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Edited Transcript of COF earnings conference call or presentation 21-Jan-20 10:00pm GMT

Q4 2019 Capital One Financial Corp Earnings Call

MCLEAN Jan 24, 2020 (Thomson StreetEvents) -- Edited Transcript of Capital One Financial Corp earnings conference call or presentation Tuesday, January 21, 2020 at 10:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Jeff Norris

Capital One Financial Corporation - SVP, Global Finance

* Richard D. Fairbank

Capital One Financial Corporation - Founder, Chairman, CEO & President

* Richard Scott Blackley

Capital One Financial Corporation - CFO

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Conference Call Participants

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* Betsy Lynn Graseck

Morgan Stanley, Research Division - MD

* Brian Dean Hogan

William Blair & Company L.L.C., Research Division - Associate

* Donald James Fandetti

Wells Fargo Securities, LLC, Research Division - Senior Analyst

* Eric Edmund Wasserstrom

UBS Investment Bank, Research Division - MD & Consumer Finance Analyst

* John Hecht

Jefferies LLC, Research Division - MD & Equity Analyst

* Moshe Ari Orenbuch

Crédit Suisse AG, Research Division - MD and Equity Research Analyst

* Richard Barry Shane

JP Morgan Chase & Co, Research Division - Senior Equity Analyst

* Ryan Matthew Nash

Goldman Sachs Group Inc., Research Division - MD

* Sanjay Harkishin Sakhrani

Keefe, Bruyette, & Woods, Inc., Research Division - MD

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Presentation

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Operator [1]

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Welcome to the Capital One Fourth Quarter 2019 Earnings Conference Call. (Operator Instructions) This conference is being recorded. Thank you.

I would now like to turn the call over to Mr. Jeff Norris, Senior Vice President of Global Finance. Sir, you may begin.

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Jeff Norris, Capital One Financial Corporation - SVP, Global Finance [2]

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Thanks very much, Matt, and welcome everyone to Capital One's Fourth Quarter 2019 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've included a presentation summarizing our fourth quarter 2019 results.

With me this evening are Mr. Richard Fairbank, Capital One's Chairman and Chief Executive Officer; and Mr. Scott Blackley, Capital One's Chief Financial Officer. Rich and Scott are going to walk you through the presentation. To access a copy of the presentation and 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 our actual results to differ from -- to differ materially from those described in forward-looking statements. And for more information on these factors, please see the section titled Forward-looking Information in the earnings release presentation and the Risk Factors section in our annual and quarterly reports accessible at the Capital One website and filed with the SEC.

And with that, I'll turn the call over to Mr. Blackley. Scott?

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Richard Scott Blackley, Capital One Financial Corporation - CFO [3]

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Thanks, Jeff. I'll begin tonight with Slide 3. Capital One earned $5.5 billion or $11.05 per diluted common share in 2019. On an adjusted basis, earnings per share were $12.09 for 2019. In the fourth quarter, net income was $1.2 billion or $2.25 per share. Net of adjusting items, our EPS in the quarter was $2.49 per share. We had 3 adjusting items in the quarter, which are outlined on Slide 14 of our earnings presentation.

First, we had a $48 million or $0.08 per share expense of launch and integration costs associated with our Walmart partnership. This brings the full year total expense to $211 million and concludes the onetime expenses related to the Walmart partnership launch. Additionally, we had an allowance reserve build for the acquired Walmart portfolio of $84 million or $0.13 per share. The reserve build as well as the launch and integration costs are recorded in our domestic card business.

Lastly, we had $23 million of charges related to the cyber incident that we announced at the end of July. These charges were partially offset by an insurance reimbursement receivable of $7 million, resulting in a net impact of $16 million or $0.03 per share. We continue to expect a portion of these charges in insurance recoveries will extend beyond 2019. In addition to the adjusting items, we recognized $31 million in costs related to the redemption of our Series C and D preferred stock on December 2. We also had an incremental $17 million of dividend expense associated with the cost of carrying the new Series I issuance in addition to Series C and D for most of the quarter. Collectively, these costs decreased Q4 earnings per share by $0.10. As a reminder, preferred dividends impact EPS, but they do not impact net income.

Moving on to quarterly performance. Relative to a year ago, adjusted pre-provision earnings increased 17%, with revenue increasing 7%, operating expenses increasing 4% and marketing decreasing by 15%. Compared to the prior year quarter, provision for credit losses increased 11%, owing to a larger allowance build and a modest increase in charge-offs.

Let me take a moment to discuss the quarterly movements in our allowance across our businesses, which are detailed in Table 8 of our earnings supplement. Our Card business saw an allowance build of $107 million, essentially flat outside of the $84 million initial allowance reserve build for the acquired Walmart portfolio.

In our Consumer business, there was a build of $31 million, driven by continued growth in our auto business. And lastly, reserves in our Commercial business declined by $4 million, as charge-offs in the quarter more than offset builds in allowance related to our energy portfolio.

December 31, 2019 marked the end of the allowance accounting that we have all known for decades. We estimate that the 1/1/2020 adoption of CECL will increase our allowance by approximately $2.9 billion and reduce our CET1 ratio by 16 basis points in the first quarter. We have broken out the CECL allowance transition impacts by reported segment on Slide 4.

Turning to Slide 5. Net interest margin was 6.95% in the quarter and 6.83% for the full year of 2019. Relative to the prior quarter, net interest margin was largely flat. On a linked-quarter basis, net interest margin increased 22 basis points or 14 basis points, excluding the negative impact in Q3 from U.K. PPI. The 14 basis points of improvement was partly driven by asset mix, including the onboarding of the Walmart portfolio in the quarter, which reduced cash and securities and partly by the effects of seasonal loan growth. We continue to have a relatively neutral near-term posture to interest rate changes. Over the longer term, persistently low interest rates will be a headwind for us and the industry.

Turning to Slide 6, I will cover capital. Our common equity Tier 1 capital ratio on a Basel III standardized basis this quarter was 12.2%. In the fourth quarter, we purchased approximately $941 million or 10 million Capital One common shares. We've now completed approximately $1.4 billion of our 2019 CCAR authorization of $2.2 billion. Recall that in October, the Fed finalized the tailoring rule with an expected implementation in the first quarter of 2020. When we adopt the rule, we expect to opt out of AOCI for regulatory capital purposes. As a result, on December 31, we transferred our held-to-maturity securities to available-for-sale, resulting in an AOCI increase of approximately $890 million. Inclusive of this transfer, our December 31 AOCI position for AFS securities increased CET1 in the fourth quarter by about 30 basis points. Accordingly, when we opt out of AOCI in the first quarter, Q1 2020 CET1 will decrease by about 30 basis points, all else equal.

As we are preparing for CCAR 2020, we still believe that our long-term capital needs is around 11% CET1. Let me take a minute to talk about the factors impacting our capital need. In the 2019 CCAR, the Fed's implementation of the new card loss model created a headwind to our capital under stress. Conversely, the effects of the recently finalized tailoring rule will provide a tailwind to our capital reduction under stress. We also believe there's an opportunity for further capital relief under the stress capital buffer framework, and we continue to keep an eye on the Fed's implementation of CECL, which will occur in CCAR 2022. How and when the Fed implements these changes in CCAR will be a key factor in when we will be able to manage our CET1 closer to the 11% long-term capital need.

With that, let me turn the call over to Rich. Rich?

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Richard D. Fairbank, Capital One Financial Corporation - Founder, Chairman, CEO & President [4]

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Thanks, Scott. I'll begin on Slide 9, which summarizes fourth quarter results for our Credit Card business. The Credit Card business delivered solid results with stable credit and strong growth in loans, purchase volume and revenue. Credit Card segment results and trends are largely driven by the performance of our Domestic Card business, which is shown on Slide 10.

Domestic Card ending loan balances increased by $11.3 billion or 10.5% year-over-year driven by the addition of the acquired Walmart portfolio and strong growth of branded cards, partially offset by our choice to exit several small partnership portfolios in the second quarter.

Branded Card loans, which exclude all private label and co-branded cards, grew 5.7% from the prior year quarter. Domestic Card average loans for the quarter were up 9.3% compared to the fourth quarter of 2018. We posted another strong quarter of purchase volume growth as we continued to grow our heavy spender franchise. Year-over-year, Domestic Card purchase volume growth was 10.7%. Net interchange revenue for the total company grew 9.2%. Revenue increased 7.2% from the fourth quarter of 2018, driven by the growth in average loans. Revenue margin declined 31 basis points. More than 100% of the decline was driven by the revenue sharing agreement on the acquired Walmart portfolio.

Noninterest expense was essentially flat compared to the prior year quarter. Domestic Card credit remains strong and stable. The charge-off rate for the quarter was 4.32%, a 32 basis point improvement year-over-year driven by the addition of the acquired Walmart portfolio. Because the delinquency rate is not affected by the loss-sharing agreement, the addition of the Walmart portfolio put upward pressure on the fourth quarter 30-plus delinquency rate. Despite this upward pressure, the 30-plus delinquency rate improved 11 basis points from the end of the prior year quarter to 3.93%. Pulling up, our Domestic Card business continued to deliver strong results with top line growth and strong and stable credit.

Slide 11 summarizes fourth quarter results for our Consumer Banking business. Ending loans increased 6.5% year-over-year. Average loans for the fourth quarter grew 5.5% from the prior year quarter. Our auto business delivered strong year-over-year originations growth and a modest acceleration of loan growth, along with stable credit results and loan yields, all in a marketplace with increasing competitive intensity. Digital innovation is a key driver of our momentum in the auto business.

Powered by our national banking strategy, ending deposits in the consumer bank were up $14.5 billion or 7.3% year-over-year. Average deposit interest rate for the quarter increased 10 basis points compared to the prior year quarter. The rate increase was primarily a result of a product mix shift toward higher rate deposit products throughout the year. The deposit interest rate declined 11 basis points from the sequential quarter, driven by the market interest rate environment. Our average deposit rate paid going forward will depend on several factors, including the market interest rate environment, our deposit mix, our funding needs and competitive dynamics.

Consumer Banking revenue decreased 1.8% from the fourth quarter of last year. Underlying revenue growth from higher auto loans and retail deposits was more than offset by 2 effects. Differences in the timing of Federal Reserve rate cuts versus our deposit pricing moves pressured revenue in the fourth quarter and the fourth quarter of 2018 included a small tail of revenue from the legacy home loans and investing businesses. There was no revenue from these legacy businesses in the fourth quarter of this year.

Noninterest expense was up 2.3%. Volume-driven growth in expenses and our continuing investments to grow and transform were partially offset by the lack of expenses from the legacy businesses. Fourth quarter provision for credit losses increased $32 million year-over-year. Auto loan growth drove an allowance build. The auto charge-off rate improved 8 basis points compared to the prior year quarter to 1.90%. Better-than-expected auction values and the benign economy continue to support strong auto credit. We continue to expect that the annual auto charge-off rate will gradually increase as the cycle plays out.

Moving to Slide 12. I'll discuss our Commercial Banking business. Ending loan balances were up 5.9% year-over-year. Quarterly average loan balances were up 6.5% compared to the fourth quarter a year ago. Average deposits increased 4.4%. Fourth quarter revenue was up 7.5% from the prior year quarter, driven by growth in average loan balances and strong noninterest income. Noninterest expense was up 1.6% compared to the prior year quarter. Provision for credit losses increased compared to the fourth quarter of 2018, driven by our energy portfolio.

The Commercial Banking charge-off rate for the fourth quarter was 0.35%, and criticized loan rates were relatively stable compared to both the prior year and sequential quarters. The criticized performing loan rate for the fourth quarter was 2.9%, and the criticized nonperforming loan rate was 0.6%.

In our Commercial Banking business, we're keeping a watchful eye on market conditions. Unregulated competitors continue to put pressure on pricing, loan spreads and loan terms. Against that backdrop, we are carefully choosing our spots and staying disciplined in our underwriting and origination choices.

Pulling way up, in the fourth quarter and for the full year 2019, Capital One continued to post solid results as we invest to grow and to drive our digital transformation. Our marketing investments continue to build momentum across our businesses. In Domestic Card, we generated strong year-over-year growth in purchase volume and solid growth in loans. Credit results were strong and stable, and we successfully launched the Walmart partnership. In Consumer Banking, our auto business delivered solid loan growth with stable credit and loan yields and our national banking strategy achieved strong year-over-year growth in retail deposits.

Looking ahead, marketing will, as always, depend upon our continuous assessment of opportunities in the competitive marketplace. As we enter 2020, we continue to see resilient growth opportunities in all of our businesses, and we'll have a full year of marketing for the new Walmart partnership. With the momentum we have in Domestic Cards and national retail banking plus the incremental Walmart marketing, we expect full year 2020 marketing expense will be moderately higher than full year 2019 marketing expense. We remain all-in on our technology transformation, and our progress continues. We are realizing significant and growing benefits across the company. Faster to market, better products, better customer experience, better risk management, more growth, better economics.

We're on the home stretch of our transition to the cloud, and we're on track to exit our data centers near the end of this year. Until then, we continue to operate with 1 foot in the legacy data center environment and 1 foot in the cloud. Along the way, we're working hard to improve operating efficiency even with the elevated cost of straddling both the data center and cloud environments.

In 2019, we posted a 45 basis point improvement in annual operating efficiency ratio net of adjustments, and we expect to achieve another year of modest improvement in 2020. We continue to expect a bigger move down in annual operating efficiency ratio to 42% in 2021, net of adjustments. We expect the larger improvement in 2021 to be aided by the full exit of the data centers and the associated cost of straddling 2 environments, increased traction in our businesses enhanced by technology and the step-up in revenue share on the acquired Walmart portfolio which will occur in the fourth quarter of 2020.

We continue to expect that the improvement in annual operating efficiency ratio will drive significant improvement in annual total efficiency ratio by 2021 as well. As the many benefits from our technology transformation continue and increase, we are well positioned to succeed in a rapidly changing marketplace and create long-term shareholder value.

Now Scott and I will be happy to answer your questions.

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Jeff Norris, Capital One Financial Corporation - SVP, Global Finance [5]

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Thank you, Rich. We'll now start the Q&A session. As a courtesy to other investors and the analysts who may wish to ask a question, please limit yourself to 1 question plus a single follow-up. If you have any additional follow-up questions after the Q&A session, the Investor Relations team will be available after the call.

Matt, please start the Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question will come from Ryan Nash with Goldman Sachs.

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Ryan Matthew Nash, Goldman Sachs Group Inc., Research Division - MD [2]

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Maybe just to start off a question for Scott. So thank you for the moving pieces on CECL across the different products. I guess now that day 1 is behind us, any color you can give us regarding the day 2 impact? And maybe can you just talk about it across each of the different portfolios? And I have 1 follow-up.

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Richard Scott Blackley, Capital One Financial Corporation - CFO [3]

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Yes. Sure. Well, when I think about day 2, I'm going to start off by just saying we gave segment level multiples. And I think they are a good foundation for you to use those multiples and apply them to what you would have been estimating under the prior regime for allowance builds in 2020. So I think that's, in general, a good place to start in terms of thinking about day 2. I think that the multiples that we've talked about could change gradually if performance -- the portfolio performance or the portfolio mix really changes in the future. But I think those are going to be changes that happen over time. So the transition multiples are probably a good place to start.

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Ryan Matthew Nash, Goldman Sachs Group Inc., Research Division - MD [4]

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Got it. And Rich, maybe just a question on both operating and overall efficiency. So you made nice progress in 2019 despite a handful of headwinds. I guess, what are the biggest swing factors that could impact reaching 42%? Or is it the fact that everything is coming offline in the fourth quarter that you have such a high degree of confidence? And then, I guess, second, just given where we are in the cycle, you talked about marketing being up moderately this year. Is there a scenario where you could see it accelerating? Or would you expect us -- it to remain at around these levels, plus or minus, like you articulated in your outlook?

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Richard D. Fairbank, Capital One Financial Corporation - Founder, Chairman, CEO & President [5]

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So Ryan, let's talk about the operating efficiency ratio. We're like a year into when we set this guidance, and it was certainly a stepping out of character for Capital One to be so specific so many years out. And as we have talked all along the way, the -- there are several things that have driven our confidence. There are certain things that are -- to call them math is a little bit understating the sort of incredible work associated with doing it. But in a sense, getting out of the data centers is something that with the extraordinary achievement of doing it, we have a -- I think, a very good handle on what the cost of what's -- of what straddling those environments have been and what the benefit of just being all-in on the cloud is.

The math of the Walmart step up, that is what it is, that's contractual. And so I think that's a very reliable thing. The -- another thing that aids the continued improvement here and the larger improvement in 2021 is the increased traction that we expect in our businesses that we can, in fact, see unfolding and that we expect to continue. Obviously, that has uncertainty around it, like any estimate of future business performance and growth. But a lot of that is sort of in the works. It can be affected by changes in the marketplace, changes in the economy, changes in choices that we make, but this is the product of a bunch of work that we have been doing. The success in -- of our marketing and account origination in prior years, which we've spent a lot of time talking about and the -- some of the technology innovation that has been going on. So we feel good about that. Obviously, that has uncertainty to it.

And the other element in the uncertainty equation is, what happens to operating costs of one minus the data center exit and the -- and all the associated costs of straddling that will be eliminated. And there can always be risk to cost estimates, but we've spent -- we've worked very hard, and this is not like a new thing. We've worked hard for years driving -- gradually driving down the efficiency ratio and being very disciplined on operating costs. We do have some growing benefit that comes on the technology side here with respect to technology cost savings.

And collectively, when we put all that together, while as always, there is uncertainty in this. Here we are, we had our bold shingle that we hung out a year ago. Here we are a year into it, and we feel as good as we did at the time that we launched it. And I'm pretty struck by in a world where so many things change about how -- what we had in mind is continuing to unfold, and that's because it's the product of a lot of work for a long period of time.

With respect to marketing. The first thing I want to say is we don't give precise, well, in most years, in many ways, we don't even give marketing guidance at all. And we -- what I would say about marketing is and the impression I want to leave you with is we continue to feel very good about our marketing investment. We -- in Card, marketing is strengthening our heavy spender franchise, driving strong new account originations, growth in purchase volume, net interchange revenue, loans on the bank side. The increased marketing is fueling deposit growth along with the Café and brand awareness. We're seeing a lot of traction just overall in our brand metrics and brand equities that are critical to building a franchise. And also, we're a company that doesn't have 6,000 branches. We're a company that actually isn't at the top of the lead table in terms of co-brand partnerships and a lot of things. So we have to build our business the old-fashioned way, kind of 1 customer at a time. And our marketing machine is the key part of that.

So what I would leave you with is we continue to feel very good about the marketing. We've got a new addition here in terms of a full year of the Walmart marketing. And so that's going to be yet another factor that pulls up the numbers there. There's always -- we will always make our final determinations based on the opportunities and necessities that we see in the marketplace, but I wanted to just give you that general window into how we're feeling about the marketing.

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Operator [6]

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Your next question will come from Sanjay Sakhrani with KBW.

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Sanjay Harkishin Sakhrani, Keefe, Bruyette, & Woods, Inc., Research Division - MD [7]

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I wanted to follow-up on the day 2 CECL impact, Scott. When you look at the Street consensus provisions out there, and I'm just looking at our own, we're assuming 6%-ish loan growth, flat charge-offs, and we have the provision up 20%. I mean, does that look commensurate to sort of what you're articulating? Or is it something else?

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Richard Scott Blackley, Capital One Financial Corporation - CFO [8]

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Sanjay, why don't I just step back and give a little bit of a picture of what's going to happen with CECL. So just to go back and ground out how CECL is going to work. Allowance movements under CECL are really driven by the same factors that drove the allowance under the prior regime. So you start off with loan balances at the end of the period, you've got expected future losses and recoveries on balances, and then we have qualitative factors that are not captured in our modeling and we add those on top.

Of those 3 factors, it's really the second one that changes under CECL. And because we're now going to be holding an allowance for the expected lifetime losses and, importantly, we're also going to be having the lifetime recoveries, and that's -- I'll come to that in just a minute as to why that's such an important factor. So that's the biggest step change under CECL.

So let me kind of just put this together for you and tell you how we're going to do it. We start with a 12-month loss outlook, which we forecast. We then extend that into a lifetime forecast. And when we do that, we assume a gradual reversion of losses to historical averages after that first year and then we overlay that with future recoveries. And future recoveries are a big offset to our CECL allowance.

Prior to CECL, we offset our allowance with expected recoveries for only the next 12 months. With CECL, we'll be offsetting our allowance with the -- with all estimated future recoveries. And relatively speaking, recoveries have a larger offsetting impact under CECL than they did under the prior allowance regime because we tend to see a longer tail of recoveries on our charge offs. So net of all of that, I think you're going to see a 1.42 multiple on our allowances, our Domestic Card business at the point of transition; 1.49 multiple for our auto business. And as I mentioned in my first answer, I think those are relatively stable.

Your question about, well, how might this look in periods of stability and in periods of growth. Let me just kind of answer that real quick. In periods of stability, you're really just going to have take that multiple and apply it to whatever allowance build that you are thinking about, and that includes model -- moderate growth and a stable economy. There's a couple of things that could cause that implied CECL multiple to vary over time. And let me give you a couple of examples.

So the first is that, as you know, and we've talked about CECL pulls forward the allowance expense associated with new lending. And so all else equal, our implied CECL multiple would probably go up in periods of higher growth. And just to give you a bit of a sensitivity there. During our growth surge in 2014 to 2015, the implied multiple during that period, if we had lived under CECL would have been higher, perhaps in the 1.6 range. So just to give you a sense, like there's a lot of things that could move around, but if we just kind of took hindsight and applied kind of where we see things, we could see the multiple going up into that range.

On the flip side of that, in periods of high recoveries, you could actually see the multiple go down. So in periods immediately after a downturn, where there's higher -- we've got this big portfolio of recoveries, those might actually start to be a bigger factor and push the ultimate multiple down. So I know that was a bit of a long answer, but hopefully that gives you a sense of kind of the moving pieces of how CECL is going to work day 2.

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Sanjay Harkishin Sakhrani, Keefe, Bruyette, & Woods, Inc., Research Division - MD [9]

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All right. I have 1 follow-up. On the Walmart portfolio, I know it was known to have a lower tender share penetration. I was wondering if that's a big growth opportunity in 2020 and a contributor to Card growth. And then just a clarification on the marketing expense outlook for 2020. Would this year's growth be moderately higher, sort of, was that a good comparison in terms of the growth rate?

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Richard D. Fairbank, Capital One Financial Corporation - Founder, Chairman, CEO & President [10]

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So could you repeat the second question, Sanjay, your clarification question?

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Sanjay Harkishin Sakhrani, Keefe, Bruyette, & Woods, Inc., Research Division - MD [11]

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Yes, yes. Yes, on the marketing expense growth, you mentioned moderately higher. I was just wondering if 2019's growth rate would be commensurate with moderately higher. It was like mid-single digits growth.

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Richard D. Fairbank, Capital One Financial Corporation - Founder, Chairman, CEO & President [12]

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Okay. So the -- I think what we have this year is a continuation of the momentum that we had last year. And I want to say also to my response to Ryan Nash's opening question that -- and one of the important drivers of 42% is the continuing traction in the business, and marketing is a very important element of that. And in fact -- so we -- a way to think about it is we start with an opportunity, in a sense, a growing opportunity on the marketing side, consistent with what we're seeing, overlay that with Walmart, which is a new thing. And those 2 things together is what is driving our guidance of a moderate increase in marketing.

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Richard Scott Blackley, Capital One Financial Corporation - CFO [13]

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Rich, do you want to talk about this question on the growth opportunity from...

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Richard D. Fairbank, Capital One Financial Corporation - Founder, Chairman, CEO & President [14]

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Growth opportunity in the Walmart portfolio. Yes, let me say, it's certainly an honor and an opportunity to partner with the large -- but not only world's largest retailer, actually the world's largest company, a Fortune 1 company and to launch a digital-first card program. So the -- for Capital One, the opportunity divides itself into a back book, where we have converted the old Synchrony back book, and we've told you a lot about the size and the general parameters associated with that. And then there will over time be a growing front book that will be the originations that we do under this new partnership. We're not going to be specifically guiding to that front book because, in many ways, this will have a lot of similarity to many of the front book things that we do at Capital One. Certainly, the size of Walmart and, at this point, the -- relative to other partnerships, the penetration levels of the Credit Card relationships, there is certainly upside there. And I think Walmart certainly believes that and so do we. But it's -- we're in the very early stages of this, but I think we are very pleased with the way our 2 companies are partnering here.

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Jeff Norris, Capital One Financial Corporation - SVP, Global Finance [15]

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Next question, please.

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Operator [16]

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And your next question will come from Moshe Orenbuch with Crédit Suisse.

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Moshe Ari Orenbuch, Crédit Suisse AG, Research Division - MD and Equity Research Analyst [17]

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Great. You referred to a 5.7% growth in the branded cards, that, I think, was the same number that you referenced in the third quarter, so roughly the same level as growth. Could you just talk a little bit about what the kind of the outlook is? I mean, because that does exclude Walmart. So talk a little bit about whether that branded growth is going to be accelerating or decelerating and the impact maybe on overall growth from Walmart. And I do have a follow-up.

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Richard D. Fairbank, Capital One Financial Corporation - Founder, Chairman, CEO & President [18]

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Yes, Moshe. So first of all, the front book of -- since it starts at 0, the front book, by definition, will be a growing book. I also want to point out the back book of Walmart with the loss rate that it has is a runoff portfolio that's running off at a pretty sizable clip relative to portfolios otherwise that we have. So are there going to be 2 forces going in opposite directions there, and we'll have to see how that plays out, but we're certainly very happy to have that partnership. The outlook, look, I think we continue to feel good about the growth opportunities in the card business. But I think it's more a continuation of the story that we've been talking about before in terms of -- we're benefited by a number of years of strong account origination, we have been over time increasing credit lines as we have validated each successive vintage is coming in as good as it is. And in fact, if anything, the recent vintages are outperforming in a good way by a bit, some of the earlier vintage. So all of that is good. That gives us the confidence to continue to drive the originations and also the continuing confidence on the credit line side. Now this is all in the context of an economy that's already the longest in length in recorded history here between recessions. But -- so with a cautious eye at the environment, the things that we've been talking about for a number of quarters are continuing to find traction and that -- and a very important element of that is the success of the marketing. So that's why we feel good about the growth opportunity.

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Moshe Ari Orenbuch, Crédit Suisse AG, Research Division - MD and Equity Research Analyst [19]

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Got you. And just as a follow-up, a little bit of housekeeping. Noninterest income outside of interchange revenue and service fees, kind of that other line was up very nicely, both in the third quarter and a year ago. Was that primarily just the change in the absence of the PPI charge? Or are there other factors as well?

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Richard D. Fairbank, Capital One Financial Corporation - Founder, Chairman, CEO & President [20]

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Moshe, can you just -- which specific line item are you looking at?

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Moshe Ari Orenbuch, Crédit Suisse AG, Research Division - MD and Equity Research Analyst [21]

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What you guys have called kind of other income was up like kind of 55%, 60% in Q3 and 90% or so from a year ago, I believe both of those had the PPI charges in them, but...

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Richard Scott Blackley, Capital One Financial Corporation - CFO [22]

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Yes. So a few things that impact that line item. So other noninterest income really is driven by oftentimes marks on a variety of different situations. So the first is, we actually have some compensation-related assets that we mark, and we take the benefit of those marks, run through this line item in revenue, and there's an offsetting expense that runs through and elevates [STMB]. So in the period with the run-up in the market, there was a pretty healthy amount of mark on compensation. The other thing that runs through there, we do occasionally have partner payments that are coming in under the contracts, those can run through there and be a bit lumpy. I think that the level that you're seeing in Q4 is a bit elevated to what I would expect on a run rate basis.

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Operator [23]

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Your next question will come from Betsy Graseck with Morgan Stanley.

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Betsy Lynn Graseck, Morgan Stanley, Research Division - MD [24]

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Just switching gears a little bit, talking about NIM, I know that NIM went up nicely in the quarter and -- which I think you had a comment in your prepared remarks around how lower rates are a little bit of a headwind. So I just want to square those 2 things and understand how you're thinking about the outlook for NIM. You had a nice decline in the deposit cost. Maybe you could speak to that a little bit.

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Richard Scott Blackley, Capital One Financial Corporation - CFO [25]

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Betsy, as I mentioned last quarter, we have been talking for a number of quarters about headwinds from deposit mix and deposit pricing, and we started to see those abate a little bit last quarter. When I look at NIM this quarter, I mentioned that there were 2 primary factors that drove NIM up on a linked-quarter basis. One of those was asset mix, which was the larger of the 2 factors that I described. The other was -- the other factor was seasonal loan growth. So we're seeing a bit of that traction in there. The costs -- deposit pricing is embedded in that as well as things like accelerated amortization on the premiums that we have, some of the securities. All of that's embedded in there. So overall, I think that when it comes to the impact of deposit pricing, our betas have been relatively low since the declining rate cycle started. That may be an opportunity. Rich mentioned the types of factors that would drive where deposit pricing goes. So I think we'll have to see where that moves to. But at this point, I don't really see any outsized impacts whether positive or negative on our net interest margin.

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Betsy Lynn Graseck, Morgan Stanley, Research Division - MD [26]

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Okay. And then you have some mix really driving the bus on that. When I think about the CECL outlook here, and I know you've already talked about day 2 quite a bit. I just wanted to see if you could give us some color around the Commercial Banking increase in your day 1. I ask just because some of the other folks that we look at had declines in commercial. So I want to understand what was driving a little bit of a different outcome for you?

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Richard Scott Blackley, Capital One Financial Corporation - CFO [27]

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It is so hard for me to judge what others are doing on their estimates. It depends on the life, a variety of factors. So I can't even hazard a guess when it comes to commercial just because the portfolios are pretty different. So I really honestly don't have an answer to you on that one.

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Operator [28]

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And your next question will come from Rick Shane with JPMorgan.

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [29]

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I think we'd all agree that $100 loan balance on January 1 after the holidays would have a different repayment behavior than a $100 loan balance on May 1 after tax refunds are distributed. I realize from a CECL perspective that you're supposed to take lifetime loss assumptions on both. But I'm trying to understand how does the practical difference in terms of that near-term repayment behavior impact your lifetime loss reserve? And said slightly differently, is 5% growth in December the same as 5% growth in June?

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Richard Scott Blackley, Capital One Financial Corporation - CFO [30]

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Rick, I would just say that seasonal growth and transactors, we look at those. We look at the likelihood of revolving. We use historical empirical data about how quickly those get paid down. They don't tend to have large lifetime allowances. And in general, I would say, those aren't really a factor that's driving the multiples that we disclosed.

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [31]

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Got it. So as a follow-up to that, we wouldn't necessarily expect to see that same seasonality because you're already able to factor in, in the short-term the repayment behaviors.

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Richard Scott Blackley, Capital One Financial Corporation - CFO [32]

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Yes. Broadly speaking, all else equal, I think that's true.

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Operator [33]

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And your next question will come from Don Fandetti with Wells Fargo.

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Donald James Fandetti, Wells Fargo Securities, LLC, Research Division - Senior Analyst [34]

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Yes. Rich, there's been a lot of talk in the banking and payments industry about B2B and Capital One as the top 3 small business card issuer. Can you talk a little bit about the competitive dynamic there and what your thoughts are in terms of growth? And is that growing faster than your Consumer Business?

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Richard D. Fairbank, Capital One Financial Corporation - Founder, Chairman, CEO & President [35]

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So the -- our Small Business business, we don't break that out separately. We are -- as we are in the consumer side, one of the top players in the league table. In that particular space, AMEX is way north of the rest of us, unlike the shorter distance between competitors on the consumer side. But that business is a business that a simple extrapolate -- a simple transfer of a consumer approach or a lift and shift of a commercial approach ends up being a suboptimal thing. And the traction and success we've gotten in the Small Business space comes from really working backwards from the customer and the customer needs over a very, very long period of time. And the -- so a lot of the underlying dynamics are the same in that business in terms of the shift in payments, the reduction in cash and checks and so on. But what I would leave you with is, like our -- some of the other investments we've made at Capital One, this is many years kind of in the making, and we're continuing to generate successful growth there.

The one thing I would say is that on both the consumer side and certainly the Small Business and the commercial side, the change that is going on in payments is breathtaking. I think it's really at the vortex of technology change in all of banking. And that's partly because the digitization of transactions is a very natural place to go. But it's also one of the places that is not regulated or is very lightly regulated. And furthermore, it is the place where many tech companies who really don't want to be carrying around bank holding company badges and things like that focus on how they can try to win on the front end of banking and leave a lot of the back end of banking to the banks. So I'm excited by the opportunity in -- on the business side as well as the consumer side, but I'm certainly struck by the breathtaking rate of change. And I think for every player in the business, there is a real imperative to come up with a strategy and work backwards from where the world is going, instead of forward from where we are.

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Operator [36]

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Next question will come from John Hecht with Jefferies.

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John Hecht, Jefferies LLC, Research Division - MD & Equity Analyst [37]

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Just not looking for guidance, but just thinking conceptually long term. It would seem logical that you could do more digital customer aggregation with the digital bank in place. With that, is it fair to think that customer acquisition costs, the costs tied to physical mailings and so forth may be more efficient going forward?

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Richard D. Fairbank, Capital One Financial Corporation - Founder, Chairman, CEO & President [38]

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I want to make sure, John, could you explain a little bit more of your question again.

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John Hecht, Jefferies LLC, Research Division - MD & Equity Analyst [39]

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It's just you guys have invested a lot more to digital banking platform, and it's clear to us that as a user of your website, you can do more online. And so the question is, given that your consumers can do more online, are there cross-selling opportunities? Are there other opportunities to reduce your customer acquisition costs for specific product?

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Richard D. Fairbank, Capital One Financial Corporation - Founder, Chairman, CEO & President [40]

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Yes. So from the -- interestingly, from the founding notion of this company, one of the founding notions was that marketing is going to be reinvented by the technology and information revolution. And so way back with old-fashioned direct mail, we set out to build a business. And we also didn't have a -- it was by being very small, we didn't have much of a cross-sell opportunity. So much of the heritage of the company for a long period of time was focused on the origination of business.

And one of the great prizes that awaited us over time was to have a scale franchise, and there are 2 parts of that. One is to really be large, but the other is to be a franchise. And if you overlay the whole digital revolution on that, I want to redouble your point that, I think, the opportunity that awaits the companies who have -- who bring 3 things to the table is extraordinary. One is the table stakes is you really need to be large. And however important scale was in the past, it is more important every day, and I believe it was very important in the past. The second thing that one needs to bring to the table is great digital capability. And that's not just in terms of nice apps and that kind of thing, but also the information-based capabilities, which increasingly are very benefited by real-time big data and the use of machine learning. So there's a great opportunity there. That's the second leg of the stool, if you will.

But I really, really -- what we believed at the outset and what we certainly live every day is there's a third leg of the stool. And that is that you have to have a loyal customer franchise. Just having eyeballs lying around, just having a large customer base, it's nice. But the nonlinear things that happened when there is a deep and loyal franchise is a great thing. If you look at the essence of Capital One strategy over all of these years, we started with nothing and spent years and years in the quest for scale. Secondly, we have -- starting with an information-based strategy many years ago and really -- and that was again pre-Internet and all of that. But where we've come over time, the whole tech transformation, driving toward great digital capability and real time machine learning, big data capability.

And then finally, and maybe of all of them, this is the hardest one to build is really building that loyal customer franchise, which is all about a great customer experience, products that people can rely on, a customer relationship that to tell your friends about and ultimately a brand that stands out. And I appreciate your question because that has been 3 legs of the strategy for many, many years. And I think the growing traction that we're having on a lot of fronts, including on the financial side, is a product of that opportunity. And I think the -- there's a lot more upside from here.

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Operator [41]

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Your next question will come from Brian Hogan with William Blair.

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Brian Dean Hogan, William Blair & Company L.L.C., Research Division - Associate [42]

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First question is on the competition and your views on the Apple Card and the potential pressure that could come from that large competitor and the growth has been pretty dramatic in the first years. And then a follow-up on that is actually potential competition from like the challenger banks like Chime, Varo, N26 and others, are you seeing any customer losses from those?

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Richard D. Fairbank, Capital One Financial Corporation - Founder, Chairman, CEO & President [43]

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Right. So Brian, your questions about competition are focused really more on the sort of the tech side and the new innovation as opposed to just the -- let me start with just a comment about competition in general in the card business, and then let me pivot to some specific things. The credit card business, I think, had -- I think back to the founding of Capital One is I would say that Capital One is a very young company the most -- compared to most of our bank competitors. They've been around for over 100 years. In Capital One's case, it's not an accident that we started with credit cards because we had a belief way back then that credit cards structurally had a number of advantages that would allow them to have very good earnings power and also be absolutely at the tip of the spear of where the whole tech revolution and information revolution were taking it.

It is funny over 25 years into this journey, I'm finding a lot of the same observations that we had before. And I think the credit card as a business is kind of standing out in these times relative to the earnings power of the business like this as well as some of the growth opportunity that it has. That said, that insight is not lost on our competitors, and this is a very competitive business. But because of the scale requirements in the business, it's a very consolidated business. And I think most of the competition revolves around the top 10 players in the business. And I think the competition is intense, but I think it's fundamentally rational. But the intent shows up in the marketing intensity, rewards offers, pricing and various things. But if we pull way up and I cross-calibrate to other parts of banking in which we play, this feels like the area with the highest opportunity and the most kind of rational marketplace at the moment.

Let me pivot to the tech marketplace. Often we're asked by investors about fintechs and what about this start-up and that start-up. And of course, we keep an eye on that. I think the sort of elephant in the room is the gigantic tech companies and the sort of opportunities that they have. And so we've always had a lot of respect for that. And frankly, our tech transformation is motivated in many ways by trying to emulate and learn from some of the best practices of those companies. It certainly has our attention when Apple launches the Apple Card, I think it was a really, really well-done marketing campaign, which is universally what we've observed from Apple for many, many years. And we'll keep an eye on that, but I would say that now adds to the list of impressive competitors and impressive offerings that we are up against.

If we pivot to the challenger banks that are out there, so I'm going to switch more to the deposit and banking side of the business. There's some really striking numbers that have been posted by companies that are trying to establish themselves in banking. We know from having spent a lot of years doing this, and right now having a national banking strategy and you see us on television, it is a really hard thing to dislodge business from the established banks with great scale and local presence. And so that all of us are working very hard on that. I have been struck by the numbers of account originations that are coming out of some of the challenger banks. The biggest question I have, and I don't know the answer, it was just a question I have is how much activity level and true sustaining traction do they have? I'm not saying they don't. I think it's something that is an important place to look. But we're inspired by some of the innovation our competitors are doing, and it's a reminder to all of us that if we really lean into tech innovation, there's an opportunity to chip away at the extraordinary position that a few of the biggest banks in the U.S. have.

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Operator [44]

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And your final question in the evening will come from Eric Wasserstrom with UBS.

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Eric Edmund Wasserstrom, UBS Investment Bank, Research Division - MD & Consumer Finance Analyst [45]

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Okay. Rich, in your commentary, you alluded to the fact that competition in the auto space intensified to some extent. Can you just give us a little more insight on what you're referring to and what way is that manifested? And then I have one quick unrelated follow-up.

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Richard D. Fairbank, Capital One Financial Corporation - Founder, Chairman, CEO & President [46]

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Yes. So the auto business has a relatively small number of very large players. And I've often said, Eric, that competition in auto is even more impactful than -- in the short term than competition in card only because on the auto side, you have a dealer in the middle of an auction. And when the dealer sees something from a particular lender like a looser credit policy or a different pricing, the dealer can drive a significant amount of business in a way that just doesn't happen in the one-to-one marketing that happens on the card side. So it's why almost every conversation that we have about auto and every time we celebrate a particular growth that we have, we always caution how big that factor is and how much that factor can create adverse selection if people are loosening their credit policies.

So what we do is we invest heavily in technology in this business, and we're absolutely, every quarter, we're out there to get whatever opportunity we can have consistent with our own standards and with a very, very watchful eye on the competition. In the last -- over the last few years, there was a pullback of a couple of competitors that we took advantage of. Both of them have certainly returned and are pretty aggressive players in the space. And what we would describe to you is that the competition is increasing in the auto space. It's nothing to wave red flags about. But it's generally increasing. And the -- it's a little bit unusual that at the same time we're saying competition is increasing that we're also saying we -- our originations and even our book of business overall actually increasing. That is something that may be a little bit anomalous.

There is also something hard for us to tease out is the growing traction that we're getting by the very heavy investment we have in technology in the auto business. That's in terms of underwriting real-time big data-driven underwriting, the creation of products for customers and dealers in this space that are very sophisticated tech-driven products that actually have real-time mass scoring of any car anywhere across the nation and the continued success that we've had in building deep dealer relationships. So particularly kind of good quarter for Capital One. But I think the impression I would leave you is, the competitive meter is rising, and we'll have to keep an eye on that. And the other very important thing that is probably the most important thing that we all should keep in mind in this business is that the auto business has been credit performance.

I'm speaking of the industry now has been benign for a long period of time. And at the top of the list as why that is so is what has happened, what is going on with used car prices which have been stayed at a relatively high level for a long period of time. This is a collateral-driven business. I also think when you have businesses where the collateral values have been high for a long period of time, one have to -- we have to ask ourselves what collateral assumptions -- collateral value assumptions are underwriters making across the industry. I'll tell you what we do, and we assume they're going down. I can't speak for the whole industry, but I just want to put a caution that we've had good times for a long time in that business and collateral values have been an unusually strong ally and won't forever.

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Eric Edmund Wasserstrom, UBS Investment Bank, Research Division - MD & Consumer Finance Analyst [47]

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And my very quick follow-up, Scott, is just on the tax rate. It looked like it came in around 19% in this quarter or so. How should -- was there anything special in this period, some true-up or something? And how should we think about the appropriate rate going forward?

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Richard Scott Blackley, Capital One Financial Corporation - CFO [48]

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Yes. Let me comment on more of the full year tax rate because that's why I would point you to the full year tax rate was about 19.5%. I would say that's a reasonable baseline. It's going to be plus or minus from there depending on the income levels, evolutions in our credit, the businesses that generate tax credits, but nothing particularly large. We did have some discretes in the quarter, which drove down the quarterly rate, but 19.5% a good starting point for how you should think about the future.

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Jeff Norris, Capital One Financial Corporation - SVP, Global Finance [49]

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Thanks, Scott, and thanks, everyone, for joining us on the conference call today. Thank you for your interest in Capital One. The Investor Relations team will be here this evening to answer some follow-up questions that you might have. Have a great evening, everybody.

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Operator [50]

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Once again, that does conclude our call for today. Thank you for your participation. You may now disconnect.