Capital One Financial Corp

NYSE:COF

Earnings Call Analysis

Capital One's Q2 2024 Highlights: Revenue and Earnings Growth amid Strategic Shifts

Capital One reported significant year-over-year growth in various segments during Q2 2024. The company's net income for the quarter was $597 million, with earnings per share adjusted to $3.14 after accounting for the Walmart partnership termination and other non-recurring costs. Domestic Card business saw 8% growth in average loans and a 9% increase in revenue. The net interest margin rose slightly to 6.7%. Marketing expenses surged by 20% year-over-year, emphasizing the focus on high-spender customer acquisition and enhancing the digital banking experience. Capital One anticipates completing the Discover acquisition later this year, positioning itself as a diversified global payments platform.

Quarterly Performance Overview

In the second quarter, Capital One reported earnings of $597 million, equivalent to $1.38 per diluted common share. However, when adjusted for significant items such as the termination of the Walmart partnership and integration costs with Discover, the earnings per share were substantially higher at $3.14. Despite flat average loans, period-end loans held for investment saw a modest increase of 1%. Deposits remained steady, with average deposits rising by 1%. Revenue for the quarter grew by 1% owing to increased net and noninterest income, while noninterest expenses witnessed a 4% reduction due to lower operating costs. Pre-provision earnings climbed by 7% from the previous quarter.

Credit Loss Provisions and Allowance

Capital One's provision for credit losses surged to $3.9 billion, marking a significant $1.2 billion increase from the prior quarter. This hike was mainly attributed to a higher allowance build, notably $826 million from the end of the Walmart partnership. The overall allowance balance now stands at $16.6 billion, representing a coverage ratio of 5.23%, up 35 basis points. In the Domestic Card segment, the coverage ratio increased by 69 basis points to 8.54%, primarily due to the Walmart partnership's termination. Conversely, the Consumer Banking segment saw a marginal decline in its allowance and coverage ratio, while the Commercial Banking segment remained mostly unchanged.

Liquidity and Capital Position

Liquidity reserves fell by approximately $5 billion to $123 billion, with a $45 billion cash position at quarter's end, down $6 billion from the previous quarter. Factors contributing to this decline included wholesale funding maturities, loan growth, and decreased commercial deposits, slightly offset by growth in retail banking deposits. The average liquidity coverage ratio also decreased from 164% in the first quarter to 155% in the second quarter. The net interest margin was relatively stable at 6.7%, benefiting from the end of the Walmart revenue-sharing agreement but offset by higher retail deposit rates. Capital One's common equity Tier 1 capital ratio improved by 10 basis points, ending the quarter at 13.2%.

Credit Card Business Performance

The Domestic Card business showed robust performance with a 5% year-over-year growth in purchase volume and an 8% increase in ending loan balances. This translated to a 9% rise in second-quarter revenue, largely driven by the growth in purchase volume and loans. The revenue margin remained strong at 17.9%, despite a 6.05% charge-off rate for the quarter, which was somewhat affected by the end of the Walmart loss-sharing agreement. The 30-plus delinquency rate increased marginally year-over-year but showed stability on a sequential basis. Marketing expenses rose 20% year-over-year, driven mainly by initiatives to grow the Domestic Card business.

Consumer Banking and Commercial Performance

The Consumer Banking segment experienced an 18% year-over-year increase in auto originations, although ending loans decreased by 2% year-over-year. The segment’s revenue was down 9% from the previous year, influenced by higher deposit costs and lower average loans. In the Commercial Banking segment, both ending and average loans decreased by 1% compared to the previous quarter, mainly due to tightened credit measures. However, the segment’s noninterest expense reduced by about 6% from the linked quarter, indicating better cost management.

Guidance and Strategic Outlook

Capital One remains optimistic about its strategic direction, with continued investments in marketing and technology transformation to drive future growth. The end of the Walmart partnership is expected to have a mixed impact, increasing charge-off rates but potentially improving operating efficiency ratios. For the full year 2024, the company expects a modestly down operating efficiency ratio compared to 2023, assuming certain regulatory changes take effect as anticipated. Additionally, Capital One is focusing on expanding its franchise, particularly at the top of the market, by enhancing customer experiences and leveraging data and machine learning for better marketing outcomes.

Discover Acquisition and Future Prospects

Capital One's acquisition of Discover is progressing, with anticipated completion late this year or early next year, subject to regulatory approvals. This strategic move aims to create a more diversified, vertically integrated global payments platform, leveraging both companies' strengths. The acquisition is expected to enhance growth opportunities and deliver significant value for merchants, consumers, and shareholders. The combined entity will benefit from Capital One's ongoing technology transformation, enabling better customer experiences and operational efficiencies across the board.

Earnings Call Transcript 2024-Q2

[Operator]

Good day, and thank you for standing by. Welcome to the Capital One Q2 2024 Earnings Call. 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, executive]

Thanks very much, Josh, and welcome, everyone, to Capital One's Second Quarter 2024 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 2024 results.

With me this evening 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 press release, please go to Capital One's website, click on Investors then click on Quarterly Earnings Release.

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

Numerous factors could cause our actual results to differ materially from those described in forward-looking statements. And for more information on these factors, please see the section titled Forward-Looking Information in the earnings release presentation and the Risk Factors section in our Annual and Quarterly Reports, accessible at the Capital One website and filed with the SEC.

And with that done, I'll turn the call over to Mr. Young. Andrew?

[Andrew Young, executive]

Thanks, Jeff, and good afternoon, everyone. I will start on Slide 3 of tonight's presentation. In the second quarter, Capital One earned $597 million or $1.38 per diluted common share. Included in the results for the quarter were adjusting items related to the Walmart partnership termination, Discover integration costs and an accrual for our updated estimate of the FDIC's special assessment. Net of these adjusting items, second quarter earnings per share were $3.14.

Relative to the prior quarter, period-end loans held for investment increased 1%, while average loans were flat. Ending deposits were flat versus last quarter, while average deposits increased 1%. Our percentage of FDIC insured deposits increased 1 percentage point to 83% of total deposits. Pre-provision earnings in the second quarter increased 7% from the first quarter. Revenue in the linked quarter increased 1% driven by higher net and noninterest income, while noninterest expense decreased 4% driven by a decline in operating expense.

Our provision for credit losses was $3.9 billion in the quarter. The $1.2 billion increase in provision relative to the prior quarter was almost entirely driven by higher allowance. Included in the second quarter was an $826 million allowance build from the elimination of the loss sharing provisions that occurred within the termination of the Walmart partnership. The remaining quarter-over-quarter provision increase was driven by $353 million higher net reserve build and a $28 million increase in net charge-offs.

Turning to Slide 4. I will cover the allowance in greater detail. We built $1.3 billion in allowance this quarter. The allowance balance now stands at $16.6 billion. Our total portfolio coverage ratio increased 35 basis points to 5.23%. The increase in this quarter's allowance and coverage ratio was largely driven by a build in our card segment. 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 coverage ratio increased by 69 basis points to 8.54%. The substantial majority of the increase in coverage was driven by the impact of the termination of the Walmart loss sharing agreement. In our Consumer Banking segment, the allowance decreased by $23 million, resulting in a 5 basis point decrease to the coverage ratio. And finally, our commercial banking allowance increased by $6 million. Coverage ratio remained essentially flat at 1.74%.

Turning to Page 6, I'll now discuss liquidity. Total liquidity reserves in the quarter decreased about $5 billion to approximately $123 billion. Our cash position ended the quarter at approximately $45 billion, down about $6 billion from the prior quarter. The decrease was driven by wholesale funding maturities, loan growth and declines in our commercial deposits partially offset by deposit growth in our retail banking business. You can see our preliminary average liquidity coverage ratio during the second quarter was 155%, down from 164% in the first quarter.

Turning to Page 7, I'll cover our net interest margin. Our second quarter net interest margin was 6.7%, 1 basis point higher than last quarter and 22 basis points higher than the year ago quarter. The relatively flat quarter-over-quarter NIM was the result of largely offsetting factors. NIM in the quarter benefited from the termination of the revenue sharing agreement with Walmart as well as modestly higher yields in the auto business. These 2 factors were roughly offset by the seasonal effects on yield in the card portfolio and a slight increase in the rate paid on retail deposits.

Turning to Slide 8, I will end by discussing our capital position. Our common equity Tier 1 capital ratio ended the quarter at 13.2%, 10 basis points higher than the prior quarter. Net income in the quarter was largely offset by the impact of dividends and $150 million of share repurchases.

During the quarter, the Federal Reserve released the results of their stress test. Our preliminary stress capital buffer requirement is 5.5%, resulting in a CET1 requirement of 10%. However, as we disclosed in our last 10-Q, the announcement of the acquisition of Discover constituted a material business change. As a result, we are subject to the Federal Reserve's preapproval of our capital actions until the merger approval process has concluded.

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

[Richard Fairbank, executive]

Thanks, Andrew, and good evening, everyone. Slide 10 shows second quarter results in our Credit Card business. Credit Card segment results are largely a function of our Domestic Card results and trends, which are shown on Slide 11. In the second quarter, our Domestic Card business delivered another quarter of strong results as we continue to invest in flagship products and exceptional customer experiences to grow our franchise. Year-over-year purchase volume growth for the quarter was 5%. Ending loan balances increased $11.1 billion or about 8% year-over-year. Average loans also increased about 8%. And second quarter revenue was up 9%, driven by the growth in purchase volume and loans.

Revenue margin for the quarter remained strong at 17.9%. The revenue margin includes a positive impact of about 18 basis points resulting from the partial quarter effect of the end of the Walmart revenue sharing agreement. The charge-off rate for the quarter was 6.05% and the partial quarter impact of the end of the Walmart loss sharing agreement increased the quarterly charge-off rate by 19 basis points. Excluding this impact, the charge-off rate for the quarter would have been 5.86%, up 148 basis points year-over-year.

The 30-plus delinquency rate at quarter end was 4.14%, up 40 basis points from the prior year. As a reminder, the end of the Walmart loss sharing agreement did not have a meaningful impact on delinquency rate. The pace of year-over-year increases in both the charge-off rate and the delinquency rate have been steadily declining for several quarters and continued to shrink in the second quarter. On a sequential quarter basis, the charge-off rate, excluding the Walmart impact, was down 8 basis points, and the 30-plus delinquency rate was down 34 basis points.

Domestic Card noninterest expense was up 5% compared to the second quarter of 2023, primarily driven by higher marketing expense. Total company marketing expense in the quarter was $1.1 billion, up 20% year-over-year. Our choices in domestic card are the biggest driver of total company marketing. We continue to see compelling growth opportunities in our Domestic Card business. Our marketing continues to deliver strong new account growth across the Domestic Card business. Compared to the second quarter of 2023, Domestic Card marketing in the quarter included increased marketing to grow originations at the top of the marketplace, higher media spend and increased investment in differentiated customer experiences like our travel portal, airport lounges and Capital One Shopping.

Slide 12 shows second quarter results for our Consumer Banking business. After returning to positive growth last quarter, auto originations were up 18% year-over-year in the second quarter. Consumer Banking ending loans were down $1.6 billion or 2% year-over-year, and average loans were down 3%. On a linked quarter basis, ending loans were up 1% and average loans were flat. Compared to the year ago quarter, ending consumer deposits were up about 7% and average deposits were up 5%.

Consumer Banking revenue for the quarter was down about 9% year-over-year, largely driven by higher deposit costs and lower average loans compared to the prior year quarter. Noninterest expense was up about 2% compared to the second quarter of 2023, driven by an increase in marketing to support our national digital bank. The auto charge-off rate for the quarter was 1.81%, up 41 basis points year-over-year. The 30-plus delinquency rate was 5.67%, up 29 basis points year-over-year. Largely as the result of our choice to tighten credit and pull back in 2022, auto charge-offs have been strong and stable.

Slide 13 shows second quarter results for our Commercial Banking business. Compared to the linked quarter ending loan balances decreased about 1%. Average loans were also down about 1%. The modest declines are largely the result of choices we made in 2023 to tighten credit. Ending deposits were down about 6% from the linked quarter. Average deposits were down about 3%. The declines are largely driven by our continued choices to manage down selected less attractive commercial deposit balances.

Second quarter revenue was essentially flat from the linked quarter and noninterest expense was lower by about 6%. The Commercial Banking annualized net charge-off rate for the second quarter increased 2 basis points from the sequential quarter to 0.15%. The Commercial Banking criticized performing loan rate was 8.2%, up 23 basis points compared to the linked quarter. The criticized nonperforming loan rate increased 18 basis points to 1.46%.

In closing, we continued to deliver strong results in the second quarter. We delivered another quarter of top line growth in Domestic Card loans purchase volume and revenue and a second consecutive quarter of year-over-year growth in auto originations. Consumer credit trends continued to show stability and our operating efficiency ratio improved. We had guided to 2024 annual operating efficiency ratio net of adjustments to be flat to modestly down compared to 2023, assuming the CFPB late fee rule takes effect in October, and we're on a very consistent path with what we expected when we gave that guidance. If the implementation of the rule is delayed, that would be a tailwind to 2024 annual operating efficiency ratio.

One thing that has changed is the Walmart relationship. Our partnership ended in the second quarter, which will increase charge-off rates but have a positive impact on operating efficiency ratio. Including the Walmart impact, we expect full year 2024 operating efficiency ratio net of adjustments to be modestly down compared to 2023.

We continue to lean into marketing to grow and to further strengthen our franchise. In the Domestic Card business, we continue to get traction in originations across our products and channels and our origination opportunities are enhanced by our technology transformation, which enables us to leverage machine learning at scale to identify the most attractive growth opportunities and customize our marketing offers.

We are also getting traction in building our franchise at the top of the market with heavy spenders. It is not lost on us that competitive intensity and marketing levels are increasing at the very top of the market, and we know we have important investments to make. We continue to be pleased to see our investments pay off in customer and spend growth and returns. And we're building an enduring franchise with annuity-like revenue streams very low losses and very low attrition.

In Consumer Banking, our modern technology and leading digital capabilities are powering our digital-first national banking strategy and we're leaning even harder into marketing to grow our national checking franchise, which has had industry-leading pricing with no fees and industry-leading customer satisfaction.

Pulling up, marketing is a key driver of current and future growth and value creation across the company, and we're leaning hard into our marketing investments. We expect total company marketing in the second half of 2024 to be meaningfully higher than the first half, similar to the pattern we saw last year.

We are all in and working hard to complete the Discover acquisition. Our applications for regulatory approval are in process, and we're fully mobilized to plan and deliver a successful integration. We continue to expect that we'll be in a position to complete the acquisition late this year or early next year subject to regulatory and shareholder approval.

The combination of Capital One and Discover creates game-changing strategic opportunities. The Discover payments network positions Capital One is a more diversified, vertically integrated global payments platform, and adding Capital One's debit spending and a growing portion of our Credit Card purchase volume to the Discover network will add significant scale increasing the network's value to merchants, small businesses and consumers and driving enhanced network growth.

In Credit Cards and Consumer Banking, we're bringing together proven franchises with complementary strategies and a shared focus on the customer. And we will be able to leverage and scale the benefits of our 11-year technology transformation across every business and the network.

Pulling way up, the acquisition of Discover is a singular opportunity. It will create a consumer banking and global payments platform with unique capabilities modern technology, powerful brands and a franchise of more than 100 million customers. It delivers compelling financial results and offers the potential to create significant value for merchants and customers.

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

[Jeff Norris, executive]

Thanks, Rich. We'll now start the Q&A session. As a courtesy to other investors and analysts who may wish to ask a question, please limit yourself to one question plus a single follow-up. If you have any follow-up questions after the Q&A session, the Investor Relations team will be available after the call. Josh, please start the Q&A.

[Operator]

[Operator Instructions] Our first question comes from Sanjay Sakhrani with KBW.

[Sanjay Sakhrani, analyst]

Rich, Andrew, just looking at the credit metrics. As Rich mentioned, it seems like the trends are pretty favorable. I mean, in most segments, things are improving, if not stable, and then U.S. card there's an improving trend in that second derivative. I'm just curious how we should think about reserve rate going forward? Because I think even excluding the Walmart impact, the reserve rate went higher.

[Andrew Young, executive]

Sure, Sanjay. Well, let me start by covering this quarter's allowance and then I'll talk about the future. So in the quarter, as you said, first, we had the effect of Walmart, the $826 million build that we spelled out as an adjusting item. We also reserved for the growth we saw in the quarter. Beyond that coverage in card, as you referenced, grew, I think it was just over 10 basis points, which is a little over 1% of the allowance balance. And so as part of that process each quarter, not only are we rolling forward our baseline forecast but we're also looking at a range of macroeconomic and consumer behavior uncertainties, including things like the changing seasonal customer behavior we talked about last quarter. And so as a result, in this quarter, we increased the qualitative factors to reflect those uncertainties, and that's what drove the modest increase in coverage this quarter.

As I look ahead, and talking conceptually here, but in a period where projected loss rates in future quarters are projected to stabilize and ultimately decline and might indicate a decline in the coverage ratio, I would say you could very well see a coverage ratio that remains flat for some period of time as we incorporate the uncertainty of those future projections into the allowance. And in a period where forecasted losses are rising. We're quick to incorporate those higher forecasted losses and also potentially add qualitative factors for uncertainty, like you saw early in the pandemic. But I would say it is unlikely to be symmetric on the way down.

And so, eventually, the projected stabilizing and ultimately lower losses will flow through the allowance particularly as the uncertainties around that forecast become more certain. But at this point, I'm not going to be in the business of forecasting when that's actually going to take place for us.

[Sanjay Sakhrani, analyst]

Got it. And then, Rich, maybe you could just talk about the consumer and sort of the uncertainties there. Is there any discernible like change that you've seen since the last quarter in terms of the state of the consumer? We've obviously seen the spending trend sort of slow somewhat across the industry. But anything else to sort of point out?

[Richard Fairbank, executive]

Sanjay, I think what we see is something that's very stable. The U.S. consumer remains a source of strength in the overall economy. Of course, the labor market remains strikingly resilient rising incomes have kept consumer debt servicing burdens relatively low by historical standards despite high interest rates. When we look at our customers, we see that on average, they have higher bank balances than before the pandemic, and this is true across income levels.

On the other hand, inflation shrank real incomes for almost 2 years, and we've only recently seen real wage growth turn positive again. And in this high interest rate environment, the cost of new borrowing has gone up in every major asset class, mortgages, auto loans and credit cards. So we'll obviously keep an eye on that. And I think at the margin, these effects are almost certainly stretching some consumers financially. But on the whole, I'd say consumers are in reasonably good shape relative to most historical benchmarks.

And as our credit numbers came in -- I'm sorry, can you hear me? Can you still hear me? You can hear me. Okay. I just had some cross message coming in on my phone.

But the -- but with respect to credit, we were very pleased with the credit performance in the quarter. We had talked a bit about the seasonality, maybe people want to ask a question about that. But we saw basically pulling up, we see things settling out nicely in the card business and the things are very strong in the auto business.

[Operator]

Our next question comes from Mihir Bhatia with Bank of America.

[Mihir Bhatia, analyst]

Maybe just turning to NIM for a second. With the Fed or at least expectations for rate cuts coming into view, can you just comment on the current backdrop for deposit competition? How do you -- and how do you expect deposit betas to trend during the early stages of the Fed rate cutting cycle?

[Andrew Young, executive]

Sure, Mihir. What we've seen, at least within our walls, and you saw the evidence of it this quarter, in a quarter where seasonally, you typically see a decline in deposit balances, looking at H8 data. We saw a few, I think it was $4 billion of growth. We've been quite pleased over the course of the last couple of years with all of the investments we've made over many years in building a deposit franchise and are certainly benefiting from that. And so with respect to the beta going forward, first, looking at what we saw in the up cycle here, the total cumulative beta that we've seen in this cycle this quarter, I think, cumulatively, was 62%.

And so assuming that the Fed's next move is to bring rates down. It's hard to precisely predict what's going to happen to deposit costs and therefore, betas and in particular, the pace of those declines because market dynamics competitive pricing actions, other actions related to companies looking to potentially preserve NIM that's going to drive betas in the future cycle. But I think you get a pretty good sense for our pricing and mix based on what you saw in the up cycle and within that backdrop that I just described, that's going to influence what happens to our beta on the way down.

[Mihir Bhatia, analyst]

Got it. That's helpful. And then just switching back to the health of the customer overall. As you look across your portfolio, we've heard a little bit of talk about people pulling back, particularly on discretionary spend and low income cohorts, et cetera. Is that a dynamic you are also seeing when you look at your customer base?

And then relatedly, Rich mentioned, how pleased [indiscernible] with the progress you're making on the higher income side, if you will, on the big -- on the transactor -- in that high-end transactor balance side. I was just wondering, how does that change your portfolio as you think about it like over the next few years, like as you grow that book further?

[Richard Fairbank, executive]

Yes. Well, just with respect to spending, we see pretty proportional movement in discretionary versus nondiscretionary spending, nothing really striking there when we look at the portfolio, spending metrics. The spend per customer is really pretty flat when you see spend growth at a company like Capital One and the purchase volume growth is really being driven by the new accounts. So things are really pretty stable, flat and stable, healthy but pretty flat on a per customer basis.

With respect to the question about the gradual transition of our portfolio to a higher-end customer. Let me just pull up and talk about that. We have, for decades, been a company that sort of serves the mass market really from the top of the credit spectrum through to even down to some subprime customers. And we have continued very consistently with this strategy, probably the most striking thing though that's happened over the last 10 or 14 years, I guess, 14 years ago is when we launched the Venture Card.

We have systematically leaned into going after the top of the market, not leaving the other behind, but really as an additive strategy. And we have continued through our marketing and through the products that we're offering to just keep moving higher and higher in terms of the target customers and the traction that we're getting. And by the way, we continue even as we're growing purchase volume overall, where we see the highest growth rates in purchase volume are as we go higher in the market. So we're very happy about that.

And when we think about the portfolio effects that happened there, this is one thing that we see is that payment rates have, along that journey, gone up quite a bit at Capital One. And when we look to see our payment rates coming back to where they were pre-pandemic, they sort of -- they probably just aren't going to return all the way because that would be a reflection of the portfolio shift. We just, in general, have had the kind of mix shift that you'd expect with higher payment rates and just higher levels of spend, higher spend rates in the business, and that's been very successful.

So -- but from an outstandings point of view, it doesn't -- the top of the market business doesn't have that much impact on outstandings because these folks generally pay in full. So when you see the outstandings movement of Capital One, it's pretty consistently driven by the mass market part of our business. It's just that inside some of the portfolio metrics are moving because of the mix shift toward more spenders.

[Operator]

Our next question comes from Rick Shane with JPMorgan.

[Richard Shane, analyst]

Look, given the breadth of your reach across the consumer income levels. Can you talk a little bit about sort of any patterns that you're seeing? We've heard, for example, some slowdown in spending for lower-income consumers. I'm curious, particularly you'd made a comment earlier in the quarter about an increase in minimum payment rates. I'm curious if you're seeing anything in terms of payment behavior that we should consider by income level?

[Richard Fairbank, executive]

Yes. Okay. So let's just pull up for a minute on just talking about how the subprime consumer is holding up. So way back in the global financial crisis, we observed that credit metrics in subprime moved earlier in both directions. Subprime also worsened less on a percentage basis than prime. But of course, it -- in absolute delta, it still moved more. In the pandemic, subprime credit moved more and more quickly than prime. It normalized more quickly and appears to be stable -- and appeared basically to stabilize sooner as well. And that's in the context of lower income consumers seeing disproportionate benefits of government aid and forbearance on financial products and then the unwinding of that over time. And so subprime is, of course, not synonymous with lower income, although they're correlated, and we saw these effects across credit, both in talking about the credit spectrum and also the income gradient.

So on the other hand, just a couple of other effects just on the credit side that have happened over recent years. subprime consumers have been subject to more industry credit supply, including FinTech competition during and after the pandemic. So that's been something we've always kept a close eye on and worried about whether that was going to disproportionately impact the credit performance of subprime customers. I don't really -- I mean, given the overall pretty strong performance in subprime, I think we haven't seen that effect too much.

And another thing to point out is that, income growth has been consistently higher for lower income consumers over the past several years, and this is the opposite of what we saw during and after the global financial crisis.

But while no 2 cycles are like, I think, again, we're seeing that subprime consumers and lower-income consumers, again, they're not the same thing, but they tend to move earlier, but not necessarily more than the overall market.

Now when you -- let's talk a little bit about payment rates. So throughout the course of the pandemic payment rates increased not only for us but across the industry. And more recently, payment rates have drifted down from pandemic highs as the effects of stimulus have waned. And the payment rates, generally, we have seen this effect -- so the effect that we've seen on payment rates going down relative to where they were 1 to 2 years ago, relative to their peak, basically in every part of our business, they have come down, but are still above where they were pre-pandemic.

And again, I think part of that is the mix effect that we talked about in the prior question. There's a mix effect, not only across our whole portfolio but even within the segments of our portfolio, we've just had more emphasis on the spender side versus the revolver side internally. And so I think you see some of that showing up in the metrics.

One other thing I want to say is that, I talk about your question about minimum payments. So we have simultaneously -- we're sort of seeing an effect where payment rates, while they're going down, continue to be well above pre-pandemic levels even as minimum -- the percentage of customers paying minimum payments. This, by the way, is not a subprime effect. This is a portfolio effect I'm talking about. The percent of customers paying minimum payments is also somewhat above pre-pandemic levels.

Now it seems a little odd to have both of those effects happening at the same time. But I think in many ways, this is a very natural way that normalization is happening. And you've heard us talk for a long time now about what we call the delayed charge-off effect in consumer credit that so many customers got stimulus and forbearance that I think a lot of people who otherwise would have charged off we're able to avoid that charge-off. Many hopefully, were able to permanently avoid that. But for some, we have believed it was more of a deferral of an inevitability and this phenomenon of delayed charge-offs, which can't be separately measured, we believe, is a driving factor behind why credit has been settling out higher than pre-pandemic because I think there's just a delayed charge-off effect for some of these customers who otherwise would have charged off earlier.

And that then would be consistent with a very healthy consumer payment rates generally even being higher than pre-pandemic, but there is a tail of consumers paying a higher percentage on minimum payments and some of them going through a charge-off that might have otherwise happened a few years earlier.

[Operator]

Our next question comes from Ryan Nash with Goldman Sachs.

[Ryan Nash, analyst]

Maybe to ask about marketing. So I think our -- the guide that you provided said around $2.6 billion roughly of marketing spend in the second half. And you talked a little bit about the competitive intensity in the top of the market is increasing. Can you maybe just talk about, how much of the increase in marketing is being driven by the investing more to acquire more customers versus competition pushing up the cost to acquire?

And then just given what you just talked about around low-end consumers, are you pulling back in else anywhere to cover the increased cost of acquiring?

[Richard Fairbank, executive]

Ryan, our comments about the competitive intensity, let me just elaborate a little bit more about that. The card business is very competitively intense across the spectrum. It's been consistently intense. Competition has -- competition in things like rewards have certainly heated up over the last couple of years. And the thing that I was pointing out is just something that, again, is not something that is like the realization of the last month or so. It's a phenomenon we've seen for some time, but it is striking, which is at the very top of the market.

We are seeing for the -- especially a couple of competitors that we have that most intensely play at the very top of the market, you can just absolutely see they are stepping up, investing more in lounges, in experiences, in dining, investing in companies, marketing levels, it's -- I'm sure all the investors can see it. We can all see it and they talk about it. And it's not lost on us that these are strong competitors, and we certainly have -- we already have had very important investment plans in these areas, and we note that others are investing heavily too.

So but with respect to the -- let me just now kind of pull up now and just talk about the marketing sort of where we are from a marketing point of view. We continue to see great opportunities and really across our businesses. We remain very excited about the success of our origination activities especially in our current products and channels and of course, what's happening in the bank. The 2 big areas that are driven by marketing spend. This continues to be powered by our technology transformation. And just to favor a little bit because we often pointed that, why does the technology transformation help here? It gives us the ability to leverage more and more data and machine learning models to identify the most attractive growth opportunities, and it allows us to increasingly tailor our solutions to down to the individual customer level to ensure that we're meeting them right where we are.

So kind of the first point, I would say and key reason we're leaning into the marketing is, we're getting a lot of traction in our tech transformation is certainly helping to power more opportunities. Secondly, we continue to expand on our success in building a franchise at the top of the market and with a heavy spenders in this quest -- well, for years, we've been talking about going after the top of the market every year, as we get more traction, we reached just a little bit higher. These customers are very attractive.

In addition to the obvious spend growth, they generate strong revenue, very low losses, low attrition. And the business helps elevate our brand really across the company. Now it's also something that we've known all along is that it's expensive and requires quite a bit of investment to build a business at the top of the market in the form of upfront cost and also in the form of a sustained commitment to customer benefits and experiences and building a brand.

So, yes, you have early spend bonuses that are important cost of doing business. That shows up in the marketing line item. Brand makes a huge difference. And brand, of course, requires a long-term commitment to build. And as we continue to move up the market. We are moving increasingly into areas where consumers are looking for exclusive services and experiences that aren't available in the general marketplace such as airport lounges and access to select properties and iconic experiences.

So we've seen at the top of the market, our 2 biggest competitors really lean in here. and we certainly are leaning in as well. Ryan, I wouldn't -- there are sometimes I've seen over the years that marketing levels just rise. And so you just got to market more and more and more just to hold your own. And I don't feel that we're in an environment like this. I feel that the -- certainly competitive intensity is increasing. But when we're talking about in general in the card business where competitive intensity is increasing a bit and specifically, with respect to these investments at the top of the market, these are just important things that you have to build and win at the top of the market, but we are very pleased with the traction we're getting the economics of our heavy spender business. And so this is -- we just -- it's just not lost on us. A couple of our other competitors are very focused on the same thing. So we continue to lean into growth here, both in terms of upfront customer acquisition and our ongoing investment in brand and exclusive experiences and benefits.

Now let me now turn to the third part of our marketing story, which is our investment in building our national bank. So this has been a journey that we've been on for many, many years. When we bought ING Direct way back in 2012, we said this is going to be not only a great financial acquisition, but it's going to be a transformational strategic acquisition because now as a player with a significant branch network and a national direct bank, we have the building blocks to build a unique national bank. And that's what we're building a digital first national bank. We've got smaller physical branch networks that we lean more on our cafe network, which is in cafes in 21 of the top 25 MSAs, lean very heavily into our digital experiences and really importantly, without a branch on every corner across the United States, the role for Capital One that marketing and brand play in building this national banking business is absolutely a central role.

So we are very pleased with the growth that we're getting, the traction, the performance of this business. And the opportunity just gets bigger when we think about in the context of the combined entity now joining forest wood Discover. So these are the compelling opportunities behind our marketing growth, and we continue to feel really good about the success and the opportunities in front of us. And that's why we are leaning in very much into the marketing and specifically with respect to the rest of the year, why we pointed to -- and of course, virtually every year at Capital One in the second half of the year has quite a bit more marketing than the first half. We pointed to the pattern kind of like what we saw last year in terms of proportional increases in marketing. Thanks, Ryan.

[Operator]

Our next question comes from Bill Carcache with Wolfe Research Securities.

[Bill Carcache, analyst]

Following up on your credit commentary, there had been an expectation among many investors that we would see peak charge-offs somewhere around the second half of this year given the delinquency trends that you're seeing. Is that a reasonable expectation? And if so, it seems like your credit outlook has derisked somewhat given an improving loss trajectory, but higher reserve rate driven by qualitative factors. Is that a fair thought process?

I'll just ask my follow-up as part of this. You mentioned, Andrew, that your capital return is subject to Fed approval given the pending acquisition. How should we think about the pace of incremental buybacks as we look ahead at the rest of the year?

[Richard Fairbank, executive]

Yes, Bill, yes, let me make a couple of comments on credit. Let me seize the moment in the spirit of Henry Kissinger, who says, I hope you have questions for my answers. I -- let me just ask myself a question, so I can answer it because it sets the table for answering your question. Which -- you may remember last quarter, we pointed at tax refund patterns and said that there may be a new seasonality pattern emerging. And it would be too early to call that, but it was making it a little bit -- things were not following as closely on a month-by-month basis to pre-pandemic delinquency patterns that -- our hypothesis was, 3 months ago, that we're seeing a tax refund effect. So let me just talk about that for a second, and then Bill, I'll pull up and talk about just sort of what does this mean for sort of how I feel about where we are with respect to credit.

So the -- let's just talk for a second about how seasonality works. We've always seen seasonal credit patterns in our card business. And our portfolio trend they have generally been more -- they've had more pronounced seasonal patterns than the industry average. I think that's because we have a higher subprime component. And those customers are even more linked, I think, to the seasonal patterns associated with tax refunds that would be our hypothesis there.

Now the second quarter tends to be the seasonal low point for delinquencies and Q4 tends to be the seasonal high point for delinquencies. Card losses lag relative to delinquencies. The losses tend to be seasonally lowest in the third quarter and the highest in the first quarter.

Now we believe that tax refunds, again, are a significant driver of these seasonal trends. And tax refunds drive a large seasonal improvement in delinquent payments in the February, March time period, which then flows through to lower delinquencies in April and May and then to lower charge-offs and tax refunds also drive a seasonal uptick in our recoveries. So the tax code actually, new tax withholding rules went into effect way back in 2020. They were passed in 2019, went into effect in 2020, but the pandemic and the normalization since then have kind of swamped seasonality. So we haven't really been able to get a really good read of it. So we've tended to benchmark to the seasonality of pre-pandemic like 2018 and 2019.

But we've now had several more months to look at this pattern, and we're seeing a pattern. Well, let me back up. What we've done is, what we call de trending of our credit metrics. So we, in hindsight, take the trends out of them to the best we can. So we can see what the net seasonality effects are. And on a de trended basis, last year showed a seasonality with less amplitude on the high side and the low side than had previously been seen prepandemic. We assumed that was probably again, a manifestation of the new behaviors going in with the new tax refunds.

As we now have seen this tax season play out. The seasonality, the payment patterns have been very close to our de trended 2023 line so that we believe that we are seeing, and it's very plausible, we are seeing a new seasonality. I just want to share that with investors. So later tax refunds and later and lower sort of lowered the seasonal improvement in delinquencies, but we think the seasonal increase in delinquencies that we see in the back half of the year likely will also be less pronounced going forward than it has been in the past. All of this, by the way, happens in auto seasonality, but an even faster, more concentrated way.

So -- so we -- what we see, we felt it was a little bit noisy. Last quarter, when we were talking to you, we were finding each quarter, things were coming in a little bit -- I mean the second derivative was still doing great things. But relative to our sort of close-in expectations based on seasonality, things were a little bit off. With the revised seasonality, what we see is, things very nicely settling out in card credit and we feel very good about the last couple of months that came in relative to that new seasonality curve. So I think settling out is the real word from here.

Given that from -- to your question about peak, we're not really going to -- we're not giving really forward guidance about declarations of peak. But from a seasonal point of view, things should head down from here in Q3 and then sort of pop up around October. October is often a month, we tend to get just a little bit of an October surprise, so we'll keep an eye on that.

But the other thing I just want to say about credit is, our recoveries inventory is starting to rebuild, and that should be a gradual tailwind to our losses over time, all else being equal. And then other than the economy, I think the other real factor that's going to drive credit performance for us and other issuers in the next couple of years will be what is the size of this delayed charge-off effects from the pandemic.

[Andrew Young, executive]

And then, Bill, with respect to the derisk comment, Rich, just provide a lot of color on our view of losses. I would just say, given the accounting rules, we forecast losses under a variety of scenarios and use qualitative factors for uncertainties around that. And I would say, therefore, like we are appropriately reserved for all of that.

With respect to your question around repurchases, I'll just note, our agreement with Discover doesn't prohibit us from buying shares. The only restriction that will need to be out of the market during the S-4 proxy vote period. However, we are not operating under the SCB, as I said in my prepared remarks, and we laid out in the last Q, the announcement of the intention to acquire Discover did constitute a material business change. And therefore, like we did in this recent quarter, in the second quarter, we're subject to Fed preapproval of our capital actions until the merger approval process has concluded. And so that's what's going to dictate the pace at which we repurchase until that process has concluded.

[Operator]

Our next question comes from Don Fandetti with Wells Fargo.

[Donald Fandetti, analyst]

Rich, can you talk a bit about how you're seeing loan growth in auto? And also as banks potentially come back in, are you seeing or worried about spread or yield compression on new originations?

[Richard Fairbank, executive]

So Don, it's an interesting thing. We always seem to zag while others zig -- while others zag in the auto business. As we discussed in the last quarter, we have an optimistic outlook on the auto business. We're seeing a lot of success in the auto business and our investments in infrastructure are also reaping a lot of benefits for us. So just on the numbers, our originations grew 21% versus last year in Q1 and the trend continues in Q2 with 18% growth on the year-over-year quarter. And the loss performance has normalized and it's stable.

We -- very importantly, we made -- intervened and made an adjustment for what we felt was credit score inflation that was happening during the pandemic. And so we pulled back in '22 and '23 by just in a sense, worsening the otherwise scores one would see under a belief that they were artificially inflated. And that enabled our vintages all through this period of time, '22, '23 and all through the normalization to perform very well. We like the economics of the loans were originated and we're very satisfied with the performance of the overall portfolio.

So when we think about the headwinds in the business, interest rates remain high. And of course, that along with high vehicle values continue to pressure affordability. And auto used car prices, which are still high relative to historical standards. They are probably in a position to gradually be coming down. So we'll have to keep an eye on that.

For a long time, we were concerned about the margins in the business because competitors had not pass through higher interest rates into the cost of the auto loans. We pulled back quite a bit, John, as you remember, during that period of time. We have seen those margins basically return to where they were. So I think that's a pretty good sign there.

So all things considered, with a watchful eye on used car values, we are seeing enhanced opportunities in the auto business with margins that have good resilience to them and quite a bit improved relative to the period where we were raising the alarm bells a bit about what was happening to the effective resilience in that business.

[Operator]

And our final question this evening comes from the line of Moshe Orenbuch with TD Cowen.

[Moshe Orenbuch, analyst]

Great. When you talked about the increase in the reserve rate, not the dollars of the reserve, not the Walmart piece, but the reserve rate itself, Andrew, you didn't mention like mix of receivables. Is it -- has there been any shift towards mass market or subprime from super prime within the card business?

[Andrew Young, executive]

Not in any material way that would have a significant impact on the allowance motion.

[Moshe Orenbuch, analyst]

Got it. Okay. And just as a follow-up, Rich, given what's happened with Walmart and the pending Discover acquisition, could you talk a little about your thoughts on the partner or private label business kind of in the current environment? Like what are your thoughts now in terms of your existing contracts and the tendency to want to get new ones? Any thoughts on that in this environment?

[Richard Fairbank, executive]

So thank you. I think the -- well, the Walmart partnership was a very unique one that I think there's not a lot to extrapolate to other partners on that. I think we've ended up in a situation there where we the loss share was a very good thing, so we're going to be carrying around loss rates that are something on the order of 40 basis points higher on our portfolio for that. So we'll have to just make sure we all see that. But we've got the full economics on the business. Increasingly, that portfolio -- the portfolio we inherited is now very seasoned and the rest of it is the portfolio we ourselves originated so we know it well. And I think that we feel very good about that.

So the partnership business is a very partner-by-partner business. I think where people get into trouble is feeling they've got to drive to a certain scale. We all know scale matters in the credit card business and scale matters in the partnership business. But here's the thing, we have certainly learned over time how unique -- or how individual different partnerships are and we've seen great ones. We've seen not so great ones.

Here's Moshe, what we -- if I pull up on the patterns of what we most look for. It's, first of all, a healthy franchise, a company that is itself healthy and that that's certainly a good sign. Now the credit card business does have a pretty good default structure, whereby if a partner runs into trouble and can't continue, we inherit the portfolio, which now Walmart, of course, is a very strong company, but we're -- here's an example of inheriting the portfolio where I think things are going to continue very successfully there.

But the other thing that we really look for is, what is the reason that the partner is driving this either co-brand or private label business. Is it to -- is the -- on one end of a continuum is it's the sheer quest for profits and on the other end of the continuum, it is having the card partnership at the -- as a centerpiece in driving a franchise. And the behaviors that a partner has the incentives that get baked into programs, they tend to be very driven by where on that continuum.

One is, we've walked away from a lot of opportunities over the years where things were just too focused on the card partnership as sort of the means to drive profit for the partner more so than a way to really build the franchise. But those are some of the patterns. There are always exceptions to every rule.

But so we're still very much a believer in the card partnership business, but the key is we're going to be selective and never knowing that it's an auction-based business. That's the other thing one has to really be willing to walk away when the price is right. So with that, those are my thoughts, Moshe.

[Jeff Norris, executive]

Thank you, Rich, and thanks, everyone, for joining us on the conference call today. Thank you for your continuing interest in Capital One. Have a great evening.

[Operator]

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