Okay, we're going to get started. Thank you everyone for joining. Very pleased to have Capital One here with me again this year. With me on stage, we have Richard Fairbank, CEO, and Jeff Norris, SVP of Finance. Welcome, gentlemen.
Thanks, Terry.
Thank you.
All right. Let's jump right into it. Maybe let's begin with the state of the consumer. There's been lots of headlines this year around inflation, energy prices, and the health of lower income households. As you look across your customer base today, how would you characterize consumer health across income cohorts and credit segments?
If we read the news every day, it is pretty alarming the things we see out there. I think it is natural for people to be pretty concerned about where the consumer is. But if we actually look at the numbers, some of the macroeconomic numbers and our own portfolio, we see really quite a striking strength. Let us just talk about the macro numbers for a second. Unemployment is low. The new job creation just rebounded very recently. Consumer spending is pretty strong. Bank balances, when we look at bank balances, they are up a little bit over last year on average per person.
The consumer, there is a lot of indications that despite all the noise out there and despite the inflation and tariffs and wars that are going on, the consumer seems to be in a pretty good place. With respect to our own metrics, if we start with credit, our credit delinquencies continue to come in strong. We just posted our monthly numbers yesterday, and delinquencies were coming in right consistent with seasonality. Charge-offs came in, again, better than seasonality, and that would be powered really by the high level of recoveries that we are enjoying, which came really from the higher level of charge-offs from the last few years.
But really over the course of pretty much the whole 2026, consumer credit has been in a very generally slightly improving kind of place. Most recently looks right there steady with seasonality. The consumer spending on our portfolio continues to be strong. With respect to income levels, we see a similar spending strength across our credit spectrum, including some of our lowest income consumers.
Now, I do want to say that is not the same as a statement about what is happening across the whole economy because income is one of the things that we use in underwriting. I do not think we have a window into the very lowest income consumers. But overall, the consumer continues to show a lot of strength even in the face of a lot of uncertainty out there. Obviously, we are monitoring it closely. But this would be one of the reasons we continue to lean into growth across our credit businesses.
Got it. That is helpful. You touched on credit. Maybe let us just double click on auto credit. That has been an area of focus. Auto credit has really remained benign at Capital One, and loan growth has been particularly strong at low double digits. What is your view on the auto market from both a pricing and underwriting perspective, and how sustainable is this double-digit growth?
The auto business is a very competitive business. The swings are amplified relative to our credit card business. Let me compare the difference from our point of view. In the consumer credit card business, we are underwriting each customer one customer at a time and have a direct relationship with each customer. In the auto business, there's a dealer right in the middle of the transaction, and the dealer is holding an auction across lenders saying, "Who can give me the very best deal?"
Included in that is if there's a lender out there who is undercutting and maybe cutting the corners from an underwriting point of view, the dealers can turn to other lenders and say, "You need to match this particular offer." What we learned long ago in the auto business is we have to take what the market gives us and not lean in too hard for growth. We've got to always hold firm with respect to what is the credit profile and the margin and the overall resilience of the product that we are booking.
That has, over time, caused us to sometimes be the lowest in the league tables in growth, sometimes being the highest in the league table of growth. We have often zigged while others zagged. Let me turn to the credit story in auto. It's really interesting to look back and go back to pre-pandemic and look at what happened to credit since then. Of course, you had the pandemic and credit performance became amazing all across all lending businesses. But we flagged that there was a dangerous downside in the form of artificial inflation of people's credit scores because their credit performance was sort of artificially improved by all the windfalls consumers were getting in the form of stimulus and forbearance during that period of time.
We flagged this to investors, and we intervened in our own underwriting to try to do the best we could to normalize for credit scores. That caused us to, for a period of time, be at the bottom of the league tables in terms of growth. But over time, the industry started seeing some worsening credit performance that we did not observe. Capital One has turned around and now powered through quite a bit of growth, and we're sort of at the top of the league tables these days.
While I think the industry has had a lot of volatility with respect to credit, I'm pleased with the stability in credit performance we've had at Capital One, not only indicated by the charge-off rates that you can observe over the years, but if we look at the performance of individual vintages over the years. For years now, our origination vintages have come in pretty much on top of each other and consistent with pre-pandemic, at a time when that would not be the case for the industry.
This is a very competitive industry. We only take what it gives us, and it really helps not to have our divisions in the company feel that they are driven by growth targets. We do not have growth targets anywhere across our businesses. People have growth projections, but they all understand at Capital One, go out and create the business that's a healthy business, and we'll let the numbers be what they are.
Great. Good color. Thank you. Maybe we'll switch gears. I wanted to touch on the Discover migration. New Discover originations were scheduled to move on to Capital One's platform this quarter. How has the transition gone? Do you still expect the Discover back book migration to be complete by early 2027? What are the biggest lessons learned so far?
Yeah. The Discover migration. Let me start with one of the most important lessons. This was not a surprise to us, but I'm still struck as it plays out. The tremendous value of the modern tech stack that Capital One has built because this is a very complex integration, but it really would be tough if we were taking a legacy platform and converting it onto another kind of old school set of capabilities. The modern tech stack that we have is very helpful in terms of the ability to do this in the time frame and the cost involved. There are some legacy vendor connections that we're still making that have quite a bit of complexity to it.
Anyway, the timing is very much consistent with what you said, Terry. New originations. Originations of Discover credit cards as of the beginning of this month are now entirely on Capital One's technology. The conversion of the back book is being done in waves. Starting from the first wave was in July, and the final wave will be in January of next year. It's a big effort, but things are moving along and very consistent with the time frames that we had projected.
Got it. You've also indicated that Capital One should begin growing out of the Discover-related brownout in the second half of this year. Is that still the expectation?
I want to clarify how you characterized it. Let me pull way up. The brownout, that's a term that we coined to describe the shrinking of Discover's credit card loan portfolio that has been going on for quite some time. Our point when we coined the phrase many months ago was for people to understand this would continue for a while. What we're talking about therefore is a shrinking in the Discover loan portfolio. Why would this be happening? The first big driver of this is Discover ran into some credit challenges in 2023.
In 2024, they started dialing back very dramatically, and so you had several years of origination vintages that were just a lot smaller than the ones before that. Piling smaller vintages on top of each other tends to lead to a shrinking portfolio. Secondly, not at all surprising to us because it's a thing we had observed from the outside. When we went in to really look deeply at the Discover business, we found that we wanted to dial back around the edges of some of their lending to more indebted consumers.
We have philosophically had more of a lean toward spend first portfolios than Discover has. Not surprising to us, we dialed back from some of the more indebted lending. That also contributed to the brownout. What will turn the brownout around is bringing Discover onto Capital One. We just talked about the timing of the front book and the back book with respect to bringing them on. We've been looking forward to originating Discover cards on the Capital One platform because there are a number of growth-related opportunities that we have.
We have a wider credit box than Discover has, so we underwrite both lower in the credit for a given flow. Imagine all the flow of applications is coming in for Discover. We can underwrite lower than they did successfully with years of experience on the subprime side. We have a way to lean in and create more opportunity on the upper end as well. Additionally, we have found that compared with Discover, we mine more marketing channels more deeply than they traditionally did. All of this gives us an opportunity to create growth that otherwise wasn't there for Discover, helping to offset those dynamics that will continue, such as our more conservative approach toward more indebted customers.
Let's talk about the timing. While I gave you the timing of when the conversions are happening, I don't want people to think that that instantly creates growth out the other side because, for example, on the originations, now that we're originating on the platform, some things we're already starting to roll out and some things we are testing before rolling out. So there's the kind of testing period that we have to account for. Then even when we originate new accounts, it takes a while for the balances to build.
Therefore, this effect is very real, but it takes a while to manifest on the overall size of the portfolio, and a similar set of observations on the back book. The way we will measure progress comes from sort of the second derivative turning in the sense that the rate of shrinking kind of stabilizes, then the shrinking becomes less, but it's still shrinking. Finally growth happens on the other side. These are milestones along the way that we will look forward to.
Then on a related note, the opportunity to sort of address the brownout and get the growth going probably comes with all else equal, some incremental marketing.
Yeah. Great point, Jeff.
Got it. Okay. Wanted to touch on Brex. It has been about five months after closing the acquisition. Maybe just talk to us about how the integration has progressed relative to expectations. More broadly, can you remind investors how Brex fits into Capital One's strategy to expand across commercial payments?
Yes. Let me start with the strategy side. Think about Capital One. While so often we talk about we are a credit card company or a consumer lending company or a bank, we really should think in terms of Capital One also is a payments company. We have, from the founding days of the company, been very focused on payments is the tip of the spear through which financial services is going to change. We, along the way, have been very much working backwards from being a payments company. We built, of course, a very strong consumer credit card and payments business.
We built a small business card business. We are the third largest in purchase volume in terms of small business cards that are underwritten by the owner of the business, personally underwrites these. That is called the personal liability business. Next on the spectrum is credit cards still, but it is corporate liability. In other words, the owner of the business is not personally accountable. Continuing from there, you get into treasury management. Across the spectrum, we have looked to fill out that whole thing. We have a small corporate card business, or often called commercial card, corporate card. That is the corporate liability business.
That is the business that Brex is in. We, again, had a small presence there. But we saw that the size of that market was as big, like $1 trillion, as the personal liability business. We were always struck that Brex, of course, created a great growth play in that marketplace. But their growth play is not just an ordinary growth play where someone reinvents one aspect of a business and brings modern technology. Brex has actually looked at three different marketplaces and said, "Those are really one, but the industry does not treat it as one." They looked at it and said: "These are three markets, and they are being served by more traditional technology, and they are being served individually."
What are those three markets? One is the corporate card itself, one is the accounts payables business, and one is spend management of all the employees in a business. From a business manager's point of view, those are all different parts of the same challenge. Brex looked at it and said, "This is really one business, and it is a modern reinvention of how the payment side of a business works." They created their product and have had a lot of success with that. So we were very excited to buy this high-growth company with a great product.
We knew down the road, by the way, that would not only reinvent how the corporate card market is, but that is the very same reinvention we knew that we had to drive on the personal liability side of the business. We get a bit of a two-fer there. Since the acquisition has happened, now that we are five months in, I am struck at how we feel the very same as we did at the outset. We are very struck by the management team, very struck by how much the management team is leaning in and all-in on this quest, very struck by how good the technology stack of Brex is, very struck by the killer app that this trilogy of capabilities has.
What we are focusing on is so far a light integration of the things that absolutely need to be integrated. What we are also doing is putting a lot of energy toward adding capabilities that they can really benefit from Capital One, and that includes our marketing. It includes our brand, our marketing machine, all the marketing channels that we access at Capital One, the huge customer base of small businesses, some of whom are graduating into a need for commercial cards, lower cost of funds.
That is what we are focusing on right now, and there are some promising green shoots that we are seeing along the way. In the longer run, we also look forward to bringing Brex into our own existing small business side of the house, and also integrating it with our travel business, which is a fast-growing part of Capital One and would have a very big opportunity on the commercial side. We are just as excited as we were before. There is a lot of work and a lot of investment going on, but we like our chances.
Got it. That is helpful. I want to turn the discussion back to Discover synergies. Capital One has achieved the targeted revenue synergies this year, and the focus is now on the expense synergies of $1.5 billion. You have mentioned around 1/3 of the operating expense synergies were realized in the second quarter. How should investors think about the cadence of the realization going forward?
That was very well described, Terry. The remaining operating expense synergies are dominated by benefits that come on the other side of the technology conversion. You do not get those benefits until the full conversion of a particular piece of technology happens. That just turns out to be mostly back-loaded in the integration timing. There will be some operating cost savings that happen along the way, but a bigger portion of the rest will come toward the end. What is the end that we are talking about? Sort of middle of next year.
Got it. Just to be clear, middle of next year is what you just said.
Middle of next year is, well, that is when the integration is essentially done. There will be a few loose ends that need to take a little longer, but essentially, the integration will be done by the middle of next year, and that is when the operating synergies will reach a run rate at that time.
Got it. That is helpful. Maybe we should move to earnings power. You have consistently said that you remain confident in the earnings power of the combined company outlined when the Discover deal was announced. However, Capital One today looks somewhat different than at the time of announcement. Discover has evolved, and Brex and Hopper are now under the same roof. How should investors think about the earnings power of the combined company?
One of the real benefits of the Discover deal, in addition to bringing scale, in addition to bringing a network and all the opportunities there, is the potential to really pull together and have very strong earnings power out the other side of this combination. At the time that we announced the deal, we did our very best to estimate what we thought would be the earnings power as measured in ROTCE coming out the other side of integration. Since then, many things have sort of changed along the way, including, and they've changed in sort of both sides of the ledger.
In terms of one of the challenges has been the Discover brownout, which was a bigger effect than we had originally estimated. Obviously, that brings along with it less earnings growth or less loan growth than we had anticipated. On the plus side, margins at Discover and at Capital One have had quite a bit of strength over this period of time. Credit has come in really quite strong.
The other big factor that sort of happened along the way is just the continual leaning into the investment agenda at Capital One, which really comprises two primary pieces. One is continued investment in capabilities themselves. Technology capabilities, swapping out legacy vendor technology, for example, to modern internal capabilities, investing in AI and things like that. The other part of it has been just the pursuit of future growth opportunities.
With a lot of things on both sides of the ledger, our guidance has been that despite all the moving pieces, oh, and by the way, other moving pieces was the acquisition of Brex and the acquisition of the technology of a copy, essentially, of the technology platform from Hopper, along with a bunch of their people. With all of the moving pieces, our point has been that the earnings power coming out the other side of this integration is strikingly sort of right around the same level as we anticipated at the beginning.
Okay. I think almost equally as important is the rate at which that earnings power compounds over time. If Discover and Brex integrations proceeded as expected and Capital One returns to normalized growth, how should investors think about the long-term earnings growth profile of the combined company? Also, what gives you confidence in Capital One's ability to grow earnings over the next three to five years?
We have been, since our founding, constructed to be an organic growth company. I think a lot of banks are built, or certainly over the last number of decades, to have their primary growth focus is just buying other banks. We have really been built for organic growth. Ironic that I am saying it given that we have had a couple notable acquisitions here recently. But to your point, Terry, these investments that I am talking about that have led to a large investment agenda and I think a bigger investment agenda than maybe the next bank down the street might have, they work backwards from being able to have growth and value creation opportunities as the world evolves.
I think Capital One is well-positioned in terms of earnings power and the prospects for earnings power because we sit on a modern technology stack. We have invested in a number of growth vectors, like going after heavy spenders at the top of the credit card market, building a national retail bank organically, something no other major bank is doing. Businesses like Capital One Shopping and our Auto Navigator financing platform.
Brex and our travel business and things like this. I think collectively, when you see us talking so much about we have a lot of things to invest in, it is in service of being able to continue to grow the business and grow the earnings of the company. In a world where there are no guarantees, I like how we are positioned to do that.
Got it. Okay, so the pace of investment and expenses has remained a focus for investors. How should we think about the balance between operating leverage and investment spending? When you are evaluating incremental marketing or tech investments, what return thresholds matter most?
When we look at incremental business investments, we are very much focused on what is the long-term value that can be created for them. Pretty much any new business growth opportunity, before the investment, during the investment, and afterward, we measure what is the value that can be created from these investments. From an IRR point of view, on a risk-adjusted basis. That is the most important metric that we use for all of our business investments. At the same time, we also very much keep an eye on the vertical, what I call the vertical current period financial performance of the company because I know investors care a lot about that, and it is also an indicator of progress along the way.
But I want to say that while I think a lot of companies come in with their primary focus is sort of the vertical financial performance of the company, our primary focus is in a business that's all about creating annuities, is to create very valuable annuities that we rigorously measure. So in the context of that, Terry, if you look at the history of Capital One, we've tended to, well, sort of the recent history over the last decade is quite a bit of improvement in operating leverage along the way, even as we have invested so heavily.
Now that's because of the growth that has been created as well as the savings that come from modern tech replacing legacy technology. Some of the investments we're investing in at Capital One actually are in business areas that have higher inherent operating efficiency ratios than the lending businesses. So we'll keep an eye on a little bit of a mix change there that could move things in the other direction. But pulling way up, the investments of the company work backwards specifically from creating value over the long term. And I think the long track record of Capital One indicates the benefit of that approach.
There's another thing that I think is less talked about that in addition to all the rigor and the infrastructure we've built around measurement of the horizontals and the investment themselves, another way you could think about our total expense base is comprised of a bucket called investments and a bucket called everything else. And there's not a day that goes by where we're not highly focused on managing both of those buckets as efficiently as possible. And we don't often talk about the one minus investments and all the efforts to harvest the digital productivity gains and drive efficiencies in that part of the thing. And that's an important part of balancing efficiency and investments along the way as well.
Got it. That's helpful, Jeff. So maybe we'll just turn to capital. You have a CET1 ratio of 13.7%. That remains well above the stated capital needed or at least the target capital level. How do you think about the balance between growth investments and shareholder returns moving forward?
I want to pull way up on that kind of strategically since the founding of the company. We have been very focused on, unlike most banks that do everything, since we started by not doing. We weren't in anything. We very carefully chose the businesses that we're in, because I don't believe all businesses are attractive in banking, and we have focused very much on entering and building a lot of scale in inherently attractive businesses with good growth and earnings power prospects. Along the way, we built a business model, leveraging technology and analytics and measurement, the things that we've talked about, to be able to have high-octane businesses.
We're in a position where the inherent earnings power of Capital One is very strong. Now, we therefore have believed that an important way that we create value for investors is through investing for future growth, but also the ability to return capital to shareholders, and that we have the earnings power to do both. We've said all along that return of capital to shareholders is an important part of the value equation. At the same time, we also very much believe that we have a very conservative approach to capital because we believe the benefits and costs associated with capital can be very asymmetrical.
We of course know that during downturns and when the times get tough, the value of extra capital is just tremendously high, both from if you had to raise it would be very expensive, but also the opportunity to play offense and lean into growth at a time when others are pulling back. Capital is sort of asymmetrical with respect to its value.
That's why we have a conservative view there. But again, because of the inherent earnings power of the company, we believe we can simultaneously take the conservative capital approach. We can be a company that's investing very much in our future to position ourselves to continue to win and still be able to deliver significant capital to shareholders. That has been a very important part of the collective value-creating equation in the past, and we expect that very much to continue.
Great. I think that takes us to time. Thank you very much.
Thank you.