Capital One Financial Corp

NYSE:COF

Earnings Call Transcript 2021-Q1

[Operator]

Good day, ladies and gentlemen. Welcome to the Capital One First Quarter 2021 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] Thank you.

I would now like to turn the call over to Mr. Jeff Norris, Senior Vice President of Finance. Sir, you may begin.

[Jeff Norris, Senior Vice President of Finance]

Thanks very much, Keith, and welcome everybody to Capital One's first quarter 2021 earnings conference call. As usual, we are webcasting live over the Internet. To access the call on the Internet, please logon to the Capital One website at capitalone.com and follow the links from there. In addition to the press release and financials, we've included a presentation summarizing our first quarter 2021 results.

With me today are Mr. Richard Fairbank, Capital One's Chairman and Chief Executive Officer; and Mr. Andrew Young, Capital One's Chief Financial Officer. Rich and Andrew 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.

With that, I'll turn the call over to Mr. Young. Andrew?

[Andrew Young, Chief Financial Officer]

Thanks, Jeff, and good afternoon, everyone. I'll start on Slide 3 of tonight's presentation. In the first quarter, Capital One earned $3.3 billion or $7.03 per diluted common share. Pre-provision earnings increased 1% in the quarter to $3.4 billion and we recorded a provision benefit of $823 million. After recognizing $535 million of gains during 2021 on our Snowflake investment, we had a loss on our position in the first quarter of $75 million or $0.12 per share. We've now fully exited our position with a cumulative gain of $460 million.

Turning to Slide 4, I will cover the quarterly allowance moves in more detail. In the first quarter, we released $1.6 billion of allowance. The release was driven by strong credit performance across all of our businesses and a more favorable economic outlook that includes the $1.9 trillion stimulus package passed in March. Our allowance continues to assume that the relationship between economic metrics and credit performance reverts to historical patterns. And despite the strong credit performance and more favorable economic outlook, we continue to hold significant qualitative factors to account for a number of remaining uncertainties.

Turning to Slide 5, I'll provide some detail on the allowance coverage by segment. After the impact of the $1.6 billion allowance release, our coverage levels declined modestly across all segments from the prior quarter and remained well above pre-pandemic levels. Our Domestic Card coverage is now 10.5%, down from 10.8% last quarter. Our Branded Card coverage is 12.1%. Recall that the difference between Branded and Domestic coverage is driven by the loss-sharing agreement in our partnership portfolio. Coverage in our consumer business declined 38 basis points to 3.6%, and coverage in our commercial banking business fell 23 basis points to 2%.

Moving to Slide 6, I'll discuss liquidity. You can see our preliminary average liquidity coverage ratio during the first quarter was 139%, well above the 100% regulatory requirement. Our liquidity reserves from cash, securities and federal home loan bank capacity ended the quarter at approximately $151 billion. The $7 billion increase in total liquidity is largely attributable to strong inflows of consumer and commercial deposits in the last few weeks of the quarter.

Turning to Slide 7, I'll discuss our net interest margins. NIM declined 6 basis points in the linked quarter due to a 14 basis point headwind from having two less days in the quarter, as well as a higher mix of cash. These factors were partially offset by the full quarter effect of deposit pricing actions we took in the fourth quarter and a modest increase in loan yields.

Lastly, turning to Slide 8, I will cover our capital position. Our Common Equity Tier 1 capital ratio was 14.6% at the end of the first quarter, up 90 basis points from the fourth quarter and 260 basis points higher than a year ago. We continue to estimate that our CET1 capital need is around 11%. Recall that in January, our Board of Directors authorized a repurchase plan of up to $7.5 billion of the company's common stock. In the first quarter, we repurchased $490 million of common stock at an average price of approximately $114 per share. Based on the Fed's extension of the trailing four-quarter average earnings rule, our share repurchase capacity will be limited to approximately $1.7 billion in the second quarter. The timing and amount of all future stock repurchase activity will be a function of any regulatory restrictions, stock trading volumes and our holistic view of our capital position.

With that, I will turn the call over to Rich. Rich?

[Richard Fairbank, Chairman and Chief Executive Officer]

Thanks, Andrew, and it's great to have you as our CFO. I'll begin on Slide 10 with our Credit Card business. Year-over-year credit card loan balances and revenue declined in the first quarter, driven by the continuing impact of the pandemic. Purchase volume rebounded compared to the first quarter of 2020. And the biggest driver of quarterly results was the provision for credit losses, which improved significantly. Credit Card segment results are largely a function of our Domestic Card results and trends, which we show on Slide 11.

For the third consecutive quarter, the story of our Domestic Card business continues to be two sides of the same coin. Historically, high payment rates amplified by the effects of government stimulus continue to put pressure on loan balances. And on the flip side, the same factors are driving exceptional credit performance.

Looking first at growth, we continued to see purchase volume rebound from the sharp declines early in the pandemic. Domestic Card purchase volume for the first quarter was up 8.4% year-over-year with growth accelerating in March. Compared to the first quarter of 2019, purchase volume is up 17%. Most spend categories are now exceeding the pre-pandemic levels we saw in 2019. T&E spend is still lagging pre-pandemic levels, but it's catching up. T&E purchase volume is growing faster than overall purchase volume.

The payment rate, which has risen to a historically high level, continues to put pressure on loan balances, even with the pickup in consumer spending. At the end of the first quarter, Domestic Card ending loan balances were down $18.5 billion or about 17% year-over-year. Excluding the impact of a partnership portfolio moved to held for sale last year, first quarter ending loans declined about 15% year-over-year.

The year-over-year percentage change in ending loan balances this quarter was approximately the same as it was last quarter. Strikingly strong credit was the biggest driver of domestic card financial results in the quarter, just as it has been for the prior two quarters. The domestic card charge off rate for the quarter was 2.54%, a 214 basis point improvement year-over-year. The 30% plus delinquency rate at quarter end was 2.24%, 145 basis points better than the prior year. First quarter provision for credit losses improved by nearly $4 billion year-over-year, we had a large allowance release in the first quarter this year versus a large allowance build in the first quarter last year.

Strong credit and purchase volume growth were also key drivers of domestic card revenue margin, which was up 229 basis points year-over-year to 17.2%. Total company marketing was up modestly compared to the first quarter of 2020. Our choices in card marketing are the biggest driver of total company marketing trends. In the midst of the pandemic, we're finding opportunities to continue to build the business and we continue to lean in to marketing. Pulling up, our domestic card business is delivering significant value and building momentum.

Slide 12 summarizes first quarter results for our Consumer Banking business. Auto growth, continued strength in retail deposits and exceptional auto credit are the main themes in the first quarter Consumer Banking results, driven by auto first quarter ending loans increased 10% year-over-year in the Consumer Banking business. Average loans grew 9%. Auto originations were up 16% year-over-year and up 20% from the linked quarter. We've seen competitive intensity increase through the second half of 2020 and in the first quarter of 2021. And with most competitors holding excess deposits, we expect that competitive intensity will continue to increase going forward.

First quarter ending deposits in the Consumer Bank were up $36.4 billion or 17% year-over-year, average deposits were up 16%. On a linked quarter basis, ending deposits were up 2% and average deposits were flat. Elevated consumer savings rates fueled by continuing government stimulus are driving year-over-year deposit growth. First quarter Consumer Banking revenue increased 22% from the prior year quarter driven by growth in auto loans and retail deposits. First quarter provision for credit losses improved by $986 million year-over-year, driven by an allowance release and lower charge offs in our auto business.

Credit results in our auto business are strikingly strong and continue to benefit from historically high auction values and government stimulus. Year-over-year the first quarter charge off rate improved 104 basis points to 0.47% and the delinquency rate improved 217 basis points to 3.12%, a sharp uptick in used car values coupled with a stimulus driven surge in customer payments resulted in a negative net charge off rate in March. We expect the auto charge off rate to increase from its unusually low level as auction prices normalize and stimulus impacts play out. The Consumer Banking business continues to deliver resilient growth in auto loans and retail deposits.

Moving to Slide 13, I'll discuss our Commercial Banking business. First quarter ending loan balances were down 9% year-over-year. Average loans were down 3%. In C&I we've seen a reduction in commercial line utilization, which peaked early in the pandemic as customers facing elevated uncertainty, drew down their lines, that behavior has since diminished. In our commercial real estate business originations were down and pay downs increased compared to the first quarter of 2020. Quarterly average deposits increased 24% from the first quarter of 2020 and 4% from the linked quarter as middle-market and government customers continued to hold elevated levels of liquidity.

First quarter revenue was up 4% from the prior year quarter. Higher loan and deposit spreads, and growth in average deposits were partially offset by lower average loan balances. Provision for credit losses improved significantly compared to the first quarter of 2020, driven by a swing from an allowance billed to an allowance release and lower net charge offs. For the first quarter, the commercial banking annualized charge off rate was nine basis points. The criticized performing loan rate was 9.2% and the criticized nonperforming loan rate was 0.9%. Our Commercial Banking business is delivering solid performance as we continue to navigate the pandemic and build our commercial capabilities.

I will close tonight with some thoughts on our results and our strategic positioning. Three key themes are evident in our first quarter results. High payment rates continue to put near term pressure on loan balances and revenue growth, particularly in our domestic card business. On the flip side, strikingly strong credit drove a third consecutive quarter of record earnings per share. And our investments to transform our technology and transform how we work are paying off. Our modern technology is powering our response to the pandemic and putting us in a strong position for opportunities that emerge as sweeping digital change transforms banking.

Pulling way up, we continue to focus on the things that create enduring value when delivered and sustained over the long-term, continuing to transform our technology from the ground up, capitalizing on our transformation to drive innovation and growth, generating positive operating leverage and improving efficiency over time, and managing capital efficiently and effectively including significant planned capital distribution. And now we'll be happy to answer your questions, Jeff?

[Jeff Norris, Senior Vice President of Finance]

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. And if you have follow-up questions after the Q&A session, the Investor Relations team will be available after the call. Keith, please start the Q&A.

[Operator]

Thank you. [Operator Instructions] We’ll take our first question from John Pancari with Evercore ISI. Please go ahead.

[John Pancari, Evercore ISI]

Good evening. Want to see if you could talk a little bit about the long growth outlook, perhaps maybe a timing of the inflection, just given us as stimulus benefits, ultimately abate and payment rates peak. And I want to see similarly when you would expect to see that peaking of payment rates or at least an inflection there. Thanks.

[Richard Fairbank, Chairman and Chief Executive Officer]

All right. Thanks, John. Good evening. The growth story is, I’m sure you’re mostly focused on card with that question, so let me turn there. It is really striking that of all the asset classes, one really stands sort of unique in the industry as the one asset class that shrank since the start of the pandemic and that’s Credit Card. And of course that’s because it is a discretionary spending and borrowing product. In the current environment, the biggest drivers of card growth are spend and payment behavior, and of course the traction that we’re getting in the marketplace. Let’s just talk about spend for a minute, which is recovering.

In the first quarter, you saw the Domestic Card purchase volume was up at 8.4% year-over-year, and we’re seeing just about every spend category rebounding. And even by the way on T& E, while it’s down, it’s certainly accelerating. Let’s just give you a few stats here. T&E spending at the beginning of the pandemic was down more than 80%. And by December it was down about 50%, and in March it was down about 25%. So from a growth point of view, both the growth and purchase and loan growth, there’s some strength that we see on the spending side.

Turning to payment rates, which are of course historically high. The government stimulus, how big of a driver is that of what’s going on in payment rates, obviously consumers have been very conservative as well, but it’s certainly really amplifying the payment rates. And I think while not a perfect proxy for our overall Domestic Card results, you can get an idea of what’s happening with payment rates in our publicly disclosed trust results. For example, in March, the payment rate in our Master Trust was just under 46%. That’s an all-time high for Capital One and up more than 12 percentage point year-over-year.

Now remember that the payment rate represents the percent of the prior month ending balance that was paid off. So a 46% payment rate means that nearly half of our beginning balances in the trust were paid off in March, which is just remarkable, said another way, all else equal. Each percentage point increase in payment rate is a percentage point decrease in year-over-year. Now we need to always remember, and this is a really important point, the flip side of high payment rates is strikingly strong credit performance, which drives strong profitability and capital generation.

Now the other big driver of growth is what happens with originations and line increase. And as the pandemic has played out, we’re seeing some attractive origination opportunities and these opportunities are enhanced by our technology investments. And so we are continuing to lean into marketing. That origination, we are also gradually increasing credit lines as well.

So pulling way up, we are certainly very pleased with our opportunity to continue to grow our customer franchise. The net growth of outstandings will of course be affected by payment rates. So here is, we’re not – now to your question, John, we’re not predicting the timing of an inflection point. I think we have certainly learned that high payment rates while they slow down growth are just a really good guide for, not only the earnings power of the company, but just the performance quality of the consumer. We encourage our customers to pay down whenever they can. We find every opportunity actually to encourage them and remind them to pay down. So I think there’s certainly a good thing going on.

What we’re focused on from a growth point of view is what we can do to drive the underlying franchise and we like our opportunities there. And so we’re not predicting exact timing of inflection points and things like that. What I would leave you with is we like our opportunity on growing the underlying franchise. And we’ll see how payment rates play out in terms of driving sort of the final kind of outstandings growth number. But to us, an underlying growth of the franchise and the really strong dynamics that are going on the payment side of the business is just a healthy place to be, and we feel really good about that.

[John Pancari, Evercore ISI]

Thanks, Rich, for all that detail. That’s helpful. Just one quick follow-up on the marketing side and you indicated that you’re still continuing to lean in there. The low single-digit growth year-over-year marketing expense was better than we had expected. Could you just possibly give us a way to think about how much of a lean in that you’re looking at here incrementally as we look at the remainder of the year? Thanks.

[Richard Fairbank, Chairman and Chief Executive Officer]

Thank you, John. So, from marketing point of view, this first and foremost is going to be powered by what we see on the opportunity to grow originations. Marketing and originations are really something that’s very linked, of course, outstandings growth is not as closely linked in time or as directly. But so we see good opportunities to grow account originations and we’re investing in marketing consistent with those opportunities. In card, we’re certainly – in all our businesses, we’re leaning in where we see some signs of strength.

We also are continuing and sort of increasingly so to tell our story in terms of the customer experience we’re building, some of the benefits of our technology we’re building, and that’s part of our story that gets reflected in the marketing. And that’s something that powers the growth as well. And then we’re continuing to invest in our brand and our national banking strategy. So that’s why it kind of pulling way up with the collective set of opportunities we’re seeing we’re continuing to lean in to the market.

[John Pancari, Evercore ISI]

Great. Thank you.

[Jeff Norris, Senior Vice President of Finance]

Next question, please.

[Operator]

We’ll take our next question from Ryan Nash with Goldman Sachs. Please go ahead.

[Ryan Nash, Goldman Sachs]

Hey, good evening, guys. Maybe to ask about capital. So, if I look at the 11% target, you have over $10.5 billion of excess, you’ve got $3.5 billion of reserves above day one. And if I look at expectations, I think the market’s looking for almost $10 billion of earnings the next few quarters. So I wanted to get a sense for how we should think about capital allocation, timing of the execution of the $7.5 billion you previously announced. And could we see either upsizing of the current program into the next year, or how do we think about the ability to sustain capital returns at these levels? Thanks.

[Andrew Young, Chief Financial Officer]

Sure, Ryan. I’ll take that. It’s Andrew. The first thing I would highlight is, as you know, we’re still under the capital preservation rules from the Fed. So in the second quarter, as I mentioned in my prepared remarks, our repurchase capacity is going to be limited to just under $1.7 billion and we will also be limited to our prior dividend. And so we recognize that capital distribution is important component of our returns and our current position, and at least the prospects of earnings from here.

So how quickly we complete that $7.5 billion that the board has already authorized is going to tieback to any unforeseen additional regulatory restrictions, but also trading volumes in our stock, and then just taking a step back and looking holistically at our capital position. But what I can say is we’re excited at the prospect of moving under the SCB framework in the third quarter. So we’ll have more flexibility in our choices looking ahead.

[Operator]

We’ll take our next question from Sanjay Sakhrani with KBW. Please go ahead.

[Sanjay Sakhrani, KBW]

Thanks. Rich, you mentioned the strikingly strong credit backdrop. I’m just curious, using your analogy of sort of borrowing through the mountain, so do you think we’d get through to the other side with this round of stimulus? And maybe I’ll just ask my follow-up now. Andrew, maybe you could just give us some sense of how the NIM projects for the rest of the year, understanding there’s different puts and takes, maybe you could just walk us through your sort of baseline assumption? Thank you.

[Andrew Young, Chief Financial Officer]

Yes, Sanjay. So I think the main factor, particularly in the near-term with NIM is going to depend on how that pandemic impacts our balance sheet. Most notably what you’ve seen over the last few quarters in terms of asset mix and deposit balances and our cash position, I think those are the things that are mostly going to have the impact for the next few quarters. I think over the longer term, I’d expect our cash position and the size of the investment portfolio to come back down to more normal levels, I’ll call it, and be a tailwind to NIM all else equal. But it’s again important to know that the uncertainty of what we’re seeing in deposit volumes and the impact of payment rates, as Rich said on loan growth, those are all factors that are going to create some variability and uncertainty in them in the near-term.

[Richard Fairbank, Chairman and Chief Executive Officer]

And Sanjay, with respect to your credit question and the burrowing through the mountain metaphor, let me just kind of pull up and give thoughts about what’s going on with credit. The U.S. consumer continues to demonstrate striking resilience. And consumers went into this downturn with like twice the savings rate that they had before the great recession, lower payment obligations and none of the structural issues they faced a decade ago with the housing sector. And because everything sort of went into vertical, a drop at once as the pandemic began, they certainly reacted strongly and rationally, and launched this trilogy of behaviors of spending less, saving more and paying down debt. And then of course, the year end of the pandemic, direct government support to consumers, including enhanced unemployment benefits remains in place.

And in fact, last month, in March, was the single largest month of direct government payments to consumers in dollar terms since the pandemic began. And the consumer savings rate was 17% in the first two months of 2021 more than doubled what we saw before the pandemic and something like five times what it was in the years before the great recession. And then we also have the forbearance factor. Although forbearance is winding down in card and auto, it is still relatively widespread for student loans and mortgages.

And as we’ve said before, the benefits of some of these effects like higher savings are probably cumulative to some extent, improving consumer balance sheets in ways that could lead to some sustained credit benefits. And now to the metaphor that I know I use all the time, every month that the consumer remains healthy, we’re burrowing a longer tunnel underneath the mountain of still high unemployment. And we’re reducing the cumulative losses through this downturn rather than just delaying the impacts.

Now we should all keep in mind a few things here. There remains a great deal of uncertainty. As you know, COVID cases remain elevated, new variants continue to emerge. And while the U.S. has been moving in a pretty good direction, of course, a lot of the world is moving in the other direction with respect to COVID. The economy while improving still has a lot of strain elements in it. And so that we still look at this just extraordinary kind of paradox of the separation of some of what happened to the economy and what happened to consumer credit. But we should all keep in mind, the uncertainty that still remains out there.

And then there’s one other point that I just like to put on the table here. In the spirit of pattern recognition, I do want to flag that this period of unusually strong credit could lay the groundwork for credit worsening down the road as an industry point. And let me elaborate on that just for a moment here. Reliance on consumer credit characteristics that may be more temporary driven by things like stimulus and forbearance can be a real challenge for credit modeling. And the benign rear view mirror could encourage lenders to reach for growth and to loosen underwriting standards, which as you know, can invite adverse selection. And then overlay on top of that, the excess liquidity and capital that’s out there, and that could push lenders to stretch for less resilient business.

So what we have here is a pretty benign period where we are right now. We’re also watching the physics of how markets, not only economic markets, but how credit markets work. And so what we’re doing at Capital One is leaning into the opportunities that we have. But by having a view of how the physics of some of these things work, we’re very much watching out for that in all the choices that we make. And it’s again, another reason why we’re focusing as always on making sure that we book resilient business.

So pulling way up, we’re not ready to predict that the tunnel comes out just all the way across the mountain. And we are talking about some topography that can exist out there longer run as the consequences of some of the physics of how the current situation lasts. But those are some thoughts on the credit environment, Sanjay.

[Jeff Norris, Senior Vice President of Finance]

Next question, please.

[Operator]

We’ll take our next question from Don Fandetti with Wells Fargo. Please go ahead.

[Don Fandetti, Wells Fargo]

Rich, can you talk a little bit about what you’re seeing on used car values in April? We’ve heard from some competitors that cars are barely on the lot for a day. And then what is your strategy on loan growth? Because competition obviously is picking up across the board, yet the returns are still very attractive. How are you thinking about that business?

[Richard Fairbank, Chairman and Chief Executive Officer]

So, Don, the used car prices are pretty electrifying here. Auction prices ended the quarter at all-time high, driven by strong demand and persistent constraints on new vehicles supply. And over time we still expect auction prices to normalize as these vehicles supply constraints work themselves out. But the time horizon for normalization has expanded given the strong recovery of demand and the continuing stress on global supply chains. So for example, microprocessors shortages have held back new vehicle production for some time.

The first quarter saw disruptions due to winter weather events, and that impacted petrochemical supplies used for parts. And then most recently rubber shortages have manifested themselves. So the supply is shortage, there are signs of it everywhere. And for example, we see rental car companies are normally a source of used vehicle supply, but they have very lean fleets at the moment with little access to sell. So we still expect auction prices to normalize over time. And a very important thing is in our underwriting, we make conservative assumptions with faster normalization now.

With that very unusual context there, and again, my view is that we cannot underwrite under an assumption that we’re going to get the benefit of those things. It’s certainly something we’re enjoying on our portfolio. But as we always do, and particularly at this point, we need to look past that in our underwriting and that’s certainly what we’re doing.

With respect to growth, industry retail auto sales were strong in the first quarter and especially in March. And in addition to tax refund seasonality, I’m sure payments, stimulus payments likely really held strong sales both in the new and the used vehicle segments. So at Capital One over the course of the pandemic, we actually have – we tightened up in certain segments, especially, early on, but we are still probably net tighter than we were at the outset. We’re watching things closely, but we have benefited by the tide rising for everyone in the industry, certainly it’s been a very exceptional time. But also on top of that, our investments in industry-leading technology products have allowed us to maintain very strong relationships with dealers during these uncertain times and generate the ability to have less in-person face-to-face interaction during the pandemic has also really helped lift the digital products and the digital capabilities that we have both for customers and for dealers. So we have found on top of the rising tide, maybe a little bit of extra boost at Capital One, but I've also said that even more so than the card business, the auto business is hypersensitive to sort of the level of competition.

And that's because a dealer sits there and holds an auction in ways that doesn't happen in a direct-to-consumer business like card. So it's not lost on us that – the tide rising everywhere in auto has caused quite a buoyancy in the auto business, so what we're going to do is continue to lean into the opportunities at that moment. But again to use my physics term, again, really keep a watchful eye on the physics of how the markets work and be looking for some of those things that can come on the side of excessive competition, as well as over time a breaking of the extraordinary things going on, a normalization of the used car prices.

[Jeff Norris, Senior Vice President of Finance]

Next question, please.

[Operator]

We'll take our next question from Rick Shane, JPMorgan. Please go ahead.

[Rick Shane, JPMorgan]

Hey guys, thanks for taking my questions this afternoon. When we look at the non-interest income, particularly in the domestic card business, it seems to be decoupling and outperforming the increase in spend. I'm curious how much of that is being driven by some sort of release of suppressed fees or how we should be thinking about catalysts for that?

[Andrew Young, Chief Financial Officer]

Hey, Rick, it's Andrew. This suppression is actually flowing through net interest income. So that's not driving it. I think the biggest driver, if you're looking at it on a margin basis is we're seeing spend volume and interchange spend growing at a faster rate than loans. So that's providing a little bit of a tailwind to non-interest income as it relates to overall revenue margin in card.

[Rick Shane, JPMorgan]

Okay, great. That – I think that helps, but if we look at the year-over-year increase in spend and we look at the year-over-year increase in non-interest income, there's still a pretty significant gap. One of the things that's always a little bit hard to figure out with Capital One is where some of the rewards run through, is it a function potentially of lower rewards rates given what's going on in the market or is there something else as well?

[Andrew Young, Chief Financial Officer]

Yeah, I don't think there's a big story there with respect to rewards or interchange Rick.

[Rick Shane, JPMorgan]

Okay. I will follow up offline, thank you guys.

[Andrew Young, Chief Financial Officer]

Thank you.

[Jeff Norris, Senior Vice President of Finance]

Next question, please.

[Operator]

We will take our next question from Moshe Orenbuch with Credit Suisse. Please go ahead.

[Moshe Orenbuch, Credit Suisse]

Great, thanks. Rich I was hoping to go back to the competitive dynamic, maybe a little less from a credit standpoint, but you guys have taken some actions recently with respect to your T&E products. Just talk a little bit about the rewards environment at your high end consumers, and then maybe the things that you did discuss with respect to kind of concerns about the competitive environment and what it kind of, how it informs your credit line increase side of the business?

[Richard Fairbank, Chairman and Chief Executive Officer]

Okay. Moshe, great questions there. Let's kind of pull up and talk about card competition. Competition can show up in a variety of ways, including the marketing intensity, the product offers, including there the upfront bonuses, enhanced rewards, pricing and other things. Competitive intensity is back to a tie levels, particularly as you point to Moshe in the reward space, at the higher end, the heavy spender end.

Let's talk about marketing, marketing and media spend obviously dropped dramatically in the second quarter and since then activity has steadily increased. We get our data on a bit of a lag basis, but I feel it's very likely that marketing levels are now at or above pre-pandemic levels. The rewards offerings remain intense. And let's talk about some of the elements of that.

Upfront bonuses have actually been relatively stable with some modest increases, mainly in the travel space and likely in anticipation of returning demand. As far as for rewards earned on spend, we've seen additional categories like groceries and restaurants qualify for enhanced rewards over the past year. And while the shifts have slowed down, reward levels overall remain high. And we've even seen a couple of a few competitors talk about still planning to be tinkering with their rewards here. So I think it's a very natural thing that's happened with spending having been way down. And also some of the things Moshe that are naturally rewarded are not the activities people tend to be doing that much of right now. There's been somewhat of a mixed change and I think a forward lean by the industry on this.

So I think it's – the thing that I've said so often about the card business, these days, I think it's very competitive industry, but there's a rationality to it that I'm pretty struck by and one that I would not use, some of those terms to describe some of the other markets that we're in. So what are we doing, we are continuing to look at our opportunities lean into where we have opportunities. I think we feel good with the general structure of the rewards products we have, but we do know that competition is high and it's probably going to be increasing.

We ourselves are going to lean into to marketing and – but, I don't necessarily see some sort of dramatic changes in the structure of offers out there to change to us the attractiveness of this. Part of the thing is, most of us operate on a relatively thin net margin, because while interchange rates are high, we are passing most of the interchange rates on to consumers in the form of really attractive deals. So pulling way up, we continue to like our opportunities. We have a lot of years of experience with the high level of intensity and I think we should probably prepare for that.

[Moshe Orenbuch, Credit Suisse]

Then on the other side of the [indiscernible] increases, yeah.

[Richard Fairbank, Chairman and Chief Executive Officer]

Sorry, Moshe. Yeah. So as you know gosh, think about the number of years we talked about even before that the pandemic probably for 18 months, maybe Moshe we were talking about kind of pulling back onlines when the – we were – the recovery was so long in the tooth and we saw some of the things going on in the marketplace. So we took a pretty conservative policy with lines. And then during the pandemic, we took a particularly conservative strategy with lines. And so that contains some potential energy, as we've always talked about. It turns into kinetic energy when of course, we grant the line increases and there's more opportunity for people to spend.

And the opening of lines has been something we've been doing over the last number of months. It's been kind of invisible with – to the outside world in terms of growth, because it's getting washed over by the extraordinary payment rates, but we continue to see an opportunity to open up some of the lines gradually and Moshe, I think that represents an extra part of growth opportunity. We're not doing anything really dramatic, but it's just part of the gradual leaning into the opportunity with what we're seeing with the performance of our customers.

[Jeff Norris, Senior Vice President of Finance]

Next question, please.

[Operator]

We'll take our next question from Bill Carcache with Wolfe Research. Please go ahead.

[Bill Carcache, Wolfe Research]

Thank you. Good evening. I'll ask my questions upfront on efficiency. Rich, can you give us an update on how you're thinking about the strategic significance of your physical branch footprint? Is there any room for the branch optimization, either to fund further investments in the digitization of the business or simply extract greater efficiencies? And then also, if you could give us an update on the cloud migration, that would be great.

[Andrew Young, Chief Financial Officer]

Okay. Bill, so let me start with the branches, as you know Capital One has over the years sort of leaned into the closing branches in conjunction with our building of our more national banking business, and also the – all the digital investments we were making, because we spent so much energy on creating an experience that doesn't need to have a branch on every corner.

And we've been pleased with our strategy so far. But there's – we don't, I think there's more of a continuation of where we are, I think we're in – continuing to lean into the same strategy we've had for quite a period of time there. So I wouldn't look at our network and say, wow, there's a huge kind of potential to unleash there. We've just been gradually making our choices and continuing to develop our digital opportunities, watching customer behavior and then just continue down the same path.

With respect to our cloud strategy, as you know we completely exited data centers last year. So we are 100% in the cloud. And we are enjoying the benefits of being in the public cloud, the hassle free access to infrastructure. The ability to ride the incredible wave of innovation that's happening on the cloud, both from the cloud providers as well as from the rest of the world software companies that are building on the cloud. So this is something we've been, you know many years in the making and we're happy to be all-in on the cloud.

But it doesn't mean our journey is done on the cloud we find as we get there, there's – the opportunity to build many more capabilities, the opportunity to really enhance resilience, operating resilience, fail over capabilities, efficiency, the ability to over time move. Basically one of the real benefits of the cloud is the ability to abstract the developers from being burdened with the details of the infrastructure that they're operating on. And the cloud itself is in an abstractor of that the infrastructure worked for a developer, but within – if you just look at what's happening to cloud, the continuing migration sort of abstracting up the tech stack and where cloud has gone with containers, and now where it's going with serverless, just continues to liberate developers so that they can focus on doing what they came to do, which is to create great things and ship products.

Now, all of that doesn't happen automatically, companies have to continue to stay on the forefront. So Capital One is continuing to invest in the serverless side of the business for example, as we continue to move the level of abstraction up the tech stack and create opportunity for the software to be developed faster, more effectively and safer.

[Jeff Norris, Senior Vice President of Finance]

Next question, please.

[Operator]

We'll take our next question from Betsy Graseck with Morgan Stanley. Please go ahead.

[Betsy Graseck, Morgan Stanley]

Hi, good afternoon.

[Richard Fairbank, Chairman and Chief Executive Officer]

Hey, Betsy.

[Betsy Graseck, Morgan Stanley]

I had a couple of questions one on – just Rich, in thinking about the marketing investment spend and also the opportunity to pick up some new customers. Just wanted to understand the kind of timeframe that you think you'll be getting that return on investment relative to maybe pre-COVID? And I'm wondering if it might be a longer timeframe to get that return on investment, given the stimulus that's in people's pockets right now, or could it be the same because the target market you're going after is not a stimulus receiver, just trying to think out loud about how that's going to happen?

[Richard Fairbank, Chairman and Chief Executive Officer]

Well, the first thing to think about marketing always is good marketing, while it can influence balance levels, marketing is really about growth of a franchise, growth of accounts and building brand and those kinds of things. So I think a way to think about the pandemic is that it took a company like Capital One and our card business, and just set us back like 15% behind the starting line. And that's a pretty jarring thing to happen in our flagship business in a very successful and profitable business, but this whole payment phenomenon essentially did that.

Now in that context, as we start farther behind the starting line, as we look at the opportunity to grow accounts, the opportunity to build the franchise, the opportunity to get out there with some of our really great digital products and things like this, the ability to – and of course on the banking side, the ability to grow the national bank that is still very – that opportunity is still very much there. And isn't really – it isn't really that changed by the pandemic.

Now on the outstanding side, first of all have the pay-down story. So that definitely is pushing us and others farther back, all other things being equal. There's the – sort of the issue for how much credit demand there that we'll see from folks on that. We certainly have the spend weakness on the travel side of the business as well. So I think that we feel the effectiveness of our marketing in building the franchise is very much like it was before. The outstandings metrics of the company started farther behind and they have headwinds to them.

But – since we've always talked about, if payment rates stay high, we're going to have to live with all the great credit performance that we have, and the earnings and the ability to distribute capital. So the benefits come in a different way, but we are very focused on continuing to build the franchise. And I think Capital One is in a similar position to do that as we were pre-pandemic in many ways, maybe even a little bit better position, because we're farther along on our tech transformation.

Do you have follow-up Betsy?

[Operator]

We'll take our final question this evening from John Hecht with Jefferies. Please go ahead.

[John Hecht, Jefferies]

Afternoon, thanks for fitting me in here. You've talked about competition quite a bit on this call, but maybe an extension at it, I guess, how does the calculus of competition change with all these Neo banks and the other kind of digital product platforms you're competing for first time customers? Does it change anything with respect to the opportunity set?

[Richard Fairbank, Chairman and Chief Executive Officer]

John, let's talk about that from a couple of perspectives. First of all, as I often say, Capital One was one of the original fintechs before anybody used that word. So I think fintechs are particularly near and dear to my heart and I watch with tremendous interest. The growth of fintechs, there are some of the really clever innovation they're coming up with, we should all know of course, that all of these fintechs are born in the cloud, they're starting with modern technology, and that already gives them a bunch of advantages relative to a lot of banks.

I think, Capital One being in the cloud, I think has been – it's in a sort of much better position competitively relative to that, but we – what we should all favor about the fintechs is the modern tech platform they have and that's – it's always – and I think those advantages are larger nowadays than they were in the past, because the difference between being built on a modern tech stack versus not is just a greater advantage and something that's motivated us to do a very big tech transformation as you know.

So the – and the fintechs journey is not just sort of use some clever technology, they're also very much positioning themselves to take advantage of some of the opportunities to gather more data, different data than typically gathered and to leverage it in real time, so there are some bunch of impressive things there.

When we look at the fintechs, we are both generally impressed. We think that they do represent threats to the business, but to us I think they are very much also just a good examples of the kind of innovation that's possible and the kind of innovation that companies like Capital One who are in the cloud with on a modern tech stack, the kind of things that we can do as well. So we look at it from that perspective and we fire it, worrying and inspiring at the same time.

Then you have the lending side of business. I want to make a special comment about lending. Half an hour ago, I put a caution note out there that we've got to – that I worry about we are in the marketplace lending goes from here with people building models that are looking at a recession that was very, very unusual with sort of spectacular credit. And I worry particularly about fintechs who are not that experienced in some of the credit choices they can do and the impact on our marketplace. So I think the fintechs and you can see in the commentary by banks, I think banks are becoming a lot more sort of realizing the scale, the growth, the collective size of the growth rate and the innovation that the fintechs are bringing.

And they're going to be a force to reckon with, and to us there are continued impetus that we've got to lean forward, we've got to continue on our tech transformation, and we need to lead the way ourselves with innovation.

[John Hecht, Jefferies]

Appreciate that. Thank you.

[Richard Fairbank, Chairman and Chief Executive Officer]

Thank you.

[Jeff Norris, Senior Vice President of Finance]

Well, thanks everyone for joining us on the conference this evening, and thanks for your interest in Capital One. And as a reminder, the Investor Relations team will be here this evening to answer any further questions you might have. Have a great night everybody.

[Operator]

Ladies and gentlemen, this concludes today's conference. We appreciate your participation. You may now disconnect.