Jeff Norris - Senior Vice President Global Finance Stephen S. Crawford - Chief Financial Officer Richard D. Fairbank - Chairman, President & Chief Executive Officer.

Ryan M. Nash - Goldman Sachs & Co. Bill Carcache - Nomura Securities International, Inc. Sanjay Sakhrani - Keefe, Bruyette & Woods, Inc. Richard B. Shane - JPMorgan Securities LLC Donald Fandetti - Citigroup Global Markets, Inc. (Broker) Moshe Ari Orenbuch - Credit Suisse Securities (USA) LLC (Broker) Eric Wasserstrom - Guggenheim Securities LLC Bob P.

Napoli - William Blair & Co. LLC Betsy Graseck - Morgan Stanley David S. Hochstim - The Buckingham Research Group, Inc..

Welcome to the Capital One First Quarter 2015 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 period. Thank you. I would now like to turn the call over to Mr. Jeff Norris, Senior Vice President of Global Finance. Sir, you may begin..

Thanks very much, Jennifer, and welcome, everyone to Capital One's first quarter 2014 earnings conference call. As usual, we are webcasting live over the Internet. To access the call on the Internet, please log on to Capital One's website at capitalone.com and follow the links from there.

In addition to the press release and financials, we have included a presentation summarizing our first quarter 2015 results. With me today are Mr. Richard Fairbank, Capital One's Chairman and Chief Executive Officer, and Mr. Steve Crawford, Capital One's Chief Financial Officer. Rich and Steve will walk you through this presentation.

To access a copy of the presentation and 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 entitled Forward-Looking Information in the earnings release presentation and the Risk Factors section in our annual and quarterly reports which are accessible at the Capital One website and filed with the SEC. With that, I'll turn the call over to Steve Crawford..

Thanks, Jeff. For the first quarter Capital One earned $1.2 billion or $2 per share and had an average return on tangible common equity of 15%. On a continuing operations basis we earned $1.97 per share. Net income was up $154 million driven by higher pre-provision earnings and lower provision expense versus the prior quarter.

Pre-provision earnings increased by $69 million versus the prior quarter as lower revenue was more than offset by lower marketing and operating expenses. Provision for credit losses decreased on a linked quarter basis driven by a smaller allowance billed and lower charge-offs versus the previous quarter.

Turning to slide four, I'll briefly touch on net interest margin. Reported NIM decreased 24 basis points in the first quarter to 6.57%. The quarter-over-quarter decrease was primarily driven by two fewer days to recognize income and temporarily higher cash balances.

We don't expect any incremental margin pressure to meet the LCR since we're already above the fully phased in LCR requirements as of March 31, 2015. Turning to slide five, let me cover capital trends. Our common equity Tier 1 capital ratio on a Basel III Standardized basis was 12.5% as of March 31.

On a fully phased in basis we estimate this ratio would be approximately 12.1%. We reduced our net share count in the quarter by 5.4 million shares or 1%, primarily reflecting our share buyback actions that began last April. Over the past year we have reduced shares outstanding by 24.9 million or 4%.

We entered parallel run for Basel III Advanced Approaches on January 1 and we continue to estimate that we are above our 8% target. We were pleased with our 2015 CCAR results and believe they continue to demonstrate our strong commitment to return capital to shareholders.

Our approved submission include a plan to increasing our quarterly dividend from $0.30 to $0.40 per share. In addition, our plan authorizes the repurchase of up to $3.125 billion of common stock through the end of the second quarter of 2016. Our long-stated preference for the focus of capital return continues to be in the form of share repurchases.

And while investors can expect an ongoing ability to generate strong returns and a commitment to return excess capital subject to regulatory approval, investors should not infer a long-term commitment from our recent payout ratios. With that, let me turn it over to Rich..

Thanks, Steve. And I'll begin on slide seven with our Domestic Card business. Loan growth accelerated in the quarter. Ending loans were up about 9% year-over-year and average loans grew about 7%. We continue to post strong growth and see goods opportunities in the parts of the market we've been focused on for some time.

Purchase volume on general purpose credit cards, which excludes private label cards that don't produce interchange revenue, grew about 19% year-over-year. This growth was driven by the success of our rewards programs, increased new account originations across our card business, and credit line increases.

Compared to the first quarter of 2014, revenues were up 7%, in line with average loan growth as revenue margin was stable. On a linked quarter basis, revenue margin decreased seasonally to 16.9%. Year-over-year non-interest expenses increased 2% driven by higher marketing, consistent with our return to loan growth.

As expected, non-interest expenses decreased about 6% from the linked quarter with seasonal declines in marketing. Credit in the first quarter was stronger than expected. We experienced better than forecasted delinquency flow rates. The charge-off rate increased 16 basis points to 3.55%. The delinquency rate improved 35 basis points to 2.92%.

As first quarter delinquency favorability rolls through to charge-offs, we expect quarterly charge-off rates in the lower end of our previously communicated mid-to-high 3% range, perhaps even getting into the low 3% range at the third quarter seasonal low point.

The improvement in our outlook for Domestic Card credit drove a modest allowance release in the quarter. We also expect favorable credit to drive lower than expected past due fees, putting modest pressure on revenue. Longer term, our credit expectations are unchanged and are driven by growth math.

As new loan balances season they put upward pressure on losses. While this impact on the charge-off rate is modest at first, we expect that the impact will grow throughout 2015 and beyond. We still expect growth math to drive quarterly charge-off rate to be in the mid-to-high 3% range in the fourth quarter and higher from there in 2016.

In addition, while this quarter shows that we may not have allowance builds every quarter, we expect growth to drive allowance additions going forward. Our Card business remains well positioned to deliver growth with attractive and resilient returns. Slide eight summarizes first quarter results for our Consumer Banking business.

Ending loans were up about 1% from the prior year. Growth in auto loans continues to be offset by expected mortgage run-off. Auto originations increased about 10% year-over-year driven by strong auto sales and deepening relationships with our existing dealers. Consumer Banking revenue was up 1% year-over-year driven by growth in auto loans.

Revenue continues to be pressured by persistently low interest rates on the deposit business, declining mortgage balances, and margin compression in auto. Provision for credit losses grew $66 million to $207 million, driven by a change in allowance. In the first quarter of last year we had a modest allowance release.

In the first quarter of this year, growth in auto loans and normalizing auto credit drove an allowance build. Our Consumer Banking businesses are delivering solid performance in the face of continuing industry headwinds. Persistently low interest rates will continue to pressure returns in our deposit businesses, even if rates begin to rise in 2015.

In our auto business, we've been experiencing normalization of both credit and returns from once in a lifetime levels coming out of the great recession. Credit performance is gradually worsening in the industry and we see slightly higher losses on newer originations. We've been cautious on industry underwriting and competitor practices for some time.

As a result, our subprime originations have been essentially flat for nearly two years. In the first quarter, we observed increasingly aggressive underwriting practices by some competitors, particularly in subprime. We are losing some contracts to competitors who are making more aggressive underwriting choices.

And used vehicle values remain at historically high levels. A decline in used car prices would put pressure on our results, but we assume lower prices in our underwriting, so we remain comfortable with the resilience of the business.

Despite our heightened caution, we will continue to pursue opportunities in auto lending that are consistent with our long-standing focus on resilience including adding new relationships with well-qualified dealers and gaining greater share of prime originations with existing dealers.

Moving to slide nine, I'll discuss our Commercial Banking business. Ending loan balances increased about 10% year-over-year with most of the growth in specialized industry verticals, in C&I and CRE. As we've been signaling, our year-over-year growth is slowing compared to prior years in response to market conditions.

Loan balances declined modestly from the linked quarter as we've seen some slippage in industry underwriting standards in pockets of the market. Revenues increased 13% from the prior year driven by growth in average loans as well as increased fee income from agency multi-family originations.

These factors were partially offset by loan yields which declined 25 basis points compared to the prior year driven by increased competition. Non-interest expenses were up 7% from the prior year as a result of growth in our portfolio and continuing infrastructure investments.

Provision for credit losses increased $28 million in the quarter to $60 million. The provision in the quarter was primarily driven by an allowance billed for our $3.6 billion of loans to the oil and gas industry driven by the impact of lower oil prices. We remain highly focused on managing credit risk and working with our oil and gas customers.

Through Hibernia we've been in this business for more than 50 years through multiple cycles. 96% of our loans are secured and 73% are shared national credits. Our largest exposure is in exploration and production in which we benefit from holding loans at the top of the capital structure and is counted in collateral values.

Many of our borrowers are least partially hedged against falling oil and gas prices. Our second largest exposure is in oilfield services in which our customers face greater downstream challenges as E&P companies cut back in response to low asset prices. We're working through these issues on a customer-by-customer basis.

We are also a lender in the Taxi Medallion Finance industry, with a small portfolio of less than $1 billion in loans. Medallion values have softened because of increased competition from new entrants like Uber. We continue to closely watch this sector. Overall, commercial charge-offs, non-performing loans, and criticized loans remain strong.

While we continue to closely manage credit risk, we don't expect these levels to be sustainable through the cycle. Our Commercial Banking business remains well positioned to navigate a challenging environment in which intense competition continues to put pressure on growth, margin and returns. I'll conclude my remarks this evening on slide 10.

Capital One posted strong results in the first quarter. We're delivering attractive risk adjusted returns today, and we expect that will continue. For the full year of 2015, we expect growth in revenues driven by growth in average loans. As you can see in our Domestic Card business, we are experiencing very strong growth.

And in this window, we are likely to increase marketing to take advantage of the opportunities we see to help sustain the current trajectory. While growth opportunities would drive long-term value creation, the higher marketing and the higher operating expense of additional volumes will put pressure on efficiency ratio.

As a result, we are likely to be in the higher end or possibly modestly above the 53.5% to 54.5% efficiency ratio range excluding non-recurring items.

We're managing costs very tightly across our businesses to stay within the range, but we will also strive to make the right business choices to drive long-term value as growth opportunities unfold through the year.

Pulling up, our strategic priorities for 2015 have not changed, and we remain focused on the levers to create value and sustain strong performance. We'll continue to pursue growth opportunities. We'll maintain our long-standing discipline in underwriting across our businesses and our preemptive focus on resilience.

We'll manage costs tightly while we invest to grow, be a digital leader, and continue to meet rising industry regulatory requirements. And we'll actively work to return capital to shareholders, as capital distribution remains an important part of how we expect to deliver value to our investors.

And now, Steve and I will be happy to take your questions.

Jeff?.

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

Thank you. And we'll go first to Ryan Nash from Goldman Sachs..

Yeah. Hi. Just wanted to follow-up on the update to the efficiency. I think you guys came in at roughly in the middle this quarter.

And I was just wondering, Rich, can you give us a little bit more clarity on how we should think about the incremental costs that you need to spend on marketing and how it flows through to loan growth? How long of a lag should we see on growth? And then I'll have a follow-up..

Ryan, our initial guidance on efficiency ratio, we did I guess three quarters ago. We updated it for the dramatic changes in interest rates. And over this period of time, there have been – we have constantly responded to the growth opportunities we see in the marketplace.

We've continued to invest to capitalize on those opportunities, and we've continued to refine our forecast, if you will, of what are the actual growth numbers that we think will come in the near term. And kind of the byproduct of all those moving pieces has been – leads to my commentary on the efficiency ratio.

I mean, the bottom line is – to grow we need to spend money. We believe this is a very, very important window of opportunity, and we're taking action to capitalize on that and along the way working very hard to manage sort of one minus, the cost of that, and keeping our investors posted along the way..

Got it. And then just following up on your outlook on credit. You talked about a mid-3%s charge-off with the exit run rate closer to the mid-to-high 3%s.

How should we think about the impact on the provision if loan growth is sustained at these levels? Should we expect the provision to track charge-offs and then build for – and then have a subsequent build for loan growth? And then just related to that, Rich, you commented that it continues to increase as we move into 2016.

At what point do we actually start to see the charge-offs leveling off?.

what the loan balance is at the end of the period; what our charge-off forecast would be over the next 12 months; and then there are qualitative factors which really cover the risk that are not captured by models.

So if you're really trying to model the allowance in future quarters, you're going to need to make assumptions on all of those, the growth rate and the assumption for loans. And remember if you're not doing a year-over-year growth rate, you've got to think about the seasonality because they can run off in different ways.

Next you also would need to however – whenever you want to forecast that for the balances, look at what charge-offs are over the next four quarters after that. And then with regards to our qualitative factors, they've been about 10% to 15% in benign periods but they can vary pretty significantly if you're entering or exiting a credit cycle.

So I'm trying to give you a little bit of a picture of why small movements and assumptions can create swings in a quarter which end up being meaningful.

And the most impactful of the three assumptions is really the net charge-off rate and just looking at this on a static basis with our current loan balances of $74 billion, a 15 basis point change in loss rate in a quarter, all other things being equal would drive $100 million change in allowance.

As Rich talked about, in the first quarter we experienced better than expected delinquencies and flow rates. So the starting point for our next 12 months loss forecast has shifted down and as a result we had allowance releases. Had that not happened, growth would have actually probably driven allowance builds.

So going forward it's a combination of growth and our expectations for loss that suggest that we're going to need allowance builds. But it's really hard to go a lot further than that given all the factors that I've been through. Hopefully that helps Ryan, in the way you think about constructing what could happen to allowance..

when will this level off? We are reluctant to be predicting something that's going to have a lot of factors driving that when we get there.

But I think our point is that 2016 will be a year of rising charge-offs off of the trajectory with which we leave 2015 just because, again, the accumulated math of the vintages of the new business that we're booking..

Next question, please?.

Thank you. And we'll go next to Bill Carcache from Nomura..

Thank you. Rich, I was hoping that you could update us with your current thinking on the strategic importance of the international credit card business and perhaps talk about its growth outlook. And maybe tie in reports this quarter that Capital One was cutting its credit card rewards in the U.K.

and how that may influence how you're thinking about it..

Okay. Bill, first of all, I want to say that most of you may be aware that in both the UK and in Canada, there have been regulatory-based moves to lower interchange. Neither of our businesses there, particularly our UK business are highly dependent on purchase volume for the economics of the business.

So I don't think this will have a big impact on our particular overall economics even though it's an important move in the marketplace. Already a number of issuers have come out in response to the lower interchange rates in the UK and have notified their customers that future rewards will be at a lower rate.

I think that's pretty natural in a tight margin business, and the rewards business is a very tight margin business with the interchange and the high payment of reward benefits. That's pretty natural market phenomenon and we already see that going in the UK.

Interestingly, there's been some pushback and noise on the consumer side because consumers really do like their rewards and I think we should all take note that even in a country where the rewards rates are lower, there is some pushback there, and I think it's a reminder that in the U.S.

consumers who are enjoying higher rates of rewards are pretty vocal for us, for the preservation of these benefits..

Thank you, Rich. That's very helpful. I appreciate that commentary. If I may ask a bit of a high level question on what we're seeing in the partnership business.

The view I believe I've heard you express in the past is that you like the partnership business, but that your optimism is somewhat tempered by the fact that contracts come up for renewal every five years or so and the potential exists for outsized profits to get competed away in that process.

I know I'm paraphrasing, but that's the sense I've gotten from your commentary.

But there are others in this space who are expressing a bit more of an optimistic view on partnership businesses and kind of taking – talking about how the thing that they're most focused on is how their merchant partners are looking for them to help them drive incremental sales growth and they talk about how their pipelines are very strong.

And so I guess the question then is what do you think is driving these differences in views that some folks in the partnership business are a little bit more optimistic in their outlook and that's it? Thank you very much..

Yeah. Well, thank you, Bill. First of all, I think in many ways it's all relative and relative to what.

So as one who built this company initially on a direct to consumer model one customer at a time, you have seen the long history and current performance of that business, and it a little bit spoils me relative to pretty much everything else in the banking business. And I kind of start from there for my calibration.

And frankly, the big difference between – as you said, between the regular direct to consumer credit card business and the partnership business is the holding of auctions that happens on average every five years. And that tends to, all other things being equal, be quite a mitigator in terms of some of the upside potential.

So many of my comments have been just that calibration. The partnership business is a very interesting and intriguing one to me and for a lot of the reasons that you cited, others are talking about. As you know, the retailing business, for example, is in massive strategic turmoil.

And the impact of digital and the need for retailers to reinvent themselves is an extraordinary in many ways kind of existential kind of imperative.

And I think that companies like Capital One that are doing very significant investments in digital and in mobile and in not just the customer experience associated with that, but all the underlying infrastructure that is behind what it takes to actually innovate in digital, companies like ours I think are in a very good position to partner with retailers and help them strategically and actually in terms of real product innovation and execution in that transformation.

So we are also investing in that opportunity and we have partners with whom we're working right now on some pretty cool digital innovations. And so look, that's one reason I like the space a lot. It's also such a natural sibling to our regular branded business.

But what we're doing is we're – how do we deal with sort of this overhang of the auctions? We just make sure that we never say we have to win no matter what. We go out there.

We're selective relative to making sure these are great companies we're working with, companies that are in the partnership business with us for the right reason, where it's really motivated to build a franchise and not just for the making of near-term money that sometimes comes at the sacrifice of customer practices.

And finally selectively where the ultimately the price of the deal is something where both parties can win..

Thank you..

Next question, please..

Thank you. We'll go next to Sanjay Sakhrani from KBW..

Thank you. I guess I got a question on credit quality again. So the seasoning math was supposed to impact 2015 and I guess now it's not. So what's really driving that better performance? Is it fuel prices or something else? And I have one follow-up after that..

Sanjay, I think in the very near term there is – as we grow, there is some what we call a speedboat effect that growth in the near term sort of has a depressive effect a little bit before it inexorably raises the charge-offs some months down the road, but that's really a small effect.

I mean mostly what – essentially what we're talking about here is something that we've seen on not infrequently over, for me, the 20-year history of being in this business, is that from time to time we notice that all our flow rates, our delinquency flow rates move in a similar direction all at one time.

And usually when this happens, there's not necessarily an explanation for it. Often we're able to go back later and tie it back to economic data that comes out later and so on. Now this is not a huge effect. I don't want to get carried away. I've seen much bigger effects in other times.

But because we have actually gone out to give sort of quarterly guidance, all we're saying is coming in better than the quarterly guidance in the relatively near term relative to when we did it just relates to better than expected flow rates without having a perfect explanation there's probably some general economic effect that is going on.

But then our most important point is that we don't necessarily see any evidence that this should change our longer term view about the trajectory and magnitude of the charge-off we're talking about..

Okay. Understood. And then the follow-up question is just I want to make sure the expense take-up on the guidance, that's just more opportunistic spending, right? And to the extent that you're being opportunistic, can you just about where those opportunities are? Thanks..

The opportunities, we are – gosh, the more things change, the more they stay the same. For a long period of time, Capital One, well, pretty much always in our history, we have always been one to invest in growth opportunities.

The investments begins by investing in innovation, in testing, in brand building, and in creating and looking for opportunities. We're real students of the windows of opportunity. And then when we see them, we tend to seize them because we've also learned markets continue to move. So that's the phenomenon that's going on here.

Where we are seeing the growth opportunity is pretty much in our branded book across the board where we are investing. And we are pretty much investing in all places other – as we've talked about – other than high balance revolver. So pretty much one minus that is where the opportunities are happening there.

And they're a byproduct, again, of a lot of work over the years, behind the scenes and investing in things to be in this position. But there's something that still requires us to invest quite a bit in marketing and the associated cost of growth as the opportunities continue..

Next question, please?.

Thank you. We'll go next to Rick Shane from JPMorgan..

Thanks guys. You talked a fair amount about the provision on the credit card side.

I'd like to talk a little bit more about the provision on the commercial side, which you'd sort of talked about some of the qualitative factors that drove the increase in provision, but I'd like to relate it back to Steve's comment about how you think about reserve levels.

Obviously, this quarter we saw a pickup in provision, pretty substantial without any deterioration in credit. Obviously, that's forward-looking related to what you see going on in the oil patch.

I'm curious if there're specific credits within the portfolio that you've already identified as particularly at risk, or is this just a generic reserve related to the qualitative factors Steve talked about?.

Yeah. Well, the comments that I was making were really directly off of card. But let me address commercial. As Rich said, that was really driven principally by energy. And if you think about that, it's a little bit of both. It's a little bit of specific credit observations.

It's a little bit of trying to get ahead of what we see in the marketplace using our historical experience, developing a scenario and making sure that that's reflected in our provision and allowance as well. Those are the things that are really driving the number in the quarter.

One of the things I would say is we're early in the cycle, but we're obviously trying to use the experience we have in energy to forecast what could happen..

Got it. And I'll bootstrap a follow-up question a little bit.

Are you seeing anything on the consumer side in the oil patch that has you concerned at this point as well?.

No. When we look at geographical segmentations of where there is the greatest oil-related activity in those more local markets, we do see a tick-up in some of the consumer credit metrics that you would expect. Nothing dramatic at this point, but it is visible in the markets that are most highly concentrated with respect to oilfield activity..

Next question, please?.

Thank you. And we'll go next to Don Fandetti with Citi..

Yes. Rich, you've been pretty cautious on subprime auto for a while now. It seems like your comments today are perhaps a little more cautious. And what do you think is driving the more aggressive lending, let's say, this quarter? Because it's interesting. Credit looks like it's actually gotten a little better in subprime.

And is it the smaller players? Can you talk a bit about that?.

people don't live with growth targets at Capital One. We forecast growth when we think it's going to come, but people all know that job one is to raise your hand and flag when you see opportunities, and the most important thing is that we go after resilient business.

We are flagging some of – yes, we've ticked up a little bit our commentary on this, although we have been talking for quite a while about it. We talked -- in many ways taken two different perspectives.

Partly what we've said over time is just understand coming off a once in a lifetime, unique situation of incredibly tight credit and incredibly a conservative borrowers, some of the kind of loosening that's going out there would be in the category of normal reversion to the mean.

Some of the stuff that we're flagging here would, I think, be on the other side of that. But on the other hand, this a not something where we're saying, oh my gosh, this is – you're going to see us just pull out of this thing.

We still believe there is selectively very good opportunity for Capital One to go get the assets that we want and continue to build and even expand the number of dealer relationships that we have.

But we wanted to just put the Street on increasingly on notice in the sense for this – that we're very carefully watching the practices, and we're going to make the choices that we make for resilience, and we hope that there're really in many ways two offsetting forces with respect to growth.

We're clearly losing deals one customer at a time sometimes that we might have won in the past because others have moved farther in their underwriting.

On the other hand, some of the innovations we have and the really sustained success in building deeper dealer relationships, moving up through their prime relationships and expanding dealer relationships is a force in the opposite direction that still generates growth. So the net effect of those two things will drive our results.

You can see that, in general, subprime is where we have – you don't see that much growth going on anymore and most of it really has been in prime lately..

Yeah. And then what is the percentage mix over your recent card loan growth between existing and new accounts? And do you – in terms of the seasoning, I guess you see more of the seasoning impact on new accounts.

Is that a fair assumption?.

Yeah. Well, the only seasoning that one would have on existing accounts – well, first of all, existing accounts always, the outstandings ebb and flow with people's spending and borrowing and just general kind of ambient activity.

The only big mover on the existing file would be line increases and having been in sort of a brownout period for a couple of years with respect to line increases, as we said, getting back into line increases led to, if you will, sort of a surge of catching up for a second.

We're on the slightly higher side of equilibrium probably at the moment, I would say, there. The seasoning of those is a different seasoning dynamic with respect to new business. The line increases tend to – all the economics of line increases have upfront – it's sort of upfront very good things, doesn't cost much to get them.

There's no kind of spike of diabolical behaviors or anything. So what you tend to have is – and for a while people use their line to pay any obligations and so on. So what you have there is more of a steady, delayed sort of rise in charge-offs over time with that vintage. That is an important but minority part of the overall growth right now.

It's an important minority, shall we say. The majority of the growth is coming from the origination side of the business or from recent originations and the very immediate credit line moves we might make relative to those. But I put that all in the category of originations. The vintage dynamics for that are very different.

First of all, all the economics are upfront. You take all your pain. You've got your high cost to originate, the big allowance builds. There's even sort of a – the peak of charge-offs comes pretty early and then moderates over time so that sort of all the good news aspect of that thing happens over time.

The majority of our growth is coming on the origination side, but there's a sizeable minority that is on the line increase side. And that's approaching an equilibrium now. It's on the high side of equilibrium..

Next question, please..

Thank you. We'll go next to Moshe Orenbuch from Credit Suisse..

Great, thanks. Rich, you talked a little bit about the rewards in the UK coming down a little bit on tight interchange in the market. Could you talk a little bit about your outlook for the U.S.

where rewards have generally gotten more aggressive and the like in the prospect of perhaps at some point seeing a higher interest rate environment and whether that will have any impact on the industry?.

Sorry, Moshe. Repeat your question....

Yeah. Basically, you've had aggressive rewards competition. It's been increasing both on a co-branded and also just even on cash back and mileage type programs.

The question is, does that turn around? Does it turn around if interest rates start to move up when profitability on a customer who's basically using the card like a charge card would go down?.

Yeah. Well, Moshe, you're talking about a sector that, as long as I've been around it, has been pretty intensely competitive. Now it tends to be lopsided relative to a lot of competition from a small number of players and sort of modest involvement from everybody in the business. This rewards space is – certainly is still very competitive.

And the recent manifestation of extra competition there has been, early spend bonuses have continued to rise. That's probably the most noteworthy thing. I think others in general have come out with products that are a little better than what they have for the existing books.

So there's a little movement on product value and continued competition on early spend bonuses. So we have our eye on that. And of course the other place for the competition of course is just in the amount of marketing. And people are stepping up the amount of marketing as well.

So overall, I would say there has been modest, pretty, pretty modest, now in the overall scheme of things, sort of increase in the intensity of competition there. Now you talk about – so in the context of all of that, as rates go up at some point, I think a sizeable increase in interest rates will probably have a fair amount of impact on that.

I wouldn't expect modest interest rate changes to impact that too much. But I know, Steve, you've spent a lot of time thinking about this.

What were you going to say...?.

Yeah, just with respect to interest rates, three observations. First, when we book new accounts, we fund the balance, what we assume the balance is going to be, going forward. So there's not rate risk as you would say on the existing book. The rewards that we have are obviously that we're accumulating are expensed.

And as Rich said, the underwriting that we do on the accounts does assume some stress level in the rate environment, so it's not booked based on current spot rates. So there's a lot of thought into the interest rate risk associated with the business..

And just as a follow-up, any update on what you're seeing in your relationship with Costco in Canada? And if not now, when do you think we'd hear about that?.

Yeah. We're excited about our new agreement with Costco. This was launched in September of last year. And of course we're the exclusive credit card issuer for the retail brand in Canada. This didn't, by the way, just didn't come with a portfolio acquisition. So this is really one that we're sort of, from scratch, working to build the customers.

And as the first – in the first six months since the partnership launched, we're seeing pretty strong demand as Canadian consumers appear to be certainly very willing to take up what is a quite attractive MasterCard product..

Next question, please..

Thank you. We'll go next to Eric Wasserstrom from Guggenheim Securities..

Thanks very much.

Steve, if you wouldn't mind, can you just clarify what you meant in your comment about the payout ratio going forward just so I understand it in the context of what Rich concluded with in terms of the payout outlook?.

Look, we'd ask you to look more at our actions and our commitment to return capital over the last two years. I don't think you'll ever see us, certainly not in the near term, but my guess is probably ever committing to a payout ratio. The business is just – we'd like to retain the flexibility.

And obviously, if opportunities arise or the economy changes, there can be a whole bunch of things that change. In the near term, you saw that this year our test improved a fair amount in terms of how the Fed looked at us, which was good news. And we hope things continue to move in that direction. But we can't be assured that that's the case.

The other big uncertainty we've talked about and continue to have going forward is how CCAR and advanced approaches will come together. So there's just a whole bunch of reasons why we don't want people to lock into what we have done over the last two years and just assume that's the minimum going forward..

Got it. So you're really just underscoring the need to maintain capital flexibility in light of competitive conditions and a continuously evolving regulatory environment..

Absolutely..

Great. All right. Thanks very much..

Next question, please..

Thank you. We'll go next to Bob Napoli from William Blair..

Thank you. Just a question on growth and a follow-up on regulation. Just the – Richard, what do you expect, what are your thoughts on the growth rate of your credit card business? You've had very strong growth, accelerating growth, as you said, helped by credit line increases as well as your branded product.

Are we done with the credit line increases? Are we going to continue to see an acceleration in that business? And – I mean your spend growth in the U.S. is pretty amazing compared to the industry. And I guess that's credit line-driven as well. So outlook for growth.

And are we – which products, and are you near the end of the credit line increases?.

Yeah. So, Bob, let me talk about the outstanding growth, to start with. That is being driven somewhat by line increases and also by the success of origination programs on, sort of across the various parts of – across all the parts of the business that we're investing in.

So, on the line increases, I guess, my description was, we're on the higher side of equilibrium, but they're sort of approaching an equilibrium level. But we're probably on the bit – on the higher side of equilibrium there. On the spend side, that is – that's driven by – I mean you were kind of right where you're going in a sense.

The spend is, yes, partly the success we have in the rewards programs we have, it's also people filling up their lines in a sense, either coming from line increases or a lot of new originations where people are starting to ramp up their spending there.

So there's a number of things that have come together to make really quite extraordinary spend growth. And all of that I think is reflective of – if I kind of pull way up and just talk about our growth here for a second, the growth that you see here – and Bob, you've known Capital One for a long, long time.

Our strong growth is really driven by the investments we've made in the last few years and the current market dynamics that represent a window of opportunity. And we're continuing to invest to try to sustain this trajectory. And I've just been around long enough to know that life's about windows of opportunity.

And the way Capital One works is, when we see windows, we really do kind of go for it. We also, interestingly, if there's a reverse window, if you will, when we think market dynamics get in a kind of negative sense, we, a lot of times, exceed the market in the other direction, sometimes in pulling back.

But this is one of those things where a number of things have come together and the byproduct of a lot of investment and opportunities, some digital innovation that's going on, and we'll capitalize on it as long as it lasts.

We're reluctant to give a growth outlook because almost by definition, when you're growing at some of the kind of rates you've seen here, it's just hard to predict where things go from here. But we certainly are continuing to invest. And that's reflective in some of our comments about on the cost side..

Thanks.

And just on regulation, are you seeing – are we getting near the end of the increase in regulatory costs? Do you have any sense that things are settling down? I mean you hired 5,000 people over the last year and there's a lot of investment, I don't know what – I mean how much has regulation pressured your business from an operating expense and operating perspective? And do you feel like maybe you could see the light at the end of the tunnel or not?.

Well, I don't think you could probably find a bank executive in the entire United States that would predict that the increase in regulatory costs has come to an end.

So, Bob, I think there are some companies who have gotten themselves in a very complicated situation and are trying to rectify some sort of big, very public problems and things like that. I think for us, the philosophy that we take and look, the regulatory bar dramatically increases every year.

And I mean every year including even the – the other day, I was giving a presentation to our associates and just listing within the last 12 years, a big, long kind of list of things that have sort of raised the bar in the past year.

The approach that we're taking is to say let's try to seize this opportunity, seize the regulatory moment, not just to fill out a checklist and get our – all of our to-do requirements done, but to work backwards from what it takes to build a really dynamic, well-controlled company in the modern kind of era, if you will, and work backwards from that and make sure that what we're putting in is consistent with a dynamic company that can innovate and do a lot of things and also embrace the spirit behind so many of the regulatory requirements that the world is really expecting and demanding a very high level of execution.

And we're going to try to step up to that bar. Along the way, the costs frankly keep going up, Bob..

Next question, please..

Thank you. We'll go next to Betsy Graseck from Morgan Stanley..

Hi. Good evening. Just had a question on some of the new partnerships that you've been announcing.

I think you've done some work with innovative companies, like some of the firms out there on the West Coast and wanted to get a sense of how much your technology investment spend has helped you to be a leader and helped you to announce these kind of partnerships early on? I'm talking about what you recently announced with Uber..

Yeah. So well, Betsy, first of all, with respect to external digital parties, there's a lot of manifestations of Capital One's commitment to digital. We've done a number of partnerships. We've done a number of acquisitions like Adaptive Path, Level Money, and things like that.

We've done a number, a very large number of recruiting successes, including some pretty high-profile folks that we've brought in. One thing is absolutely clear and it's – and we believed this from the beginning, that every bank is going to need to transform itself.

The digital revolution is changing banking on just about every dimension that you can imagine basically. It's changing what it takes to win in payments, in distribution, in marketing, in brand, foundational infrastructure, experience design, if you will, the way information is used.

And in the end, that really means the role of talent is central to that kind of transformation. And so in the talent marketplace, in the partnership marketplace, I think these folks, you can't just go out there with a checkbook and say here we are. We're here to bring you into the fold.

I think these folks look to see and they come in and kick the tires to say, is this a company that's bolting digital onto the side of a traditional bank? Or is this a company that is really, like in our case, trying to build a really leading information-based technology company, in a sense? And the key manifestations of that are inside the company.

Are the leaders committed? Are they digitally fluent? Have they digitally reimagined their business? Are they bringing technology talent not just into some like place in IT in a sense, but is it really being brought right into the heart of the business and become sort of who you are? So when you heard me talk a lot about digital, it's just that this reminds me a lot of 20 years ago sort of building an information-based company.

I'm incredibly excited and sobered by what it takes to actually really build an information-based technology company, and I really like our chances.

And along the way, as we go on that journey, the more success we have there will correlate also with a lot of people from the outside saying, you know what? That is the kind of company that I think speaks our language and is one of us. And you'll see more of the kind of partnerships and successes that you alluded to..

That's great. And just a follow-up on that is on – the impact on real-time payments. I know there's obviously a lot of work streams going on at the Fed regarding trying to move the payment system to be real-time settlement. I'm sure you've thought a lot about that and are working on that as well.

I'm just wondering what kind of opportunities does that potentially give to you as real-time payments come to fruition..

Well, gosh, there's a lot of dimensions to that particular thing. It is ironic that the banking system is from stem to stern built on a batch basis. So you pretty much look at anything, and from the old direct mail stuff that Capital One and so many of us have done over the years, the whole way clearing works.

And so – and really, while there are many, many aspects to the batch nature of this thing, right at the center is this irony that in a world that increasingly is going toward pure electronic payments, there's a massive kind of, oh yeah, lag in the end to make those things fully happen.

Most banks – pretty much all of us banks have built middleware layered to, in a sense, simulate real-time, even in the context of a reality that's very much batch-based. I'm not sure that real-time payments will actually transform banking as much as a lot of people think it will.

But the reality of when the world moves, if we pull up from real-time payments and clearing technically to the larger point of the world moving to such immediate interactivity and such a mobile world, the really dramatic transformation that's going to happen to banking is it's going to become real-time, far beyond kind of real-time payments.

And I think that – I think banks are so, in a way, ill-suited to drive to that destination, yet the world will drive us banks there. I think that you kind of put your finger on something from a broader point of view that I think is at the heart of the whole reinvention of banking that is coming.

It's just that for banks to get there, the banking system and for banks individually, there's a lot that that entails. And we're going to need to think more like technology companies and maybe a little less like banks..

Next question, please..

Thank you. And our final question today will come from David Hochstim with Buckingham Research..

Thanks.

Just following up on that, what do you think it would cost in time and money to transform the company into a real-time entity?.

Capital One?.

Yes..

Well, I mean in some ways, I mean it's a lifelong, forever journey. This is not like we're going to say by next year, we're going to be real-time.

I'm just saying, so from a journey for me that started 20 years ago and looking at the banking industry and saying in many ways this is really the information business, not necessarily just the traditional banking business.

I'm saying the world has – it's very clear at the accelerating rate that the world is moving, the ability to – the dimensions of how information is leveraged, the real-time nature of information and the software revolution that has changed everything, the connected revolution here.

Working backwards from that will be a lifelong journey, but I think that the companies that, for all of us, it will be gradual.

But as we continue to leverage those opportunities, I think the difference between companies that are really taking advantage of that versus companies that are following the more traditional model, there will – in the end, this is going to translate, I think, into growth opportunities and economic differences and a number of things that are pretty significant.

But this is something in a sense that is going to be a lifelong effort for banks like ours..

But you think it will take a long time..

In some sense, it'll probably take forever because the world's going to keep moving that fast.

The main thing is that we already see the benefits of some of the things we've been investing in and some, one of the important drivers of some of the growth opportunities we have right now is coming from the digital innovation that we have spent a number of years doing..

Well, thank you very much, everyone, for joining us on the conference call this evening and thank you 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 evening..

That does conclude today's conference. Thank you for your participation..