Welcome to the Capital One Fourth Quarter 2021 Earnings Conference Call. . I would now like to turn the call over to Mr. Jeff Norris, Senior Vice President of Global Finance. Sir, you may begin..

Thanks very much, Justin, and welcome, everyone, to Capital One's Fourth Quarter 2021 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, capitalone.com, and follow the links from there.

In addition to the press release and financials, we have included a presentation summarizing our fourth quarter 2021 results. With me this evening are Mr. Richard Fairbank, Capital One's Chairman and Chief Executive Officer; and Mr. Andrew Young, Capital One's Chief Financial Officer. Rich and Andrew are going to 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, 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.

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. With that, I'll turn the call over to Mr. Young.

Andrew?.

Thanks, Jeff, and good afternoon, everyone. I'll start on Slide 3 of tonight's presentation. In the fourth quarter, Capital One earned $2.4 billion or $5.41 per diluted common share. For the full year, Capital One earned $12.4 billion or $26.94 per share. On an adjusted basis, full year earnings per share were $27.11. Full year ROTCE was 28.4%.

Included in the results for the fourth quarter was an upgrade to a legacy rewards program, which increased our rewards liability and decreased noninterest income by $92 million. Both period end and average loans held for investment grew 6% on a linked-quarter basis. Ending loans grew 10% in Domestic Card, 7% in Commercial and 1% in Consumer Banking.

Revenue in the linked quarter increased 4% driven by the loan growth I just described, while total noninterest expense increased 12% in the quarter driven by increases in both operating and marketing expenses. Provision expense in the quarter was $381 million as net charge-offs of $527 million were partially offset by a modest allowance relief.

Turning to Slide 4. I will cover the changes in our allowance in greater detail. For the total company, we released $145 million of allowance in the fourth quarter, bringing the total allowance balance to $11.4 billion. The total company coverage ratio now stands at 4.12%. Turning to Slide 5.

I'll discuss the allowance of each of our segments in greater detail. As you can see in the graph, our allowance coverage ratio declined in each of our segments. In Domestic Card, the allowance balance remained flat at $8 billion. The decline in card coverage was driven by the impact of balance growth that I highlighted earlier.

In our Consumer Banking segment, continued strength in auto auction values drove a decline in both the allowance balance and the coverage ratio. And in Commercial, the decline in allowance balance was driven by modest credit improvement in the existing portfolio.

In addition to the allowance decline, the coverage ratio was also aided by growth in lower loss segments. Turning to Page 6. I'll now discuss liquidity. You can see our preliminary average liquidity coverage ratio during the fourth quarter was 139%. The LCR remained stable and continues to be well above the 100% regulatory requirement.

We continue to gradually run off excess liquidity built during the pandemic. Relative to the prior quarter, ending cash and equivalents were down about $5 billion and investment securities were down about $3 billion as we used our liquidity to fund loan growth and share buybacks. Turning to Page 7, I'll cover our net interest margin.

You can see that our fourth quarter net interest margin was 6.6%, 25 basis points higher than Q3 and 55 basis points higher than the year ago quarter. The linked quarter increase in NIM was largely driven by balance sheet mix as we had a reduction in cash and securities as well as a higher amount of card loans.

Outside of quarterly day count effects, the NIM from here will largely be a function of the change in card balances, cash and securities levels and interest rates. Turning to Slide 8. I will end by discussing our capital position.

Our common equity Tier 1 capital ratio was 13.1% at the end of the fourth quarter, down 70 basis points from the prior quarter. Net income in the quarter was more than offset by share repurchases and growth in risk-weighted assets. We continue to estimate that our CET1 capital need is around 11%.

In the fourth quarter, we repurchased $2.6 billion of common stock, which completed our $7.5 billion Board authorization. Our Board of Directors has approved an additional repurchase authorization of up to $5 billion of the company's common stock. With that, I will turn the call over to Rich.

Rich?.

Thanks, Andrew, and good evening, everyone. I'll begin on Slide 10 with our Credit Card business. Accelerating year-over-year growth in purchase volume and loans, coupled with strong revenue margin, drove an increase in revenue compared to the fourth quarter of 2020.

Credit Card segment results are largely a function of our Domestic Card results and trends, which are shown on Slide 11. As you can see on Slide 11, our Domestic Card business posted strong growth in every top line metric in the fourth quarter.

Purchase volume for the fourth quarter was up 29% year-over-year and up 30% compared to the fourth quarter of 2019. The rebound in loan growth accelerated with ending loan balances up $10.2 billion or about 10% year-over-year. Ending loans also grew 10% from the sequential quarter, ahead of typical seasonal growth of around 4%.

Ending loan growth was the result of the strong growth in purchase volume as well as the traction we're getting with new account origination and line increases, partially offset by continued high payment rates, and revenue was up 15% year-over-year driven by the growth in purchase volume and loans.

Domestic Card revenue margin increased 123 basis points year-over-year to 18.1%. Two factors drove most of the increase.

Revenue margin benefited from spend velocity, which is purchase volume and net interchange growth outpacing loan growth, and favorable year-over-year credit performance enabled us to recognize a higher proportion of finance charges and fees in fourth quarter revenue. Credit results remain strikingly strong.

The Domestic Card charge-off rate for the quarter was 1.49%, a 120 basis point improvement year-over-year. The 30-plus delinquency rate at quarter end was 2.22%, 20 basis points better than the prior year. On a linked quarter basis, the charge-off rate was up 13 basis points and the delinquency rate was up 29 basis points.

Noninterest expense was up 24% from the fourth quarter of 2020. The biggest driver of noninterest expense was an increase in marketing. Total company marketing expense was $999 million in the quarter. Our choices in Domestic Card marketing are the biggest driver of total company marketing trends.

We continue to see attractive opportunities to grow our Domestic Card business and our growth opportunities are enhanced by our technology transformation. We continue to lean into marketing to drive growth and build our Domestic Card franchise. At the same time, we're keeping a watchful eye on the competitive environment, which is intensifying.

Pulling up, our Domestic Card business continues to deliver significant value as we invest to grow and build our franchise. Moving to Slide 12. Strong loan growth in our Consumer Banking business continued in the fourth quarter. Driven by auto, fourth quarter ending loans increased 13% year-over-year in the Consumer Banking business.

Average loans also grew 13%. Fourth quarter auto originations were up 32% year-over-year. Our digital capabilities and deep dealer relationship strategy continued to drive year-over-year growth in our auto business. In the fourth quarter, we saw a pickup in competitive intensity in the marketplace.

On a linked quarter basis, auto originations were down 16%. Fourth quarter ending deposits in the Consumer Bank were up $6.6 billion or 3% year-over-year. Average deposits were up 2% year-over-year. Consumer Banking revenue grew 7% from the prior year quarter driven by growth in auto loans, partially offset by declining auto loan yields.

Noninterest expense increased 15% year-over-year. Fourth quarter provision for credit losses improved by $58 million year-over-year driven by an allowance release in our auto business. The auto charge-off rate and delinquency rate remain strong and well below pre-pandemic levels.

On a linked quarter basis, the charge-off rate for the fourth quarter was 0.58%, up 40 basis points. And the 30-plus delinquency rate was 4.32%, up 67 basis points. Slide 13 shows fourth quarter results for our Commercial Banking business, which delivered strong growth in loans, deposits and revenue in the quarter.

Fourth quarter ending loan balances were up 12% year-over-year driven by growth in selected industry specialties. Average loans were up 8%. Ending deposits grew 13% from the fourth quarter of 2020 as middle market and government customers continue to hold elevated levels of liquidity. Quarterly average deposits also increased 14% year-over-year.

Fourth quarter revenue was up 19% from the prior year quarter with 29% growth in noninterest income. Noninterest expense was up 17%. Commercial credit performance remains strong. In the fourth quarter, the Commercial Banking annualized charge-off rate was a negative 2 basis points.

The criticized performing loan rate was 6.1%, and the criticized nonperforming loan rate was 0.8%. Our Commercial Banking business is delivering solid performance as we continue to build our Commercial capability. I'll close tonight with some thoughts on our results and our strategic positioning.

Growth momentum is evident throughout our fourth quarter results. In the quarter, we drove strong growth in Domestic Card revenue, purchase volume and loans. We also posted strong auto and Commercial growth. Credit remains strikingly strong across our business and we continue to return capital to our shareholders.

As we enter 2022, we continue to see attractive opportunities to grow our businesses and build our franchise. We will continue to lean into marketing to capitalize on these opportunities and drive growth. For years, we've talked about how sweeping digital change and modern technology are changing the game in banking.

Last quarter, I noted that the stakes are rising faster than ever before. The investment flowing into fintech is breathtaking and it's growing. Also, many legacy companies are embracing the realization that technology capabilities may be an existential issue for them and are increasing technology investments.

The war for tech talent continues to escalate, which is driving up tech labor costs even before any headcount increase. All these developments underscore the significant opportunity for players who have modern technology and who are in a position to drive growth. Capital One is very well positioned to do that.

We've spent years driving our technology transformation from the bottom of the tech stack up. We were an original fintech, and we have built modern technology, infrastructure and capabilities at scale. And we're investing to leverage these capabilities to grow and to realize the many benefits of our digital transformation.

We have been on a long journey to drive our operating efficiency ratio down. We expect that the striking rise in the cost of modern tech talent, on top of our growth investment, will pressure annual operating efficiency in the near term.

But these pressures do not change our belief in the longer-term opportunity to drive operating efficiency improvement powered by revenue growth and digital productivity gains. Pulling way up, we're living through an extraordinary time of digital change. Our modern technology stack is powering our performance and our growth opportunity.

It's setting us up to capitalize on the accelerating digital revolution in banking. And it's the engine that drives enduring value creation over the long term. And now we'll be happy to answer your questions.

Jeff?.

Thank you, Rich. We will now start the Q&A session. . Justin, please start the Q&A..

. And our first question will come from Moshe Orenbuch with Credit Suisse..

Great. Rich, I want to kind of circle back to the efficiency ratio comment that you highlighted. I guess if I look at the fourth quarter, it's tough to know how to think about that level of expenses kind of going forward.

It's not generally your practice to give specific guidance, but it would really be helpful because in the fourth quarter relative to the third quarter, it's not just an efficiency ratio that deteriorated, it's actual -- PPNR was down because even though revenues were quite strong, the increase in expenses was more than that in dollars.

So is there -- can you talk about are there any gating factors in terms of when you think about expense levels kind of into 2022?.

Moshe, there are a number of different factors going on in the fourth quarter, and maybe Andrew can comment specifically about the fourth quarter. But my point about the efficiency is really -- and some of the factors that were -- that I'm talking about in the efficiency ratio certainly manifested themselves in the fourth quarter.

But our real point is that we're on a journey to improve operating efficiency. We've been leaning into this, and we're very optimistic about not only what we've done but what we can continue to do. And we're just flagging the tech talent costs and the continued investment in the opportunity.

And that opportunity continues to be toward the top of the tech stack, which translates more into growth opportunities probably than some years ago when our investment began at the bottom of the tech stack. These investments are very important.

And our point is that collectively, these things will pressure annual efficiency ratio in the near term, but it's really the same journey and the same drivers of opportunity and efficiency. Andrew, I don't know if you want to make any comments about the fourth quarter specifically..

Sure. Yes. Moshe, you're well aware that we seasonally typically have higher expenses in the quarter, largely driven by the marginal cost of growth. Beyond that normal seasonal pattern, there were a few things that are reflected in this fourth quarter, the first of which is we saw some revenue driven and other incentive compensation.

We also chose to make some of the investments, that Rich just described, in the professional services side to help accelerate some of the technology and other project work that Rich is referencing that will drive future growth. And so those couple of factors, some of which will continue as we head into next year.

And we're seeing a little bit of the leading edge of the wage pressures so I would expect that to accelerate a bit, but some of the marked-related items in incentive compensation, some of the project work, will likely fall off..

Right. And maybe just as a follow-up, just to talk specifically about marketing, it was just about $1 billion in the quarter. December was the industry's largest month of mail volume in a decade. So you're not alone in that, although the level is fairly high.

Maybe if you could just talk a little bit about how long do you see that -- and I do know that marketing was also typically high for you in the fourth quarter, but it was particularly low in the first half of 2021.

How do we think about it as we go into 2022?.

Moshe, it's clear that competition is intense. And you can see from the one you pointed out, direct mail is back at pretty high levels. You can see media advertising increasing throughout 2021. Of course, earnings calls from card players have indicated an expectation of increasing competition.

And also in the rewards space, you can see competition is pretty intense there. So we have a very careful eye on that. I would say, though, that even as we have a very careful eye on that, I am struck by how the consumer is in a very good place right now. I think there's some natural growth capacity there.

And I'm really struck by the traction that we're getting at Capital One. We continue to see some really good origination opportunities really across our businesses, and we like very much the results that we're seeing.

And the other thing about the competitive intensity at this point is more in upfront investments, such as marketing and upfront bonuses. And at this point, we're not seeing, in the competitive environment, sort of the sacrifices in margin and resilience. I'm talking particularly in the card business there.

So we have experience through competitive cycles, and we know what to look for. But we are really pleased by the results, really struck by our opportunity to capitalize on them. And that's why we're leaning in. And that's also why we're flagging, of course, that we have our eyes on the very important issue that you mentioned relative to competition..

Our next question comes from Betsy Graseck with Morgan Stanley..

Rich, I wanted to get a sense from you on the opportunity set that you have in front of you with regard to the loan growth. And I'm asking the question because I get investor questions on, hey, is this revenue -- is this loan growth rate we're seeing right now reflecting peak levels the cycle that we could get.

So I would rather hear from you as to what do you think about the loan growth acceleration that you got in the fourth quarter.

Was it being driven by in terms of new accounts versus increased line utilizations, increased offers? And what's the legs on this as we go into the next year?.

Betsy, great questions there. So we feel very good about our growth and our growth opportunities that we're seeing right now. Let me start with purchase volume. Obviously, our 29% purchase volume growth was really significant. And we've seen a lot of purchase volume growth across the industry. Of course, that's not just a Capital One effect.

But with Capital One, specifically, we are seeing a lot of traction in our various spender programs. We're optimistic about that trajectory.

And the loans, I've been talking for quite a while about the poor loans are sort of losing out in the growth rates to purchase volume and some of the other things that card issuers don't really disclose like originations of accounts, the building of the franchise.

And that, of course, was driven by another kind of elephant in the room, which has been the high payment rate. And so I think for a lot of players, the payment rates have really muted the loan growth. That includes Capital One.

But I think what's striking, what you see, Betsy, here is that we saw still very high payment rates, and you can look in our trust to see some of the electrifying levels there. But still, even despite that, some very nice traction in the quarter on loan growth.

So what's driving that? In many ways, this stands on the shoulders of a number of years of leaning hard into origination growth and having the balances build over time.

Also on credit line increases, we are leaning into those as well, not like a big dramatic thing, but I think in this environment and seeing the results we're seeing, we are leaning more into the credit line opportunity as well. So loan growth is still going to be a hard one to predict and very affected by the payment rate.

Parenthetically, we love high payment rates because I think it's a very healthy customer base, an indication of a healthy consumer and we love what it does for the credit side. But I think that we see the opportunity for loan growth, in addition to the other growth metrics, as good..

Do you have a follow-up, Betsy?.

Can you hear me?.

Yes..

Yes, we can..

Okay. Sorry about that, just pivoting to Capital. I saw the Board authorization for $5 billion.

Can you give us a sense as to the time frame that that's over and if there was a view on what drove that decision to do $5 billion as opposed to any other number?.

Betty, it's Andrew. I'll take that. So we take into account a number of factors to drive these programs.

So as always is the case, our pace for this repurchase authorization as well as the pace and amount of future authorizations are driven by a number of factors, including our actual and forecasted levels of capital and earnings and growth as well as market capacity to repurchase shares.

And it also needs to consider the results from each unique CCAR cycle, which effectively happens at the midpoint of each year. So we take all of those factors into account to figure out the amount and the pacing of that.

And so we will dynamically manage that given that we are now under SCB, and we have a great deal more flexibility to execute than we have previously..

Our next question comes from Rick Shane with JPMorgan..

Rich, when we think of the factors that are contributing to the high payment rate, we're all aware of a lot of the economic factors.

One thing that we've started to wonder about is, is there some sort of 80-20 rule on transactions? Are large idiosyncratic transactions getting scraped off by some of the alternative products? And is that changing the composition of the book anyway in terms of payment rates?.

are there kind of on little cat feet, effects going on from the fintechs, the huge investment in them and their own investment in our very business, I think they are great things to look for.

One thing I would say about payment rates, though, is how broadly across the spectrum of our card business that we have seen payment rates increase over this period of time. It's really not seen to exist or be dominated by a particular segment, let's say, the top of the market or whatever. It's been really pretty broad-based.

We also ourselves have had another growth story going on beneath our growth story, which is the continuing gains and growth in the heavy spender side of the business.

And so what we see is -- maybe your effect is going on, but what we see, if anything, is particularly good growth rates over time in the heavy spender side of the business, which I think is more a manifestation of our investments in the kind of products that we've been marketing for a number of years and our investment in the comprehensive experience to really win in that part of the market..

And our next question will come from Bill Carcache with Wolfe Research..

Rich, I wanted to follow up on your payment comments.

Are you at all concerned about the normalization of credit outpacing the normalization of payment rates? Or would you expect those metrics to normalize together?.

Well, I think 2 things are kind of driving elevated payment rates right now. And it's really a funny thing. I've been in this business for, as you know, like 3 decades, and payment rates are just not something in general that people always talk about. We would always watch them.

Some years ago, even before the pandemic, we started noticing some elevation in payment rates, but we probably more attributed that to the gradual mix change towards spenders in our own portfolio. But if we talk about the 2 main drivers of elevated payment rates, first is payment rates tend to correlate with spend levels.

And for obvious reasons, when people are spending more, they're not going to be spending for very long unless they're also paying to keep their open to buy there. So I think that pattern is sort of almost, in a way, sort of just spend and payment math.

And given how strong spending has been that, that is an important factor, I think, behind the payment rates. And then there's the continued impact of healthy consumer balance sheets.

And it's unmistakable the effect that, while there are many factors going on, just watching what happened across various segments of our business as things like government stimulus came in and what happened to payment rates, it's pretty clear that consumers, when their balance sheets improved, really used a bunch of those resources to pay down on their credit card and build more open to buy.

And we have gone back and really studied the relationship between payment rates and credit for the whole history of our company, and the relationship is unmistakable. Bill, to your point, though, it's not like one-for-one. And I think that we could certainly expect there could be some divergences there.

On the topic of normalization, when we think about the normalization of payment rates, my mind first goes to the normalization of credit. And I think these record levels of low credit losses inevitably have to normalize.

And I think when you pull out a magnifying glass and sort of look at various metrics and things in the numbers and behind the numbers, you can see the early signs of normalization that are a little bit ahead of seasonality, for example, that's a very natural thing.

Probably what strikes us and kind of surprises us is how modest and moderate those are, but we certainly operate with an assumption of normalization. So I would expect the payment rates to follow, not exactly in lockstep, but I think that, that should follow. And so what happens for investors is a little bit of a trade.

At the moment, the financial trade is lower payment rates, lower growth of loans and really spectacular credit. And as things normalize, I think that gives a boost to the loan growth but sort of is offset on the credit side of the house.

So the other thing that's going on at Capital One because if you look at our trust data -- now by the way, our trust, and it's probably true for every player, the securitization trust is not an absolutely representative sample of anybody's full portfolio.

But if you look at payment rates at Capital One, probably, even in particular, have just risen so significantly over this period of time. And I haven't looked at it lately, but it wouldn't surprise me if it even rose sort of more than for a number of other competitors.

And I think that also reflects another Capital One specific thing that's going on, which is the continued traction of the spending side of the business at Capital One which, of course, manifests itself year-after-year being kind of at the high end of the league tables in terms of purchase volume growth..

That's super helpful, Rich. If I could squeeze in a related follow-up.

Maybe could you expand on that a little bit and discuss your confidence level in the normalization of payment rates and maybe what some of the puts and takes are to the extent that the normalization occurs a bit faster or slower?.

Well, I, again, think of payment rates, I just go back to the 2 drivers. So one is the strong correlation with spend levels. So one needs really an outlook for what's going to happen to purchase volume in our business and in card businesses. Purchase volume has an incredible strength to it right now, a manifestation of the consumer.

Some of it, by the way, is catching up for big pullbacks, of course, during the pandemic. But there's real strength there. If that strength continues, and that's pretty plausible, that would tend to have an upward boost on the payment rate. And then you get to the consumer credit side of the business.

And I just believe reverse gravity has got to pull these numbers up. And we all have to understand that, that normalization, the word normal is a really important part of that. It would be extremely normal. It would be expected. We are certainly managing the business to expect that.

But as that happens, count me is betting that, that driver of payment rates is going to pull the payment rates down..

And our next question will come from Ryan Nash with Goldman Sachs..

So Rich, in your prepared remarks, you noted that all these investments that you're making in tech and tech talent will pressure the efficiency ratio. But I guess, just given a follow-up on some of the questions from earlier, the revenue backdrop is clearly much better, 10% exit run rate loan growth.

And I was wondering, can you maybe just talk about -- you actually used the phrase pressure.

I'm wondering, are you actually expecting the efficiency ratio to increase? And if you are, maybe can you just give us some parameters on how long do you expect this to last? How much of an increase can we see over an intermediate time frame? And maybe what are some of the things that you and the team are doing to offset some of these pressures?.

Okay. Thanks, Ryan. So we're not giving really explicit operating efficiency ratio guidance. There's so many factors that go into that, and you know them well. What we wanted to point out is we always want to share with investors the things that we see going on in our company to make sure that they understand this.

And the first one, this tech cost, I'm struck a lot of companies, most companies are kind of waiving at labor costs. And I think tech labor costs are an elephant in the room, and every tech company I've talked to is this is an absolute elephant in their room.

And I think when you stand back and think about it, that's because every company in the world pretty much these days and we really need to drive tech change and opportunities as fast as we can. How long that supply and demand imbalance is going to last, we'll have to see.

It is the biggest imbalance I've seen in my 3 decades of building and running this company in a labor market. And it may be that this is more of a headwind right now for Capital One in our numbers than for some of the banks or just others. And I want to savor that for a second.

One of the big things we've done in our tech transformation is bring in-house engineering talent at scale. And a lot of companies do a lot of outsourcing of that. So we have built a very big engineering team and the related families there. And we've built a brand, and we're a destination for really top tech talent.

And that's a wonderful thing, and it really helps us on the recruiting side. But I just wanted to flag that one because how long that imbalance last, I don't know, but it's something that to me is very, very clear. The other point is on the investment side.

And I really want to say it, it's not like we're just going along, doing our tech transformation and looking at the market and say, "Oh my gosh, we have to just massively invest in ways like we weren't before." That's not really what I'm saying. What I'm saying is that we are continuing to move up the tech stack in terms of where our investments are.

And that's a wonderful thing because the closer you get to the consumer and the top of the tech stack, the more of those opportunities directly can be capitalized in the marketplace. So that's a good thing. And we've been investing for a long time.

My point is that we are still really leaning into this opportunity because the opportunity, the time frames, the imperative is real. And already, what's driving a lot of the growth that you're seeing is the benefits of those things, and it's what will drive a lot of the future growth as a company.

So back to your question, while we're not giving explicit efficiency ratio guidance, the use of the word pressure is to explain those 2 phenomena that are going on that I wanted to share with investors that are real, and that pressures the efficiency ratio.

Exactly what number come out in the end depends in the end on a lot of things and revenue growth and things. But I just wanted to share that. And I made the same comment in the call the quarter before..

As a follow-up to Moshe's question on marketing, I understand the thought that you're leaning in and we're obviously seeing really, really good traction on the growth side. But if I think about the competitive intensity, we've heard Amex saying that marketing is going to come down a little. Discovery's growing. JPMorgan is accelerating.

And I think all of us are just looking for some parameters to maybe understand where you are in the stage of investment. And maybe can you just help us understand.

Are we at run rate levels in the back half of the year? Do you see another step-up? And just any color that you could provide on how you're thinking about the pace of marketing spend, I think, would be helpful..

Yes. Ryan, it is striking the comments that everyone is making about this and probably a little bewildering for investors to understand where equilibrium is these days. You know our philosophy, Ryan. You and I have known each other for a long time.

We don't really start the year by saying, this is precisely the marketing -- I mean we always make a budget, but we don't start the year and say, "Well, this is what everybody has in marketing dollars, no matter what." Sometimes we contract what we put in there. Sometimes we expand it. But it's very focused on what's the nature of the opportunity.

We also have a strong belief that there are windows of opportunity for growth. And you capitalize on those when you get them or those windows pass. And so that doesn't also lend itself to the kind of let's go and just allocate the same marketing budget every quarter to different parts of our business or anything like that.

So what we do at Capital One is when we see opportunities, we really lean into them. I can't, in advance, tell you quite how far we lean into them because we really look at what's the productivity at the margin for what we are investing. And we look at marketing efficiency on average. We look at it at the margin. We look at it in all of our programs.

And of course, also, we look at our brand investments and the other things that we're doing to lift the votes. My message to you here is really 2 points. One, this is a lean-in time and we're going to continue to do that to the extent that the opportunity is there.

And you can see the fourth quarter was a pretty high level of lean-in, so that would be an example of that. My other point is we are, as closely as you, watching the competition and the choices they're making. And higher levels of competition themselves can manifest in different ways. It can affect the ability to generate response.

It can affect pricing. The worst thing is when it starts making its way into underwriting practices and starts affecting the credit side of the business.

But right now, if I pull way up on the marketplace, we've got a strong consumer where kind of everybody is sort of roaring out of the sort of pandemic, not society necessarily when I'm talking about many of the metrics here. And the marketplace is still generating this opportunity resiliently, and we are leaning into that..

Our next question will come from Sanjay Sakhrani..

So maybe just to ask Ryan's question a little bit differently.

I mean shouldn't we expect revenue growth to be above average given these accelerated investments you're making? Maybe you could just give us a sense of what kind of revenue growth you're targeting and what some of the specific products might be that you're rolling out that are sort of unique and separate yourselves from the peers.

I'm just thinking about buy now, pay later.

Like where are we with the product rollout?.

Okay. So we're not giving specific revenue guidance. We are commenting and pleased with the momentum that we have, particularly momentum you saw that picked up in the fourth quarter, and we certainly hope to keep our momentum going there. So I think on the purchase volume side, there's a lot of thrust.

We're very pleased with the account originations that we have been able to generate from the enhanced marketing that we're doing and the loan growth, which is a very important part of the revenue growth. That one is always kind of the hardest one to sort of predict because of its linkage to the payment rate. But we do see a good trajectory there.

We're not giving specific guidance, but we like what we see there. In terms of what is driving the growth, I don't think -- you'll occasionally see Capital One on TV with a new product or whatever. We are always coming up with new products, so is competition, by the way.

Our surge in growth is not the result of some new product there that's suddenly driving this. This is the result of many things coming together, working particularly well right now.

I think a lot of it is really driven by opportunities and capabilities and expansion and experiences for the customer that stand on the shoulders of our tech transformation. So we're hopeful we can continue to drive some strong growth. We're not giving guidance on that.

And the biggest, I think, question will be what happens to payment rates and what that does to loan growth..

And maybe just another follow-up on expenses. I'm sorry I'm asking the same questions everyone else is. Rich, you seem to think that the work for sort of inflationary pressure is transitory.

Is that the only risk in terms of getting back to sort of that 42% operating efficiency ratio? So if that sort of passes at some point, you guys can get back there? Or is there something else too?.

So we are still driving toward the same destination for operating efficiency improvement. But the timing, that needs to incorporate the imperatives of the current marketplace and particularly the one we flagged here more recently, the striking rise in the cost of modern tech talent.

The investment imperatives of the marketplace and the rising cost of tech talent will pressure our operating efficiency ratio in the near term, as we have discussed.

But modern technology capabilities are the engine that drives revenue growth and digital productivity gains, and the investments we're making today are the drivers of the efficiency improvements that we expect to continue to get over time. So we're not in a position to declare the timing of operating efficiency destinations.

It's the same journey, the same engine powering it. There are some pressures we shared with you in the nearer term, but it's the same journey. And delivering positive operating leverage over time continues to be one of the important payoffs of our technology journey and a key element of delivering long-term shareholder value..

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

I'll shift gears a little bit, but I do also agree it would be helpful to have some kind of sizing around the expenses just given the environment. You have a really good story to tell outside of that.

I guess on auto lending, are you signaling that you might moderate a little bit of growth there? And the Auto Navigator product, which I think is really benefiting from the public cloud, are you getting penetration on that? And can you size that?.

Yes, Don, the auto business has really been growing strongly. And for starters, that's, very importantly, an industry point. A lot of factors have aligned to create a lot of demand, a lot of demand for used cars, high used cars, car valuations.

And it's certainly been, for us and really for the industry, a bit of one of our strongest periods in history.

But if we look beneath that because, obviously, all those things normalize over time, we continue to leverage our leading technology, our data and underwriting capabilities to identify market opportunities that we think have attractive and resilient risk-adjusted returns.

And by the way, a very important part of that is keeping an eye on the very, very high used car prices and as we underwrite, assuming a significant decline in those. So we don't count on something that's not going to be long term sustainable. Whether the industry fully does that, we'll have to see.

Our technology journey, and you mentioned the Auto Navigator product, that's a manifestation of a lot of the technology we've built in the auto business.

It really helped us not only deepen our relationship with consumers but also with dealers because Auto Navigator is a winning product for dealers as well as it is for consumers because it's bringing in consumers who've already done a lot of the work to prequalify themselves, and it's the highest quality lead like a dealer can have.

So we're not giving out data on the success of Auto Navigator, but we believe that it is a powerful product.

And I've often said to investors, "Hey, if you want to look at an example and go kind of see the differentiation that Capital One has created in a tech-based, information-based, machine learning-based product, the Auto Navigator and the real-time underwriting of any car on any lot in America in less than a second is a manifestation of that." And that is getting traction.

But I do want to say that there are a lot of changes going on in the auto industry, a number of competitors working hard to reinvent how car buying works. And I think for Capital One and a lot of players who are on the frontier of some of those changes, I think there is opportunity for us.

And I think some of the success in auto is exactly a manifestation of that. Let me say one other thing, though, with respect to growth in the auto business.

I've always said that the auto business is even more sensitive to competition than the Credit Card business is because of the role that a dealer plays between the consumer and the lender in holding an auction. And so the dealers understandably really tend to drive their business toward the lender who is the most flexible on pricing and terms.

And we have seen some of those metrics move in the last quarter. And I think a very robust auto market, it's a natural thing to expect that competition might overheat and pricing and practices could be affected along the way. So I don't want to overstate my point. It's a caution that I put out there, but we are still leaning into our opportunity.

But the bit of the volume decline in the fourth quarter, I think, was a competitive effect of the very thing we're talking about..

Our next question will come from John Hecht with Jefferies..

I guess I'm interested in maybe talking through the mechanics of your net interest margin. Obviously, I want to hear your thoughts on what maybe each rate hike might do to the margin.

But beyond that then, there's a lot of other moving factors, like you're going to get some suppression of yield with the evolution of NPAs, you're going to get some late fees to offset that and so on and so forth.

So maybe can you give us a sense of what to expect as all those factors come to play in the next few months?.

Sure, John. It's Andrew. And maybe I'll expand the horizon beyond the next few months because it will take a while for some of the factors that you just described to play out, but why don't I start with the rate side of the equation that you brought up. Our current balance sheet is asset sensitive.

So as rates move up, it will clearly be a tailwind to NII. At this point while it's moved a fair amount over the last few months, including, I think, about a 10 basis point retraction over the last week in the 10-year, so it's a volatile number, but the market is currently, last time I checked at least, expecting around 4 hikes in '22.

And so that equates to an average Fed fund rates that's about 50 basis points higher for the full year. And you can get a directional indication of the impact of that. In our Q3 disclosures, I think we showed that relative to forwards, the 50 basis point shock impacts the next 12 months of NII by 1.9%, I believe, is the number.

So that's just roughly under $500 million. So that's the dollar effective rates. If you translate the dollar effects into NIM, to the other side of your question, the 3 big factors that are ultimately going to impact NIM are the 3 things that I highlighted in my talking points. And that is just the quantum of card balances.

Even though some of the factors you described will potentially impact card margin, it's much more about the card balances to the overall company NIM.

The other is cash and securities, which you saw we had an investment portfolio at $100 billion at its peak, it was probably something like $15 billion higher than what is a more normal level and cash levels that were also really high. So you could see cash and securities coming down, which all else equal benefit NIM.

And then finally, the rate effect that I just described. So really, those are the 3 things that we're primarily looking at and will ultimately have the biggest effect on NIM on a run rate basis. In terms of the next few months, the only thing that I know for sure is there's 2 fewer days in the first quarter.

So that's roughly a 15 basis point headwind to NIM, all else equal, but the other effects are really what's going to drive the NIM over the longer term..

That's great. I really appreciate that detail. I guess an unrelated follow-up is it seems like you guys have put out a lot of products over the past several quarters that may be targeting some of the fintechs and neobanks. I think you've canceled overdraft protection or moderated that. You've got early payment mechanisms.

You've got direct auto type products.

I guess the question is, are you able to quantify how that impacts your customer base? Do you get good cross-sell? Does it affect retention rates? Or generally speaking, how do these compete against these new banks that are trying to, I guess, disrupt the overall system?.

Yes, John. Well, I love the focus that investors have on fintechs. And let's talk about the reasons for that.

First of all, I think the investors are voting with their feet to just the amount of money that is poured into fintechs on the venture capital side, the valuation of fintechs, although the last little bit has been rough for them really speaks to a belief, I think, in the investor community that banking is going to be transformed and the fintechs are going to be important drivers of making that happen.

And we're an original fintech. So maybe I have a soft spot in my heart for fintechs and also an understanding of the challenges they face as well. But one thing, we start with one thing that's very clear, Fintech start with modern technology. Everybody starts in the cloud. They don't have all the scale technology you need.

They got to build a lot of things, but they start in the cloud. There's also another phenomenon going on, and that is that one of the most successful parts of fintech has been the platform companies building the shoulders for other fintech to then stand on and build their business.

So the ability to enter businesses and move quickly and have modern technology is really striking. The fintechs are also unregulated. So there's a whole vector there in terms of some of the things they're doing and some of the ways that they move and operate that wouldn't be consistent with the banking side of the business.

But I favor all that because I believe also, as do so many investors beating a path into this space, that banking is absolutely in the process of being transformed. And it's kind of striking, the industry has taken as long as it has to be as transformed relative to a lot of other industries.

And I think a big reason for it is the regulation that has tended to surround the banking space. Interestingly, by far, the biggest growth vectors have been sort of in the least regulated side of things, in payments and platforms and crypto. And I think the almost unmitigated success of companies in those spaces are really striking.

But let me now go back to Capital One. And I say this as an original fintech and a fintech that really transformed itself into and became one of America's biggest banks. We are building essentially a fintech, and we have built a fintech at scale. We don't have some of the benefits that fintechs have.

We have a lot of benefits a lot of fintechs don't have, including a gigantic customer base and national brand, a 3.5 decades of underwriting experience, an unbelievable amount of data that we have collected and have, through our tech transformation, built a very sophisticated, kind of comprehensive way to manage big data and machine learning in real time to create opportunities to be at the forefront of how banking is being transformed.

We, as a bank, face our own unique set of challenges fintechs don't have. Fintechs face a lot of challenges they have.

But it's not an accident that you noticed Capital One out there with a number of products and even a bit of a brand personality consistent with where fintechs are because we are leaning into some opportunities, the same ones the fintechs are. Some are ones that we're creating in places they're not.

But when you hear an optimism in my voice and an excitement, it relates to standing on the shoulders of our tech transformation and the scale and market position we have as a company to create opportunities that I think Capital One is uniquely positioned to do it. It's a tough journey.

It requires continued investment, which we talked about, and it's not easy. But I really like our chances. And I think Capital One is ideally positioned to take advantage of the accelerating transformation in banking..

And our last question will come from John Pancari with Evercore ISI..

On the credit front, I just wanted to see if you can give a little bit of color on the increase in charge-offs and delinquencies on the non-card consumer businesses. I know you mentioned auto. Just wondering if you can give a little bit more granularity on the drivers there. And then also on the reserve side, another sizable reserve release.

As you're looking forward here and as loans begin to strengthen in terms of the balance sheet, do you expect ultimately to begin matching or building reserves here in the coming quarters?.

Okay. John, let me talk about credit. Andrew will do the reserve question. So the consumer credit just remains strikingly strong. I mean in all my years, I've never seen anything quite like what we have been through with consumer credit in the last couple of years, and it's still strikingly strong.

We, of course, have been saying all through this, normalization is bound to happen. How fast, and it does, and at what trajectory we'll have to see. In the fourth quarter, our card losses, on a quarter-over-quarter basis, they were up 13 basis points, which is consistent with normal seasonal trends.

Our card delinquencies increased 29 basis points, and that increase is a bit more than the normal seasonal trend. And I would point at that as an indicator of, more likely than not, early signs of some normalization off of a very, very low base, of course. In the auto business, let's talk about credit performance there.

Auto credit performance has been strikingly strong through the pandemic. Fourth quarter losses were just 58 basis points, and that's roughly 1/3 of what they were before the pandemic.

In addition to all the positives that have supported consumer credit in general, like you see in our card business, auto is seeing exceptionally strong recoveries supported by record-high vehicle values. And this was enough to push losses negative earlier in 2021. And obviously, that's not sustainable.

But by any measure, losses remain exceptionally low. The quarter-over-quarter increase in Q4 was largely normal seasonality. Auto vehicle values remain about 50% above pre-pandemic levels backed by strong consumer demand and ongoing supply constraints.

So we certainly would expect auto losses to increase from current levels even if the health of the consumer remains strong, especially because auction prices should normalize over time as supply constraints are resolved.

So it's an amazing period that we're in, and we are trying to lean in and capitalize on the opportunities to grow the business with the strength the consumer has and the capacity to grow their own balance sheet. And we are especially watchful of the natural things that can happen to credit at a time like this. I'm talking about the industry.

And let me just name 2 there. One is, of course, the natural things like more aggressive marketing and, in the auto business, more aggressive practices with the dealers and things like this.

There's also just one other thing we'll all have to keep an eye on, and that is when we think about -- any of us, and we ask ourselves this question, but I think we're in a stronger position to answer it than maybe many, but when one is doing credit underwriting, how do you build models? What are your models supposed to be looking at when they look in the rearview mirror and see the best credit in the history of these businesses? And so Capital One has a very long kind of history of data on consumers, and we very much point our models to a longer horizon there.

But I do worry, especially for the fintechs who are building their own companies from scratch, exactly what's the rearview mirror and what's the information-based underwriting capabilities that can be built here? So we'll just keep an eye out for those effects and expect normalization to occur and take advantage of the opportunities while they're in front of us.

Andrew?.

Yes. John, with respect to the allowance, unfortunately, I don't have an easy yes/no answer for you around allowance releases. So let me just start by describing the current allowance because I think that backdrop will be helpful in just painting various pictures of how the coming quarters might unfold. In that way, you have as much knowledge as we do.

So when we think about the composition of the allowance, the first thing is just our expectation of future losses and recoveries. And so right now, our outlook assumes relatively swift normalization of losses from today's unusually strong levels. The second factor is just qualitative factors, which we've described before.

And today, these qualitative factors remain elevated to account for the remaining uncertainties around the pandemic and the economy, and this is why our coverage ratios remain high. And then the last factor is just the size of the balance sheet at each successive quarter.

And so keep in mind that under CECL allowance, impacts of new growth is pulled forward, so it definitely adds to the quantum of allowance that we need as we grow. But future allowance movements from where we are today will just be determined by how all of these effects net out.

And so if normalization plays out and we continue to grow at a significant clip, we could see allowance builds over the next few quarters.

The other scenario could be, and clearly, there's many scenarios, but another scenario is favorable credit trends continue the uncertainties that drive the qualitative factors subside, and growth is a little bit more modest than we would likely see further allowance releases.

So I just wanted to give you a window into all of the pieces that go into the calculation, and we'll go through a rigorous process every quarter, and we'll see how it ultimately plays out over the year..

Got it. Okay. That's very helpful. And then just lastly, can you just maybe comment a bit on the commercial loan growth trends you're seeing? I know your commercial segment loans were up double digits year-over-year. So I just want a quick bit of color on the drivers there..

Yes, John, our commercial loan growth was 7% quarter-over-quarter and 12% year-over-year, and it outpaced industry growth. Normalizing for PPP forgiveness, we're much more in line with the growth of our peers.

While we did see a slight increase in our revolver utilization this quarter, our growth was almost entirely driven by originations in our specialty businesses where we generate strong risk-adjusted returns.

And of course, just the other thing I would point out, of course, is our activity in commercial reflects the increased economic activity and a quite attractive market, quite attractive lending conditions in 2021. So it's been, I think, a good time for all commercial lenders.

This is in the context of actually a market that still we have a very cautious eye of looking at with the tremendous growth of nonbank lenders and some of the lending practices that are happening outside the banking industry that make their way into our customers. So I think it's a great period at the moment.

We continue to be cautious about the opportunity in the context of the bigger marketplace. But thanks very much, John..

Thanks, Rich. And thanks, everybody, for joining us on tonight's conference call. Thank you for your continuing interest in Capital One. Investor Relations team will be here to answer any follow-ups you may have later on, and have a good evening, everybody..

Thank you. And that does conclude today's conference. We do thank you for your participation. Have an excellent night..