Capital One Financial (COF)

Q2 2010 Earnings Call

July 22, 2010 5:00 pm ET


Richard Fairbank - Founder, Executive Chairman, Chief Executive Officer and President

Jeff Norris - Managing Vice President of Investor Relations

Gary Perlin - Chief Financial Officer, Principal Accounting Officer and Executive Vice President


Matthew Kelley - Sterne, Agee

Sanjay Sakhrani - Keefe, Bruyette, & Woods, Inc.

John Stilmar - SunTrust Robinson Humphrey Capital Markets

Brian Foran - Goldman Sachs Group Inc.

Moshe Orenbuch - Crédit Suisse AG

Bruce Harting - Barclays Capital

David Hochstim - Bear Stearns

Christopher Brendler - Stifel, Nicolaus & Co., Inc.

Henry Coffey - Sterne Agee & Leach Inc.



Welcome to the Capital One Second Quarter 2010 Earnings Conference Call. [Operator Instructions] I would now like to turn the call over to Mr. Jeff Norris, Managing Vice President of Investor Relations. Sir, you may begin.

Jeff Norris

Thanks very much, Michael. Welcome, everybody, to Capital One’s second quarter 2010 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 and follow the links from there. In addition to the press release and financials, we have included a presentation summarizing our second quarter 2010 results.

With me today are Mr. Richard Fairbank, Capital One's Chairman and Chief Executive Officer; and Mr. Gary Perlin, Capital One's Chief Financial Officer and Principal Accounting Officer. Rich and Gary will walk you through this presentation. To access a copy of the presentation and the press release, please go to the Capital One website, click on Investors, then click on Quarterly Earnings Release.

Please note that this presentation may contain forward-looking statements. Information regarding Capital One's financial performance and any forward-looking statements contained in today's discussion and the materials speak only as of the particular date or dates indicated in the materials. Capital One does not undertake any obligation to update or revise any of this information, whether as a result of new information, future events or otherwise. Numerous factors could cause our actual results to differ materially from those described in forward-looking statements.

For more information on these factors, please see the section entitled Forward-Looking Information in the earnings release presentation and the Risk Factor section in our annual and quarterly reports, accessible at the Capital One website and filed with the SEC.

And now I'll turn the call over to Mr. Perlin. Gary?

Gary Perlin

Thanks, Jeff, and good afternoon to everyone listening in to the call. Let's go straight into the income statement on Slide 3. Capital One earned $608 million or $1.33 per share in the second quarter, with all of our businesses posting a profit. As we foreshadowed in last quarter's call, lower provision expense more than offset the expected decline in pre-provision earnings.

Total revenue declined $385 million or 9%. As net interest margin was stable, the revenue decline was driven by a 4.5% decline in average loans and a decrease in noninterest income. The single largest driver of the decline in noninterest income was the absence of the first quarter's mortgage I/O bond sale. In addition, noninterest income was impacted by significantly fewer security sales and a full quarter impact of the reduction in overlimit fees resulting from the move to opt-in mandated under the CARD law.

Marketing expenses rose somewhat from seasonally low first quarter levels and will likely continue to rise in the second half of the year, though the magnitude of the increase will depend on the opportunities for growth. Operating expenses increased $114 million in the quarter, which included a number of onetime items, including legal reserves and a tax accrual due the legislative changes in Canada. We expect near-term operating expenses to moderate a bit, with second half expenses approximating the level realized in the first half of the year.

Credit performance continues to improve, and as a result, provision expense declined 51% or $755 million in the quarter. Charge-offs declined in each of our businesses, yielding a $301 million aggregate improvement in the quarter. Also benefiting provision expense was the release of just over $1 billion of allowance, up from a $566 million release in the prior quarter. More on the allowance in a moment.

One final item of note on the income statement was a $404 million rep and warranty expense, approximately 3/4 of which was recorded in discontinued operations. Wherever possible we have now incorporated probable future losses on an expected life-of-loan basis. The single biggest impact of this change was on GSE loans, which are now fully accounted for on this basis.

Turning to Slide 4, I'll discuss the balance sheet. Total ending loans declined by $3 billion or 2% in the quarter, with more than all of the decline accounted for by run-off portfolios and elevated levels in charge-offs. Our Domestic Card portfolio was down $1.6 billion in the quarter or 3%, as $1.3 billion of charge-offs and $1.2 billion of run-off of our Installment Loan portfolio more than offset gross originations in the quarter. With increasing quarterly origination of new accounts, improving charge-offs and a gradually moderating impact of run-off, we expect Domestic Card balances to be approaching their lows.

The Commercial Banking Loan portfolio continues to hover around $30 billion, although we did have an approximately $500 million increase in unfunded commitments for our Commercial customers in the quarter. We expect to see modest growth in this portfolio over the balance of the year.

The Consumer Banking portfolio decreased $1 billion in the quarter, about 2/3 of which was caused by the continued decline in our run-off Mortgage portfolio. Auto Finance outstandings are approaching an equilibrium where our level of new originations will equal the run-off of prior originations for that business.

We grew our Securities portfolio by $1.1 billion in the quarter, with the bulk of growth in agency mortgage-backs and floating rate asset-backed securities. The portfolio continues to perform well, and our unrealized gain position is now $930 million, up from $482 million at the end of the first quarter.

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