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Capital One Financial Corporation (COF)

June 12, 2013 8:00 am ET

Executives

Stephen S. Crawford - Chief Financial Officer

Analysts

Betsy Graseck - Morgan Stanley, Research Division

Betsy Graseck - Morgan Stanley, Research Division

Next up [ph] today, Steve Crawford, CFO of Capital One. And similar to the other presentations, I'd like to get your feedback on what would drive you to add to your Capital One position. So we do have polling questions. And the polling question is going to be: a, card loan growth accelerating; b, buybacks; c, expense management? So if you could take a second and find the polling device that you have. What would drive you to add to your COF position: a, card loan growth; b, buybacks; c, expense management? So as we countdown to 1, we will reveal what the audience here is thinking today.

[Voting]

Betsy Graseck - Morgan Stanley, Research Division

All right. And the answer is card loan growth. All right, by a wide margin. So we're delighted to have with us today Steve Crawford, CFO of Capital One. Steve joined Capital One in February of this year and took over as CFO on May 24. And prior to Capital One, he was Partner and Co-Founder of Centerview Partners, where he served as an Adviser to Capital One on a range of strategic and financial issues. And prior to that, Steve was at Morgan Stanley as a banker CFO and Co-President. [indiscernible] with Capital One as improving consumer loan, balance sheet should benefit. Capital One, which is skewed to consumer loans. And with that, I'll turn it over to Steve.

Stephen S. Crawford

Thanks, Betsy. So we'll definitely get into, I think, all 3 topics that you had enumerated there, appreciate the invitation. So I'm still settling into Capital One, took over on May 24 as CFO. What I wanted to do was go through the 4 items listed here. You've heard a lot about most of these in our first quarter call. And hopefully, this represents the areas that are of greatest interest to the people in the room and on the phone. And as CFO, the first 3 items on the agenda I want to cover today are a particular focus to me.

But before going into that, I wanted to spend a second on how we are positioned strategically. And there, I would say, our strategy is definitely defined, differentiated and, I think, financially compelling. If you look at it, we are not trying to have a branch on every corner. We're not trying to provide all products to all segments. We are focused on consumers, small business and middle market. We've got an emphasis in particular products, where we have scale and we think there's compelling industry structure. And we have scale positions in these businesses with the fraction of the size that some of the money centers have.

In terms of differentiation, for as long as Capital One has existed, you've heard us talk about IBS, the rigorous testing analytics and NPV-based decisioning that we do to underwrite credit. We believe our brand and marketing, we've built one of the most recognizable and valuable brands in financial services. And we feel digital is positioned to transform the industry in the coming years. And Capital One is incredibly well positioned. We feel like we have all of the pieces of the puzzle to succeed and are mindful that bigger is not better. In fact, most of our constituents probably feel bigger is worse.

Financially, we feel like we've got a compelling proposition. We're trying to maximize risk-adjusted profitability. We believe we have superior revenue, superior and sustainable returns relative to our competitors and we feel like our organic growth prospects are higher than the industry's. Capital allocation, as always, is going to be critical.

So let me spend a second now on that topic. It's clearly one of the driving forces for the industry. And I just listed on here kind of a balance of scale, if you will, on what goes through our mind when we're thinking about capital allocation. On the left-hand side, why we're thinking about distributing more, there's a long list of reasons. First, our stock price, we view to be attractive with both the low relative and absolute PE. Consistent with the past, we believe we'll be able to generate high and sustainable returns. Industry-wide organic growth has clearly slowed down. And in our case, that's amplified by a runoff from HSBC and ING. If you look at it in a historical context, Capital One's liquidity and capital position has never been better. And finally, as I mentioned on the prior slide, we feel very good about our strategic positioning and business mix.

The other side of the scale, there's still a fair amount of ongoing uncertainty on the capital and liquidity frameworks for the industry. Regulators always prefer we retain more. It's complicated by uncertainty for us around the final resolution of Rep and Warranty claims from prior acquisitions. So where does that lead us? You saw a big increase in dividends in 2013. In the first quarter, we talked about trying to put additional buyback through this year associated with the Best Buy divestiture. And for 2014, we've got a total payout ratio that's going to be meaningful above what we believe to be industry averages of 50%.

So let me turn for a second on costs. This has been an area of focus for the entire industry, given the revenue pressure. And to be successful, we recognize it's got to be a way of doing business, not a one-off program. For us, the last several years represented a step function in infrastructure investment. We had the regulatory and business adjustments coming out of the Great Recession. We had substantial scale that we added from 2 acquisitions. And we believe in the coming years, we should be able to leverage all of those investments. In addition, I want to go into a little bit more detail on 2 other areas which we think are profitable on the cost side.

This page looks at our second half of 2012 expenses, noninterest expenses annualized. This is not info that's publicly available in this format for most of our peers. But we believe we do more outsourcing than the industry. You can kind of see that if you look at our comp as a percent of expenses or our professional services. We believe there's huge potential to improve our expenses in leveraging these relations. We've brought in talent from the outside with considerable experience in doing this. And we've centralized the management of our third-party relationships. In any 1 year, we'll have a percentage of these up for renewal and you should see us work through the potential savings over the coming 3 or 4 years.

Costs of service on the digital front is another major opportunity for us. It's not just about cost, I'll come back to that in a couple minutes. Here, our card business has always been front and center on the digital side. And with the addition of ING Direct, we had another step function in our digital capabilities and opportunity. We feel there's a huge opportunity to infuse the digital culture throughout the operating environment and customer experience at Capital One.

Let me dive into digital a little bit more. Obviously, we want to continue to build our brand's identity, our brand's digital identity. But the evidence suggests that digital is much broader than an expense opportunity. People that have a higher digital component in their business are better controlled and compliant. Their customer service is better. The customer retention is higher. And as we look at it with the infrastructure improvements, the technology developments and increasingly looking at demographics, this is the way our customers are going to want to interact with their financial service provider. And we see within Capital One steady progress in our migration towards a digital environment. You can see it in our customers' enrollment in digital services. You can see it in their level of engagement, how frequently they use the services we have, and then obviously creates a huge ability for us to move away from an analog world. A good example of that would be paper statements.

But we are looking to accelerate what we're doing on the digital side. It requires scale to do this, not something that every bank can do. And this is not something where customers comparison shop the way they do for a car or for a computer. Once captured, in a digital framework, these customers are very sticky. And that's both a good thing and a bad thing. We want to make sure since there's a shot clock on this opportunity that we're very well positioned. Finally, on the digital front, you know how important IBS is to us. But to become a digital IBS institution, where we're combining scale data with our analytics, we think, is a very significant opportunity as well.

So let me talk for a second about complexity. It's never a good thing for our investors to predict, for our managers to manage or for our regulators to regulate. When we think about Capital One, is it more complex relative to the money centers? It isn't. We are mostly a domestic institution with few nonbank businesses and limited market and derivatives exposure. Relative to the regionals, you've got a similar funding model, a little bit of a higher concentration in consumer lending, which may drive a little bit more volatility and provision expense. But I think it's fair to say that our acquisitions, recent acquisitions, have lowered predictability. It's harder to figure out what the run rate product profitability is and what's core versus deal-related. We are at a point where those acquisition impacts are moderating. I promise to work with you to continue to give you the best sense of core profits, enabling you to be able to forecast as best as possible.

Philosophically, you'll also see us move away from line item guidance. And having talked to a number of investors, there's really a mixed point of view as to whether we need to do more or less. But it's not the way that we manage the business. There are often many factors that can drive a ratio. Ultimately, what we can pay dividends and profits out of are after-tax profits. What we will do and what we're looking to do is moving toward through the cycle return guidance. We've already stated that we want to be at the higher-end of banks in terms of returns. But I think we'll look to put a finer point on that in the coming quarters. And in general, I think you'll see a greater focus throughout the company on an outside-in perspective. And to that end, we continue to review our disclosures for enhancements.

So let me turn for a second to our card business, which generates a lot of questions. And really I want to spend a second on 3 things. First, the industry and card growth being weak; strategically, a rotation that's going on in Capital One from high balance revolvers to transactors; and finally, the addition of our partnership business. While these factors are all largely about growth, there are also some profitability impacts that I want to discuss. If you look coming out of the Great Recession at growth rates of relative peers, one of the things you can see is, first of all, backing up from the individual peers, the return to a more stable economy has not meant a return to extraordinary growth across the card segment. But as you can see on this chart, we have grown a little less than some of our card-focused peers but a lot more than some of our diversified peers in an industry that I think when you look at the statistics is largely moving sideways in terms of outstandings growth.

You also heard Rich talk a lot about the strategic choices we are making in card. One of the biggest factors there is the greater emphasis we have on building our share in the transactor business. You can see some of the early evidence of success in the segment by the purchasing -- relative purchasing volume growth rates, where we compare very favorably to our peers in capturing consumer spend. Here, we believe we're the beneficiary of a secular trend, where credit is replacing cash, a trend that we think still has a fair amount of legs to it.

As you would expect, our decision to move more towards transactors and away from high balance revolvers is based in analytics. I put this page together to give you a little bit of sense for some of the things that happen on the income statement as a result of that mix shift. First, per account, we're obviously generating fewer loans. These are more spend customers than borrowing customers. The interest income we generate per dollar of loans is lower than for a revolver. But the fees, given the spend levels, are higher. Marketing expenses are higher in generating transactor customers, but we don't have the balance transfer teaser rates that you generally do with the high balance revolver segment. Credit costs in the transactor segment are better and the customer relationships have a longer duration. So with higher marketing costs for transactors and lower credit costs in the high balance revolver sector, given where we are in the cycle, the near-term profitability of transactors is going to be lower. But we believe they are more attractive from a profitability and resilience standpoint through the cycle.

Finally, on the card side, we've achieved a scale position in partnerships with the acquisition of HSBC. As evident on this chart, which kind of looks at relative outstandings in general purpose and partnership, you can see it's a very big part of the market. And actually, if you looked at spend volume, it would be even more compelling in terms of how important partnerships are with respect to the card business. This is an alternative way for us to access great customers through the strength of loyal retail relationships. This isn't a business one can feasibly build organically, it requires scale. And we believe there are few competitors that are truly dedicated to this business in the long-term. There's a significant overlap with our skills as a leader in consumer lending, whether it be credit underwriting and management or a compelling product capabilities. And our success in providing credit across a variety of different customer profiles is very important to the retailers. While this is lower return than general purpose cards, it's a business that still is financially compelling.

So in conclusion, on the card business, while there are clearly opportunities to improve the business, our relative performance is excellent. We had very strong results through the Great Recession, which hopefully will be the best test of the business model any of us in the room will ever see in our careers. And there is growth in all of the segments that we're emphasizing in the card business.

So let me conclude by saying we think our priorities are clear and overlap very much with what investors' priorities are. We believe our businesses provide profitability and growth advantages relative to the average financial institution. And we believe our execution agenda is centered around making good businesses even stronger. Why don't I stop there, Betsy, and...

Question-and-Answer Session

Betsy Graseck - Morgan Stanley, Research Division

Super. Okay, thanks, Steve. So Capital One was going to have a breakout, but it's difficult for them from a timing perspective. So I just want to make sure that everybody gets their questions in now in the 12 or 13 minutes we have left for Steve. Steve, maybe I could give kick off and just ask as it relates to the card business, you indicated an interest in partnerships. You do have some partnerships in your current portfolio. But maybe if you could give us a sense as to how important it is for you to grow beyond partnership arrangements that you have today. There are some potential partnerships out there. Every year obviously they're up for RFQ. And the question is would you be interested in...

Stephen S. Crawford

Yes. We got into the business because we expected to build it. We think it's a great way of building customers, but it's got to fit a list of criteria that I think Rich has been very explicit about, which has got to be a strong retailer that's interested in more than just the financial dynamics of the card. It's got to be a relationship that makes sense for both of us financially and a contract that works. So it's not growth for growth's sake, but it's a business that we find to be compelling and we're dedicated to building over the long run kind of portfolio-by-portfolio.

Betsy Graseck - Morgan Stanley, Research Division

And then as it relates to the capital return related to the Best Buy, right? So you indicated that there's an interest in seeking to buy back the capital associated with that portfolio. So how do I square the 2? Are we going to be using incremental capital for buybacks or for the potential to expand the portfolio?

Stephen S. Crawford

Well, in 2013, we've been -- this question came up before. We've been pretty explicit that we're not going to do anything that gets in the way of our ability to return capital. I think going forward, looking into 2014, we feel like we have the earnings generation to both meet the payout objective that we've laid out, as well as building our business.

Betsy Graseck - Morgan Stanley, Research Division

Sure. Just look to the audience and see folks have questions. Yes, up here in the middle, please?

Unknown Analyst

The ING Direct acquisition and the customer base there was certainly very unique customer base. I'm interested if there's been any attrition from that deposit base at all as those people maybe just don't like the Capital One model, as well as their old ING Direct. And secondly, could you update also on Rep and Warranty issues?

Stephen S. Crawford

Yes. So on the ING Direct, that's not a number I have -- I haven't memorized all the numbers at the top of my head. But I think if you look at it, the retention of the customer base, even through the brand transition, has been quite good. And that's a customer base and a capability that's incredibly important to the institution, so we've been very careful about how we manage that customer base. Rep and Warranty, there is a very good footnote in our 10-Q, which is incredibly detailed. And I'm not just going to you refer you to that, but I would encourage you to read it. If you look at it, you will find that we provide unpaid principal balance by category. You will find that we provide potential loss content, both realized losses and 90-plus day delinquencies. You'll see that we detail existing repurchase requests. We give you a sense of how that $1 billion reserve we have is allocated and what the drivers are of that reserve. And we give you an enumeration of the drivers of the $2.7 billion in reasonably possible losses. What I can't give you is how legal precedents are going to evolve, but there's plenty of detail in there for the exposures.

Betsy Graseck - Morgan Stanley, Research Division

Okay. A question in the back.

Unknown Analyst

Yes. You said you're moving away from line item guidance through the cycle, I think you said returns or profitability. Do you still stand by your expense guidance for next year?

Stephen S. Crawford

Yes.

Betsy Graseck - Morgan Stanley, Research Division

Okay. Steve, just a follow-up on the ING Direct question. Could you just give the room a sense as to how you're managing the business, the customer-facing banking channel business? Are we organizing it all into one type of combined delivery? Or are we going to have a separate go-to-market strategy for the Internet-based versus the physical base?

Stephen S. Crawford

I think there's still a very important differentiation between the retail business and the direct business. So there are areas of cooperation, but it's important that we keep the direct and the retail side of the business with their own identity.

Betsy Graseck - Morgan Stanley, Research Division

Okay. Other questions from the room? Yes, up here in front, please.

Unknown Analyst

Given the answer to the polling question Looking for credit card loan growth and given the shift towards transactors, is there an environment in which we would see a more robust credit card loan growth?

Stephen S. Crawford

Yes. Look, I think that's -- the shift to transactors is relative to high balance revolvers, but that's a segment of many segments in the card business. And as we look at it in all the segments that we're prioritizing, our growth is as good as all of our competitors. I can't give you a better sense than anybody else from a macro standpoint when growth will return to the card business. When I look at our asset mix, cards and others, I do feel like that the underlying secular growth of that asset mix is better than the average financial institution.

Unknown Executive

And Steve, I'd just add one point on card growth, while it's not a prediction about when and how much we might see, the one other factor we haven't really talked about that's impacting growth is the runoff, the planned runoff of some of the HSBC loans. And that's excluding the portfolio sale we talked about. Remember, we said in 2013, we'd expect about $2 billion of planned runoff in our card business. And in 2014, that's going to go down to about $1.2 billion. So there will be -- the runoff will abate over time, which will help us a little bit.

Betsy Graseck - Morgan Stanley, Research Division

Yes, a question right here.

Unknown Analyst

Just more of a macro type of question, I guess, since you have such a cap into the consumer, I'm wondering if you can give us any thoughts if you see any changes in what you're seeing in spend and purchase or anything like that recently within your book of business.

Stephen S. Crawford

I don't think there have been any dramatic changes over the past since we updated people in the first quarter. Certainly, with each month that feels the employment numbers and other things were getting a little bit stronger, and hopefully that will translate into greater volumes. But I don't think there's been a dramatic shift since we've talked about it.

Betsy Graseck - Morgan Stanley, Research Division

Is that a question? Okay. Steve, you mentioned in the presentation the information on third-party versus nonthird-party expenses. And maybe you'd give us a little bit of color around the group you've brought in to work with you on that, what the target goal is for -- the third party, I would assume that's where you're really going to be focusing your efforts.

Stephen S. Crawford

That's one. I mean, I think expense management, it's kind of 1,000 things in hand-to-hand combat. But given that the percent of external spend, what we did, we didn't bring in a consultant, we actually hired 1 or 2 individuals with a lot of experience at larger institutions managing third-party spend. And I don't have a dollar amount that I'm going to share publicly. But suffice it to say, we probably have 20% to 30% of that spend rolling through every year. And we're going to try and -- we've centralized it, whereas before, a lot of times when you want to do something like this, you bring it back into the center, and then distribute it back out into the businesses. We've done that, the businesses are very supportive of that. And we're going to try and make sure we get the most leverage we can out of those relationships and obviously start where the bigger spend areas are.

Betsy Graseck - Morgan Stanley, Research Division

And maybe you could remind everybody where Capital One is with regard to the integration, what's left to do there and with regard to higher expenses associated with being a larger bank of capital and regulatory requirements.

Stephen S. Crawford

Well, the integration, I think we're a long way through the agenda for both ING and HSBC. What was the second part of the question, sorry?

Betsy Graseck - Morgan Stanley, Research Division

The higher expense associated with the...

Stephen S. Crawford

Look, as I said in the prepared remarks, there was certainly a big investment as a result of industry-wide pressures coming out of the recession and then also with the acquisition side. I think we've given you guidance on how the integration spend is coming down. We're working our way through other massive projects, like Basel II, but we're not at the front of the curve there, where some of our larger money centers are, so there's still a little bit more work to do. But I do really believe over the next 2 or 3 years, there will be good opportunity to normalize spend levels for some projects and work that we had to do over the last couple of years.

Betsy Graseck - Morgan Stanley, Research Division

Okay. One other question on just the CCAR. So is it fair to say that you are in process with the request for the incremental buyback? Yes, okay. And then as you look towards next year, indicated that your thoughts are a payout ratio in excess of what you would consider your average peer group, roughly 50% or so. And can you just give us a sense as to level of where that conviction comes from? Is it a function of the earnings generation you have?

Stephen S. Crawford

It's really if I went back to that chart on the left-hand side, on the right-hand side, we feel like the balance is much more towards not just for us but industry-wide, distributing capital as opposed to retaining it, and we know it's going to be a huge focus of us delivering on our promise, which is returns at the higher end of our peer group. And when we look at what we believe we're going to be able to generate in earnings and what the runoff is and what the organic growth prospects are and what we might need, the one area where we continue to look obviously is on the partnership business. As we've talked about earlier, we feel like in excess of 50% that we gave guidance to in the first quarter is good guidance.

Betsy Graseck - Morgan Stanley, Research Division

And just one last question on the potential for acquisitions, as you move into 2014 and beyond, what kind of size of portfolios do you think you'd be comfortable with in terms of looking at?

Stephen S. Crawford

I think these generally come in small dollar billions of size, not massive kind of portfolio acquisitions, so I think very manageable within the capital generation that we have.

Betsy Graseck - Morgan Stanley, Research Division

Okay. Super. Okay. Any last questions from the room? Thank you very much, Steve.

Stephen S. Crawford

Thanks, Betsy.

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Source: Capital One Financial Corporation Presents at Morgan Stanley Financials Conference 2013, Jun-12-2013 08:00 AM
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