All right, good afternoon, everybody. So, last but definitely not least on our agenda, we have Capital One. So, joining us on stage today is CFO Andrew Young. Thank you for coming.
Thank you.
Senior Vice President of Finance, Jeff Norris. Thank you for coming.
Happy to be here.
So, Andrew, let me start with you. Rich gave us a great update on the state of the consumer when you reported earnings several weeks ago, and I was hoping to unpack some of that even more. So, spending accelerated nicely at Capital One and your closest peers, and one of your peers reported later and gave us some insight that the momentum from Q4 continued into January. Could you perhaps provide us some color on what you were seeing in consumer spending?
Well, thanks again for having us. Great to be here, Erica. Probably best to rewind to what happened over the course of 2024 to then talk about the exit of the year that we saw. And I won't be giving intra-quarter updates like it sounds like one of our peers did, but when you take a step back and look at what we saw over the course of 2024, I'll split it between the higher end of the market and the lower end of the market. In the higher end, we saw spend on a per-customer basis be roughly flat for the first half of the year, and then it picked up in the last couple of quarters. At the lower end, what we saw was customers on a year-over-year basis, spend was actually a bit negative for the first couple of quarters.
But the acceleration in the subprime market picked up more than what we saw at the upper end of the market on a relative basis, such that we exited the year at about the same level from those two segmentations. So, overall, spend after being roughly 5% through much of the year on a year-over-year basis ended up exiting the fourth quarter at 7%, given that strong exit velocity that we saw.
And you alluded to this. You also talked during the earnings call about the lower-end consumer doing relatively better at the moment, but also that a proportion of customers are making just the minimum payment. Could you isolate that to a particular cohort?
I'll split it based on sort of average and people at the margin.
Yeah.
And so, when you take a step back and look at the average payment rates across the portfolio, they've stabilized over the last few months, and they've stabilized at a level that is above where they were pre-pandemic. That said, there are pockets of the portfolio where we are seeing that payment rates are teetering closer to the edge, such that when we look at that particular portion, the percentage of people just making the minimum payment is also higher than where it was pre-pandemic, despite the average payment levels being elevated. So, we're keeping a real close eye on the population at the margin.
That being said, the delinquency data that you reported from both a seasonally adjusted and year-over-year basis was encouraging, which would imply that losses could trend lower from here. Now, I know you don't give charge-off guidance. That being said, if the U.S. economy continues to be strong-footed, are we closer to going back to a better correlation between delinquencies and unemployment this year?
Let's also rewind on the delinquency side.
Yeah.
And what we saw over the course of 2024 was delinquency rates largely maintaining kind of a seasonal effect to the level it had been in the prior year. But as we got towards the end of the year, we saw separation there, such that delinquency rates were actually improving relative to seasonality. And one side note on seasonality that Rich has talked about on the last couple of calls is when you look at tax effects over the last couple of quarters, those have been a little bit different than what we had seen pre-pandemic. And so, we're calling it a bit of a revised seasonality there.
But relative to what we've seen over the last couple of years, the trends have been more or less moving in line with that seasonality until the end of the year, where we actually saw in December that delinquency rates were actually lower year-over-year in December. So, delinquencies are always going to be the leading indicator of where losses go. And so, what we're closely keeping an eye on, of course, are those delinquencies. But the things that are affecting delinquencies beyond, to your point, the regular economic effects are if you look at interest rates and what effect that ultimately has to the consumer, particularly at the margin. But then when we take a step back and stare at what we're calling the delayed charge-off effects.
Yeah.
That is just like an uncertain effect that is playing through when we go back to 2020 and 2021 and 2022, where loss rates were well below historical averages as a result of the combination of stimulus and forbearance and people not traveling. What we're calling the delayed charge-off effect is the better than what you would expect given economic data over that period. Now, we're seeing a bit of a trailing effect there to where losses are actually higher. And so, when you then look at what that ultimately means for loss rates and delinquencies, adding to that effect, you have recovery rates.
Yeah.
From lower back book of recoveries than what we saw pre-pandemic. So, all of that sort of wrapped together is why we had delinquencies that remain above pre-pandemic levels and loss rates that remain pre-pandemic levels, but a trend that is kind of heading down from here, and as I said, lower year-over-year in December.
Thank you for the summary. So, switching gears a little bit, competition in the premium segment has always been fierce, but as a consumer and an analyst, it does feel like the temperature continues to turn up. So, the momentum in high-end travel cards are particularly strong at Capital One. How are you approaching customer acquisition in 2025? And could you share a bit about your strategy to win against your peers in this particular space?
The high-end competition has been and remains intense. I'll think about it or I'll articulate it really in two ways. One is product intensity. And so, we've seen a number of competitors out there in terms of teaser length or early spend bonuses or rewards rates. Competition there has been sustainably quite intense. The other piece, though, that I think is really important to factor in is at the upper end of the market, it's not just about the product, right? It is about the things that are wrapped around the product in terms of experiences and offerings, things like the concierge services or access to events or.
Taylor Swift?
Taylor Swift and has a tremendous payback.
Yeah.
There, but requires investment, and so, we, as you know, have been on this journey over the course of really the last decade to win at the top of the market with heavy spenders, and it's not just about the products. It is about sustainably investing in all of the things that I just enumerated to create an experience for the customers, and there are very few people who are making the investments to win there, and Capital One being one of them, and so, that is something as we look ahead to 2025, that will be a sustained investment for us to continue to get traction there, and we're really pleased with the progress we've made, particularly over the last few years, but the economics of that, there's tremendous loyalty, very low attrition rates, high levels of spend.
So, we really like the economics of the franchise that we're building there, but it requires that sustained level investment. But what we're seeing overall, I would position as it is intense but rational, which tends to be the card market. But differentiating ourselves there really requires the creating additional experiences, and that's something, again, that we're really pleased with the progress that we've made.
As we think about overall domestic card growth in 2025, how much of it will rest on organic momentum accelerating versus new account acquisitions?
If I look at just organic volume and spend per customer, that's going to be a function of a couple of things that we don't control and one that we do. Then I'll come back to the point about organic growth of customers.
Yeah.
But on a per-customer basis, it's a combination of spend behavior, which we touched on, of accelerating in the fourth quarter. We'll see how things ultimately play out in 2025 there. But it's also then the payment rates.
Yeah.
And so, payment rates have sort of settled at a higher level. It had been. Loan growth had been benefited.
Yeah.
By payment rates coming down over time, at least on a relative basis. And what we've seen over the last couple of quarters is they've stabilized. So, that's no longer on a relative basis, the tailwind that we had been seeing over the last couple of quarters. But those are two things that are outside of our control. They're customer behavior. The thing that we do control are credit lines for existing customers. And that, just like our normal underwriting, is a place where we see opportunities. And I would characterize what we're doing today on credit lines as more or less in line with our historical practices. So, that is the sum total of those three things are driving loan volume per customer. The whole other category is the traction that we're seeing on customer originations.
And when we look out there, we see large swaths of opportunities that we continue to lean in. We've gotten great traction with customer growth. And clearly, that's always a line of scrimmage call for us. But based on what we've seen over the last number of quarters, we continue to like what we see out there, and we continue to lean in to generate new customers.
Talking about maybe the other side of the balance sheet, it's been a while since we've seen a non-zero neutral rate. What's your strategy for deposit repricing from here? And do you expect to see similar deposit rates on the way down as on the way up? Or do your growth prospects translate into a lower ability or lesser ability, rather, to reprice?
With respect to strategy, I would say our strategy isn't changing at all. We're incredibly proud of the deposit franchise that we built. We've seen very strong growth over the last couple of years. And so, overarching deposit strategy isn't changing. With respect to pricing specifically underneath that, if I compare back to the last cycle, what we've seen in the first couple of quarters really mimics almost exactly what we saw in the last down cycle. I think the Fed had moved about 75 basis points over a couple of quarters, and cumulative betas were in the very, very low double digits, something like 12 or 13, if I remember correctly. What we've seen in a period where the Fed has moved 100 basis points over a couple of quarters, our deposit beta in the fourth quarter was 11.
From here, though, I think there's a few things that are going to potentially cause a deviation relative to the trend over the subsequent few quarters. The first is in the last cycle, recall that the Fed very quickly dropped 150 basis points because we were early in the pandemic.
Yeah.
And so, that naturally just creates a beta lag. Likely doesn't change the destination all else equal, but it will create a lag in the beta over those few quarters. So, that's something that we're keeping an eye out for because clearly, if the Fed doesn't move or move slowly over the next couple of quarters, we would expect that the sequential betas will probably be higher than what they were before. The second effect, though, is where the Fed ultimately lands.
Yeah.
Because last time they effectively went to zero.
Yeah.
Which creates a floor. If we see the Fed settle out over the course of this cycle, call it the next couple of years, it's something more like three or three and a half, then there's not a natural floor that could impact pricing. The third effect is the industry demand for deposits.
Yeah.
And to me, there's probably a couple of elements to that. One is just loan growth because in that last cycle, loan growth was incredibly tepid because people weren't traveling, and it was early in the pandemic. And we may see a bit higher loan growth than we saw at that point in time. But then when I think about our products, our product mix kind of being the last factor where you saw a rotation over this cycle, the last number of quarters where consumers moving from lower rate-paid products or different tenors. In the last cycle, there wasn't that same effect because on the way down going to zero, you would expect that there would be less product rotation. And we may see some lingering effects from rates being just absolutely higher.
Yeah.
So, even as rates are coming down with higher levels of rates, there may be some remnants of that rotation still taking place. So, I share all of those factors to say I think it's reasonable to assume that in the, call it next handful of quarters, you could see betas being higher than what they were in the last cycle. But ultimately, as I take all of those factors into effect, you could see a terminal beta that is at or below where it ended up last time. So, a lot.
Yeah.
In there and a lot of uncertainty, and the loan growth and competitor behaviors are certainly going to impact where we land, but those are the things that we're closely monitoring to just see how things play out.
And that was very helpful. Before I get into my next set of questions, I just want to remind the audience that if you want to ask a question later, if we have time, use the QR code and scan. I think there's a little sign at the table. I'll get it in this iPad. We also have the old-fashioned way in terms of a mic in case you don't want to do that. So, another question for you. Investment spend for the future has always been a hallmark of Capital One, and it feels like these investments, like in the cloud, have set the company up well for a more seamless integration of Discover ahead. How much of the tech spend would you classify as front-loaded versus continuous improvement for a company that always likes to be at the forefront?
Erica, why don't I jump in on that one? Give Andrew a chance to catch his breath.
Sure.
You know, you're right. I think we are the company that invests for the long term. It's kind of in our DNA. And we have this metaphor inside the company called coiling the spring, which is a metaphor for sort of investing and storing up some potential energy that you can release over time to create and sustain long-term value. The tech transformation is a hallmark of that. And let me unpack that and talk a little bit about how it works. So, 13 years ago, we started to invest to transform ourselves into a modern technology company. And the initial investments were pretty foundational. It starts with recruiting and retaining and growing a world-class set of talent that's digital native. So, software engineers, user experience designers, data scientists, and the like.
And then it moves up the tech stack to things like getting massive amounts of data streaming in real time on the cloud. And you can continue to climb the tech stack from there. And those first couple of rungs working from the bottom of the tech stack up feel really like they're front-loaded because there's a lot of investment and not much sort of customer-facing activity. But as we continue to climb the tech stack and where we are today, more and more of the investments we make in technology are customer-facing, do generate revenues. And when we stop and look at that sort of whole 13-year period, we've been able to generate a bunch of benefits. I mean, it's everywhere we look around the company, it's improving our underwriting outcomes. It's driving revenue growth. It being technology. It's resulting in better compliance outcomes.
It's, as I said, driving cost efficiencies along the way. And it's in no small part positioned us really well to make and hopefully soon to integrate the Discover acquisition. So, the key to it is to, if you do it the right way, if we do it the right way, we invest for the long term, we coil that spring and store potential energy. But the benefits of those investments grow and accumulate over time. And that's exactly what we've seen on our tech journey. And so, that's kind of part and parcel of how we run the company. The one thing I'll note is on the continuous improvement side.
Yeah.
The world is continuing to change, and since our strategy works back from where the world is going, there's always this continuous improvement element along the way until and unless the world stops changing, but I don't expect that anytime soon.
No, I don't think so either. So, let's talk about the Discover deal. You continue to sound confident about an early 2025 close, which hasn't wavered since you announced the deal a year ago. Investors were less confident prior to the election, more confident now. What can you share with us that gives you confidence on the path forward to approval?
Over that year, we have been deeply engaged in conversations with the Fed and the OCC, who, as a reminder, are the two approving bodies of the transaction. We also have engaged deeply with the Department of Justice, who provide the consultative role to the Fed and the OCC. Those conversations progressed as we expected. In addition, Discover being a Delaware state chartered bank.
Yeah.
We required approval from the Delaware State Bank Commissioner, which we have received, and as you're well aware, we also needed to file the joint proxy for the shareholder vote, which is scheduled for next week, so that's another really important milestone that will be upon us here in a week, and so we continue to believe now, as we did a year ago, this deal is pro-competitive, pro-consumer, and the conversations, as I said, have been playing out as we expect, and we look forward to hopefully closing, getting approval and closing the transaction here early in 2025.
Feedback from investors indicates a pretty widespread positive reception to the deal. The one piece of pushback that I receive is the amount of reinvestment you would likely need to put back into the Discover credit and debit network. Is there a way for you to help frame the level of investments contemplated within your expense synergy estimates?
Let me start by reiterating what we shared in terms of synergies at the time of the announcement. We said the operating net operating expense synergies would be 26% of Discover's expense base. I emphasize the word net to say that there are really three big components of the synergies. One is they have a card business and a retail business that overlap from an operational perspective quite significantly with ours. That is the source of the gross synergies. As we bring them onto our platforms, the marginal cost of digital products in card and retail marginal costs there are quite small. We see meaningful synergies from an operating perspective in those two businesses. Discover also has a couple of businesses that we aren't in. They're exiting student. But beyond student, they have their home lending business and.
Personal loans.
Personal loans. Gosh, sorry. And so, with those two businesses, because we're not in those businesses, we are not assuming any synergies there. The third category, though, are what I would label as dyssynergies. And so, we have assumed gross dyssynergies for the investments that we've really been talking about since the deal, in particular the need to continue to build risk and compliance. And so, that is not just a run rate dyssynergy, but we've also made assumptions on our integration costs for investments that will need to be made over this integration period there. And we've also assumed dyssynergies associated with the network. And so, all of those things combined together is what is underlying the 26% net synergy number that we quoted.
Very helpful. You mentioned risk and compliance. So, on legal day one, you do inherit Discover's regulatory issues. Of course, your risk and control processes are completely different, I would imagine. And you just talked about the dyssynergy of investing more. Should investors expect a quicker resolution after legal day one of Discover's regulatory issues? Or maybe I should ask this another way. Should we expect any of the regulatory issues at Discover to be prohibitive to any business momentum for the combined company?
We are acutely aware of what it takes to create a world-class risk and compliance organization. We've been investing for a number of years, many, many years in our people, in our processes, in our technology. We also experienced consent orders coming out of the cyber event in 2019. We understand it takes a lot of very concerted efforts to work through those. We have every intent to bring Discover up to the standard we've set for ourselves, regardless of whether or not we formally inherit the consent orders. We absolutely are committed to maintaining our level of risk and compliance that we've been operating with as a standalone company as we bring Discover in. We recognize that's going to require investment and focus. To your question about prohibiting things, no, it's not going to prohibit business operations or choices we make.
But we will absolutely be maniacally focused on making sure that we are bringing them to the standard we've set around risk and compliance.
So, in nine days, it'll be the one-year anniversary of the announcement of the deal. I think it was President's Day. I think everybody was eating breakfast. And I think that breakfast is still abandoned on the counter. Clearly, the macro and the regulatory outlook has shifted materially since the announcement. Have there been any changes in how you feel about deal economics? So, what's coming in a little bit better as you refine the math, and what's coming in a little bit worse?
Well, let me remind everyone that we continue to be two separate independent public companies. And so, there are a lot of things that we still don't know beyond what we learned during diligence. That said, let me also remind everyone of what we assumed from an economic perspective, which was we used consensus estimates for 2024. And we removed the effects of student because they had already announced their intention to sell that portfolio. We also assumed consensus credit estimates for 2024. For 2025, we assumed, unlike consensus, that credit would be similar in 2025 to what it was in 2024 at a time when consensus estimates were for credit to improve relative to the forecast for 2024.
I state that to say a lot of what we know is visible to the investment community because we can look at how 2024 transpired across all of the individual line items. I think the one added non-underlying effect was some of the costs that they incurred related to the card misclassification issue that are one-time in nature or more one-time in nature. The underlying trajectory, we liked what we saw in their actual full-year results that they had their call a couple of weeks ago. One thing I would say is credit trending a little bit better to what it was assumed to be in 2024. What we have are their public comments around trends from here and consensus estimates.
But what they said about credit continuing to improve from here, again, recall that what we assumed was it was going to be at the 2024 levels that were assumed as of a year ago and being similar there. So, overall, my punchline is we like what we see in terms of the overall deal economics. We continue to be just as excited strategically and financially as we were a year ago. There are a number of things that are going to move, line items that are going to continue to move until we get to close. But there's nothing that we've seen in their actual results or their commentary a couple of weeks ago that suggests anything but the trends are playing out in a way that aligns with our expectations.
So, just as a technical follow-up, as we think about credit, does that impact sort of the day one loan mark or the day two provision? Or it doesn't matter because it all falls to the impact on pro forma book value and CET1?
There are going to be a whole lot of things that get impacted on legal day one. So, recall that we're now under a regime where we have to do purchased credit deteriorated PCD or non-PCD, which some of which will flow just through the balance sheet and ultimately impact NIM and other pieces that will flow through the P&L. So, all of those marks, PCCR, the CDI for the deposit intangible, we're going to work through that when we get to close. So, we'll have more to say when we finally get the mark. But so many of those factors, including the ultimate consideration paid because it's a fixed ratio to share price. So, the total consideration won't even be known until we actually get to close.
So, a few more questions from me. The Discover Network was one of the key assets clearly that attracted you to the acquisition. And there are certainly some benefits that come from having that direct relationship with merchants. As you work to integrate Discover over the coming years, where do you see the greatest potential for Capital One to extract value from becoming an issuer with your own network?
I'll jump in on that one again, too. I'd probably change the wording a little bit. I don't think it's a matter of extracting value as much as it is creating value over the long term.
Yeah.
In the very short term, the network's a key driver of some pretty sure-footed revenue synergies that Andrew talked about. It's also in the intermediate term, I believe, because of the vertical integration economics, an accelerant to an already pretty successful trajectory of growing checking accounts on a national scale without the cost and complexity of having to build or buy a national branch infrastructure. The potential that's really exciting over the long term comes from the direct access to merchants, as you rightly pointed out.
Let me just sort of say we've been on a quest for many years to have more direct access to merchants because we believe that the combination of our customer base and our massive data streaming in real time and analytical capabilities has the potential to sort of do some really attractive things for merchants, like lower fraud costs and drive increased sales. There's always been a big network intermediary standing between us and the merchants that has kept us from sort of completing that loop. Where we've done it on a small scale, for example, in our partnerships business in credit cards, we've seen the impact of giving customers great deals, which attracts more customers, which makes the merchant happy, which creates value that they share with customers, and you kick off this virtuous cycle.
But in the partnerships business, it's a handful of merchants and a subset of our customers. As we build the capability of the network and move more and more of our volumes over there, we're talking about a massive increase in scale, right? And so, it's tens of thousands of merchants, 100 million customers, big data streaming in real time that sort of has a multiplicative effect on the things that we might be able to discover and share to create value and kick off that sort of flywheel effect. Now, that takes some time. It takes some investment. But I think the marriage of our 100 million strong customer base, our analytical capabilities and heritage, the modern technology company that we've become, and direct access to merchants through the network, that's where the game-changing potential comes from.
Great. And just maybe to end on a few questions on capital, there's been significant regulatory momentum or at least signal coming from Washington. What in the pipeline could be most material to Capital One? And just maybe a technical question. Are you entering a 2025 stress test as a standalone company? And if the deal closes early 2025, as you expect, do you need to resubmit for this year?
We are entering stress testing as a standalone company. Like last year, what we intend to do is have a kind of supplemental view of pro forma. But of course, we're limited to externally available information. So, that's a pretty limited and non-binding view. And this is the first instance where an SCB bank is buying another SCB bank. And also, with Discover being Category IV, they're not required to go through stress testing this year. So, there's still some uncertainty of how stress testing will ultimately play out this year. But for now, we're working through our machinery to file. And then we'll have just an addendum, essentially, that has our view of pro forma like we did last year.
In terms of the regulatory environment, I would say we're always rooting for stability and predictability and certainty, but also a world where each individual element isn't overly restrictive, where the aggregation of them is so onerous that we're all holding so much capital and liquidity for a scenario that seems nearly unbelievable.
Right.
What we're hoping for is almost to your point about deregulatory. I think just consistency for us is something that we would, and certainty is something that we would really appreciate, not rooting anything in particular.
Even the rest of your peers. Right. So, finally, as you assess the risk of the company from the inside, what do you think is the proper normalized CET1 target for either Capital One? Or you could answer it also for the combined company.
From a combined company perspective, we still don't have the information we need because we remain independent from one another.
Independent.
So, we don't have the information we need to really evaluate what we believe the combined CET1 ratio should be. We modeled, as you know, as part of the deal, using consensus estimates, 12.5%. But I want to be very explicit that that is not an assumed target. That is just a deal model assumption using consensus. When we get on the other side of close, we're going to pull their information into our machinery and evaluate the capital need on a combined basis. And I think implicit, perhaps, in your question is share repurchase and capital return, given the level that we're operating at today, 13.5% for us and roughly 14% for them, to the extent that we get to that moment where we have a combined view and our capital need we determine is below where we're operating.
We understand the importance of repurchasing shares as part of creating value for shareholders. We lived through a period a couple of years ago where we were in the high 13s early in the pandemic CET1, repurchasing shares at a very rapid rate, something like $2.5 billion a quarter, to bring that ratio down into the 12s. And so, we have the ability and history to repurchase shares. But we're at a moment where we're focused on getting to close, getting their data, evaluating the combined need, and then we will make those choices on the other side. But for now, as you've seen, we've maintained that repurchase level and allowed our CET1 to accrete up in advance of the transaction.
On the other side, we will do everything that I just described to evaluate that combined need and take the actions from a capital perspective that we deem appropriate on the other side.
That was pretty perfect timing. We're out of time. There are no questions on the iPad. Thank you, Andrew and Jeff, for coming to Florida.
Thank you so much, Erica.