KBW FINTECH ECOSYSTEM CONFERENCE - CAPITAL ONE FINANCIAL CORP

So, yeah, for our next discussion, we have Andrew Young, CFO of Capital One. Andrew has been with Capital One for 31, sorry, 30 years and has served as CFO since 2021. He previously led Capital One's business line CFO teams and oversaw enterprise planning and budgeting. He also served as CFO of the company's national bank. Capital One has been one of our favorite stocks for the year. unfortunately lots of things have uh not gone right but this you guys have executed so i think fundamentally everything's gone right uh so you know it's disappointing a little bit but uh but thank you for executing so andrew it's been five and a half years since you became cfo uh and i know you were the com with the company uh for some time before in the role when you reflect on your time as cap at capital one uh how do you think the company's changed uh both from a strategic and financial perspective. Well, first, Sanjay, thanks so much for having me. Thanks to all of you for your interest, those in the room and those listening on the webcast. As you mentioned in your opening remarks, been with the company 30 years. It's amazing how quickly time flies. And maybe I'll start with the answer to your question of what's the same before I answer what's different. You know, and what's the same to me, even 30 years ago, we were always working back from where do we think the world is going and how do we see ourselves winning in that future, bringing an analytical rigor, bringing a deep reverence for the customer in everything that we do. and that continues to this day. What I think is different over the last six years that I've been in the CFO seat is probably twofold. First, the pace of change in the world around us is unbelievable, and it's just accelerating every single day. I only half-jokingly tell the team that the pace of change will never be as slow as it is today, even as we feel like so much is going on at this point. And then the second thing is the breadth of opportunities that are there for us at this moment. And whether it's in our core businesses, whether it is in the adjacent businesses, payments, network, with the acquisitions of Discover and Brex, or even in some cases, things that are not in our core businesses as we're going into Capital One shopping or travel or software. And so the opportunities abound at this point. So if I put that all together, I would say how we operate is the same as it was 30 years ago, but the pace and the breadth of opportunities is just so much greater than even what it was six years ago absolutely and i guess like when we think about the financial part of where you are today versus where you've been in the past right obviously you know you've moved the model towards a more bank-oriented model shored up a lot of the funding side of the business um seems like now you've got a network maybe you can just talk about financially how the business model has evolved over time yeah um i would say the opportunities rooted in both the the technology and i'll i'll be importantly create the distinction that it's not just the architecture of technology but the data infrastructure, the sources of data, the ability to bring multiple sources of information together in real time to think about the entirety of the business. And so I can kind of go down the list of the P&L. It's almost easier to highlight where that technology transformation isn't changing what we're doing. It isn't change the PNL from the top, thinking about growth and the prospects there, ability to target customers in a way that we weren't just a few short years ago. I just brought up the new businesses, whether shopping, travel, software, there's a bunch of other sources that are just changing the vectors of growth that we have. But as you continue down the P&L, again, the technology and data just changes everything, whether it's credit and how we're able to use platforms and more micro-segment credit, whether It is the efficiency of how we operate you know our software engineers being able to produce uh code at a level that is you know so much different than even it was a year ago um but i also think things like the customer experience that we're able to to produce for uh our customers uh you might have seen not that we run the company for awards, but six years in a row being J.D. Power's number one customer satisfaction for large banks. But ultimately, at the bottom of all of that is talent. And again, not that we're doing it for awards but evident insights coming out with their AI list of big banks, Capital One being number one in both innovation and in talent. And so being able to have the talent that enables us to do, back to your question, so many different things on a base of tech and data that kind of the opportunities abound. Yeah, I want to dig into that because I know you've invested heavily in modernizing the technology stack, you know, well ahead of many peers, maybe you could talk about the advantages it provides you guys, right? Because I think it's kind of easy to just, for it to get lost in the story a little bit. Yeah. I mean, I think a lot of what I just highlighted kind of gets to how tech and data fundamentally changes. The world is moving at a pace that people are expecting real-time, intelligent solutions being proactively kind of landing in their in their laps gone are the days of sort of the batch processing and i go get one single financial product you know and three years later i go back and search for for the next product i think what people are expecting is their financial institution to really be ingrained in their daily lives and giving them customer experiences that delight them. And that has become really the expectation. And so our ability to consume and analyze data is really at the core of all of that. Cool. So, you know, I think you've mentioned also the credit outcomes are part of the tech transformation. You know, obviously credit's been a successful, it's been a bright spot for Capital One, and quite frankly, for the industry as well. Maybe you can articulate why Capital One has seen such stellar performance, and maybe just the overall health of the consumer, too, because the consumer's been resilient through a lot. Mm-hmm. Yeah, very much so. You've known me for long enough, Sanjay, that you know that I like to, I think, and I talk in frameworks, so maybe I'll use this opportunity to kind of provide the framework about credit. So to me, I'd say that there's three main sources of the credit performance, the drivers of credit. One is more macro industry-wide, which is early in the pandemic, we'll all recall that credit was pristine, largely on the back of forbearance and stimulus and people not traveling. And I think we coined the phrase of the delayed charge-offs phenomenon. And we saw those delayed charge offs come in over the past couple of years. So one tailwind we're experiencing now is just the gradual decline of those delayed charge-offs. Relatedly, there's also the back book of recoveries that comes from those elevated levels of losses. And so we're also benefiting from that. And those are really industry phenomenon that are working. The second category that I would say is the judgment that we apply to our decisioning. And by that, I mean, we don't work back from growth targets. And that gives us the flexibility to make the decisions that we think are right at any point in time. And so we have intervened over the last number of years looking at things like credit score inflation, looking at consumers' balance sheets being propped up as a result of the effects that I described a moment ago, and looking at the role that fintechs played in giving people debt, much of which wasn't reported on bureaus for a while. And so we used the opportunity a few years ago, the fact that we don't have growth targets to intervene into our decision-making and give up growth at the margin in the service of what we believed would result in better long-term credit outcomes. So that's my second category. And then the third one comes back to what we were just talking about, which is the technology and data. The modeling that we have, our ability to incorporate in a variety of sources of data, monitor in real time, and really leverage those more sophisticated models to better make selections up front, but also to dial in at the margin. And that's been aided, by the way, with the Discover acquisition, where we see things like the best of both worlds. So we're seeing it in the recovery side with Discover and Collections, Discover's practices. We looked at what we did and we looked atwhat they did. And bringing those insights to bear, in addition to bringing the technology together, is also proving to be a source of tailwind. So I kind of put all of that together and say there's industry effects, there's judgment effects. And then there's just the technology and data capabilities that are now inherent in our company. And all of those things are helping to drive really strong credit outcomes. So as we think about the health of the consumer, what are some of the things that you're looking out for to keep your finger on the pulse? Well, let me start at the top of the funnel, as I'll call it. And I'll sort of walk through those pieces. I mean, first, it really begins with employment, and it's fundamentally an issue of customers' ability to pay. And so the first variable being employment, and seeing the prints over the third quarter see last week's results where job creation is strong, You know, the fires are relatively low and stable, and that is resulting in an unemployment rate, the most recent print of 4.1. Interesting to note that we've now had, I think it's 62 months in a row of unemployment being under 5%. So the employment picture has been strong and stable. The next category to me beyond just who's employed is looking at real wage growth, which is a function of both wages themselves juxtaposed against inflation. And so when you look at hourly wages, they've been reasonably strong. if you horse race that against inflation over the last few months, there's actually been a little bit of a gapping out in favor of inflation. But one thing that I think is often overlooked when we look at hourly wages is it doesn't take into account hours worked. And so if you look at Fed data where it is weekly wages that incorporate hours, the horse race between inflation and weekly wages has basically drawn to a tie over the last number of months. So the combination of strong employment and real wages that have been stable then kind of leads you down into, okay, what are the decisions that consumers are making on a day-to-day basis? And so debt servicing levels are stable, payment rates, you know, spend behavior is healthy, as I'm sure you've heard throughout this conference, but in addition to healthy spend levels, we've seen revolve rates that are stable and strong. You've seen payment rates that are actually improving a bit. And so you put all of those things together and more at the bottom of this funnel, you see delinquencies have been stable. And delinquences being the precursor to to charge offs, which also, you know, had improved for a number of quarters and find themselves to be, you know stable to slightly better than stable over the last number of months. And so all of that together, we're looking throughout that whole continuum, but really most upstream is the, the employment and wage picture. Cause that ultimately manifests itself in, in customer behaviors downstream. Well, that's, that'S really encouraging. And that'S good to No, you know, the consumer's hanging in there because it's two thirds of the economy, that's for sure. So I think one of the big strategic moves that Capital One made was moving to the affluent marketplace. Obviously, it's a big investment area for you guys. Maybe you could articulate how this move up market impacts the story and strategic positioning. Yeah, that quest that began in earnest for us in around 2010 with the launch of venture and you know as we looked at the the top of the market there was so much to like about the the economics and what it means financially to to your question these are customers that are uh you know have high levels of spend if you look at the revenue new components of this. You're generating fees from them. They have high levels of spend, and so therefore you have interchange, of course, you still get some interest income from them, but it's all based in much lower levels of capital. They have very low losses, even in periods of stress, and they have very low attrition rates. And so when you look at all of those things together, it's no surprise that it is an incredibly attractive portion of the market. And so then the natural question is, well, why doesn't everybody go there? And it's because it requires a sustained level of investment, because people who are at the top of the market are not just looking for apr or product terms it requires experiences it requires travel and lounges and dining and exclusive things that you can't get elsewhere and that requires a commitment to invest for a long period of time to generate these great annuity streams. But that also shows up in our P&L as we make the investments, particularly in marketing, to generate these customers. But it just is an annuity that pays dividends for years and years to come. And it also, by the way, provides something aspirational for the rest of the book to look up to. And so we believe that it sort of helps lift the tide across the portfolio where those customers are aspiring to improve standing in credit and, you know, take those things on and we can help them improve their financial lives and then bring in other people who are new to credit and keep this virtuous cycle going. That's very important. I guess as we think about the investments that still need to be made, I mean, do you see that, is there pressure on that because it's so competitive or do you think it's a steady rate of investment that needs to be done over time? I mean I'm just curious like how these things ebb and flow through these competitive dynamics. I think that marketplace, for the reasons I just described, where it requires a meaningful amount of investment to generate the customers, it requires a brand that people trust, those are very high barriers to entry. And so what we've seen is a small number of very formidable players in that space who continue to make the investments to compete for that pool of customers. But I would say those players are all very rational and we see a highly competitive space, but we see irrational one in the combination of those two things generally lead to things being, I'll call it more sustained as opposed to spiky times and then, you know, an ability to steal a bunch of share without making an investment. I just don't think that that's plausible. I think what you need to do is have a long term commitment with the ability to make those investments over time and just sustain that. And that's generally what we see in the marketplace. Do you think owning a network makes it better or makes it easier to make these investments in that market? Do you get more efficiency out of it? Well, with the market, especially the top of the market Those tend to be customers that travel internationally And as we talked about, one of the things with the acquisition of Discover That we're incredibly excited about, the opportunities that it brings It also comes with a near-term need to invest And that is investing in acceptance Because the last thing that you would want is to have somebody at the top of the market, you know, who is somewhere on international travel and the card not work. And so, you know, over time, perhaps it could be a source of competitive advantage. But what we're focused on now with the network is really finding those places where our cardholders travel and ensure that there's a very high degree of acceptance so that the customer experience is up to the standard that we set for ourselves there. And so we need to make sure that international in particular has the acceptance where we would feel comfortable having the top of the market running on a network that just doesn't yet have parity with Visa and MasterCard. And so we have the flexibility and a great relationship with Visa and MasterCard to offer products that run on multiple rails. And, you know, we're continuing down that path to build out broader acceptance while at the same time maintaining the very strong partnership with what we have with those two companies. Great. So maybe just sticking with marketing, obviously, CapOne has a history of leaning into marketing when the returns are attractive. Maybe you could just talk about the ROI framework that gives you the confidence of making the said marketing investments that you guys make. Why don't I start with categories of marketing? Because that may help with thinking about the ROI. So I'll bucket it into five broad categories. with the first being direct response or stimulus response. So targeting consumers and having ads that generate a new account, category one. Category two adjacent to that is brand. Category three, we talked quite a bit about as one of the benefits of the Discover transaction is in generating checking accounts and continuing to invest in our retail bank. So it goes just beyond checking. We don't have a branch on every corner. And so the way that we've also generated over $400 billion of savings products is through that marketing channel. So retail sale being a big category in and of itself. The fourth category is what we just talked about with premium, all of those experiences that are necessary to compete in that space. And then fifth is a variety of other things, including things like Capital One Shopping. So getting back to your question, I think it's important to differentiate between those categories because the way that we approach the ROI differs for those. It's pretty easy for us to look at the direct marketing and be able to calculate an NPV of a solicitation. We can see what we spend, we can see the customers that we book, the response rates, what those customers look like over time. So that lends itself to sort of the hallmark of who Capital One is in terms of our analytics and the NPV framework that has been at the center of how the company's operated for over three decades. There's another category of things, the premium space, that I would say doesn't quite lend itself to that same at least stimulus response. NPV, we have to look at premium in the context of the overall economics of that whole business so the marketing investments that we're making they're coupled with the direct marketing within that space in aggregate to the overall academics of a premium customer and so it's really hard to deconstruct that line item and say how much of a response rate is really driven by the fact that, you know, Sanjay can now get into a lounge in Dulles. But we test and learn as best we can. But the real value comes in looking at things on an integrated basis and ensuring that we really like those integrated economics and make our decisions that way, as opposed to just looking at each individual line item within marketing to determine should we go invest in another lounge so i think like the another hallmark of capital one through good times and bad is the flexibility of marketing spend right like when things are bad there's this room to like you know take things down and intuitively it makes sense because you probably aren't growing as fast in a downturn as you are in a good part of the cycle. I guess with this move, the mix changes in marketing, has your discretion over that line changed some so that it's not as flexible as it's been in the past? Like, how should we think about that? I'll go back to the categories, because a number of those categories existed, you know, five, 10 years ago. When you look at overall marketing spend levels and marketing efficiency for us over the last few years, that has grown in large part because we've added some additional categories. And what I would say is in those things where there's a somewhat natural hedge in the broader economy. In direct marketing, for instance, the ability to pull back exists just as it did early in the pandemic. You saw us bring down our marketing spend by something like 25% in a single year. So there is a lot of ability to pull back if conditions warrant. But what I would also highlight is a number of the new categories are things that there's a higher bar, I'll at least put it that way, of whether or not we'd pull back because the sustainable investment in upmarket that I just described, the economics that we see in deposit gathering and generating new checking accounts, there are things that regardless of the economic environment around us we probably would continue to lean into a little bit uh harder at least on a relative basis to the direct marketing spend and so there there's the same level of kind of dollar sort of percentage pushback but on a percentage that itself is higher if that math makes sense so we continue to see those opportunities to pull back. But I would think that you would see the absolute dollars still be at a higher level than what they were historically because of the additional categories investment that are not as directly tied to the economy at any given moment. And I mean, is there a way to sort of talk about broadly expenses, like less marketing in some kind of framework, you know, like as we look ahead and think about leverageability and you know and obviously the ability to flex up and down is there any any way to think about that or is that still a working process in terms of the magnitude yeah or just you know in in the path you know well i think the path is quite simple meaning again i think that the best case that i would point to is early in the pandemic being able to pull back very rapidly and not be as prevalent in the marketplace looking to generate new accounts, given that there's uncertainty. And, you know, we underwrite with an assumption of a recession. So, you Know, the path, depending on the scenario, even if we were to see some dark clouds in the broader economy, I wouldn't make an assumption that that immediately means that we're going to bring down market expense by X percent, because if we continue to believe that through our underwriting that those are still NPV positive accounts, we may lean into it. But it really works back from what do we see as the opportunity at any given time? And then we have the ability to pull back if the situation warrants. But we also, at least as we sit here today, we're firing all cylinders, really excited about what we see across all five of those categories. And you see us leaning in at this point. Got it. Maybe we switch to capital management. Obviously, you guys are sitting at very high levels of capital, I mean, greater than 13%. Maybe you could talk about, you know, the path to bring it down towards your target. through buybacks and others, and what's the timeframe to get to the 11% target? Well, we look at our balance sheet and stress test it in a variety of ways to assess what level of capital do we believe we need. And I'm gonna parse words here because I think it's important, which is 11% being a need versus a target. And so that is rooted in our analysis of our balance sheet. And so in terms of how we manage capital levels relative to that need, I start from a place of we have worked very hard to create a company that has high inherent earnings power. And what that allows us to do is to invest for the future. and to invest and support growth. And so those are the two highest callings as we think about like the P&L and ultimately capital. Beyond that, on average over time, we likely would generate capital and we understand the importance of returning capital to shareholders as part of our value proposition. You've seen us give back $10 billion of capital over the last four quarters. So I want to make sure that that is clear, that that it's an important part of it. But after you take those things into account, there is some level of capital that remains. And so as we think about the level at any given time, we're going to take into account a variety of factors which is growth prospects, which is AOCI and stock price and potential regulatory changes. And so those also need to be considerations for us. And so that's kind of a window into how we think about capital levels. But you and our investors should just assume that we see asymmetric value in capital, where for defensive purposes, in the event of the world turning very quickly, for offensive purposes, the best growth opportunities often tend to come when other companies are pulling back. So we take all of those things into account as we think about managing our level of capital and with the flexibility that we have under SEB to change our buyback pace for any given reason, we're going to take advantage of that flexibility. And as we Think about using that capital for offense, like, you know, inorganic growth, I mean, obviously, you guys did Brex, you've done Discover. Like, are there more such cases, or do those just come up opportunistically and you want to be prepared for it? Well, almost definitionally, acquisitions don't come with a preset timetable. And so we, of course, put an incredibly high bar on acquisitions. We look for things that strategically are aligned with where we see the world going and that provide some clear value to us getting to that destination, whether it is augmenting existing capabilities, whether is getting us into something that we don't currently have, like the network, for instance, in Discover. And so we just need to look at the opportunities as they arise and put them through a very rigorous filter strategically and financially. And like we do with basically all of our investments, have an eye towards what is the long-term value creation of making an investment, whether it is investment in technology, whether it is an investment in acquiring another company, kind of using the same philosophy there and being opportunistic as we see those strategic and financial forces align. Got it. So, at this conference, we've talked extensively about agentic commerce. It's, I mean, a big topic of the future in terms of how consumers will consume everything, it seems. So maybe you could talk about what the CAP1 sort of house view is and what you guys are doing to take advantage of the opportunity or risks. Well, I haven't yet had the advantage of listening to what others have said, but I imagine it is some form of agentic commerce is going to fundamentally change how the world works, how we, you know, live and play and travel. And that's exactly where I was going to go, making sure the transcript picks it up, but timing uncertain. And so we're keeping a close eye on that in these early days. I'll start by saying we feel very well equipped given the technology foundation that we've built, the capabilities, the talent that we have to adjust. And we also have a relentless focus on the customer experience, knowing that that builds loyalty. And so we're very focused on ensuring that we create the ability for consumers to operate in the way that they prefer with one important caveat and that is in these early days especially we want to make sure that our consumers are safe and so thinking about fraud or data loss or other risks to the consumers in what is a very nascent technology. We're also going to at least unleash new capabilities and prevent customers from operating in our ecosystem. For now, we've blocked agents from working within Capital One because we want to make sure that those loose ends are tied up so that we can ensure, again, that we can protect customers as these capabilities very very quickly evolve but the way that we're mostly thinking about it is then to prepare for any eventuality and and have the capabilities for wherever the whatever the future may bring and do you see it more of an opportunity or a risk you know, I mean, or is it both? I'm curious, like, do you think it adds to Capital One? I think there's multiple dimensions to it. You know, I imagine you've also had people talking about either does it change customer spending behaviors? Does it change first and wallet? Does it changed deposit costs and behaviors? The way we've always operated Capital One is to create incredibly compelling products that we believe are attractive to customers. And having that on a foundation of 150 million customers, the brand that we've established over multiple decades, creates the opportunity again for us to pivot and meet the customer where they are. And I'd like to think that particularly that optionality rooted in the foundation that I just described on balance is a positive. But we also need to, again, make sure that we're ensuring that our customers, their money, their data is safe as we go down this path. So we're gonna operate cautiously outwardly, but be working as hard as our little legs can carry us internally to be developing the capabilities as we see where the market is going. Okay, last question, Brex. I think Brex was a really good deal because it added another leg to the stool. Maybe you could just talk about initial observations on Brex and how you see the growth path manifesting itself over the next several years and when we'll start seeing some progress being made and it affecting the numbers. Well, just as a quick reminder for the audience, because I think the why is an important starting point, the payment space is a true $2 trillion marketplace, about a trillion business payments, about a trillion that is personal liability where we were already firmly entrenched, another trillion or so that is commercial liability where our business was nascent. And as we were thinking internally about the future of where that marketplace goes, we were convinced that it isn't just about cards. It was about the intersection of cards, AP, accounts payable, expense management, procurement, and bringing all of those things together in real time for the office of the CFO to be able to optimize the spend in these, everything from VC-backed startups all the way to large enterprises. And we saw that Brex was down that path with incredibly talented people building from the bottom of the tech stack up. And that's what drew us to them. What we brought to them or bring to them is a balance sheet, funding, lower cost uh funding model uh the the wherewithal to make investments for the long term a brand a client base and leads that we were convinced would just aid them on their journey and and help them sort of ascend to where they and we were both looking to go and so early days still only a of months in. Integration is going well. We're making sure that, you know, the regulatory needs, the cyber, all of the risk management pieces that we're doing what is necessary. But we're also making sure they have the flexibility to take advantage of all the things that Capital One brings, but continue on that path and accelerate their journey. And so we're just as excited today, strategically and financially about what Brex brings to the table and that the integration is going really well. All right. Well, we're out of time. Andrew, thank you so much for giving us a little time here at the conference. Hey, thanks so much, Sanjay. Appreciate it.