Exactly. If we can get the next ARS question like we've been doing for everyone else. But, you know, if we can get seated as everyone comes back from lunch. Next up, kicking off this afternoon's sessions of bank stock presentations, very happy to Andrew Young and Jeff Norris, SVP of Global Finance. Thank you, gentlemen, for joining us.
Thanks for having us.
Great to be here.
Maybe the best place to start, you know, is big picture with the health of the consumer. You guys get, you know, tons of data, great analytics. Just love to hear what you're hearing on the consumer front. You know, how are customers behaving, you know, with this higher interest rate environment, elevated inflation, pre-pandemic cash offices have been kind of used up and, you know, kind of just what you're seeing.
Well, I'll start, Jason, by saying consumer continues to be a source of strength in what was, for a number of quarters, I would say, a pretty uncertain economy. You just brought up a number of the dimensions that I would use as evidence points in terms of savings. For instance, we saw consumer savings accrue to an incredibly high level a couple of years ago, and that's gradually been coming down over time. As we sit here today, savings are still aggregate, slightly, above pre-pandemic levels, but, you know, when you de-average that by income, you have the lower income are roughly back to where they are in pre-pandemic, but still they're a position of strength. You brought up unemployment, that metric that I've been highlighting during conversations today.
The unemployment level is still below 4%, really healthy. We have, you know, the number of available jobs per unemployed person hit a peak of about two earlier in the pandemic. It's down to about 1.5, as of the reading that I saw a month or two ago, but still well above the 1.2 that we saw pre-pandemic. And as you look at the inflation, really putting inflation in the context of wages and looking at real wages, yes, inflation was high and put pressure on the consumer, but at the same time, we saw elevated levels of wages didn't fully offset the inflation, and so that wage compression for a period of time, consumers were able to offset that by bringing down the savings that they accumulated.
I would say that what is really helping at this point is the fact that all of these variables are playing out gradually. It's when we see shocks to any of those variables is when we typically see unnatural behavior. But putting all of that together, I think the consumer is in a really solid position. It's been strong. We see credit normalizing as we would expect, but overall, again, consumer is looking pretty good.
I guess we saw, I guess we'll get August credit card metrics on Friday, but if you look at July, you know, balance is up, you know, a healthy 18% year-over-year, but, you know, it did accelerate for the fifth straight month, and that was the slowest pace we've seen in over 17 months, despite the BJ's purchase in there. Can you maybe just talk to, you know, what's driving the deceleration? Kind of, do you expect that to persist? And, you know, maybe just any differences you're seeing, between kind of high spender or, or lower income, higher income customers.
Sure. As we look at credit as an end-of-last resort, I mean, we're continuing to see the consumer largely play out as we expect, and that normalization, if anything, is a little bit better than we expected, looking at delinquencies and charge-offs. There's a few factors that I would highlight for us that are important as you're interpreting those credit results and as you talked about the trends that you just described. The first of which is we tend to move earlier than most. So you can look at our delinquencies and look at charge-offs, and both on the way up and the way down, it's happened in the great financial crisis, it happened earlier in the pandemic, it's happening now. So that early move is one force at play.
The second is recoveries, which, you know, play an important part in the net loss, you know, not driving the delinquency variables, but as you look at charge-offs, you know, the lack of, or the reduced, I should say, level of recovery inventory after a couple of years of strikingly low losses, we have less of a back book of recoveries to go after than drives the NCO rate, the net charge-off rate, a bit higher, all else equal, for at least a period of time. And then the third factor is we, stealing Rich's language from a couple of calls ago, but we've dubbed this forced reverse survivorship.
I'm sure you recall coming out of the financial crisis, so what we saw was the credit performance of people who hadn't charged off during the financial crisis. When you look at their credit performance in the few years on the other side of the financial crisis, if we plugged in our models and all of the variables and spit out an estimate of what we expected losses to be, at that point, losses were lower than what those credit variables would otherwise suggest. And at the time, we dubbed that the survivorship bias. It was if people made it through the financial crisis without charging off, they just had this sort of inherent ability to survive. Right now, we are seeing in our models a little bit of residual in the opposite direction.
So we're seeing people, if you plug in all of these economic variables and, you know, look at what the models would anticipate, delinquency and loss rates would be, it's a little bit above that. The observed credit is a little bit higher than that, so we're dubbing that reverse survivorship. But ultimately, delinquencies are the leading indicator, and we've seen those trends playing out. And if you look one or two quarters out past the delinquencies, it's generally what we're seeing in the charge-off line. So as you look at the 8-K data that comes out later this week, and just looking at the trends playing out, it's really the delinquencies that will be the future indicator. But I just wanted to make sure that I highlighted this whole notion of things that at least temporarily will put upward pressure on losses.
And then, you know, just thinking about the juxtaposition of credit and growth, right? We're seeing credit kind of continue to normalize. It's. The other phenomenon through the pandemic was the, you know, remarkable growth we've seen coming out of the pandemic, right? So you said yourself, at 18%, it's still pretty healthy, so it's decelerated. But when you're decelerating at 18%, it's still pretty robust growth in the context of an industry that's also continuing to grow. I think that, you know, we're seeing a couple things. We're seeing 20%+ growth rates were not sustainable, and I don't think we or anybody else expected that to continue.
You know, at 18%, we're seeing a combination of effects, one of which is, you know, on new account originations, we're continuing to see pretty strong and robust growth. Another aspect of it is payment rates, which are falling a little bit. Revolve rates, the converse of that, are going up, so that's, you know, continuing to build balances. But, and then on the spend levels, you know, we've seen that really come down from highly elevated levels, accelerating out of the pandemic to where on a spend per customer basis, it's essentially flat. And, you know, those dynamics are causing the growth trajectory to slow a little bit, but still pretty good.
Yeah, and sorry, Jason, I heard 8-K, and my mind immediately went to credit, so I gave you a credit answer. But I think Jeff did a really nice job of enumerating the growth side, and so that the comp of the high teens or twenties absolutely is not sustainable for, you know, a $130 billion card book. But I do think for Ziply, in terms of new account origination, in particular, is something that continues to power underlying growth.
Well, credit was my next question, so it's all good there. But you, you mentioned this concept of reverse survivorship. Maybe help us to kind of quantify or dimensionalize that in terms of, you know, how much you think that's impacting results, and then maybe how long, or how long does it take for that to play through the numbers?
Well, the second question of how long it takes to play through, you kind of look at how strong—the duration of how strong credit was over the last few years. So I can't give a precise estimation, but I think it's reasonable to assume that roughly the period of strikingly good credit, you could probably see a bit of that having to take a roughly same similar amount of time on the other side to work its way through. Although, just like credit on the positive side, it was really pronounced early on, and then it gradually resolves over time. In terms of magnitude, I would say it's one of the things that we're trying to size and looking at the individual variables and the tie to the economic-...
Assumptions, but they're not going to give a specific view of it. But I do know that it's going to be temporary for some period of time.
I guess presumably you guys have been actively building your allowance for loan loss reserves. You're probably the most above your CECL day one levels versus any other bank. I guess that's incorporating this, you know, expectation of rising delinquencies. But, you know, how should we kind of just think about the reserve in this CECL world, you know, given in this kind of normalizing loan loss delinquency backdrop?
The first thing with the reserve is always growth. So we'll be, you know, reserving for the growth that we book in the quarter, and that growth also has a coverage ratio that is higher than the portfolio average because it definitionally isn't coming with a back book of recoveries, which then gets netted out of the allowance. So in this period of high growth, you've seen us building a pretty meaningful reserve. As we look ahead, what matters is not only the delinquencies and what that implies about near-term credit, but what we're assuming for 12 months out. So our reasonable and supportable period is 12 months, and from there, we revert back to a historical average.
So as you think about the size of the allowance, not only the growth in the near term credit trends matter, but what we're assuming a year from now, and that's why it's a real close eye on how the economy is playing out, how consumers are behaving tend to be the best indicators for what we should be expecting, you know, 12 months out, which then, of course, we're bringing back into the allowance today.
Got it. And maybe shifting gears to the auto side. You know, Capital probably be a little bit early, kind of pulling back growth from there. A lot of these kind of regional banks followed. Kind of recent conversations, just maybe you're kind of leaning back in while there's kind of still pulling out. Maybe just kind of update us your thoughts in terms of, you know, where you are with that portfolio.
Sure. Yeah, auto went through a period of really strong growth. Consumers were flush with cash. We saw vehicle prices increasing, which increases the total pool of loans to underwrite, and interest rates were incredibly low. And so all of that led to, you know, a lot of supply in the marketplace and, you know, people underwrite going out and buying cars, which then helped drive up loan growth for us and the industry. We then saw for a period of time, a few factors sort of re-reverse that. One is supply, through supply chains, kind of pinching the availability of cars so that total pool of lending that was done shrunk. But within that, you saw us pulling back as a result of what we're seeing in terms of pricing.
And so some competitors were not passing through the increases in rates. And, you know, the way that we approach underwriting is we pick the credit box, we pick the terms and, you know, take what the market gives us. And as a result of that, the combination of a lower pool from supply restriction, coupled with the pricing choices that we were making, drove our originations down. Now, you're seeing both of those forces starting to reverse themselves. So I think those will likely be tailwinds, all else equal. I think the big question mark at this point all really is circled around the consumer. With rates higher than they were during this period of exceptional growth, you know, affordability becomes more of a question, and consumer credit broadly becomes more of a question.
But we see some good opportunities to grow there, but we're also trimming a little bit around the edges on the credit side, and we're being a bit cautious. So those are all kind of forces that will be at play as we look to growth over the coming couple of quarters.
Just so you know, I think I'm probably as guilty as anyone about talking about this in terms of pulling back and leaning in. But to Andrew's point, the way we approach our originations across our businesses, but particularly in auto, is to set a credit box and pricing terms that we're going to be comfortable with and see what the market gives us. And so, you know, when we were not chasing the price, the market gave us less in terms of originations. That's a little different than us proactively pulling back, so to speak. It's just, you know, sticking to our convictions, the originations fell. And so rather than talking about it as we're going to lean in, it's more like we're still doing what we always do from an underwriting perspective.
We're probably a notch more optimistic that the market will be a little bit kinder in terms of originations, but we're, at the same time, a notch more cautious on credit. So, you know, we'll have to see how it all plays out.
I guess on the credit front, you talked to that, you know, reverse survivorship on the credit card front. Is there a similar phenomenon on the auto side? And then just, you know, we've had, I saw, I saw stabilization this past month, but used car prices down each of the prior four months before that. Just maybe you can give your outlook in terms of the kind of auto credit quality.
I would say underneath the surface, there's a lot of similar dynamics between card and auto, given that you're largely dealing with the same consumers. What is different is the role of collateral and how that ultimately plays out. And so when we look at credit trends in the auto business, a lot of it will be influenced by car prices. You know, and that's one where the life of an auto asset is much shorter than the credit card side. And so the earlier question of how long will we potentially see reverse survivorship play through in card, in auto, you see credit trends move even more rapidly than card, in part influenced by the collateral values.
That's a place where, depending on where the pace at which they normalize and to what level, that could have an effect on loss rates. But unlike card, where loss rates have just crossed over in July, crossed over 2019 levels, but delinquencies had crossed 2019 levels a few months prior. In auto, we see delinquency rates are actually still below 2019 levels, and loss rates are higher, and that's really because of the role that the recoveries and collateral value ultimately plays. Keeping a close eye on vehicle values. From an underwriting perspective, we always assume you know, broader pressure in the economy, we assume a recession, and in auto specifically, we assume vehicle values come down. What we're seeing in terms of credit performance in auto, we really like.
What we booked in 2020 and early this year is performing in line or even a little bit better than what we saw pre-pandemic. And so even with car prices coming down a bit, but something we're watching every day.
Thank you. The liability side of the balance sheet. You guys have a maybe a little bit different deposit model than a traditional bank, given the Capital One 360 offering. Just maybe talk to some of the, you know, deposit trends you're seeing, maybe the ability to kind of pick up new customers in light of some of the turmoil in the banking industry experienced earlier this year.
Yeah. Well, if you go back a decade, we acquired ING Direct incredibly highly regarded direct banking business. And for the last decade, we've continued to build on that and have a complementary, you know, branch network. And so it's been a great franchise for us. Of course, it, you know, it allows us to generate the liabilities and generate deposits, but we also think about it as an opportunity to build lasting customer relationships. So over the pandemic, you saw growth there, very strong.
And if you go back even over the last few quarters, I think on the retail side, we grew something like 5% in the fourth quarter and 5% again in the first quarter, and last quarter had a little bit of shrinkage, but absolutely in line with what you historically see in HA data from tax flows. So we have a lot of flexibility with how we manage that book, and it really works back from having a great customer experience, great product offering. We don't need to lead the direct bank lead tables there. Of course, we need to be competitive, but you know, it is more than just a funding vehicle for us.
It's really a great opportunity for us to build the franchise, but it also is something with national scale, allows us to sort of dial things up and dial things back, as needed, depending on balance sheet needs at the margin.
You know, just, it's always important to sort of reemphasize the uniqueness of our particular deposit franchise, right? Because it does have higher rate paid than some of the branch-based regionals. It does have higher marketing costs, but it has significantly lower infrastructure cost and complexity. I think we've gone from a branch count of around or a little above 1,000 to, you know... What is it now, Andrew?
Little under $300.
Little under 300. So the all-in economics work pretty well for our business model.
Do you have this, you know, higher cost deposit base, lower fixed cost, a much higher kind of yielding asset side, you know, driven by card? You mentioned kind of at the margin, I know you aren't getting at it, but, you know, maybe we could just talk about net interest margin, you know, for, for a second. It's been a lot of focus.
Nice segue.
Yeah, I like that. No one, no one commented on my shifting gears to auto. So maybe I try something else. But could you just maybe talk about kind of your expectations, you know, for the NIM, how you think about managing the balance sheet against this dynamic rate backdrop?
Yeah. So there's a few forces at play, some of which are potentially going to have more of a near-term impact, some of them having, you know, a more medium-term impact. So from a headwind perspective, I'll start there. Just to transition from your question about retail, one of the things with having a leading liquid savings product is, you know, as the Fed is moving rates, the assets are repricing quickly, but deposit pricing, the betas lag at least, you know, a month or two or three. And we're feeling a bit of that catch up over the last couple of quarters. Fed moved again in July, assets reprice.
But if you look at the, you know, direct bank players and their pricing moves over the course of the last couple of months, there continues to be a bit of a lag in the pricing, and that, at least for some period of time, till things equalize, can be a bit of a headwind to NIM. The second piece is, with credit normalizing, revenue suppression is growing. So we are suppressing more of the fees we deem them to be uncollectible, and so that also is putting pressure to NIM, and that will largely correspond with the timing of credit normalization. At some point, that will all hit an equilibrium. There are tailwinds, though. I always like to highlight the mechanics of how we approach NIM, which day count matters.
So at least in the third and fourth quarter, we'll get an extra day that all else equal provides a tailwind. Of course, that's something that just flows through every year. But the two things that I think are more longer-term tailwinds are, one, the, you know, cash. So over the last couple of quarters, we're holding roughly $40 billion cash on the balance sheet, up from pre-pandemic levels that were mid. I think, given some of the marketplace dynamics over the last couple of years, you know, we might hold more cash than we typically did pre-pandemic, but you could see that coming down over time. The other is card becoming a higher percentage of the balance sheet relative to other asset classes. That also provides a bit of a tailwind for us.
And so as you see those forces playing out, it's really the timing and the magnitude of, you know, the degree to which they're ultimately coming in and how large will drive the NIM trends, both kind of short term and longer term. But as I look to the much more distant future, there's really nothing that suggests that NIM will settle out roughly at a level that we saw kind of pre-pandemic, again, dependent on a lot of the mix, the mix shift of the businesses, but nothing really structural that's different.
Helpful. Maybe in terms of expenses, you know, marketing, you guys have been fairly active in the second quarter, but still a little later relative to history. Can you talk to in terms of just kind of your outlook on both kind of dollar expenses and kind of, you know, where you're actually focusing those dollars?
On the marketing side specifically?
Yeah.
Yeah. You know, marketing is a place where we continue to see opportunities. Tying it back to your first question around the consumer continues to be strength there. So I think about marketing in really four big buckets. One is generating new accounts, and that's a place where we're seeing opportunity now across the spectrum. We continue to lean in there. The second is our focus on the very top of the market with heavy spenders. That's of course part of the leaning in to generate new accounts, but that's a place where the market should spend. It is higher on a per customer basis because it's not just about having a product that, you know, the customers want with specific terms. Winning at the highest end of the market requires putting a franchise around that.
So there's things that are in the marketing line there to help us generate those accounts. You've seen our lounges in airports, our partnership on the restaurant side and dining, you know, José Andrés, places where you know you look at Capital One Shopping, and there's just a number of places that help sort of create an experience for the highest end of the market that is just necessary to win there. And so that sort of adds a dimension on top of just generating the new accounts. But then the third piece, the just comment around the branch network that we have being smaller than what it was a number of years ago, we do use marketing to help draw attention to the retail bank.
And so that's another place where we're seeing great traction by investing in marketing to generate deposits. And so all of those things are really where we're leaning in and investing, and more seeing great returns for the investments that we're making.
Then when I think about expenses, ex-marketing, you guys used to talk to this 42% efficiency ratio, kind of pre-pandemic. Is that still kind of something you're thinking about, or is the environment inflation and rate and kind of everything changed to make that kind of no longer the right number to think of?
Let me pull up and talk about where we were at that moment in giving that guidance. You know, the world was a very different place pre-pandemic. And so we did see a disruption on the revenue side. And one of the things that relative to where we were at that point in time that was going to provide a you know just singular expense tailwind for us was the movement of getting out of the data centers and we're getting fully to the cloud by the end of 2020. And as you said, the pandemic in 2020 had a huge impact on the revenue line item, but underneath the surface, things that we were driving for efficiency were still coming to fruition.
But since then, the world has moved quite a bit, how quickly technology and data have advanced. And our choice over many years to position ourselves to get into the cloud is providing tremendous opportunities. One of those is just the storing and computing and analyzing of data that drive up the cost line item. You know, the unit costs are certainly better than being in our own data centers, but that's one thing that's putting upward pressure on that line item. And the opportunities that we see to continue to develop software and capabilities. So investing in technologists that, you know, wages in that sector, when you look back a year or two ago, were incredibly you know, elevated and rising.
It's subsided a bit, but those were all forces relative to what we were assuming a few years ago, have created upward pressure. But when we think about the future, this shared path of everything that we try to accomplish coming from having a modern tech and data stack, the benefits of that are seen throughout the entire P&L. We're able to underwrite in a way that we just couldn't. Our fraud detection capabilities, you know, you look at some of the businesses that we've spun up that are generating revenue, like Capital One Shopping, like Auto Navigator, things that wouldn't be possible without the investment. The world is real-time and intelligent, and so we've been making continued investments to position ourselves for, for the future there, but we're seeing benefits for these investments throughout the entire P&L, and it's powering the future.
And so since that sort of reset that we saw in 2020, where the efficiency ratio stepped up as a result of revenue primarily coming down, we've gradually brought that down. We've said this year's efficiency will be roughly flat to modestly down from last year. And so we are continuing to focus on efficiency, but, you know, I don't think that's the sole variable here because how the investments that we're making in technology are driving substantial benefits elsewhere in the P&L. You know, we're evaluating all of those things as we look to both the short and more importantly, long term.
As I ask my next question, if we can get the next ARS question up on the screen. Andrew, since we last spoke in July, we've seen the Basel III proposal, there's been a long-term debt proposal, there's been talk of a liquidity proposal. Maybe just help us size the potential impact of, you know, each of those and how you're thinking about it.
Yeah. So still in a proposal phase, we hope to see the modifications to the current draft and the timing for virtually all elements of it will phase in over time. But let me talk first about long-term debt and then I'll come to Basel III Endgame. On the long-term debt side, we started a couple of years ago issuing out of the holding company a modest difference in costs. They felt like gave us some flexibility, and so right now, though, is currently constructed, we are down streaming that from the parent to the subs, and with this current construction, because that's an overnight downstream, we get LCR credit. As it's currently constructed, we wouldn't because we wouldn't be able to downstream it overnight.
And I think the question is, what are the LCR implications? Do we get LCR credit at the top of the house? ... for that? Or do we operate at a lower LCR? Or do we end up issuing more parent debt solely for holding company purposes? So there's just a lot for us to unpack depending on how that final comes out. So difficult for me to decide ultimately what that impact will be, but those are the considerations at this point. With Basel III Endgame, I think about it in a numerator and denominator way. So big forces on the denominator when you look at retail weightings for card and auto, bringing that down to below 100, all else equal, that's a tailwind to the denominator.
Even though there is some gold plating to have those risk weights be higher than international standards, even with that gold plating, that is a tailwind for us. But there is the offset within the Basel III of having to capitalize for open to buy. And so open to buy and the risk weightings of card and auto roughly fight to a duel there, and it's kind of a wash. The denominator is mostly going to be impacted by ops risk. On the numerator side, two big forces at play for us, AOCI. We had 7.5 billion or so of AOCI in the portfolio last quarter. And so we currently have 100% of the portfolio available for sale.
The ultimate impact for us is really going to be a combination of the timing and forwards, and whether or not we see some of what currently is a drag, accrete to par over time. So we'll have to see how that plays out specifically, but we also have the option of, over time, moving more of our portfolio to held to maturity, and so shield a little bit of the volatility. But then the other numerator effect for us is for tax assets, the DTA, where with our allowance being a pretty sizable portion of our P&L, that, you know, creates a deferred tax asset for us.
The times when we're building, building allowance, we see that now, and so lowering the thresholds from 25%- 10% not only potentially impacts us during, I'll call it "normal times" as we're building allowance, but it also then plays through stress testing. Because early in stress tests, we build a bunch of allowance, and that then creates a deferred tax asset, which then potentially plays through the stress capital buffer. So there's also that second-order effect that, that I would highlight. So a number of considerations, you know, there's, there's a lot to, to unpack over time. But other than the DTA, everything, you know, phases in.
We feel really good about our current capital position, where we're at, and, you know, we'll just see how, definitely where all of the final rules and timing ultimately land, but at least as currently written, those are the things that we're focused on.
The audience pegs RWA inflation is up 10%-15% for what it's worth. Do you care to give us a pro forma Basel III, fully phased in, enhanced, CET1 ratio, given all those moving pieces and operations in front of me?
Yeah, Jason, if you can work through all of the second-order effects for me, of the choices that we make in response to that, like, I would welcome your answer, but there's still just way too much for us to identify. And I think it would not be doing it justice, quite frankly, for the audience to think about it in a first-order way. All of those choices will ultimately play out over the next few years.
Right. With that, please join me in thanking Andrew and Jeff for their time today.
Thanks.