Capital One Financial Corp

NYSE:COF

Earnings Call Transcript 2023-Q2

[Operator]

Good day, and thank you for standing by. Welcome to Capital One Q2 2023 Earnings Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded.

I would now like to hand the conference over to your speaker today, Jeff Norris, Senior Vice President of Finance. Please go ahead.

[Jeff Norris, SVP, Finance]

Thanks very much, Amy, and welcome everybody to Capital One's second quarter 2023 earnings conference call. As usual, we are webcasting live over the Internet. To access the call on the Internet, please log on to Capital One's website at capitalone.com and follow the links from there. In addition to the press release and the financials, we have included a presentation summarizing our second quarter 2023 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 the presentation. To access a copy of the presentation and the press release, please go to Capital One's website, click on Investors, and click on quarterly earnings release.

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

Numerous factors could cause our actual results to differ materially from those described in forward-looking statements. For more information on these factors, please see the section 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, CFO]

Thanks, Jeff, and good afternoon, everyone. I'll start on Slide 3 of tonight's presentation. In the second quarter, Capital One earned $1.4 billion, or $3.52 per diluted common share. Pre-provision earnings of $4.2 billion were up 7% compared to the first quarter and 16% compared to the year-ago quarter.

Both period-end and average loans held for investment increased 1% relative to the prior quarter, driven by growth in our Domestic Card business. Period-end deposits declined 2% in the quarter, largely driven by tax-related outflows. Our percentage of FDIC insured deposits grew 1% to end the quarter at 79% of total deposits. We have provided additional details on deposit trends on Slide 18 in the appendix.

Revenue in the linked quarter increased 1% driven by non-interest income. Non-interest expense decreased 3% in the quarter, driven by declines in both operating and marketing expenses. Provision expense was $2.5 billion, with $2.2 billion of net charge-offs and an allowance build of $318 million.

Turning to Slide 4, I will cover the changes in our allowance in greater detail. The $318 million increase in allowance brings our total company allowance balance up to $14.6 billion as of June 30. The total company coverage ratio is now 4.7%, up 6 basis points from the prior quarter. I'll cover the drivers of the changes in allowance and coverage ratio by segment on Slide 5.

In our Domestic Card business, the allowance balance increased by $544 million, increasing our coverage ratio by 12 basis points to 7.78%. Three factors impacted the allowance in the quarter. The predominant factor was growth, as ending Domestic Card loans grew about $5 billion in the quarter.

The second factor was the impact of removing the relatively lower loss content from the second quarter of 2023 and replacing it with higher forecasted loss content for the second quarter of 2024 as part of our 12-month reasonable and supportable period. These two factors were partially offset by an improvement in our economic outlook, which still assumes worsening from today's level, but less so than our outlook a quarter ago.

In our Consumer Banking segment, the allowance balance declined by $20 million, mostly driven by the decline in loans. The coverage ratio was essentially flat at 2.83%. And finally, in our Commercial Banking business, the allowance decreased by $218 million. In the quarter, we moved approximately $900 million of loans from our commercial office portfolio to held for sale as we pursue the potential sale of a portion of the portfolio to reduce future risk.

With that move, we recognize charge-offs that were already largely reflected in our allowance, which was the primary factor driving this quarter's decrease. The decrease in allowance from moving these loans to HFS was partially offset by a build for our remaining commercial office portfolio. We have provided additional details on our commercial office portfolio in the appendix of tonight's presentation. The coverage ratio in the Commercial business decreased by 20 basis points and now stands at 1.62%.

Turning to Page 6, I'll now discuss liquidity. You can see, our preliminary average liquidity coverage ratio during the second quarter was 150%, up from 148% last quarter and 144% a year ago. Total liquidity reserves in the quarter decreased by about $9 billion to $118 billion, driven by modest declines in both cash and the investment portfolio.

Our cash position ended the quarter at $42 billion, down about $5 billion from the prior quarter. We are also disclosing our Net Stable Funding Ratio for the first time this quarter. The preliminary average quarterly NSFR for both the first and second quarters was 134%, well above the 100% regulatory minimum.

Turning to Page 7, I'll cover our net interest margin. Our second quarter net interest margin was 6.48%, 12 basis points lower than last quarter and 6 basis points lower than a year-ago quarter. The quarter-over-quarter decline in NIM was driven by deposit and wholesale funding costs increasing more than asset yields. That impact was partially offset by a continued mix shift towards card loans and one additional day in the quarter.

Turning to Slide 8, I will end by discussing our capital position. Our common equity Tier 1 capital ratio ended the quarter at 12.7%, approximately 20 basis points higher than the prior quarter. Net income in the quarter was partially offset by changes in risk-weighted assets, common and preferred dividends, and the $150 million of share repurchases we completed in the quarter.

At the end of the second quarter, the unrealized losses in AOCI -- AOCI from our AFS investment portfolio were $7.6 billion. If we were to include the full impact of these unrealized losses in our regulatory capital, our CET1 ratio would have ended the quarter at 10.4%. During the quarter, the Federal Reserve released the results of their stress test.

Our preliminary Stress Capital Buffer requirement which will be effective on October 1st of this year is 4.8%, resulting in a total Fed capital requirement of 9.3%. We continue to estimate that our longer-term CET1 capital need is around 11%.

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

[Richard Fairbank, Chairman & CEO]

Thank you, Andrew, and good evening, everyone. The Domestic Card business posted another quarter of strong year-over-year top-line growth. Purchase volume for the second quarter was up 7% from the second quarter of last year. Ending loan balances increased $21 billion or about 18% year-over-year. And second quarter revenue was also up 18% year-over-year, driven by the growth in purchase volume and loans.

Revenue margin declined 40 basis points from the prior year quarter and remains strong at 17.76%. The decline was driven by two factors. First, loans grew faster than purchase volume and net interchange revenue in the quarter. This dynamic is a tailwind to revenue dollars, but a headwind to revenue margin. And second, charge-offs increased, so we reversed more finance charge and fee revenue. These factors were partially offset by an increase in the revolve rate.

The Domestic Card charge-off rate for the quarter was up 212 basis points year-over-year to 4.38%. The 30-plus delinquency rate at quarter end increased 139 basis points from the prior year to 3 -- to 3.74%, and is now above its June 2019 level. The charge-off rate hasn't quite caught up yet, but based on what we see in our delinquencies, we expect the monthly charge-off rate will reach 2019 levels in the third quarter.

Non-interest expense was up 8% from the second quarter of 2022, driven by higher operating expense, partially offset by a modest year-over-year decline in marketing. Total company marketing expense was down about 12% year-over-year in the second quarter to $886 million. In most years, marketing is lower in the first half of the year and higher in the second half. In 2022, that pattern was less pronounced. In 2023, our marketing is following a more typical historical pattern.

Our choices in Domestic Card are the biggest driver of total company marketing and we continue to see attractive growth opportunities in our Domestic Card business. Our opportunities are enhanced by our technology transformation. We continue to lean into marketing to drive resilient growth and enhance our Domestic Card franchise and as always, we're keeping a close eye on competitor actions and potential marketplace risks.

We're seeing the success of our marketing in strong growth in Domestic Card new accounts, purchase volume and loans across our card business. And strong momentum in our decade long focus on building a franchise with heavy spenders at the top of the marketplace continues.

Slide 12 shows second quarter results for our Consumer Banking business. In the second quarter, auto originations declined 31% year-over-year. Driven by the decline in auto originations, Consumer Banking ending loans decreased about $4.3 billion or 5% year-over-year. On a linked quarter basis, ending loans were down 1%. We posted another quarter of strong year-over-year retail deposit growth.

Second quarter ending deposits in the Consumer Bank were up about $30 billion or 12% year-over-year. Compared to the sequential quarter, ending deposits were down about 2%, largely as a result of typical seasonal tax outflows. Average deposits were up 12% year-over-year and up 2% from the sequential quarter. Powered by our modern technology and leading digital capabilities, our digital first national direct banking strategy continues to deliver strong results.

Consumer Banking revenue was up 8% year-over-year, driven by deposit growth. Non-interest expense was down about 4% compared to the second quarter of 2022, driven by the timing of marketing to support our National Digital Bank. The auto charge-off rate for the quarter was 1.40%, up 79 basis points year-over-year. The 30-plus delinquency rate was 5.38%, up 91 basis points year-over-year. Compared to the linked quarter, the charge-off rate was down 13 basis points, while the 30-plus delinquency rate was up 38 basis points.

Slide 13 shows second quarter results for our Commercial Banking business. Compared to the linked quarter, ending loan balances were down 2%. Average loans were down 1%. The decline is largely the result of choices we made earlier in the year to tighten credit, as well as the movement of loans to held for sale, that Andrew discussed.

Ending deposits were down 4% from the linked quarter. Average deposits declined 5%. We saw normal outflows throughout the second quarter as clients used their cash for payroll, tax payments and other business-as-usual disbursements. And consistent with the general trend we've seen for several quarters, we also continued to manage down selected less attractive commercial deposit balances.

Second quarter revenue was up 3% from the linked quarter, while non-interest expense was down about 9% from the linked quarter. Second quarter commercial credit trends were largely driven by the commercial office portfolio, inclusive of the movement of loans to held for sale. The Commercial Banking annualized charge-off rate increased to 1.62% in the second quarter. The criticized performing loan rate was 6.73%, down 58 basis points compared to the linked quarter. And the criticized non-performing loan rate increased 10 basis points to 0.89%.

In closing, we continued to deliver top-line growth in Domestic Card revenue, purchase volume and loans in the second quarter. We continue to lean into marketing to drive resilient Domestic Card growth that can deliver sustained revenue annuities and build our franchise, and to drive growth in our National Digital Bank. And we continue to expect that the full year 2023 annual operating efficiency ratio, net of adjustments will be roughly flat to modestly down compared to 2022.

Pulling way up, Capital One is at the vanguard of a very small number of players who are investing to build and leverage a modern technology infrastructure from the bottom of the tech stack up, to put themselves in an advantaged position to win as banking goes digital. Our modern technology capabilities are generating an expanding set of opportunities across our business.

We are driving improvements in underwriting, modeling and marketing, as we increasingly leverage machine learning at scale and our tech engine drives growth, efficiency improvement and enduring value-creation over the long term. Our investments to transform our technology and to drive resilient growth, put us in a strong position to deliver compelling long-term shareholder value and thrive in a broad range of possible economic scenarios.

And now, we'll be happy to answer your questions. Jeff?

[Jeff Norris, SVP, Finance]

Thank you, Rich. We will now start the Q&A session. And 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 follow-up questions after the Q&A session, the Investor Relations team will be available after the call. Amy, please start the Q&A.

[Operator]

[Operator Instructions] Our first question comes from Ryan Nash with Goldman Sachs. Your line is open.

[Ryan Nash, Goldman Sachs]

Hey. Good evening, Rich. Good evening, Andrew. Maybe to start on the margin, Andrew, where we saw some pressure. Can you maybe just talk about how to think about the margin from here, you know you talked about card loans growing faster which is a tailwind, but you know those obviously rising deposit costs has been a headwind. So, when you put it all together, what do you see the trajectory of the margin shaking out? And embedded within that, what are your most updated expectations for deposit betas at this point? And I have a follow-up question.

[Andrew Young, CFO]

Sure. So, why don't I start with the deposit beta please Ryan, since that will feed into the NIM. As we talked about last quarter and you see playing out in the marketplace at this point, there is just a number of factors that are impacting beta between product mix and the competitive dynamics on pricing, just how quickly the Fed has moved over the last five quarters, all of this happening under the backdrop of QT.

And so, we put that on top of our view for deposits, all of the needs that we have, our desire to grow customer relationships and the like. And so those forces coupled with the fact that at this point in the cycle, deposit pricing just tends to lag yields and so you've seen our betas continue to rise over the last few quarters. I talked about the last cycle, us being, the low 40%s, and a quarter ago, I said you should expect us to kind of move up from where we were. We are now in the 52% range. I wouldn't be surprised if there continues to be upward pressure on beta from here given all of the factors that I just described.

So why don't I then start on your question about NIM with headwinds. That, of course, would be one, that the beta lag as well as what we're seeing in the wholesale funding market spreads are a little bit wider. So just overall funding costs, I think, would probably be a headwind. And then we're also seeing credit continue to normalize. Rich touched in his talking points around card margin. So revenue suppression would be another headwind all else equal. But we do see at least a few tailwinds, one being the level of revolve rate in card in the second quarter, it tends to be seasonally lower.

And just on a longer-term basis, the current run rate has been lower over the last couple of years. So both of those factors could be driving card margin up. I also think that when you look at our cash position, cash is likely to remain elevated relative to pre-pandemic levels. This quarter, we saw ending cash come down. Average cash was largely flat since we had built up, cash over the course of the first quarter. But I think you should expect that cash will remain elevated relative to pre-pandemic but over time, it probably will come down at least modestly from here.

And then the last thing is in the back half of the year, we'll have an extra day in the quarter. So as we move into Q3, that will be a definitive tailwind. So those are what I would enumerate as the primary forces at play. And so one of the big ones that's going to drive the trajectory is really what ends up happening to beta.

[Ryan Nash, Goldman Sachs]

Got it. And then Rich, maybe as my follow-up, maybe just an update on what you're seeing with the consumer. When I look in the credit in the card book, delinquencies in the past four months have been rising, let's call it, 130 basis points, 140 basis points per year. And given all the growth that has come on to the books in the past 24 months, can you give us a sense for how to think about how far past 2024 level or 2019 levels, we could be going on losses and maybe, Andrew, tie in, what this all can mean for the allowance over time? Thanks.

[Richard Fairbank, Chairman & CEO]

Okay. Thanks, Ryan. So just to put some numbers behind your comments. So the domestic card delinquencies in the second quarter were about 10% higher than the same quarter of 2019. Our charge-offs are still a bit below their 2019 levels. But based on what we see in our delinquencies, we think they'll get back there in the next few months. So when you interpret our credit metrics, there are a couple of things to keep in mind. There is one effect that is increasing our loss rate that is probably more pronounced for Capital One, at least for a time, which is related to our recovery.

Past charge-offs are the raw material for future recoveries and we just lived through three years of very low charge-offs. So our recoveries will be unusually low in the short to medium term. This is a larger headwind for us than for most others because we tend to have meaningfully higher recovery rates than the industry average and because we tend to work our own recoveries, so they tend to come in over time, not all at once, which happens in a debt sale. Also, we have to remember that the credit performance we saw over the past three years was unprecedented.

So we believe there's some catching up that happens on the other side of that, especially for consumers who might otherwise have charged off over the past three years. So we call this sort of the deferred charge-off effect. It's something that really can't be measured. We won't even be able to measure it in hindsight, how big this effect is, but it's intuitively sort of the reverse of the effect we saw in the global financial crisis, which in many ways, just pulled forward charge-offs for lots of folks that were in a vulnerable position. And then what we saw in the aftermath of that for those that weathered that, we just saw strikingly low charge-offs.

So I think really what -- kind of what's going on with this whole sort of normalization in the context of such extraordinarily low unemployment rates, I think an important part here is sort of this deferred charge-off effect. And so that's the dynamic we see going on in our business. We continue to feel very good about the credit performance. We're not giving guidance on predicting the level, but we continue to lean into our growth opportunities because the metrics we see are very solid.

[Andrew Young, CFO]

And then with respect to the allowance, Ryan, I know I've talked a lot about the mechanics in recent calls, so I'll spare all of you the tutorial. But the first thing with respect to the allowance will obviously be allowing for future growth is an obvious contributor to where the allowance goes from here. But then it's really all about the outlook for losses and in particular, what we're projecting for loss rates a year out. So Rich just described a lot of the dynamics that are at play with our outlook for quarter losses. So depending on how all those factors play out, that's really going to have the biggest impact, especially as you look out well into '24.

[Jeff Norris, SVP, Finance]

Next question, please.

[Operator]

Our next question comes from Richard Shane with JPMorgan. Your line is open.

[Richard Shane, J.P. Morgan]

Hey, everybody. Thanks for taking my question. Hey, Rich. I would describe that I think one of the hallmarks of Capital One over the decades is almost a strategic optimism. When you look at opportunities right now and where your peers are deploying capital, where is your greatest strategic optimism?

[Richard Fairbank, Chairman & CEO]

My greatest strategic optimism, Richard is in the card business. We've -- first of all, we've always been a big fan of the card business starting from the beginning of the company, it's not an accident that we chose the card business because we love the industry structure. We love the opportunity to leverage the kind of strategies that we wanted to put in place, the information-based, technology-based strategies. And while that is something one can apply across all of financial services, it certainly has tremendous leverage in a business like the card business. So we've always loved the business.

As you know, kind of, you've followed us for a long time, Richard, we -- just because we love a business, doesn't mean we constantly have our foot on the accelerator. So we very much look at the industry structure and then look at the marketplace and make our choices. We, often, we end up zigging while others zag, as you have seen in the past. We feel very good about the opportunities in the card business for several reasons. I think, well, first of all, just the health of the consumer, just consumer credit is in a very good place. The consumer is in an exceptionally strong place.

And I think that gives a foundation of strength even in the context of an economy that's got some concerning aspects to it. Then we look at the competitive environment, I think the competition is intense in card, but it is rational. We see people making credit choices. And just when we look at the competition and this isn't always true in banking, but I think we see a rational industry making rational choices. And so I think the credit that is being delivered to the consumer is balance to the appetite and so we feel good about the competitive environment. We look at margins and where they are. They are strong.

The credit environment, as we talked about in my answer to Ryan Nash, credit losses are increasing. I think there's a catch-up sort of delayed charge-off effect. But when we look at the metrics, the metrics on recent originations, the metrics on our back book with respect to performance of existing accounts, credit line increases, we just see strength across the board. So we feel very good about that and we look at our marketing programs, and they continue to generate a lot of new accounts. And so pulling way up on that, we like the metrics, we like the results of our programs and we like the marketplace in credit.

If I cross-calibrate to other parts of the marketplace. The auto business, even while we've been leaning into card, we have been -- had more of our foot on the brake over the last 18 months in the auto business for a number of factors, but probably the biggest one being what was happening on the pricing side and the difficulty in passing through increases in cost of funds. That aspect has normalized mostly in the market. The auto business has still some unique aspects to it that we got to keep an eye on used car prices and they've been elevated. They're likely to fall over time. And so -- but all in all, we see opportunity maybe expanding a little bit in the auto space, but we'll have to keep an eye on that. But in the very recent sort of months, we've seen the opportunity to lean in a little bit more.

And then on the commercial side of the business, obviously, our biggest focus has been on the office portfolio and Capital One, again, tends to take a different path than a lot of companies do. But we -- I think for a lot of banks, they tend to when they look at the credit environment when they see credit that is worsening in a particular sector. They tend to pull back on originations, which makes a lot of sense. We often see one more notch on the continuum, which is to look at the assets that we have and look from time to time at, in fact, selling those. We have -- over the last few years, we have actually unloaded something like -- this is -- well, something like $6 billion of loans. That’s not an official -- Andrew is the one who gives the precise numbers.

What I’m saying is several billion dollars of sort of exiting that we have done. Now in this particular case, we look at the market and see a lot of sustained stress in that market and feel that when we have an opportunity to relieve some of the higher stress aspects of that business, we took that opportunity. So pulling way up, you see at Capital One, we -- for some of our business, we have our foot on the brake and for other parts of the company, our foot is on the gas. But where I would leave you the net impression I would lead you it is really on the card side. That we’re really leaning in the hardest.

[Richard Shane, J.P. Morgan]

Perfect. Thank you so much.

[Jeff Norris, SVP, Finance]

Next question, please.

[Operator]

Our next question comes from Mihir Bhatia with Bank of America. Your line is open.

[Mihir Bhatia, Bank of America]

Good afternoon and thank you for taking my questions. I wanted to start maybe with expenses. Did it come in a little bit better than I think what we were expecting, they were down quarter-over-quarter. You mentioned -- you talked a little bit about returning to normal in your prepared remarks. And I was just wondering if you could expand on that a little bit. Was there a decision like to slow down on growth investments, buyback? Like, I guess, what changed just in terms of the expenses or the cadence of expenses through the year?

[Andrew Young, CFO]

Typically Mihir, I'll take that one. If you're talking just Q1 to Q2, in the first quarter, we typically have seasonal effects to compensation when bonuses are paid, payroll tax issues, you see that in the ST&B, salary, tax, and benefit line there. So, that's really the largest single factor, not necessarily a fundamental shift in any trajectory.

[Mihir Bhatia, Bank of America]

Okay. And then maybe just going back to the NIM conversation. I mean, I think you talked about some of the puts and takes in the near term, but I was curious just about company-wide NIM or compared to historical, right, I mean, it wasn't atypical for Capital One's NIM to be closer to 7%, high-6%s, do you expect you'll get back there or has something fundamentally changed in the business, whether it's the growth in the high balance transactors or something else where you wouldn't get back there?

[Richard Fairbank, Chairman & CEO]

Well, I don't think there's anything fundamentally different in the business, Mihir. I think there is a lot of question around what happens to consumer behavior and we talked about revolve rate in card and other things. And then also on the funding side, partially dependent on what the Fed ends up doing over an extended period of time, where rates eventually settle out. I mean I think those are all factors that could ultimately impact where the final resting place is for NIM, but there is -- there is nothing that is really fundamentally different across our book from where it was years ago.

[Jeff Norris, SVP, Finance]

Next question, please.

[Operator]

Our next question comes from Betsy Graseck with Morgan Stanley. Your line is open.

[Betsy Graseck, Morgan Stanley]

Hey, good afternoon.

[Andrew Young, CFO]

Hey, Betsy.

[Richard Fairbank, Chairman & CEO]

Hi, Betsy.

[Betsy Graseck, Morgan Stanley]

So, I know, Rich, you mentioned marketing following the typical seasonality this year and so, expecting it to ramp up in the back half, which makes a lot of sense. And I'm just wondering when you think about where you want to spend those dollars, is it more on new account acquisition, spurring outstanding line utilizations, if travel is relatively you know easier one to pull at this stage and I guess what I'm just wondering is, is there an opportunity to even get more return for your marketing dollars now versus maybe what you've had over the past couple of quarters, given the need for people to borrow perhaps more than they had to a year ago? So, just those are some of the questions that I have. Thanks.

[Richard Fairbank, Chairman & CEO]

Thanks, Betsy. Let me talk about the marketing. Yes, thanks for commenting about the seasonality. I mean every year is different in terms of the quarterly patterns. But we pointed out, this year is, it seems like a more normal year with the back half, with the more common back half, higher back half than we've had in some of the anomalous times during the pandemic. The marketing was flat compared -- in this quarter was flat compared to the prior quarter and down 12% year-over-year, but I wouldn't draw really strong conclusions from that. Because as I already talked about, we're leaning into the marketing just from a timing point of view as some of our marketing, it was just didn't happen to fall as much in this quarter.

And let me talk about the opportunities that we see and why we're investing heavily in marketing, really, first of all, we just see attractive growth opportunities across our business. Particularly in the card business, we continued to expand our products and our marketing channels. We're seeing very good traction. These opportunities are significantly enhanced by our technology transformation that enabled us to leverage more data, access more channels, leverage machine learning models, and provide customized solutions that continues to just generate very good performance and we're leaning in to capitalize on that. So, it's sort of category one, is just the good opportunities that we see.

The second thing that's behind our marketing levels is something we've been talking about for a long time, which is our ongoing focus on heavy spenders. And it was really back in 2010 that we declared a strategic push for heavy spenders and we knew in looking at the business that that's not a thing that we can go lean in one year, pull back another year, this is a whole part of the marketplace, which is about commitment. It's about building exceptional experiences, great products, and the brand. So, starting really with the venture launch way back in 2010, we've been leaning in hard there. But of course, it hasn't just been about flagship cards, it's been about working backwards from what it takes to win with heavy spenders and investing across really the digital experience, the servicing experience, the lifestyle and product experiences as well.

And what's been nice about this is that we've -- and you've seen in our purchase volume growth, a lot of growth in purchase volume, but another strong manifestation of this is, the rate of growth year-after-year has been higher at the higher-end than the average. So, we continue to get increased traction going up and up in the pursuit of heavy spenders. Now, of course, heavy spenders have much higher upfront costs of marketing and promotions and brand building and hence it's a big factor in why the marketing levels at Capital One, if you compare back to many years ago, they are sort of structurally higher. But that's in pursuit of this really I think company transforming benefits that we're getting there.

A third factor driving our marketing levels, Betsy, is our continuing investment in building our National Retail Bank. As you know, we have only a modest presence in terms of physical distribution. And so to get there, we lean heavily on our modern technology and a compelling digital experience and along with that, a sustained investment in marketing. So, that's a bit about what's behind our marketing levels that you're seeing and the opportunities we see. And if we really look across those three sort of buckets, just the growth opportunities we see, the opportunities in building the heavy spender franchise and then the building of the National Bank being sort of the one bank that's building a full service bank without trying to do it via a branch on every corner, all of this, marketing is the engine behind this and we continue to lean into it and be very pleased with the performance.

[Betsy Graseck, Morgan Stanley]

And its growth rate expectation should be following similar patterns to the pre-COVID environment?

[Richard Fairbank, Chairman & CEO]

We're not going to -- well, let me comment for a second. Well, let me first say, we're not really giving a growth outlook. A thing I really want to say about marketing is, marketing drives the origination of accounts. The real growth of our card business comes really from balance growth and also from purchase volume growth, of course. But the -- those are not one-for-one things, but what we have been focused on since the founding of the company is building a company that has an organic growth engine, focused on originations and leveraging the technology and analytical capabilities that we've built and so our -- when you see our leaning in hard to marketing, think about that is the engine that's driving new accounts and over time, those accounts really are, to your point, even though the timing is not one-for-one, those accounts are really the foundation for the continued outstandings and revenue growth of the company.

[Jeff Norris, SVP, Finance]

Next question, please.

[Operator]

Our next question comes from Sanjay Sakhrani with KBW. Your line is open.

[Sanjay Sakhrani, KBW]

Thank you. Andrew, I hate to do this, but I want to go back to the allowance coverage trends going forward. If we zoom into that complex calculation of removing previous and adding future quarters of net charge-offs, in your current forecast, do you have losses sort of rising through the end of next year? And maybe you could just talk on -- touch on the new macro baseline from what the unemployment rate assumption is?

[Andrew Young, CFO]

Yeah. So, the baseline assumption in our outlook focusing -- I imagine you're looking mostly for unemployment rate. So, we have it increasing from the 3.6% it is today to 4.3% at the end of this year and then moving higher in the 4%s, but staying in the 4%s through 2024. That compares to our assumption last quarter of I believe it was 5.1%. But remember that our models tend to use the change in unemployment rate or the rate of job creation which we are forecasting to come down to nearly zero, rather than the level of unemployment. And so, it's not just about those factors too in our allowance, we're also considering downside scenarios that are much more severe than that baseline.

So, when you take that into account, to your first question around what are we assuming, I'm not going to give specific forecast. Rich listed out kind of the factors that we believe will create upward pressure on our loss rates in the near term at least. And so, we did assume that there is higher losses in the second quarter of next year than the quarter that we just left, sort of mechanically as I described this quarter's allowance, but where that goes from here is just so heavily assumption laden focused on the back half of the year. I'd really focus your attention much more to delinquencies as the leading indicator to charge-off, especially in the near term, because that's where the economics ultimately are felt, as opposed to the allowance that is going to move quarter-to-quarter based on assumptions, looking many quarters into the future.

[Sanjay Sakhrani, KBW]

Okay. Rich, I asked this question to one of your competitors earlier, but can you just pinpoint what's exactly attractive about the growth you are seeing in card today versus in the past? They are also growing at a pretty rapid rate and obviously, you guys have been very successful at growing this business over time, but the market remains competitive, you've talked about the credit normalization, there is this obviously a potential for economic challenges, I'm just trying to think through the risks.

[Richard Fairbank, Chairman & CEO]

So, Sanjay, there certainly are things to be worried about. The economy is unusual and it has aspects of a lot of strength and a lot of concern. The credit normalization, we all see it, so I'm going to -- I'm going to make the worry case just slightly here for a second. The credit normalization has -- credit is still at very attractive levels, but it still has an upward slope to it and nobody -- well, we certainly don't feel in a position to predict exactly where that settles out and so we'll have to keep that very much front and center and the market is very competitive, absolutely. So, you know at a time like this, we -- so, well, on the strong side, I start with the health of the consumer.

So, let's just think about this, because the U.S. consumer is a real source of relative strength in this uncertain economy. The labor market has proven strikingly resilient over the past year and there are signs of cooling. But so far, they are playing out gradually without abrupt or severe job losses that we see in severe downturns. Another striking thing, the debt servicing burdens remain low by historical standards despite rising interest rates. Home prices have started to tick back up after falling for a while. And we've talked a lot about consumers and their excess savings that they built up through the pandemic and they still have some excess savings, although that buffer is shrinking, and for many consumers, I think it's been fully consumed by higher prices.

The big negative, back to negatives, the big negative out there has been inflation. And real wages have been pushed down since really over the last couple of years and consumer confidence, that's been pretty shaky. But on the whole, I'd say, consumers are in reasonably good shape. So, then we also believe when the -- we have believed for quite a while, you remember in our conversations, even as the losses are rising these days, because we do believe that the deferred charge-off phenomenon is something that is very natural to occur, we're not alarmed by where losses are going. Then we look at our own metrics and if we -- obviously, we talked about delinquencies, we've talked about charge-offs, we also look at payment rates and revolve rates.

And I just want to make a comment about payment rates. I'm struck by the strength in payment rates. Throughout the course of the pandemic, payment rates increased, not only for us but across the industry. And more recently, very naturally, payment rates have drifted down from pandemic highs. But -- and you can see in our trust metrics, the pretty whopping payment rates that is still there. I guess what I'm struck by is, the payment rates not only overall for Capital One, which could definitely have a mix-shift toward heavy spenders as potentially driving that, but even when we look by segment, we're struck by the continuing relative strength in payment rates.

So, that's a good guy and probably the biggest factor that we look at is the recent originations, the vintage curve performance. And the overall level of risk that we are seeing so far in our new originations is consistent with -- certainly consistent with our expectations, but also on a comparative basis. When we look at the earliest delinquencies on our newest monthly vintages of originations, we see performance that is consistent with pre-pandemic risk levels in each of our major segments. And vintage over vintage, we're also seeing relatively stable risk levels over time.

Now, one thing I want to say and Sanjay, you remember, we've talked about this. There is two ways you can -- this can happen. One is the sort of unmanaged and the other is the managed way. My favorite way is when vintage performance, with the same credit policies as several years ago, when that is on top of the old things, the old originations from years ago, that's actually not the case on what we call a like-for-like basis. The recent originations aren't -- they have worst credit than they had years ago.

Again, not surprising at all to us. We all along the way have been managing reactively and proactively around the edges where we either see or would expect maybe performance to be not as good. And the -- and so we have trimmed around the edges in our originations. And so on a net basis, it is -- sort of just happens to be that originations these days are on top of where they were several years ago.

So, pulling way up and based on, for me, more than three decades of experience of doing this in the card business, the opportunities that we see and enhanced by a lot of technology innovations and things like that, we see it as a good time to keep leaning in. We have a very watchful eye on all those negatives that you and I talked about. But on a calibration basis, I would -- I like the opportunity.

Just want to say one more thing which, you are right, a lot of times we have leaned in when others are pulling back. As a general observation, most of the industry is leaning in, that gets our attention. It's not as sustainable when -- often when that's the case. So, we're going to watch it carefully. But that gave you a little window into how we're looking at this and the optimism that we feel at this moment.

[Jeff Norris, SVP, Finance]

Next question, please.

[Operator]

Our next question comes from Don Fandetti with Wells Fargo. Your line is open.

[Donald Fandetti, Wells Fargo]

Yes, Rich. Can you talk about what you're seeing on credit card spend, growth rates, recently in terms of a like-for-like account basis? I know it was sort of flat-to-down last quarter and do you think that we'll continue to see moderation?

[Richard Fairbank, Chairman & CEO]

So, it's -- let's pull up, first of all, our domestic card purchase volume was up 7% year-over-year. But that's to your question, Don, that's really powered by the growth in our customer base. When you look at spend per customer, this has moderated and is now generally flat from a year ago. And the moderation in spending appears to be broad-based. We've observed it across income bands and card segments. We've also seen it across both discretionary and non-discretionary categories. By the way, it's not surprising at all that this would sort of level out. The consumer pulled the way back in the pandemic, just an unprecedented amount of pull back, and now -- and sort of has come roaring back on the other side, that I think for the individual customer, things are sort of settling out.

And so, I think when we ask what would we wish for, I think this is a sensible -- like so often, I always say, it's the most sensible constituency and all of the marketplace tends to yet again be the consumer. But overall, we think that spend moderation is a sign of a rational and healthy behavior on the part of the consumer. And then we match it with the payment rates and those are -- look, those are normalizing somewhat. The revolve rates are normalizing somewhat, but both the payment rate and the revolve rates on a segment-by-segment basis are still not there yet -- they're not at the pre-pandemic levels yet, which indicates an underlying strength at least on average, even when maybe at the margin, you are seeing some of these deferred charge-offs that are driving up credit losses.

[Donald Fandetti, Wells Fargo]

Got it. Thank you.

[Jeff Norris, SVP, Finance]

Next question, please.

[Operator]

Our next question comes from Arren Cyganovich with Citi. Your line is open.

[Jeff Norris, SVP, Finance]

Arren, are you there?

[Operator]

Our last question comes from Dominick Gabriele with Oppenheimer. Your line is open.

[Dominick Gabriele, Oppenheimer]

Hey, great. Thanks so much for taking my questions. Rich, I was just thinking about turns in the credit cycle. What are some of the mistakes that you think card issuers make and even lenders in general? And where do you look for the weakness in the overall space of lending to give you caution when you start to see that turns in the credit cycle? And I also have a follow-up. Thank you.

[Richard Fairbank, Chairman & CEO]

So, yes, it's -- I really appreciate the question, Dominick, because I've often said, we're not in a position -- I wouldn't have any of you put any more stock or stake. I guess you investors put stock in, but I wouldn't put any particular stake in our ability to predict the economy. But the credit cycle and the economy are not the same thing. They're correlated, but I think that the credit cycle is the thing that we really focus a lot on because I think a lot of elements of it are pretty predictable. Obviously, it is influenced by and influences the economy. So, the -- so let's sort of pull way up. We were in this extraordinary period no one's ever seen before in terms of the credit quality during the pandemic.

And we enjoyed and our investors enjoyed the high returns that we made in that time, but some of you may remember my saying, be careful what you wish for. Because with every passing month that this cycle is abnormally good, we will pay the price later on the other side of that causally. Because what -- and so, if you get into the behavior -- and it really links not so much at all to the behavior of consumers, it's really about kind of, to your question, what happens to lenders, providers of credit in this part of the cycle, especially in an extreme thing. And we saw alarming things happening during the most extremely -- extreme periods during the pandemic.

The most striking one to me was the absolute surge in FinTech lending, how much of it there was, who knows, because most of them are reporting to the credit bureau, so it's just a matter of, trying to infer what's going on, but -- so there was a big surge in supply, particularly to subprime, which is where almost all FinTechs go after. And that was alarming to us and we felt with every month that that supply keeps coming there, as I said earlier, there is a price to be paid.

Then you look -- then we look at the context of overlay on top of that, the -- to your question about the common mistakes, what the FinTechs almost by definition were doing, because I'm not sure what else they would do, is, they were leveraging technology, building models in a lot of cases, but the rear view mirror that they were looking into, the dataset their models had, were the greatest credit economy in the history of lending. So, that's a dangerous kind of dataset for the models.

It was exacerbated by credit scores that had drifted dramatically more, a lot of subprime customers moving into prime just by sort of the way scoring works and what was happening as a result of the savings rates going up for consumers. So, the -- so with FinTechs particularly, but for all the players in the business, the danger of the rear view mirror, the danger of the misreading the credit risk of customers, because they were artificially -- their scores would be artificially good, by the way, in our case, we pretty much just intervened in our own modeling and created a way to assume worse than the data says.

We also, in our case, put heavy reliance on data and modeling from way back in the last few decades, that allows us to sort of get past that. So, that is primarily the over-exuberant of lenders in the environment of a combination of a great rear view mirror and frankly a lot of extra earnings and feeling the ability to deploy a bunch of that into marketing. Now what's happened since then, I think this sort of great normalization has been a very healthy thing. It would be shocking if it didn't happen, but from a health of the industry point of view, I think it's a very good thing. Obviously, the FinTechs -- FinTech lending has gone way -- most of it is retreated significantly.

I am struck -- my earlier comment, as we watch very carefully the credit card industry, I think the major players seem to be pretty rational about the credit choices they make and now for everybody with charge-offs rising and without leveling necessarily manifesting itself, I think it's bringing back the appropriate cautions in time for a softer landing here than, you know, might otherwise have been there. So, those are some of the thoughts that we have and those are -- those are things to keep an eye on.

One other thing that I just sort of seize a moment here on things that are on our mind, because I always try to -- my goal here is to always give you a window into how we're thinking and what net impression do I want folks to come away with. As we look at opportunities and a thing that's very much on our mind is, the CFPB efforts on late fees. And I just -- I want to just comment on that because that, it's a very important thing that's going on. The CFPB late fee proposal effectively reduces late fees by approximately 75%. And the CFPB is going after the fee that we believe is the most important fee in the consumer credit business.

Late fees provide a direct and clear incentive for customers to pay on time and avoid becoming delinquent and damaging their credit record. And you know a small late fee may not have that deterrent effect. Late fees are also a way that issuers can partially price for risk and this enables greater access for consumers, greater access to credit, and a lower cost of credit on average. A reduction in late fees is almost certain to reduce credit access to certain parts of the population.

And the CFPB proposal is of course not yet finalized and it could be subject to delays or changes due to litigation. But we have to plan for the potential of this becoming law early next year. And Capital One has pursued a strategy of offering very simple credit card products with limited fees and complexity. And ironically, the late fee has been an important part of our product structure, because of the reasons that I cited earlier. If the proposed rule is implemented, there will be a significant impact to our revenue, gradually resolving over time. And there are ways to mitigate the impact, but as a practical matter, those solutions will take several years to work their way through the portfolio.

So, as we pull up, and I share with you how we're thinking of the business, we really like the opportunities in the card marketplace, we -- for all the reasons that I've talked about. But we also need to really stare at this proposal that may become the rule of the land and I just wanted to share with you how we're thinking about that. And the -- that's an important focus of Capital One, and our solutions to that will be very focused on finding solutions that are consistent with maintaining a winning customer franchise and that's a thing that takes a time to work its way in. Do you have another question, Dominick, you wanted to ask?

[Dominick Gabriele, Oppenheimer]

Yes. Thanks so much, Rich. I can't agree with you more on the late fee comments as well, especially access to credit makes perfect sense. This one is not as interesting. I guess, I was just looking for some help on the model. When you look at professional fees or professional service expense, it was down pretty big year-over-year, while the salaries were maybe a little elevated versus seasonality.

I was wondering if you brought some of those folks in-house or how to think about the professional services, given that is some of the debt collection fees, I believe? And then, was there a gain in the other non-interest income from the sold portfolio? Any help there would be great and thanks for everything on the comments.

[Richard Fairbank, Chairman & CEO]

Sure. So, I think you've got it right in terms of looking at salaries and benefits and professional services in conjunction with one another. As we were making substantial investments in technology, we were supplementing that with some third-party resources. We brought that down as we've been able to use our brand, our recruiting brands to bring incredible talent into the organization. So, it's really looking in some ways at those two lines in conjunction with one another to get a sense for the kind of underlying overall labor trend.

And then in other non-interest income, no, it's -- well, not specifically a sale. One of the biggest things in that creates some quarter-to-quarter fluctuation is agency income in our Commercial business, so it's a little bit lumpy, but we saw some real strength in the quarter. And so, that's what drove the quarter-over-quarter increase there.

[Jeff Norris, SVP, Finance]

Well, that concludes our Q&A session and our call for this evening. I want to thank everybody for joining us on the conference call today and thank you for your continuing interest in Capital One. Investor Relations team will be here this evening to answer further questions you may have. Have a good night everybody.

[Operator]

This concludes today's conference call. Thank you for participating. You may now disconnect.