Thursday, October 16, 2008

Capital One Conference Call: Downturn "extended and long"

by Bill McBride on 10/16/2008 06:26:00 PM

Comments about credit cards

We have tightened underwriting standards across the boar. In our US card business we have gotten more conservative. We have begun to reduce credit lines. We have continued to tweak our underwriting models and to the recalibrate models this may be unstable. We have adapted our models and approaches as the economic environment has changed and we are intervening judgmentally even more than our models would indicate.
Auto Loan Business
We repositioned our auto business at the beginning of the year. We pulled back on origination and we are shrinking the book of loans and originations. We have leveraged pricing and shrinking competitive supply and we [continue] to aggressively manage operating costs. Originations for the second quarter were $1.4 billion, down 56% from the third quarter of 2007. We are on track for auto loan originations for the full year of 2008 to be at least 45% lower than 2007 origination. The total auto loan portfolio shrink by $2.8 billion year-to-date. Dealer customers, the credit characteristics of new originations continue to improve as evidence by rising average FICO scores, and improving and encouraging early delinquency performance of our 2008 origination vintages. We have been able to maintain pricing power while improving the credit characteristics of new originations. Expected seasonal increases in charge offs will put significant pressure on profitability for the remainder of 2008. The continuing pressure from the seasoning of 2006 and 2007 vintages and broader cyclical economic challenges are likely to be a drag on results throughout 2009 and the continuing decline in loan balances will impact the optics, for example declining loan balances would reduce the denominator like charge offs, and operating expenses as a percentage of loans [the 30 day DQ rate increased to 9.3% from 7.6% from last quarter]
[Are you inclined to get more aggressive here in pursuing new business?]

Capital One
It is very clear in all of our markets competition is easing in some places, there's more pricing power. We can be more selective et cetera… what holds us back has nothing to do with frankly either capital or liquidity at the moment with respect to originations. It really is - the elephant in the living room is about the economy. From our experience over 20 years of doing this, our [conclusion] is that the assets originated as economy is getting worse tend to have more adverse characteristics than assets at other times. The one thing I would say, though, is everything I said relates to our origination strategy. I think with respect to acquisitions, acquisitions of seasoned businesses and portfolios, distressed sales of those in this environment can in fact be exceptionally profitable. So our capital raise and our kind of looking out on the horizon at the moment is related to acquisition benefits.

My follow up question just on the incremental trends in consumer spending, the spending on your cards were flat year-over-year and I just wondered if you could giver a little color into what you have seen September, October trends year-over-year spending patterns of consumer, how much have they worsened?

Capital One
…the right way to look at it on our portfolio is purchases per account. I think it is 4 something percent, but it is just a little bit below the overall growth in purchases that has happened in the industry. We have, everything that we have seen recently has been a mirror of what you see out there in the economy. But, the window we see into the consumer is almost exactly what you see on the outside and all of the public metrics.

it just seems like we are just starting to feel the impact of the weakening employment environment. Where do you see charge offs peaking in '09 if you had to guess today?

First of all, the way we create this outlook is that we base it on a couple of models. One model is a model built on the last downturn, unemployment is the key driver there, and then another model we built in this downturn which not surprisingly, the big driver of a credit worsening is changes in home prices. So, so what we do in our process we go out and we look at kind of consensus estimates for the macro economic variables... The economic outlook assume in the outlook that Gary talked about is unemployment around 7% by mid 2009, and a nationwide peak to trough home price decline of 25%. Although I don't want to get too literal with that… there are so many new things associated with each downturn….. what we share with you is an outlook that we are managing the company to - an underlying assumption [the downturn] is going to be extended and long.