was up 7% from the linked quarter and non-interest expense was up by about 5%.

The Commercial Banking annualized net charge-off rate for the fourth quarter increased 4 basis points from the sequential quarter to 0.26%. The commercial criticized performing loan rate was 6.35%, down 131 basis points compared to the linked quarter. The criticized non-performing loan rate decreased 16 basis points to 1.39%. In closing, we continued to post strong and steady results in the fourth quarter.

We delivered another quarter of top-line growth in Domestic Card loans, purchase volume and revenue. In the Auto business, we posted growth in originations for the fourth consecutive quarter and the return to year-over-year growth in loan balances and consumer credit trends remained stable. Our full-year operating efficiency ratio net of adjustments was 42.35%, consistent with our guidance of the low 42s, even after incurring $100 million in accelerated philanthropy contributions. And turning to the Discover acquisition.

The shareholder votes are scheduled for February 18th, and we continue to work closely with the Federal Reserve, the OCC and the Department of Justice as our applications continue to work their way through the regulatory approval process. We remain well-positioned to complete the acquisition early in 2025, subject to regulatory and shareholder approval. Pulling way up, the acquisition of Discover is a singular opportunity. It will create a consumer banking and global payments platform with unique capabilities, modern technology, powerful brands, and a franchise of more than 100 million customers.

It delivers compelling financial results and offers the potential to enhance competition and create significant value for merchants and customers. And now we'll be happy to answer your questions. Jeff?

Thank you, Rich. We will now start the Q&A session. Remember, as a courtesy to other investors and analysts who may wish to ask a question, please limit yourself to one question plus a single follow-up. And if you have any follow-up questions after the Q&A session, the Investor Relations team will be available after the call. Josh, please start the Q&A.

Thank you. [Operator Instructions] And our first question comes from Ryan Nash with Goldman Sachs. You may proceed.

Hey, good afternoon, everyone.

Hey, Ryan.

Hey, Ryan.

So Rich, delinquencies have been in line or better for nine straight months losses, and you talked about delinquencies now being down on a year-over-year basis and losses have sort of followed suit, but at a little bit of a slower pace. And you've outlined a lot of the reasons, deferred charge-offs, the press recoveries. But when you think about credit from here, just broadly, what are you seeing from the consumer and how are you thinking about loss performance as well as any other factors that could be impacting losses? And do you think we're on a downward trajectory from here?

Thank you. And I have a follow-up.

All right. Thank you, Ryan. So let me start by just talking about the health of the consumer and then maybe I'll turn and talk about the credit performance at Capital One. So the US consumer continues to be a source of strength in the overall economy.

The labor market remains strong and we saw signs of softening in the first-half of 2024, but in the second-half of the year, the unemployment rate has been stable and job creation data has shown renewed strength. Incomes are growing steadily in real terms as inflation settles out a bit. Consumer debt servicing burdens are stable near pre-pandemic levels. Consumers have higher bank account balances than before the pandemic.

Now, of course, the circumstances of individual consumers and households are highly variable and so talking in averages doesn't always fully cover what's going on. We do see some pockets, as I've been saying for some time now -- we do see some pockets of pressure related to the cumulative effects of inflation and elevated interest rates among consumers whose incomes have not kept up with inflation or who have high debt servicing burdens. And of course, there's still some inflation pressure and longer-term interest rates strikingly have increased since the Fed started lowering rates in September.

So we do see a bit of a disconnect between the average consumer and the folks closer to the margin. And you can see that, for example, in payment rates in our Card business. On the one hand, card payment rates remain on average meaningfully above pre-pandemic levels. And this is true overall and within each of our major customer segments.

On the other hand, the proportion of customers making just the minimum payment is also running somewhat above pre-pandemic levels, which is consistent with our card delinquencies running above pre-pandemic levels. Now, I should add that we're seeing this minimum payment effect across the credit spectrum. I'm not making a point here about the low end of the market or even about subprime. In fact, if anything, the lower end appears to be doing relatively better at the moment.

So just pulling up, I believe we're almost certainly still seeing some pandemic-related effects like delayed charge-offs from the period of unprecedented stimulus and forbearance in 2020 and 2021 and 2022, this effect is impossible to isolate, but we can infer it from our own credit trends and industry credit trends over the past several years. But sort of pulling up on the consumer. I think consumers are in good shape compared to most historical benchmarks. There are -- as we've been saying for some time, there are pockets of pressure that have to work their way through before levels can get down -- credit loss levels can get down to sort of pre-pandemic levels.

But I think the consumer story is very consistent with what I've been saying for a number of quarters and it is very solid. So let me turn to Capital One Credit. Over the course of 2024, our card delinquencies have moved in line with normal seasonality with losses following about a quarter behind. Now as a reminder, earlier this year, we flagged that changes in the level and timing of tax refunds due to tax law changes were probably changing seasonal credit patterns in our Card business.

We derived new seasonality benchmarks for card delinquencies based on post-pandemic performance. And those benchmarks have less amplitude in both directions than in the past. So we've now had a full year to look at what we were hypothesizing as the new seasonality benchmark and as we now look at the whole year, this experience is very confirmatory and we very much sort of believe that we've got the benchmark right. And when we first saw delinquencies settling out, it is clear that for -- really for the whole year now, we've been calling stabilization.

We've not been declaring a peak or declaring that credit would improve from here, but we can now look at the whole year and see a really nice stabilization. In the fourth quarter, and again, you saw this in the monthly -- the month we just reported. We saw our delinquencies improve on a seasonally adjusted basis in the quarter for the first time since normalization began. And they ended the year slightly lower on a year-over-year basis.

So that's certainly an encouraging sign. Looking ahead, we're not giving guidance on future credit, but over time, there are a number of forces that play out. Our recoveries inventory will continue to rebuild and that should be a gradual tailwind to our losses over time, all else equal. Still, high interest rates will probably remain a source of pressure for some consumers, especially those with higher debt servicing burdens.

And there still is, we believe, the phenomenon of delayed charge-offs and of course, this effect is hard to measure and certainly hard to forecast. But over time, it should play through, but how long it plays out, that's just something that is just a matter of speculation. I think we will eventually get back to the place where traditional labor market indicators are the main drivers of change in Consumer Credit. But that will still take some time.

And finally, as we move into the new year, we'll keep an eye on the level and timing of tax refunds since we know these can materially affect seasonal movements in card credit.

Got it. Thanks for the color. If I can throw in one high-level follow-up. So Rich, efficiency improvement has been a hallmark of Capital One for the last seven or eight years, ex a small period during COVID.

You recently talked about investments you wanted to make in the network once the deal hopefully closes at some point in the first quarter? I guess the question is, do you expect to continue to be on an efficiency journey, fully recognizing that the cost saves obviously make it easier, but just curious how you're thinking about efficiency for the consolidated company over the medium term, fully recognizing that there's going to be a lot of noise in the results?

So we look-forward to the completion of our deal and actually really getting inside the financials and the performance and all the details of the business. The businesses at this rather remarkable company Discover. But as we've talked about, when we look still from the outside, we see just a great opportunity there. And of course, we have said there are three areas that are going to need in continued investment when we think about virtually anything that all the strategic upside of this Discover deal, it's sort of all roads lead through three areas, kind of obvious areas of continued investment.

And the first, of course, is compliance and risk management. And Discover has really been leaning into that and we, of course, are doing everything we can to prepare to continue to lean into that and we'll do whatever it takes on that front. Obviously, that's an investment. The second is we -- is network acceptance.

We've talked about how struck we are and how struck we were to find out and confirm just how good the acceptance is in the United States for Discover. You can see, in fact, they've been putting some ads on TV sort of touting that and it's a very good story. And internationally, they've been investing there and focusing on where their customers travel and they've made a lot of progress there. When we look at our customer base at Capital One and where we would love to be over time in terms of being in a position to add more-and-more volume onto the Discover network, we think an incredibly important objective is to increase the depth and breadth of acceptance internationally, sloping the work, of course, working backwards where -- from where our customers and Discovers travel.

So that -- that's going to be a multiyear thing that -- that's a very important strategic imperative, I think, for us. And then the third one will be building the network brand. We plan to keep the name Discover for the network. We think it's a great brand.

And we're really happy with the underlying reality of where acceptance is. We know there are challenges in terms of consumer perception relative to those realities and we know also we need to, in fact, build the international reality and then the brand perception that follows that. So those are the three strategic -- the kind of obvious and strategic investment areas that we've been identifying really since the start of the deal. And back to your question about what do we think -- how do you think -- how do we think that fits in relative to efficiency ratio?

We, of course, on the Capital One side have had a long -- decade-long journey of continuing to improve operating efficiency ratio and it's striking that improvement has come even as we have continued to really ramp up investment in technology. Now the way that paradox works is the technology is -- we're also investing more in technology and at the same time, getting all the benefits on the efficiency side, both in terms of growth and in terms of costs that come from such an investment in technology. So the engine that drives operating efficiency ratio strategically will continue at Capital One and it should continue it with the combined institution as well.

Now then you ask, will the big three investment areas that we talk about, what will that do to operating? I think the -- we always at Capital One have strategic imperatives that we're investing in. I think the overall picture of how Capital One's tech journey helps pay -- one of the important ways investors get paid is through operating efficiency improvement. I think that story to me stays strategically intact even as we have new investment areas because we'll also have new areas to capture synergy and growth opportunities and things that really wouldn't have been possible for either of our companies alone.

So thanks for the question. Operating efficiency is a really important way that we create value for investors. And in the long run, we continue to really see increased opportunities there.

Next question, please.

Thank you.

Thank you.

Our next question comes from Terry Ma with Barclays. You may proceed.

Hi, thank you. Good evening. I wanted to follow-up on Credit first. It seems the trend that we've seen for the second derivative suggests there's room for that to continue to go lower.

Is there some sort of framework to think about how much lower DQs can go -- can trend going forward? And is there anything in the near term that can cause the second derivative to inflect higher again? And I have a follow-up.

So Terry, yes, so thank you for the question. Obviously, well, since the founding of the company, we've always had our microscopes out looking at delinquencies because they're the single best predictor of credit of all the metrics. There are many metrics we watch, but that certainly is at the top of the list. And it is, I think, a really important -- it's certainly a gratifying milestone to where finally the second derivative cross the horizontal axis effectively and we'd certainly note that milestone.

The first thing I would say about as we all get our microscopes out to look at trends on a monthly basis is to just talk about seasonality itself. And we don't publish a seasonality curve per se because there's no precise benchmark with which to do it, but we certainly like to guide our investors about how we think about that. Seasonality for Capital One has tended to have more amplitude up and down over the course of the year than most other card players. And one might ask, why is that?

We believe that the biggest driver of seasonality, while there are several, the biggest driver of seasonality is tax refunds. And since we have a larger subprime book than most other players who really don't do subprime, those customers do tend to have higher seasonality in their credit performance than folks higher upmarket. So I think that's why Capital One has a greater seasonality effect. And for these customers in particular, tax refunds certainly in terms of the monthly flow of cash can end up creating something very nice that comes seasonally and some of that makes its way into payments.

Now the changes in the tax withholding rules a few years ago led to fewer tax refunds and lower average refund payments. And the IRS was also paying certain refunds later than before. So that created a lot of noise, as I've been saying on recent calls. You'd think it would be easy to reestablish a seasonality curve, but while credit was normalizing so dramatically, it was sometimes swamping the seasonality effect.

But we created sort of this detrended seasonal curve from 2023 to the best we could and that turned out to really be right on for 2024. If I were to pull up and kind of summarize what we saw in 2024. 2024 settled out with fewer refunds paid than before the pandemic and about 25% lower total refund volume in real terms. Delinquencies moved with our new post-pandemic seasonality benchmarks, which have similar timing, but if I were to summarize what this new curve versus the one we've had for many years, it appears to have about 35% to 40% less amplitude in both directions than in the past. By the way, just a note for a second on, auto, all of this also happens in auto seasonality, but in an even faster and more concentrated way.

We tend to see auto delinquencies at their seasonal low in Q1 and losses in Q2. And this year that seasonal improvement was delayed a bit. So that's the backdrop for now talking about the credit performance that we see. If you start, Terry, with the sort of foundation that the consumer is in very good shape. The economy is in quite good shape overall, you know one would certainly feel there's sort of a gravitational pull toward even better credit in the business that is helped by the math associated with recoveries that our recoveries rate has been very constant, but the recovery inventory that we have had to collect on, it got very small in -- during the pandemic and that has been replenishing and so there's sort of a good guy gradually coming as recoveries fully restore.

And then that really gets us to whatever effects there are of inflation, whatever effects there are on the consumers on the tails that are not in as good shape as sort of the averages that we all look at. And that's -- and what we see there is probably the way actually that the delayed charge-offs are actually playing out. They're probably playing out exactly through these consumers on the tail that are not -- they're still struggling at the margin. So the credit metrics are looking great.

We have more solid benchmarks, Terry. The consumer is in a great place. But I think the sort of bigger picture phenomenon of delayed charge-offs that still has intuitively to play out and sort of these effects going on at the tail puts us in a position not to be declaring that things are headed down from here, but it's certainly positive indicators that we see at the margin.

Got it. That's helpful. Maybe just to talk about the auto business. You called out the loan book return to growth this quarter. Should we expect you to lean into that and see loan growth accelerate? And maybe can you just talk about the overall profitability of the loans you're booking today versus what you've seen historically? Thank you.

So we feel very good about the auto business. You know, the credit performance is really striking and in fact, let's just savor something that is I think an outlier relative to the industry. But our auto delinquencies have remained consistently below pre-pandemic levels and they've been lower on a year-over-year basis for the past two quarters. And so the auto business is -- when you -- there are many similar things about our card business and the auto business, but if you were to compare the two, the degree with which we sort of intervened in the business and trimmed credit around the edges, it might have been even more dramatic than the term around the edges, what we did in the auto business over the last over the last few years when we were worried about margin pressures in the business as prices were not being sort of past -- inflation pressures were not being passed through.

So there were margin pressures, there were declining vehicle values and there was inflation of credit scores. So all of that led us to pull backend each of those have sort of -- have been resolving themselves. You asked about margins, the margins are sort of much more sort of normal in the business right now. The grade inflation on credit scores is resolving itself as credit normalizes.

Vehicle values we'll have to continue to keep an eye on those. But pulling way up on the shoulders of a lot of the changes that we have made and the technology that we have massively invested in this business in underwriting and in originations and in our auto navigator platform, all of those put us in a position to feel bullish about leaning into auto. And I think we -- all the trends that we see on margins, credit and competition, we feel good about and that lines up to a story of leaning in on the auto business.

Next question, please.

Thank you. Our next question comes from Rick Shane with J.P. Morgan. You may proceed.

Thanks for taking my question. Hey, Rich, you did a great job laying out the factors that have caused the historical relationship between labor and credit to weaken. And one of the factors you mentioned was the impact of rates. And that makes sense credit cards are one of the two largest classes of floating rate consumer debt.

As we think about reversion to historical norms, should we expect charge-off rates to be structurally higher as long as interest rates are structurally higher or is it possible to get back to historic loss rates in a high interest rate environment?

It's a great question. It's interesting how all of us -- some of us were around doing similar things back when in -- well, Capital One, we hadn't even come up with the idea for Capital One back when inflation was really raging the last time around. So I think we would be speculating there. But I think, Rick, if we pull up and think about interest rates and their impact, we think about how higher rates as a thing affect consumer credit.

So debt servicing burdens for consumers, of course, can get affected the higher rates as they work their way through consumer products gradually, but not immediately sort of make their way into higher debt burdens. So you have mortgages that tend to have fixed rates, auto loans have fixed rates. So you have time delays before interest rates make their way to more pressure on consumers, but still that effect obviously can continue. Most credit cards have variable APRs.

So rising interest rates have tended to lead to somewhat higher minimum payments for consumers overall. But if we if we pull up, I think that if wages -- if things stabilize and wages tend to keep up with inflation, I would think on the Credit Card side, there's -- it is plausible that charge-off rates could be very consistent with what they've been in a lower ambient rate environment. I think it gets very challenging when they're suddenly in motion up, but if they stabilize, I'm just speculating here at a moderate level that's higher than they were for the last couple of decades. I think as wages sort of stabilize to make real incomes move the way they should, I would think that credit numbers could be very consistent with historical patterns.

I think the biggest driver of why they're not right now, if I were to speculate, probably number one on my list is really the just unprecedented number of years of which charge-offs with all the government stimulus and the forbearance that so many consumers got a lifeline that those for whom that lifeline was a little more temporary in its benefit, some of those issues are still resolving themselves in terms of current charge-offs. It's always an interesting thing to just take a look at the area under the curve in credit losses for -- if we look back over the last number of years and look at where credit losses would typically have been versus where they were and you look at the area under the curve and ask yourself, well, what if all of that were delayed charge-offs?

You still have a majority of that area under the curve that would still have to play out in terms of delayed charge-offs. Now we don't believe that anything close to all of the area under the curve would need to come on the other side. But I think if you know a one-sentence sound bite to me of why in such a benign environment, credit losses in businesses like credit cards are running higher than pre-pandemic. It is the delayed charge-off effect.

And time should be our friend there that should resolve itself overtime. And there are a lot of positive factors behind that are putting sort of good gravitational pull in the right direction in this industry.

Thank you very much, Rich.

Next question, please.

Thank you. Our next question comes from John Pancari with Evercore ISI. You may proceed.

Good evening. Just on the efficiency side, just a follow-up to Ryan's line of questioning. I know you've guided to an operating efficiency ratio in the low 42% range for 2024. Does this 42% range remain the case as you look at 2025 or do you see a change to the upside or the downside off of this level? Thanks.

So, we I think the operating efficiency ratio has really been -- hopefully our investors share our excitement that this 700 basis point improvement that has happened since we began our tech transformation in 2013 has certainly been a very good guy. There are multiple things behind that, but the biggest driver is the technology transformation. And even as we invest a lot, there are also ways to create savings, savings through reduced vendor costs, the really high cost of a lot of legacy technology, the benefits on the cloud and really the ability to then on the other side of the technology transform -- transformation sort of rebuild the company and how it operates on a foundation of modern technology.

And so that's a journey that continues and so we see benefits there. I do want to say though also, you have -- we've had a lot of beneficial increase in the ratio in the last couple of years. And I wouldn't want people to just draw -- take the curve and say, wow, that thing almost looks like it's accelerating down. And you no, we don't give guidance in the short term.

There are a lot of things that very important investments we're making in the business. But what I like to do is really just point out that when we stand back over a longer time frame and look at the journey of Capital One, this has been a journey for which the efficiency was never the objective function. It was one of the many benefits of a tech transformation, but it's very gratifying to see that continue. But I think the extrapolation from any one year to the next is not something that we would recommend.

And so -- but it's a great long-term story.

Got it. Okay. Thanks, Rich. And then one -- a quick second one.

I assume this will be a pretty quick answer, but would be helpful if there's any -- have you changed -- made any changes to your expected deal metrics tied to the Discover deal, either the 15% or greater of EPS accretion in [‘27] (ph) or the expense efficiencies or the timing of adding the $175 billion in purchase volume to the network? Thanks.

Hey, John. Yes, what I'll say is it's two independent public companies. We still are operating separately at this point, and there are a number of variables that have moved and will continue to move between now and legal day one. And so I'm not going to specifically comment on how any one of those variables or metrics are changing since the deal model.

What I will say is we considered a wide range of outcomes across each of the line items and we continue to be comfortable with the estimates that we included in the deal model. We feel very good both strategically and financially about the deal today as we did nearly a year ago when we announced it. And so as we get to legal day one and put the marks on the balance sheet, we'll provide updates on the relevant metrics at that point.

Next question, please.

Our next question comes from Mihir Bhatia with Bank of America. You may proceed.

Good afternoon and thank you for taking my questions. I wanted to start first by just talking about NIM a little bit. You called out the Walmart impact this quarter. Any other call-outs for the quarter?

It just feels banks have been quite disciplined about lowering saving accounts interest rates as the Fed has reduced rates? Do you think that continues or are you starting to see some demand for deposits or deposit competition ramping as we start contemplating loan growth here into 2025? I guess just related to that, if you could just talk about some of the puts and takes on NIM in 2025 that'd be great? Thank you.

Sure, Mihir. Well, let me start with just reminding everyone that the one thing for sure we know is that in the first quarter, we have two fewer days. And so that will drive a 15 basis point roughly decrease in NIM. But if I kind of pull up and think beyond day count and look at a longer term -- the longer term, a lot of the same forces that I've been describing for the last number of quarters as potential headwinds and tailwinds still exist today.

So if you think about the headwinds, first of all, we're very modestly asset-sensitive. And so you'd see a small decrease in NIM if rates continue to decrease and you saw a little bit of that effect here in this quarter. And the other one, you bring up deposit beta, of course, in our rate risk modeling, we make assumptions around deposit betas. So to the extent that betas are lower or slower on the way down, we would be a little bit more asset-sensitive in that scenario.

So those could be headwinds. But on the tailwind side, the steepening yield curve relative to forwards would be a good guy if that persists. But then probably the single biggest factor and we've seen this play out over the last number of quarters is the card growth and card becoming a bigger percentage of our balance sheet, all else equal is a pretty meaningful tailwind to NIM. So those are really the forces at play that I would highlight for you.

Got it. Thank you. And then maybe just turning quickly to capital return. You've been doing $150 million in buybacks last few quarters.

Your CET1 is up to 13.5%. We understand with the deal, you have to get approval right for any capital actions. But the question is -- two-part question there is, A, is that approval keeping you a little conservative right now? And two, once the deal is approved, should we assume you'd be pretty aggressive in getting that down or would it probably fair to assume it stays elevated for a little bit even post deal as you get through the integration?

Yes. I'll wrap my answer to both of those questions into one for you, Mihir. First of all, just go without saying, but I will say it too, which is we clearly recognize that over the longer term capital return is a key component of shareholder value creation. And you've seen in prior periods, we've executed substantial share repurchases.

But in the near term, our pending deal is certainly influencing our approach to capital in a few ways. As you said, we're still under regulatory pre-approval rules for each of our capital actions. And then second, we will need to run our own bottoms-up analysis as a combined company to just assess our view of the combined capital need and we continue to be two separate companies and therefore, don't have the ability to do that analysis until after close. And then third, we will need the Fed's approval to go back to operating under the SEB framework.

So if I pull up from there, and put all of those together, I think it's likely we're going to stay at a slower repurchase pace until we resolve these factors, but after that, we'll have more flexibility.

Next question, please.

Our next question comes from Bill Carcache with Wolfe Research Securities. You may proceed.

Thank you. Good evening, Rich and Andrew. It was good to hear all the references to the Capital One Arena around the inauguration. I wanted to ask about your ability to better compete against the big banks in debit, assuming the Discover transaction closes as you expect?

We know debit rewards for Visa, Mastercard issuers essentially went away after the force reduction in interchange under Dodd-Frank, but would reintroducing debit rewards be something that you'd consider given the greater flexibility that owning the Discover Network will afford you?

Hey, Bill. So obviously, a really key part of the deal is our excitement about getting the network and being able to add such a key dimension in vertically integrating our business. And we talk so much about credit cards all the time, the debit business is a really important one. And on little cat feet, Capital One has really been investing in our national banking business.

So -- and by the way, having our own network will be valuable there and we'll be able to enjoy the vertically integrated economics of owning a network and the scale that comes of course from pulling Discover and a bunch of Capital One's volume together. Now, I just want to pull back and just talk a little bit about Capital One's Consumer Banking strategy, and therefore and debit is of course, right in the transaction business right at the heart of that. If you pull way up and think about consumer banking way back to when banks began, you had banks with branches on every corner. And then in the last 15 or 20 years, there have been the evolution of direct banks and they have been savings only, offering higher rates and they have no physical distribution whatsoever.

And we, of course, also through our acquisitions, have acquired several banks with branches on every corner. And we also acquired the nation's largest direct bank, and I announced at the time of that acquisition, this is a great financial trade, but it is also a strategic game-changer for Capital One. That was back like 12 years ago. So since then, we have been very steadily, systematically, relentlessly and patiently if I could put so many adjectives on -- adverbs on that, pursuing a business model that actually doesn't really exist right now because we have those two endpoints.

But what we're really trying to do is build, in a sense the Bank of the future. And we believe that Bank of the Future is not just a direct bank, it's also not a bank with a branch on every corner, it is a bank with thin physical distribution. For us, we've got branches, but then also in major metropolitan areas, we have put in cafes that are really basically less about coffee, but really more about being sort of a hybrid of a branch and a showroom for Capital One and a place people can go and understand Capital One is there to help them and get a sense for really what this company is about and how it may be able to help them live their life more effectively.

So as we've been -- so this strategy has been about, if we work backwards from what we believe is the bank of the future. From a distribution point of view, that's thin physical distribution and highlighted by these Cafe showrooms it also -- a very central part of that is digital capabilities that enable something that's a very, very difficult thing to do, which is to take just about everything that can be done in a branch and make it available digitally. Now there are some things like safe deposit boxes we haven't figured out how to create a digital safe deposit box for your valuables. And there are a few things that just you can't get there on a digital basis.

But what's -- but as we've looked at this, we said just pretty much virtually all the activities that people go to branches for, we want to be able to deliver to them through our thin physical distribution plus massive full-service digital capability. And that's what we've been building over these years. Additionally, it requires -- in order to generate business, we need great products and we've been the only major bank out there with no fees, no minimums, and even a recent move of no overdraft fees, and those better deals come from having built the -- in a sense superior economics that come from this sort of physical distribution light model.

Now then you asked the question, so what will be our debit card strategy? We haven't completed the deal. We haven't fully gone in on the other side of exactly seeing, how things are working on the Discover side. But we are very pleased with the results that we're having with our current strategy, including our current debit card strategy.

And we are investing heavily to continue to grow that business. You look at the significant increase in marketing over the years. One of the drivers of this is that Capital One is building a National bank organically and without a lot of physical distribution and to get there, it takes a lot of marketing. So I think the best way to think about it is Discover gives a shot in the arm and a boost to a strategy we've been pursuing for more than a decade and the best way to think about it, I think is picture just more of the same from Capital One with a little bit of an accelerator.

I appreciate all the details, Rich. Thank you.

Next question, please.

Our next question comes from Moshe Orenbuch with TD Cowen. You may proceed.

Great. Thanks. Rich, you talked about better growth in Auto and Card, you talked about the high-end cards. Talk about the non-prime businesses in both card and auto, given the improved credit, how you're thinking about growth in those businesses in the coming quarters?

Moshe, the word that I would use at the lower -- and the sort of lower end of the business, obviously, there are parts of the market below where we play. But if we sort of loosely call it at the lower end of the non-prime or subprime part of the marketplace, the word that I would use to describe it is stability and stability of -- let's look at the key aspects of that. On the consumer credit side, actually, the first part of our business to normalize really to settle out with respect to credit was the lower end of the market. That's been very stable.

The -- our originations in that segment and really pretty much across our business, the originations are coming in on top of each other for years. So that has a stability there as well. Competitively, it's a very competitive part -- it's a very competitive part of the business that has many in addition to regular card players, many non-traditional players as well. So the competitive intensity is high, but we watch it very carefully.

And so with the stability of performance and the strength of the consumer, we in both the card and the auto side of the business continue to lean in a very similar way that we have -- well, for card, it's just been very consistent for years. With auto, we kind of pulled back quite a bit in that part of the business and we're leaning in as we often have done historically. So we're leaning into both of them and we're really pleased with the stability and strength of the metrics that underlie those businesses.

Got it. Thanks. And maybe just as a follow up, when you think about reserve levels, given that you are seeing or likely to see some improvement in credit losses kind of on a core basis or like-for-like. And it sounds like the growth is probably -- a growth that you have on the balance sheet is probably going to come in your lower loss categories, not the higher ones, thoughts about the reserve level as we move forward?

Sure, Moshe. So what's going to happen in future quarters starts with what happened this quarter. So I just want to reiterate a couple of the drivers of this quarter as a jumping-off point. As I said in the prepared remarks, your coverage was down 33 basis points by two things.

The bigger effect being that we typically have seasonally higher balance -- balances in the fourth quarter that require very low levels of coverage and that denominator effect from those balances put downward pressure on coverage. The other effect was that the allowance we needed for what I'll call non-seasonal growth was offset by favorable observed credit performance. And so we added $0 of allowance balance to the numerator, but the non-seasonal growth impacted the denominator. And so in the first quarter, I just wanted to provide that backdrop to say the seasonal balances will run off and so there will be a corresponding upward pressure on coverage, all else equal from that effect.

But beyond that, it's really going to come down to growth and our loss forecast and loss forecast specifically for the coverage. And to the extent that loss forecast improves, changes in coverage could be modest in the near term as we just reflect the uncertainty of our projections and the allowance. But eventually, the improved loss forecast is going to flow through the allowance and continue to bring the coverage ratio down as uncertainties become more certain. And so while the direction of travel would be down, the pace and timing is going to depend on a variety of factors, one of which will include the mix of businesses, as you say, but when it's denominated to the whole portfolio, the relative growth of different forecasted loss portions of the of the book aren't going to have material impact to coverage just given that the new originations as a percentage of the overall book in any given quarter is relatively small.

And then the only thing I also want to remind you of is, I know our investors look at history as a potential guide for levels of coverage. And I just want to remind you that we called out the roughly 50 basis points of impact to coverage from the termination of the loss-sharing agreement with Walmart. So that created a step function change in coverage relative to our prior history as well.

Next question, please.

Our next question comes from Don Fandetti with Wells Fargo. You may proceed.

Yes, Rich, your Credit Card purchase volume growth on a like account basis has picked up. I'm just trying to get a sense if this is a Q4 blip or are you thinking that the consumer is actually more confident here after the election? And are you seeing that same improvement in consumer and small business as well?

Well, we have -- if we think about our purchase volume, our growth in overall purchase volume continues to be driven by growth in our branded card customer base and the branded card includes both our consumer and our small business. The growth that you see and that we've seen for several years now is certainly a thing powering. It has been a strength in originations and some strength in originations at the higher end of the market. But the other way to think about your question is at a customer level, what you know, on a per customer basis, what's been happening to spend growth.

And even as our spend metrics were growing over overall, the spend growth per customer in our consumer business have been largely -- they had been largely flat through 2023 and really the first-half of 2024. And then they started to pick up midway through last year and they grew further in Q4. And I don't have in front of me the small business card numbers. They're embedded in the numbers that I gave you. So the fact that we have seen spend per customer finally pick up here is striking, whether it will continue and exactly what's driving it is hard to say, but I did want to point out that positive trajectory as the year finished off.

Got it. And Andrew, you touched on this, but your '24 vintage, can you talk a little bit about how you're feeling -- how you're seeing that shape up in terms of credit performance? I've seen some industry data that shows delinquencies are still pretty high for '24?

Yes, Don, why don't I take that. So recent originations in our card business, we continue to see stability in the performance of our originations. It's really striking here. We've been calling this out consistently over the past few years.

Vintage over vintage, we're seeing mostly stable risk levels over time. And also striking is our overall front book of new origination vintages continues to perform in line with pre-pandemic vintages. Now when you compare with pre-pandemic vintages, you can't look at 2019 because 2019 very quickly got sort of corrupted by the pandemic. So we're looking at 2017 and 2018 when we make these comparisons.

But from a Capital One point of view, I think this is this stability in origination performance and quarter-over-quarter and the consistency with pre-pandemic is the result of our intervention to deal with inflated credit scores and the high level of industry supplies that were flooding, particularly the subprime marketplace back there. So we trimmed around the edges and continued to very closely watch the origination vintages. And that has led to a sustained stability on the part of Capital One and some of our most recent vintages. Now again, we're still looking -- you've got to look like, six months in the rearview mirror to see much, but we continue to see some very positive results there.

We also have looked at industry data that shows some gapping out in vintages over the last couple of years. So I think the industry effect is not probably consistent with what we have described. And if I were to explain why because I think they're very capable companies doing this. I think the -- I'm not sure that most of the industry adjusted for inflated credit scores.

And we intervened on our models with a belief that the university was suddenly giving out As that should be Bs basically and so we intervened and then kept validating along the way. But for a while, we didn't have validation. We just intervened because we believed it was the right thing to do. So I think what we had -- what has been seen if you look at just overall industry originations is, as you say, some gapping out and I think that would be the biggest driver.

Next question, please.

Our next question comes from Sanjay Sakhrani with KBW. You may proceed.

Thank you. I guess, Rich, just one more on the deal. Given the timeline that you've outlined earlier this year, is it fair to assume like everything is going pretty smoothly in terms of the regulatory approval process and there hasn't been any surprises? I'm also wondering sort of where you guys are in terms of the integration efforts and how much work has been done there?

Okay. Yes, so no, the approval process continues to move forward. We've made substantial process in the recent months. We remain actively engaged with the Fed and the OCC about our merger applications and it is the Fed and the OCC who ultimately decide on our merger application.

Late last year, we received approval from the Delaware State Bank Commissioner, which we needed because Discover is a State Chartered Bank. We of course, had the big public hearing in July and that went very well, we feel. Earlier this month, of course, we finalized a joint proxy statement with the SEC setting up the February 18 shareholder vote. So that was good progress finally there.

We are also engaged with the Justice Department as they play a key role in advising the Fed and the OCC on the competitive aspects of the deal. And we continue to believe that this transaction is both pro-competitive and pro-consumer, bringing our best-in-class products and services to a broader set of consumers and small businesses, and really enhancing opportunities and benefits for merchants as well. So pulling way up, it's certainly the deal process is a long labor, but we remain well-positioned to get approval of the deal early this year. And we are really proud of the work everyone is doing here and we look forward to getting this over the goal line.

Okay. Just to follow-up on a question Ryan asked some time ago on sort of when you put the companies together and the efficiencies, and sort of the investments that need to be made. I guess when you put the two companies together, the efficiency ratio actually goes down and obviously, there's a lot of synergies both on revenues and expenses. Do you think those are sufficient enough to sort of accomplish?

I'm just trying the question again. Do you think those are sufficient enough to make all of the investments that you sort of outlined? Or do you think that there's others that you might have to make as you peel the onion a little bit when you have the company?

So, I don't think we're in a position to -- and it's not just because we want to be coy about it. We -- we're not in a different place than we were at the time we announced the deal. And we should point out that we are working really hard preparing for integration, but we are still separate companies and Discover is working incredibly hard and working on their compliance and I know they're doing preparations for integration as well and we certainly are. We're not getting an inside view of their numbers, their performance, their business model.

So we're mostly sort of where we were at the outset. But if we pull up to your point, so Discover operated -- operates with a significantly lower efficient -- operating efficiency ratio than Capital One. That's certainly a good thing for the combined company. I think it is also the case that the -- I think Discover has had a heritage of probably less investment in certain areas than Capital One.

And in a few cases, they're sort of making up for lost time there. But I think having not seen on the other side, we assume that there are some areas that we will -- and we've assumed this from the beginning, we're going to need to step-up the investments and obviously on the risk management side, there's a lot of investment to be done, whether it is how -- what ultimately needs to be done compares with what they're investing and all of that remains to be seen. We obviously had assumptions in our deal model about leaning in on that. But what we get is -- so there's going to be a lot of effects that are all pretty significant that just go in different directions.

A company with an amazing efficiency ratio, a company that's probably underinvested in a number of areas that's relative to Capital One and we would shore up some of those investments. We also get a lot of synergy that comes from bringing overlapping businesses together. That's a very a strong effect. And then these three -- the investment areas, the three that we're pointing out, we are talking about investing in those at a level that's a lot different than what Discover has done traditionally.

Obviously, the risk management one, we've all talked about that and they're leaning in hard now. On international acceptance, they certainly -- again I'm amazed with their not that great scale, what they've done, but we would expect to invest at a higher level than they have there and in terms of the network brand relative to -- I wanted to make a comment about the network brand and some of this other investment. It is -- we have sloped -- we have taken our card business and sloped the business that we think most naturally and easily can go to the Discover network and it involves folks that aren't big international travelers, for example.

So we've sloped the work. There is -- we think it's very straightforward to move this business front book and back book business to Discover. And some of these investments that I'm talking about leaning into are particularly important for the longer-term opportunity of being able to move more business than what we put into our deal model. And again, in doing that, we would -- we sloped -- we took our whole customer base and imagine sort of sloping it in terms of what part of the business fits most naturally within the context of the capabilities and the brand of Discover's network.

And then as we want to move more we're going to need the bar to be raised relative to acceptance in brand and that's why I think you know these other investments were talking about will be multi-year they'll be overtime and there'll be things that help the deal payoff even more so in the longer term.

Next question, please.

And our final question comes from John Hecht with Jefferies. You may proceed.

Good afternoon, guys, and thanks for fitting me in here. First question, just thinking about the mix of the overall consumer book. I mean, you've got some new cards like the Venture One and Quicksilver, and some of those are attracted to different demographic groups. And then you've got the subprime mix and then you've got auto.

Where do we see just given kind of in-bound customer mix? Where do we see that going this year as a standalone business? And then, Rich, do you have any comments of what the total portfolio might look like assuming the combination with Discover?

Yes, so thank you, John. So we -- so let's -- let me take Discover just in a minute. So if you pull way up on Capital One for a long, long time, Capital One has been a sort of a full spectrum player. We have had -- for several decades, we have had a subprime business that is tailor-made for the information-based strategy we have because it's all about surviving and winning on the credit side of the business, but also in that business, we've also very, very much focused relative to others who play in the space to degree of exceptionally good deals.

It's not just about sort of surviving on the credit side, but really giving great deals, helping people use credit wisely. And in fact, really, I think the deals that we're offering are very, very simple and profoundly better than a lot of the deals that are available in the marketplace. And so that business has -- is a very stable part of what we do at Capital One and we continue to lean into that. The -- probably the most dramatic thing that's been happening in the last decade in Capital One's card business is, as you referenced, the quest toward the top of the market and that is a journey that as far out as we can see, we will continue to lean into that because there is so much opportunity at the top of the market.

And obviously, it takes a lot of investment, but the key indicator to us that when we stratify the segments of our business by spend levels, the part that's growing the fastest consistently year after year at Capital One is the heaviest spenders. And there's just so much upside north of where we are, we will continue to invest in that. Now if you stand back, just think about our Card business, while our subprime business has been going along and we keep leaning into that, there has been a gradual mix shift upmarket for the company. And even within each segment, within the sort of the subprime book, the sort of the prime book, and certainly the top of the market, there has been a gradual mix change with a spender first philosophy that permeates our business.

So that's -- and some of that you can see in just some of the structural changes in the payment rates at Capital One. So I believe that what you see and what you have seen for numbers -- a number of -- for many years is a good prognosticator of probably how the future of legacy Capital One would likely go. Meaning, continued leaning in across the spectrum, but differentially an awful lot of investment toward the top of the market and the most growth opportunity there. Now we -- now let me turn to Discover.

Discover, interestingly, has taken a very different approach than Capital One. While we have taken a very broad approach playing in all parts of the market, Discover has had a very focused strategy on the prime part of the business and they've done a very, very good job there and we certainly always admired them from the outside. So we will be bringing into our company a significant increase in that portion of the market, which probably differentially got a little less emphasis if anything. It's not like we weren't playing there, but if anything, we had a greater emphasis probably north and south of that part of the business.

But so from a mix point of view, we certainly -- we will be bringing in a business that's very homogeneous relative to the very heterogeneous business that we have. And then on the other side of all of that, I think that we will -- if I were to summarize our strategy, it will be to continue. Everything we were doing is Capital One because we're getting a lot of traction in that, and then making very sure that we don't crush the butterfly of this beautiful business model that Discover has in the prime part of the market, but that we go in there and while, yes, integrating things like technology and some of the risk management processes and a lot of things, do everything that we can to make sure that we don't directly or even unwittingly sort of crush the really nice butterfly of what they do.

And in that way, we hope to bring in a growth business that Discover has and add it to the very complementary growth businesses that Capital One has and collectively continue to try to get the best of both worlds, bringing along the way some -- better efficiencies and really bringing top technology to all aspects of the business.

Great. Very much appreciate it. Thanks.

Well, thank you everyone for joining us on the conference call today and thank you for your continuing interest in Capital One. Have a great night, everybody.

Thanks, everybody.

This concludes today's conference call. Thank you for your participation. You may now disconnect.