Capital One Financial Q1 2024 Earnings Call Transcript

Presentation

[Operator]

Good day, and thank you for standing by. Welcome to the Capital One Q1 2024 Earnings Call. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Jeff Norris, Senior Vice President of Finance. Please go ahead.

[Jeff Norris, Senior Vice President, Global Finance at Capital One Financial]

Thanks very much, Josh, and welcome to everyone. We are webcasting live over the Internet this evening. 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 have included a presentation summarizing our first quarter 2024 results.

With me this evening are Mr. Richard Fairbank, Capital One's Chairman and Chief Executive Officer; and Mr. Andrew Young, Capital One's Chief Financial Officer. Rich and Andrew are going to walk you through this presentation. To access a copy of the presentation and press release, please go to Capital One's website and click on Investors, then click on Financials, 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 contained in today's discussion in 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. For more information on these factors, please see the section called Forward Looking Information in the earnings release presentation and the Risk Factors section of our annual and quarterly reports accessible at Capital One's website, and filed with the SEC.

And with that, I'll turn the call over to Rich -- to Andrew. Mr. Young?

[Andrew M. Young, Chief Financial Officer at Capital One Financial]

Thanks, Jeff. And good afternoon, everyone. I will start on Slide 3 of tonight's presentation. In the first quarter, Capital One earned $1.3 billion, or $3.13 per diluted common share. Included in the results for the quarter was a $42 million additional accrual for our updated estimate of the FDIC's special assessment. Net of this adjusting item, first quarter earnings per share were $3.21.

Relative to the prior quarter, period-end loans held for investment decreased 2%, and period-end deposits increased 1%. Both average loans and average deposits were flat. Our percentage of FDIC-insured deposits remained at 82% of total deposits. Pre-provision earnings in the first quarter increased 13 % from the fourth quarter, or 6% adjusting for the impacts of FDIC special assessments in both quarters. Revenue in the linked-quarter declined 1%, largely driven by lower non-interest income. Non-interest expenses decreased 6% on an adjusted basis, driven by declines in both operating and marketing expenses.

Our provision for credit losses was $2.7 billion in the quarter, a decrease of $174 million compared to the prior quarter. The decrease was driven by $257 million lower net reserve bills, partially offset by an $83 million increase in net charge-offs.

Turning to Slide 4, I will cover the allowance in greater detail. We billed $91 million in allowance this quarter, bringing the balance to $15.4 billion, an increase of less than 1% from the fourth quarter. The slight increase in allowance balance was driven by modest builds in our auto and domestic card portfolios. Our total portfolio coverage ratio increased 11 basis points to 4.88%.

I'll cover the drivers of the changes in allowance and coverage ratio by segment on Slide 5. Our baseline economic forecast modestly improved this quarter compared to what we assumed last quarter, which generally aligns with consensus. We continue to consider a range of economic outcomes in our reserving process. In our domestic card business, the allowance coverage ratio increased by 22 basis points to 7.85%. The increase in coverage was primarily driven by the denominator effect of the runoff of the fourth quarter's seasonal outstandings.

In our Consumer Banking segment, the allowance increased by $46 million, resulting in a 7 basis point increase to the coverage ratio. The allowance increase was primarily driven by a higher level of originations in the auto finance business. And finally, our commercial banking allowance decreased by $7 million, primarily driven by portfolio contraction. Coverage ratio increased by 1 basis point to 1.72%.

Turning to Page 6, I'll now discuss liquidity. Total liquidity reserves in the quarter increased to $127 billion, about $7 billion higher than last quarter. Our cash position ended the quarter at approximately $51 billion, up about $8 billion from the prior quarter. The increase in cash was driven by continued strong deposit growth in our retail banking business, and the seasonality of our card balances. Our average liquidity coverage ratio during the first quarter remained strong and well above regulatory minimums at 164%.

Turning to Page 7, I'll cover our net interest margin. Our first quarter net interest margin was 6.69%, 4 basis points lower than last quarter and 9 basis points higher than the year ago quarter. The quarter-over-quarter decrease in NIM was largely driven by the impact of having one fewer day in the quarter. Modestly higher asset yields were mostly offset by higher funding costs in the quarter.

Turning to Slide 8, I will end by discussing our capital position. Our Common Equity Tier 1 capital ratio ended the quarter at 13.1%, approximately 20 basis points higher than the prior quarter. Strong earnings and lower risk-weighted assets more than offset the impact of CECL phase-in, dividends, and share repurchases. We repurchased approximately $100 million of shares in the first quarter. Our repurchase activity in the quarter was impacted by blackout restrictions and daily purchase volume limitations related to the announcement of the Discover transaction.

With that, I will turn the call over to Rich. Rich?

[Richard D. Fairbank, Chairman and Chief Executive Officer at Capital One Financial]

Thanks, Andrew. And good evening, everyone. Slide 10 shows first quarter results in our credit card business. Credit card segment results are largely a function of our domestic card results and trends, which are shown on Slide 11.

Top-line growth trends in the domestic card business remained strong in the first quarter. Year-over-year purchase volume growth for the first quarter was 6%. Ending loan balances increased $12.9 billion, or about 10% year-over-year. Average loans increased 11%. And first quarter revenue was up 12% year-over-year, driven by the growth in purchase volume and loans. The charge-off rate for the quarter was up 190 basis points year-over-year to 5.94%, about 18% above its pre-pandemic level in the first quarter of 2019. The 30-plus delinquency rate at quarter end increased 82 basis points from the prior year to 4.48%. On a sequential quarter basis, the charge-off rate was up 59 basis points, and the 30-plus delinquency rate was down 13 basis points.

The linked-quarter delinquency and charge-off rate trends were modestly worse than what we would expect from normal seasonality. We believe this is largely driven by lower and later tax refund payments to consumers so far in 2024 relative to what we've historically observed.

Tax refunds are an important factor in credit seasonality, each year they drive an improvement in delinquency payments and recoveries starting in February. Our portfolio trends generally have a more pronounced seasonal pattern than the industry average. Last quarter, our view was that the charge-off rate was settling out about 15% above 2019 levels in the near-term. That was based on an extrapolation of our delinquency inventory and flow rates over three to six months, and that was the horizon of our estimate.

If the trend of lower tax refunds sustain, it could raise the level of charge-off somewhat in the near-term. But this does not change our view that credit is settling out modestly above pre-pandemic levels in 2018 and 2019. The continuing deceleration in the pace of credit normalization trends, sometimes referred to as the improving second derivative, supports our view. The pace of year-over-year increases in both the charge-off rate and the delinquency rate have been steadily declining for several quarters and continued to shrink in the first quarter.

Domestic card non-interest expense was up 6% compared to the first quarter of 2023, with increases in both operating expense and marketing expense. Total company marketing expense of about $1 billion for the quarter was up 13% year-over-year. Total company marketing drives growth and build franchise in our domestic card and consumer banking businesses and builds and leverages the value of our brand. Our choices in domestic card are the biggest driver of total company marketing. We continue to see attractive growth opportunities in our domestic card business.

Our opportunities are enhanced by our technology transformation. Our marketing continues to deliver strong new account growth across the domestic card business. And in the first quarter, domestic card marketing also included higher early spend bonuses driven by strong new account growth, higher media spend, and increased marketing for franchise enhancements like our travel portal, airport lounges, and Capital One shopping. We continue to lean into marketing to drive resilient growth and enhance our domestic card franchise. As always, we're keeping a close eye on competitor actions and potential marketplace risks.

Slide 12 shows first quarter results for our consumer banking business. In the first quarter, auto originations increased 21% from the prior year quarter. A return to growth after several quarters of year-over-year declines. Consumer banking ending loans decreased about $3.1 billion or 4% year-over-year. On a linked-quarter basis, ending loans were essentially flat.

We posted another quarter of year-over-year growth in consumer deposits. First quarter ending deposits in the consumer bank were up just under $10 billion, or 3% year-over-year. Compared to the sequential quarter, ending deposits were up about 2%. Average deposits were up 6% year-over-year and up 1% from the sequential quarter. Powered by our modern technology and leading digital capabilities, our digital-first national direct banking strategy continues to deliver strong consumer deposit growth.

Consumer banking revenue for the quarter was down about 13% year-over-year, largely driven by lower auto loan balances and higher deposit costs. Non-interest expense was down about 3% compared to the first quarter of 2023. Lower operating expenses were partially offset by an increase in marketing to support our national digital bank.

The auto charge-off rate for the quarter was 1.99%, up 46 basis points year-over-year. The 30-plus delinquency rate was 5.28%, up 28 basis points year-over-year. Compared to the linked-quarter, the charge-off rate was down 20 basis points while the 30-plus delinquency rate was down 106 basis points. The linked-quarter charge-off rate improvement modestly underperformed the typical seasonal patterns we've historically observed, driven by the tax refund trends I just discussed. Even with the tax refund effects, auto credit performance remains strong.

Slide 13 shows first quarter results for our Commercial Banking business. Compared to the linked-quarter, ending loan balances decreased about 1%. Average loans were also down about 1%. The modest declines are largely the result of choices we made in 2023 to tighten credit. Ending deposits were down about 5% from the linked-quarter. Average deposits were down about 8%. The declines are largely driven by our continued choices to manage down selected, less attractive commercial deposit balances.

First quarter revenue was up 2% from the linked-quarter. Non-interest expense was up about 6%. The commercial banking annualized net charge-off rate for the first quarter decreased 40 basis points from the sequential quarter to 0.13%. The commercial banking criticized performing loan rate was 8.39%, down 42 basis points compared to the linked-quarter. The criticized non-performing loan rate increased 44 basis points to 1.28%. Commercial credit risks continue to be most pronounced in the commercial office portfolio, which is less than 1 % of total company loan balances.

In closing, we continued to deliver strong results in the first quarter. We posted another quarter of top-line growth in domestic card revenue, purchase volume, and loans. Domestic card credit trends continue to stabilize, and auto credit trends remain stable and in line with normal seasonal patterns. We grew consumer deposits, and we added liquidity and maintained capital to further strengthen our already strong and resilient balance sheet. Over the last decade, we've driven significant operating efficiency improvement, even as we've invested to transform our technology. And we continued to drive for efficiency improvement over time. For the full-year 2024, we continue to expect annual operating efficiency ratio, net of adjustments, to be flat to modestly down compared to 2023. Our expectation includes the partial year impact of the proposed CFPB late fee rule, assuming the rule takes effect in October 2024. The timing of the new rule remains uncertain. If the rule were to take effect at an earlier date, it would be a headwind to the 2024 operating efficiency ratio.

Of course, the biggest news in the quarter was our announcement that we entered into a definitive agreement to acquire Discover. We've submitted our applications for regulatory approval and we're fully mobilized to plan and deliver a successful integration. The combination of Capital One and Discover creates game-changing strategic opportunities. The Discover payment network positions Capital One as a more diversified, vertically integrated global payments platform. And adding Capital One's debit spending to -- and a growing portion of our credit card purchase volume to the Discover network will add significant scale, increasing the network's value to merchants, small businesses, and consumers, and driving enhanced network growth.

In the credit card business we're bringing together two proven franchises with complementary strategies and a shared focus on the customer. And we can accelerate the growth of our national digital-first consumer banking business by adding the Discover consumer deposit franchise and the vertical integration benefits of the debit network. We will be able to leverage and scale the benefits of our 11-year technology transformation across every business and the network, which will serve as a catalyst for innovation and enhanced capabilities in risk management and compliance, underwriting, marketing, and customer service.

Pulling way up, the acquisition of Discover is a singular opportunity. It will create a consumer banking and global payments platform with unique capabilities, modern technology, powerful brands, and a franchise of more than 100 million customers. It delivers compelling financial results. And it offers the potential to create significant value for merchants and customers, and an unparalleled strategic and economic upside over the long-term.

And now we'll be happy to answer your questions. Jeff? Thank you, Rich. We'll now start the Q&A session. Remember, as a courtesy to other investors and analysts who may wish to ask a question, please limit yourself to one question plus a single follow-up. And if you have follow-up questions after the Q&A session, the Investor Relations team will be available after the call. Josh, please start the Q&A.

Questions and Answers

[Operator]

Thank you. [Operator Instructions] Our first question comes from Ryan Nash with Goldman Sachs. You may proceed.

[Ryan Nash, Analyst at The Goldman Sachs Group]

Hey. Good evening, guys.

[Andrew M. Young, Chief Financial Officer at Capital One Financial]

Hey, Ryan.

[Richard D. Fairbank, Chairman and Chief Executive Officer at Capital One Financial]

Good evening, Ryan.

[Ryan Nash, Analyst at The Goldman Sachs Group]

So, Rich, maybe to just start off on credit, it sounds like you're running a little bit ahead of what you had outlined last quarter. But when you put aside the timing of tax refunds, can you maybe just talk about what you're seeing from the consumer? And do you think we've now reached the inflection where we can more closely follow seasonal patterns? And once the noise settles, do you think we're kind of back at that 15% level that you had outlined? Thank you.

[Richard D. Fairbank, Chairman and Chief Executive Officer at Capital One Financial]

Thank you, Ryan. Look, I think that the story continues to be one of -- well, in terms of -- well, there's sort of the consumer itself, let's just talk about the consumer for a second, and then let's talk about Capital One's credit performance. But just the health of the consumer, I think the U.S. consumer remains a source of strength in the economy. The labor market remains strikingly resilient. Rising incomes have kept consumer debt servicing burdens relatively low by historical standards.

When we look at our customers, we see that they have higher bank balances than before the pandemic, and this is true across income levels. On the other hand, of course, inflation shrank real incomes for almost two years. And in this high interest rate environment, the cost of new borrowing has gone up in every major asset class. And I think at the margin, these effects stretch some consumers financially. But on the whole, I'd say consumers are in reasonably good shape relative -- in a pretty darn strong shape relative to historical benchmarks. So, in terms of Capital One's performance, we continue to see it settling out. We believe that for Capital One, I can't speak for all card issuers, but we definitely have seen what we think is sort of a landing. And our -- so we feel very good about where the credit is.

The point that I wanted to make about the tax refunds, let's just pull up for a second on that. The tax refunds are something that nobody knows for sure exactly what's behind seasonality. But I think it's, we believe, a very important driver of seasonality. It's a bigger effect for us than other players because, I think, tax refunds just play a little bit bigger role collectively across our customer base. So, the tax refunds in the very near-term affect credit performance that, Ryan, what you're referring to, the 15% guidance that we gave, that was not an annual guidance number.

That was saying, if we just extrapolate in the very near window of just what we see in terms of delinquencies and delinquency roll rates, that's where we would see charge-offs. And charge-offs tend to be higher in the first half of the year. So what we're doing is giving a window to the higher part of charge-offs for the year. And we were saying they were settling out it looked like around 15% above 2019 levels.

Part of that -- so basically what I'm saying is that that includes our assumptions about what happens with tax refund and the seasonality effect. As we can see in the government data tax refunds are lower and later than by historical patterns. And so that affects our near-term credit performance. And actually, we often talk about, well, isn't the six-month window basically once charge-offs start bubbling and going through the roll rate buckets, we can pretty much see where charge-offs are going. Tax refunds actually affect the payment rates in every bucket.

So, our point was, in the very near-term it actually leads to a bit of a higher charge-off rate than we had guided to over that near window. But that doesn't change our view that credit has settled out. But 15% was not a guidance for the year. We haven't really given credit guidance for the year. What we're really saying is, we have seen credit settle out, but we wanted to just flag that both in the credit card business and in our auto business. While credit continues to be very strong and you've seen things like really improving delinquencies, we just wanted to point out that in the very near-term relative to what we have seen in terms of historical seasonality and kind of confirmed by what we watch as the patterns of tax refund there is -- it's coming in lower and later. And we just want to flag that effect because it affects the very near-term numbers that we cited earlier.

[Ryan Nash, Analyst at The Goldman Sachs Group]

Got it. Maybe as my quick follow-up for Andrew. I guess, given Rich's answer, what does that mean for the trajectory of the allowance? It seems like we've heard a handful of other issuers talk about as being at the peak or maybe even coming down, and potentially being below where it ended the prior year. Can you maybe just talk about what you think this means for Cap One given your credit expectations?

[Andrew M. Young, Chief Financial Officer at Capital One Financial]

Yeah, sure. Ryan, I'd like to say from my perspective, that there's a simple answer but there's not. And in there, there's a host of things that are going to drive allowance from here, not the least of which is growth but just focusing on coverage, and assuming that's what others are pointing to. The first thing I'd highlight and I'd said in my talking points that fourth quarter had seasonal balances, they quickly pay off in the first quarter, and therefore have negligible coverage, which we see every year.

So, coverage ratio this quarter is up a bit from last quarter is really a result of that dynamic. But if you look at coverage ratio now, it's largely in line with the preceding quarters. And the biggest driver as we look ahead are the projected loss rates in, as we've been saying for a number of quarters, delinquencies are the best leading indicator of that. And so every quarter we're going to look out over the next 12 months and then the reversion from there. Then we're going to take into account a range of outcomes and uncertainties. And so you've seen over the last few quarters keeping the coverage ratio flat.

I will note, though, even in a period where projected losses in future quarters are lower than today and might indicate a release otherwise, you could very well see a coverage ratio that remains flat or only modestly declines as we incorporate the uncertainty of that future projection into the allowance. So eventually the projected losses will -- when they're lower, will blow through the allowance and bring the coverage ratio down as those uncertainties become more certain. And under that scenario, you would be a decline. But at this point, like I'm not going to be in the forecasting business of when that actually is going to take into account because, like I said, we really need to take the factor of the uncertainty as we look ahead every quarter that we go through the reserving process.

[Jeff Norris, Senior Vice President, Global Finance at Capital One Financial]

Next question, please.

[Operator]

Thank you. One moment for questions. Our next question comes from Mihir Bhatia with Bank of America. You may proceed.

[Mihir Bhatia, Analyst at Bank of America]

Hi. Thank you. Maybe Rich, if I could switch for a second to the Discover acquisition. There's been a lot of talk around deal approval particularly focusing around potential anti-trust issues within the card business. And I was wondering if you could share your thoughts and perspective on that issue, if you've heard anything from regulators, but also just to hear how you're thinking about that issue. Thank you.

[Richard D. Fairbank, Chairman and Chief Executive Officer at Capital One Financial]

Okay. Thank you, Mihir. So we have filed our merger applications with both the Fed and the OCC, and we are engaged with the -- sorry, with the DOJ, as they of course play a key role in advising the Fed and the OCC on competition questions. We believe our applications make a very compelling case for approval. We believe strongly that this merger will increase competition among banks and credit card issuers and payment networks, and provide significant benefits for consumers, merchants and the communities that we serve. While some have raised concerns about competition, we believe that the facts in favor of the deal will be compelling.

On the network side, let's remember that we're not currently in that business. If the deal is approved, we will still have four networks just like we do today. But we will be adding new customers and scale to the smallest by far of the four networks, and be able to leverage our technology, talent and marketing capabilities to greatly enhance Discover's competitive viability. Their market share was 6% a decade ago and sits at just 4% today. The significant investments that we are planning will provide substantial benefits for consumers and merchants as we've outlined in our regulatory applications.

On the credit card side, the regulators have found, every time they've studied it, that the credit card market is highly competitive and not at all concentrated. In fact, it's less concentrated today than it was 10 years ago. Consumers can choose from over 4,000 issuers, all able to offer products with similar capabilities. Imagine this, a card issued by a small credit union can be used every place that a card issued by a bank like Capital One can be used, anywhere in the world. That kind of level playing field doesn't exist in any other industry, and certainly not in airlines or grocery stores or many of the others.

There's a reason that we ask folks what's in your wallet. We compete not only with these 4,000 other issuers to gain your business in the first place, but also with every other card you likely already own. Put another way, we have to compete every day for every single transaction because our customers can simply choose at any moment to use another card. And if they don't like the card they have, they can stop using it entirely or close the account or switch to another card with another bank, large or small, in minutes.

We also believe that the facts will show that there are no barriers to entry in the credit card business, as thousands of current issuers and the new ones are forming all the time demonstrate. New and incumbent fintechs backed by significant VC funding are able to leverage the infrastructure of sort of credit card as-a-service players, like Marqeta, to achieve instant scale and high growth. Also, any existing bank can choose where on the credit spectrum they play simply by changing their credit policy.

Let's also remember that consumers can choose to use another form of payment entirely, cash, debit, or buy now pay later, which has exploded onto the marketplace. New fintechs are entering the payments and small dollar credit space every day, all looking to take market share from traditional credit card players like Capital One.

We've faced this competition for years and will continue to face it in the future. It's powerful evidence of a healthy and fiercely competitive marketplace, but we have been successful by focusing on the needs of our customers and offering credit card and retail banking products with the most straightforward terms and fewest fees in the industry. We're the only major bank where all of our deposit products come with no fees, no minimums, and no overdraft fees.

So pulling way up, we believe the facts will show that this transaction is both pro-competitive and pro-consumer, bringing our best-in-class products and services to a broader set of consumers and small businesses, and greatly enhancing opportunities and benefits for merchants. In the end, that is what we believe the regulators will use their very vigorous process to evaluate.

[Mihir Bhatia, Analyst at Bank of America]

Thank you, that is helpful. Just turning back to the health of the consumer for a second for my follow-up. If you could just talk a little bit about the environment for card acquisition? You did mention I think that the growth opportunity -- good growth opportunities in the card business. So I'm wondering if you could expand on that, maybe talk about just some of the puts and takes as you consider where to make those investments. Are there parts of the market where you're being more cautious given the environment? Thank you.

[Andrew M. Young, Chief Financial Officer at Capital One Financial]

Mihir, we are leaning in pretty much across the board in the card business, powered by a healthy consumer and the traction that we're getting in our business. We are -- really all parts of the card business are seeing very nice account originations, seeing good traction on the purchase volume side. And so it's very much a positive time for leaning in, as you see reflected in our marketing, as you see reflected in some of the growth numbers. And as I see -- as you see reflected and as I see in numbers behind the numbers that you see, just a lot of traction.

And let's just savor for a second some of the things that are powering that, two things that I would flag is. One, the continued investment that we are making to win at the top of the market. And I think that not only affects our success at the top of the market, but I really believe there's a lifting of all boats from those investments and that traction there.

Also, we continue to just get a -- have a lot of success powered by our technology transformation, including not only the customer experience and some of the product capabilities that we're able to offer, but really impacts on the whole way that we run the business and very notably on the credit and marketing side of the business, the ability to create mass-customized offerings and real-time solutions just enables us to have more traction on the growth side. Also, I'd just want to say that we also are pleased to see things picking up in the auto business, and also we continue to have a lot of traction on our national bank.

[Jeff Norris, Senior Vice President, Global Finance at Capital One Financial]

Next question, please.

[Operator]

Thank you. Our next question comes from Rick Shane with JPMorgan. You may proceed.

[Richard Shane, Analyst at JPMorgan Chase & Co.]

Thanks for taking my questions this afternoon. Hey, Rich, I want to make sure I fully understand what you're describing in terms of credit. The framework is that charge-off rates will be about 15% higher than '18, '19 levels in the near-term, but now with tax refunds it might be a little bit higher than that. Then over time it will converge back towards slightly above '18, '19 levels. When I look at the delinquencies, and one of the things we've observed is that roll from delinquency to charge-off is actually higher than it has been pretty much at any time in recent history. Does that suggest that delinquencies actually need to get back below 18, '19 levels to achieve that level of charge-off performance?

[Richard D. Fairbank, Chairman and Chief Executive Officer at Capital One Financial]

So, well, Rick, that's a lot. First of all, let me clarify some of the things that you were saying weren't exactly, I think, as we intended to state them. So let me just -- so we talked about -- so, yes, we talked about credit, saying credit settling out. We said in the very near-term where charge-offs are -- tend to be higher in the first half of the year. In the near-term, based on extrapolation from delinquency buckets and roll rates, we would expect them to settle out at 15% higher than pre-pandemic. That was a near-term forecast. That was not an annual forecast.

And then you -- just to -- your comment said, and over time it will converge back to slightly above 2018 and 2019. I just want to say those are your words, not ours. We have not given guidance on full-year charge-offs. We tend not generally to give guidance on full-year charge-offs, but we very much like to give you the feel of how things are going. So, we very much see credit settling out. You can see the trends that continue on the second derivative of delinquencies, and that's a very positive thing.

There's another factor that affects charge-offs, which is recoveries, and the recoveries have been -- we've been saying for quite some time, recoveries are lower than usual because of the very low charge-offs we saw over the past three years. So that, all else equal, pushes up net losses relative to pre-pandemic levels. And that impacts probably larger and more prolonged for us than some of our competitors, because we tend to have higher recovery rates than the industry, probably as a result of our business mix and our strategy. And we tend to work most of our recoveries in-house rather than selling debt, so we see a longer tail of recoveries from past charge-offs than most do. So, by the way, the recoveries we had talked about, recoveries have probably sort of been at their bottom in terms of that brownout, and over time probably heading in a more positive direction. But that also impacts the relationship between charge-offs pre-pandemic and where they are today.

So pulling way up, we don't have guidance for credit for the year. We continue to be very happy about charge-offs the way after years of -- after a long period of normalization that charge-offs are settling out. We've given -- we just wanted to flag that the seasonality, let's just comment -- let's just pause for a second on the seasonality. It still remains to be seen whether the tax refunds are just lower end of story, or whether they're later. The key thing right now is, they are lower cumulatively than they have been -- than they were pre-pandemic for this period of time. And what we'll take a look at is how it plays out from here to see how much was just later and how much was lower.

But what we're saying is, to the extent that it's lower, then that impacts in the very near-term the charge-off numbers that we had talked about before. But it doesn't change our view about credit settling out, doesn't change our view about, very positively about the consumer, about credit, credit performance. But it's just something we wanted to flag across both the credit card and auto business.

[Richard Shane, Analyst at JPMorgan Chase & Co.]

Thank you. Very helpful.

[Jeff Norris, Senior Vice President, Global Finance at Capital One Financial]

Next question, please.

[Operator]

Thank you. Our next question comes from John Pancari with Evercore ISI. You may proceed.

[John Pancari, Analyst at Evercore ISI]

Good afternoon. I guess back to the Discover combination, any update to your thoughts around the timing of the deal close? I know the Fed and the OCC just extended the comment period, I know you put out there you expect late '24, early '25. So any change in terms of your expectations around the timing of the close or any of the key financial metrics that you set out?

[Richard D. Fairbank, Chairman and Chief Executive Officer at Capital One Financial]

Okay. Thanks, John. So let me comment on the Federal Reserve and the OCC extending the comment period. It's a standard practice for the Federal Reserve to extend the comment period on bank mergers. We expected the extension, and we don't take any signaling on our deal from the Fed's decision here. So with respect to the overall timing, the Fed and the OCC typically take several months to work through bank merger applications in consultation with the DOJ on competition questions, and they engage frequently with our team along the way. And, of course, that process is underway, and we continue to have the same views about the timing of all of this that we did at the time of the announcement.

[John Pancari, Analyst at Evercore ISI]

Okay. Great, thanks. And then separately, just regarding your expectation on the CET1 front for a pro forma CET1 ratio of about just shy of 14%, any change to that expectation and any change to your thoughts around buyback activity in the near-term, could you remain active on that front? Thanks.

[Andrew M. Young, Chief Financial Officer at Capital One Financial]

Yes, John, with respect to the deal, I'll just say, as we talked about when we announced it, we, at the time, used a blend of consensus estimates of where we would have the CET1 at the time of close. There's a number of variables that are going to move between now and legal day one, not just the standalone performance of each of our companies, but balance sheet marks, some of which are driven by credit and stock price. And so I'm not going to be in the business of, quote, recasting every time a little number moves. But I will say, our evaluation of the deal considered a wide range of outcomes. And so we remain just as excited today about the financial and strategic benefits of the transaction as we did when we announced the deal.

With respect to our standalone repurchases, Capital One's, I'll note that the agreement with Discover does not prohibit us from buying shares. I noted in my prepared remarks, we were blacked out for a period leading up to the deal. And afterwards, the SEC and Safe Harbor rules that limit the daily average amount of purchases we can do for a period of time after the announcement. So as a result of those limitations, Q1 had a pace that was less than what we've done in recent quarters. I will also just note that there's also blackout restrictions on repurchases during the proxy vote period. But again, outside of those blackouts, we're not prohibited and we're able to continue repurchasing shares.

[Jeff Norris, Senior Vice President, Global Finance at Capital One Financial]

Next question, please.

[Operator]

Thank you. Our next question comes from Moshe Orenbuch with TD Cowen. You may proceed.

[Moshe Orenbuch, Analyst at TD Cowen]

Great, thanks. Rich, putting aside the tax refund thing, I mean, you're -- we're sitting here looking, you've still got what has been a somewhat persistently high inflation environment and the potential for increases in unemployment, given the nature of your portfolio, you've got kind of a lower-end consumer and higher-end consumer. How do you think about that, those factors? And in terms of thinking about, what type of charge-off level you're going to reach over some period of time, not a particular point in time, but over some point in the next year or two, like where you think about that, are they driving a higher level of charge-off expectations, or how should we think about that?

[Richard D. Fairbank, Chairman and Chief Executive Officer at Capital One Financial]

Moshe, so our -- I think what you're partly getting at is, because we have part of our portfolio is subprime consumers, how do we feel about how they're performing and sort of in the context of an environment of higher inflation and so on. Let me just comment a little bit about the sub-prime consumer. In the global financial crisis, we observed that credit metrics in sub-prime moved earlier in both directions. In sub-prime we saw that, but then we saw sort of everything move proportionally. In fact, sub-prime moved, frankly, somewhat less proportionally than prime as a multiple, but obviously all portfolios worsened quite a bit during the global financial crisis.

In the pandemic, sub-prime credit improved more and more quickly than prime. But it also began to normalize more quickly, too. And, of course, that's in the context of lower-income consumers seeing disproportionate benefits of government aid, and then unwinding that over time. And sub-prime is, of course, not synonymous with lower income, although they are somewhat correlated. So, on the other hand -- so if we look at how they have been doing, the income growth from for, let's take lower-income consumers, has been consistently higher over the past several years. And we have seen really quite, other than the tax refund effect which does show up more in our lower-end part of our customer base than the higher credit end, really we have seen the sub-prime performance be very strong. It just worsened faster, and then on a proportional basis everything caught up with it. But it, frankly, always seems to be a first mover, and it settled out, frankly, a little bit earlier than -- started settling out a little bit earlier than the rest of our portfolio.

So, based on current performance, we feel very good across the credit spectrum. It certainly catches our attention when we see the inflation specter sort of become greater lately, so we have a real eye on that. As you know, we continue to look at the marketplace and trim around the edges and so on. But the net impression that I would leave you is, we continue to feel very good about really the full spectrum of our customers. We continue to lean into the growth opportunities. We have for some time just been doing some trimming around the edges and just being a little tighter on the credit lines and things like that, credit line increases. But the impression that I want to leave with you is that we are still pretty -- feel good about this marketplace and the growth opportunities there.

[Moshe Orenbuch, Analyst at TD Cowen]

Got it. And maybe just as a follow-up question. You alluded to, or Andrew alluded to the fact that you expect that the late fee, you can still kind of achieve your objectives from an efficiency ratio even with the late fee coming into effect. But could you talk a little bit about your thoughts about any mitigating efforts that you're planning or in the process of doing? Or is it something that you're going to try and use from a competitive standpoint to take share? How do you think about it?

[Richard D. Fairbank, Chairman and Chief Executive Officer at Capital One Financial]

Okay. Thanks, Moshe. So, let's just pull up and reflect on the fact that the CFPB's rule on late fees is scheduled to take effect on May 14th. We are prepared to implement the rule on this timeline if necessary. But ongoing litigation efforts continue to create uncertainty on the ultimate outcome and the timing of the rule. As we've said before, when the rule is implemented, there will be significant impact to our P&L. We expect that this impact will gradually resolve itself within a couple of years from the implementation of our mitigating actions. These mitigating actions include changes to our policies, products, and investment choices. Some of these mitigating actions have already been implemented and are underway. We are planning on additional actions once we learn more about where the litigation settles out. Ultimately, these mitigating actions will play through different line items in the P&L and will mitigate the impact of the late fee rule on our P&L within a couple of years of their implementation.

[Jeff Norris, Senior Vice President, Global Finance at Capital One Financial]

Next question, please.

[Operator]

Thank you. Our next question comes from Don Fandetti with Wells Fargo. You may proceed.

[Donald Fandetti, Analyst at Wells Fargo & Company]

Yes. Rich, can you provide your latest thoughts on auto lending. I know a lot of focus has been around cards, but -- and used car prices have been a little bit lighter recently, as well as the tax issue. Maybe talk a bit about, a potential pivot there.

[Richard D. Fairbank, Chairman and Chief Executive Officer at Capital One Financial]

Yes. So we're feeling very good about the auto business. So let's just pull way up. Auto industry margins have recovered somewhat over the past few quarters. Our origination volumes in Q1 were up 20% on a year-over-year basis and quarter-over-quarter basis, and we're pleased with that growth. Now, there are still headwinds to the auto business. Affordability remains a concern due to the combined effects of high interest rates and still high car prices. And even as car prices have normalized significantly from their peaks, they haven't yet reached a new equilibrium.

So we anticipated the risks in this business, tightening up credit back in 2022, I think several quarters before some of our competitors. As a result, the performance of recent originations from '22 and '23 has been really strong. And frankly, even better than our pre-pandemic originations. And vintage over vintage, that risk remains stable. And as margins have recovered a bit, we're seeing an opportunity to lean back in. So, our years of investments in industry-leading technology and credit infrastructure have allowed us to remain nimble, and enabled us to make targeted adjustments to our origination strategies where we see opportunities for growth or emerging risks.

So looking ahead, we remain confident in the business that we're booking and bullish about the opportunities for growth. So we continue to set pricing in terms that we're comfortable with and feel good about the opportunities that we see in the market. And after talking for really a couple of years about sort of dialing back, I think this is sort of a period where it's moving more into a leaning into it situation for Capital One. And we're, I think, very benefited by the choices that we made over the last couple of years and seeing very strong performance in our vintages.

[Donald Fandetti, Analyst at Wells Fargo & Company]

Thank you.

[Jeff Norris, Senior Vice President, Global Finance at Capital One Financial]

Next question, please.

[Operator]

Thank you. Our next question comes from Sanjay Sakhrani with KBW. You may proceed.

[Sanjay Sakhrani, Analyst at Keefe Bruyette & Woods]

Thank you. Rich, I think your point on tax refunds is clearly a very valid one. Interestingly, though, to your point on the second derivative, that's improved quite nicely even into March. And I think when I look at the tax refund stats now from the IRS, it seems like you've seen a catch-up in refunds, and it seems like the average refund numbers have kind of come in line with last year, if not slightly higher. So I think those are improving, too. Is there a lag effect there? So like, should we see that more pronounced if that's the case in April and May? How has it been in the past?

[Richard D. Fairbank, Chairman and Chief Executive Officer at Capital One Financial]

Yeah. So I can see that you're a student of tax refunds. Just think of all the areas of expertise that you've developed over the years trying to really get your head around this credit card business, things that neither you nor I thought we would really have to learn. Let me make a couple comments here.

So a key question is, what are we benchmarking things to? So relative to -- if we talk about relative to last year, the things were even lagging relative to last year, and they've actually crossed over, very, very recently crossed over the curve from last year, which I think you're referring to, but then last year really was somewhat of an outlier relative to pre-pandemic. Now, one might ask, well, why didn't we just do -- or use last year as the seasonality benchmark? Last year itself was an odd year, and from a credit point of view, with all the normalization, it was hard to read things through the noise.

As we watch the patterns this year, we're going to really end up comparing, by the time it's done, how this year compares to last year, and whether collectively this year and last year represent sort of a new seasonality that we have to modify relative to the past. I think it's premature on that, and relative to reading seasonality, it's really hard to look at last year's credit metrics just because there was so much normalization. So we've had an eye on this. We have, tended to stick with our seasonality benchmarks, which are developed over a number of years. And I think when this is -- when we're done with this period, we'll sit back and look at it and say, did we learn something about the business that where seasonality might be less magnified in a business like ours than it was before. I think it is too early to tell, but to your other point, even relative to last year, it has very recently crossed over in terms of tax refunds. And yes, to your point, these are things that themselves then have lag effects because people have to get the refunds and they have to make payments.

So this is why very much we are flagging a phenomenon that is sort of in the middle of happening. And the key thing will be by the time it's done, what's the cumulative tax refund effect? And we're just, kind of sharing with you as we go along. And the reason I'm particularly leaning into this particular one is because last time, we made a very near-term sort of extrapolation just from our windows of delinquency buckets about where the -- given that in a year, the high part of the year is in the first half of the year, we were just kind of saying in that high part of the year where things were sort of settling out. And I wanted to give that little bit, we're not revising the number, but just to say, if, the seasonality patterns are, probably driven by the tax refund effect, if it doesn't catch up to historical patterns, then in the very near-term, the numbers will be higher than that, in this very -- this window we're talking about, higher than the 15% number that I said.

[Sanjay Sakhrani, Analyst at Keefe Bruyette & Woods]

Understood. The second derivative looked good nonetheless for March.

[Richard D. Fairbank, Chairman and Chief Executive Officer at Capital One Financial]

Yeah. So look, can I just -- I want to just seize that point. The second derivative continues to be strong. In fact, when you look at, sort of all the card players that you can see, the strength of Capital One's, second derivative, there's another topic, see, you didn't know when you were studying all that calculus that this would be at the heart of what you do. But -- so, there's lots of good to pull from this. I just wanted to just clarify the tax refund effect, which I think has a little bit more impact on Capital One than certain other players, and to point out that we actually think we see that effect in both of our consumer businesses.

[Sanjay Sakhrani, Analyst at Keefe Bruyette & Woods]

Great. Just one follow-up for Andrew, just on the capital return question earlier. Can we step up the run rate relative to some of the last quarters as we look ahead? I know there's been a lot of volatility on some of the regulatory proposals on capital. But as we look ahead, I know there's no limitations, but can we see a step up in the level of capital return relative to the past few quarters as we look ahead, given your capital levels today?

[Andrew M. Young, Chief Financial Officer at Capital One Financial]

Well, there's two parts to that, Sanjay. The first is, given the transaction, we are in the process of submitting a new capital plan. So that's just a procedural piece. So once that new capital plan is approved, then we have unlimited capacity relative to the SEB in this intervening period. The amount that we repurchase is constrained to what we've requested.

[Jeff Norris, Senior Vice President, Global Finance at Capital One Financial]

Next question, please.

[Operator]

Thank you. Our next question comes from Bill Carcache with Wolfe Research. You may proceed.

[Bill Carcache, Analyst at Wolfe Research]

Thanks. Good evening, Rich and Andrew. Following up on your comments in auto, how much of an advantage is your excess capital position? Are you seeing competitors who are capital constrained and perhaps can't take advantage of the attractive market conditions to the same degree? And then I'll just ask my follow-up now. As Capital One continues to grow, could you speak to your Category 2 preparedness?

[Andrew M. Young, Chief Financial Officer at Capital One Financial]

Yes, I'll start, Bill, with the -- go ahead Rich, do you want to do that?

[Richard D. Fairbank, Chairman and Chief Executive Officer at Capital One Financial]

Well, our dynamics in auto -- in auto, here is my observation about the auto business is that it's still a very competitive marketplace. But when we see our opportunities to grow, we tend to zig a little bit while others zag. And so, we sort of pulled back for a little while and others leaned in. And my point is really, now I think we're leaning in and others are pulling back a little bit more. I hadn't really sort of analyzed it in terms of really capital choices really as much as just the very natural rhythms of the marketplace and some of the advantages that Capital One has by virtue of our choices that we made over the last couple of years, but we'll have to think about that. But I just think this is just very much sort of as you've seen numerous times in the past where there's a little bit of an inflection point for Capital One at a time that's a little different and occasionally in a different direction than the inflection points of others.

[Andrew M. Young, Chief Financial Officer at Capital One Financial]

And then, Bill, with respect to Category 2, well, first, let me just note we're going to be below the $700 billion threshold at closing and the trigger is really a four-quarter average beyond that. So I just wanted to mention the specifics of what is going to trigger it. But within category 2 to category 3, there's really three big distinctions, the first one is losing the tailoring benefit for LCR and NSFR and you can see based on the ratio that we hold there and our conservatism around liquidity, we feel very well prepared.

The other two which are the inclusion of AOCI and regulatory capital and the DDA threshold going from 25 to 10, those are both already included at least in what was proposed for the Basel III Endgame rules. We all know that those proposals are being debated and refined it. But, ultimately we were looking at those two implications as part of the proposal anyway. And so, we don't really see a big difference in the long-term implications. At least as we sit today, again that the proposal may take a different form, but from a planning perspective, those were two things that we already had our eye on until we ultimately feel well-prepared to all of the implications of either Category 2 or the Basel III Endgame proposals if they were to go in as currently constructed.

[Jeff Norris, Senior Vice President, Global Finance at Capital One Financial]

Next question, please.

[Operator]

Thank you. And our final question comes from Jeff Adelson with Morgan Stanley. You may proceed.

[Jeffrey Adelson, Analyst at Morgan Stanley]

Hey. Good evening. Thanks for fitting me in. Rich, I just wanted to circle back on your comment about how you continue to kind of trim around the edges. I think last quarter you were suggesting that the trimming was sort of abating after a number of years of trimming. But given your comments today about how you're continuing to lean and how the U.S. Consumer remains a strength of source, how are you thinking about potentially opening up the credit box a little bit more from here? And relatedly, does the pending deal with Discover factor into how you're thinking about allocating capital at all into more growth at this point?

[Richard D. Fairbank, Chairman and Chief Executive Officer at Capital One Financial]

Thanks, Jeff. The trimming around the edges is, of course, what we do all the time in reactively to not only what we observe in the marketplace, but what we think may be coming in the marketplace. We are very much sort of in the same place we were three months ago when we've been talking about this. In other words, the trimming around the edges and the dialing back was a little bit more pronounced in the quarters during the big credit normalization than it has been as we see things settling out. And the drivers of that continue to be probably, in addition to what I said about the consumer, very much also the observing our credit performance, not only just the overall portfolio performance, but very much the performance of our originations.

And strikingly, our originations continue to come out generally on top of each other quarter-after-quarter. Obviously, that's lagged data that we're viewing, but we've been struck by how long it's been and how consistently it's been that our originations have been generally on top of each other. And a lot of that comes from the trimming around the edges that we have been doing even as there's been some underlying, a little bit sort of worsening of overall consumer credit metrics. So, we're at a very similar place to where we were. We feel good about our credit performance and origination performance. We are leaning in across the credit spectrum.

With respect to the Discover deal, it's not really altering our origination strategy, that's very much continuing as it was before. Obviously, we're very excited about the Discover deal. But I think that with respect to our own strategy, it's really pretty much the same as it was before.

[Jeffrey Adelson, Analyst at Morgan Stanley]

And I also wanted to just ask really quickly about the small business card strategy. I know you recently just launched that new Venture X business card recently. Seems like a really unique value proposition with the charge card component. Can you just talk a little bit more about the opportunity to drive growth there, maybe how that's going so far, any early reason to the type of customers you're getting?

[Richard D. Fairbank, Chairman and Chief Executive Officer at Capital One Financial]

Okay. Yes, Jeff. We launched the Venture X business card broadly in the third quarter of last year, and we're pleased with the market response and the customer engagement so far. So Venture X business, much like our Spark Cash Plus card, was developed to help business owners run and invest in their business with no preset spending limit, great travel benefits, and elevated earn everywhere. And it's a great example of our businesses leveraging each other's innovations, because we've taken many of the industry-leading travel features of our Consumer Venture X product and combined them with the business-grade capabilities of our small business offerings, including the flexible spending capacity that is designed for larger businesses.

So, we have been investing in our small business card program; and more broadly, to win at the top of the market for years. And this launch stands on the shoulders of all of that investment, it stands on the shoulders of our technology transformation, and is another example in the continuing drive of Capital One to win at the top of the market across consumers and small business. So, I appreciate the question, and we certainly are excited by our continuing progress.

[Jeff Norris, Senior Vice President, Global Finance at Capital One Financial]

Thanks, Rich and Andrew. Thanks everybody for joining us this evening and for your continuing interest in Capital One. Have a great evening.

[Operator]

[Operator Closing Remarks]

Participants

Corporate Executives

• Jeff Norris, Senior Vice President, Global Finance
• Andrew M. Young, Chief Financial Officer
• Richard D. Fairbank, Chairman and Chief Executive Officer

Analysts

• Ryan Nash, The Goldman Sachs Group, Inc.
• Mihir Bhatia, Bank of America Co.
• Richard Shane, JPMorgan Chase & Co.
• John Pancari, Evercore ISI
• Moshe Orenbuch, TD Cowen
• Donald Fandetti, Wells Fargo & Company
• Sanjay Sakhrani, Keefe Bruyette & Woods
• Bill Carcache, Wolfe Research
• Jeffrey Adelson, Morgan Stanley