Jeff Norris - Capital One Financial Corp. Richard D. Fairbank - Capital One Financial Corp. R. Scott Blackley - Capital One Financial Corp. Unverified Participant Stephen S. Crawford - Capital One Financial Corp..

Ryan M. Nash - Goldman Sachs & Co. Eric Wasserstrom - Guggenheim Securities LLC Donald Fandetti - Citigroup Global Markets, Inc. Elizabeth Lynn Graseck - Morgan Stanley & Co. LLC Arren Cyganovich - D. A. Davidson & Co.

Matthew Hart Burnell - Wells Fargo Securities LLC Christopher Roy Donat - Sandler O'Neill & Partners LP Sanjay Sakhrani - Keefe, Bruyette & Woods, Inc. Christopher Brendler - Stifel, Nicolaus & Co., Inc. Richard B. Shane - JPMorgan Securities LLC Bill Carcache - Nomura Securities International, Inc. Kenneth Matthew Bruce - Bank of America Merrill Lynch.

Welcome to the Capital One Third Quarter 2016 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer period. [Operation Instructions] 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, Kevin, and welcome, everyone, to Capital One's Third Quarter 2016 Earnings Conference Call. As usual, we are webcasting live over the Internet. To access the call on the Internet, please log on to Capital One's website at capitalone.com and follow the links from there.

In addition to the press release and financials, we've included a presentation summarizing our third quarter 2016 results. With me today are Mr. Richard Fairbank, Capital One's Chairman and Chief Executive Officer; Mr. Steve Crawford, Capital One's Head of Finance and Corporate Development; and Mr. Scott Blackley, Capital One's Chief Financial Officer.

Rich and Scott 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.

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, which are accessible at the Capital One website and filed with the SEC. And with that, I'll turn the calling over to Mr. Fairbank.

Rich?.

Thanks, Jeff, and good evening, everyone. I'll begin tonight on slide four with our Domestic Card business. Loan growth and purchase volume growth remained strong. Compared to the third quarter of last year, our ending loans grew $8.8 billion or about 11%. Average loans were up $9.4 billion, or about 12%.

Third quarter purchase volume increased about 12% from the prior year. We continue to like the return and resilience profile of the business we're booking.

In the quarter, we also announced that we entered into an agreement for a new partnership with Cabela's, and the acquisition of Cabela's co-branded card portfolio, which has roughly $5.2 billion in outstandings. The agreement is subject to regulatory approvals and customary closing conditions.

Cabela's is a great retailer with a powerful brand and highly engaged and loyal customers. Revenue for the quarter increased 8% from the prior year quarter, slightly lagging average loan growth.

Even with the positive margin impacts of higher subprime mix, revenue margin declined year-over-year as expected, with our exit of the back book of payment protection products at the end of the first quarter. Revenue margin for the third quarter was 16.6%. Non-interest expense increased 4% compared to the prior year quarter.

Our Domestic Card business continues to gain scale and improve efficiency. Net interchange revenue for the total company grew 9% from the prior year quarter versus the 12% growth in Domestic Card purchase volume. As we've discussed, there's considerable quarterly volatility in the relationship between these two metrics.

For the past several years on an annual basis, net interchange growth has been well below Domestic Card purchase volume growth. We'd expect this difference to continue as we originate new rewards customers in our flagship products and extend rewards to existing customers.

Additionally, a few of the largest merchants have negotiated custom deals with the card networks. These deals are putting pressure on interchange revenue and we expect the pressure to continue.

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

Growth math began to impact charge-off rates in 2015. We still expect the peak impact of growth math in terms of its contribution to year-over-year change in our loss rate to be in 2016 with a diminishing effect in 2017 and only a modest effect beyond that.

In the third quarter, growth math drove the increase in charge-off rate compared to the prior year and seasonality drove the improvement in charge-off rates compared to the linked quarter. Looking ahead, two effects are together moderately impacting our charge-off outlooks since last quarter.

One effect is better than expected growth, especially in subprime. While we are growing nicely everywhere we are investing, we are seeing particular success in subprime, which has raised the mix modestly. Our proportion of loans below FICO 660 has grown from 35% one quarter ago to 36% at the end of the third quarter.

Subprime has higher losses than average and they're also more front-loaded, so it tends to have a pretty immediate impact on our near-term credit metrics.

Beyond the growth and mix effect, we have revised slightly upward our front book loss expectations for 2017 and slightly downward our front book loss expectations for 2018 based on the composite performance and projections for hundreds of credit programs.

These effects together lead us to raise our full-year 2017 charge-off guidance from the low 4s to the mid 4s, with normal seasonal variability and excluding the modest benefit we expect from adding the Cabela's portfolio. With nine months of actual results in the books, we expect 2016 full-year charge-off rate will be around 4.15%.

We expect the changes in guidance to largely play out over the next three or four quarters, so the expected impact of higher charge-offs is mostly captured in our current allowance.

While we are modestly raising our loss outlook for 2017, our internal view of 2018 losses is unchanged with slightly improved expectations for front book performance offsetting higher subprime mix. Pulling up, the higher growth in subprime mix are also driving up our revenues and pre-provision earnings.

We continue to see attractive growth opportunities in our Domestic Card business, but it's clear this opportunity won't last forever. The marketplace is moving and competitive intensity across the Card business remains high; and revolving credit growth is now 6% year-over-year. We will continue to monitor the marketplace vigilantly.

But in the meantime, we continue to like the opportunities that we see. Slide five summarizes third quarter results for our Consumer Banking business. Ending loans grew about 2% compared to the prior year. Growth in auto loans was partially offset by planned mortgage runoff. Ending deposits were up about $8 billion or 5% versus the prior year.

Third quarter auto originations were $6.8 billion, about 22% higher compared to the third quarter of last year, with strong growth in prime, near-prime, and subprime.

Similar to our Domestic Card growth, we liked the earnings profile and resilience of the Auto business we're booking and continue to believe that the through-the-cycle economics of our Auto business are attractive. The auto market and competitor practices remain dynamic.

While we see opportunities for growth, we remain very vigilant about competitor practices. Our underwriting assumes a decline in used car prices. We continue to focus on resilient originations, and we continue to expect a gradual decrease in margins and a gradual increase in charge-offs as the cycle plays out.

Consumer Banking revenue for the quarter increased about 3% from the third quarter of last year. Higher revenue from growth in auto loans and higher deposit volumes was partially offset by margin compression in auto and planned runoff of mortgage balances.

Non-interest expense for the quarter also increased 3% compared to the prior-year quarter driven by growth in auto loans and an increase in retail deposit marketing. As we've discussed in prior quarters, we've been optimizing both the format and number of branches to better meet the evolving needs of our customers as banking goes digital.

In the third quarter, actual changes related to branch moves were about $60 million. Year-to-date, we've recognized about $106 million of the $160 million in expected costs for 2016. We expect branch optimization costs to continue in 2017. These costs show up in the other category rather than in the Consumer Banking segment.

Third quarter provision for credit losses was up from the prior year, primarily as the result of charge-offs and additions to the allowance for loan losses for the auto portfolio.

Growth in auto loans, the expectation of gradually rising auto charge-off rates and the expectation of declining used vehicle values drove the trend in consumer bank provision for credit losses. For several quarters, we've said that we expect pressure on our Consumer Banking financial results.

In the home loans business, planned mortgage runoff continues. In auto finance, margins are decreasing and charge-offs are rising modestly. And our deposit businesses continue to face a prolonged period of low interest rates.

We expect that these factors will negatively affect Consumer Banking revenues, efficiency ratio and net income even as we continue to tightly manage costs. Moving to slide six, I'll discuss our Commercial Banking business. Third quarter ending loan balances increased 28% year-over-year, including the acquisition of the GE Healthcare Finance business.

Excluding the $8.3 billion of loans acquired from GE, ending loans grew about 12% over the same time period. Average loans increased 28% year-over-year, while average deposits increased 2%. Revenue was up 27% from the third quarter of 2015. Credit pressures continue to be focused in the oil and gas and taxi medallion portfolios.

We've provided summaries of loans, exposures, reserves and other metrics for these portfolios on slides 14 and 15. For the total Commercial Banking business, third quarter charge-offs were $108 million, primarily driven by charge-offs of Chicago taxi medallion loans and to a lesser extent, oil and gas loans.

The charge-off rate for the quarter was 66 basis points. We added to reserves for some third quarter weakness in New York City taxi medallion values, but the reserve additions only partially offset the charge-offs flowing out of reserves, resulting in a net reserve release in the quarter.

Combining both charge-offs and reserve changes, provision for credit losses declined $14 million from the prior year quarter to $61 million. Criticized and nonperforming loan rates were relatively stable in the quarter. The criticized performing loan rate for the quarter was 3.7%, and the criticized nonperforming loan rate was 1.5%.

Now I'll pass the call over to Scott..

Thanks, Rich. I'll begin on slide seven. Capital One earned $1 billion or $1.90 a share in the third quarter. Excluding adjusting items, earnings per share was $2.03.

Adjusting items in the quarter included a $63 million build in our UK Payment Protection Insurance customer refund reserve, of which $47 million was an offset to revenue and $16 million was captured in operating expense. A slide outlining adjusting items can be found on page 12 of the slide deck.

Pre-provision earnings increased modestly on a linked quarter basis as higher revenues were only partially offset by higher noninterest expenses.

As I highlighted last quarter, we had a one-time rewards expense that reduced net interchange income by $38 million, driven by the completion of some system enhancements that moved our rewards liability cutoff to the last day of the quarter.

Provision for credit losses was flat on a linked quarter basis as higher charge-offs were almost entirely offset by a lower linked quarter allowance build. An allowance roll-forward by segment can be found on table eight of our earnings supplement. Let me take a moment to explain the movements in our allowance across businesses in the quarter.

In our Domestic Card business, we built $349 million of allowance. This build was driven by growth and subprime mix in the quarter and incorporating our charge-off expectations for the next 12 months into our allowance calculation.

In our Consumer Banking segment, allowance increased $31 million in the quarter, almost entirely driven by growth in our Auto business. In our Commercial Banking segment, we had a $48 million reduction in reserves, driven by charge-offs in our taxi medallion portfolio.

Recent reserve movements have focused on taxi and our oil and gas portfolios, and we have provided details for those portfolios on slide 14 and 15 of the appendix of tonight's slide deck. Turning to slide nine, you can see that reported net interest margin increased 6 basis points from the second quarter to 6.79%.

That was primarily driven by day count. NIM also increased 6 basis point year-over-year, which was fueled by strong growth in our Domestic Card business. Turning to slide 10, I'll discuss capital.

As previously announced following the approval of our 2016 CCAR capital plan, our board authorized repurchases of up to $2.5 billion of common stock through the end of the second quarter of 2017. In the quarter, we accelerated the pace of our buybacks and repurchased 17 million shares, or $1.2 billion of our authorization.

Our common equity Tier 1 capital ratio on a Basel III standardized basis was 10.6%, which reflects current phase-ins. On a standardized fully phased-in basis, it was 10.5%. And with that, I'll turn the call back over to Rich..

I'll close tonight with some thoughts on third quarter results and our outlook as we head into 2017.

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

We've been working hard to improve efficiency by growing revenues, realizing analog cost-savings and other efficiency gains as we become a more digital company, and tightly managing costs across the enterprise. Our efforts are paying off. Our efficiency ratio for the quarter was 52%.

Excluding the impacts of UK PPI, the adjusted efficiency ratio was 51.4% for the third quarter and 51.8% year-to-date. It's clear that we're on track to deliver much more than our prior guidance of some improvement in our full-year 2016 efficiency ratio, excluding adjusting items.

Even with the expected significant seasonal increase in non-interest expenses in the fourth quarter, we now expect that our full year 2016 efficiency ratio will be substantially lower than full-year 2015.

In 2016 we are already on pace to deliver the efficiency ratio improvement we had expected to achieve in 2017, primarily driven by enhanced revenues and concerted efforts to drive out analog costs.

From this more efficient starting point, we expect that our near-term annual efficiency ratio, excluding adjusting items and the expected impact of Cabela's will be in the 52%s, plus or minus a reasonable margin of volatility.

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

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

We continue to be in a strong position to deliver attractive shareholder return driven by growth and sustained returns at the higher end of banks, as well as significant capital distribution, subject to regulatory approval. And now, Scott, Steve and I will be happy to answer your questions..

Thank you, Rich. We'll now start the Q&A session. As a courtesy to other investors and analysts who may wish to ask a question, please limit yourself as usual 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. Kevin, please start the Q&A..

Thank you. [Operation Instructions] And we'll take our first question from Ryan Nash with Goldman Sachs. Please go ahead..

Hey. Good evening, guys. So, Rich, thanks for the update on the credit guidance. Can you maybe just flush out a couple of those comments for us; and in particular, what it means for the allowance? You talked about higher charge-offs, but that largely being in your allowance already.

So I guess just one, what is driving the changes in the back book expectations for 2017 and 2018, and is that just mix? And you noted that you still think that you're on track to deliver solid 2017 EPS growth. You referred to it as a coiled spring.

Do you still think that's achievable given your expectations for slightly higher charge-offs?.

Okay. Ryan, there's a bunch of great questions that you have. I think, Scott, you can take the allowance thing. So, first of all, when you said it's – tell me about your change in back book expectations. We don't really have any change in back book expectations.

The change in expectations that we're talking about is driven by two factors, okay, and a key part of this point is that better than expected growth, especially in subprime is a key part of our revised guidance. And as for our front book loss expectations, we revised them up....

Yeah, sorry. Rich, I meant front book..

A, higher than the back book; B, that have their losses more front loaded; and C, of course, it flows right through allowance. And so this brings a lot of pressure right upfront when we grow at the kind of trajectory that we're talking about.

Hopefully, you can see when you look at the numbers and do the math on what we are booking here, this is a coiled spring of a lot of earnings power, and we're – and that's why we continue to work hard to originate and grow what we can very prudently during this window of opportunity.

Scott, why don't you comment about the allowance part of this question?.

Yeah. Yeah. Ryan, let me spend a minute and just kind of walk through some of the puts and takes in the allowance. So, one way to look at the build is to start off by taking the coverage ratio from last quarter and applying it to the change in ending balances.

That really ignores the effects of growth and subprime mix that are impacting the loss rate, but you can see that if you kind of start with that static coverage ratio and apply it to the change in balances, that's going to explain roughly a third of the build.

Be mindful that when you get to Q4 if you're going to try to do that calculation, you need to adjust for seasonal balances. So just keep that in mind. Now the rest of the build is really associated with the loss rate and kind of the mechanics of doing the calculation of the allowance.

Rich just walked through in detail the drivers of our updated charge-off guidance, growth in mix, and performance. So most of that guidance change happened during periods that are included in our Q3 allowance. And so we captured those as part of our updated allowance calculation this quarter.

In addition to that, the mechanical effect of the quarter swap, which is moving forward the loss forecast one quarter, results in us dropping off Q3 2016 and adding Q3 2017 to the allowance calculation.

Our forecast, as you know and as we've been saying, is for losses to be higher in 2017 versus 2016, so that change in quarters, all things equal, adds to the allowance calculation. And on top of that, we always have qualitative factors which are for risks that are outside of the models.

So just kind of pulling up, though, looking ahead, I want to give you kind of some of the building blocks as you think about how you can calculate the estimates of the allowance movements in 2017. So we told you a couple of key things. One, we told you that what the full year loss rate for 2017 is expected to be.

We told you that the increase in our loss guidance has already been captured in the current allowance. And we've told you that we expect the impact of growth math is diminishing in 2017 and only has a modest effect beyond that.

So all of those factors, I think, collectively give you a good base to start kind of building up what your loss expectation is going to be in your 2017 allowance..

Thanks for taking my questions. I'll step aside so others can ask questions..

Thanks, Ryan. Next question, please..

Next with Eric Wasserstrom with Guggenheim Securities. Go ahead, please..

Great. Thank you for taking my question and thanks for that very detailed explanation about the ALL (27:47) outlook. If I could just maybe follow up, Rich, on the commentary about the coiled spring, which Ryan also referred to.

I mean, should we expect 2017 net income given the factors that you've just highlighted to be above the 2016? And I guess the issue I'm really getting to is we're seeing this outstanding growth at incredible marketing efficiency, and yet we're seeing ROE decline despite the impacts of the share repurchase.

So I'm just trying to understand kind of what we're looking for in terms of secular profitability?.

So, Eric, I don't want to go beyond the forward-looking statements that we made in the prepared remarks. But I think the key way to look at this, again, is a pretty dramatic growth for several years on the order of what we're talking about puts a lot of pressure on the P&L of the Card business, and it has been absorbing that.

Now meanwhile and I always used this term of a coiled spring, I think it's a great metaphor, but meanwhile when we look at the value of what we're retaining here, we're very bullish and that's why we're growing at the rate that we are. But I think all I would say is, again, just think through the mechanics of kind of the timing of how this plays out.

You start with a lot of growth, which has more cost but especially, most importantly, impacts the credit metrics and especially goes right through the allowance line. So how the earnings power shows up, the line item where the earnings power will really start to hit that inflection point is really as allowance builds start to mitigate.

And that, of course, happens right at the time when looking ahead, the growth math effects are also starting to really settle out. And our point is we are approaching that period in this dramatic period of growth in the Card business, and I think that's why we're not giving specific guidance on earnings power.

We're just saying that we should start seeing earnings power play out over time as this – the growth math does its very predictable things..

Okay, thanks that's very helpful. Thanks very much..

Next question, please..

Your next question, Don Fandetti with Citi. Go ahead..

Thank you. Rich or Steve, I guess, I wanted to clarify, it sounds like you said that the 2016 vintage is coming in better than the 2015, and 2015 worse than 2014, which makes sense.

I mean, it just seems – can you talk a little about how 2016 could possibly be coming in better, and why that might be the case?.

Right. There's many, many ways we look at that, but starting with mechanically, the actual vintages themselves and the very early credit metrics, things like delinquencies on those vintages.

Additionally, Don, we also just look at the mix of what are the metrics, things like credit scores and so on of the business that we're booking, what is that blended distribution. And all of the key indicators we look at, and this matches our own intuition about what's going on as well, show a positive impact for 2016 versus 2015.

Now I want to make it very clear, 2015 is going to be a very successful year and very profitable and with very good long-term credit performance. We're talking about small changes relative to expectations as we revise – as we always do every quarter, our own credit outlook.

We're just kind of painstakingly trying to break down the components so you get a better understanding of this. But we feel great about 2014 front book. We feel great about 2015 front book. 2016, all the early indicators of 2016 suggest that from a credit point of view, it's going to come in a little bit better than 2015..

Okay. That's real helpful. And then just quickly, you've been pretty active in subprime cards. Do you expect the other banks to sort of reach down? You saw JPMorgan talk a little bit about it as early as Q2.

Can you talk about competition in that segment?.

Yeah. It's a striking thing. We've talked a lot about industry growth, and we talk often about industry growth has gone from very low single-digits or even occasionally negative a couple of years ago to 6% and that has our attention. But here's another stat that's an interesting one.

If you look at the composition of the industry's growth over the last 12 months, about – and I'm going to just exclude Capital One from the whole calculation because your question is an industry effect there, about 31% of the growth is in subprime.

And so subprime growth has certainly picked up now, it's growing faster than prime, and certainly that has our attention. Now I do want to say, on the other hand, it remains well below pre-recession levels in absolute terms because there was such an exodus from that part of the business over the years following the Great Recession.

So, at times I think you hear from some players, subprime we don't do that. Well, all I'm saying is 31% of all the growth is subprime, and somebody is doing it. And so, yeah, that has our attention.

And it's part of – it's one – it's an important part of the overall – if you kind of look at the industry story and this, by the way, is the number one thing that we worry about, more so than like the next recession; obviously, we worry about things like that, too.

But the industry growth being at 6% and the subprime component of that, and then also the, beyond card growth when you look at student lending, auto lending, installment lending, that's been running for a while now at around 7%. So we're pretty obsessive about these things.

It causes us to believe, first of all, that we have a window, and it's just another reason we've doubled down and gone really hard while we have this window.

It means we have to be doubly and triply obsessive about looking for indicators of things that inevitably happen when supply goes up a lot, and those indicators can be broad-based impact on credit metrics, as well as, of course, just directly affecting response rates and things like that.

So we're on the lookout and as we kind of always do for our investors, try to raise these flags. But we feel very good about what we're booking. We like the resilience of what we're booking, and we still are moving forward with resolve to continue to capitalize on these opportunities.

But there's no doubt the industry growth data is just one more reason to remind ourselves that everything is a window of opportunity and we have to carefully watch the industry from here..

Next question, please..

And we go next to Betsy Graseck with Morgan Stanley. Go ahead please..

Hi. Good morning or good afternoon. It feels like morning here.

I'm just wondering on Cabela's, maybe you could give us a little bit of some color around how you expect it's going to be impacting various line items in the business overall? Any investment spend that you need to do to prepare for it? And if there's any of what you expect Cabela's to do to your numbers in the commentary that you gave on the outlook for 2017?.

Hey, Betsy. This is Scott. In terms of our guidance, so all of the guidance that we gave is excluding Cabela's. We haven't yet finalized all of our projections in terms of impact for Cabela's. We think it's a fantastic partner. We're extremely excited to have won that business. It's a powerful brand. Incredibly loyal and engaged customers.

So we're pretty thrilled about that. We're still working on all the details of the closing of that transaction, so don't have more information about that at this point..

Okay. And then just separately, follow up on the vintage discussion that we just had. Just wondering, I know you mentioned that 2016's seasoning better than 2015.

Are we talking about the first quarter of 2016? Just wanted to get a sense as to how long you think it takes for things to season and why the trajectory so soon into the 2016 cycle is looking better?.

Well, I mean, this is all something that with every passing month gives you a little bit more clarity.

And that's why on all of this stuff we triangulate from just the literal vintage analysis but we already looking at all the vintages of 2016, can see a gap relative to early vintage reads versus 2015 and in the same way that 2015 had a gap relative to 2014.

But again, there are – it is a triangulation, or it's reinforced by just kind of watching the underlying dynamics of what – of even the mix within the mix of all of the programs and looking at the distributions of who's applying and it's something that's composite across hundreds of programs, but all of the signs are consistent with us that there is this – all of this we're talking about is modest effect.

But enough that I – it was worth mentioning that 2016 is a positive relative to 2015..

Next question, please..

Go next to Arren Cyganovich with D. A. Davidson. Go ahead, please..

Thanks.

I guess, relative to the window of opportunity you still see in Domestic Card in thinking about how much the subprime has grown, do you still expect to see that higher take-up rate on the subprime? Or do you have any kind of expectations for limiting that at some point if it grows too large relative to the other piece of the portfolio?.

Arren, one thing we've kind of been featuring subprime here. I don't want to diminish the really good momentum that we have in pretty much all of the parts of the Card business that we're investing in. And we're pretty bullish about our growth opportunity in all of the areas.

We've had more recently kind of a surge on the subprime side, and – but who knows, I – I don't want to project what will happen to mix on a relative basis. I think we like all of the things we're booking.

I think we have reasons to believe we can continue to grow in all of the areas, but it was worth highlighting, though, that the kind of recent surge that we've had on the subprime side. But I wouldn't extrapolate to that to some significant continuation of that surge..

Okay, thanks. And then just secondly, wondering if you had any updates on Capital One 360 Cafés that you've been testing in different markets.

If it's too soon for anything you can share from the impacts of putting those stores into various cities?.

Well, the Capital One Cafés just tended to pull way up. As you know, we're a national company in just about everything we do, except we are local in really only 20% of the nation in retail banking.

And so, Capital One Cafés are kind of the manifestation of how we're re-imagining the future of banking and also how we can kind of enhance the national banking presence we already have through our old ING book that, of course, we call Capital One 360 now. The key thing there is it's not about putting a branch on every corner; far from it.

It is about building kind of, if you will, flagship stores in key metropolitan areas and using that as, in many ways, a manifestation of banking re-imagined relative to the very traditional way that banking has been done for forever, basically. So we have been gradually expanding our footprint in the cafés.

We've been very pleased with the early results from the cafés and we are – what we see is reinforces our view that this will – this is a good thing to continue to build out on a very thin basis, distribution in major metropolitan areas with these cafés..

Thanks, Arren. Next question, please..

Next to Matt Burnell with Wells Fargo Securities. Go ahead, please..

Good evening. Thanks for taking my question. I appreciate all of the detail you've provided on the credit card side of things in terms of your expectation for losses. The question I frequently get from investors is your outlook for the auto portfolio given that that's also growing at a relatively healthy pace.

Can you give us a sense as to – and maybe a similar way of thinking about losses and originations in 2016 versus 2015, and what your thoughts are in terms of forward-looking losses for the auto portfolio?.

So thanks, Matt. I'm not going to give you specific like numerical guidance about the Auto business, but let me just pull way up about auto. As we've talked about – first of all, we really like the Auto business. I think it plays to Capital One's strengths, and we built a very strong and kind of leading presence in that space.

The Auto business after the Great Recession was something that I don't think we'll see again in our lifetime in terms of unique opportunity to grow and create value with high margins and exceptional credit quality because so many players had headed for the hills and consumers were, gosh, they were even at times walking away from their houses and still paying on their cars.

And used car prices were just at incredible highs. So much of our commentary about auto has been predicting, saying it's got to be that this thing will normalize over time, and the journey since then has really been one of normalization where pretty much every year the margins are going down, every year credit losses have kind of gone up.

Now in Capital One's case is – two things I want to say. Anything that we – we've also had a mix change going on within Capital One over the last few years that has been more market growth and so that has tended to dampen this effect.

But let me also say, really, if you stack vintage after vintage year after year in auto, they have been, the last few years, going up year over year, but the overall thing that we've seen is we've been – surprised is probably an overstatement, but I think we have kind of predicted something, a more rapid normalization than we've actually seen.

All of that said, I think the Auto business is still in a good place for us to generate profitable business. But it is mostly kind of normalized, and it has a number of things going on in the industry that cause us to be very vigilant, most importantly, kind of underwriting practices there.

But I would say really over the last few years, the actual credit performance has been strikingly good and maybe even a little better than expected..

Next question, please?.

Okay..

Oh, I'm sorry, Matt.

You have a follow-up?.

Yeah. Just to follow up on the – if I can for Scott on the buyback.

If I take the average price of Capital One shares over the course of the third quarter, that was about $68.68 versus the 17 million shares you said you repurchased, is a little less than $1.2 billion in buybacks versus the $2.5 billion announced buyback program for the four quarters of the capital planning cycle.

Can you give us a sense, Scott, as to how you all are thinking about the buybacks for the next three quarters?.

Well, you can see that we've – this wouldn't be a ratable use of the buyback..

Right..

So I think that's the one thing that we point out. And obviously, we're trying to be opportunistic and look at the market and use the authorization that we have within CCAR in the way that we feel is most productive. And that's really what has led to the acceleration year-to-date in the total amount of repurchases we have authorized for the year..

(48:54).

Thanks, Matt. Next – oh, I'm sorry. Go ahead..

Just to finish that thought.

So looking forward, Steve, should we think about acceleration over the – relative to a ratable buyback over the next three quarters?.

Again, we don't have a tremendous amount of flexibility as it is with our repurchase authorizations, so I don't think I'm going to get more specific. Obviously, we have the limitation in CCAR that we can only do the amount authorized for the year.

And it's really just a function of looking at the marketplace and where we are and how quickly we want to use that authorization. But I think we've demonstrated that it – you shouldn't count on it always being ratable going forward..

Thanks, Matt.

Next question, please?.

Go next to Chris Donat with Sandler O'Neill. Go ahead, please..

Hey. Good afternoon. Thanks for taking my questions. Wanted to first ask on – really on the efficiency of your marketing. We saw marketing spend go down 6% quarter on quarter. I know it will bounce around a bit. But with your Domestic Card growth in the double digits, it looks like you're being very efficient with that spend.

I'm just wondering if you've cracked the code to higher efficiency or if there's something sort of temporary going on with the lower spending on marketing..

competitors have stepped up their marketing. Competitors are stepping up their advertising. Competitors are working – in a number of cases they have, in fact, sort of duplicated some of the Capital One products themselves. This game will require a pretty high level of marketing.

And that's probably the case even as the growth opportunity wanes a little bit just because it's the nature of how this competition works. So, we feel great about our marketing, but to continue to succeed it's going to take a fair amount of marketing..

And then just shifting to the oil and gas, your held for investment portfolio decreased quarter on quarter, but unfunded exposure increased only by $100 million or so and mostly in midstream, is that just a reflection of confidence in that portion of the oil and gas portfolio?.

Yeah, this is Scott. I think that if – when you look at that portfolio, we obviously see some opportunities in midstream. We think that there's been a lot of rationalization that's happened in the E&P sector as well.

And then in oilfield services, that's probably the area where we continue to see risk, those are companies that are still struggling with kind of the effects of reduction in capital spending. So that is an area where in midstream we are seeing some selected opportunities and taking advantage of those..

Thanks, Chris. Next question, please..

We'll go next to Sanjay Sakhrani with KBW..

Thank you. I guess I have another question on the loan loss reserving from here on out. Scott, maybe you could just go through it a little bit more, I want to paraphrase a little bit of what you said.

It seems like you probably have one more quarter of pressure in terms of build because you're lapping a tougher quarter and taking out an easier one, but thereafter, you're kind of going to grow the provision in line with loan growth.

Is that a fair assumption to make?.

Yeah, thanks for the question. And just to kind of go back. So what we've told you is that we expect losses are going to grow into 2017. We haven't given you any kind of specific quarterly guidance, so I'm not going to go into kind of the – how you might calculate the quarterly swap.

But I do think you've got kind of the right thread, which is that we do expect the impact of growth map be diminishing in 2017 and with a modest effect beyond that. That's going to meaningfully impact kind of the way the allowance works out as we get into 2017..

Okay. And I guess a follow-up question for Rich, just on Cabela's, you've talked about how these large deals are pretty aggressively priced historically.

I mean, what was – what kind of struck you with Cabela's that it made it quite worthwhile for you to go for it?.

Well, I've been pretty vocal about the nature of the auction environment and how easy it is for companies to get caught up in the frenzy of this kind of bidding. What we have said is on a selective and disciplined basis, we really do want to grow the partnership business.

We want to grow this business where we can find partners that have attractive, loyal and growing customer bases, compelling value proposition, and who want – who their view of what they're trying to achieve through a partnership is, in fact, very consistent with what we would want to do and very customer focused. Now Cabela's is an amazing franchise.

I mean, for I think anybody who walks into one of these Cabela's sees this is not your, like, typical store. This is all designed around a customer experience. People, customers spend – the amount of time the average customer spends in a Cabela's is actually measured in terms of hours. It's different from your typical kind of shopping experience.

So we are attracted to the customer focus that they have and it's all about brand and franchise and that kind of thing. So what we did is enthusiastically went after this, but said that it still has to be within the context of a financial deal that really works for us and, of course, that works for Cabela's.

In this particular case, I think that we found a meeting of the minds, and I think Cabela's liked the opportunity they saw with us, and we were able to maintain our financial discipline and actually win this transaction..

Thanks, Sanjay.

Next question, please?.

Go next to Chris Brendler with Stifel. Go ahead, please..

Yeah, thanks. Good afternoon. Actually to follow up the last question. Just overall, your opinion of the private label market, the attractiveness of that market, the competitiveness, it seems like these deals are difficult to win.

Could you talk all of how merchants or retailers you've added to the portfolio since you've bought it from HSBC? It seems that they're – this is sort of a unique situation here at Cabela's being run (57:08) public, but have you had success winning other retailers? And do you like this business? Any disclosure on how fast it's growing relative to the rest of the Card business would also be helpful.

And then a follow-up question, a different question, on the share count is down a little over 3% this quarter, nice reduction. Is that all buyback? Is there anything else going on there? Thank you..

Okay. So first of all, your question was about private label. One thing I want to say is that the Cabela's deal is actually a co-brand partnership, so let me just pull way up. In what we call our partnership business, there are two types of credit card programs. One is private label, which is not a Visa, MasterCard. That is just a retailer's card.

And the other is co-brand where the retailer or the issuer is issuing a Visa card or a MasterCard, and there is spend both at the store and outside of the store. As it turns out, the key to a co-brand program, and a really good co-brand program is kind of the Holy Grail.

That's what – when you probably talk to any card issuer, I think the great – there are a handful, a few – a couple of handfuls and maybe a little more than that of like truly great co-brand programs.

And the thing that characterize it, in addition to strong retailers and that kind of thing, is this is where you see high out-of-store spend to supplement good in-store spend.

And when you see that, then all the kind of strong economics and the way credit cards work is a great thing and that's why there's a lot of – all the card issuers are really trying to get those great flagship programs. I would put – absolutely put Cabela's in that category.

Now private label is, again, it's a different business, not a co-brand business by definition. All the spend that's going on is inside the store. And there, our – I think our focus has been going after the really top of the line retailers. And we have not been going after the middle or lower end of that marketplace.

So where you see us, where we've had a lot of growth and great success is, for example, with Kohl's. We also have Neiman Marcus. We have Saks. But Capital One's focus has been more at the upper end, and we've added – I don't know have the count, but we've added several brands that are really good, modestly sized brand on the private label side.

The private label business is pound for pound not as profitable as the pure branded Card business. It's a great business to have in conjunction with a branded Card business. But it, for us, has lower returns, but it's a natural part of our business.

The top co-brands are something that are very additive to any card program, and we're pursuing those with a lot of interest..

On your second question, the reduction was all a function of repurchase, but as we talked about earlier, we obviously can't keep it at the same level for the next three quarters. We used more than our pro rata authorization this quarter..

Next question, please..

Go next to Rick Shane with JPMorgan..

Thanks, guys, for taking my question. Hey. I just want to sort of do a little back of the envelope math about the change to the charge-off guidance for 2017.

If we sort of take a rough estimate and say that you've increased the outlook for charge-offs in 2017 by about 30 basis points and we also make the assumption that the 2015 vintage, which is driving this, represents somewhere between 15% and 20% of the book.

That would suggest in order to get to the change that you have described, somewhere between 150 and 200 basis point change in your loss outlook on that particular vintage.

If you can walk through that math and either point out – either agree with it or sort of dispute one of the points here, that would be helpful, so we can understand the magnitude of the change?.

Rick, I don't even know how you would get there, because we talked about so many factors in the calculation of the allowance, growth and mix and the quarter swap, there's tons of – so decomposing that to just the vintage composition, I don't know how we could do that without having a 45-minute conversation and getting into a lot more detail than we're going to..

Okay..

So I understand the effort, but I don't see how we could actually get there..

Got it.

I mean, so let – perhaps given the numbers that you have, you could, without sort of – could you put some context around the change to the 2015 vintage from where you were at the beginning of the year to where you are now?.

I think, Rich can put context around it in terms of these were really modest changes..

So, Rick, I want to go back to – remember an important part of the change in the guidance for 2017 is about growth in subprime mix. So we're already dealing with a – only a part of this effect. And then beyond that, this is the composite effect of many, many different things that are going on.

My point about 2015 was in many ways to help, if you pull way up to give a little bit of kind of tangibility to – well, why would be saying one year's loss outlook is up by a little bit relative to a quarter ago and the next year's loss outlook is down a little bit relative to a quarter ago? And it's really just because as these things play out, 2015 is coming in a little higher than 2014.

And 2016 is coming in a little better than 2015, and that's pretty much the way the math works out. These are all very successful years of origination with – I think you're going to really like what we have booked there..

Thanks, Rick. Next question, please..

Go next to Bill Carcache with Nomura. Go ahead, please..

Thank you. I wanted to ask about a different topic.

Can you share any thoughts on the current expected credit loss model? And any perspective for, I guess, the broader industry? And then for Capital One in particular in terms of how you guys are thinking about the impact?.

Yeah. Hey, Bill. Thanks for asking about that topic. It's, obviously, something that we are focused on, have a lot of people who are starting to build out some of the work. I have a couple of thoughts on that. One, the rules that have come out there allow for a fair amount of judgment and guidance, or judgment.

It's more principle-based guidance as opposed to a set of rules. So I do think that you may see some divergent practices initially. And I think that you'll see the of the industry kind of coming together on some topics over time.

So I'm a little cautious about getting ahead of – putting out kind of estimates and guidance on CCIL (01:05:38) because I do think that we'll see kind of people's estimates kind of converge over time as we all kind of get together on some of the interpretation issues.

Pulling up for us, when we look at kind of the effects of CCIL (01:05:55), I think we're probably not going to be in the business of giving any kind of estimates on that until we are well into kind of being certain that we know how the standard is going to be interpreted and kind of what the net impacts are going to be here.

So, that may not be that you're going to hear from me on this topic until well into next year..

And just to add a little bit of color to that, one of the reasons to hold off, right, is to the extent that you have literally all of the losses you expect over the life of the loan to be booked upfront through your income statement, one could assume that there would be positive benefits to how much capital you need to carry as well.

So there's a whole bunch of things that are going to move here and how CCIL (01:06:41) gets integrated and how people think about the combined reserves and capital you need for the business..

Thank you..

Next question, please..

We'll take our final question today from Ken Bruce with Bank of America Merrill Lynch. Please go ahead..

Thank you and good evening. Thanks for squeezing me in. My question is on credit. Sorry, I know we've been beating this to death, but I'm hoping you might be willing to discuss what you think normalized losses are within the U.S.

credit card book and I don't mean necessarily within your guidance, but just how do you think about normalized losses, and dimensionalize it by prime and subprime, if you could.

Just realizing we're not there yet, but as you think about what normalized would look like at some point in the future, you kind of said that auto is back to being normal, and I don't think credit card is.

So if we could understand how that looks, that would be very helpful?.

Okay. Well, Ken, first of all, I want to say, and I don't think auto is fully normalized per se. I mean, I think it's inched up a little – I'm talking industry losses now. It's kind of – I think there's a little bit still to go in the normalization of auto losses.

And as I said, in many ways, it keeps a little bit outperforming in a good way, our own expectations of that normalization, but I think there's a little more normalization still to happen. In the U.S. Card business, every card player has a back book that is at exceptionally low loss levels. It's because for years – a couple of things behind that.

And most importantly, anybody in our back book who like survived the Great Recession, not surprisingly, is pretty resilient and having great credit performance at this point. Additionally, most players didn't grow very much for a whole bunch of years there, so that there isn't a lot of kind of front book effects on people's existing books.

So, against that backdrop, our belief is, at some point, there will be some normalization of that credit. And I'm reluctant to pick numbers, because that's going to depend on a lot of things. And one of the things it's going to depend on is how much subprime the industry does, for example.

You go back to the late 1990s, there was a – in the middle of an economy that didn't really move at all, credit card losses went up quite a bit just due to a lot of – and probably subprime is a wrong word, just a lot of risk expansion, a lot of lending in the Card business.

And so I've just been around long enough that I find myself the longer I do this, the more reluctant I am to declare what a normalized loss rate is. But I think there is a net pressure over time that will pull up losses for kind of existing books of all players including Capital One.

We also have one other effect that at some point will be beneficial to Capital One, which is the actual – the other side of growth math, which is the seasoning that – remember, we've talked about the general pattern of credit programs is they have higher upfront losses.

Now, it depends on what kind of credit program, whether it's an origination, a line increase, what part of the subprime is a little different than prime, but if you pull it all together, the general pattern is for front book programs, they have higher losses early on, and then they gradually settle out over time.

So with the big front book that we have at Capital One, that will at some point become a bit of a good guy in terms of the seasoning effects. I'm not here to predict the exact timing of that and so on.

So I think over the longer run when we think about our own book, there is kind of just upward pressure on all Card businesses and some long run seasoning that I think will be beneficial for Capital One.

The key thing that we focus on since I don't think that we feel we can absolutely predict, like the precise through the cycle loss rate for our businesses is everything that we underwrite, we assume significant worsening and we focus actually more so than the loss rate itself that we predict, our biggest focus is on resilience, because even some of the low loss programs, this is really the story of banking in general.

A lot of times some of the low loss programs look great and until they don't and they don't have much of a buffer there.

So in all of our underwriting, we are very – in addition to doing all the projections we always do about losses and the whole life cycle of a vintage, we are very focused on resilience so that we have a maximum chance to not only like the business in its full net present value, but to like the business a lot when we get there in the middle of a bad economic cycle.

So that's kind of a long answer, but that's – in the context of all of that, we believe that the business we're booking over in this front book is particularly resilient, and frankly has particularly good economics..

For a long time, so you can't argue that. Thank you. I think that's it. You've been very generous with your time. I appreciate it..

Thanks, Ken..

Thanks, Ken..

And thanks, everybody, for joining us on the conference call today. 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, everybody..

Ladies and gentlemen, this concludes today's conference. Thank you for your participation..