Capital One Financial Corp
NYSE:COF
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Capital One Financial Corp
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Welcome to the Capital One First Quarter 2020 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. [Operator Instructions] Today's conference is being recorded.
Thank you. I would now like to turn the call over to Mr. Jeff Norris, Senior Vice President of Global Finance. Sir, you may begin.
Thanks very much, Matt, and welcome, everyone, to Capital One's first quarter 2020 earnings conference call. As usual, we are webcasting live on the Internet. Something that's not quite as usual in a time of social distancing, we're each webcasting from our own home, so please be patient with us if there's an occasional awkward pause or dog barking.
To access the call on the Internet, please log on to Capital One's website, capitalone.com and follow the links from there. In addition to the press release and financials, we have included a presentation summarizing our first quarter 2020 results. With me today are Mr. Richard Fairbank, Capital One's Chairman and Chief Executive Officer; 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 the press release, please go to Capital One's 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. 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, accessible at the Capital One website and filed with the SEC.
And with that, I'll turn the call over to Mr. Fairbank. Rich?
Thanks, Jeff, and good evening, everyone. Before we get into first quarter results, I'll begin tonight with an overview of COVID-19 and its impact. In roughly the last two weeks of the first quarter, the world changed abruptly as the spread of COVID-19 accelerated. Like all of you, we're watching with empathy and gratitude as people and communities take extraordinary action, care for the sick, support first responders and slow the transmission of the virus.
At Capital One, we're focused on the well-being of our associates, our customers and the communities we serve, and we've fully mobilized to do our part to make an immediate positive impact. Enabled by our technology transformation, about 80% of our associates and 98% of our non-branch associates smoothly transitioned to remote working arrangements and are now securely and productively working from home.
For our associates who must be at Capital One location, we've taken steps to improve social distancing, adopted flexible attendance and leave policies and increased hourly pay. For our customers, we're offering a range of forbearance options and taking steps to make it easier for banking customers to access their money while social distancing.
COVID-19 has catalyzed three unprecedented events that are sweeping the world with breathtaking speed; a global pandemic, a partial shutdown of the global economy, and the fiscal intervention of a magnitude not seen since the Great Depression. It is difficult to predict the magnitude and duration of the disruption.
Capital One is well-positioned to weather these challenges. Throughout our history, we focused on resilience in all of our choices on liquidity and capital. As a result, our balance sheet is strong. We have deep liquidity reserves and a strong capital position.
We've also been obsessed with resilience in our choices of businesses and segments and in all of our underwriting decisions in good times and bad. We've avoided or exited less resilient businesses and segments. We built stress testing into our underwriting decisions years before the advent of industry-wide annual stress tests.
We model, measure and analyze the resilience of our loan portfolios from origination throughout the life of the loans. And as always, we're focused on resilience and long-term value creation in the choices we're making today to manage through the pandemic and its impact.
Our businesses have demonstrated a track record of successfully weathering recessions, including the Great Recession and emerging in a position of strength on the other side.
We are working hard to help our customers who have been impacted by COVID-19. That help takes different forms depending on the business. In card and auto, forbearance is primarily in the form of short-term payment deferrals and fee waivers. In the retail bank, we are waiving selected fees for impacted customers. And in commercial, we are working with our clients on a more customized basis.
As of April 17, domestic card forbearance enrollments covered about 1% of active accounts or 2% of loan balances, and in our auto business, about 9% of our customers or about 11% of balances.
Our investments to transform our technology and how we work are powering our response to the pandemic. I've already mentioned our quick and essentially issue-free transition to working from home, which was enabled by our move to the cloud and our broad integration of mobile technology.
Digital and data capabilities are also powering rapid changes and enhancements in underwriting and modeling and expanding the scope and effectiveness of real-time monitoring.
Turning now to guidance. Because of the economic disruption and uncertainty caused by COVID-19, we are withdrawing our efficiency ratio guidance, including our guidance of annual operating efficiency ratio of 42% in 2021.
We're only a handful of weeks into the pandemic and its economic effect and there is a wide range of possible outcomes. It is difficult to forecast specific efficiency targets or timeframes while the pandemic runs its course. But we remain focused on delivering positive operating leverage over time. It's one of the most important payoffs of our digital transformation and a key element of delivering long-term shareholder value. We are also withdrawing our guidance on 2020 marketing. We continue to make marketing decisions at the line of scrimmage, based on our dynamic assessment of market risks and opportunities. Consistent with our long-standing focus on resilience, we're pulling back on marketing in the near term based on our current view of COVID-19 risks.
Pulling up, we're entering a time of significant challenges spawned by the global coronavirus pandemic and the near shutdown of economic activity across our country and the world. The largest government stimulus in decades and increased forbearance should help to mitigate some of these challenges, but it's difficult to predict how it will all play out. On top of that, it's even more difficult to predict the course of the pandemic and the length of time that economic activity will remain shut down.
As we manage through what lies ahead, I believe we will continue to be well served by our strong balance sheet, our resilient businesses, our digital transformation and most importantly, our deep experience and learnings from managing through good times and bad times for 2.5 decades. We are ready to take on these challenges.
Now I'll turn the call over to Scott.
Thanks, Rich. Capital One lost $1.3 billion or $3.10 per share in the first quarter. Net of adjusting items, our EPS loss in the quarter was $3.02, driven by a $3.6 billion allowance build.
Turning to Slide 4, I'll cover the allowance in more detail. The adoption of CECL increased our allowance by $2.8 billion, as of January 1, 2020, in line with previously communicated expectations. Our first quarter allowance build of $3.6 billion consists of $2.2 billion in card, approximately $600 million in auto and approximately $700 million in commercial.
We modeled several economic scenarios and then we added some judgmental overlays in determining our allowance. The most heavily weighted of these economic scenarios included a sharp increase to a peak unemployment during Q2 2020 of 9.5%, followed by an improvement into 2021. I would encourage you not to get too focused on the headline unemployment rate because it was just one of the many variables impacting our allowance.
For example, after we completed our modeling, we added qualitative overlays, reflecting risks and uncertainties due to the more severe economic forecast we saw around and after quarter end.
On Slide 5, you can see that our coverage ratio in domestic card has more than doubled since December 31 to almost 9%. Our U.S. branded card coverage ratio was 10.1%. The difference between these ratios is driven by loss sharing agreements in our partnerships portfolio, where we only allow for our portion of the estimated losses. Our auto coverage now stands at 3.4%, over two times the coverage at year-end. And commercial reserve coverage has also doubled to almost 2%, driven primarily by oil and gas. We have included an oil and gas slide in our appendix with details on that specific business.
Next, I'd like to discuss our capital and liquidity positions. As Rich mentioned, we focus on the resilience of our liquidity and capital positions in good times and in bad. And accordingly, we enter into the COVID-19 situation with strong levels of capital and liquidity.
On slide 6, you can see our preliminary average liquidity coverage ratio during the first quarter was 145%, up from 141% at year-end and well above the 100% regulatory requirement. At the end of the quarter, we had total liquidity reserves from cash, securities, and Federal Home Loan Bank capacity of $106 billion, including about $25 billion in cash.
Turning to slide 7, I will cover capital. Our common equity Tier 1 capital ratio was 12.0% at the end of the first quarter, well above the regulatory minimum requirement of 4.5% and about $3 billion above our 11% long-term capital target. In the first quarter, we purchased approximately $312 million or 3.7 million common shares prior to suspending our share repurchase program on March 13th.
In terms of the impact of new regulations, in Q1, we adopted the Federal Reserve's final tailoring rule and elected to opt out of including AOCI and regulatory capital measures. We also elected to adopt the five-year CECL transition to regulatory capital. These impacts of the elections are included on slide 7.
Lastly, turning to slide 8, you can see net interest margin was 6.78% in the quarter, eight basis points lower than the prior year quarter. On a quarter-over-quarter basis, net interest margin decreased 17 basis points, largely driven by lower day count, the higher average cash balance that I mentioned previously and lower yields on our loan portfolio. This was partially offset by lower interest expense paid on deposits.
Looking forward, our net interest margin will continue to be impacted by a variety of factors, including our asset mix, deposit pricing, cash positions and day count. And as we have previously mentioned, we generally view a continued low rate environment as a headwind and a higher/positively slow yield curve as a tailwind. All else equal, a significant decrease in rates and our elevated levels of cash are likely to create a headwind to net interest margin in the near-term.
And with that, I would turn the call back over to Rich. Rich?
Thanks, Scott. This quarter, there is an obvious recurring theme in each of our businesses and for the company. First quarter results reflect two distinct time periods: January 1st through mid-March before COVID-19 impacts took hold; and the last two weeks of the quarter when COVID-19 drove sharp changes in many metrics and trends.
Pre-COVID-19 results generally show solid momentum and strong performance on growth, credit and efficiency that have put Capital One in a strong position. Post-COVID-19 trends show a clear inflection, but there's too much uncertainty to simply extrapolate recent trends.
With that context, I'll pick up on slide 10, which summarizes first quarter results for our credit card business. Pre-provision results were solid in the first quarter, with continued year-over-year growth in loans and purchase volumes. Credit card segment results and trends are largely driven by the performance of our domestic card business, which is shown on Slide 11.
Domestic card ending loan balances increased 8.4% year-over-year, driven by the addition of the acquired Walmart portfolio. The emergence of COVID-19 impacts late in the quarter caused a deceleration in the growth of ending loan balance. First quarter average loans grew 11% year-over-year. First quarter purchase volume was up 8% from the first quarter of 2019, with strong growth through most of the quarter partially offset by sharp declines near the end of the quarter.
By the end of the first quarter, weekly purchase volume was running at a year-over-year decline of about 30%. Consistent with industry trends, our largest declines were in travel and entertainment, restaurants and discretionary retail. These category decreases were partially offset by an increase in spending at supermarkets and discount stores.
Through April 17, weekly purchase volume continues to be down about 30% year-over-year. Revenue increased 2% year-over-year. Growth in average loans was offset by lower revenue margin. The revenue margin declined 129 basis points compared to the first quarter of 2019.
A majority of the decline was driven by the expected impact of the revenue sharing agreement on the acquired Walmart portfolio, the expected math of comparing to the first quarter of 2019, which benefited from a rewards liability release and lower net interchange revenue resulting from the late quarter drop in purchase volumes.
Non-interest expense was up 2% from the prior year quarter, in line with the trend in revenue. The charge-off rate for the quarter was 4.68%, a 36 basis point improvement year-over-year, driven by the addition of the acquired Walmart portfolio. Because the delinquency rate is not affected by the loss sharing agreement, the addition of the Walmart portfolio, put upward pressure on the first quarter 30-plus delinquency rate.
Despite this upward pressure, the delinquency rate improved by 3 basis points year-over-year to 3.69%. There were no significant COVID-19 impacts on domestic card delinquency and charge-off metrics in the first quarter. However, we had a significant allowance build in the quarter reflected -- reflecting the expected credit impacts of the shutdown of economic activity. Pulling up, in the first quarter, our domestic card business delivered solid results and quickly mobilized to respond to COVID-19 impacts.
Slide 12, summarizes first quarter results for our consumer banking business. The auto business posted 9% year-over-year growth in ending loans and 8% growth in average loans. But by the end of the quarter, leading indicators of growth started to show COVID-19 impact. Weekly dealer applications were down an average of about 35% year-over-year in the second half of March and down about 25% year-over-year in the first half of April. Weekly dealer originations were down an average of about 25% year-over-year in the second half of March and down about 45% year-over-year in the first half of April.
Ending deposits in the consumer bank were up 6% year-over-year. Average deposit interest rate for the quarter declined 12 basis points compared to the prior year quarter and 14 basis points from the sequential quarter, driven by the market interest rate environment. Our average deposit rate paid going forward will depend upon several factors, including the market interest rate environment, our deposit mix, our funding needs and competitive dynamics.
Consumer banking revenue decreased from 3% from the first quarter of last year. Underlying revenue growth from higher auto loans and retail deposits was more than offset by two factors: differences in the timing of Federal Reserve rate cuts versus our deposit pricing moves, pressured revenue in the quarter, and our deposit mix continued to shift toward higher rate products.
Non-interest expense was essentially flat year-over-year. First quarter provision for credit losses increased $625 million year-over-year, primarily as a result of an allowance build in the auto business driven by COVID-19 and CECL. The auto charge-off rate increased 5 basis points compared to the prior year quarter to 1.54%.
Moving to slide 13, I'll discuss our commercial banking business. Ending loan balances were up 14% year-over-year. About half of this growth resulted from customers drawing down lines late in the quarter. After peaking in March, line draws have subsided thus far in April. First quarter average loans were up 7% compared to the first quarter a year ago. Average deposits also increased about 5%.
First quarter revenue was up 8% from the prior year quarter, driven by growth in average loan balances and strong non-interest income. Non-interest expense was essentially flat compared to the prior year quarter. Provision for credit losses increased $787 million compared to the first quarter of 2019, driven by a significant allowance build.
A little more than half of the allowance build is related to pressure in the oil and gas portfolio caused by the sharp drop in commodity prices in the wake of the shutdown in economic activity. The remainder of the build is related to COVID-19 impact across the portfolio. We've provided a breakout of oil and gas portfolio composition and reserves on slide 16. The commercial banking charge-off rate for the quarter was 0.57%. The criticized performing loan rate for the first quarter was 3.6%, and the criticized non-performing loan rate was 0.6%.
Pulling way up, in the first quarter, Capital One rapidly mobilized to respond to COVID-19 and the disruption it is causing, with a focus on our associates, our customers, and our communities. We are in a position of strength to weather the pandemic, and we're closely monitoring conditions and managing our businesses for resilience and long-term value creation.
I am struck by how fast, how unpredictably and how much the world can change in just two weeks. Rapid change can leave companies scrambling to make choices in the heat of the moment, in a swirl of uncertainty and anxiety. But so much of the leverage is in the choices one makes before coming face-to-face with sudden challenges.
I've often said that the choices you make during the good times that have the most impact on how you weather the bad times. And that's a core tenet of how we manage Capital One every day.
From our founding days, we have hardwired resilience into every choice we make on credit, capital, and liquidity. Our balance sheet is strong, we've built resilient businesses and a resilient loan portfolio. We have invested to transform our technology and how we work, and we're taking decisive actions to aggressively manage credit risk and further strengthen resilience, leveraging what we've learned over two and a half decades.
There are certainly challenges ahead for the economy, for our customers and for Capital One. At this point, it's very hard to predict how the great -- how great the challenges may be or how long they may last. But we're well-positioned to navigate and manage through these uncertain times and to emerge with the strength to find attractive opportunities on the other side.
Now, we'll be happy to answer your questions. Jeff?
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 to one question plus a single follow-up. If you have any additional follow-up questions after the Q&A session, the Investor Relations team will be available to answer them. Matt, please start the Q&A.
Thank you. [Operator Instructions] The first question will come from Betsy Graseck with Morgan Stanley.
Good evening. Thanks for taking the call and hope everybody is safe there. Rich, I guess I just wanted to understand how you're thinking about the card business as we go through the next couple of years, in particular, how to integrate the new Walmart portfolio and relationship into the business that you've got and what it means for growth in that portfolio with that customer set?
So, Betsy, good evening. The Walmart integration has really happened. And so we have a wonderful working partnership with Walmart, really exceptional. And they -- I've been struck by how much they appreciate the importance of the card in their business and in their future digital business opportunity. And so we've been optimistic for what this partnership can be.
At the moment, financially, the partnership is dominated by the economics of the back book portfolio that we acquired and that's fully integrated and that's performing as expected.
And we have been working very hard with Walmart to put in place the elements and the channels and the opportunities for originations. COVID-19 coming along is a bit of a challenge in the middle of this, and so probably that business will, like all of our businesses, probably be subject to some of the demand impacts and changes that I mentioned relative to what typically happens in a downturn.
But we're still very focused on moving forward with them. And what I'm struck by also is the -- we take the very same perspectives on how to manage credit in this environment, where to find the opportunities. And so we'll be continuing to move forward.
Okay. Thanks. And then as a follow-up, just wanted to turn to the outlook for the reserve you went through very detailed segment by segment, which is very much appreciated. Wanted to understand, how you think about that reserve as we -- as the next couple of quarters unfold.
I realize the 9.5% peak unemployment is 2Q 2020, but that you put the qualitative overlays on. So how much more unemployment do you feel like you've baked into the current reserve level just so we can get a sense as to when we see the numbers come out, how we should be flexing future reserve builds, if any?
Hey, Betsy, thanks for the question. I think that the -- I would start off by saying the reserve -- when we topped up the reserve at the end of the quarter, we actually didn't go and do another model run. We just did an overlay. So I can't get too precise in saying like, 'Hey, here's a specific number that I would tie to our reserve in terms of unemployment level.'
And just in general, in terms of how to think about the reserve going forward, I would just say that, that may not be quite as simple as just taking the headline unemployment and tying that to the size of the allowance. I just was talking about the fact that we did do this late add to the reserve based on some of the worsening economic forecasts we had.
And then the second thing I would just say is that we've got -- I think we're just going to see a lot more data in the next 90 days before we have to close the books again. And thinking about kind of the path of the country's response on the virus, how the consumer is going to react to all the stimulus, and we'll actually also have some credit data by the time we close the books next quarter, which, of course, we're going to use all those things to refine our allowance estimate. So at this point, I'd really like to see that data before I speculate on where the allowance might be added.
Next question, please.
Next question will come from Don Fandetti with Wells Fargo.
Thank you. So Scott, thanks for the color on the reserve build. I mean, if I look at your allowance, my personal view is that you guys took a more conservative approach, so we appreciate that. I think some of the card issuers may have a bigger reserve build next quarter. But Rich, I was wondering if you could talk a little bit about loan growth and what your plans are in cards. I know, if I go back to the credit crisis, your loan growth declined significantly. And can you just provide some thoughts on stimulus in terms of what the offset might be and how we could think about that?
Yes. Thanks, Don. So the first thing that I think is striking -- well, from my experience across several downturns and then thinking about how to interpret this downturn, of course, we haven't seen anything as precipitous as this particular one.
But a couple of things tend to naturally happen in cards. The lower purchase volume, obviously, very striking, particularly in this downturn at this point, but lower demand for credit, lower requests for credit line increases, and I want to pause on that because I think there is a intuitive logic people would think, well, wait a minute. When customers feel the strain of a downturn, surely, a lot of them have to be beating a path to try to get more credit. And what I've seen in the past and what we're already seeing here is that consumer behavior tends to be in general one of battening down the hatches a bit, being more conservative, increasing their savings if they have an opportunity to do that, sometimes paying down debt.
Now, obviously, there's a huge gradient across customers. But I just wanted to say that our expectation and what we're seeing in a matter of weeks is something that is left on the demand side, and I think -- I would guess that during the period when consumers feel a lot of uncertainty, I think that at least for that period of time that demand will be less. It's also really quite plausible that as things settle out on the other side, consumers will still carry that cautiousness with them. We saw some of that after the Great Recession that there were some behavioral changes in that particular case.
Then I want to overlay on top of that what we're doing at Capital One. We're making here very, very early and into the, sort of, free fall period of the economy. We're making choices that are right out of our playbook in downturns and certainly, I think, make a lot of sense of this downturn, tightening our extension of new credit to avoid the heightened risk of adverse selection.
And then we're also pulling back on near-term marketing in response to the decreased opportunity at this very moment for quality growth. And, of course, the decreased marketing has a bit of a -- that will itself flow into a little bit on the growth side. So the combination of these natural trends and our actions put downward pressure on loan balances.
Now, I really want to stress that this is a moment in time and this is how the market's reacting, the consumer is reacting and the choices we're making at this moment in time.
We have really structured our business and our playbooks to be always testing and looking for inflection points and to see where the opportunities can come and we will pounce on them when they do. One other thing, I want to say is, it's not like there's going to be a single inflection point and then suddenly sort of the -- the sun is going to come out. The way opportunities will emerge, will be probably really quite sloped by product area.
We found, across business lines, the sort of inflection point varied by many, many months in our business. And then it will vary by segment, probably by geography. So right now, it's the time to be cautious. And -- but we're very, very closely monitoring where opportunities and -- where and when opportunities will present themselves.
Do you have a follow-up Don? Next question please.
Our next question will come from Sanjay Sakhrani with KBW.
Thanks. Hope you guys are doing well. Rich, you talked about pulling back on marketing, and obviously, that wasn't as evident in the first quarter. But when we think about magnitude that you could pull back on marketing and even other expenses, could you just walk us through how you're thinking about it over the course of the period that we're going to experience this weakness as a result of COVID-19?
Yes. Let me talk about the -- let me start with the marketing first. So right now, we're pulling back in a number of areas to avoid the heightened risk of adverse selection. So these areas include some pullbacks in digital and online origination channels, direct mail; on the advertising side, certain product-oriented national advertising.
At the same -- we're continuing to originate through some channels. We are -- but we're also continuing to invest in our brand, although the overall brand investment is down, and we are at full levels of marketing on our national banking side. In fact, the whole -- most of the things that are going on, the incredible importance of digital banking experiences the -- just about all of the trends are sort of consistent with an acceleration and the kind of things, we’ve been looking towards consumer behavior relative to our national bank. So we’re -- saw a green light on that one.
So and again, I am talking moment in time and these things are lines of coming calls like I have always said, so this is not -- these are not predictions of sustained set of choices we’re making. I am just sharing with you the choices that we are making in this particular phase of this downturn.
So relative to expenses overall and we have wonderful momentum in our company, and in our businesses and in our tax transformation. So the very immediate choices are more around choices of credit risk in the margin, the marketing that we're doing, we are tightening up on hiring and tightly managing operating expenses as we continue to monitor the trajectory and character of this downturn.
Okay. And I appreciate slide 16, which goes through some of the commercial oil and gas portfolio exposures. But I don't know, Scott, if you could just help us think through the sensitivities around this, because we're hearing all sorts of stuff happening with the price of oil. Maybe if you could help us think about how that sort of translates into this. And also, there were lots of news articles about hedging and derivative contracts and how it affects you. Maybe you could just clear the air on that as well. Thank you.
Sure. Thanks, Sanjay. So just starting off on E&P. On -- or excuse me, the energy business. So that business you see in the slides is really predominantly an exploration and production business. And when we did the allowance, we based a lot of the allowance on where the revenue stream that those producers are going to have, which is basically the forward oil prices. And even with this near -- the short-term disruption, that was all about spot prices and not so much about the longer-term prices. So I wouldn't get too worried about kind of that short-term disruption in the market.
Overall, when I look at that industry and where we are and what is going on with just the incredible reduction in the use of oil and gas, I would just say this. When we set this reserve up, the significant portion of it, we added some non-specific reserves, these aren't reserves associated with specific names that are struggling. We did a pretty healthy amount of qualitative reserves, just based on the risk of a number of these names just continuing to struggle. So I feel pretty good about the level that we put in there in spite of everything that we've seen in the last several weeks.
And then moving on to your other questions about kind of what is going on with the commodities. So Capital One has a business which does some commodities trading on behalf of our customers. And our net exposure to commodity price risk is de minimis. We did ask the CFTC for a temporary relief from being designated as a major swap participant, which is the lowest level in that regulatory hierarchy. And we did that mainly because there could be some -- the price volatility could move some of our positions into levels that would trigger that registration. And we really do appreciate the speed that the CFTC granted relief for us and against not having to necessarily register.
However, because the request was really broadly misunderstood in the marketplace, we did notify the CFTC that we're not going to rely on that waiver, and we're going to go ahead and register if derivative volumes reach the threshold that would require us to register.
I just have a couple of other comments there. So, one, our commercial bank does not engage in speculative derivative trading. Since 2015, we've provided, as I said, commodity price hedges as a service to our oil and gas customers. And then when we do these trades, we basically have back-to-back trades. We enter into a trade with our customer and we enter into an offsetting trade with Wall Street, and so we're really sitting here in a very low-risk position.
And I would just say, at the moment, there's no outstanding margin calls. We reduced our risk exposure to commodities essentially to zero. And you can look in our 10-Ks and Qs and see that this is normal hedging activities. And if there's any updates there on that, we'll point that out there. But hopefully, that clears the air there.
Next question, please.
Our next question will come from Eric Wasserstrom with UBS.
Thanks for taking my question. Can you hear me okay there?
Yes.
Okay, great. Thanks. So, also on a credit question. As we think about the reserve adequacy in the card segment, if you -- I know that you indicated that it's, I think, only reserving for the proportion of the COVID-19 programs in what you actually bear the risk. But is the loss content in those programs significantly different than it is in your overall portfolio such that it will significantly skew that ratio in some way?
I think that Eric, the thing I would just say there, so one, the loss sharing in those arrangements, we only recognize in our allowance and in our charge-offs our portion of the loss, and some of these loss sharing arrangements, we've talked about that the Walmart loss sharing arrangement includes significant loss sharing.
And so as a consequence, we -- it really does decrease the amount of coverage that is necessary required to cover our portion of those losses. So, while the book itself may have losses that are appropriately reflective of the types of customers that are in there, we end up having a much smaller portion of losses that we recognize and our coverage levels are appropriately lower given that relationship.
Okay, great. Thank you for that. And just as a follow-up, maybe to reframe some of the questions that had been posed. I mean, I think one of the things that the investment community is struggling with is that subsequent to the close of the quarter, I think saw economic conditions and expectations have continued to deteriorate. And so in that context, again, like how should we think directionally about the adequacy of reserves across the different products? Is there a greater likelihood of needing to do another true-up under the position, forward-looking economic expectations? Or do you feel like you had a lot -- a good enough look into April trends such that the first quarter's provision really compensated a lot of that already?
Well, we did -- I mentioned this, we did make some adjustments to our modeled reserve as we closed the books in the first week of April. I really want to just emphasize that I -- we have certainly seen some scenarios, particularly economic scenarios that are more severe than what we modeled. But on the other hand, we've seen more stimulus that's been brought to bear since then as well.
And I said this earlier, but I really think that we -- it is very hard for us to predict where this -- the allowance might be headed. There's such an important relationship of government stimulus and hardship programs that really are going to work to help offset some of the economic challenges that we're seeing right now. And I just -- I don't have a good sense about the allowance going to be bigger or smaller. I really just want to see a little bit more data before we have a lean in either direction.
Next question, please.
Our next question will come from Ryan Nash with Goldman Sachs.
Can everyone here me?
Yes, we can Ryan.
Hey, good evening, everyone. So maybe one question and a follow-up for me. So Rich, if you look, the stock's trading at a $30 discount to tangible capital since this pandemic began on concerns that this could obviously end up eating into the capital base of the company.
When I look, your 12% CET1 is amongst the highest in the industry even after building significant reserves. So when you just think about -- I know it's hard to predict at this time, but when you think about the different range of outcomes, combined with the fact that you're halting buybacks, the balance sheet sounds like it's going to be shrinking, how do you think about capital and capital progression in this kind of environment?
Well, Ryan, I think we entered this downturn, I think about the choices that we have made over the years and coming from the sort of risk management philosophy that deepened in the way this company is founded and even a number of choices that were made over the last few years, and I think we enter this downturn in a really good position.
And Ryan, would it be useful possibly to the aperture of your question and sort of compare -- do a little bit of a calibration about going through the Great Recession and calibrate to how I feel about this time around? Not that we can predict this downturn, but in other words though, just thoughts about that experience and comparing some of the resilience dynamics, would that be helpful in -- my question?
Well, my follow-up question was actually going to be, and I think everybody is kind of alluding to this on this call, the fact that as we see unemployment reach certain levels, there's an underlying assumption that losses are going to rise to similar amounts.
So I actually think it would be helpful for you to compare and contrast this to the financial crisis. What's different? And what are the factors, whether it's the card Act or anything else that's changed across the industry that you think will make those relationships no longer hold?
Yes. So knowing, of course, that this particular downturn is so early, nobody knows how prolonged this will be, how severe it will be, what the recovery will look like, or how much government support and forbearance there will be and how it mitigates the economic effects.
So with those caveats, let me talk a little bit about the marketplace as we entered the downturn, some of the things on both sides of the ledger at -- in terms of resilience levers and opportunities and then -- so let me start with the marketplace.
Let me start with the consumer. I think the U.S. consumer is in much better shape than at the outset of the Great Recession. Consumer debt levels are lower on a per capita basis. Payment obligations are lower still, supported by low interest rates. The savings rate over the past few years is double what it was before the Great Recession. And we're not dealing with a structural problem in the economy like the housing sector pre-Great Recession that had to work itself out over multiple years before we could see a sustained recovery.
In corporate markets, as we've mentioned in earnings calls over the last few years, there are some mounting, kind of, competitive challenges, including higher debt levels, lower interest coverage, weaker covenants, all of which feel weaker than before the Great Recession. On the other hand, the banks have been a smaller part of this trend and increasing leverage, with capital markets and non-banks taking an increasing share of this growth.
At Capital One, we weathered the Great Recession very well and demonstrated the resilience of our business model. Today, we have a stronger capital position and a stronger liquidity position than we had going into the last crisis.
And let me comment briefly about each of our major lending businesses. There are some offsetting factors that impact the resilience of our card business relative to the last downturn. The Card Act has leveled the playing field but it has negatively impacted resilience by banning the repricing of existing balances.
And changes to accounting rules now dramatically amplify the volatility of allowance, although this doesn't change the underlying resilience of our lending portfolios. And, of course, there, we're talking about both FAS 166, 167 and CECL. And our returns, while still very strong are somewhat lower than they were prior to the Great Recession. We have changed the mix of our portfolio, reducing our exposure to high balance revolvers and significantly growing our spender business at the top of the market and building a stronger customer franchise across the portfolio. And we built loss sharing into most of our partnership deals, which improves our resilience.
In the auto business, we have lower charge-offs, higher returns, a strong franchise built one deep dealer relationship at a time and a more resilient strategy. Our commercial business did exceptionally well in the Great Recession, but was aided by a business mix and a geography that did not get severely impacted during the downturn.
Our commercial portfolio was still in a developing stage in '08. It looks pretty different today. We've exited or reduced exposure to several less resilient segments like small ticket commercial mortgages and equipment finance. We've invested in building specialty businesses to generate better risk-adjusted returns. And we've increased noncredit revenues significantly.
But we think the overall commercial sector is in worse shape as companies have taken on more debt and increased leverage. And the creditor protections have gotten weaker and borrowers have used more aggressive add-backs to inflate earnings. Now again, that's not mostly a description of what's happened to bank lending, but really to lending in the broader marketplace, which, of course, impacts banks as well.
Of course, no two downturns are the same and we get to look at the Great Recession in hindsight, and that's of course, 2020. At this point, we know very little about how the COVID-19 pandemic and its economic impacts will play out. We know, of course, that the onset was more abrupt and that the initial worsening is likely to be steeper, faster and deeper.
We also know that the downturn is being met with a more rapid and much bigger fiscal -- particularly, fiscal and monetary intervention, the largest fiscal intervention we've seen since the Great Depression. We know that forbearance is available to customers on a much greater scale than it was last time around. So our strategy in the face of the current challenges and uncertainties is to aggressively manage credit and resilience from a decision-making point of view because downside risks can be nonlinear.
We take a very cautious approach at this very moment, while the economy is descending. Also though, while very proactively positioning for opportunities that may emerge on the other side of this, and that's why we've said we're tightening our extension of new credit with a real eye toward the probably high adverse selection that would be -- is prevailing out there and pulling back on near-term marketing, tightly managing expenses and being really ready to be responsive as this downturn evolves and knowing that we need to evaluate that on a segment-by-segment basis across our business.
So pulling way up, Ryan, we feel really good about the choices that we made over the years. We feel very good across liquidity capital and credit resilience choices as we entered the downturn. With the tech transformation, we've been able to have a company that can move very quickly. And I feel very good about where we are. It's hard to predict exactly what will happen here. But I think the choice is I wouldn't change just about any -- I really wouldn't change any of the choices. Knowing where we are now, I would not change the choices we made leading up to this and I really like our chances.
Next question, please.
Our next question will come from Moshe Orenbuch with Credit Suisse.
Great. Thanks. Maybe Rich or Scott, could you give us just a little bit of a little more detail about the specific forbearance programs that you have in card and auto? In particular, how long they might last and what the take-up has been in terms of -- has it peaked? Can you talk a little bit about that in a little more detail?
Yes, Moshe. So for card customers who enroll, we are allowing them to just give one payment with no late fee on a month-to-month basis. Interest continues to accrue. And as of April 17, as we said, 1% of active accounts have received assistance, representing 2% of balances.
For auto, customers can skip one to two payments with initial interest continuing to accrue and payments added to the end of the loan. And I want to comment there. When I say things are monthly or every two months, this is not like that's their only chance, but we wanted to give ourselves more flexibility to evaluate the situation, knowing how fast things are changing. But it's certainly likely that customers who are on a monthly program will be extended if the opportunity calls for that.
And as we've said before, as of April 17, 9% of customers have received assistance, representing 11% of balances. It's striking as we look between auto and card how much higher the requests are on the auto side. And I think that while it's striking, I don't think it's necessarily surprising. We have found, in fact, across our businesses if a -- you can see visually that the size of the payment amount is a key driver of the number of requests that we get. And of course, auto payments are typically much higher than credit card minimum payments. And the other reason, of course, is that in auto, the stakes are higher for the customer. They're very motivated to make sure that they can keep their car.
Got you. And as a follow-up, maybe could you just talk a little bit about -- you talked about the things you're doing to tighten in the card business. Any changes that you would either think about making or see within the industry with respect to competitiveness of rewards and the kind of products you might see as we -- the next several quarters as we kind of put -- one hopes come out of this process.
Well, I think we -- the rewards marketplace was very competitive in terms of offers and early spend bonus and things like that, but it kind of settled out into an equilibrium.
With purchase volumes down and probably for most card issuers, some tightening up in this very moment. I don't think we would -- I think that I would expect the competitiveness to be, in terms of products and product offers, to be probably stable.
The intensity of the competition is probably going to lighten up just probably because people are going to cut back on marketing. And certain of the products, when you think about it, for the reward industry and for Capital One, are oriented towards the things that people aren't able to do right now; travel, entertainment, dining, and a lot of things like that.
So, I think that this will be a period where I think issuers will be focused on meeting the needs of their customers and be planning for opportunities when things change. And opportunities can emerge much sooner than the entire economy recovering.
Again, as I said, this is a segment by segment and situation by situation kind of thing. So, we're already working to figure out where opportunities, individual opportunities can be there, possibly even that have become bigger opportunities because of the situation the world is in.
Next question, please.
Our next question will come from Bill Carcache with Nomura.
Good evening. We've seen other banks this quarter generally set their reserves at levels sufficient to cover about 50% on average of cumulative losses contemplated in their severely adverse scenarios under DFAST. Can you share any thoughts on why you guys might differ on this metric?
Yes, Bill, thanks for the question. So, obviously, there are different scenarios, that's a starting point. I won't go into all of the differences there. But just kind of a few points as you think about, if you're calibrating us against others. The first is that when you think about our allowance versus the way the Fed models DFAST, one of the issues that impacts that comparison is that the Fed uses industry average recovery rates. And as I mentioned last quarter, our practice is to work recoveries, which results in a longer tail, and that's really important under CECL because in CECL, you take the undiscounted recoveries as an allowance offset. So our CECL recoveries, I believe, are going to be quite a bit higher versus the Fed and their industry average recovery rates.
The second point I would make is that when these partnerships that we talked about that have loss sharing arrangements, that meaningfully reduces the losses that are attributable to Capital One. And we only have to allow for our portion of those losses in our allowance and in our provision.
And so that is how we do our resilience and modeling processes. While we don't have visibility into the Fed modeling approaches, I don't think that the Fed necessarily gives us credit in DFAST for that offset because they've historically not collected all the data necessary to make those adjustments. So just a couple of factors that you should consider in terms of how we sit relative to others.
Next question, please.
Our next question will come from John Hecht with Jefferies.
Good afternoon. Thank you taking my questions. First one is, I'm just -- I'm trying to think through how stimulus might be different this time. I mean, if you think about it, there was some information put out in the Wall Street Journal today that for a lower income worker stimulus, to the extent they have unemployment, either is a pay increase for a period of time for them, whereas for a prime consumer undergoing unemployment and receiving benefits of the CARES Act, it's still a substantial decrease in compensation for a while. How do you guys think through that in terms of relative performance in your non-prime book versus your prime book this go around?
John, the -- I think the -- what's striking about the fiscal stimulus here, where there are many things probably striking to all of us about it. But when we've gone back and specifically calibrated to the Great Recession, I don't have the numbers right in front of me, but I was struck by the fact that the benefits for those who get like unemployment benefits, the unemployment benefits are higher.
It's across the -- across a range of relevant incomes, the entire line is higher and the eligibility is significantly higher. So those two things are -- it's hard to quantify how much of an impact that will be because no one can quantify how much of an impact it was the last time. But intuitively, I think that effect can have quite a bit of impact in a good way on people's ability to weather their individual storms and make it to the other side. With respect to subprime versus prime, the first thing I always say is, I think if I showed you the -- by income, if I -- prime or you take, prime and subprime, you've got at the top of the market, there tends to be some very high income folks. But I think you would be surprised that there's not as much slope as one might think relative to things like income on -- across our business as you move along the credit spectrum. There is some slope, but not all that much.
All of that said, though, the fact that I think the government is working hard to create a safety net for people who don't necessarily have all of the buffers some people might have in life and the fact that that net is extending wider and broader -- or deeper, I think that that will -- should have a pretty positive benefit for consumers and their ability to, among other things, pay their bills and their credit card bills.
And I do want to say that while it's only a small number of days of data, we could see in our payment rate, some -- a spike-up around the time -- those individual checks were coming in. So that could be a short-term thing, but that would be confirmatory of the intuition that we would have.
Okay, that's very helpful color. And then a separate question is tied to the stay-at-home situation or have you seen any different types of behavioral action, given the [Technical Difficulty] digital bank…
Hey, John, I'm sorry. John, I'm sorry to interrupt you. You're breaking up. We can't understand the question. Can you…
You guys hear me now?
It's better.
Okay. The question, as we've been on [Technical Difficulty] type of environment for a while, have you seen any behavioral change with respect to interaction with your consumer bank? And -- pretty heavily in that opportunity.
John, I'm so sorry. Let's try one more time and then we might have to move on. But…
Well, John, were you saying -- given that we've invested heavily on our consumer bank in terms of the digital side of the business, are we seeing anything particular there? Would that be close to the question that you have?
Yes, particularly given that we're stay-at-home situation and you're going to have a greater opportunity to interact with the digital -- over the digital channel.
Well, an interesting thing is, we are probably in the best position in America to have a calibration about -- because we not only have a digital bank, we also have a branch-based bank in some of our geographies as well, and so we certainly can see the calibration.
There is -- look, the first thing I would say is there certainly are a core of customers who still need and want to -- well, they very much want to use the bank, and we've been able to keep most of our branches open by -- like 75% of them by having drive-through and some glass windows for some social separation. So we've certainly seen a continued volume there.
But if I pull up, I think that this moment is some people say they predict, gosh, people will have very different behaviors on the other side of this moment. I'll make a different prediction. I think this is going to be an accelerant to the behaviors that we were all, as a society, heading for anyway. And the advantage, I think, that the banks who have really driven their customers to digital and built the capabilities that can help a customer pretty much do everything digitally,
It was always where the world's going, but I think it's just an acceleration of -- the bell curve shifted in terms of, I think, the number of folks. This is me talking more intuitively than empirically. But this is why I said earlier when I talked about, we're going to keep our foot on the gas with respect to the marketing and the investment in our national banking strategy because, of course, what that is -- as I've often called it, we're trying to build the bank of the future. And I think that years in the evolution of America and consumer behavior possibly just got compressed here.
Next question, please.
Our next question will come from Rick Shane with JP Morgan.
Hey guys, thanks for taking my question. Two questions. First, in the past, you talked about a 25 basis point benefit from the loss sharing in the Walmart agreement throughout 2020. I'm wondering if there's any cap on that or how much we could expect that to flex as charge-offs rise related to COVID-19?
Hey Rick, how are you. Look, as you think about Walmart, we did talk about a 25 basis point impact to delinquencies and on an ongoing basis, about that same level going forward. And I think that there's -- yes, we could absolutely see variability in the impact of that to the total, just given movements in the loss rates of either part of that calculation.
I would anticipate them to be relatively small because the loss sharing is so significant with Walmart, but it's -- it could move up a bit and still not really impact our overall loss rate all that much. But there's not a cap in the contract, if by chance, you were asking that, so this loss share is on a percentage basis and it will stay that way.
Okay, great. And then, Rich for you, look, you're a serious student of human behavior. And I'm curious what you have seen in terms of consumer behavior so far that has surprised you the most.
I'm not sure anything has been surprising, I'm certainly struck by. Here's the thing that's interesting about this particular downturn. Almost all other downturns -- most other downturns have the following characteristics. They kind of happen on little cat feet and then things start picking up, but it's a slow kind of descent into that.
And the other thing is, so often, there are structural problems. This is an economy point, but structural problems in market that sort of bleed to that. And then the resolution of it needs to fix those structural problems on the way to fixing all the other problems that come from it. So I think what's so extraordinary about this is the just swiftness of this thing and the fact that it's really the entire world going through this and the sort of vertical descent from an economy point of view, that happened so quickly.
So things that I'm struck by on the consumer behavior side, I have been really struck at the early behaviors that I see that are consistent with the model that we have believed -- in fact, let me back up for a second and say, there's a saying that I used to -- that I've said for years, is that consumers are a lot more rational than the institutions who serve them, including the financial institution who's served them often over the years.
I have always been struck over the years, despite all the things that are written and speculated about consumers, just how rational they are. And so I was struck during the Great Recession at their rationality. There was some irrationality before the Great Recession. This time around, the consumer was in a solid, very balanced shape going into this downturn.
And the little things that I have seen, behaviors on the savings side, on our bank side, behaviors on the payment side, the purchase volume side, even on the delinquency side of things, and what I see is a rational consumer and I think that what we all should think about as we calibrate to any other recession. This is a downturn that came to the whole world right at once and it's a downturn without a bad guy. That's the other part of this thing.
And so what's the implications of a downturn without a bad guy is it's a lot easier politically to mobilize solutions. For consumers, that's a political and economic point, but I think that is going to be a good guy in this downturn and its resilience.
The other thing -- the other final thing I'll say about human behavior or the behavior that we've certainly seen, I am amazed, I'll talk about our company. This is really a point about consumers; it's a point about people. I am amazed how productive people are, and we just did an associate, it's an all associate survey and engagement and morale is still at very high levels. People are all in, they're engaged, and the productivity is extraordinary from people working from home. It doesn't mean that everybody, when the world opens up, everybody is going to just stay home.
But I think that back to my earlier point, I think there's a compression in years in the learnings and the behaviors associated with digital. And I think every company's going to walk away from this experience struck by the extraordinary productivity that -- or certainly most companies or certainly ones that are digitally in a good position by what just happened on the productivity side and that is some learnings for all of us there.
Next question, please.
And our final question will come from Brian Foran with Autonomous.
I know the call's gone long, but just on the OpEx, totally understand pulling the target, given how much flux there is. But on the core effort of moving to the cloud and retiring the data centers, is any part of that core expense dollar effort and timing changed? Or is it more just revenues in flux, maybe some call center volumes and stuff like that? Has the data center strategy changed at all, I guess, is the crux of the question?
No, not a single bit. I mean, we are incredibly well served by our move to the cloud, the ability to scale up for some extraordinary things that have happened, so many things. So, the cloud strategy, the technology transformation, everything about it, we felt this experience is validating.
With respect to the data center exit itself; we are on the very same timing of later this year. I mean, we are already fully in the cloud. So, what -- but the data centers are still open because there is -- you think once you get out, well, then you just -- you're done but there is a period of much of a year to actually do all the wind down activities associated with the data center.
So, we're 100% in the cloud, and the wind down is going right on schedule and we're talking later this year and the associated economic benefit of those moves.
Okay. Well, I think that wraps it up for this evening. Thank you for staying with us. Thank you for joining us on the conference call today, and thank you for your interest in Capital One. The Investor Relations team will be available later this evening to answer any further questions. Have a great evening.
Ladies and gentlemen, that does conclude our call for today. Thank you for your participation. You may now disconnect.