Capital One Financial Corporation (COF)

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Capital One Financial Corporation (COF)

Q3 2009 Earnings Call

October 22, 2009 5:00 pm ET


Jeff Norris – IR

Richard Fairbank – President & CEO

Gary Perlin – CFO


Andrew Wessel - JP Morgan

Christopher Brendler - Stifel Nicolaus & Company

David Hoxton – Buckingham Research

Mike Taiano – Sandler O’Neill & Partners

Rick Shane – Jefferies & Co.

Moshe Orenbuch - Credit Suisse

Aaron [Stackonovich] – Ladenburg Thalmann & Co.

Bruce Harting - Barclays Capital

Sanjay Sakjrani - Keefe Bruyette & Woods

Scott Valentin – FBR Capital Markets

Donald Fandetti – Citi Investment Research

Robert Napoli - Piper Jaffrey & Co.



Welcome to the Capital One third 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

Thank you. Welcome everybody to Capital One’s third quarter 2009 earnings conference call. As usual, we are webcasting live over the Internet. You can access the call on the Internet by logging 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 third 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 Forward-Looking Information in the earnings release presentation and the Risk Factors section in our Annual and Quarterly reports which are accessible at the Capital one website and filed with the SEC.

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

Gary Perlin

Thanks Jeff and good afternoon to everyone listening to the call. In the third quarter Capital One earned $426 million or $0.94 per share. Earnings per share improved 77% from the linked quarter excluding the second quarter costs of repaying the government’s preferred share investment.

The improved bottom line performance was largely driven by three factors that boosted revenue by $482 million or 12% quarter-over-quarter. First, higher yield more than offset balances in our domestic card business and drove approximately $180 million of the revenue increase. Second, better performance in our credit card trusts and market conditions in general led to a $150 million sequential improvement in the valuation adjustment to our retained securitization interests. Next, we opportunistically reallocated portions of our investment portfolio to lower risk, more capital efficient securities while recognizing $150 million of gains in the process, about $100 million more than last quarter.

In addition to increased revenue the bottom line benefited from a 6% sequential decline in noninterest expenses driven mostly by not having an FDIC special assessment in the quarter as well as modestly lower marketing and restructuring expenses. While pre-provision earnings were up $600 million this was partially offset by a $296 million increase in our provision expense quarter-over-quarter.

Net charge offs were up modestly as expected but the primary sequential change was a shift from an allowance release in the second quarter to a small build in the third. The modest allowance build was the result of a material increase in our commercial banking allowance mostly offset by releases in both our credit card and consumer banking allowances. More on the allowance in a moment.

Our tax rate fell to 25% in the quarter as we released some of our tax reserves in recognition of a favorable court ruling for the treatment and the timing of interchange income. All told the $1.03 of continuing operations earnings per share in the quarter was flat to the year-ago quarter despite the significant challenges we all faced over the past 12 months.

The $44 million after-tax loss in discontinued operations includes $83 million in expenses related to repurchase obligations under reps and warranties made principally by Green Point in connection with its mortgage sales before it ceased originations in 2007.

As we turn to slide four I will describe our economic outlook and our allowance associated with continuing operations. Unemployment and home prices have been and continue to be the economic variable with the greatest impact on our results. We still expect the unemployment rate to hit the low 10% range in the first quarter of 2010 and now believe it is likely to remain stubbornly high. To date the Case Schiller Housing Price Index has declined by about 31% from its peak. Despite a couple of months of promising news we continue to assume home prices will fall by about 42% since the trough.

Our overall allowance rose by $31 million as a result of larger, mostly offsetting allowance changes across our businesses. First, our credit card business had a $78 million release in allowance more than entirely driven by the $2.1 billion decrease in reported card loan balances. Consistent with our cautious economic outlook our coverage ratio of allowance to reported card loans rose to 10% in the quarter. The slight decrease in allowance to delinquencies was caused both by the increases in delinquencies off second quarter’s seasonal lows as well as a change in the delinquency mix as early stage delinquencies rose during the quarter and caused overall levels to rise while late-stage delinquencies that typically require higher allowance coverage ratios have improved.

In the consumer banking segment the better than expected credit performance of the auto finance business and modest loan shrinkage in the quarter led to a $190 million release in our allowance for that business. This was partially offset by a $66 million build associated with the other consumer banking businesses so the segment overall had a modest decline in allowance coverage of delinquencies.

Finally, degradation of collateral values especially in the construction portfolio and the impact of rising charge offs caused us to build the commercial banking allowance by $256 million in the quarter. The coverage ratio of allowance to loans rose over 60% or 90 basis points to 2.3% while the coverage of allowance to NPLs now stands at 85%.

Excluding the run off small ticket CRE portfolio the allowance coverage to NPLs in this segment is 108%. Rich will discuss credit trends in the commercial banking segment in greater detail in a few minutes. It is also important to note that none of these coverage ratios factored in the assets that were acquired in March as part of the Chevy Chase bank acquisition. Those assets continued to perform in line with our expectations at the time of the mark and therefore did not impact our allowance in this quarter.

Overall the $31 million build of the allowance coupled with the shrinkage of our balance sheet led to a 24 basis point increase in our overall coverage ratio and positions our balance sheet to absorb high levels of losses in the quarters ahead.

Turning to slide five I will discuss the balance sheet. Average managed earning assets decreased by $6 billion in the quarter as we had varying degrees of shrinkage in each of our businesses. Our domestic card portfolio was down about $2.6 billion driven by elevated charge offs, lower loan demand in revolving card businesses and the continued run off of our installment loan portfolio.

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