Capital One Financial Corporation (COF)

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Capital One Financial Corporation (COF)

Q2 2009 Earnings Call

July 23, 2009 17:00 pm ET


Jeff Norris – IR

Richard Fairbank – President & CEO

Gary Perlin – CFO


Craig Maurer - Caylon Securities

Unspecified Analyst – Ladenburg FSG

Christopher Brendler - Stifel Nicolaus & Company

Steven Wharton - JPMorgan

Joe Mack - Meredith Whitney Advisory Group

Henry Coffey - Sterne Agee & Leach

Moshe Orenbuch - Credit Suisse

Bruce Harting - Barclays Capital

John Stilmar - SunTrust Robinson Humphrey

Andrew Wessel - JP Morgan

Brian Foran - Goldman Sachs

Sanjay Sakjrani - Keefe Bruyette & Woods

Ken Bruce - Banc of America

Robert Napoli - Piper Jaffrey & Co.



Good day everyone and welcome to the Capital One second quarter 2009 earnings conference call. (Operator Instructions) I would now like to turn the call over to Mr. Jeff Norris, Managing Vice President of Investor Relations. Sir, you may begin.

Jeff Norris

Welcome everyone to Capital One’s second quarter 2009 earnings conference call. As usual, we are webcasting live over the Internet. To access the call on the Internet, please log onto Capital One’s website at and follow the links from there. In addition to the press release and financials, we have included a presentation summarizing our second quarter 2009 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 and Principal Accounting Officer. Richard and Gary will walk you through this presentation. To access a copy of the presentation and the press release, please go to Capital One’s website, click on Investors 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. 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 the actual results to differ materially from those described in forward-looking statements. For more information on these factors please see the section entitled Risk Factors in our Annual and Quarterly reports filed with the SEC and accessible at the Capital One website and also the forward-looking statements section in the earnings release presentation.

Now I will turn the call over to Mr. Perlin.

Gary Perlin

Thanks Jeff and good afternoon to everyone listening to the call tonight. I’ll begin on slide three, in the second quarter Capital One earned $224 million or $0.53 per share prior to impacts from the government’s preferred share investment. After including a $462 million accounting impact of the June redemption of the shares, and $38 million dollars in preferred dividend payments in the quarter deposited $0.53 per share becomes a loss of $0.65 per share available to common shareholders.

These quarterly results also include a pre-tax expense of $80 million for the FDIC special assessment partially offset by a pre-tax gain of $65 million from the sale of MasterCard stock. Performance in second quarter continuing operations primarily reflects the economic environment, and our actions to manage the company through the downturn.

Revenue increased $418 million in the quarter driven largely by two factors, first our margins improved. This improvement was driven primarily by reducing our funding costs through better pricing and managing the mix of our liabilities to bring down our weighted average funding costs by 36 basis points. More on funding costs in a moment.

And second we posted a full quarter of Chevy Chase Bank revenues. Let me point out that while Chevy Chase Bank’s results remain in the other category in the segment reporting supplemental tables we’ve also included a specific schedule in the tables to outline its results for the quarter.

Chevy Chase Bank will be merged into Capital One NA on July 30 and the results will be integrated into our existing business segments in the third quarter. While they didn’t materially impact the quarter over quarter revenue change, we also recognized a negative $127 million valuation adjustment to our retained securitization interests and suppressed $572 million in fees assessed but deemed uncollectible in the second quarter.

About half of the valuation adjustment was driven by an increase in the amount of subordinated asset backed notes we retained in conjunction with the issuance of new public ABS in the quarter. And the other half of the valuation adjustment was driven by an increase in the size of spread accounts as we slipped just below our three month average 4.5% BBB trigger in the common securitization trust.

The overall improvement in revenue was partially offset by an increase in non-interest expense which resulted primarily from a full quarter of Chevy Chase Bank expenses and the FDIC special assessment. Provision expense was down $228 million quarter over quarter with an expected modest increase in charge-offs more than offset by the swing from a $124 million allowance build in the first quarter to a $166 million allowance release in the second quarter.

US card more than accounted for the entire allowance release in the second quarter where $1.9 billion of reported loan contraction led to $183 million release in that business despite the fact that we maintained card coverage ratios. The $68 million build in the local banking segment driven mostly by worsening credit trends in commercial was mostly offset by the $61 million release in auto to reflect both improving charge-off trends and declining loan balances.

As we turn to slide four I’ll discuss how the changes to our allowance have impacted our coverage ratios. For the total company our allowance as a percentage of reported loans remained flat in sequential quarters at 4.8%, up 143 basis points from the year go quarter. In the second quarter we maintained our increased our ratio of allowance to both reported loans and reported delinquencies in nearly all of our businesses as we anticipate higher losses than today’s levels.

The loan exception was a slight decline in coverage in auto finance which experienced a full quarter’s worth of improving charge-offs. With a coverage ration of allowance to reported delinquencies at historical highs for our unsecured lending businesses, our allowance anticipates a full 12 months of losses that are higher than today’s levels.

Let’s turn to slide five where we see that both cost and revenue margins improved in the quarter. On the revenue side we saw significant improvement in both our net interest and revenue margins. Our NIM improvement of 30 basis points was driven by a reduction in our cost of funds.

Despite the continued mix shift of assets from loans to lower yielding investment securities we managed to maintain a stable weighted average asset yield allowing the cost of funds improvement to fully benefit NIM. Its also worth noting that this 30 basis point improvement is actually understated as a full quarter of the lower yielding Chevy Chase Bank portfolio decreased NIM by about 10 basis points quarter over quarter.

In addition to the factors driving up NIM revenue margin improved as gains from the sale of securities from our investment portfolio and of shares in MasterCard were accompanied by an increase in gross interchange income stemming from 10% higher purchase volume in the quarter.

We continue to aggressively manage our costs bringing down our efficiency ratio even while absorbing a full quarter of the historically higher efficiency ratio of Chevy Chase Bank, the FDIC special assessment and ongoing integration expenses. Looking ahead while our efficiency ratio may fluctuate as a result of these integration expenses and potential swings in revenue we remain committed to driving run rate efficiencies over time.

Since our results will continue to be influenced by the composition of the balance sheet I’ll discuss our asset mix and funding in more detail on slide six. Our strong and flexible balance sheet continue to reflect both a secular shift from the strategic choices we’ve made especially the transformation of our funding mix as well as cyclical trends caused by the current economic environment. Especially the impact of lower rates and reduced demand for loans. Average earning assets increased by approximately $5 billion in the quarter more than entirely accounted for by the effect of a full quarter of Chevy Chase Bank loans. Excluding Chevy Chase Bank loans average managed loan balances in legacy segments declined by about $4 billion despite about $5 billion of new originations.

Several factors caused loan balances to fall in the quarter including the run off of over $2 billion in loans related to businesses we repositioned or exited several quarters ago, such as auto and installment loans. In addition rising charge-offs, low purchase volumes, particularly in revolving card businesses, weak loan demand, and normal attrition also contributed to the decline in loan balances.

Our average securities portfolio grew by approximately $3 billion in the second quarter and now represents 20% of our earning assets up from 18% in the first quarter. While lower yields on the securities we purchased in the quarter led to an overall yield on the investment portfolio the weighted average yield on all earning assets remained stable because of margin expansion in our loan book.

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