Welcome to the Capital One Fourth Quarter 2016 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. [Operator Instructions] I would now like to turn the conference over to Mr. Jeff Norris, Senior Vice President of Global Finance.

Sir, you may begin..

Thanks very much, Anne, and welcome, everyone, to Capital One's Fourth Quarter 2016 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 2016 results. With me today are Mr. Richard Fairbank, Capital One's Chairman and Chief Executive Officer; Mr. Steve Crawford, Head of Finance and Corporate Development; and Mr. Scott Blackley, Capital One's Chief Financial Officer.

Rich and Scott will walk you through the presentation. To access a copy of the presentation and the press release, please go to Capital One's website, click on Investors, and 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 Factors section in our annual and quarterly reports, accessible at the Capital One website and filed with the SEC. Also note that this presentation may include a discussion of certain non-GAAP measures.

You can find a reconciliation of these measures to GAAP financial measures in our SEC filings and in the financial supplement available on our website. And with that, I'll turn the call over to Mr. Blackley.

Scott?.

Thanks Jeff. Let me begin tonight with Slide 3. Capital One earned $791 million or a $1.45 per share in the fourth quarter. Pre-provision earnings were down from the third quarter as higher revenues were more than offset by higher marketing and operating expenses driven by seasonal and growth related costs.

Noninterest income in the quarter was negatively impacted by $42 million of accounting hedge and effectiveness driven by the magnitude and shape of the rate changes in the quarter. Provision for credit losses increased as the smaller allowance build compared to the third quarter was more than offset by higher charge-offs.

Notable items in the quarter included the following; a build in our U.K.

payment protection insurance customer refund reserve of $44 million or $0.09 a share, an impairment charge associated with certain acquired intangibles and software assets of $28 million or $0.04 a share, and an allowance build in our auto business reflecting a change in accounting estimate of the timing of charge-offs of bankrupt borrowers of $62 million or $0.08 per share.

Turning to full-year 2016 results, Capital One earned $3.8 billion or $6.89 per share. Pre-provision earnings of $11.9 billion were up 15% year-over-year as higher revenues were partially offset by higher noninterest expense.

Net income for 2016 was down 7% as higher pre-provision earnings were more than offset by additional provision for credit losses. Full-year efficiency ratio was 52.7% excluding adjusting items down from 54.3% in 2015.

As you can see on Slide 4, reported net interest margin increased six basis points in the fourth quarter to 6.85% in line with the prior year increase and primarily driven by higher card yields.

Turning to Slide 5, as of the end of 2016 our common equity Tier 1 capital ratio on a Basel III Standardized basis was 10.1%, which reflects current phase in. On a standardized fully phased-in basis it was 9.9%. We reduced our net share account by 9 million shares in the quarter or 2%. Full-year 2016 share count came down 9%.

As you know we had an authorization to repurchase up to 2.5 billion of common stock. We've now completed 80% of our authorization at an average price of under $72 per share. With that let me turn the call over to Rich.

Rich?.

Thanks Scott. I'll begin tonight on Slide 8 of our Domestic Card business. Loan growth and purchase volume growth remained strong. Compared to the fourth quarter of last year our ending loans grew $9.2 billion or about 10%. Average loans were up $8.9 billion or about 11%. Fourth quarter purchase volume increased about 10% from the prior year.

We continue to like the return and resilience profile of the business we're booking. Revenues for the quarter increased 9% from the prior year slightly lagging average loan growth.

Even with the positive margin impacts of higher subprime mix, revenue margin declined year-over-year as expected with our exit of the back book of payment protection products at the end of the first quarter. Revenue margin for the fourth quarter was 16.8%. Domestic Card purchase volume grew 10% versus the fourth quarter of last year.

Fourth quarter net interchange revenue for the total company was flat versus the year ago quarter. As we discussed there's considerable quarterly volatility in the relationship between these two metrics.

For the past several years on an annual basis net interchange growth has been well below Domestic Card purchase volume growth and we'd expect that to continue. Noninterest expense increased just 4% compared to the prior year quarter. Our Domestic Card business continues to gain scale and improve efficiency.

As we discussed for several quarters the dominant driver of year-over-year charge-off rate trends is growth math which is the upward pressure on delinquencies and charge-offs as new loan balances in our front book season and become a larger proportion of our overall portfolio relative to the older and highly seasoned back book.

In the fourth quarter growth math drove the increase in charge-off rate compared to the prior year. Seasonality and growth math drove the increase in charge-off rate compared to the linked quarter. For the full year 2016 charge-off rate was 4.16% in line with our guidance.

We continue to expect full-year 2017 charge-off rate to be in the mid-4 with quarterly variability. Growth math remains the largest driver of expected trends in the 2017 charge-off rate. Growth math began to impact charge-off rates in 2015.

In terms of contribution the year-over-year change in the charge-off rate, the peak impact of growth math was in 2016. We expect the impact to moderate in 2017 especially in the second half of the year. Beyond 2017, we expect growth math will have only a modest effect.

As an update on our Cabela's transaction, we do not expect to receive regulatory approval prior to October 3, 2017. This is the day when any of the parties involved in either the retailer deal or the bank deal can choose to terminate the transaction.

Within the next week or so we expect to either withdraw our bank merger act application or have our application denied by the OCC. Ordinarily a bank would withdraw its application before receiving a denial but in this case our bank deal is tied up with the retailer deal which requires us to get consent from Cabela's in order to withdraw.

In either case whether we withdraw application or it is denied we will not be in a position to refile our application until after we have completed our work under the AML consent order. We remain committed to this deal and we will continue to work with Cabela's and Bass Pro toward completing the transaction.

Pulling up, we continue to see attractive growth opportunities in our Domestic Card business but the marketplace is moving. Competitive intensity across the card business remains high and revolving credit has been growing at about 7% year-over-year meaningfully faster than household income growth.

As these trends continue, we believe the Domestic Card industry has moved into the more intense part of the competitive cycle. Now against this backdrop we continue to monitor the marketplace vigilantly and we continue to dynamically manage our origination and underwriting and anticipation.

We believe the growth window of opportunity remains open but it's clear that this opportunity won't last forever. Slide 9 summarizes fourth quarter results from our consumer banking business. Ending loans grew about 4% compared to the prior year. Growth in auto loans was partially offset by planned mortgage runoff.

Ending deposits were up about 5% versus the prior-year. Fourth quarter auto originations were $6.5 billion with strong growth in prime, near prime and subprime.

Some of the aggressive competitor practices have moderated somewhat but we see opportunities for continuing growth the auto market and competitor practices remain dynamic and we will be very vigilant. Similar to our Domestic Card growth, we like the earnings profile and resilience of the auto business that we're booking.

Our underwriting assumption include a decline in used car prices. We continue to focus on resilient originations and we continue to expect a gradual decrease in margins and a gradual increase in charge-off as the cycle plays out.

We also expect upward pressure on the auto charge-off rate as a result of the accounting treatment of bankrupt accounts that got discussed. Consumer banking revenue for the quarter increased about 3% from the fourth quarter of last year.

Higher revenue from growth in auto loans and higher deposit volumes was partially offset by margin compression in auto and planned runoff of mortgage balance. Noninterest expense for the quarter increased 5% compared to the prior-year quarter driven by growth in auto loans and an increase in retail deposit marketing.

For the full year we recognized about $160 million in branch optimization cost in line with our expectation. These costs show up in the other category rather than in the consumer banking segment.

Fourth quarter provision for credit losses was up from the prior-year primarily as a result of charge-offs in addition to the allowance for loan losses for the auto portfolio. We expect that several factors will continue to negatively affect consumer banking financial results.

In the home loan business planned mortgage runoff continues and in auto finance we expect that margins will continue to decrease modestly and net charge-off rate will rise. Moving to Slide 10 I'll discuss our commercial banking business. Fourth quarter ending loan balances increased 6% year-over-year driven by growth in selected industry specialty.

Average loans increased 16% year-over-year. Average loan growth resulted primarily from the acquisition of the GE healthcare business in the fourth quarter of 2015. Revenue grew 18% from the fourth quarter of 2015 and noninterest expense was up 15% consistent with the growth in average loan.

Provision for credit losses declined 52 million from the fourth quarter of last year as allowance release driven by the impact of higher oil and gas prices was partially offset by higher charge-offs. Fourth quarter charge-offs were primarily driven by continuing pressure in our taxi medallion portfolio.

The charge-off rate for the quarter was 47 basis points. Criticized and nonperforming loans rate were stable in the quarter. The commercial bank criticized performing loan rate for the quarter was 3.7% and the criticized nonperforming loan rate was 1.5%. Credit pressures continue to be focused in the oil and gas and taxi medallion portfolio.

We've provided summaries of loans, exposures, reserves and other metrics for these portfolios on Slide 14 and 15. I'll close tonight with some thoughts on fourth quarter result and our outlook as we head into 2017.

We posted another quarter of strong growth in Domestic Card loan balances and purchase volumes, as well as growth in auto and commercial loans driving strong year-over-year growth in revenue and related increases in operating expense and provision for credit loss.

We've been working hard to improve the efficiency by growing revenues realizing analog cost savings and other efficiency gains as we become a more digital company and tightly managing costs across the enterprise. Our efforts are paying off.

Our efficiency ratio for the full year 2016 was 52.7% net of adjusting items an improvement of 164 basis point from 2015. We continue to expect that our near-term annual efficiency ratio excluding adjusting items will be in the 52s plus or minus a reasonable margin of volatility.

Over the longer term we continue to believe that we should be able to achieve gradual efficiency improvement driven by growth and digital productivity gains. Pulling up our strong growth over the last two years puts us in a position to deliver solid EPS growth in 2017 assuming no substantial change in the broader credit and economic cycle.

We expect that revenue will grow and will drive growth in pre-provision earnings as well. We expect the upward pressure from growth math on the allowance for loan losses will moderate and we're reducing share count.

We continue to be in a strong position to deliver attractive growth in return as well as significant capital distribution subject to regulatory approval. Now Scott, Steve and I will be happy to answer your questions..

[Operator Instructions] And we’ll go ahead and take our first question from Sanjay Sakhrani with KBW..

Thanks. Rich, you mentioned the Domestic Credit market is in the intense part of the competitive cycle, I guess.

When we think about how that impacts the growth trajectory looking out to 2017, should we expect the growth rate to moderate because of that?.

I think that it will contribute to a - I think this window is still open but as I've been saying kind of every consecutive quarter you know this thing won't stay open forever so I’ll leave you with two points.

One, we're still all-in in pursuing the window but I think that but let me comment for a bit just about the kind of natural physics that go along with the what's happening on the supply side. First of all just to comment on the supply side.

You know after a number of years post the great recession where the growth of revolving debt was near zero or even negative, it is crept up in the last couple of years and now it is running at a 7% year-over-year rate and obviously that's a faster growth rate than the economy is doing.

And if you look at this growth it is broad-based although subprime growth has picked up and is now growing faster than prime. So currently if you exclude Capital One's impact on the metric about 34% of the industry's growth is in subprime and subprime card loans are growing 13% year-over-year versus prime which is growing about 6% year-over-year.

Now I really want to stress this is off – and particularly in the subprime side off of a - much lower base following the great recession, so let's just ground that a little bit. We went back and looked at the data here, prime loans decreased 12% from prerecession levels and they began growing again in 2011.

Subprime loans decreased 43% from prerecession levels and didn't start growing until 2014. So subprime industry outstandings right now are at 74% of prerecession levels and prime industry outstanding are basically right at prerecession levels.

So clearly the subprime growth is - happened later and its off of the lower bank but the growth has physics and that's what I know - I'm always focused on because when you have - consumers taking on debt and competitors you know supplying more debt that can affect both the volume and the selection quality of new origination, as well as of course you know impacting existing customers who along the way can take on more debt.

So what we do when we see that is we just - we try to manage Sanjay in anticipation of this because we view it as the physic and we are very - we've always said we can't predict the economic cycle but we really can watch and react to the credit cycle which isn’t the same thing as the economic cycle.

So we are very focused on resilient, we try to anticipate how supply changes end up making their way into the credit performance of who we might originate and if I pull way up on all of that, we can continue to make very conservative assumptions in our underwriting, we managed to a belief that we are now in the intense part of the cycle but even with all that considered we still see a important growth opportunity available for us, is the window of opportunity and we will continue to pursue it obviously with our eyes very wide open..

Thank you. My follow-up question is on the Cabela's portfolio.

So when we think about that deal, can that deal be consummated without the bank merger occurring? So could you buy the portfolio without doing the bank deal? Or is that a non-starter for Cabela's? And I guess when we think about the partner you have in on that deal, are they willing to be patient and wait for you to sort out the AML stuff?.

If we are to buy this it requires a bank merger act application and approval. Now we and Cabela's all the parties in this transaction are working incredibly hard to make this happen and obviously with respect to our own AML order which is the thing at that needs to get to for the approval to happen here, we're all in working incredibly hard.

We're working with Cabela's, we are very committed to this transaction and we believe this can be a great deal for us and for Cabela's Bass Pro..

Thank you. We’ll next move to Don Fandetti with Citi..

Yes, Scott. I just wanted to clarify, the $42 million hedge amount, I guess that's why the other segment had a negative, and in theory, I guess we add that to the adjusted revs of $6.593.

Am I thinking about that right?.

Yes, I think we experienced what I think a lot of other banks experience where the shape of the curve moved. That does go to other and it is a offset to noninterest income..

Got it.

And then Rich, real quick on the 2016 Card vintage, Domestic Cards, was curious if you had any update on how that's trending?.

We still see '16 as coming in better than 2015 so our prior statement we feel viewing that the same way..

Next question comes from David Ho with Deutsche Bank..

Hi. I just want to parse out the rate of increase in 2017, for the credit card charge-off rate, in the mid-4%s. You did mention that the growth math would slow.

At what point do you think the credit normalization impact would slow, or do you?.

What are you defining as the credit? The credit normalization impact meaning growth math..

No, just the natural re-levering of the consumer, some of the leverage impact you're seeing on the margin, just getting back from historically low levels, aside from growth math..

Look what we have tried to describe to help our investors think about the credit card growth - the trajectory of credit card charge-offs is to divide it into two very different thing. One is what we call growth math which is the impact of - on the charge-off rate of the seasoning from a acceleration in origination.

And the other is the general probably industry-wide affect that relate to the consumer, the amount of debt they're taking on and probably where things are in the economic cycle.

We said for some time now that the - that our numbers are going to be dominated by growth math and we are we're still saying that but I'm also saying that we should just all understand we are kind of at that part of the cycle where the industry I think is off the bottom with respect to the exceptionally low levels of charge-offs that we've seen from the very, very seasoned portfolios, all across the industry.

And so over the longer run our portfolio like all the card players is going to be - our performance is really going to be driven by this industry and affect but for now still the big story at Capital One is the seasoning of the - our front book and the math of how that plays out over - particularly over - as we played out in '16 and now in 2017..

And in terms of the….

Sorry, go ahead David..

Sorry. Just one more question. I was fascinated by - you bring up a very good point about leverage kind of rising above income.

Do you think that that in isolation could create an environment where consumer credit, and that space, continues to exhibit some of the lost attributes that you just called out, in absence of any kind of shock to rates, gas prices, or employment?.

I think we have to take the holistic picture here. I mean I think it is the card business has been benefited by a number of years of having relatively low growth and particularly on the subprime side a big shrinkage and a delayed growth.

So I think it's all has to be evaluated in the context of - from where it started and for how long it's been going in and where it's headed. So our primary point has been - look in the end this is physics.

The year after year just amazingly low losses it is - as we've said some quarters ago this has to be the bottom, things are going up from here all of that said you know I think that - I mean we are still - we are pursuing growth opportunities and continue to be optimistic about the originations that we can generate., So again we try to adjust based on an assumption that over time things will just gradually normalize.

We try to get in front of that anticipate that, make our origination choices in the context of that and this view that we carry around internally, we just share that with our investors. So I think we're still pretty bullish about the opportunity.

But I've said probably a year ago, I said that when I cross-calibrate all the businesses especially the parts of commercial, the auto business and the card business that the card business was in the most benign and competitively benign part of the cycle and that auto and commercial were farther along in the competitive and credit intensity.

I would say the card business is certainly, I think caught up to the others - the others interestingly have had a little bit of almost a low if you will, and some stability there but all of the businesses in pulling way out banking in general is still moving along towards the more intense part of the credit cycle. But I think card has caught up..

Next question comes from Moshe Orenbuch with Credit Suisse..

Great, Rich. Thanks.

Following up on that last answer, how should we think about the things like marketing and rewards cost growth into 2017, given that commentary? Is there going to be any reduction there? And how do you think about Capital One's kind of role in that kind of competitive dynamic?.

I want to separate in a sense the intensity of competition around the heavy spender from the commentary I gave about lending. It's really in a sense two different business, the spending business and the lending business and both are competitive, both have become more competitive.

But my commentary was really about the lending business because of the interaction between supply and ultimately the performance and things that make their way into consumers and credit performance and things over time and what I call kind of the physics of how cycles work.

The spender business is one that when I get concerned about supply and the intensity of competition, it's not a concern that is going to ripple into the credit performance. It's all a matter of the level of competition. How much it cost to get accounts, how we go out and market to get those accounts.

What is the prevailing level of rewards that people are offering and in the end what choices should we be making. So in the - so let me now comment about that business. That has also and it's - it will be a surprise to no one that say this, that has also become more competitively intense.

You have seen some players on the cash back side kind of raise their offers up to a level higher than they were before and more consistent with some of the industry leaders there. You've seen probably the most intensity is come at the very top of the market going right after the very heavy spenders and that's a very priced customer segment.

It's also very tough to prevail in that space, and that's very competitive. So we have said all along this - this market, I can't remember the last time I said that this market is not that competitive. I think it is very, very competitive and it is particularly competitive at this moment.

Now when we look at this we - and you made a comment about our role in this whole thing, I mean as there are a few players who I think have gone very heavy into the spender business and we are one of them and all of us are contributing to that competitive intensity.

But one thing I have found over the years and I believe so strongly about this business, this is a business that's about sustained commitments and building of a brand, building of a customer experience that is at the very high end a digital experience now that becomes very, very important in this thing, it's about the building a brand the marketing capabilities, and also product offer.

Now we - it is not our view to just go rush out and just keep changing product offers constantly. It is our view that we need a very good offer, which I think we have across our businesses and then the leverage is in really being great across the dimensions that I mentioned.

All of that said we continue while the competition is intense, to continue to grow that business significantly, we continue to really like what is happening to our customers when we get them and their balances, their utilization, the percentage that are first and wallet and a lot of characteristics that are key to the success of the program.

So this is going to be competitive, I don't see a real course correction for Capital One here. I think that we are continuing to be one of the players that's going hard at this space and I think that we continue to see everything that we see is consistent where this is very value creating and generating of great long-term annuities..

Thanks.

Just as a somewhat unrelated follow-up, on the Auto bankruptcy, Scott, did you say like what caused - what triggered this, and over what period of time it would have otherwise been reported?.

Yes, Moshe thanks for the question. I'm just kind of run through a summary of what we're doing. So the bankruptcy change is accelerating charge-off timing for certain bankruptcy accounts. So starting in 2017 within 60 days of receiving the notification of bankruptcy, we're going to charge that loan down to collateral value regardless of payment status.

The net impact of that as you might be able to figure out is that we'll accelerate the charge-off timing and then we're subsequently going to have an increase in recoveries. So we would expect that over time, those things are basically going to start to offset each other.

The change here is really an accounting shift and doesn't reflect a change in what we're seeing in the business for our expectations, recoveries or cash flows. We are still working through some of the process changes to implement that. So there's a bit of uncertainty as to when the exact impact will show up in charge-offs.

You'll see this in a few other process change we're making, they’re going to start impacting the auto charge-offs really in the first half of 2017. You're going to see kind of a one-time larger impact as we process our current portfolio of BK loans. That will show up in the monthly metrics. We're going to put a marker on that so that you can see it.

And then in terms of why, really this is something where I think our past practice has been pretty much where others have been in the industry. We're moving to a more conservative practice. I think that's really consistent with how regulators prefer big banks like us to manage things..

Next question comes from Ryan Nash with Goldman Sachs..

Hi, good evening, guys. Rich, in the past you used the phrase uncoiling the spring. I'm not sure if you referenced solid EPS growth on the call.

But, I was wondering, do you still feel confident that we could see an acceleration in EPS growth? Or do you feel that the competitive pressures that you've talked about, from either the window closening or too much supply coming to the market, are going to prevent us from inevitably seeing that?.

I feel great about our prospects for generating earnings power from the coiled spring of growth that really three years of growth in the card business, where we have gone all into seize the opportunity when we really like this opportunity and you have watched the, pretty breathtaking upfront costs of doing that particularly in terms of - on the credit side, both the front-loaded - the front-loaded nature of credit cost in what we originate but then of course that even being more front loaded by the allowance builds that precede that.

So that creates quite a coiled spring of earnings power and while it is true that the industry dynamics always are at play here, I think there is a lot of coiled earnings power here and while the precise levels of exactly how would, how it delivers itself always depends on industry things too.

This is a pretty big effect and I do look forward to having the in a sense the potential energy that's been stored up in this spring to turn into the kinetic energy of earnings..

Got it. Maybe just one follow-up. Rich, you talked about all the progress that you made on efficiency this year, with over 160 basis points.

When I think about the outlook today versus the last time we heard you speak, we've obviously seen the outlook for interest rates improve a lot, which I know historically was a headwind to efficiency gains in prior years. You talked about $160 million of Branch optimization costs, which I would assume likely won't repeat.

Can you just give us a sense of, what are the incremental investments that you're being forced to make that are preventing you from making further efficiency gains this year relative to what you did in 2016? Thanks..

So I don't feel we're being forced to make a lot of incremental investments.

We are certainly continuing to invest important places we're investing is as we talk, many, many times is on the digital side and it's - as I've said for a long time the digital transformation of us really into operating like a technology company that's not a one or two or three years thing that is, that is the transformation that - that in many ways the lifetime transformation because the world will continue to change.

What I do want to say about that though is, while we continue to invest in that business.

The very visible well, there are many benefits including growth and customer experience and ability to have an increasingly well controlled environment and compliance, the associated experience and all the stuff there are many benefits the meter, if you will of visible cost benefits that we're able to achieve directly as a result of the digital investments that meter is also growing too.

So we don't have any change to share with you in terms of our outlook in the near term relative to efficiency ratio.

But what we see – benefit that one of which is on the cost side, I think it is going to be a good guy that's going to help us over the long-term continue to achieve increased efficiency in the company, even as we also go out and capitalize on the enormous benefits that come from this digital transformation..

Next question comes from Betsy Graseck with Morgan Stanley..

Hi good evening. Question just on the efficiency topic you were talking about.

Expectation is that it remains around 52%, which what I hear in that is, that you're expecting the - that any expense build is going to be in line with revenues, or is it the other way around? I mean, with marketing in particular, do you anticipate maybe a near term continuation of an uplift driving revenues, and then feeding the revenue growth behind it to hit that 52%?.

Well first of all, I want to say the guidance is in the 52s plus or minus reasonable variant of uncertainty there. But so we do believe that we're continuing to capitalize on the growth window.

I think our marketing investment is going to be still pretty significant when you look at the competitive levels on the one hand but also the opportunity on the other hand. I think marketing investment is certainly going to be there and I have commented on some of the other investments.

But I think when you pull up on all of it, which is a growth agenda and investment agenda and a whole bunch of savings that are also happening in the mix master, it nets out to an expectation of efficiency ratio in the 52s over the near term..

And then on the provision side, you talked about Domestic Card 4.5%-ish, in that range. Is that -- we get typical seasonality throughout the year, I would expect.

But is there anything else that would drive how that NCO is likely to traject throughout the year besides just seasonality?.

Yes. So if you - so the two things - so seasonality we would expect to be the typical seasonality effect. We have talked about growth math on an annual basis that growth math being the upward, the upward pressure on charge-offs that comes from the seasoning of this front book of substantial originations.

So, we've described, its biggest effect is in 2016 it still has an important effect in '17 and then it becomes pretty modest after that, that speaking one year at a time. If you look within a year it tends to move okay.

That it's a bigger effect in the first part of this year then it is in the latter part of the year, just not as a seasonal thing, but consistent with the fact that this is gradually diminishing as an effect. So that, so that in addition to seasonality I think it's useful to put a little slope on the growth math effect over the course of the year..

One thing - Betsy this is Scott, one thing I do want to clarify our guidance is that losses in 2017, are going to be in the mid-4s. I think you put out a point estimate we've intentionally used mid-4s..

Next question comes from Eric Wasserstrom with Guggenheim Securities..

Thanks for taking my questions. Just a couple of small follow-ups on Auto. Rich, you mentioned that the competitive environment there is improving a little bit, and I think you made similar commentary last quarter.

If we can just understand in what form you're seeing that, is that on pricing or on rate? Or, how is that manifesting itself?.

Okay. First of all, we should use a small letters not capital letters, with respect to this effect.

It is - and we made a pretty big deal - we spoke with some alarm really about a year ago and you may remember it was in the year ago quarter that our originations I think our subprime originations dropped and then it dropped pretty materially at that time because we were alarmed about the underwriting practices that we started to see in the marketplace but not by most players but on a more isolated but important basis, we saw in one or two cases and it one or two competitors.

That was more of a subprime phenomenon. It related to the amount of documentation and data that was going to be required to underwrite a loan and willingness to do it on a more low doc basis, which we didn't want to go there. That has not disappeared. That has mitigated if you will, so that we see the effect, but it is not as rampant as it was a year.

So that is improving with a small eye if you will. Okay, but certainly don't - and then the other, the other thing that's going on I think in the prime part of the marketplace which has been very competitive in many ways, probably a little bit more competitive than cycle average, if you look at some of the effects on the margin side.

I think there might be just a tiny bit of easing maybe about related to and I'm speculating here with respect to maybe certain capital requirements for players and the attractiveness of prime auto relative to that, this is again a relatively small effect, but certainly I would say the kind of steady - in steadily increasing pressure on the - competitively on the prime side has lightened up a little bit, but it's not, it's not a big effect but it was enough that we who especially when we talk about the auto business, we take what the market will give us and we don't take anything more than it will give us and buy and in the context of that, we've just found that this year it's got a little bit more to give us..

Great. Thanks for that.

And just on the - backing out the bankruptcy effect from this change in recognition, is there any change in your underlying you view on credit evolution?.

No, so if you separate that effect, we have said even obviously that the bankruptcy accounting effect that raises the expected number for next year. If you take that effect out, we do still expect that our charge-offs will be higher next year than this year.

This is actually just a continuation of the kind of normalizing effect it's been going on for a number of years.

And as we've mentioned over the years, we have seen and probably over the last few years, just a - each year successive vintage coming in just a little bit higher in terms of credit losses than the year before all very much consistent with very good business and all of that and is again the natural physics of kind of how the marketplace works.

And the other thing on Capital One's loss rate is that we have for years our prime percentage in our portfolio has been going up and so that has - that's been an offsetting factor in the loss rate but as we've said over a number of years, there is still this gradual normalization that's going on and we still feel very good about the opportunity in the business..

I just want to pile on, I mentioned this earlier, but I just want to reiterate that the change that we made in accounting really was not associated with new or different view about recoveries or how we look at that and really was just moving to a more conservative process in that business..

Next question comes from Chris Brendler with Stifel..

Hi. Thanks. Good afternoon. On the net interchange growth of just 1%, I understand that it can be volatile on a quarter-to-quarter basis.

I just want to make sure I'm clear here, that roughly 9% growth for the year, is that a good run rate? And can you just help us figure out or explain what drives that quarter-to-quarter volatility? I think in the past it may have been expansion of rewards programs or tweaking rewards programs.

Just given the level of investor concern about rewards costs these days, any comment there would be he helpful..

Okay. So first of all - and we've always said the quarterly this thing balances all over the place and this is - you can't draw a lot. So I want to talk a little bit about the volatility and then let's talk about sort of the bigger picture though trends that are going on.

So quarterly it can fluctuate because an individual quarters we update our rewards liability based on points earned and redeem, redemption mix, redemption rates. It includes partnership contractual payments, international card, consumer bank net interchange. And so, there are lot of things that go into the quarterly number.

What we have said is this phenomenon of interchange - net interchange growth being well below purchase volume growth, I think is something that while individual quarters can bounce around that is a real effect that's been going on for the last couple of years and we would expect it to continue.

We're building a long-term franchise by upgrading rewards products for our existing rewards customers, we're extending rewards products to some existing customers who don't have rewards very importantly of course we're originating a lot of new business with strong flagship products like Quicksilver Venture, our spot products for small business that have very attractive rewards.

So our continued investment in the business and continuing to build a franchise that affect will continue.

The other thing that has gone on – on a rolling basis over the course of this the past four, three or four quarters is what's happened with respect to a few a small number of merchant deals where interchange was renegotiated downward and that there is two ways that plays into our portfolio.

One is when the interchange rate drops, obviously we feel that effect but there is kind of a lasting effect too because the handful of merchants where this interchange became lower are also growing faster than the economy.

And so their growth will over time continue to roll through our numbers, so pulling way up, we continue to be very bullish about the opportunity to grow our spender business, all of our calculations are with our eyes wide open about the fact that net interchange growth is going to lag the pretty eye-popping growth.

We've been able to get in the - on the reward side of the business, but when we incorporate the full economics of our spenders and we have years and years of experience with this and lots of tests and rollouts and many, many things that the integrated economics for Capital One given the franchise that we have built, I think continues to be very attractive even in the context where there is will be a delta between purchase volume growth and net interchange growth at least in the in the foreseeable future..

That's helpful. Thank you. And then, a follow-up on a related basis. The U.K. business has seen some interchange reductions. I assume that's filtering through there. But I'm surprised International Card was not broken out separately in the release.

Any signaling there? And also, I'm also surprised that the weaker pound isn't having a more dramatic effect on the outstandings in that segment, just because it would seem like the underlying growth, actually, is a little stronger, just given how much the pound has been hit..

Hi Chris, this is Scott. Yes, so on the international given that component of our total card businesses just gotten continued to be smaller and smaller, we no longer felt like it was important to material for us to break that out separately. So going forward, you'll see us having total card and Domestic Card.

We're not going to separately break out Canada or the U.K. so you'll see that kind of working its way through our monthly metrics and the rest of our financial reporting starting with our 10-K..

Next question comes from Bill Carcache with Nomura Instinet. Please go ahead..

Thank you. Rich, I wanted to follow up on your comments around subprime growth in Card. In looking through the public filings, it doesn't seem like the larger players are increasing their sub-660 FICO exposure.

So, I wondered whether you were perhaps seeing smaller players growing in subprime? Can you comment on where the supply is coming from?.

It is coming from all of the above. It is definitely coming in some of the larger players. And I can't speak to their back books, what I can speak to is the good solid data we have on what is happening in the origination marketplace and there has been.

And the data that I gave you, that is excludes Capital One therefore, by definition is the industry, but, and I think you've actually seen a player to comment on, stepping up a little bit here and I don't want to overdose with the point. This is off relatively small base.

And it is in the context of some other players also growing probably across the board, all the way from the top of the market but there is a tail that is extending into the - below 660 marketplace that is real and these are real customers picking up more debt and we also validate this too when we look - we can follow the industry's trends with our own customers by looking at the credit - while beyond, looking at our own customers and what are their balances we look on collectively all of their credit bureau reports and see what's happening there.

And we see that same phenomenon that is in the industry data, it would be shocking if we didn't. But we can see some increase and these are relatively small effects but some increase in indebtedness for example in our own customer base..

Understood. That's very helpful. Thank you. Separately, if I could throw in a question about capital. If we were to stick with standardized, how much room is they for your CET1 ratio to fall below, call it the 10% range? Obviously, some regionals are running below that, but they don't have as much exposure in Cards.

I was hoping you could share with us a little bit about how you're thinking about that..

Yes, I don't want to front run the process on capital, I think we understand the importance of capital return, I think we've been very creative in our process, whether it was - I think the first to use the de minimis exception last year front-loading, stock repurchases this year at attractive valuations.

I think one of the things we're actually most pleased about is the fact that we've been able to put a lot of capital to work organically and acquisitions, which I know this is a market that particularly in the financial services industry, good growth has been hard to come by.

So, I’ll end where were Rich ends, where Rich ended his prepared comments with the profitability that we have we believe we can both continue to fund growth and return a good amount of capital to our investors and we think we can do that even though there is still a fair amount of uncertainty in the environment with respect to the regulatory front.

How CCAR is going to change, what's going to happen to Basel IV, Cecil, some of the other long-term factors that are going to drive the way we allocate capital..

Next question comes from Matt Burnell with Wells Fargo..

Thanks for taking my question. Scott, maybe just a quick one for you. In terms of the bankruptcy change, just want to make sure that what you're - what I think you're saying is, that the reserves that you took in this quarter are basically the entire effect that you think you'll see in terms of the provision that will be needed for the Auto portfolio.

Then going forward, it's just - it's effectively business as usual in that business, other than the bankruptcy effect on the loss rate itself.

Correct?.

Now you've got that right and just to kind of repeat that to make sure we've got that clear. So the allowance build reflected kind of the change that we saw in accelerating losses into the allowance window. So I think that's going to cover the vast majority of the effect.

And so I mentioned, we'll start to see recoveries come in overtime and offset that increase. So, you will see a bubble in '17 and then you'll see that start to settle down..

Okay. And then for my follow-up, just a question on the revenue margin. Obviously, that came down about 30 basis points this year, year-versus-year because of the U.K. portfolio. How are you thinking about that margin going forward? Is there going to be the same effect on revenue margin in the card business from the U.K.

portfolio in 2017, as we saw in 2016?.

I'm sorry, just to clarify, are you talking about the year-over-year decline in the Domestic Card revenue margin?.

Yes..

So the Domestic Card revenue margin won't be affected by U.K.'s PPI..

Okay. My mistake.

But, is your outlook for that going to be basically flat? Or is it going to continue to come down because of the competitive pressures?.

Matt, we have really gotten into forecasting revenue margin by line of business.

I think what we've done is kind of pulled up and look at the things that are driving margin for the company overall and general rates going to be a positive assuming forwards play out the way that they have that hasn't happened in the past, but I think there is more feeling that rates could actually mature the way that the forwards are expected.

I mean if you look we've gotten benefits from a higher mix of card and a lower mix of mortgage. So I'll let you know make your own forecast there in terms of mix probably being a beneficiary. There have been some, as Rich mentioned these were throughout his comments there's also been a little bit of rate pressure on auto and normalization there.

So it's kind of - the story hasn't really changed over the last couple of years. We've gone out and made big predictions about potential changes in revenue margin and ultimately they been pretty flat. So that's made us a little bit less bold.

I think you have all of the factors that you have to think about the major things are going to drive net interest margin for the company..

Next question comes from Ken Bruce with Bank of America..

Thanks. Good evening. Appreciate all your comments in trying to tease out some of the moving pieces here. I guess, in the context of transactors, in particular, you kind of point out that the economics of that business are still very attractive.

I think many of us are concerned that they look attractive to everybody, and so that there's going to continue to be this pressure on the rewards and the various incentives used to kind of acquire those cards.

Is there a way to frame, in your mind, kind of how that annuity looks today versus maybe five years prior to now? Does it take you 30% longer to effectively have a positive NPV out of those cards? Can you give us some sense as to how it's -- kind of the timeliness of the economics on that business?.

Ken I think this annuity - look I want to go back to - this has been incredibly intensely competitive for a long time.

We see that there is a flurry right now with respect to a few products, some breathtaking giveaways in terms of - for a period of time up front miles and things like that but the - first of all I just seen anything ebb-and-flow over time a lot.

The second thing I would say is in many ways our own - when we look at these annuities in many ways they are improving every year for Capital One because of the investments that we're making to really build the business I want to go back to the part that I think you all see - the world sees so much is what is being offered in terms of rewards and obviously that has become more competitive.

But the - for the last several years we've been offering pretty much the same rewards products and so you know we've already internalizing those economic.

The reason I say this is an all in business that it doesn't work to just bounce in and bounce out is what incredibly important is things like the - how long these annuities last, what is the attrition rate, what is the first in wallet rate, what is the mix, the profile of how heavy your spenders are when you're getting them, what is happening to customer metrics on customer satisfaction, net promoter scores, the digital experience, and we have had nothing but progress year-after-year on this and our own annuities are actually getting better and better and actually more economically attractive.

It’s not to say I don't worry a lot about competition and focus on that and we talk about it all the time but this is about franchises and people can't will themselves in the franchises overnight is taken us a number of years to build it and I have a lot of respect for the competitors who are going after this space and there's some great players that are doing this but this is attractive business for those who have built a franchise and I'm as excited today about it as I was three months ago, six months ago and one year ago..

Understood. I think I get a sense of that. Okay. And just a quick follow-up. Looking at the subprime growth in the portfolio, it's been roughly over two times kind of the prime growth on the revolver side, U.S. Card business. And, I can hear the caution that you're kind of trying to lead us to in terms of kind of where we are in the cycle.

I appreciate that.

Does, in your mind, that need to slow in order to kind of achieve some of the -- kind of the lower growth math impacts that you're talking about for 2017 and 2018?.

Ken you known me for many, many years. We obsess in the best of times. We obsess about everything credit because in the worst of times is too late to be obsessing about everything credit. So I remember one of our leading investor called me Dr. Doom in the 90s because I kept focusing on that even though we're in such an amazing kind of boom time.

My point is these are all effects that play out over a course of years.

My real point has been that just people need to watch all the metrics as I’ve been saying for a lot of quarters and we really believe there is power that you can manage - to say something I said earlier it's hard to predict economic cycles but there's a lot of leverage in managing within the credit cycle.

And so I give you a calibration of where we see the marketplace is, it means that we add probably even an extra layer of caution in our own originations and in our choices to the earlier question does that impact growth.

I mean in some sense all other things being equal it slows down growth a bit but with all of that going on a lot of - we've been talking about this and anticipating this interactions for a long period of time. So I still go back if I pull way up in this business we're very happy we see the growth window when it is been there.

It is still there the competition is heating up, we're still going after it. We continue to build a coiled spring of earnings power that - there's a lot of upfront cost now but a lot of earnings power that is being compressed in this spring.

All of this is in the context of an industry marketplace that is moved off the bottom, it's only got one way to go and over time it is just physics but we can't predict exactly how these will play out but I think that the - the earnings power and the growth math that are associated with how that plays out is a real phenomenon and I think has a lot of value creation baked into that.

And we continue to be bullish about the business and about our prospects to deliver some nice numbers for our investors..

Thank you, sir. Ladies and gentlemen, that does conclude our call for this evening. I will now turn the conference back over to Mr. Jeff Norris for closing or additional remarks..

Thanks very much, and thanks everybody for joining us on the conference call today and for your continuing interest in Capital One. Remember the Investor Relations team will be here this evening to answer any further questions you may have. Have a great night..

That does conclude our conference for today. We thank you for your participation..