Capital One Financial Corporation (COF) Earnings Call Transcript & Summary

Andrew has been with Capital One for 31 -- sorry, 30 years and has served as CFO since 2021. He previously led Capital One's business line CFO teams and oversaw enterprise planning and budgeting. He also served as CFO of the company's National Bank. Capital One has been one of our favorite stocks for the year. Unfortunately, lots of things have not gone right, but you guys have executed. So I think fundamentally, everything has gone right. So it's disappointing a little bit, but thank you for executing. So Andrew, it's been 5.5 years since you became CFO, and I know you were with the company for some time before in the role. When you reflect on your time at Capital One, how do you think the company has changed, both from a strategic and financial perspective?

Well, first, Sanjay, thanks so much for having me. Thanks to all of you for your interest as in the room and those listening on the webcast. As you mentioned in your opening remarks, been with the company 30 years. It's amazing how quickly time flies. And maybe I'll start with the answer to your question of what's the same before I enter what's different? And what's the same to me, even 30 years ago, we were always working back from where do we think the world is going? And how do we see ourselves winning in that future, bringing in analytical rigor, bringing a deep reference for the customer in everything that we do and that continues to this day. What I think is different over the last 6 years that I've been in the CFO seat is probably twofold. First, the pace of change in the world around us is unbelievable. And it's just accelerating every single day. I only have jokingly tell the team that the pace of change will never be as slow as it is today, even as we feel like so much is going on at this point. And then the second thing is the breadth of opportunities that are there for us at this point. And whether it's in our core businesses, whether it's in the adjacent businesses, payments network with the acquisitions of Discover and Brex or even in some cases, things that are not in our core businesses as we're going into Capital One shopping or travel or software. And so the opportunities abound at this point. So if I put that all together, I would say how we operate is the same as it was 30 years ago. But the pace and the breadth of opportunities is just so much greater than even what it was 6 years ago.

Absolutely. And I guess like when we think about the financial part of where you are today versus where you've been in the past, right? Obviously, you've moved the model towards a more bank-oriented model, shored up a lot of the funding side of the business. seems like now you've got a network. Maybe you could just talk about financially how the business model has evolved over time.

Yes. I would say the opportunities rooted in both the technology, and I'll be -- importantly, create the distinction that it's not just the architecture of technology, but the data infrastructure, the sources of data, the ability to bring multiple sources of information together in real time to think about the entirety of the business. And so I can kind of go down the list of the P&L. It's almost easier to highlight where that technology transformation isn't changing what we're doing. It isn't changing the P&L from the top, thinking about growth and the prospects there, ability to target customers in a way that we weren't just a few short years ago. I just brought up the new businesses, whether shopping, travel, software, there's a bunch of other sources that are just changing the vectors of growth that we have. But as you continue down the P&L, again, the technology and data just changes everything, whether it's credit and how we're able to use platforms and more micro segment credit, whether it is the efficiency of how we operate our software engineers being able to produce code at a level that is so much different than even it was a year ago. But I also think things like the customer experience that we're able to produce for our customers, you might have seen not that we run the company for awards, but 6 years in a row being J.D. Power's #1 customer satisfaction for large banks. But ultimately at the bottom of all of that is talent. And again, not that we're doing it for awards, but evident insights coming out with their AI list of big banks, Capital One being #1 in both innovation and in talent. And so being able to have the talent that enables us to do, back to your question, so many different things on a base of tech and data that kind of the opportunities abound.

Yes. I want to dig into that because I know you've invested heavily in modernizing the technology stack, well ahead of many peers. Maybe you could talk about the advantages it provides you guys, right? Because I think it's kind of easy to just -- for it to get lost in the story a little bit.

Yes. I mean I think a lot of what I just highlighted kind of gets to how tech and data fundamentally changes. The world is moving at a pace that people are expecting real-time intelligent solutions being proactively kind of landing in their labs, garner the days of sort of the batch processing and I go get one single financial product. And 3 years later, I go back and search for the next product. I think what people are expecting is their financial institution to really be ingrained in their daily lives and giving them customer experiences that delight them and that has become really the expectation. And so our ability to consume and analyze data is really at the core of all of that.

So I think you've mentioned also the credit outcomes are part of the tech transformation. Obviously, Credit has been a successful -- it's been a bright spot for Capital One and quite frankly, for the industry as well. Maybe you can articulate why Capital One has seen such stellar performance. And maybe just the overall health of the consumer too, because the consumer has been resilient through a lot.

Yes, very much so. You've known me for long enough, Sanjay, you know that I like to I think, and I talk in frameworks. So maybe I'll use this opportunity to kind of provide the framework about credit. So to me, I'd say that there's 3 main sources of the credit performance, the drivers of credit. So one is more macro industry-wide, which is early in the pandemic, we all recall that credit was pristine largely on the back of forbearance and stimulus and people not traveling. And I think we coined the phrase of the delayed charge-offs phenomenon. And we saw those delayed charge-offs come in over the past couple of years. So one tailwind we're experiencing now is just the gradual decline of those delayed charge-offs. Relatedly, there's also the back book of recoveries that comes from those elevated levels of losses. And so we're also benefiting from that. And so those are really industry phenomenon that are working. The second category that I would say is the judgment that we apply to our decisioning. And by that, I mean we don't work back from growth targets. And that gives us the flexibility to make the decisions that we think are right at any point in time. And so we have intervened over the last number of years and looking at things like credit score inflation, looking at consumers' balance sheets being propped up as a result of the effects that I described a moment ago and looking at things like the role that fintechs played in giving people debt, much of which wasn't reported on bureaus for a while. And so we used the opportunity a few years ago, the fact that we don't have growth targets to intervene into our decision-making and give up growth at the margin in the service of what we believed would result in better long-term credit outcomes. So that's my second category. And then the third one comes back to what we were just talking about, which is the technology and data, the modeling that we have, our ability to incorporate in a variety of sources of data monitor in real time and really leverage those more sophisticated models to better make selections upfront but also to dial in at the margin. And that's been aided by the way, with the Discover acquisition, where we see things like the best of both worlds. So we're seeing it in the recovery side with Discover and collections Discover's practices. We looked at what we did and we looked at what they did and bringing those insights to bear in addition to bringing the technology together is also proving to be a source of tailwind. So I kind of put all of that together and say, there's industry effects, there's judgment effects and then there's just the technology and data capabilities that are now inherent in our company and all of those things are helping to drive really strong credit outcomes.

So as we think about like the health of the consumer, what are some of the things that you're looking out for to keep your finger on the pulse?

Well, let me start at the top of the funnel as I'll call it, and I'll sort of walk through those pieces. I mean, first, it really begins with employment. And it's fundamentally an issue of customers' ability to pay. And so the first variable being employment and it seen the prints over the third quarter, see last week's results where job creation is strong. The fires are relatively low and stable, and that is resulting in and unemployment rates, the most recent print of 4.1. Interesting to note that we've now had, I think, it's 62 months in a row of unemployment being under 5%. So the employment picture has been strong and stable. The next category to me beyond just who's employed is looking at real wage growth which is a function of both wages themselves, juxtaposed against inflation. And so when you look at hourly wages, they've been reasonably strong. If a horse race that against inflation over the last few months. There's actually been a little bit of a gapping out in favor of inflation but one thing that I think is often overlooked when we look at hourly wages is it doesn't take into account hours worked. And so if you look at Fed data, where it is weekly wages, that incorporate hours, the horse race between inflation and weekly wages has basically drawn to a tie over the last number of months. So the combination of strong employment and real wages that have been stable, then kind of leads you down into, okay, what are the decisions that consumers are making on a day-to-day basis. And so debt servicing levels are stable payment rates, spend behavior is healthy, as I'm sure you've heard throughout this conference. But in addition to healthy spend levels, we've seen revolve rates that are stable and strong. You've seen payment rates that are actually improving a bit. And so you put all of those things together and more at the bottom of this funnel, you see delinquencies have been stable and delinquencies being the precursor to charge-offs, we also had improved for a number of quarters and find themselves to be stable to slightly better than stable over the last number of months. And so all of that together, we're looking throughout that whole continuum, but really most upstream is the employment and wage picture because that ultimately manifests itself in customer behaviors downstream.

No, that's really encouraging, and that's good to know. The consumer is hanging in there because it's 2/3 of the economy, that's for sure. So I think one of the big strategic moves that Capital One made was moving to the affluent marketplace. Obviously, it's a big investment area for you guys. Maybe you could articulate how this move upmarket impacts the story and strategic positioning.

Yes. That's a quest that began in earnest for us in around 2010 with the launch of Venture. And as we looked at the top of the market, there was so much to like about the economics and what it means financially to your question. These are customers that are -- have high levels of spend if you look at the revenue components of this, you're generating fees from them. They have high levels of spend. And so therefore, you have interchange, of course, you still get some interest income from them. But it's all based in much lower levels of capital. They have very low losses even in periods of stress. And so -- and they have very low attrition rates. And so when you look at all of those things together, it's no surprise that it is an incredibly attractive portion of the market. And so then the natural question is, well, why doesn't everybody go there? And it's because it requires a sustained level of investment because people who are at the top of the market are not just looking for APR or product terms. It requires experiences. It requires travel and lounges and dining. And exclusive things that you can't get elsewhere. And that requires a commitment to invest for a long period of time to generate these great annuity streams, but that also shows up in our P&L as we make the investments, particularly in marketing to generate these customers, but it just is an annuity that pays dividends for years and years to come. And it also, by the way, provides something aspirational for the rest of the book to look up to. And so we believe that it sort of helps lift the tide across the portfolio where those customers are aspiring to improve standing in credit and take those things on and we can help them improve their financial lives and then bring in other people who are new to credit and keep this virtuous cycle going.

That's very important. I guess as we think about the investments that still need to be made, I mean, do you see that -- is there pressure on that because it's so competitive? Or do you think it's a steady rate of investment that needs to be done over time? I mean I'm just curious like how these things ebb and flow through these competitive dynamics?

I think that marketplace for the reasons I just described, where it requires a meaningful amount of investment to generate the customers. It requires a brand that people trust. Those are very high barriers to entry. And so what we've seen is a small number of very formidable players in that space, who continue to make the investments to compete for that pool of customers. But I would say those players are all very rational and we see a highly competitive space, but we see a rational one in the combination of those 2 things generally lead to things being, I'll call it, more sustained as opposed to spiky times and then an ability to steal a bunch of share without making an investment, I just don't think that that's plausible. I think what you need to do is have a long-term commitment with the ability to make those investments over time and just sustain that, and that's generally what we see in the marketplace.

Do you think [indiscernible] a network makes it better or it makes it easier to make those investments in that market? Do you get more efficiency out of it?

Well, with the market, especially at the top of the market, those tend to be customers that travel internationally. And as we've talked about, one of the things with the acquisition of Discover that we're incredibly excited about the opportunities that it brings. It also comes with a near-term need to invest, and that is investing in acceptance because the last thing that you would want is to have somebody at the top of the market who is somewhere on international travel and the card not work. And so over time, perhaps, it could be a source of competitive advantage. But what we're focused on now with the network is really finding those places where our cardholders travel and ensure that there's a very high degree of acceptance so that the customer experience is up to the standard that we set for ourselves there. And so we need to make sure that international, in particular, has the acceptance where we would feel comfortable having the top of the market running on a network that just doesn't yet have parity with Visa and MasterCard. And so we have the flexibility and a great relationship with Visa and MasterCard to offer products that run on multiple rails and we're continuing down that path to build out broader acceptance, while at the same time, maintaining the very strong partnership with what we have with those 2 companies.

Great. So maybe just sticking with marketing. Obviously, Capital One has a history of leaning into marketing when the returns are attractive. Maybe you could just talk about the ROI framework that gives you the confidence of making the said marketing investments that you guys make?

Why don't I start with categories of marketing because that may help with thinking about the ROI. So I'll bucket it into 5 broad categories. with the first being a direct response or stimulus response. So targeting consumers and having ads that generate a new account, category on Category 2 adjacent to that is brand. Category 3, we talked quite a bit about is one of the benefits of the Discover transaction is in generating checking accounts and continuing to invest in our retail bank. So it goes just beyond checking. We don't have a branch on every corner. And so the way that we've also generated over $400 billion of savings products is through that marketing channel. So retail being a big category in and of itself. The fourth category is what we just talked about with premium, all of those experiences that are necessary to compete in that space. And then fifth is a variety of other things, including things like Capital One shopping. So getting back to your question, I think it's important to differentiate between those categories because the way that we approach the ROI differs for those. It's pretty easy for us to look at the direct marketing and be able to calculate an NPV of a solicitation. We can see what we spend, we can see the customers that we book, the response rates, what those customers look like over time. So that lends itself to sort of the hallmark of who Capital One is in terms of our analytics and the [ NPV ] framework that has been at the center of how the company has operated for over 3 decades. There's another category of things, the premium space that I would say doesn't quite lend itself to that same at least stimulus response NPV. We have to look at premium in the context of the overall economics of that whole business. So the marketing investments that we're making there, coupled with the direct marketing within that space, in aggregate to the overall economics of a premium customer. And so it's really hard to deconstruct that line item and say how much of a response rate is really driven by the fact that, Sanjay, can now get into a lounge in Dallas, but we test and learn as best we can, but the real value comes and looking at things on an integrated basis and ensuring that we really like those integrated economics and make our decisions that way as opposed to just looking at each individual line item within marketing to determine, should we go invest in another lounge.