Capital One Financial Corporation(NYSE:COF)
Q3 2007 Earnings Call
October 18, 2007 5:00 pm ET
Jeff Norris - VP of IR
Gary Perlin - CFO and PrincipalAccounting Officer
Richard Fairbank - Chairman andCEO
Bob Napoli - Piper Jaffray
Ken Posner - Morgan Stanley
Chris Brendler - Stifel
Stephen Wharton - JP Morgan
Scott Valentin- FBR Capital Market
Greg Regan - Cedar Hill Capital
Rick Shane - Jefferies &Company
Moshe Orenbuch - Credit Suisse
Bob Hughes - KBW
Welcome to the Capital One ThirdQuarter 2007 Earnings Call. All lines have been placed on mute to prevent anybackground noise. After the speakers' remarks, there will be aquestion-and-answer period. (Operator Instructions).
I would now like to turn theconference over to Mr. Jeff Norris Vice President of Investor Relations. Pleasego ahead.
Thank you very much, Sharvon andwelcome everyone to Capital One's third quarter 2007 earnings conference call.As usual, we are webcasting live over the internet. To access the webcastplease log on to Capital One's website at www.capitalone.com and follow thelinks from there.
In addition to the press releaseand financials we have included a presentation summarizing our third quarter2007 results. With me today is Mr. Richard Fairbank, Capital One's Chairman andChief Executive Officer and Mr. Gary Perlin, Capital One's Chief FinancialOfficer and Principal Accounting Officer will walk you through thispresentation.
To access a copy of the presentationand the press release, please go to Capital One's website, click on"Investors" then click on "Quarterly Earnings Release."
Please note that thispresentation may contain forward-looking statements. Information regardingCapital One's financial performance and any forward-looking statementscontained in today's discussion and the materials, speak only as of theparticular date or dates indicated in the materials. Capital One does notundertake any obligation to update or revise any of this information, whetheras a result of new information, future events or otherwise.
Numerous factors could cause ouractual results to differ materially from those described in forward-lookingstatements. For more information on these factors, please see the sectiontitled "forward-looking information" in the earnings releasepresentation and the risk factor section in our annual and quarterly reportsaccessible at the Capital One website and filed with the SEC.
At this time, I'll turn the callover to Perlin. Gary?
Thanks, Jeff and good afternooneveryone. Let's jump straight into the highlights of the quarter on slide 3 ofthe presentation.
Capital One posted a loss of$0.21 per share in the third quarter of 2007 comprised of a profit of $2.09 pershare from continuing operations offset by a loss of $2.30 per share associatedwith the shutdown of GreenPoint Mortgage.
More on the shutdown and how itimpacted our financials in a moment. EPS from continuing operations in thequarter grew smartly from the second quarter of 2007 and the third quarter of2006 reflecting significant revenue growth offset in part by higher provisionexpense. Rich and I will focus on each of these important trends in greaterdetail throughout the call.
Moving on with the third quarter highlights. We executed on$480 million of open market share repurchases. In addition, our $1.5 billionaccelerated share repurchase or ASR program was completed in August. Althoughyou recall that the ASR program reduced our share count by about $20 millionshares, as of April 2nd, when that program was launched.
We are on track to meet our objectives of completing $3billion in share buybacks originally projected by mid 2008 by the end of thiscalendar year. This means, we will target about $770 million of repurchases inthe fourth quarter. The third quarter of 2007 was the first full quarter forour cost restructuring initiative. Although, it is early days, we are gaininggood traction and feel confident that the benefits will be realized as plannedthrough 2009 more details on this in a moment.
Finally, despite the very difficult capital marketconditions, we all experienced in the third quarter, Capital One has executednearly $4 billion in funding transactions across the variety of asset classes,two-thirds of which was asset-backed funding and the balance was long-termunsecured funding for the holding company. For 2007, we continue to expectdiluted earnings per share of approximately $5.
Moving on to slide four, let’s take a look at how theshutdown of GreenPoint impacted our results in the quarter. When we announcedthe shutdown of GreenPoint operations on August 20, we estimated the associatedcharges would total $860 million after tax. As we move towards completion ofthe shutdown and final disposition of loans, we now expect the total chargeswill be slightly higher than that or just over $900 million. The vast majorityof which was recorded in the third quarter.
You can see this in the box atthe top of slide four along with the results from GreenPoint operations in thequarter. The modest operating loss of $15 million combined with $883 million incharges resulted in a total loss from discontinued operations of $898 million.
There are two notable variancesin current estimated charges as compared with the estimates we have made andshared with you on August 20. The higher than expected level of charges relatedto evaluation adjustments partially offset by lower than expected restructuringcharges associated with our exit from origination business.
Evaluation adjustments include a$74 million allowance billed related to the $680 million in loans held forinvestment in the GreenPoint our Mortgage Banking segment. The HELOC loans weretransferred from held for sale during the second quarter of 2007 and weanticipated this allowance billed as a component of our estimated charges onAugust 20.
The balance evaluationadjustments represent lower of cost or market marks on loans committed are soldsubsequently or move to HFI. The bulk of GreenPoint's loan warehouse inpipeline was subject to forward sales commitment or flow agreements, when weannounced the shutdown and we valued accordingly at that time. However, certainlong-term buyers backed away from their bids, which caused us pre-market asubstantial portion of those loans.
Lower gain on sale marginscontributed to the loss from operations. All downward evaluation adjustmentswere required on loans to be sold or move to HFI. The lower box on slide 4provides details on the disposition of GreenPoint's HFS loans. I don’t walk youthrough all the data, but would highlight that $3.7 billion in HFS loans about$1.3 billion were sold by the end of the third quarter.
We had firm commitments to salean additional $1.2 billion in loans, as of September 30 more than half of whichhave already settled in October. We chose to hope for investment about $1billion in loans, the characteristics of which are detailed for you on theslide.
Having marked those loans, we believe they will produceattractive risk adjusted returns. After disposing of the bulk of GreenPoint HFSloans, we are left with approximately $151 million of repurchase and otherloans in the warehouse, which we intend to sell. These loans are being carriedin an average of 55% a part.
Lastly, we retain risk for further repurchases of soldloans, but which we are currently carrying a rep and warranty reserve of $146million related to this exposure. We are in the final stages of shutting downvarious GreenPoint facilities and except to terminate the last leases by early2008.
A GreenPoint team continues to manage the originationshutdown process with the same professionalism that characterize the way inwhich they ran the business for so many years, impacted employees have beennotified and are receiving severance benefits.
Moving forward GreenPoint’s mortgage servicing operations,and the $1.7 billion of the HFI loans held in our former mortgage banking subsegment will be included in our local banking segment in the fourth quarter.
Let’s now move to slide 5. Improving operating efficiency isnot a new area of focus for Capital One. We formerly launched a significantenterprise wide cost initiative in June, as we completed a number of importantimprovements to our operating infrastructure. We remain on track for realizinggross cost savings of $700 million by 2009 and recognized $15 million of runrate savings in the third quarter.
We continue to expect the reported level of operatingexpense to fall in 2008 by $100 to $200 million. We also continue to expectoverall program charges of around $300 million towards slightly less. However,our expectations for restructuring charges to be incurred in 2007 have beenreduced from $200 million to about $150 million.
Realized and expected charges andsavings related to GreenPoint Mortgage are now captured in discontinuedoperations. As a result they are no longer accounted for in our costinitiative. Still we remain committed to the targets for charges and grosscosts savings in the broader program and we will continue to update you on ourprogress.
As we turn to slide 6, pleasekeep in mind that year-over-year comparisons on the balance sheet and incomestatement are affected by the acquisition of North Forkon December 1, 2006. For that reason we have noted changes on a linked quarterbasis.
Let’s start with the balancesheet. Total deposits in quarter end decreased by about $2 billion on thelinked quarter basis, the largest driver of the decline was the intended runoffof high cost brokered and public fund deposits.
During the quarter we executedseven wholesale funding transactions nearly $4 billion of funding, despitedifficult capital market conditions. We took advantage of our diverse and stockfiled funding options to sit on the sidelines during the period of highestuncertainty in the capital market and executed our transaction, when we sawattractive opportunities to do so.
Managed loans held for investmentincreased on a linked quarter basis largely driven by loan growth in our GFS sub-segment.Looking forward we expect low-to-mid single digit loan and deposit growth in2008.
Our tangible common ratio atSeptember 30 was 6.17% slightly above our 5.5% to 6% target range. As Iindicated we expected to repurchase about $770 million and shares during thefourth quarter of ’07. We have also indicated that we expect to increase ourdividend beginning in the first quarter of 2008 through a fixed dollar amountof approximately 25% of expected 2008 earnings. Beyond that, we expect toreturn the balance of our excess capital generated in 2008 through continuingshare repurchases.
Finally, revenue and net interest margins both expanded inthe quarter. Margins were relatively stable in the bank, while our U.S. Cardsub-segment experienced significant margin expansion. Rich will walk throughmargins and our sub segments in a moment.
Turn now to the next slide for a quick look at the thirdquarter income statement. Allow me to focus on just a few highlights. First,revenue from continuing operations is up on a linked quarter basis drivenprimarily by revenue margin expansion in our U.S. Card sub segment that Richwill discuss more about in a moment.
Looking forward, we expect 2008 revenue growth will be inline or just slightly higher than asset growth of low to mid single digit.Operating expense declined in the third quarter by $35 million driven bycontinued efficiency gains across our businesses. Operating expenses includepretax expenses of $30 million related to bank integration and $52 million ofCDI amortization.
Looking forward, we expect our operating efficiency ratioincluding marketing, but excluding restructuring charges to be in the mid 40sfor the full year 2008. Provision expense was up quarter-over-quarter andyear-over-year as charge-offs rose. And as delinquency experience cause us toanticipate higher charge-offs over the next 12 months particularly in our U.S.Card and Auto Finance sub segments.
The increase in provision included an allowance build of$124 million. This build represents an increase to the allowance of about $200million for our national leading businesses partially offset by a $68 millionreduction in the banking segment, which itself was driven by $91 millionreduction due to the alignment of allowance methodology across our localbanking franchise.
Please not that the provisionexpense does not include $74 million allowance billed related to HFI mortgageloans I discussed earlier. Those loans and the associated allowance arecurrently held in discontinued operations, although both will move to the localbanking segment beginning in the fourth quarter.
With that I turn the call over toRich.
Thanks, Gary. I'll begin on slide 8, with a look atoverall credit trends.
Now local banking segment lossesremain stable and low at 19 basis points for the quarter. Non-performing loansas a percentage of loans held for investment increased eight basis points.
Charge-offs in our nationallending segment increased 49 basis points driven by credit performance in ourUS Card and Auto Finance sub-segment. Delinquency in nation lending rose to4.7% in the third quarter from 3.89% in the prior quarter. I will describe thereasons for these changes in the context of our operating segments in just amoment.
Based on year-to-date trends, weare currently expecting charge-offs in the fourth quarter of 2007 to about $1.2billion. In 2008 we expect charge-offs of approximately $4.9 billion this wasrepresents an increase of approximately $800 million over 2007.
Our $4.9 billion estimate for2008 charge-offs include a full year effect of the credit normalization we havebeen experiencing throughout 2007. It also reflects the delinquency trends wehave witnessed in recent months, but does not speculate on future trend. Inthis slide, it is worth remembering that we are not estimating total provisionexpense, which would require that we speculate on the level of allowance thatwe might need to build in 2008 based on expected losses well into 2009.
Our actual charge-offs experienced in 2008 could varysignificantly from the current estimates, given current uncertainties and theoutlook for the credit markets and the broader economy. Here we think it'shelpful to quantify our current view given what we have experienced thus farand to update you regularly on changes to our outlook, as we see how thingsplay out.
One way we will help provide insight is to publish managedcredit metrics for our major businesses on a monthly basis. We will beginproviding that data in November 2007 for this month results.
Slide 9 is an overview of our National Lending and LocalBanking business segment. On a year-over-year basis sustained profitability inour U.S. Card, Global Financial Services and Local Banking businesses more thanoffset the declines in Auto Finance. You will note some continuing themesacross our businesses in the third quarter.
Loan and deposit growth remains modest, while revenue growthand revenue margins are strong. Credit losses and delinquencies across ourNational Lending businesses have risen largely, as a result of continuingnormalization and expected seasonality.
In the third quarter, we have also observed some businessspecific credit trends that I will discuss in a moment and our focused cost andefficiency moves continue to payoff resulting in improving operating leverageacross our businesses.
I will discuss our U.S. Card business on slide 10. Onceagain, U.S. Card delivered solid year-over-year net income growth, as increasein credit cost were more than offset by strong revenue growth and expensereductions.
But looking beyond the third quarter results for a moment,our US Card business has been and continues to be and important source ofstrength, as we have anticipated and met company wide challenges throughout theyear.
Most of the third quarter resultsin US Card are eroded in a set of carefully chosen moves we’ve been makingthroughout the year as we have anticipated these near term challenges. Weselectively move to enhance revenue and anticipation of credit normalization.
We’ve stayed focused onsub-segments of the market with the best risk adjusted returns and the mostresilient through economic cycles. We maintained pricing in credit linediscipline, balanced with our continuing commitments for long-term customervalue. And we’ve leveraged our new operating platform and infrastructure tostreamline process and increase our operating efficiency.
Collectively, this set of moveshas driven the trends in revenues, loans, credit metrics and operating efficiency.Managed loans declined 3% from the third quarter of 2006 to just under $50billion. As we have discussed for several quarters, we’ve chosen to avoid partsof the market like prime revolvers, which are dominated by very long teaserpricing, high credit line and high asset turnover.
We believe this combination offactors hinders the building of the long-term customer franchise and result ina portfolio of loans that is less resilient to economic cycles. We have mostlythen on the sidelines in the sub-segments for several quarters. In the thirdquarter we chose to reduce our investment in teaser led marketing to primerevolvers even further. As a result we’ve seen a significant decline in lowmargin, high balance prime revolvers assets.
We continue to focus on productand marketing strategies with the most attractive risk adjusted returns andresilience. These include transactor products for prime and super primecustomers and attractively price revolver products across the risk factor thatdo not rely on aggressive penalty repricing in order to achieve profitability.
Our marketing investments haveresulted in solid growth in parts of the market that do not generate bigbalances, but in our assessment they have the best potential for prudent growthand profitability in the long run.
The net effect of our marketingchoices has been modest shrinkage in overall managed loans and shift towardhigher margin businesses. While we expect seasonal loan growth in the fourthquarter, we expect to end the year with lower loan balances than at end 2006.
Purchase volumes were essentiallyflat to the prior year quarter. The deceleration in purchase volume growthresulted from slower retail sales trends, our exit from two transactor focusedretail partnerships earlier in the year and the decline in prime revolver loanI just mentioned. We expect to return to modest growth in purchase volume inthe fourth quarter.
We continued to generate strongrevenue in the third quarter, as we’ve played catch-up and relieved the pent-updemand for customary account management moves that is previously have beensuppressed due to the conversion of our card billing system.
For example following the TSYSconversion, we cleared the sizable backlog of account, where the funding had expiredafter several years and was needed to repriced to market rate. We alsoimplemented selected [C policy] changes following the conversion to bring ourpolicy nearer to or inline with the industry. For example the industrytypically has a 20-day grace period and we moved our grace period from 30 daysto 25 days.
Collectively, these movesaccounted for the bulk of our revenue growth in the quarter. The revenue marginexpansion we experienced in 2007 as mostly run its course. While we expect thatrevenue will grow in 2008 largely due to the full year impact of the revenuemoves we have made this year.
Our revenue margin is likely to moderate somewhat. Webelieve that the significant revenue benefits we are currently experiencingwill be partially offset by somewhat higher attrition and charge-offs in thecoming quarter. Raising prices generally causes increased attrition, which thencreates some adverse selection.
Additionally, raising prices can cause an acceleration indelinquency [bill] rates followed by subsequent raises in charge-offs. Weexpect these effects to be more than compensated followed by the significantrevenue benefits of these pricing changes. Charge-offs increase on both ayear-over-year and linked quarter basis. Continuing charge-off normalizationand the mix effects of our decline in prime revolver loans drove theyear-over-year increase.
The sequential quarter increase resulted from the samefactors plus the fact that our June implementation of 25-day grace period,depressed second quarter charge-offs by 31 basis points. Delinquencies rosemore sharply then charge-offs increasing 105 basis points from the sequentialquarter. While these numbers might suggest pressure on credit quality most ofthe increase is explained by factors that don’t indicate any fundamentaldeterioration. Normal seasonality drove about 35 basis points of the increase.
Another 35 basis points resulted from the 25-day graceimplementation, which had two effects. The change in grace period suppresseddelinquencies in the second quarter and created a onetime increase indelinquencies. Another 15 basis points resulted from the mix effects of ourdecline in prime revolver balances. The remaining 20 basis points includes theearly effects of credit worsening associated with and pricing policy changes, Ijust discussed as well as other economic factors.
These delinquency trends are largely consistent with theexpected rise in card charge-offs in the fourth quarter, which we have beensignaling for sometime. We expect that the recent increase in delinquency isassociated with both the 25-day grace implementation and the fee and pricingpolicy changes will roll through the delinquency buckets to charge-offs in thefirst quarter of 2008.
We expect that this result in about $175,000 million ofextra charge-offs in the first quarter. This amount is included in the expected2008 total company charge-offs of $4.9 billion that I mentioned earlier. Wecontinue to expect rising charge-offs for the balance of the year. Perilously, wehad indicated our expectation for fourth quarter charge-offs were about 5%.
Given further declines in prime evolver loans and currentdelinquency trend, we now expect the charge-off rate to be closer to five and aquarter percent in the fourth quarter. With continued revenue strength andoperating leverage, our U.S. Card business remains well positioned to sustainstrong profitability.
Results for our Global Financial Service or GFS business aresummarized on slide 11. GFS net income for the quarter was $118 million up 10%from the third quarter of 2006. Net income growth resulted from strong revenuegrowth and increased operating leverage, but partially offset by higherprovision expense. GFS managed loans ended the quarter at $29 billion up 8%from the year ago quarter. About half of the dollar growth resulted fromstronger Canadian and UKcurrencies versus the third quarter of last year.
Once again North American GFS businesses provided thestrongest growth in both loans and profit. Small business, installment loans,and Canadian credit cards all delivered double-digit loan growth and ourorigination businesses also grew.
Point-of Saleoriginations were up 23% year-over-year. Capital One home loan originationswere up 26% as compared with the third quarter of 2006, although originationsdeclined modestly from the linked quarter as expected in the current mortgagemarket.
UK credit card loans declinedmodestly year-over-year as we maintain a cautious past year in that market. Inthe third quarter charge-offs and delinquencies were essentially flat versusthe sequential quarter. Charge-off rate rose by 30 basis points anddelinquencies were up by 16 basis points from the prior year quarter.
In North American GFS businessesthe story is very similar to our card business minus some factor like the25-day grace period change that are unique to card. The biggest factor in GFSis the continued gradual normalization of charge-offs when they very low levelsin 2006. Credit in the UKremains stable. Our GFS businesses delivered another solid and steady quarterof profitable growth.
You see a summary of thirdquarter results for Capital One Auto Finance on slide 12. Our Auto Financebusiness posted a $4 million net loss for the quarter compared to a profit of$38 million in the third quarter of last year, while revenues were up 6% withstrong operating leverage. These trends were more than offset by a 52% increasein provision expense.
Credit results and outlookcontinued to be the key story in our Auto Finance business. Both charge-offsand delinquencies rose sharply from the very lower levels we experienced in thethird quarter of 2006. They have also risen significantly from the secondquarter of this year.
Both delinquency and charge-offperformance are driven by the same three factors. First we experienced a normalseasonal increase this quarter. In a sequential quarter comparison this is thelargest single driver.
Second, we continue to see elevated losses from our recentdealer prime originations. As we talked about in the past two quarter earlycalls, we have responded by implementing second and third generation creditmodels and adjusting underwriting criteria.
We believe we have turned the corner in the dealer primebusiness and the loans, we are originating today have better creditcharacteristics. However, actual loss levels on early advantages will remainelevated until those loans amortize.
The third factor driving credit performance is elevatedlosses in our dealer sub-prime business. We are continuing to see the impactsof industry wide risk and underwriting expansion over the past several years.
Risk expansion across the industry and in our Autobusinesses, include things like longer-term loans and higher loan to valuelimits. While losses on these loans have risen, the business remains highlyprofitable and we are quite comfortable with the credit performance and risksadjusted returns of these loans.
Originations in the quarter were $3.2 billion roughly flatcompared to the third quarter of 2006. Originations were pressured downward bydeclining Auto sales across the industry and by our pullback on dealer primevolumes. These pressures were offset by continued success in sub-prime anddirect prime as well as the early success of our new business model withdealers.
As I discussed in the last quarters call, we implemented anintegrated program across our 18,000 dealer relationships completing therollout in the latter part of the second quarter. While it is still very earlydays, our first full quarter of results has been encouraging. Dealersatisfaction has increased and loan originations are strong and the creditquality of new origination is better enhanced by positive selection.
Obviously Auto Finance resultsthus for in 2007 are disappointing largely as a result of credit challenge as Idiscussed, but based on solid originations improving operating efficiency andthe early success of our integrated dealer approach. We believe our AutoFinance business positioned to return to stronger growth and profitability in2008.
I will discuss our local bankingbusiness on slide 13. The slide shows actual results for the 2007 quarters andpro forma results for the 2006 quarters. Net income for the quarter was $192million up more than $15 million from the second quarter. The primary driver ofthe increase was a reserve release the result when we aligned our local bankingsegment loan loss allowance methodology to be consistent with Capital Onemethodology.
Revenues decline modestly fromthe second quarter as did non-interest expense. Total deposits declined byabout $1 billion from the second quarter to $73 billion. Several largecustomers withdrew a portion of their deposits in the quarter as theyreposition their real-estate holdings.
Deposit mix and pricing werestable in the quarter. Loan balances were flat at $42 billion. Commercial loansgrew modestly offsetting the expected pay down in the mortgage portfolio. Thecommercial real-estate in multifamily loan portfolios were flat from the secondquarter.
Credit performances remain strongand stable. The charge-offs rate remaining is just 19 basis points.Non-performing loans as a percentage of managed loans rose eight basis pointsto 27 basis points.
Once again the biggest news inour local banking business in the third quarter is our continued progress onintegration. Lynn Pike has built her leadership team by selecting experiencedexecutives from Legacy Capital One, North Fork, Hibernia,and key external candidates. The senior management team is now largely inplace.
Beyond the transition of the leadership team our integrationefforts continue to be on track. Integration efforts will continue toaccelerate over the next two quarters with the deposit platform and brandconversions scheduled for the first quarter of 2008. In the third quarter, ourLocal Banking business continued to deliver solid results, while managing anddelivering on a successful integration.
I will close tonight on slide 14, which is the summary ofcurrent expectations, we provided for 2008. The expectations, we provided forkey operating metrics and capital targets effectively constitute our guidancefor 2008. While they provide enough inputs to develop a reasonable range ofexpected earnings for 2008, we believe there are both longer-term andshorter-term benefits to provide a new with this level of detail.
As compared to a calendar year EPS range, these metricsprovide visibility as to how we are doing against the goals and targets we haveset that will deliver long-term shareholder returns like operating leverage andcapital discipline. Moreover this approach shed light on important top line aswell as bottom line trends, which will drive the performance in the future.
In a shorter-term this approach allows us to give you a clearpicture of where specific variables like credits are pointing in the moment andthe factors what you are likely to drive them going forward without embeddingthem in an earnings range wide enough to catch your all possible scenariosespecially during uncertain economic times such as lease.
It also allows us to provide frequent update on thosevariables, which are more visible to us like monthly credit metrics In ournational Lending sub-segments and exceptions for future quarter charge-offswithout having the speculate on variables like the allowance, we might need tobuild over the course of the given calendar year to anticipate loss experienceanother 12 months out.
I hope you will be able to join us in McLeanor over the webcast for our fall investor conference on November 6th. At thattime you will have a chance to hear directly from the leaders of our businessesabout our strategy and outlook for 2008.
Garry and I will also discuss our overall corporate outlookwith the focus on how we except our strategic and business results to translatethe shareholder value over the next couple of years and longer term.
Now Garry and I will be happy to answer your questions,Jeff.
Thanks, Rich. We will now start the Q&A session. If youhave any follow-up questions after the call, the investor relation staff willbe available to answer them.
For the courtesy to other investors and analysts and theywish to ask a questions, please limit yourself to only one question and onefollow-up question. Sharvon, please start the Q&A session.
(OperatorInstructions). We will have our first question from Bob Napoli, PiperJaffray.
Bob Napoli - Piper Jaffray
Thank you. Good afternoon. Rich,question in order to get your stock moving appreciate the return of capital,the dividend certainly a significant moves. But I’m trying to get understandingof kind of the growth rate of the company, if I think about your business, theCard business there appears to be a cash call with net of return on assets isvery high probably not going to get a lot of expansion in ROA.
So, probably grow maybe in linewith the loan growth? The Auto business, a big challenge not a great growthindustry, the bank seems to be modest growth, it seem like you have some growthdrivers in GFS? But I just looking at this, I’m just trying to understand maybeyou can give me some color on the long-term growth potential of Capital One?
Thank you, Bob. I think,certainly Capital One relative to the Capital One of many years ago, where weare growing at double digit rate, pretty strong double digit rate. It’s a verydifferent Capital One at this point. We have two anchor tenants that are bothin relatively slow growing industry. The most striking thing about these anchortenants is about their, they are franchise potential in terms of enhancing theoverall business of the company. But also, they have very strong capitalgeneration.
So, you are right in the sensethat we are not going to push these businesses to do natural thing for the sakeof growth. What we are going to do is leverage these businesses to generate thevalue that they can, which is primarily at this point around very substantialreturn of capital. And all the actions that you can see are consistent, we aredoing that.
So, the bank at the moment ofcourse is mostly, is in pretty stable situation, but mostly really the focus ison integration. I think the Card business is a classic case Bob, where you cansee that as we react to the pressures in the marketplace. We are not doinganything unnatural instead we are really driving a lot of capital generation,and that creates value in a way different from just underlying asset growth.
And you talk about the AutoFinance business, the Auto Finance business, while the industry is honestlygrowing in a couple of percent in fact this year very slow for the industry.The auto business like virtually all of our GFS businesses are leveraging ourstrategy of being consolidators and while the industries may grow slowly. Ithink in GFS and auto we have the chance for substantially higher growth. Allof that growth needs to be cautiously pursued in the context of the creditmarkets that we have out there.
Additionally though on how wedrive the shareholder value that we have, you can see the actions we have takenon the revenue side of the business, the dramatic actions that we taken on thecost side of the business and again making sure on the capital side of thebusiness. That we are very careful with our investments and both with respectto return of dividend and but also in comparing alternative investments tounderstand the power of share buybacks particularly in the context of our stockrates right now.
So to me at the end of the dayour focus is in making Capital One a growth company. Our focus is in valuecreation and I think we are very well positioned to do that. Even in thecontext of the company that still has I think a lot of growth potentialrelative to the industry over the longer run.
Bob Napoli - Piper Jaffray
Thank you. Just a follow-up onthe credit side, are you seeing anything alarming obviously ranges raised yourcharge-off outlook a little bit for the fourth quarter, you broke down thepieces, but you feeling a much more concerned with the economy today in youreven 30 or 45 days ago?
Well, Bob the economy itself isdepending on whether your glass is half full or half empty. You look at theeconomy you will see a lot of things to like; there are, lot of things not tolike. But certainly the metric, we’ve always focused on as we look at theeconomy has been employment and I think, there is a lot of strength andconsistency with respect to the most important metrics, we look at the economy.
We also look at just thetrajectory of our underlying businesses and as we talk about when you see aspike and delinquency here are some of the big changes you will see. Obviously,we do a lot of digging to make sure that we can explain the various effects andalways in search of sort of worsening on a standalone basis. And as you cansee, there are strong explanations for some of the credit metrics, as we talkedabout.
As we look, we continue to notsee direct effect from the mortgage crisis affecting our own customers. We see verystable differences between our mortgage holders and renters, and we talk a lotabout this in the past. We have now that more data is coming out, we’ve done apretty deep look at the markets, where housing prices have, home priceappreciation has been very dramatic over the last number of years, and what wesee Bob as we go all the way back to 2004.
We can see that in those markets,the credit performance on our portfolio of the sort of the high octane HPAmarket. The credits performance improved differentially more in those marketsthan everywhere else on our consumer portfolio. It peaked in’05. It was stable.This differential peaked in ’05.
It was stable in ‘06 and what wesee in ‘07 it basically regress back to the main. So in other words the California’s,the Florida’s, Arizona’s the superior performance in consumer credit that wehave observe over the last few years is more or less regress toward or to themain.
Though as we look at thosemarkets also we see that again this does not then appear to be the directmortgage effects, renters and homeowners in those markets in the past and inthe present they tend to move together. So what it offers to us, it basicallygoes back to the core principle of that. It’s about the economy. We see astrong economy. We see basically stable performance adjusted for the things. Weare talking about in our own portfolio.
And so I think we feel very goodabout that. Nonetheless I think there is more uncertainty Bob, than usual atthe moment. It’s why we are just being extra careful in underwriting and doingthe things we have the reason behind. The revenue moves that we’ve done to putourselves in a position, whether this norm may or may not be out there in thefuture.
Next question please?
We will go next to Ken Posner,Morgan Stanley.
Ken Posner - Morgan Stanley
Hi, Richard I just want toclarify the one last point you made. Your explanations were very helpfulcompared to just looking at the raw numbers in the press release. So you aresaying you are seeing no real deterioration in the underlying consumer at thispoint, when you back throughout the policy and pricing changes?
Yeah. Ken, let me try to clarifybecause one thing I want to say is all these time when we have been talkingabout normalization, I’ve always said my caution is and always has been thathere you had incredibly good consumer credit performance in '06. And we allknew that that can’t last forever and when we all declared there would be“normalization” a return to normal. Now normalization itself as people becomedelinquent to charge-offs. They don’t have labels on and that’s say, I’m herenormalizing. They don’t have labels that say I’m a substitution of factorwhatever.
Ken Posner - Morgan Stanley
So, that my caution is alwaysbeen in some ways in an environment of normalization what is worsening versusnormalization, it’s a little bit of a hard form. We’ve said all along that ourcredit performance has been coming in pretty much on top of the forecast, wemade a year ago, and that comforting to us. When we get behind thenormalization that has happened over the past year remember we always talkabout the one thing that was puzzling was that the low in charge-offs wasgreater than the spike and bankruptcy. So, in some sense 2006 fooled us byvirtue of how good it was.
And I think, now as we dig intothe numbers it was not only sort of the bankruptcy effect, but there also wasthis exceptional performance in the rapidly home price appreciating marketsthat is more now regressing through the mean. So, to us, I think broadly Ken, Iwould call this all part of normalization in the sense those things areregressing through the mean we've got bankruptcies returning more to normallevel, I think.
Well, there are no labels on thesubstitution that we would expect certainly is consistent with what we see. So,as we itemize this delinquency spike, if I too clarify one thing Ken to you thedelinquency spike that we had in the third quarter, we spend a lot of timelooking at this thing and of course given that we projected charge-offs wouldbe quite a bit higher by the end of the year.
This is the natural effective onthe delinquency side of what we have already projected. But to just go back anditemize again the fact that, the 25 day grace effect is very isolatable andit’s a bubble kind of moving through the pipe in a sense and that’s 35 basispoints of the delinquency.
The seasonality, honestlyseasonality now it doesn’t have label associated whether we have been look theover past 6 years we find seasonality that would be consistent with about 35basis points to this. Absolutely it just math the mix shift that comes fromfewer revolver balances. So that’s the 15 basis points.
What I want to say is the 20basis points that left over. It is our belief, but we can’t prove it at anearly point. So that’s a very natural effect of the fee in pricing policychanges, but I can’t prove that to you. And I said we could find agenda that isworsening in another form. What we’ve done is we isolated a relatively smallamount of delinquencies that. We are going to keep an eye on but the net effectof all other things saying is, it is more uncertain than usual, but I thinkthere is solid and explainable performance that’s going on.
Ken Posner - Morgan Stanley
Richard, thank you and it isreassuring to see that contrast with some of the mortgage companies, which wehave seen a very sudden deterioration in credits. So I really appreciate theclarification.
Next question please?
We will go next to ChrisBrendler, Stifel
Chris Brendler - Stifel
Hi, thanks. Good evening. On thecredit side I just, I understand all the subjects you’ve discussed, thedrivers, but it looks to me, if you look your competitors. The major bankcompetitors in the Card business the few sub-prime competitors, we look out inthe Auto Finance business, your trends are not in line with lot of thosecompanies.
And I think that I’m sure, youare worried about the concept of adverse selection, their pricing strategy youare using, it doesn’t seem to be tracking the way you expected it because youare already raising your fourth quarter loss guidance for Card? So, I just wantto know, do you feel that it’s an accurate statement that you are arguing withsome ones of adverse selection in both the Auto or Card business or was there abetter explanation?
Chris, there are really a bunchof things wrapped up in your question. First of all, when us versuscompetitors, I think, we tracked on top of it or maybe slightly better in thesub-prime auto space than the competitors. We talked about in the prime autospace; I have talked extensively about some of the issues, I think that wasCapital One specific and some of the vintages there.
But I think, overall the autoperformance is very much tracking the way that we see the industry tracking andwe could talk more about that in other question questions if people want toask. On the Card side, this is not a story of adverse selection. This is astory of consistency about things we’ve done for many, many year.
So, compared with competitors,they didn’t have the 25 day grace effect. They generally if you look at usversus competitors everybody has got bit of a different portfolio. Wedefinitely have more seasonality than they do, and this is the period of themost significant seasonality increase that you would see with respect todelinquencies. The mix shift again every company has their own mix thing.
This is absolute map just theeffect of the mix shift out of the prime revolver business. As I said thereactually is some adverse selection, Chris that comes with pricing changes. Andwe are pretty much in advance declaring that we expect that and we expectattrition and we expect some adverse selection with pricing change. We expectthat to be slump frankly by the revenue benefit, but honestly there is someadverse selection with respect to that. But that is not a big effect related tothe current numbers that we were.
Chris Brendler - Stifel
Let me ask in a different way inthe linked quarter you guys talked about 5% loss rate in the fourth quarter.Now you are talking about 5.25% and it's not a macro thing. So are you seeingthe deeper pricing not worked the way you’ve expected to whether grace period?I mean grace period really shouldn’t drive losses. It should be a temporarylate fee benefit and a delinquency blip because in couple of times you bad youare charging them. They are missing the payments for the five days. So whatexactly drove the increase in losses for the fourth quarter? And then a relatedquestion did you have any meaningful adjustment to your IO strip in the carbusiness this quarter?
Okay. First of all in the fourthquarter losses quite a while ago we said we expected charge-offs to be aroundfive. And I think a number of people said I’m troubled getting myself. So howdo we get there, and we said, look I think essentially just making in the math ofthe things that have been going on in the business.
And the increase in that estimateto five in a quarter about half of that is or good chunk of that is basicallythe nominator a fact related to less asset growth and some of it, a lot of itjust relates to the math that’s working through that itemization associatedwith delinquencies that I did earlier including again the numerator effectsassociated with the mix change. So, that’s pretty much how I would explainthat. Garry, you want to talk about the IO strip?
Sure, Rich. And hey Chris, weactually had a small write-off in our Card IO strip during the third quartersomething between $17 and $18 million. I know, that’s all different then whatyou have seen with some other folks and just keep in mind that there are somepositive benefits from the strong revenue growth, which more than offset theincrease in credit costs, and some of the small increase in funding cost, so up$17 to $18 million.
Next question please?
We’ll go next to Steven Wharton,JP Morgan
Stephen Wharton - JP Morgan
Hi, Rich and Garry. I guess, myquestion is, I appreciate the kind of initial 2008 guidance that you provided,and as it relates to the charge-off guidance. First of all, I wondered; if youcould, may be perhaps highlight a little bit what sort of economic environmentyou would except in terms of like GDP growth to get you the $4.9 billion?
And then secondly, I just want toget a better sense of where you are from a reserve standpoint. A number ofbanks had found themselves in a position where, when things were good they werereleasing reserves and running down reserve coverage ratios in addition to justhaving improving net charge-offs, and now it’s kind of like the opposite.
So, not only do you have theincrease in the dollar provisions and you have to provide and increase yourcoverage of your loan portfolio. So my understand I thought that Capital Onehad been low less of the former in terms of bleeding the reserves and which wayto imply that maybe the less of the ladder. So can just talk about that alittle bit?
Thank you, Steve. I will take thefirst part and Garycan talk about the reserves. I’m glad you asked the question about 2008 creditguidance, because I want to as clear as we can. It’s a year ago, when said outit turn out one of the most
probably all the metrics want toonce it turn down most close and our internal forecast turn out to be thecharge-offs. But we know any year in particular a year like this it somethingthat can have a lot variance to it. So our approach is we don’t want to justtake an unusually large number just to make sure we come in 1000.
What we want to do is try to,have you see it, as we see it at this point and could of course be subject tochange. So the way we’re looking at it Steve, is that we are assuming with theeconomy we don’t model it. So we say if unemployment is exactly X% then it meanthis on our charge-offs.
But generally we are viewing acontinuation of the economy pretty much the way that we see it. We are assumingthat the dollars, which are currently delinquent will follow through tocharge-offs. We assume the effects of normalization and shift in loan mix willcontinue we assume seasonality follows it normal patterns. We also assume thattemporary factors like increase cost by policy changes will go way overtime.
So, this is pretty much a fairway estimate. It’s certainly not, it not an estimate that is massivelyconservative, to be conservative, I think, what we try to do. So, we don’tassume a lot of additional changes in the economy or credit performance fromhere. It's more just how what we see will play out over the course of 2008. Andthat’s why; it also the important choice of not trying to predict, what arereserved bill would be next year. Gary,do you want to take the other part of that?
Sure. Absolutely, hi, Steve. Justtaking a look I obviously don’t need to remind you that our allowances are bestestimates of future losses. In order to be able to come up with thoseestimates, we need to take a look at the experience; we’re having with our bookright now. Future allowance will really depend on how that book changes.
So, as Rich said, as our mix mayshift from time to time that’s going to have an effect on future reservingneeds, obviously the actual performance of the book. So, looking atdelinquencies as the best predictor of future losses that’s going to get into,I think.
So, bottom line it’s very hard tokind of get ahead of future reserving needs because one would need a crystalball about actions, about markets, about credit that we simply don’t have. Butin taking all that into account certainly in this past quarter, there is asignificant increase in our coverage ratio in Cards from about 4.7% to 5.5%.
And that’s again because we'veseen the effects of the mix shift that comes from reduction in the amount ofprime revolvers and the books as well as the higher delinquency rates. Theother business coverage ratios are actually quite stable and that's kind ofmore of what you might expect given the performance that we’ve seen kind of afinal notes Steve, if I could on the allowance overall for the quarter justeveryone has the numbers straight.
We did add $200 million more orless for national lending, normal banking operations with let us to increasethe allowance there by about $24, $25 million and then the allowance was alsoincreased $75 million related to discontinued operations. The HELOC loans thatwill move from HFS, HFI GreenPoint in the second quarter and then netting outof that $300 more or less million [with aligns] allowance build was about $65to $67 million resulting -- $91 million change in the bank and that is $67.
But gross of 91 reduction in thebank largely as a result of what you see when any bank integration takesplaces, you integrate all of the methodologies, remove the commercialmethodologies of North Fork more to what we would be considered to bemainstream methodologies such as we added the old Hibernia, our franchise whenthe consumer coverage moved to industry norms, moving away from life timelosses to 12 months losses. So by in large we love to get a head of the future,but we need to tell what the future is, in order to do so, we will continue todo our best job of find and anticipate based on the facts as we have been.
Stephen Wharton - JP Morgan
Next question please?
We will go next to Scott Valentin, FBR Capital Market.
Scott Valentin - FBR Capital Market
Good evening.Thanks for taking my question. Some of your peers in the call, I see one peernoted some changes in the credit card usage patterns such as more cash advanceor any payments coming in slightly later and I was curious maybe if you noticeany change in payment patterns, fewer cards or even payments rates? That’s myfirst question.
Secondquestion on the positive trends, out of thought that with the ABS marketdisruption maybe would emphasize deposits more, maybe growing deposits thisquarter? Just curious to get your reaction maybe a thought when deposit growthmay resume?
Okay Scott. On our competitorthat did reference spending patterns. We did take a look at that. Of course, wewould look at these things all the time. That competitor saw ramping of cashadvances and rising utilization rates, which tend to be triggers of higherrisk. We have looked for this, and we have not seen it. So, really, honestly,the things are pretty stable. But we have things that are moving in our portfolio,the things that we identified related to mix and things like that. Gary, you want to takethat deposit question.
Sure, absolutely. Hey, Scott. Interms of deposits the big shift down in the deposit balance in the thirdquarter was really driven by a reduction in the high cost deposit. So, brokerdeposits and especially public funds in fact the level of retail depositsmeaning that deposits in our branches without public funds included actuallyrose by about $0.5 billion.
The basic funding sources for ourportfolio in the third quarter were cash that we had raised earlier this year,as it turns out quite opportunistically given the kind of dislocation in themarkets in the third quarter. So, we’ve rundown some of our cash balances inthe third quarter.
We also had some funding as youknow at the holding company, which is important to kind of maintain ourliquidity levels there. And we found things like home loan bank advances to bevery attractive funding on a marginal basis. But certainly, when it comes todeposits especially with short-term rates starting to move down, we are goingto be watching very carefully for opportunities to grow deposits and to do soin a way that builds the franchise and help us to achieve better funding costoverall.
Next question please?
We'll go next to [Greg Regan],Cedar Hill Capital
Greg Regan - Cedar Hill Capital
Hi, guys thanks for taking thecall. I just had a point of clarification on the reserve. The $75 million ofHFS provision was being captured in discontinued operation. So that did not hitthe provision this quarter, but that will be going back into the retail bank in4Q. So just how did that work on the P&L next quarter?
Okay. Well, again Greg it'salready hit the P&L through the P&L of discontinued operations. And sothe allowance is on the balance sheet and what we will be doing in the fourthquarter is simply moving those loans as well as any other HFI loans that willmove from HFS and GreenPoint, we will be moving the loans and the associativeallowance to the banking segment it will simply be a move on the balance sheet,no affect in terms of P&L.
Greg Regan - Cedar Hill Capital
Okay. Thank you.
We'll go next to Rick Shane,Jefferies & Company.
Rick Shane - Jefferies & Company
Hi, guys. Just looking at theauto business, one of the things I’m start to struggling with this given whereloss rates are right now and even just assuming that provision matches with theloss rate in ’08, does this business become profitable again. I mean, maybewhat you can do is, you can sort of dial a little bit more into your predictedloss rate for ’08 and give us some senses to where auto charge-offs are goingto go?
Yes, Rick, it’s Gary. I don’t want to do too muchspeculation. But certainly as Rich described a lot of the business that we’vebeen putting on the books of late is business that’s going to be highlyprofitable. The auto business has been doing significant work to try andimprove their operating leverage.
So, we expect that they are goingto be coming down quite substantially in terms of cost, as a percentage ofoutstanding loans. And certainly at the Investor Conference, you will behearing from our business folks there about some of the improvement there. So,I think, the combination of operating leverage having really kind of improvedour risks models around, the prime dealer business generating good volumegrowth.
I think the decline in profitability that youhave been seeing in auto, we would consider to be temporary based on the kindsof credit we’ve been seeing to-date obviously. We don’t have a crystal ballabout what credit will be in the future. But we’re going to apply that samekind of cautious underwriting we’ve for the rest of the book, and we’recertainly determined to make that business profitable.
Rick Shane - Jefferies & Company
Okay. And I guess, the way tolook at it is, and I guess this gets back to Rich’s comment about the [bubble]going through the due. When do you think on the auto side, we will see andagain, I realize on the Card side one of the issues you are dealing with thissort of a broader macro picture?
But on the Card side, I think, onthe auto side, what you are describing is a little bit of seasoning associatedwith the prime portfolio. When do you think because that is easier to predictgiven the statistics that you are looking at? When do you think that will passthrough? That’s probably a better way I should have asked the question to beginwith?
Well, Rick as you know thesevintages are much slower, I mean, they are much shorter in their overall lifethen credit card vintages and already what we are seeing in the prime businessis significantly better. Now, I don’t want to declare victory there because ittakes a while to look at vintages that they progress. But looking at just a lotof the sort of metrics at the time of origination and then the early vintageperformance, we like a lot more what we’ve done in prime.
And in fact, if you recall, weactually backed off prime originations, and significantly backed off pendingthat the rollout of our integrated auto program, which is I think is reallyhelping on the adverse selection side. It’s a combination of really gettingmore positive selection through the old relationships and also much better datafor which we have build second and third generation model.
So, the early routes on those aregood and it’s the matter of the math of better vintages sort of carrying theday as the other vintages work their way through the business. On the sub-primeside of the business, there is sort of, here is how I describe what's going on.It was something like a couple of years ago that the industry table stakes rosein terms of things like a lot of things started going to 72 months from 60months.
You had higher LTV. And therewere things associated with the higher table stakes. We looked at that at thetime, we were concerned about it. We did our best to model the results fromthis, and we concluded that while there is a higher risk, there is on a risksadjusted basis this loan should be very, very solid.
We then did those originationsand what we found and sort of, if you will maybe the first year of this twoyear industry change, we actually did better than we had projected on vintagebasis. And what we’ve seen of late is things have coming a little worse than wehad projected on vintage basis. Sort of net, net, the net effect of this is,and this certainly has impact on the profitability going forward. These thingsare still very profitable loans. It’s just that the kind of the second yearvintage versus the first has been worsened and some of that is normalizationand all the things that we’ve talked about.
So, that is really one that Ideeply believe is an entire industry phenomenon there. But we noticed theindustry has stabilized, the pricing seems rationale. And I think for the wholeindustry underwriting is sort of a notch a little bit at a higher level, Ithink of risk. I think that on a risks adjusted basis that we feel this is asolid business.
Well, I think, it’s a stableoutlook there. So, we think profitability. If you take all these effectsbetween the big allowance builds we had to do this year and vintages runningthrough the pipeline, I think, we look to a substantially better year in theauto business next year.
Next question please?
We'll go next to Moshe Orenbuch,Credit Suisse.
Moshe Orenbuch - Credit Suisse
Thanks. I wanted to kind offollow-up a little bit on the Auto business this is because really if you dolook at the history over the last kind of two and half years, it’s doesn’t seemforget the last whisper; it doesn’t seem that you really made the hurdle ratesin the majority of that period of time.
Certainly from the second half of’05 it’s probably only two or three quarters, three quarters may be at a periodof time since that internally. So, and I guess that’s my question is that, isthere like longer-term strategic plan, I mean, I understand getting back toprofitability support, but how do we kind of look at that?
Moshe, obviously the autobusiness on a vertical current period basis, looks way under hurdle rates,there is not a lot of earnings. But when we look at it from a lifecycle orhorizontal basis that are…
Moshe Orenbuch - Credit Suisse
But I am talking about threeyears Rich, that’s almost a lifecycle alone?
Maybe let me, let change my pointfor a second I’m sorry. On the sub-prime side these things have been solid interms of risk adjusted returns on the prime side. They have been well belowrisks adjusted returns and the, so the thing that as hurt the performance hasbeen just the general underperformance of the prime things that we’ve talkedabout and the excessive allowance builds that was within the verticalperspective these excessive allowance build that we’ve undertaken this year.
So, again, I think the sub-primehas consistently been well above hurdle Moshe and I think our outlook on theprime originations, as I’ve talked about and confirmed by the sort of the earlyvintage results of these is pretty positive too along the way, can I say one ofthe thing, Moshe very importantly has been a significant effort on the costside in the auto business that progressively every quarter you can go back andlook at the numbers. But we are dropping by 10 and 20 basis points a quarter.The operating cost of the business and that is a very important part of long-termprofitability.
Next question please?
We’ll have our next question fromBob Hughes, KBW.
Bob Hughes - KBW
Hi, thanks for taking myquestion. Rich, I really appreciated your conversation about credit performanceparticularly in some of the markets that have experienced much higher housingprice appreciation and that you are seeing some reversion to mean. As we lookout to 2008 and consider your charge-off assumptions and the economy backdropto what extent, if you factored in additional housing price deterioration insome of those markets?
I think Bob our projection for2008 is again the models are not -- our forecasting of 2008 is not onemetropolitan area at a time. So, in some sense, there is not a mechanicallinkage of that to the other. My point about HPA is the high home priceappreciation, those markets that where there has been a big change in homeprice appreciation. I think that is reflective of changes in the economy inthose markets.
Our overall assumption about theeconomy is one that is pretty ecstatic. We’ve kind of intervened and alteredsome of our underwriting in those HPA affected marketplace. But we’ve not putinto our credit forecast for next year. We’ve not put an assumption of further degradationin the nation's economy or the economy in any specific market. It’s really moreof just overall consistency from where we are.
Bob Hughes - KBW
Okay. I mean, it’s an interestingtopic of discussion. I mean, I think, a lot of folks have argued that housingprice appreciation as one of those markets was not necessarily driven bystronger underlying economy rather lower interest rates like underwritings etcetera speculation.
So, to the extent that thehousing price appreciation in some of those markets help to maybe mask somecredit deterioration and resulted in a much longer role return to normalizationsuppose to spike and bankruptcies? I just wondered, what your thoughts might beon how that could impact you on the other side to the extent that some of thosemarkets really start to see altering housing values and you see a deterioratingloss effect as well.
Yeah. Look now one thing I wantto make sure I don’t get on the other side of the discussion, as if I am anadvocate that there won’t be any economic worsening. For years and years, andwe had worried about all these things. I am going to talk to you aboutmechanically what how we are, what's in our credit forecast.
The thing, I want say about thehousing price the high octane housing price markets is the thing that we’vefound is that’s most correlated it’s the rate of change of house priceappreciation. And I don’t, I actually we don’t really believe and that’s reallythat’s the cause of variable because it was the specific cause of variable.
We see a [hormone] effect insteadin fact what we see is the same effect with renters as well as so in it’s alocal economy effect. The main thing that we’ve seen there is a regression tothe main. Its entirely possible those markets could in fact worsen beyond themain, it’s not something that we have put into our forecast.
But again part of our reason forgiving you when to and how we think about credit as I think the most usefulthing we can do for you is tell you what we see and how that mathematicallyworks its way in the charge-offs over the course of the next year. And all ofus will watch with the lot of anticipation, how the economy both locally andnationally mood.
One or more questions.
That does conclude ourquestion-and-answer session, sir. I will turn the conference back over to Mr.Norris for closing remarks.
Thanks, Sharvon. And thanks toall of you again for joining us on the call tonight. Thank you for yourinterest in Capital One. I’d like to just make sure we remind all our listenersthat our upcoming Fall investor conference, which will be held on TuesdayNovember 6, 2007.
The conference will be held inour McLean, Virginia Headquarters and we will also be webcast live. You canfind more details about this on our website at capitalone.com or you cancontact investor relations at email@example.com. The investorrelation staff will be here this evening to answer any further questions youmay have. Thanks again. And have a good evening.
That concludes today’sconference. You may disconnect at this time. We do appreciate yourparticipation.
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