Q3 2025 Earnings Call Transcript

Good day and thank you for standing by. Welcome to the Capital One Q3 2025 Earnings Call. Please be advised that today's conference is being recorded. [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 very much, Josh, and welcome, everybody to tonight's earnings call. To access the live webcast of this call, please go to the Investors section of Capital One's website, capitalone.com. A copy of the earnings presentation, press release and financial supplement can also be found in the Investors section of the Capital One website, capitalone.com, by selecting Financials and then Quarterly Earnings Release. 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 that summarizes our third quarter results for 2025. 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. For more information on these factors, please see the section titled Forward-Looking Information in the earnings release presentation and the Risk Factors section of our annual and quarterly reports accessible on our website and 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 3 of tonight's presentation. In the third quarter, Capital One earned $3.2 billion or $4.83 per diluted common share. There were multiple adjusting items related to the Discover acquisition in the quarter, including integration costs, intangible amortization expense and loan and deposit fair value mark amortization.

Net of these adjusting items, third quarter earnings per share were $5.95. As expected, we continue to refine our purchase accounting assumptions while we are in the measurement period. In the quarter, our adjustments included a modest increase to goodwill, along with other refinements. You can find the revised purchase consideration walk and amortization schedules in the appendix of tonight's presentation. The results in the third quarter were impacted by the full quarter effect of the Discover acquisition.

On a GAAP and adjusted basis, revenue in the third quarter increased $2.9 billion or 23% compared to the second quarter. Noninterest expense increased 18% or 16% net of adjustments, and pre-provision earnings were up 29% or 30% net of adjustments. Our provision for credit losses was $2.7 billion in the quarter. Excluding the $8.8 billion initial allowance build for Discover that we recognized last quarter, provision for credit losses increased about $50 million.

Higher net charge-offs from the full quarter impact of Discover was roughly offset by a larger allowance release. Turning to Slide 4. I'll now cover the allowance in greater detail. The $760 million of allowance release in the quarter brought the allowance balance to $23.1 billion. Our total portfolio coverage ratio decreased 22 basis points and now stands at 5.21%.

I'll cover the drivers of the changes in allowance and coverage ratio by segment on Slide 5. In our Domestic Card segment, we released $753 million of allowance in the quarter. The primary drivers of this quarter's release were continued observed credit favorability in both losses and recoveries as well as a slight improvement in the forecasted unemployment rate. These factors were partially offset by greater consideration of potential economic downside. The Domestic Card coverage ratio now stands at 7.28%.

The allowance balance in our Consumer Banking segment was largely flat at $1.9 billion. Growth in the auto business was largely offset by observed credit favorability and continued strong vehicle prices. The ending coverage ratio of 2.26% was down 3 basis points from the prior quarter. And finally, in our Commercial Banking segment, we released $37 million of allowance in the quarter.

The allowance release was largely driven by recent favorable credit performance. The Commercial Banking coverage ratio declined 5 basis points and now stands at 1.69%. Turning to Page 6. I'll now discuss liquidity. Total liquidity reserves ended the quarter at $143 billion, down roughly $1 billion from last quarter.

Our cash position ended the quarter at $55.3 billion, $3.8 billion lower than the second quarter. Our preliminary average liquidity coverage ratio increased slightly during the third quarter to 161%. Turning to Page 7, I'll cover our net interest margin. Our third quarter net interest margin was 8.36%, 74 basis points higher than the prior quarter.

Recall that in the second quarter, the partial quarter benefit from the acquisition of Discover was roughly 40 basis points. The full quarter of Discover in the third quarter drove approximately 45 basis points of incremental net interest margin. The remaining increase in NIM in the quarter was largely driven by higher yield on legacy Capital One Domestic Card loans and 1 additional day in the quarter. Turning to Slide 8. I will end by discussing our capital position.

Our common equity Tier 1 capital ratio ended the quarter at 14.4%, approximately 40 basis points higher than the prior quarter. Income in the quarter was partially offset by $1 billion in share repurchases, dividends and an increase in risk-weighted assets. In the third quarter, we completed our bottoms-up capital assessment for the combined franchise. Based on the results of that analysis, we believe the long-term capital need of the combined company is 11%.

Now that we've completed this work, our Board of Directors has approved a new repurchase authorization of up to $16 billion of the company's common stock. This new authorization becomes effective today and supersedes our previous repurchase authorization. In addition, we expect to increase our quarterly common stock dividend from $0.60 per share to $0.80 per share beginning in the fourth quarter, subject to Board approval. With that, I will turn the call over to Rich.

Rich?

Thanks, Andrew, and good evening, everyone. Slide 10 shows third 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. Similar to the second quarter, the Discover acquisition was the dominant driver of third quarter Domestic Card results, including the impact of a full quarter of combined operations, a combined quarter end balance sheet and purchase accounting effects. Looking through the Discover impacts, the combined Domestic Card business delivered another quarter of top line growth, strong margins and improving credit.

Year-over-year purchase volume growth for the quarter was 39%, driven primarily by the addition of a full quarter of Discover purchase volume. Excluding Discover, year-over-year purchase volume growth was about 6.5%. Ending loan balances increased 70% year-over-year, also largely as a result of adding Discover Card loans. Excluding Discover, ending loans grew about 3.5% year-over-year.

While competitive intensity remains high, we continue to see good traction across our legacy card business, including strong growth with heavy spenders at the top of the market. The legacy Discover card loans continued to contract slightly and will likely continue to face a growth headwind due to Discover's prior credit policy cutbacks and some trimming around the edges that we will implement going forward. While that will create a short-term loan growth brownout, we continue to see good opportunities to grow the Discover Card business on the other side of our tech integration, where we can implement growth expansions powered by our unique technology and underwriting.

Revenue was up 59% from the third quarter of 2024 with a full quarter of Discover revenue. Excluding Discover, year-over-year revenue growth was about 6.5%, driven by underlying growth in purchase volume and loans. Revenue margin for the quarter was 17.3%, including the impact from a full quarter of combined operations and amortization of the purchase accounting fair value mark. The third quarter Domestic Card charge-off rate was 4.63%, down 62 basis points from the prior quarter and 98 basis points from a year ago.

The third quarter is the seasonal low point for our card losses. But the linked quarter improvement we saw was significantly beyond what we would expect from normal seasonality. Our charge-off rate has been improving on a seasonally adjusted basis throughout 2025, following the trend of improving delinquencies that started in late 2024 and supported by strong recoveries. A small share of the linked quarter improvement, about 10 basis points was the result of incorporating the Discover Card portfolio for the full quarter.

Our Domestic Card delinquency rate at quarter end was 3.89%, down 64 basis points year-over-year and up 29 basis points from the prior quarter. The quarterly increase was consistent with expected seasonality. Domestic Card noninterest expense was up 62% compared to the third quarter of 2024, reflecting a full quarter of combined operations and purchase accounting amortization. Operating expense and marketing both increased year-over-year.

Total company marketing expense in the quarter was about $1.4 billion, up 26% year-over-year. Our choices in Domestic Card are the biggest driver of total company marketing. Compared to the third quarter of 2024, Domestic Card marketing in the quarter included the addition of Discover Marketing higher media spend and increased investment in premium benefits and differentiated customer experiences. Our marketing continues to deliver strong new account originations and to build an enduring franchise with heavy spenders at the top of the market.

Fourth quarter marketing will likely be somewhat above recent seasonal patterns. Slide 12 shows third quarter results in our Consumer Banking business. Global payment network transaction volume for the quarter was about $153 billion. Auto originations were up 17% from the prior year quarter, driven by overall market growth and our strong position to pursue a resilient growth in the current marketplace.

Consumer Banking ending loan balances increased $6.5 billion or about 8% year-over-year. Average loans were also up 8%. Compared to the year ago quarter, ending and average consumer deposits grew about 35%, driven largely by the addition of Discover deposits. Looking through the Discover impact, our digital-first national Consumer Banking business continues to grow and gain traction.

Consumer Banking revenue for the quarter was up about 28% year-over-year, driven predominantly by the full quarter of Discover as well as growth in auto loans. Noninterest expense was up about 46% compared to the third quarter of 2024, driven largely by the full quarter of Discover as well as increased auto originations, higher marketing to drive growth in our National Consumer Banking business and continued technology investments. The auto charge-off rate for the quarter was 1.54%, down 51 basis points year-over-year, largely as the result of our choice to tighten credit and pull back in 2022, auto charge-offs are improving on a seasonally adjusted basis.

The 30-plus delinquency rate was 4.99%, down 62 basis points year-over-year. Slide 13 shows third quarter results for our Commercial Banking business. Compared to the linked quarter, ending loan balances were up 1%. Average loan balances were flat compared to the linked quarter.

Ending deposits were up about 2% from the linked quarter. Average deposits were down 2%. We continue to manage down selected less attractive commercial deposit balances. The Commercial Banking annualized net charge-off rate for the second quarter decreased 12 basis points from the sequential quarter to 0.21%.

The commercial criticized performing loan rate was 5.13%, down 76 basis points compared to the linked quarter. The criticized nonperforming loan rate was up 9 basis points to 1.39%. Pulling up, the full quarter of Discover operations and the related purchase accounting impacts dominated our reported results in the third quarter. But looking through these effects, our adjusted earnings, top line growth, credit results and capital generation continued to be strong.

The Discover integration continues to go well. We continue to expect that integration costs will be somewhat higher than our original estimate, and we remain on track to deliver $2.5 billion in combined synergies. Revenue synergies are largely driven by moving our debit business to the Discover network. That effort is going well, and we expect it to be largely completed in early 2026, so we expect revenue synergies to ramp up in the fourth quarter and in early 2026. We're also making good progress on operating expense synergies.

Many expense synergies are linked to platform conversion events, which happen at various points throughout the integration period with some conversions coming closer to the end of integration. Before we get to your questions, I want to pull up and reflect once again on where we are. As a result of years of strategic preparation, we have a wealth of opportunities today that put us in an advantageous position to grow and win in the marketplace as it continues to change dramatically. To capitalize on these opportunities at this special moment, we need to make significant and sustained investments.

Our acquisition of Discover enhances and accelerates some of these opportunities and, of course, brings new opportunities as well. Let me start with the Discover network. This network is a rare and valuable asset, but it is very subscale in a scale-driven business. We are already underway with our announced plan to move our debit volume and a portion of our credit card volume to the network.

These moves are powering our revenue synergies. To fully capitalize on the strategic benefit of being one of the few payment networks, we aspire to move more of our volume onto the network. That will require additional investments in international acceptance and the network brand. While Discover is an extraordinary and unique addition to Capital One's strategic portfolio, I want to savor the unique position legacy Capital One is in as a result of years of strategic transformation.

We are in the 13th year of an all-in technology transformation. This transformation has been from the bottom of the tech stack up, essentially building a modern technology company that does banking. As we move up the tech stack, the opportunities are accelerating. We also stand on the shoulders of our data and analytics capability on which the company was built and our journey to create a national lending brand -- excuse me, just a national brand.

One of the most unique journeys at Capital One has been the building of our national retail bank. We have built what we believe is the bank of the future with full-service digital banking capabilities enhanced by thin physical distribution of showroom branches in iconic locations. We are the only major bank building a national bank organically, and we are enjoying a lot of traction. Having our own debit network accelerates this journey, but an organic growth model requires a lot of investment in marketing for many years, and those investments are growing.

Let me turn to our credit card business. We are one of a very small number of players who are sustainably investing to win at the top of the market with heavy spenders. The fastest-growing part of our card business is with these heavy spenders. But it is very clear that winning in this part of the market takes a lot of sustained investment in standout products, amazing customer experiences, access to exclusive events and a premium brand.

It is not lost on us that our biggest competitors in this space have hugely stepped up their levels of investment, and we need to do the same. And a new front in this battle will be AI-driven experiences. We are gearing up for that. As we moved up the tech stack, we are finding accelerating opportunities in new growth vectors.

Some of the ones you have seen are Capital One Shopping, Capital One Travel and Auto Navigator. These opportunities are growing rapidly, and we are investing to seize the moment in the marketplace. All of these opportunities stand on the shoulders of our modern technology stack. We continue to invest significantly in those shoulders.

There are a number of -- excuse me, there are a small number of large modern technology companies fully in the cloud, built on modern applications and data. They are in a unique position to win as the world continues to evolve. We are one of them. Since the beginning of our technology transformation, our journey has been focused on bringing AI into the heart of the business.

Many companies will be bringing in third-party AI applications, which will help transform how work is done. But transforming the business model of banking with AI requires AI to be deeply embedded in the technology, operations, processes, risk management and customer experiences of the company. That is what we have been working backwards from for all of these years in our tech transformation. These opportunities require significant investment in AI and AI talent, and we are doing that.

Having founded this company and spent these many years building an adaptive company to capitalize on the rapidly changing marketplace, I am struck by the opportunity all around us, but I also know what it took to get here, and that was investing what it takes to be in a position to win. Our opportunities are many and they are large, but so too is the investment to get there. But these investments will also be the basis for our sustained growth and strong returns over the longer term. The opportunities we are describing here have been years in the making and you have heard me talking about them for quite some time.

Importantly, the earnings power of our combined company that we envision on the other side of the deal integration is consistent with what we assumed at the time of our deal announcement, even though some individual variables have moved along the way. We are excited for the opportunities that lie in front of us. It is our imperative to lean in and capitalize on them. And now we'll be happy to answer your questions.

Jeff?

Thanks, Rich. We'll now start the Q&A session. As always, as a courtesy to other investors and analysts who may wish to ask a question, please limit yourself to one question plus a single follow up. If you have any follow up questions after the Q&A session, the Investor Relations team will be available after the call. Josh, please start our Q&A.

[Operator Instructions] And our first question comes from Sanjay Sakhrani with KBW.

Rich, it seems like great momentum in the business, but there's been a lot of chatter about the health of the consumer, some of the cracks we've seen, particularly in subprime and maybe even specifically in auto. Maybe you could just talk a little bit about what you guys are seeing. And we hear a lot about sort of underemployment and looking at these employment stats and maybe just having the reality sort of delineate from what we're seeing from the broader macro. So could you just talk about what you guys are seeing and how you see the path forward?

Yes, Sanjay, let me start with the health of the consumer. The US consumer and the overall macro economy have been quite resilient so far in 2025. The unemployment has ticked up a bit recently but remains quite low by historical standards. Layoffs and new unemployment claims are low and stable. Wages are growing in real terms and debt servicing burdens remain stable and close to pre-pandemic levels.

But I do think we are in a period of elevated economic uncertainty, we've seen inflation kick back up, there is uncertainty related to tariffs, we've seen job creation be strikingly slow. Some consumers are feeling pressure from the accumulated effects of price inflation and higher interest rates, which have increased the cost of new borrowing in most asset classes. We are watching closely as student loan repayment and collections resumed. And of course now we are in a government shutdown.

So in that context, let's talk about our credit. We -- our charge-off rate was -- let me check here, 4.63%. So that was 98 basis points lower than a year ago and 19 basis points of that was the result of incorporating the Discover Card portfolio into our Domestic Card segment. But the predominant effect was the steady improvement of charge-offs, both at legacy Capital One and at Discover over the past few quarters.

And I should note that our charge-offs have also been supported by strong recovery. The front book of new originations continues to perform well with 2024 originations tracking at or below pre-pandemic benchmarks for both legacy Capital One and Discover. Now as we look ahead, our delinquencies remain our best leading indicator of near-term credit performance. In Q3, delinquencies moved in line with normal seasonality.

This was true both in our legacy Domestic Card portfolio and at Discover. So now in auto, our credit has been very strong. And auto losses were 25% lower year-over-year in the third quarter, and those losses are in line with pre-pandemic levels and auto delinquencies continue to improve. When we compare the auto results with industry numbers, there is a really pretty striking gap there.

And I think it is probably more indicative of the choices that we've made and some of the technology behind those choices in our auto business. So I think the striking performance of auto is not necessarily a statement about the auto industry. But certainly, these are all positive indicators here. Let me turn to subprime, Sanjay, because you asked about that.

It's interesting to look at this -- subprime almost always we find is the segment that sort of turns first. So subprime was the segment where credit moved first during the period of post-pandemic normalization, but it also stabilized and began to improve first. So overall, we are finding in our own subprime performance, subprime credit performance is moving in line with prime. So there's not a lot of indicators there.

In the subprime auto, let me move to subprime auto for a minute there. There's been a lot of noise in the subprime auto space, pointing to rising delinquency rates. Our own performance in subprime auto has remained stable through this time. And again, I think this is a product of choices that we made.

We anticipated inflated credit scores normalizing credit and declining vehicle values. So that led us to pull back pretty significantly back in 2022 and 2023. As a result, our front book vintages have remained stable and in line with pre-pandemic levels. This has been true in our subprime auto segment, just as it has been in our overall auto business. But again, as I mentioned earlier, I think in the auto business, our stable performance is largely the result of our own adaptive underwriting.

So it's not really a comment on the performance of subprime across the industry. When we look at some of the credit patterns for -- look at our credit metrics and then look at it with respect to income strata or we look at it relative to FICO scores. When we look at our own numbers, we're not seeing a lot of separation there. The consumer right now on our book -- I'm back to the card business now, the consumer on our book tends to be moving in lockstep together.

It certainly isn't lost on us that some of the economic metrics out there and some of the things a little bit more pressure on consumers on the lower end of income, and we'll certainly keep an eye on that. But we're not seeing differential impacts in our portfolio.

Our next question comes from Terry Ma with Barclays.

I just want to start off with capital return. It's nice to see the buyback pace pick up in the third quarter and also get the new authorization. As we look forward, is there any time frame that we should expect you to kind of optimize toward that internal target of 11% from above 14% today?

Yes, Terry, as you saw, we did step up the repurchase to $1 billion in the third quarter as we were in the final stages of completing that bottoms-up analysis to set that long-term capital need. And we now have the $16 billion of authorization. Over time, our actions are going to depend on current and projected levels of capital, but also very importantly, the environment that's around us at any given time and operating under the SCB provides us with a great deal of flexibility, and we'll certainly take advantage of that flexibility. So I don't want to be in the business of giving specific guidance as to our plans, primarily because our plans could shift fairly quickly.

But I will say, based on what we know today, at least in the very near term, it's reasonable to assume that we'll be picking up the pace of share repurchases from here.

Got it. That's helpful. And then, Rich, I think you mentioned the Discover portfolio will face a headwind as you kind of trim along the edges going forward. Kind of any color on what you are kind of looking to trim and then how long that headwind would kind of persist for?

Thank you. So this -- what I colloquially call the sort of brownout of growth. It reminds me when I use the term, the brownout of recoveries that temporarily happened for a while. The -- what you referred to is really 1 of 3 factors in this "growth brownout." So let me just pull up and give context to the whole thing.

So following Discover's credit expansion, Discover dialed back meaningfully in their origination programs in 2023, 2024 and into 2025. These pullbacks led the portfolio to contract slightly this year and created a headwind to growth as more vintages piled on top of each other, these relatively smaller vintages as they mature. So in other words, the growth impact of tighter originations tends to extend and manifest a few years out. I should note, very importantly that these pullbacks have also led to improving credit quality in the card portfolio in recent quarters. Now as we move forward, so the first effect, therefore, of the 3 is the Discover's dial back, which turned out to be pretty significant and very extended in time period. with a bunch of benefits that came from that, but obvious impact on the growth.

Now we get to the second one, which is what you asked about. We will scale back some of their programs on the margin such as with certain pockets of higher balance revolvers. Let me just comment for a second. We've always had such a reverence for Discover.

They built an amazing business. We are very fortunate to now be together in 1 company. They have philosophically had a credit policy that leans a little bit more into the revolving side and probably a little bit more industry typical. Capital One has, for years, been cautious about what we call high-balance revolvers, not that they're not attractive, it's just from a resilience point of view, we have been more -- we have, on a relative basis, leaned more into a spender-first kind of strategy.

So we've always been looking forward to pulling -- getting inside the Discover business, again, I think they've built a great company, but we're not surprised to see that, yes, around the edges we would trim some of the places where they have been more revolving oriented, particularly relative to when there are higher balances in a consumer's -- unsecured balances on a consumer's balance sheet. So that's kind of effect #2. The third thing is we also believe that there are opportunities, good opportunities to lean in and expand Discover's legacy business from the very focused target that they have had to expand it actually above and below from a credit spectrum point of view relative to Discover.

So when you think about the flow of business that's coming to Discover and including a lot of people who come there for the brand and everything else, we have a more -- we're going to take a more expansive view of this, including really leaning in on the higher end side to grab and try to win with the heavier spenders there. And we have learned over the many years how to safely expand into the lower down in the credit spectrum than they underwrote. So we've always been looking forward to that opportunity. But basically, that will -- most of what I'm talking about there requires us to converge onto our technology so we can leverage our data and decisioning infrastructure.

And that's why from a timing standpoint, we'll be able to do the trimming before the leaning in because the trimming could be done just by adjusting current Discover credit policies, whereas the leaning in requires us to implement a very integrated and sophisticated set of technology policies and decisions. And that's why the net effect of that is a timing disconnect on cutback versus growth. And so collectively, when we pull up, we're starting a little lower in outstandings, probably than we originally expected. Again, I think they made great solid choices.

There are smaller vintages maturing, and we're going to pull back around the edges before we lean in. And these effects will collectively produce a bit of a "brownout" of Discover's outstanding growth over the next couple of years. But these effects don't take away at all from our enthusiasm for the Discover business model.

Our next question comes from Ryan Nash with Goldman Sachs.

So I have two questions. First one for Rich and then a follow-up after for Andrew. So Rich, I guess some of the last quarter at the end of the remarks, you made a decent amount of -- spend a decent amount of time talking about investments. And then there was some recognition of revenue and return that will come with these.

So I guess, first, a 2-part question. Have any of these investments made it into the run rate? Or are they all incremental from here? And second, I know you've been hesitant to give any guidance, but parameters for us to think about where results are headed, whether it's PPNR growth, operating efficiency gains or anything that will narrow the range of outcomes that I think is on the minds of investors.

And I have a follow-up for Andrew.

Okay. Thank you, Ryan. So with respect to this set of opportunities that I again talked about this quarter, these are have been years in the making. Not a single one other than the Discover opportunity that sort of is reasonably available to us.

These have all been years in the making, working backwards from what we saw as significant opportunities. But as it always works in Capital One, we identify opportunities and then it takes investment on the way to the payoff and that's been our life story. And our portfolio is a blend of things that are in different stages of the life cycle with respect to investments and their value creation. So there was very little that's new on the list, but here is an important distinction that I'm making.

The opportunities are accelerating in a lot of these areas, the size of the opportunity, the validation that we're seeing in our own investments, the impact of moving toward the top of the tech stack as we've so patiently built at the bottom of the tech stack and where you move to the top of the tech stack, you're now talking -- it turns more into business opportunities and less into just investments in core technology. So all of these are the same things we've been investing in for years. I'm just struck by the opportunity that -- and the number of different opportunities that are coming as a direct result of years of strategic investment.

And so my point is that using the same philosophy with which we build Capital One over all of these years, when we see opportunities, we work patiently to invest in opportunities and then we always feel the imperative that when they're there, we've got to really give them what they need, and that's how Capital One is where it is today. But many of the things we've been talking about for a number of years are the actual investment imperative is growing in these. So all of -- many of these things are -- and the investments associated with them are already in the run rate. But the -- my point is that the incremental investment that we're leaning into is up from where it has been, and that's -- that, to me, is something that is I'm very excited about, but I just want to make sure to flag to investors that as we have always found in the history of Capital One, opportunities take investment to have them be what they can be, and that's where we are right at the moment.

Got it. That's super helpful, Rich. And then Andrew, when I look at the reported NIM in the high 8.30s, adjusted just a tad over 8.40%, now we all know that 3Q is seasonally strong. But maybe as we look ahead, help us think about some of the moving pieces on the margin? And do you think we're at or near a sustainable level for the margin over the medium term?

Yes. Sure, Ryan. I think describing where we're going is potentially helped by where we've been. So let me just kind of take a little bit of a walk over the course of the last year.

So if you look relative to the year ago quarter, our NIM is up, excluding the fair value marks, I think, roughly 130 basis points. And so about 85 of that as we've enumerated on the last couple of calls, is from the addition of Discover. The remaining 45 basis points has really been a function of lower funding costs, so lower deposit rate paid, lower wholesale funding, lower wholesale funding mix. And those effects more than offsetting the lower yields on earning assets.

And so as you said, there's seasonal effects in NIM. So looking ahead to the fourth quarter, you've got card and cash balances. You've got day count in Q1, you've got revolve rate in Q3, as you referenced, being a strong quarter. But if I look outside of any of those quarterly effects, the things that are going to move NIM from here, there's a couple that would move it in either direction, and that's just the relative growth of different asset classes and then how customers behave in card and retail.

One other factor that's uncertain is just how far and how quickly the Fed moves and that could just bring some beta lag with it, but that effect should sort itself out over time. And so I really go back to the relative growth of assets and then customer behaviors as being the things that could move it in either direction. But overall, I would say the structural impacts that we've seen over the course of the last year and in particular, the addition of Discover is now reflected in the run rate that you see here in the third quarter.

Our next question comes from Richard Shane with JPMorgan.

When we look at the reserve rates and we adjust for sort of the Discover portfolio, your reserve ratios or your reserve rates on Domestic Card are basically have not been this low since the end of 2022. At that point, delinquencies were materially lower. I realize that the trend on net charge-offs is going to continue. But as you've talked about, the delinquency trend seems to be reverting to normal seasonality. So that cyclical tailwind seems to be abating.

Is there much room for additional reserve release? And given that it looks like charge-offs may remain above historic norms, why drift down this much right now.

Well, Rich, the movements in any quarter are obviously highly dependent on all of the assumptions that underlie the allowance at the end of the prior quarter. And then as we factor in all of the things that go into setting the quarterly allowance, your drift down comment is just a reflection of the delta between those 2 numbers. So I'll start by saying relative to the assumptions at the end of the second quarter, there were 3 things that impacted the level of this quarter's allowance. First, as Rich talked about in his response to Sanjay, observed credit including recoveries were favorable to what we had assumed a quarter ago.

And then second, as I said in my prepared remarks, most economic variables in the third quarter consensus forecast are better than what they were a quarter ago, including, I think, peak unemployment and consensus estimates for the third quarter was down like something like 15 basis points to around [ 4.6 ] now. And so that improved economic baseline, improves our view of future losses, offsetting -- partially offsetting those 2 tailwinds, we added additional consideration for uncertainties including economic downside. And so as I look ahead, the dollars will, of course, be impacted by growth. But if I focus on coverage, again, to my NIM answer too, there's always seasonality with the allowance and in the fourth quarter, we have higher balances that pay down rapidly.

But beyond that fourth quarter effect, our expectations are largely going to be driven by our view of future losses and those future losses are going to be impacted by economic assumptions and customer behavior and delinquencies are going to be the best leading indicator of future losses. And so we're going to take all of that into account, and that is what's going to drive what we book for future allowance.

Got it. And I appreciate the answer. I think the one variable that may drive this may be the catch-up in terms of recoveries as well that you may actually outperform on the net charge-off side because of that?

Correct. Well, there's 2 things. One is just the overall anticipated charge-offs, including the recoveries, but also, as you know, with CECL, we un-discount the expected overall recoveries as well. And so that's a tailwind to the current allowance because the quantum of recoveries that we now have is greater than what it was in the 2022 period that you referenced in your question.

Our next question comes from Moshe Orenbuch with TD Cowen.

Great. Rich, I was hoping we could go back to the discussion about the Discover kind of brand and kind of card and perhaps lumping the installment business as well. Given the trimming that you said that you might plan to do, but at the same time, I think Capital One has been known to be a stronger kind of underwriter with a broader range of products. Do you think that, that Discover kind of brand as it sits there as a lending tool will ultimately be back to the same share that it had before Discover made the mistakes in '22 or '23.

So Moshe, you put your finger on very important thing. So first of all, I really want to just start with the Discover brand itself. There are a small number of banking institutions in America with really national brands. We study -- as you can imagine, we study everything about national brands and brand metrics.

And Discover is up there on brand awareness, brand consideration, brand equities that really show us that -- while they haven't invested sort of as much as Capital One in our brand in many of these metrics maybe comes in on the high end. We believe this is a great asset, this brand. And so we absolutely want to nurture this and invest in this. And of course, the brand is both the network brand and issuer brand.

So on the network side, we are absolutely going to keep that brand and an important part of our opportunity to move more business onto that network is that road goes through the building of and strengthening of the Discover network acceptance brand. On the issuing side, obviously, Discover is no longer going to be able to be a corporate brand, but we very -- the way to think about it, Moshe, is that Discover will be a very salient product brand in our portfolio. So when we look at their products, we are going to retain their flagship cash product. We're going to really keep their, and really continue to invest in some of their things like their student business and a lot of the things that have helped make a discover of what they are, including, by the way, very importantly, something that they're amazingly good at, which is the servicing side of the business.

We have watched from the outside and measured things, they are -- they just are at the top of the league tables with respect to servicing metrics as we've gotten to know the company, you can just feel the whole company in the ecosystem is so geared toward creating an amazing experience when a Discover customer encounters Discover people like on the servicing side. So we're doing the sort of sharing of best practices there, but it is our plan very much to lean into and invest in and continue Discover's servicing and take some of the great insights and practices there. We also plan to keep the Discover website while we're going to integrate the -- as a practical matter, integrating onto a single app, but the -- but we actually believe there's real value to continue the Discover website and it gets hundreds of millions of visits and so that will also be another thing that we preserve there.

So -- and then finally, Moshe, to your -- on the shoulders of what they've invested in terms of brand and customer experience and products, which we're going to kind of continue. We are then going to on the other side of conversion, be able to lean in with the very sophisticated data science and analytics and modeling that we have, the technology, the marketing channels, the breadth of marketing channels that we now have cultivated and are deeply into at Capital One. And so to try to take the sort of the best of the marketing and credit machinery of Capital One and direct it to driving more business through the Discover brand itself.

So it's easy to draw this up on paper, obviously to execute on that is going to take a bunch of years and a lot of hard work. But all the early indicators are, we are optimistic about the possibilities. And then I just wanted to be sure to flag to investors that for a few reasons, the growth is going to be sort of -- in a sort of brownout period, but that's not an indication of the long-term possibilities at all. It's just something I want to make sure investors were aware of.

Got it. Maybe just as a follow-up, given what you've seen over the course of the last few months at the high end, the transactor card business, you've seen kind of product launches or refreshes from 3 major players out there, American Express, Chase and Citi. Sometimes those have effects of like bringing more people into that ecosystem. And how do you think about that competitive dynamic for Capital One?

So thank you for your question, Moshe. Let me just start by saying that I believe that the -- what I call the top of the market and our quest to win at the top of the market, which is basically the heavy spender business, that is not a simple extrapolation for card companies to take what they do and make a bit better products and better ads and spend more that since we launched -- I go all the way back to 2010 when we launch venture. That's when we -- prior to that, we had built a very successful mass market company, but we had really studied the top of the market and said, we believe we're in a position now to really go after the top of the market.

But way back then, we said we know we can't just bolt on some more sophisticated things onto the mass market product offering and experiences that what we have to do is we have to work backwards from what it takes to win in these spaces, including the technology, the experiences, the access to extraordinary things and a very tricky one to have a credible premium brand in that space. And of course, then Moshe to create products that can be differentiated and -- in which we can win. So from -- and this is in many ways, my story, I'm sharing right here is a microcosm of my sort of investment speech that I gave at the end of the prepared remarks that we really study where winning is and then we work backwards from what it takes and then we invest for years to get there.

So we have had really remarkable traction. Every year, we see that we have -- in general, the highest growing part of our business is with -- at the higher level of spenders. And then each year, we reach a little bit higher because we can, and we're sort of earning the right to do that. So along the way, we introduced Venture X and Venture X was -- has really been a standout product that we launched it in 2023. We had a lot of response and then the -- it is sustained traction from the day we launched it all the way to now.

So that has really been a great thing. And that was designed to compete against the really great players who were there in the market. And now we have watched -- to your -- to the point of your question, we have watched striking things happen. Those competitors are leaning even more to investing.

And of course, that raises the bar of competition. They're working really hard to create more offerings and for -- and more experiences for their customers. But strikingly also, they raised the price quite a bit and have -- are going after a little bit of a different model than we have had. And one is necessarily better than the other.

It's just different. They have had a list of sort of many different experiences that are available if you manage your own experiences consistent with that. And that can be a great thing. Capital One has really gone after the space of the very simple messaging and 2x on everything and then the 10x on hotels and 5x on Capital One Travel through our portal.

So strikingly, I think the competitors move probably enhances our opportunity with Venture X. But I do want to say at the same time, we have great respect for the competitors, and we too continue to really invest in experiences and differentiated opportunities at the very top of the market. So I respect very much what they've done. I think it actually opens up opportunity for us with our existing capabilities.

But also if you pull way up what they are, you can just absolutely see that they are all in to win in this extraordinary area of opportunity at the very top of the market. It's available mostly for those who are willing to invest for years patiently and Capital One is one of those companies. And we really like where we are and we're going to keep leaning in and every year stretch just a little bit higher.

Our next question comes from Don Fandetti with Wells Fargo.

Rich, can you talk a bit about the credit outlook for your commercial portfolio? I know there have been market concerns around private credit NBFIs, but your metrics were good. And I think there was a modest release this quarter.

Yes. Thank you, Don. So let me take a step back and talk about the Commercial Banking market holistically. As we have all observed, there have been large, sustained inflows of capital into private credit and private equity that have driven significant growth in commercial lending across the industry.

This rapid increase in demand, coupled with a long benign credit environment has had the natural effect of both reducing spreads and putting pressure on lending standards as the expanded group of market participants compete for loans. In response to these shifting market conditions, we have been highly focused on maintaining credit discipline even when it means sacrificing growth in market share in the commercial business. This includes decisions to begin tightening credit very early all the way back in 2022 as we saw pressures mounting in commercial real estate and the potential for rising rates to pressure corporate borrowers.

One of the results of these decisions is that Capital One commercial loans have decreased by 6% versus commercial market growth of 10% since year-end 2022. We have also made a conscious decision to shift more of our business from traditional lending to credit-enhanced structures. These structures provide the diversification benefits of pooled collateral as well as a credit enhancement from subordinated capital provided by NBFI clients that absorb losses before the senior position can be impacted. Now let's talk specifically about the NBFI sector within commercial. First, it's important to acknowledge that the term nonbank financial institution is incredibly broad and the risks to lenders can vary a lot across the many industry subcategories that span corporate, commercial real estate, consumer and financial lending within the sector.

At Capital One, we have built specialized relationship management credit and underwriting team for these sectors. We are laser-focused on the subcategories of this market where we continue to feel good about the credit, the underlying collateral and the structural protections provided by our lending vehicle in the current market. The credit performance of our NBFI lending portfolio continues to be very strong. But given the heightened level of competition that I mentioned, we continue to closely monitor the portfolio and govern our lending terms.

One of the impacts of this added caution has been a reduction in our pace of NBFI lending growth since the end of 2022, even as the industry has continued to lean into this space. So that's a general view of that industry. We are junkies at Capital One about industry structure. We didn't start -- since we started with nothing in building this company, we don't go out to do everything banks do.

I sort of quip that we do half the thing banks do and then really do them at scale. And a very critical criterion and centerpiece of our strategy is we focus so much on industry structure. As a general comment, the commercial marketplace certainly has a more challenged industry structure than most of the consumer side of the business. And very importantly, just because of the growing share that nonbank financials have in that marketplace and the fact that sometimes they have different economic structures behind them.

So we've been absolutely watching the structure of that marketplace and then rather than declare, we just have to be a certain size. What we do is work backwards from that structure and identify the high ground where we believe that we can win and we lean into that and never give our teams -- we never anywhere at Capital One set objectives, okay, this year, you need to have this kind of a growth thing. We want all of our teams everywhere to know that. The greatest choice you can make sometimes is to pull back.

And so that's a little in a nutshell, our strategy in a marketplace that's very big, but also one that requires some real care. Thank you, Don.

Our next question comes from Jeff Adelson with Morgan Stanley.

If I could just follow up on the premium card question. You discussed the investments your peers have made in premium card recently, which have come with notable increases to their annual fees as well. I think we're now sitting with a pretty sizable gap on your Venture X annual fee versus some of the others, and I don't believe you've increased that since the launch several years ago. So do you think this is an opportunity for you to maybe revisit the card's value proposition?

Or do you feel like you're still finding good success with the growth and customers you're getting coming through so far?

Jeff, thank you for the great question. I'd start with the -- I just have such respect for the leading players in this space. They do amazing things, and we try to learn from them and watch what they do. I think they are -- they continue to believe that there is just a lot of opportunity.

They too, take Chase, for example, it just keeps stretching up going after customers at the higher end and a natural part of that is going out with products that are even more premium than where they were before. I think the end game in this for the major players that are in this space is to have a set of products that meet the -- that themselves are differentiated across one's own products and then that are also differentiated versus the competition. So we are both leaning into the Venture X opportunity and also continuing to build even greater experiences and opportunities for our customers at the higher end of the market.

But I don't feel like it's an either/or choice, or we have to have a one size fits all. I think in the end, it's going to be a broad quest with several arrows in our quiver and hopefully, something for all the different kind of customers at the top of the market. And I should also mention small business is another area that Capital One has invested a lot, and that has big overlaps with the consumer side of the business and a lot of shared investment and brand opportunities there. So our quest continues, here we are 15 years after we launched Venture and the quest continues.

In fact, as I even said in my closing remarks, that we even are leaning in harder. But Venture X is beautifully -- along the way, Venture X is beautifully positioned, and I think some space has even opened up for it.

Our next question comes from John Pancari with Evercore.

I'll just ask one question, give -- one question given the timing here. Just back to Ryan's expense question, when you're weighing in the necessary significant and sustained investments that you mentioned, it sounds like it is mostly in the run rate, if I'm correct there. How should we -- if that's the case, how should we think about a reasonable near-term or medium-term efficiency ratio as you have now sized up the required investments and -- as you're making them, and if you're unable to quantify yet, do you think you may be in a position to provide that expectation as we head into 2026.

So I want to clarify you're playing back, I may not have said it clearly enough. When you said these expenses are mostly in the run rate, what I'm saying is in the run rate, our investments in every one of the opportunities that I've talked about with the exception of the new Discover investments. So they're in the run rate because these are years in the making. I mean, even some of the "new stuff" like Capital One Shopping our Travel portal, or Auto Navigator, they are years and years in the making.

And that's how -- I'm still waiting to find the first organic opportunity in the history of Capital One, that just kind of appears, and we can go for it. And everything is a -- in this -- and strikingly the Capital One as a company that our growth model from the founding days to today is all about organic growth. Now it is ironic that we just closed on the biggest bank deal since the global financial crisis. So yes, we do acquisitions from time to time, but especially with the focus on acquiring growth platforms as opposed to acquisitions being our business model.

So this is over the years at Capital One. It's a tough way to make a living, to have a business model where our organic growth is the engine of our business. Take our card business, basically you look at all the growth of our card business from where -- from basically the beginning till now, there have only been 2 acquisitions in the whole history of that. We bought HSBC's card business in 2012 and then now Discover.

So this is why, and I feel such a differentiation versus all the regional banks and other banks that are our size. We come to work every day and it's about organic growth. So what that means is a lot of strategy work really working hard to identify where the growth opportunities are. And then when we see where they are, we work backwards from that, and we tend to go all in to get there, including patiently for years on this invariably from a P&L point of view, you dig a hole before the payoff comes and we have a portfolio of places of opportunities where we're in the holding in stage and others that are in the acceleration stage and some in the mature really paying off stage.

So we -- so as I said, pulling up on this, we -- I am struck by the fruits -- just the positive indication from years of quest that we have. And again, the imperative to invest in that to capitalize on that. Ryan asked the question earlier and you're sort of asking, so -- but from a metric point of view, what -- where do these things show up. The biggest place -- the answer is partly across all the parts of the P&L.

And -- but the -- to build an organic growth company, there's a word in there, which is growth, and that is where Capital One is very focused with everything that we do. So the payoff for much of the stuff that we're investing in longer term shows up in terms of growth. Now by the way, one of the striking things about the investment in the tech transformation is that unlike most cases in business where one has to do a trade-off, do you want to like to be that over time? Or do you want to be that -- do you want to have that capability over time.

What we find is when we say we want to be a growth company, we want to be -- have amazing customer experiences, we want to be fast to market, we want to have better efficiency, we want to have world-class risk management. The striking thing is, and this is different from just about any other occasion I've seen in business. This is an occasion where the journey to any of those objectives goes through the same path. It's the same shared path.

The first 99% is the same. The last mile is different, but that path is the transformation of our technology in the company. That's the path we're down, which is why on the other side of it, we see opportunities that are exciting across growth opportunities, customer experiences, efficiency benefits, breakthroughs in credit, fraud, risk management, lots of -- and then ultimately now transformed through AI. So when we think about the metrics, the long-term beneficiary -- biggest beneficiary is growth.

Revenue growth along the way. There's a lot of investment in operating costs, also in marketing. And the timing of those, many of the investments tend to come before some of the growth. So in many ways, those investments put a little pressure on things like efficiency ratio in the shorter term.

But you can see from the historical journey of Capital One, actually, if you look back to when we started our tech journey and invested so heavily in an extraordinary rebuilding of the company, we've had a lot of -- a number of efficiency benefits along the way. So we -- so anyway, that's just a window into the choices that we're making and how they might play out over time.

Our next question comes from Erika Najarian with UBS.

All my questions have been asked and answered. Thank you.

Thanks, Erika.

And our final question comes from John Hecht with Jefferies.

Two questions. First one is just the other expense line item had -- like a step function upward, obviously, first full quarter of Discover. But is there a way for us to think that -- is there a part of that, that's integration expense? And is there a way to think of the -- what accounts for other expense.

Yes, John, there's really 3 main things going on in there. One is just the run rate of what Discover expenses would be otherwise categorized in our bucket of other. In addition to that, there's some of the integration expenses and then the third piece is recall that there were some things that we talked about or I talked about in last quarter's call around business changes and reporting alignment that was going to impact the operating efficiency by roughly 90 basis points and the total efficiency by 50 basis points that were P&L neutral, but making those geography changes and one of the elements fit into that line item as well.

So that's causing -- all 3 of those forces are causing a bit of lumpiness in that line item this quarter.

Okay. That's very helpful. Appreciate that. And then, Rich, you did talk about private commercial credit markets. I'm wondering if you could talk about your opinion on the influence that private credit is having on consumer finance at this point in time.

So John, that is a great question. I think, obviously, the -- for many, many years, private credit has just so much of all of its energy has gone toward the commercial side of the business. We're on high alert, obviously, watching some of the things going on, on the consumer side of the business. Also we participate from a business point of view in our NBFI business with some lending in that space.

But I don't have a huge strategic assessment to share with you at this point. I think it's much earlier days. And there are certain aspects of the consumer business, most notably credit cards that don't lend themselves as naturally to private credit. But again, whereas other things like installment loans and in many ways, auto lending being installment loan closed in kind of business models lend themselves more to that.

So I think we -- I really appreciate your question. We're all going to need to watch carefully in that space. And we need to both watch it from a defensive point of view, but also, as always, from an opportunity point of view as well.

That concludes our Q&A session this evening. I just wanted to close by thanking everybody for joining our conference call today, and thanks for your interest in Capital One. Have a great evening.

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