Good afternoon, everybody. Today, we have with us Jeff Norris of Capital One. Jeff, welcome to the Morgan Stanley Financials Conference. Before we get started, just gonna read off some disclosures real quickly. For important disclosures, please see the Morgan Stanley Research Disclosure website at www.morganstanley.com/researchdisclosures. The taking of photographs and use of recording devices is not allowed. If you have any questions, please reach out to your Morgan Stanley sales representative. So Jeff, kicking off with the big topic on everyone's mind here. Four months ago, Capital One announced what you called a game-changing deal to acquire Discover. You've laid out expectations out there for synergies, 15% EPS accretion. You have a compelling opportunity to scale your own network. Can you talk a little bit about how this deal further drives the evolution of Capital One over the long run?
Sure, I'd be happy to do that. First of all, let me say thanks to everybody who's here, listening on the internet. And, Jeff, you have a future as a public speaker, as a guy who reads the disclaimers for every quarterly earnings call. I thought you did a fantastic job.
I tried to copy your method, I think.
That works. But, more to the point, you know, we did call the Discover opportunity. I think the word we used was a singular opportunity, and, you know, something that has game-changing potential, and I think a lot of that is embedded in the long-term opportunity created by the Discover payments network. As you all know, it's one of only four global payment networks based in the U.S. It's a rare and valuable asset in financial services and payments space, and one that, if you tried to build organically, would be extremely difficult, if not impossible to do.
So the opportunity to be in the network business with a player like Discover and their network, where they've done, you know, a really remarkable job over the last several decades, you know, building it from scratch, and, you know, competing, even though they're, you know, kind of a distant fourth in terms of the size of the network. It's a wonderful asset and a great partner with which to sort of continue that journey.
I think what we bring to the table in a combined company is the investment capacity, the technology and analytical capabilities, and the customer base of, you know, more than 100 million people that can really accelerate the progress in sort of building out that network and making it more competitive, and really changing the sort of destiny of Capital One in the following way. The biggest opportunity that we see is the opportunity to have direct interaction in a deeper and much broader sense with merchants. Now, it's a little harder to see from the outside in, but that's a strategic quest we've been on for a long time.
In large part, the reason that we're in the retail partnership space is because of the opportunity that affords to have a more direct set of interactions with a selected group of merchants. But, you know, having a network business broadens that, you know, sort of by orders of magnitude. We've also-- that's been a driving impetus behind Capital One Shopping, which is, you know, a fast-growing and digitally enabled part of our business today. But, it's a different game to be in the networks business because with a very large number of merchants, you have the direct interactions that'll enable us to sort of, as opposed to being sort of just an issuer on the other end of an intermediary network, to have these direct relationships.
We believe that we can add scale to the network. We can drive insights and analysis, and leverage the 100 million-plus customers we have and our analytical and technology capabilities to really create a lot more value for merchants in the form of increased sales, lower fraud costs, and just an overall sort of better experience. That value that gets created can then get shared with consumers and small businesses, which will attract even more of them to the network and sort of kick off this flywheel effect, this upward spiral of value creation and opportunity, that I think can you know can really drive growth of a new revenue stream at Capital One over the long run.
There's some—you know, you get better overall economics from vertical integration in the payment space, and the revenues that come from this particular business don't come with assets or consumer credit risk. So there's a lot of sort of really appealing attributes to this. You know, we have some investments to do, some capability building to do, but we have a really wonderful place to start. The combination of Discover and Capital One, building that forward, I think looks like a great and potentially game-changing opportunity.
Just digging into the network here a bit more, you, you've talked about how you're gonna need to invest a little bit more of your own dollars into addressing some of the issues there. You know, their international acceptance, perception of acceptance in the U.S., even though they're pretty much at parity in the U.S. Can you talk about your plans there to bring the Discover brand more upmarket, and, and how to think about the investment required to do that at this point?
Sure. So the long pole in the tent is the, you know, international acceptance. Let's come back to that a little bit later. I think, the reality of acceptance of the Discover Network domestically, in our view, is pretty much at parity with the other large network competitors. And so this is an exercise in our view of changing the brand perception and the perception of acceptance. All of our brand folks would tell you that, if you're starting with a reality that's a good one, you're in a pretty good position to change the perception through management and advertising of the brand. And I think that's where, you know, kind of the initial stages of investment will be.
Now, I'll point out that the synergies numbers that we've quoted in association with the Discover transaction are what I call net synergy numbers. So they contemplate some fairly significant contra synergies to cover the investments we expect to make initially on sort of building the brand and changing the perception of acceptance. But that's probably, you know, where we'll focus our efforts on the capability building initially. You know, changing the international acceptance reality and perception will, you know, probably be something that takes a little bit longer. But I still think we'll be in a position to essentially move all of our debit business over to the Discover Network in fairly short order following the close of the transaction.
And, you know, while we'll start with a meaningful allocation of our card spending volumes, the capability building, the brand building will sort of enable more meaningful chunks to move over time as well. And, I think that's how we'll see that play out.
And that debit part will be by 2027, or maybe depending on the actual deal time closing, and then, and then is the goal to maybe get the credit, most of the credit over time, or like?
So I don't think I'd speculate about specific timing and, you know, patterns of moving the credit volume other than to say we'll start with a meaningful chunk-
Mm-hmm.
so that in combination with the debit scale, we're injecting a nice little boost of scale, kind of in very short order, and that more meaningful parts will move over time. But it'll be a little bit kind of in lockstep. You could envision a world where we make some investments, build some of the credibility and the acceptance perception, add a little bit more. We build some of the international acceptance, add some additional segments, and I think you'll see those two sort of streams of activity, the investment and the movement of volumes, kind of happening simultaneously, but sort of in, you know, kind of a ladder fashion, one, you know, one step on each path.
Okay, that's clear. So you've been also clear about the pro-competitive, pro-consumer aspects of the deal.
Mm-hmm.
As everyone here knows, I think you have a meeting with the regulators in a month, public meeting. Give us a quick update of where you are in the process, how that dialogue with your regulators is going, and maybe touch on any learnings you've had since the deal announcement about four months ago.
Sure. So, I think most of this is a matter of public record, but, we've submitted our applications for approval to the Fed and the OCC, and we continue to be in kind of what I'd call from a process perspective a normal set of interactions with those two regulators and with the DOJ in their role as, you know, consulting to the Fed and the OCC throughout this process. We've received, you know, a few rounds of questions and requests for additional information. We've responded and, I think, continue to be actively engaged in that dialogue, which is very consistent with what we would have expected in any approval process for a merger of this size and scope. You did mention the public hearing that's scheduled in July.
You know, I think that we would expect an approval process to take several months, and that's, you know, playing out kind of along with our expectations. There's nothing I can say about the specific content of those conversations. That's obviously confidential supervisory information, but from a process perspective, it's kind of in line with what we've expected, and we continue to believe that we'll be in a position to close the transaction later in 2024 or early in 2025, and we'll continue to work back from that.
Okay. And if we could maybe pivot to the recent news that that hit the other week, Walmart. A few weeks ago, you both announced an end to your card partnership. You're retaining the $8.5 billion loan book, planning to convert those, or at least a bunch of those cardholders over to your proprietary offerings. This struck me as a bit of an unusual outcome. You know, typically, the retailer wants to hang on to that book.
Mm-hmm.
But nonetheless, it does look like a more positive outcome for you. Can you just walk us through the decision to retain that and what you're thinking on the go-forward strategy from here?
Sure. I suppose it's unusual, but it's not sort of unprecedented. We've actually exited some early retail partnerships in the earlier part of the 2000s, where we've, you know, retained the portfolios and converted them over time to Capital One branded products. So, it might be a little unusual, but it's something we've actually done before and have some experience with in our distant past. I think that of the options to move forward, this was one that was a good outcome for us. As we've kind of released in an 8-K, announcing the transition from the partnership to us kind of retaining ownership of the portfolio. About 40% of the balances we're retaining are things we've originated.
The 60% remaining is stuff that was originated by a prior issuer. We've watched that season for five years. We've been able to sort of manage and impact the performance, and are very comfortable on an overall basis with the ongoing sort of resilience and profitability of what we're retaining. Over the several coming months, we will kind of begin the conversion process, where we'll you know, transition many of these customers from their Walmart products to a Capital One branded product. And you know, I think we were fairly disclosive in the 8-K, where we kind of talked about the revenue impact and the charge-off rate impact on a pro forma basis for Q1.
So I think net-net, you know, this is an $8 billion-ish portfolio with attractive economics and resilience, and, you know, we're happy to have it be part of our book. And in the context of kind of a $150 billion overall card business, the sort of near-term effects around kind of the impacts on charge-off rate and revenue margin, you know, we're fairly quickly absorb and move forward. Now, I'd be remiss if I didn't sort of say that, you know, there is, of course, the potential for a fairly significant allowance build. That'll be one-time in nature, and we sort of gave it a pro forma estimate of that, as of Q1 as well.
That's not sort of a statement about the allowance build we expect to book. It was literally a pro forma thing for Q1, and the actual allowance will depend on all the things that it normally depends on, and includes sort of the Walmart impact. But again, I think that's an impact we'll kind of absorb and move forward, and we'll be happy to have these customers and these accounts on our books.
If we think about the U.S. consumer at this point, you know, you've talked about the consumer being in reasonably, reasonably good shape versus historical standards. At the same time, though, we have seen some evidence out there of slowing spend as consumers-
Mm-hmm.
-maybe trade down and are still dealing with the last several years of inflation. So what are you seeing? Maybe you could touch on both spending trends and some of the credit trends you're seeing today.
Sure. Let me start with credit. You know, the strength of the consumer. We still, I think, view the consumer as a relative strength in the current context of the economy and credit cycle, and how they're sort of playing out, and how they're likely to move forward. You know, on any historical basis, you know, consumers today are looking relatively good. So, I think the biggest driver of that is really healthy labor markets, which have maybe defied expectations in maintaining their strength for so long. We have seen basically you know kind of modest net improvement in consumer balance sheets in the aftermath of the pandemic.
And while the amount is falling on an aggregate basis, you know, customers that we have in both our card and deposit businesses still have kind of marginally higher savings and bank balances than they did before the pandemic. So that's, I think, supported some of the strength. I think wages have sort of softened the, you know, increasing wages have softened the blow of inflation for a while. And in the recent sort of year or two, have essentially, you know, kind of in many ways, offset it in some of the segments. So, you know, net-net, everything looks pretty good. Now, the persistent inflation over a fairly long period of time, higher for longer interest rate environment, it is increasing the cost of borrowing, you know, for consumers.
And I think, you know, there are some very preliminary signs on the margin that are consistent with what you've talked about as, you know, some early signs of potential pressure. For example, we have seen a modest increase in the percentage of customers who are making the minimum payment instead of sort of something larger to pay down their balances. But that's not in and of itself, you know, kind of a reason to change our view. I think it's just a very early and a fairly modest sign that, you know, the intuition that I think anybody would have at prolonged period of high prices and high interest rates is, you know, bound to put some pressure on consumers.
But, on a credit perspective, the trends we've been seeing across our segments and across our portfolio in delinquencies, delinquency inventories, roll rates, and, you know, extrapolating forward from that sort of charge-off stabilization, are all sort of still very strong, and I think consistent with the net view that consumers are in a reasonably good place, versus historical context. And then on spending, if you pull up and look at the period of time over the last couple of years since the pandemic, our spending trends have on average over time, kind of outperformed the card market. They've slowed down. We were down to sort of 6% net spending growth in Q1, and that was essentially entirely driven by new account origination.
So if you look at it on a spend per customer basis, that's more flattish, which I think is, you know, kind of consistent with what we've been talking about, after a long period of sustained inflation and high interest rates. So that, you know, to me, looks like consumers behaving rationally, which is, you know, kind of a hallmark. Consumers are generally the most rational players, as economic cycles play out, and I think the sort of deceleration in spend is consistent with that.
As you think about the consumer being rational here, you, you've also talked about credit stabilizing modestly above 2018, 2019 levels. But last quarter, you did call out lower tax refunds as potentially adding a little bit of a near-term pressure point there. How is that playing out at this point now that we've had the tax refunds kind of more fully come through at this point? And any sort of updated view?
So, no, not an update, but I think a couple of clarifications. The first clarification is, I think some people got a little confused, that we were thinking about this year's pace and amount of tax refunds versus last year-
Mm-hmm.
which has essentially, you know, fully caught up. The point we were making was actually about the pace and magnitude of tax refunds going back to, like, 2018 or 2019. And in nominal terms, the timing and overall size of tax refunds in 2024 continues to lag 2019, for example. And if you adjust it to 2019 dollars, the lag and the gap is actually even more meaningful. That's the bad news. The good news is that the trend is, you know, at least directionally catching up. So there is that. The point we were making was you know, if you're a long student of Capital One credit trends, you know that our seasonal trends are generally more pronounced than the industry's.
And part of a big driver of that, the trends tend to be sort of improvement in the first half of the year, followed by some worsening in the second half of the year on a kind of a seasonal pattern, all else equal. I think we've seen less net improvement this year, driven by the fact that there have been fewer tax refunds and a lower overall amount of tax refunds compared to pre-pandemic years. And so, you know, when a consumer gets a tax refund, that enables them, in many cases, to get current on their credit, even if there are several delinquency buckets, you know, past due.
But if that economic benefit comes to them sort of in 12-- throughout 12 months of the year as just a slightly higher, you know, net paycheck, it doesn't have that same sort of credit impact or delinquency curing impact that we've seen. And so we've just seen a little bit less of that in the first half of this year. We believe that at least for this year, the sort of typical seasonal pattern's a little bit disrupted. We're pretty far short of declaring that there's a new normal seasonality. We'd have to see a much longer sort of data set to draw that conclusion, but we're pretty confident that it looks a little different this year. And that probably affects the net timing and the-- potentially the net amount of what modestly above, you know, pre-pandemic means.
But I think the salient point, and the one that matters most in terms of our internal decision making and choices, is stabilizing modestly above pre-pandemic levels, and that's been a view we've held throughout.
Okay. You know, as you think about the competition for, for credit at this point, you know, everyone is still broadly in net tightening mode. But we all know that Capital One likes to zig where others zag. What are you seeing from the competition today, and how are you reacting to that?
In the domestic card space, I think we're in a position of zigging while most of the other major players continue to zig as well.
Okay.
I think that, you know, while there's some tightening and trimming around the edges, as there always is, the net position of us and, and most of our competitors is still pretty much leaning in to origination and, and growth opportunities in the marketplace. So, you know, that's a testament, I think, to the, to the long-term value creation and resilience of, of the origination opportunity that we and, and others are seeing at the moment. From a competitive standpoint, that plays out in, at the very top end of the marketplace, as a continuation of, of a competitive environment that's. I'd characterize as one that's been pretty intense, since the pandemic. And you've seen, many competitors kind of increasing the rewards rate. You've seen, maybe a tick up in some of the advertising for top-of-the-market products.
And, you know, we continue and others are, you know, doing things like building out airport lounges and, you know, creating really compelling value propositions for that very top end of the marketplace. So that competitive environment, you know, remains fairly intense. We've probably seen a more moderate sort of consistent competitive environment in some of the other places we play. And on net, you know, we continue to sort of see great opportunities. And as I said, you know, kind of when you look at our choices, the conclusion you draw is that we continue to lean in, despite the fact that we are doing some trimming, as always, around the edges.
I think you just mentioned a more moderate competitive environment in other areas. What other areas might those be at this point?
Well, we're sort of still focused on the places where we've always focused, which is, you know, these days, primarily at the very top of the marketplace with heavy spenders, and on revolving customers that don't necessarily have very high balances across a number of cards, but sort of more moderate revolve behaviors, that focus begins what I call at the upper end of subprime and in through prime. So the one place where we're kind of leaning out and trying not to sort of have a lot of growth is in this cohort of, you know, kind of high balance revolvers.
What about in auto? You know, we've heard a few others highlight some increased willingness to lean in there. What are you seeing there?
Yeah. So auto is, I think, more of a mixed bag. We've seen and heard some competitors, you know, kind of leaning in. We've seen some increasing pressure at the upper end of subprime and auto from some of the smaller players and even some of the regional banks. We have seen a couple of larger players, maybe pausing and, or, or moving a little bit the other way. So it's a fairly dynamic and sort of mixed competitive read, I think, in our view. And when you juxtapose that with our portfolio trends, we've you know, as you recall, Jeff, we pulled back, pulled back fairly significantly a couple of years ago, in the face of kind of industry margin pressures. Those margin pressures have kind of essentially resolved themselves. And when we th...
You know, we're kind of looking at three things. Based largely on the pullbacks we made a couple of years ago, we've actually seen very good credit performance, that's tracking, you know, at or better than expectations, and is pretty strong relatively in the industry. That creates some opportunity to think about, you know, growth opportunities. The competitive environment, as I said, has puts and takes, but generally looks like there's some attractive pockets where we could sort of, you know, kind of resume more of a growth posture. You know, Rich told me this once, never sort of pre-number your points because you get halfway through and the first two, and you forget the third one, and so I've forgotten the third one.
But anyway, on net, we see an opportunity to sort of resume more of a growth posture. And we actually did see a year-over-year originations growth in Q1. As you know, we'll have to sort of see that continue for a little while before that translates to sort of loan balance growth. But we're cautiously optimistic, and if, you know, kind of conditions and competitive intensity holds, you know, we might, you know, see some continuing opportunities there. But we'll have to see how that all plays out. And you know, we really are kind of back leaning into selected pockets as opposed to across the auto marketplace.
And as we maybe think about technology, you know, you're well known for being what you call the original fintech, I think. And a year ago, Rich was here talking about the AI opportunity, what he described as, you know, with all its breathtaking advances at that point in time. So can you talk about how AI fits within your tech stack, how that evolution is going at Capital One today, and where you've been able to take advantage of this tech so far, and where you see that going?
Sure. That's a potentially big answer, but I'll take it on. We've talked a lot about the tech transformation we've undertaken over the last decade or more. We've talked about building it up from the bottom of the tech stack up. So, you know, insourcing essentially all the talent in what I'd call sort of one of, if not the sort of core function that's going to define competitive advantage and opportunities going forward. So we have, you know, literally tens of thousands of software engineers, data scientists, and similar sort of technology and digital native associates, bringing that capability and that advantage in-house. We've rebuilt our data infrastructure and our technology infrastructure. We're essentially 100% on the public cloud.
We've got, you know, data streaming in real time. We're, we're probably the only financial institution that I know of in the United States at least, that's actually done that full of a transformation to, to be a modern technology company, and also be a financial institution at, at, at scale. And I think that puts us in a really unique and strong position to take advantage of the sort of emerging benefits and trends and things like AI. So, we were already, based on that sort of tech capability, applying machine learning and artificial intelligence at scale in some of the core processes of our business. It's informing and driving our underwriting models that are looking at way more data and way more algorithms.
It's informing and driving our, you know, marketing and targeting models, which are getting, you know, ever more precise and effective, which tends to sort of offset the sort of otherwise kind of competitively rising pressure of, you know, things like cost to acquire. We're getting way better compliance outcomes. We're driving efficiencies as we kind of, you know, discontinue analog processes and replace them with sort of, you know, end-to-end digital processes. We're faster time to market. All those things are happening today, and a lot of it's on the back of machine learning and AI at scale. Now, that's a slightly different thing than generative AI, which is where a lot of the sort of you know current excitement lies.
But I think, you know, we're equally well positioned to take advantage of those benefits as they are generated in the marketplace. And as the focus of the world turns to sort of how generative AI can be applied in a business context, we're going to... Again, I think everybody is going to benefit from that to a certain extent. Everybody can sort of leverage the capabilities of a ChatGPT or a Copilot kind of AI, you know, generative AI-driven product.
But I think you really have to have that modern tech stack, that modern data infrastructure, and that sort of focus on technology and digital transformation as a core capability to fully drive the benefits of generative AI into the core processes of the business and how you come to the marketplace and make decisions and choices, as opposed to sort of seeing it kind of on the periphery and sort of gradually working its way in. So I think we're uniquely and certainly very positively positioned to sort of take advantage of that as it plays out, and it's one of the things that's, you know, most exciting about Capital One.
I'd also be remiss if I didn't point out that, you know, one of the key sources of that game-changing value that we started with is the combination of the network, business, relationships, and scale that Discover has built with the technology capabilities and digital capabilities that we've built, and combining those two things is really what creates a lot of that sort of game-changing potential. The ability to apply that investment that we've made and the benefits over a much larger enterprise drives both a bunch of sure-footed, sort of nearer-term benefits, like the synergies, and that sort of long-term upside opportunity. So, you know, I don't think we'd be talking about the Discover opportunity if not for the technology capabilities that we've built over the last 10 years.
Just one on capital. So, can you talk about how you're thinking about capital return from here? I understand, you know, you do have some deal-related blackout periods and a near-term dividend cap, but are you waiting for a little bit more clarity on capital rules, or the pending deal before you think about any kind of meaningful increase in buybacks at this point?
So I think, you know, to your point, there are some technical considerations around share repurchase blackout dates driven by sort of the proxy being in effect and, you know, other things that are gonna come into play along the approval process, which would sort of largely keep us, or maybe even from quarter to quarter, be a little bit below the trajectory we've been on, which is fairly modest, you know, sort of regular quarterly level of repurchases. I think what we've said all along is still our view, which is we continue to be watching largely for things like the final resolution and implementation of Basel III regulations and how that's implemented specifically for U.S. institutions.
We'd like to get through at least one more CCAR cycle and see how that plays out. And, you know, we continue to have an eye on, you know, kind of inflation and, how that might drive sort of economic trends going forward, juxtaposed to the kind of continuing organic growth that we see. So there are a number of things that we're, you know, kind of watching and assessing, and that continue to have us be a little bit more comfortable running above our long-term CET1 equity ratio target, so that we're, you know, prepared for a number of eventualities, some defensive and some, you know, kind of offensive. But the net of it is, I don't think we're gonna wanna run with excess capital levels for, you know, forever.
Mm-hmm.
And I do think that over the long term, returning pretty significant capital to shareholders is gonna be a, an important, and continuing part of our value proposition to investors. But, for the time being, watching some of those uncertainties play out in the sort of current trajectories is probably more, more what, more what we're likely to see.
Then just real quick on CCAR, we have the results coming up in a few weeks. To us, the variables this year, the test looks pretty similar to last year. Any sort of nuances for Capital One to be aware of?
You know, nothing. I think we'd probably wait and see how the Fed's modeling comes out before we'd have much to say about that.
Mm-hmm. Got it. And just one last one on, maybe wrapping up here on the Late Fee Rule.
Mm-hmm.
Probably your favorite topic of discussion, but-
I love all the topics, Jeff.
Yeah. And you, you've got some offsets out there already, but it sounds like you're holding on, holding off on most of them at this point until the rule is actually implemented. Maybe just speak to any opportunity, I mean, any examples you've actually taken so far, of actions you've taken so far, what the response rate from consumers has been like so far on that?
Sure. So you know, what I'd say about the CFPB Late Fee Rule is, you know, we, just like everybody else, continue to watch a fairly uncertain environment play out as it sort of bounces around in sort of litigation and so forth. What we've said all along is that if and when it does become a rule and gets implemented, that will have a significant negative impact on our revenue, and that our responses are likely to be focused on things like product changes, policy changes, and investment choices. I think the nuance is, I don't think it's quite right to characterize it as we're just gonna wait and see what happens. We're in a far more active mode than that.
Rather than take a bunch of preemptive actions, what we're really using this time for is more testing.
Hmm.
Because in addition to sort of a revenue impact, we believe that the implementation of this rule would have a pretty meaningful and significant impact on the marketplace, things like competitor and consumer behaviors and things like volume and credit. We're doing what we can to test some of those outcomes now. There's only so much you can test at this stage. So we'll wanna sort of see kinda how all these market, marketplace effects, you know, begin to play out, after the possible implementation of the rule. But the combination of the testing we're doing now and sort of the marketplace impacts as they play out, are gonna dictate the choices that we make.
When we make those choices, we're gonna be working back from that context and the sort of goal, or objective function of really preserving the value of the customer franchise that we've invested for years to build. We believe we've got a loyal and valuable customer franchise. We've worked really hard, you know, in essence, reducing the kinds of fees and the levels of fees, so we're down to only two in the credit card space and have probably the most simple products in the industry. We believe we're getting paid for that now in the form of, you know, higher growth, lower attrition, better credit selection, and we wanna continue to sort of reap those, you know, value-enhancing benefits. So we're gonna work back from that.
We're gonna work back in the context of, you know, testing the marketplace effects of how this thing works. And when I pull all of that together, you know, I still think we're gonna be in a place where we've essentially resolved the negative impact on a P&L basis in a couple of years.
Okay, great. Well, Jeff, I think that's all the time we have for today, so thank you for coming and, please join me in thanking Jeff.
Thanks, Jeff. Thanks, everybody.