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Capital One Financial (NYSE:COF)

Q2 2012 Earnings Call

July 19, 2012 8:30 am ET

Executives

Jeff Norris

Richard D. Fairbank - Founder, Executive Chairman, Chief Executive Officer and President

Gary L. Perlin - Chief Financial Officer

Analysts

Sanjay Sakhrani - Keefe, Bruyette, & Woods, Inc., Research Division

Christopher Brendler - Stifel, Nicolaus & Co., Inc., Research Division

Donald Fandetti - Citigroup Inc, Research Division

Moshe Orenbuch - Crédit Suisse AG, Research Division

Michael P. Taiano - Telsey Advisory Group LLC

Craig J. Maurer - Credit Agricole Securities (NYSE:USA) Inc., Research Division

Bill Carcache - Nomura Securities Co. Ltd., Research Division

David S. Hochstim - The Buckingham Research Group Incorporated

Richard B. Shane - JP Morgan Chase & Co, Research Division

Operator

Welcome to the Capital One Second Quarter 2012 Earnings Conference Call. [Operator Instructions] I would now like to turn the call over to Mr. Jeff Norris, Senior President of Investor Relations. Sir, you may begin.

Jeff Norris

Thank you very much, Mandy. Good morning, and welcome, everyone to Capital One's Second Quarter 2012 Earnings Conference Call.

As usual, we are webcasting live over the Internet. To access the call on the Internet, please log on to Capital One's website at capitalone.com and follow the links from there. In addition to the press release and financials, we've included a presentation summarizing our second quarter 2012 results.

With me today are: Mr. Richard Fairbank, Capital One's Chairman and Chief Executive Officer; and Mr. Gary Perlin, Capital One's Chief Financial Officer. Rich and Gary are going to walk you through this presentation. And to access a copy of that presentation and press release, please go to Capital One's website, click on Investors and then click on Quarterly Earnings Release.

Please note that this presentation may contain forward-looking statements. Information regarding Capital One's financial performance and any forward-looking statements contained in today's discussion and the materials speak only as of the particular date or dates indicated in the materials and Capital One does not undertake any obligation to update or revise any of this information, whether as a result of new information, future events or otherwise. Numerous factors could cause our actual results to differ materially from those described in forward-looking statements.

And for more information on these factors, please see the section titled Forward-Looking Information in the earnings release presentation and the Risk Factor section in our annual and quarterly reports, accessible at the Capital One website and filed with the SEC.

And now, I'll turn the call over Mr. Fairbank. Rich?

Richard D. Fairbank

Thanks, Jeff, and good morning, everyone. I'll begin tonight on Slide 3. Second quarter results were driven by purchase accounting impacts and a greater than usual number of other items. Gary will discuss the financial impact of these items in a few minutes. We posted second quarter net income of $92 million or $0.16 a share. We completed the acquisition of the HSBC U.S. Card business on May 1. We're thrilled to welcome the customers and associates of the HSBC U.S. Card business to Capital One. We have now completed both of the acquisitions that we announced in 2011, and we're devoting all the necessary focus to sure-footed integrations to realize the significant value of the deals.

We still have a lot of work to do on integration, but both integrations remain on track. We continue to believe that both transactions are financially and strategically compelling and we remain extremely excited about them.

By 2013, we expect that the combined Capital One, ING Direct and HSBC businesses will deliver attractive financial results and strong capital generation. We'll continue to provide information on purchase accounting and merger-related impacts to help bring these underlying trends into view during the second half of 2012.

The second quarter also reflects a number of other items beyond the expected impacts of purchase accounting. We made significant additions to our reserve for representations and warranties on mortgage loans.

In our U.K. business, we experienced additional revenue and expense impacts from claims related to the industry-wide settlement related to the sales practices of Payment Protection products. Our Domestic Card business had 2 significant nonrecurring items in the second quarter. We, along with numerous other banks, were a party to the interchange litigation and the settlement agreement announced last week. The terms of the settlement have been widely publicized. We are reserved for the monetary components of the settlement, including the temporary reduction in interchange rates. While we'll have to see how the resulting changes from the settlement play out in the marketplace, we don't anticipate a long-term impact on revenues or our business strategy.

We also announced yesterday that we've reached an agreement with the OCC and the CFPB to resolve previously disclosed issues related to our oversight of vendor sales practices of payment protection and credit monitoring products to Domestic Card customers. Between August 2010 and January 2012, Capital One's third-party vendors did not uniformly adhere to our sales scripts and the explicit instructions we provided to agents for how these products should be sold. We are accountable for our vendors' sales of products to our customers and we take that obligation very seriously. In this case, we did not monitor our vendors' performance closely enough. We deeply regret any process breakdown that impacts our customers. When it happens, we fix it and make it right. When we first learned of these breakdowns, we immediately stopped all sales of these card add-on products. We identified impacted customers to provide full refunds. As the order lays out, we decided to refund money to approximately 2 million customers who purchased the product during this period. We made this decision notwithstanding that many of the vendors' sales calls did not raise concerns and we're strengthening internal quality control processes and our monitoring of vendors. We have no intention to sell these card add-on products in the future because the economics of our Credit Card business does not depend on revenues from add-on products and we have a lot of opportunities to grow our franchise in other ways.

A couple of our retail partnerships still sell payment protection through long-term contracts. Looking through the significant noise in the quarter, the strong underlying performance of our businesses continues to demonstrate that we are well-positioned to deliver sustained shareholder value.

Slide 4 provides an overview of solid business results in the quarter. While HSBC purchase accounting dominates second quarter Domestic Card results, the underlying business excluding HSBC deal impacts continued to deliver strong performance. Excluding the HSBC loans and the continuing run-off of closed-end loans, domestic revolving credit card loans grew modestly in the quarter. Purchase volumes also continued to grow compared to the second quarter of last year. Revenue margin remains strong in the 16% range excluding HSBC deal impacts, but including the negative effect of the cross-sell settlement. Credit trends remain stable at historically strong levels with normal seasonal patterns. All told, the Domestic Card business delivered another quarter of strong underlying net income. We expect that Domestic Card growth margin and credit metrics will continue to be affected by HSBC-related items we discussed on the first quarter earnings call. HSBC impacts include: Expected run-off in parts of the portfolio; alignment of customer practices; HSBC's historical charge-off levels; and of course, the effect of acquisition accounting. But even with several quarters of these deal-related impacts on metrics, we expect our card business to deliver strong and resilient profitability and a valuable customer franchise.

The Consumer Banking business posted an exceptionally strong quarter. Ending loans were up modestly with Auto Finance growth outpacing expected mortgage run-off. Average loan growth was stronger with the full quarter effect of ING Direct mortgage loan balances.

Deposits declined modestly. Revenues were strong, driven by higher average loan balances and a modest decline in deposit interest expense, which were partially offset by lower loan yields from the full quarter effect of ING Direct mortgage loans.

Credit remains strong with seasonal tailwinds in Auto Finance. Net income was $438 million. Our Consumer Banking business continues to gain traction with national scale auto lending, local scale in attractive local markets in retail banking and growing national reach with the addition of the ING Direct franchise.

Our Commercial Banking business continues to deliver strong and steady overall performance. Loans grew 3% in the quarter at 15% year-over-year. Revenues were stable compared to the first quarter and up 13% year-over-year. And credit performance continues to improve. Commercial Banking delivered $228 million in net income for the second quarter. We expect the strong and steady performance of our Commercial Banking business to continue.

I'll conclude my remarks this morning on Slide 5. Capital One continued to deliver strong results in the second quarter of 2012, and we remain focused on delivering sustained shareholder value. Because the ING Direct and HSBC U.S. Card acquisitions are such key sources of shareholder value, we're committing all the necessary management time and talent to executed sure-footed and effective integrations. We're also building a great customer franchise. Capital One is already one of a handful of banks that is building a very large and very loyal customer base. ING Direct brings 7 million loyal, early digital adopters with attractive demographics and HSBC has 20 million -- excuse me, 27 million active U.S. credit card accounts. So the acquisitions will strengthen and expand our combined customer base. Over time, these customer relationships are a tremendous source of value as we can expand and deepen customer relationships with new products and services. We've made great strides in delivering a franchise building customer experience, and we expect to preserve and leverage this simple, compelling ING customer experience as we continue to build a great customer franchise across all our businesses. The combination of Capital One, ING Direct and the HSBC U.S. Card business puts us in an even stronger position to create sustained shareholder value through growth potential, strong returns and strong capital generation. We're focused on delivering that value, including distributing capital to shareholders through meaningful dividends and opportunistic share buybacks consistent with our long-standing commitment to maintaining a strong and resilient capital base.

Now I'll turn the call over to Gary to discuss our financial results in more detail. Gary?

Gary L. Perlin

Thanks, Rich, and good morning to everyone on the call. I presume that most of you have had a chance to review in some detail the financial results we published yesterday afternoon. So I'll limit my opening comments to the highlights and a couple of issues that may benefit from a bit of additional explanation.

Starting with the balance sheet on Slide 6, you can see that approximately $31 billion in cash was paid to HSBC on May 1 for its U.S. Card business. On that day, we recorded about $27.6 billion in loans held for investment. The difference reflects the other net assets we recorded in purchase accounting, which are described on Slide 7.

Acquisition accounting starts by separating the HSBC card loans into those which are non impaired and as revolving loans are accounted for under FAS 91, and those which have lost revolving privileges and are considered impaired. The impaired loans are accounted for under SOP 03-3. About 95% of the loans acquired were non-impaired. We posted a $1.2 billion loss allowance for these loans as of June 30. In addition, we added $174 million to our finance charge and fee reserve with respect to these revolving loans, which, as you know, is recorded as a contra-revenue item.

We anticipate modest additions to both these items in the third quarter. Consistent with FAS 91, we also booked a fair value premium of $692 million on these revolving loans at the time of acquisition. This loan premium will largely be amortized through the end of 2013, including $63 million in the second quarter. For the remaining 5% or so of HSBC's loan balances accounted for under SOP 03-3, we established a credit mark of $666 million. This mark absorbed $251 million in loan losses during the second quarter and the balance should largely be drawn down by losses over the balance of the year. The largest ongoing impact of purchase accounting will be the amortization of PCCR, a $2.1 billion intangible asset associated with purchased credit card relationships. PCCR amortization was $85 million in the second quarter. We expect this number will be somewhat higher the third quarter, owing to a full 3 months effect and will continue to amortize on an accelerated basis over 9 years. PCCR amortization, like all acquisition accounting effects from HSBC, will be allocated to our Domestic Card segment.

Slide 8 breaks out the impact of the HSBC Card acquisition on the second quarter, including the acquisition accounting-related entries described on Slide 7, plus transaction and merger-related expenses and the impact of 2 months worth of HSBC Card operations. It's worth remembering that only $10 million of the approximately $260 million in charge-offs related to HSBC loans hit the income statement in the quarter, since the vast majority of such charge-offs were recorded as a reduction in the credit mark for impaired loans I just described. In addition, revenue also benefited from the absence of $45 million in finance charge and fee reversals that were absorbed through the noncredit component of the SOP 03-3 mark.

Among the other items, which affected the Q2 income statement, I'll focus on 2. As Rich noted, we announced regulatory settlements related to cross-sell marketing in our Domestic Card business. $60 million in civil money penalties were recorded in noninterest expense. We also announced that, pursuant to our agreement with the OCC, we were setting aside $150 million in cash to fund expected customer refunds. The total income statement impact of these expected refunds totals approximately $116 million, including a $75 million reserve accrued in the first quarter to reverse previously recognized revenues and an additional $41 million reserve this quarter to reflect the final terms agreed with our regulators. Additionally, we are no longer recognizing revenue for any amounts billed for these products to affected customers. Currently, we continue to bill for products sold to these customers to ensure continuity of coverage for the products until they receive their refunds later this year. This includes approximately $24 billion of build amounts in the second quarter that were not recognized.

The other item I'll mention is the accrual in the second quarter for litigation reserves to cover the interchange settlement that Rich described and other settlements in the second quarter. We have also recorded the effects of a variety of other smaller settled and pending matters, including one we expect to resolve in the coming weeks. As we've been saying all year, 2012 results will reflect a considerable amount of noise due especially to merger-related impacts. While some of those impacts will persist for a while, as indicated in our discussion of the acquisition accounting, we continue to believe the new run rate of our combined businesses will become visible starting in the back half of this year.

Turning to Slide 9, let's touch briefly on net interest margin. Reported NIM for the second quarter was 6.04%. The negative impact on loan yield from a full quarter impact of ING Direct mortgages was more or less offset by a positive impact from the partial quarter impact of HSBC card loans. The modest contraction in NIM on a linked-quarter basis was primarily driven by a decrease in Domestic Card loan yields, primarily as a result of the $174 million finance charge and fee reserve build arising from acquisition accounting as I described earlier. The decrease in asset yields was partially offset by lower cost of funds in the quarter, largely driven by the full quarter impact of ING Direct's deposits. We expect NIM will rebound significantly from here as we experience a full quarter effect of the acquired HSBC Card loans. The longer-term outlook for NIM will, as with most banks, depend on asset mix and especially on the outlook for interest rates.

Before ending, let me quickly cover off on capital on Slide 10. As of June 30, our Basel I, Tier 1 common equity ratio was 9.9%. Risk-weighted assets rose substantially in the quarter as a result of the HSBC Card acquisition and related acquisition accounting results in -- that caused our Tier 1 common capital not to rise as much. Our Tier 1 common ratio came in slightly higher than expected, largely as a result of the considerably lower level of goodwill created as a result of the HSBC card acquisition compared to our prior expectations. We continue to be comfortable with our strong capital levels and our capacity to generate healthy amounts of capital going forward, which Rich discussed earlier, is an important element in Capital One's ability to deliver sustained shareholder value.

With that, Rich and I would be happy to take your questions.

Question-and-Answer Session

Operator

[Operator Instructions] And we'll go first to Sanjay Sakhrani with KBW.

Sanjay Sakhrani - Keefe, Bruyette, & Woods, Inc., Research Division

I just had a quick clarifying question on the add-on products. Were they sold in the first quarter? On that $24 million, is that a good run rate of what will not reoccur on a go-forward basis? And then I guess, secondarily, just on the private label portfolio, that shrank a little bit relative to deal announcement and even since you've acquired it. Could you just talk about your expectations going forward, in terms of growth and maybe the same for the broader portfolio?

Richard D. Fairbank

Okay. Sanjay, I think the -- probably a good round number estimate for the ongoing impact of this -- the foregoing revenue of this tranche of customers is about 10 basis points, on an ongoing basis, a declining function but when I look out next year, for example, that's the kind of neighborhood of the revenue impact. So -- and again, there are 2 revenue impacts, just to call to your attention for a second. One is the loss revenue from the customers we're remediating. That's the round number of 10 basis points on the Domestic Card revenue margin. And then, we will forego revenues related to future sales of payment protection and credit monitoring because we've chosen to stop selling the products. And the revenue impact of this choice is harder to predict because as we learned over the last few years, credit margins are really driven by competitive dynamics in the marketplace once you get there. On the private label partnership portfolio, there were over 20 partners in this deal. And some partners, through the process of closing this deal, have -- we have separated from several of those. Nothing that's a really material impact there. And this phenomenon of assessing each partner and making sure that our partnerships, as we continue to renew all these contracts over time, are focusing on really great partners that are very focused on making the private label credit card a centerpiece of their franchise. That's where we're going. So we feel very excited about the partnership business. And as a general update, I mean, I think things are going very well with our early relationship building with the partners and getting -- and we're basically reviewing one contract at a time and many of these contracts are multi-years and like free agents, there's always a few free agents coming up every year. We've got a couple of more still working on but overall, I think we're off to a great start with the partnership business and we look forward to growth opportunity in that business. And then you would -- go ahead. You want to talk about growth overall?

Gary L. Perlin

I wanted to just make one other mention here, Rich. This is Gary, Sanjay. The other thing to keep in mind and you saw it over the course of the last year, as our partnership book started to build, prior to HSBC, with Kohl's and other partnerships, there is an exaggerated amount of seasonality in balances in a lot of these retail partnerships. They tend to ramp up more at the end of the year. And in the first and second quarter, you see them run-off a little bit faster. So keep that in mind going forward as our partnership book starts to grow.

Operator

We'll take our next question from Chris Brendler of Stifel, Nicolaus.

Christopher Brendler - Stifel, Nicolaus & Co., Inc., Research Division

Just a question: you reported, I think, the spending growth in the quarter at 11%, including Kohl's, I believe it was mid to high-teens last quarter. Anything unusual in spending trends or are you just seeing a pronounced slowdown among your card customers?

Richard D. Fairbank

No. I mean, there's a pretty strong seasonality effects with respect to spending. But no, I don't think we see anything overall of note. I think we continue to see really strong traction with respect to our new transactor focus products and we -- the spending numbers that you see are a blend of retailer numbers and the private label and the general purpose credit card spending on our portfolio as well.

Operator

We'll go next to Don Fandetti of Citi.

Donald Fandetti - Citigroup Inc, Research Division

Rich, I just want kind of talk a little bit about the business, the card business in terms of competition. I mean, we've been talking about the banks moving to the affluent for quite some time here. When we talk with bank executives, they seem to highlight the Basel II RWA inflation and the low end of the credit spectrum. It looks like you're the only large bank focused on that particular part of the credit spectrum. Can you sort of talk about what the larger banks might be missing and could you see increased competition over time if those banks realize that they are not as profitable as they hope to be?

Richard D. Fairbank

Yes, Don. I think your observation is one that we also see. It seems that most of the card competitors are moving out of the middle end and upper end of subprime of the marketplace. And why would they do that? I think, for a number of them, the CARD Act, they found kind of altered their revenue model in a way that made that business for them less profitable. And again, I can't speak for them. But when we reverse engineer some of the things that -- the way their model worked and how it was changed by the CARD Act, that I think is one thing that started the migration. Secondly, there's, I think, been a lot of pressure on banks to try to migrate to places with lower capital pressure. And I think that Basel II, it's very clear that Basel II creates a greater tax on businesses like that. Because Basel II, unlike many risk management frameworks, including things like stress test, Basel II taxes, if you will, based on loss rate, not on the relationship between loss rate and loss under stress and revenue coverage. And so that really kind of undermines some of the -- really, from a risk management basis, sort of a little bit of a misalignment of capital allocation versus how that business really works. And so I think a lot of folks, while they have headed for other places in the business, what we've been saying all along is through the CARD Act, through the great recession and in our forward planning, we still are mostly where we were before. With respect to the CARD Act, which we were, I think, very embracing of the underlying level playing field associated with the CARD Act, we've -- you can see from our numbers, our business model is pretty intact. On the other side of the CARD Act, Basel II will be higher tax that we have to pay and, of course, we are looking closely at that. But I think that the performance of this business over the years of our experience through the great recession and even now with the other pressures on it, I think, for us, we continue to believe that what we used to do is the same business model I think is really going to work going forward. The other thing I think some of our competitors found is some pretty big losses in parts of this business where, I think, financially and in terms of our credit performance, it weathered it better. So as we've said many times, the more things change for Capital One, the more they stay the same. Where we play and how we do it is pretty much the same as it was going into the great recession.

Operator

We'll go next to Moshe Orenbuch with Crédit Suisse.

Moshe Orenbuch - Crédit Suisse AG, Research Division

Couple of things. You had mentioned that when you looked at the Domestic Card business X the deal that the revenue margin was 15.8%. What are the items that were actually embedded in that when you looked at that? And then also, 3 months ago, after the first quarter, you had talked about the HSBC portfolio at maturity kind of having an effect on the entire portfolio of raising the loss rate and lowering the revenue margin by certain amounts. I'm wondering if you're still -- if those are still your forecasts or how you think about that?

Richard D. Fairbank

Yes. So let me talk about the loss rate first, that's the simplest one. HSBC, when it comes in, because of the marking of the delinquent customers basically, as you know, Moshe, dramatically lowers the loss rate until that -- for basically a couple of quarters. And then it bounces up to its running rate. We said at the time, Moshe, that would be in the neighborhood of 75 basis net increase in the otherwise legacy Capital One running rate. I think, if anything, that's a conservative number. Conservative, meaning that it's probably going to come out on the inside of that. So as we bring HSBC on its books, we've been impressed with its loss numbers that are coming in on the -- little bit on the inside of our own estimates for them. And I think we feel it's very solid books. So something probably more -- in the 40 to 60 basis points is probably more of a revised kind of view on that. But again, that's still an increase to Capital One's otherwise card charge-off rate. With respect to revenue margin, the 15.8% second quarter card revenue margin I was talking about, excluded -- excuse me. Go ahead, Jeff.

Jeff Norris

Moshe, the 15.8% is what we reported. If you exclude the HSBC impacts, that rises into the 16%. And if you exclude the cross-sell reserve, that would be closer to 17%. So the 15.8% sort of includes the noise, if you will, on all of the items in the first quarter. And what the point Rich, I think, was making was that, excluding the HSBC impacts, still in the 16% range. And that's loaded with the other item related to the cross-sell reserve.

Richard D. Fairbank

Okay. And with respect to the impact of HSBC on our card revenue margin over time, we had highlighted that at the time of the deal decision, a key part of our due diligence was to review all of HSBC's practices and to estimate what would be the cost of bringing those practices in line with some of our practices that we had -- for choices that we have made on some of our consumer practices. And we have said, for example, talking about it last quarter, that on a phased basis, over the first and second quarter of 2013, we would be bringing those practices in line and that would be a net impact on our combined card portfolio of 30 to 35 basis points of running rate. So that, Moshe, we're in the same place we were last quarter when we made that announcement. And to be clear on these things, we're not really in the revenue margin guidance business. What we tend to do is quantify some of the revenue margin effects that we see are coming in the business, for example, the 10 basis running rate impact that we talked about a few questions ago, as well as the 30 to 35 basis point impact from the HSBC reconciliation of practices.

Operator

We'll go next to Mike Taiano with Telsey Advisory Group.

Michael P. Taiano - Telsey Advisory Group LLC

I guess, first question I had on mortgage Rep and Warranty, are the claims you're seeing there, are they more coming from the GSE side or from the private label trust, both the insured and noninsured?

Gary L. Perlin

Mike, it's Gary. What we are seeing has virtually no GSE impact on it. Let me just remind you that we announced last quarter that we had reached a global settlement, both on the pipeline on future Rep and Warranty claims, from one GSE where the bulk of our exposure in that space came from. So this is largely coming from the insured securitizations and other private securitizations areas.

Michael P. Taiano - Telsey Advisory Group LLC

Great. And then just a second question. I know you guys don't want to get into the habit of giving guidance. But I guess, now that these 2 deals have closed and you're getting your arms around and integrating them, and do you see yourself at some point either later this year or early next year giving us guidance in terms of what your capital ratio expectations are or just broadly sort of return and/or growth expectations? I know some of your peers have done sort of longer-term on average over time, I was wondering if that's something you guys would consider.

Gary L. Perlin

Yes, Mike, it's Gary again. I mean, I think, with respect to future performance trends, what Rich and I have said is that after the considerable noise that we had this quarter, which I'm glad to see that people have been able to kind of look through based on the disclosures we've made, that as the year goes on, hopefully we won't need to give you guidance. You'll see within our performance, the underlying strength of the business and the future is more likely to depend on things outside of our control, whether it's credit or loan demand or whatever the case might be and the future will depend a lot on that and you'll be able to make your own judgments. But I think in terms of our own base revenue generation capacity, our continued focus on expense management and so forth, I think you'll see that run rate emerge as the year goes on. With respect to capital, it's probably a longer-term story because as you well know, we will become a Basel II bank at the end of this year. Most of the other Basel II banks have already been in that program for the better part of the decade. So it's understandable that they have a more refined view of how that affects them. Certainly, as Rich indicated directionally, we know that we will have an increase in risk-weighted assets. But we also have a very strong capital generation outlook on any measure. So it's one of the reasons that Rich and I have both said that we believe that even as we get on a trajectory that allows us to meet any requirements going forward, we believe that we'll be in a strong position to be able to include capital management as an important part of our shareholder value proposition. Exactly what those numbers will be will emerge over time, but I think that trajectory will be quite clear.

Operator

We'll go next to Craig Maurer with CLSA.

Craig J. Maurer - Credit Agricole Securities (USA) Inc., Research Division

Just a simple question. Concerning the economic backdrop, what you have now in terms of these deals integrated, do you stand behind the accretion guidance you gave us when you first announced these deals together?

Richard D. Fairbank

Craig, that may be a simple question, I can't say it's necessarily a simple answer because as you suggest, the world is quite different today than it was when we announced these transactions in the middle of 2011. Our base trajectory is obviously going to be affected by that. I think the key drivers, however, of value in the deals are still there. The synergies we're seeing play out already. In terms of the ING Direct transaction, you can see the continued improvement in our deposit cost, which I think is definitely a benefit and particularly, at the time of lower rates, the fact that we have more variable costs in our deposit franchise is helping us quite a bit. And with respect to HSBC, both the nature of the business, the quality of the book, the quality of the people on both deals when it comes to the quality of the people, that's very much intact. And most of the synergies from HSBC are really being reflected already because many of the costs that applied to the HSBC Card business, when they were part of HSBC, did not come over. And so I think it is still our belief that these are very compelling transactions in terms of financial and strategic value. Exactly how I calculate any particular metrics today versus where we were last year, I think, is an exercise that would be a challenge for any bank to hold firm on any particular number. But the quality and value is absolutely there.

Craig J. Maurer - Credit Agricole Securities (USA) Inc., Research Division

Okay. Just to ask then in clarification. How does -- in your mind, how does the trajectory for asset growth feel versus when you announced the deals?

Richard D. Fairbank

Well, I think on asset growth, Craig, let's remember that with HSBC, I think the difference was that the actual quantity of loans acquired on the day of close was a little bit lower than we had anticipated. Some of that is seasonality, some of it were a couple of partnerships that Rich described. But we indicated from day 1, we thought that there'd be a little bit of run-off in that book. In terms of ING Direct, we said that the mortgages were likely to begin to run off and be replaced by other assets being generated by other parts of Capital One's business. But we felt that there'd be a good strength in the deposit franchise. And in fact, although our overall deposits -- our deposit volume was reduced in the second quarter, there was actually an increase in balances among ING direct depositors. So I think that, relatively speaking, the performance of both of the acquisitions on the growth front is not materially different than what we would've anticipated. If you could have told me a year ago exactly what the economic situation would've been today, I might have had a different view about overall growth in the industry. But I think our position there continues to be strong.

Operator

We'll go next to Bill Carcache with Nomura.

Bill Carcache - Nomura Securities Co. Ltd., Research Division

Can you give a little bit of color on the differential between the 11% purchase volume growth that you're seeing and the 1% loan growth?

Richard D. Fairbank

Yes. I mean, I think, Phil, the 11% purchase volume growth is -- or Bill, the 11% purchase volume growth is driven by the -- first and foremost, driven by the marketing campaigns and the investments that we're making in going right after the heavy spender part of the marketplace. We also -- that also includes partnership data and we have -- and are continuing to build partnerships with retailers that are doing well and are getting some strength with respect to purchase volume as well. And even finally, there's another effect that, over the last couple of years, what I've been saying, we're getting -- while we're not building balance transfer-focused originations, we are really building sort of more old-fashioned accounts where you get a credit line and then use it over time. Some of the purchase volume growth also is the building of balances on some of these coiled spring originations that we have built as well.

Bill Carcache - Nomura Securities Co. Ltd., Research Division

Okay, and finally, Rich, could you give us some perspective on, given some of the boom and bust cycles that we've seen over the years in the auto finance space and the strong growth that you're seeing there, could you just kind of frame for us what you guys are doing from an underwriting perspective to kind of ensure that, in the next cycle, that these loans aren't going to be ones that will end up driving significant losses for you at some point down the road?

Richard D. Fairbank

Yes, well, we all -- bankers always vow that when they go through the recession, they vow that never again and all the other banks that we've all heard and somehow, history tends to repeat itself sometimes. So what I want to say is that first of all, just to comment about the Auto market, it does have very strong growth right now related to, I think, pent-up demand from the great recession. It's a very healthy kind of industry dynamic right now. Some people were scared away from the business. Supply and demand is in pretty good shape right now. There are a lot of good things going on and used car prices are at record highs. Now all that said, that's nice. But also, when things like used car prices, which is the price of collateral and lending is at record highs, that should get people's attention. So let me tell you what we have done. First of all, we have done a retro look way back through the great recession and how the industry gradually loosen standards and sort of what would have happened had we never gone down that path and -- well, it's a hypothetical because you're not -- you can't be sure that you'll get the volume of business in relationship businesses. If one doesn't adapt, frankly, it's really striking how well the business would've done in that early stage where we lost money had we more firmly held our ground and that is a lesson that is deeply written into some of our underwriting practices. But let me also say that we underwrite to significant recessions, that's what we do at any point in the cycle. So we are assuming that there is a huge reduction in used car prices starting the day after we originate any loan. I think that has been an important part of this thing. A lot of our lending practices are also driven by where are we in the cycle. And one of the most important things to be is on the lookout for where the inflection point comes, which is the precursor to a boom, which is the absolutely worst part of the lending cycle. We are not there -- and we look by industry -- by business for that. We are certainly not at that point yet in the Auto cycle. And I think there's very good business to be had. But the main thing is we are taking very conservative choices on underwriting. And we are assuming significant recessions in hardwiring that into the underwriting decisions. And the most important things that we will have to watch, which is the 2 competitive effects is: One, the loosening of standards; and secondly, the reduction of pricing. And where that equilibrium is right now in the Auto business is pretty good. But we all know from history, those things can change and we're all over it and I appreciate very much the spirit of your question.

Operator

We'll go next to David Hochstim with Buckingham Research.

David S. Hochstim - The Buckingham Research Group Incorporated

I wonder if you could just clarify what you said about the information -- some of the information on Slide 8, the revenue and the non-interest expense from the HSBC business excluding all the one-time items. That expense number then annualizes, I guess, at about $1.5 billion or so. Is that -- are you saying that that's kind of a normal run rate and that contract you have with HSBC is included in that and that we shouldn't expect much in the way of declines over the next year if you -- with any of the integration?

Gary L. Perlin

David, I'll give you an answer to start out with, as I did last quarter when we try to break out of this information for the impact of ING Direct, which is this is less designed to give you a perfect view of the future and more designed to give you clear comparables between our second quarter with the partial quarter effect of HSBC and all the purchase accounting versus the previous quarter. That said, let's remember, so you have to adjust for the timing here, with respect to the revenue, it's slightly -- it's about where it should be because we've stripped out the purchase accounting effects there. The expenses are not a bad indicator of where they might go. The important difference that you need to keep in mind is that there is virtually no charge-off expense, no provision expense in that. And then, of course, going forward, the one thing that you will continue to see is the presence of PCCR amortization in that number. And of course, there will be some integration expenses that will continue in that number as well. So I personally would not use those numbers as an exact run rate. Certainly for the next couple of years, where PCCR amortization and integration expenses will continue. But other than that, and making sure that you put in a more normal level of charge-offs and a normal level of finance charge and fee reserves, it puts you into a reasonable ballpark. But this is not intended to be an absolute directional set of data about where we're going. But it does kind of start to give you the ability to see the outlines through the fog.

Operator

We have time for one more question, Rick Shane from JPMorgan.

Richard B. Shane - JP Morgan Chase & Co, Research Division

I have 2 quick questions. One is a follow-up to the last one. When you announced the HSBC transaction, implicitly, there was about $1.5 billion of operating expense there. And to David's point before, that's what's implied roughly from these numbers here. You talked about $350 million of operating expense synergies, which I assume were basically between the HSBC portfolio and the core Capital One portfolio. Do you still think you're on track to deliver that?

Gary L. Perlin

It's still kind of early in the process, Rick, we're still working on the integrations. And obviously, some of the synergies are going to come from scale and other things, but we're already seeing a substantial amount of it because of the costs that did not come over. And I think, in general terms, the value that we saw in that transaction at the beginning is pretty much what we would have expected. And again, just make sure that you realize that for a period of time, we're still going to have PCCR and integration expense coming out of that. So if you net out that, I think you'll start to get close to the kind of the cost synergies that we described in the announcement.

Richard B. Shane - JP Morgan Chase & Co, Research Division

Okay, great. And then really changing gears. Related to the cross-selling settlement, will you consider seeking indemnification against the partners who led you down that path?

Richard D. Fairbank

No. At this point, we don't have comments to make on that.

Jeff Norris

Okay. I'd like to thank everybody for joining us this morning on the conference call. And thank you for interest in Capital One, and the Investor Relations staff and I will be here throughout the day to answer follow-up questions that you may have. Thanks, everybody, have a great day.

Operator

This does conclude today's conference. We thank you for your participation.

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