Capital One Financial Corporation (COF)

COF 
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Capital One Financial (COF)

Q4 2010 Earnings Call

January 20, 2011 5:00 pm ET

Executives

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

Jeff Norris - Managing Vice President of Investor Relations

Gary Perlin - Chief Financial Officer, Principal Accounting Officer and Executive Vice President

Analysts

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

Michael Taiano - Sandler O’Neill & Partners

Betsy Graseck - Morgan Stanley

Moshe Orenbuch - Crédit Suisse AG

Bruce Harting - Barclays Capital

Kenneth Bruce - BofA Merrill Lynch

Brian Foran - Goldman Sachs

Christoph Kotowski - Oppenheimer & Co. Inc.

Bill Carcache - Macquarie Research

Presentation

Operator

Welcome to the Capital One Fourth Quarter 2010 Earnings Conference Call. [Operator Instructions] Thank you. 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 very much, Marie. Welcome, everyone, to Capital One's fourth quarter 2010 Earnings Conference Call. As usual, we are webcasting live over the Internet. To access the call on the Internet, please log on to Capital One's website at capitalone.com and follow the links from there. In addition to the press release and financials, we have included a presentation summarizing our fourth quarter 2010 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. Rich and Gary will walk you through the presentation tonight. To access a copy of this presentation and the press release, please go to the 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 our actual results to differ materially from those described in forward-looking statements. For more information on these factors, please see the section titled Forward-Looking Information in the earnings release presentation and the Risk Factor section in our annual and quarterly reports, accessible at the Capital One website and filed with the

SEC. Now I'll turn the call over to Mr. Perlin. Gary?

Gary Perlin

Thanks, Jeff, and good afternoon, to everyone listening to the call. I'll begin on Slide 3.

In the fourth quarter of 2010, Capital One earned $697 million or $1.52 per share, down from $803 million or $1.76 per share in the third quarter, as a reduction in net interest income and increase in non-interest expenses were partially offset by improved provision expense. Compared to the fourth quarter of 2009, earnings were up $321 million or 85%, driven entirely by lower provision expense.

A modest decline in revenue over linked quarters, coupled with a 5% increase in non-interest expense mostly driven by an increase in marketing, led to a 7% decline in pre-provision earnings during the fourth quarter. The continued improvement in charge-offs across most of our businesses offset the reduced quarter-over-quarter allowance release, resulting in a 3% drop in provision expense.

At this point, I actually think it's more telling to focus on year-over-year trends. You'll find these on Slide 4. 2010 earnings reflect in large part where we've been in economic cycle and the impact of recent changes in the regulatory environment. After tax earnings, were up over 200% in 2010 from $884 million to $2.7 billion, and following the reduction of TARP preferreds in 2009, EPS in 2010 was up more than sevenfold, from $0.74 per share to $6.01.

The biggest driver of this change was a striking improvement in credit, which impact was heightened by FAS 167 consolidation on January 1, 2010, offset by several other factors. These include reduced non-interest income, largely as a result of implementing the CARD Act, declining loan balances resulting from consumer caution, portfolio runoffs and still elevated charge-offs and an increase in non-interest expense, especially as we ramped up marketing and integrated Chevy Chase Bank. We expect that some of these trends will continue to affect our 2011 results, given the outlook for a slow-paced economic recovery and the full year effect of legislative changes.

Let's look a bit deeper into recent trends and what they say about the future. Pre-provision earnings declined in 2010 over 2009 levels for several reasons: Revenues were down, but only 4% on a year-over-year basis even in the wake of a 9% reduction in the average loans and the implementation of the CARD law in 2010 as well. These negative headwinds were partially offset by margin benefits associated with a lower cost of funds.

On the expense side, marketing increased over 60%, largely in the back half of 2010 from very low levels in 2009 as the opportunity to acquire new accounts grew during this year. While operating expenses were up modestly year-over-year, the increase was primarily related to the full year effect of the Chevy Chase Bank acquisition.

The year-over-year improvement in earnings in 2010 was primarily driven by a 50% decline in provision expense as we experienced a dramatic improvement in both losses and allowance expense. As credit improved over the course of the year, we saw charge-offs fall by some 20% or nearly $1.8 billion in 2009. The combination of a consistently better outlook for future losses and a smaller managed loan book also led to a 33% reduction in our loan loss allowance from the beginning of 2010.

Looking ahead, the lingering economic and regulatory impacts of 2010 will likely impact the full year income statement in 2011. We'll experience the full year impact of CARD law-related changes, which were implemented over the course of 2010 and expect that the lower starting point for loans will cost the average book in 2011 to be comparable to that of 2010 even as balances grow over the year. Margins will be affected by cross currents as the on-boarding of lower yielding and lower loss assets are offset to some extent by a lower year-over-year average cost of funds higher transaction volume.

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