Capital One Financial Corp

NYSE:COF

Earnings Call Analysis

Capital One Q3 2023: Earnings and Growth

In Q3 2023, Capital One reported earnings of $1.8 billion, a 7% rise from the prior quarter and 17% higher than last year. Loans and provisions saw a 1% growth mainly due to the domestic card segment which also experienced a 16% jump in ending balance and a 15% surge in revenue year-over-year. Revenue increased by 4%, whereas the expense was up slightly due to increased marketing efforts. Charge-off rates rose to 4.4%, with delinquencies increasing modestly since 2019. The forecast for key economic variables improved modestly, though some assumptions worsened. The Consumer Banking business posted a 13% growth in year-over-year deposits but saw a 10% dip in auto originations.

Capital One Sustains Profitability Amid Growth Challenges

This quarter, Capital One showcased its financial resilience, recording earnings of $1.8 billion, translating to $4.45 per share. Robust pre-provision earnings of $4.5 billion illustrate a healthy 7% and 17% rise from the previous quarter and year, respectively. Despite the macro-financial headwinds, the company maintained steady loan growth primarily fueled by its domestic card business, alongside a modest 1% increase in period-end deposits. Although expenses edged up 1%, remarkable revenue expansion of 4% powered overall performance, witnessing contributions from both heightened interest and noninterest income.

Loan Growth Drives Allowance for Credit Losses

The loan portfolio's expansion necessitated a $322 million increment in credit loss reserves, bringing the total allowance to $15 billion. The allowance coverage ratio underwent a slight 5 basis point uptick to 4.75%, reflecting a prudent, anticipatory stance towards potential economic downturns. Segment analysis reveals the domestic card business increased its allowance by $349 million due to loan growth, though the coverage ratio remained mostly untouched at 7.79%. Conversely, the consumer banking segment saw a $136 million reduction, benefiting from positive economic signals and loan balance contractions. The commercial banking segment, on the other hand, experienced a $97 million allowance hike amid growing interest rates and pressures on commercial real estate, edging the coverage ratio up by 12 basis points to 1.74%.

Liquidity and Net Interest Margin Indicate Financial Health and Strategy Adaptation

Liquidity remained robust, with the coverage ratio striking 155%, decisively up from both the previous quarter and the previous year, partly due to a $3 billion boost in cash position resting at approximately $45 billion. Net interest margin, a pivotal profitability indicator, reached 6.69%, representing a nuanced movement with a 21 basis point bump from the last quarter, although it registered 11 basis points lower year-over-year. This figure reflects a delicate balance struck between higher card yields, strategic loan portfolio composition, and increasing deposit costs.

Consumer Banking Challenges Offset By Digital Strategy and Resilient Card Segment Performance

Despite facing headwinds such as a 10% year-over-year decline in auto originations and a 5.4% dip in consumer banking ending loans, the digital-first approach helped bolster retail deposit growth, pushing ending deposits up by an impressive 13% compared to the prior year. However, consumer banking revenue fell by approximately 7% due to increased deposit costs and lessened auto loan balances and margins. Conversely, the card segment flourished with a 16% surge in ending loan balances and a 15% revenue increase from the previous year, driven by robust purchase volume. The enduring revenue margin stood strong at 18.24%, despite experiencing a 31 basis point drop from the previous year, showcasing the segment's vigor amidst economic challenges.

Solid Capital Ratios Enhance Stability and Growth Prospects

Capital ratios remain in healthy territory, with the common equity Tier 1 capital ratio concluding the quarter at 13%, displaying a steady rise and offering backbone support for strategic moves such as share repurchases. It's a reflection of the company's firm financial foundation and strategic focus on maintaining robust capital buffers.

Earnings Call Transcript 2023-Q3

[Operator]

Good day, and thank you for standing by. Welcome to Capital One Q3, 2023 Earnings Call. [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, executive]

Thanks very much, Amy, and welcome, everyone, to Capital One's Third Quarter (sic) [ 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 third quarter 2023 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 this presentation.

To access a copy of the presentation and the press release, please go to Capital One's website, click on Investors, then click on quarterly earnings release. Please note that this presentation may contain forward-looking statements. Information regarding Capital One's financial performance and any forward-looking statements contained in today's discussion and the materials speak only as of the particular date or dates indicated in the materials. Capital One does not undertake any obligation to update or revise any of this information, whether as a result of new information, future events or otherwise.

Numerous factors could cause our actual results to differ materially from those described in forward-looking statements. 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 Capital One website and filed with the SEC.

Now 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 third quarter, Capital One earned $1.8 billion, or $4.45 per diluted common share. Pre-provision earnings of $4.5 billion were up 7% compared to the second quarter and 17% 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 increased 1% in the quarter, while average deposits were flat. Our percentage of FDIC insured deposits ended the quarter at 80% of total deposits.

We have provided additional details on deposit trends on Slide 18 in the appendix. Revenue in the linked quarter increased 4%, driven by both higher net interest and noninterest income. Noninterest expense increased 1% in the quarter, as higher marketing expense was partially offset by lower operating expense. Provision expense was $2.3 billion with $2 billion of net charge-offs and an allowance build of $322 million.

Turning to Slide 4. I'll cover the allowance balance in greater detail. The $322 million increase in allowance brings our total company allowance balance up to $15 billion as of September 30. The total company coverage ratio is now 4.75%, up 5 basis points from the prior quarter. I'll cover the drivers of the changes in allowance and coverage ratio by segment on Slide 5. Relative to last quarter's assumptions underlying the allowance, the baseline forecast in this quarter for most key economic variables improved.

However, we continue to assume several key economic variables worsened from today's levels. In our Domestic Card business, the allowance balance increased by $349 million. The coverage ratio was largely flat at 7.79%. The predominant driver of the increased allowance was the growth in loans. The positive impact from the modestly improved economic outlook was largely offset by the impact of replacing the lost content of the third quarter of 2023 with a 12-month reasonable and supportable period, that now includes the third quarter of 2024.

In our Consumer Banking segment, the allowance balance declined by $136 million. The improved economic outlook and a decline in loan balances drove the release. And in our Commercial Banking business, the allowance increased by $97 million. The build reflected the impact of rising interest rates and other factors on certain commercial real estate and corporate borrowers, including our commercial office portfolio.

On Slide 17 in the appendix, we have included additional details on the office portfolio. I'll also note that in the third quarter, we completed the sale of approximately $900 million of loans from our commercial office portfolio that were previously marked as held for sale. The commercial -- the coverage ratio in the Commercial business increased by 12 basis points and now stands at 1.74%. Turning to Page 6. I'll now discuss liquidity. You can see our preliminary average liquidity coverage ratio during the third quarter was 155%. Up from 150% last quarter and 139% a year ago.

Total liquidity reserves in the quarter were largely flat at $118 billion. Higher cash balances were offset by a decline in the market value of our investment securities portfolio. Our cash position ended the quarter at approximately $45 billion, up about $3 billion from the prior quarter.

Turning to Page 7. I'll cover our net interest margin. Our third quarter net interest margin was 6.69%. 21 basis points higher than last quarter and 11 basis points lower than the year ago quarter. The quarter-over-quarter increase in NIM was largely driven by higher card yields a continued mix shift towards card loans and 1 additional day in the quarter, partially offset by higher rate paid on 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%. Approximately 30 basis points higher than the prior quarter. Net income in the quarter was partially offset by an increase in risk-weighted assets, common and preferred dividends and the share repurchases we completed in the quarter. With that, I will turn the call over to Rich. Rich?

[Richard Fairbank, executive]

Thanks, Andrew, and good evening, everyone. Slide 10 shows third 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. The domestic card business posted another strong quarter. Of year-over-year top line growth. Purchase volume for the third quarter was up 6% from the third quarter of last year. Ending loan balances increased $19 billion or about 16% year-over-year.

And third quarter revenue was up 15% year-over-year, driven by the growth in purchase volume and loans. Revenue margin declined 31 basis points from the prior year quarter and remained strong at 18.24%. The decline was driven by 2 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 revolve rate. On a linked quarter basis, the revenue margin increased seasonally by 48 basis points.

Domestic Card credit results continue to normalize from the historically strong results we saw during the pandemic, consistent with our expectations. The charge-off rate for the quarter was up 220 basis points year-over-year to 4.4%. The 30-plus delinquency rate at quarter end increased 134 basis points from the prior year to 4.31%. On a sequential quarter basis, the charge-off rate was essentially flat and the 30-plus delinquency rate was up 57 basis points. Both the monthly delinquency rate and the monthly charge-off rate are now modestly above 2019 levels.

Our delinquencies are the best leading indicator of domestic card credit performance and the pace of delinquency rate normalization is slowing. Noninterest expense was essentially flat compared to the third quarter of '22 of 2022. Total company marketing expense of $972 million for the quarter was also relatively flat year-over-year. Compared to the sequential quarter, marketing increased 10%. Our choices in domestic card are the biggest driver of total company marketing. We continue to see attractive growth opportunities in our Domestic Card business. Our opportunities are enhanced by our technology transformation.

And our marketing continues to deliver strong new account growth across the domestic card business. As a result, we are leaning into marketing to drive resilient growth and enhance our domestic card franchise. As always, we're keeping a close eye on competitor actions and potential marketplace risks. We expect fourth quarter marketing will be seasonally higher.

Slide 12 shows third quarter results for our Consumer Banking business. In the third quarter, auto originations declined 10% year-over-year, driven by the decline in auto originations, consumer banking ending loans decreased about $4.4 billion or 5.4% year-over-year. On a linked-quarter basis, ending loans were essentially flat. We posted another strong quarter in year-over-year retail deposit growth. Third quarter ending deposits in the consumer bank were up about $34 billion or 13% year-over-year.

Compared to the sequential quarter, ending deposits were up about 2%. Average deposits were up 12% year-over-year and up 1% 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 for the quarter was down about 7% year-over-year driven by the higher rate paid on deposits and lower auto loan balances and margins. Noninterest expense was down about 6% compared to the third quarter of 2022. Lower operating expenses were partially offset by an increase in marketing to support our national digital bank. The auto charge-off rate for the quarter was 1.77% up 72 basis points year-over-year.

The 30-plus delinquency rate was 5.64%, up 79 basis points year-over-year. Compared to the linked quarter, the charge-off rate was up 37 basis points, while the 30-plus delinquency rate was up 26 basis points, both of these linked quarter increases were better than typical seasonal expectations.

Slide 13 shows third quarter results for our Commercial Banking business. Compared to the linked quarter, Ending loan balances were essentially flat. Average loans were down about 2%. The decline is largely the result of choices we made earlier in the year to tighten credit. Both ending deposits and average deposits were down about 2% from the linked quarter, consistent with the general trend we've seen for several quarters as we continue to manage down selected less attractive commercial deposit balances.

Third quarter revenue was up 2% from the linked quarter. Noninterest expense was up about 6%. The commercial banking annualized charge-off rate for the third quarter declined 137 basis points from the second quarter to 0.25%. The second quarter charge-off rate was elevated by charge-offs we recognized when we moved the portfolio of commercial office loans to held for sale. We completed the sale of that portfolio in the third quarter.

Slide 17 of the third quarter 2023 results presentation shows additional information about the remaining commercial office portfolio. Which is less than 1% of our total loans. The Commercial Banking criticized performing loan rate was 8.08%, up 135 basis points compared to the linked quarter. The criticized nonperforming loan rate was essentially flat at 0.9%.

In closing, we continued to deliver solid results in the third quarter. We posted another quarter of strong top line growth in domestic card revenue, purchase volume and loans. The pace of domestic card delinquency normalization slowed. We grew consumer and total deposits. And we added liquidity and capital to further strengthen our already strong and resilient balance sheet. Turning now to operating efficiency. The third quarter operating efficiency ratio was particularly strong. Operating efficiency ratio can vary from quarter-to-quarter, driven by the timing of revenue and operating expense.

We expect 2023 annual operating efficiency ratio net of adjustments, will be modestly down compared to 2022. Pulling way up, our modern technology capabilities are generating an expanding set of opportunities across our businesses. We are driving improvements in underwriting, modeling and marketing as we increasingly leverage machine learning at scale. At our tech engine drives growth, efficiency improvement and enduring value creation over the long term. We remain well positioned to deliver compelling long-term shareholder value and to thrive in a broad range of possible economic scenarios. And now we'll be happy to answer your questions. Jeff?

[Jeff Norris, executive]

Thanks, Rich. We will now start the Q&A session. [Operator Instructions] Amy, please start the Q&A session.

[Operator]

[Operator Instructions] Our first question comes from the line of Ryan Nash with Goldman Sachs.

[Ryan Nash, analyst]

Good evening, everyone. So Rich, you noted several times that delinquency normalization has slowed. It looked like September charge-off performance was better than we would have expected. But we are hearing from others that pressure is becoming broader, not just sub-prime, but it's also into prime. So can you maybe just talk about what you're seeing within your portfolio? What do you think about the pace of delinquency normalization? And do you have any line of sight when you think losses will inevitably peak?

[Richard Fairbank, executive]

Thanks, Ryan. So let's just pull up on the metrics here. Our third quarter domestic card charge-off rate was essentially flat from the prior quarter, up 2 basis points to 4.4%. Our 30-plus delinquency rate increased 57 basis points from the prior quarter to 4.31%. On both our losses and our delinquencies are modestly above their pre-pandemic levels. Now let's talk about sort of what's happening at the margin here. The trend of normalization in our credit metrics appears to be slowing. In August and September, the month-to-month movement in our delinquencies was essentially in line with normal seasonality for the first time since normalization began.

We've also seen some stabilization in new delinquency entries. Relative to normal seasonal patterns. So we are hopeful these stabilization trends continue. Now charge-offs, of course, are a lagging metric, so they have some months of catching up still to do. In auto, we have seen stabilization even longer. Our losses are modestly above free pandemic levels, but moving in line with normal seasonality for the past few quarters. So back to our card business for a moment. There's another stabilization trend that we see as well, which is our recovery rate.

Our recovery rate had been falling for several years because of the low level of charge-offs through the pandemic. So we've had less inventory, if you will, to recover on. And this was a larger effect for Capital One than for most of our competitors because we tend to have meaningfully higher recovery rates than the industry average. And because we tend to work our own recoveries, so they come in over time and not all at once, like in a debt sale. We've now seen the recovery rates stabilize. Although it remains at unusually low levels. Now recoveries, of course, don't impact our delinquencies, but they are a pretty significant factor when -- in our charge-offs and particularly when comparing our charge-offs to pre-pandemic benchmarks.

Now another Capital One's specific point here. There's another factor sort of driving stabilization, but this is -- has been going on for a long time. And that's the stability of credit performance in our recent origination vintages. So looking ahead, the economy is, as always, a source of uncertainty. In our outlook, we still expect the unemployment rate to worsen over the coming year. And as always, we remain very focused on resilience in our underwriting and making sure that we build resilience a lot of resilience into all of our choices.

[Ryan Nash, analyst]

Maybe, Rich, as my follow-up question, so Andrew, you had highlighted that the domestic card allowance was relatively stable. And I think you gave 3 different factors. Maybe can you just remind us again what is included from a macro perspective in terms of unemployment? And if I take what Rich said regarding delinquency slowing and obviously, charge-offs are catch up a little bit. Do you think we're at the point where the replacement and the allowance is going to be less of a tailwind of a headwind going forward. And we can now finally have allowance more closely following the allowance build more closely following the loan growth? .

[Andrew Young, executive]

Sure, Ryan. So to your economic assumption point, I'll focus on unemployment rate, although recall that a whole lot more is considered a whole bunch more variables, but we are now assuming the unemployment rate moves into the mid-4s by the middle of [ '24 ]. And basically hold there for a period of time. But it's not just the absolute level of unemployment. As we've talked about before, it's also the change that influences underlying credit performance. How that then plays through the allowance though, like a number of factors are going into the allowance calculation.

As Rich said, the projected loss rates are going to be by far the biggest driver. And as we've talked about many times, delinquencies are the best leading indicator of of credit performance, particularly over the next couple of quarters. And I won't go through the reasonable and supportable and reversion process elements that -- we've discussed previously, but I will say beyond the credit forecast, it is worth noting that the allowance framework considers a range of outcomes and uncertainties which are generally wider in periods of either worsening or improving transitions. So at the core of your question, even in a period where projected losses in future quarters may be lower than today and might otherwise indicate a release we could very well see a coverage ratio that remains flat or only modestly declined, at least in the near term as we incorporate the related uncertainty into the allowance. And so we'll go through our process as we do every year to take all of those factors into account and roll forward the allowance each quarter.

[Jeff Norris, executive]

Next question please.

[Operator]

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

[Mihir Bhatia, analyst]

I was curious in terms of the health of the consumer, I was curious if you're seeing trends at all diverge between higher FICO and lower FICO scores, whether it's on credit performance or spending as we go through the recovery?

[Richard Fairbank, executive]

Yes, Mihir. Thank you for your question. So let's talk about credit performance. When credit first started to normalize, we called out that this trend was more pronounced at the low end of the market, whether defined by income or credit score. And strikingly, those were the segments that had improved the most early in the pandemic. So this was not surprising to us. .

Later, we observed that normalization was becoming more broad-based. And in fact, for many quarters now for several quarters now, every segment was basically normalizing at about the same rate. In other words, if you look at for any segment where it's credit metrics were relative to like its delinquencies, for example, relative to pre-pandemic every segment was kind of on top of each other. Everything had caught up.

Now we are seeing stabilization come more quickly at the lower end of the market. In fact, over the last few months, our delinquencies in these segments have essentially stabilized on a seasonally adjusted basis. And our upmarket segments are sort of just a little bit behind that. So now I don't think this is necessarily a description of the marketplace per se. This is what we see at Capital One. Our performance has been assisted by some of the underwriting changes that we made over the past couple of years, especially in response to credit to what we anticipated would be the impact of credit scores inflating FinTech's flooding the market.

So as we've been talking about really for a couple of years now, we -- in our originations -- and overall in our credit policy, we were trimming around the edges for things that we saw or risks that we anticipated, and this has contributed, I think, to strength and stability and performance that's now contributing to what we see here. In terms of spend, the spend is basically -- pretty -- when we look at spend per customer, this has really moderated after the surge of spending coming out of the pandemic. So year-over-year, I'm [ commit ] an overall Capital One point. Year-over-year spend growth per customer has been roughly flat for several months. So the growth in spend that you're seeing in our metrics is really being driven by new account origination.

Now with respect to the various segments. The spend on the -- at the lower end of the marketplace is certainly probably the most moderated, although we -- it moderated first, we've seen spend growth across our segments. Sort of fairly moderated, but I'd say the biggest effect on the moderating side has been in the lower end of the market.

[Mihir Bhatia, analyst]

And then maybe just turning to NIM very quickly. Can you just talk about some of the puts and takes on them in the near term, particularly on the deposit competition side. Any thoughts on where deposit betas go? What are you seeing from a competitive standpoint? .

[Andrew Young, executive]

Yes. With respect to beta -- as we've discussed in previous calls, there's really a couple of key factors that are impacting betas. The first is product mix. Sort of the rotation of customers across products. And then the second is competitive pricing. And within that, I would include the notion of just deposit pricing lags that we've talked about. And so for us, the quarter-over-quarter beta with that lag effect was something like 160%. Our cumulative beta now stands at [ $57 million ]. And so that getting factored into NIM as we look ahead on that dimension, particularly assuming if rates do stay higher for longer, I wouldn't be surprised if there continues to be some upward pressure on beta at least in the near term, driven by those factors that I described, the pricing and product mix piece.

So beyond that then, in the NIM, we have seen spreads widen a bit here and wholesale funding costs are up a bit. And I think Rich talked about suppression in card, but depending on the path of credit, there's the potential at least for increased revenue suppression. So I would lump all of those 3 things together as potential headwinds. But -- from a tailwind perspective, we can continue to see growth in card and particularly revolving card balances as a percent of the balance sheet like you saw this quarter. And then the other thing that I would note, even though cash balances remain elevated relative to historical standards, I think we will see it settle out at a level that's higher than pre-pandemic but ultimately lower than where we are today as you look ahead over multiple quarters.

So those are really the primary factors that I would say are at play with respect to NIM.

[Jeff Norris, executive]

Next question please. .

[Operator]

Our next question comes from Arren Cyganovich with Citi.

[Arren Cyganovich, analyst]

Just touching on the last discussion on net interest margin. The card loan yields expanded, I think, 89 basis points, and that was quite a bit higher than the base rate expansion for the quarter. You mentioned higher revolve rates. Is that part of what you're seeing there? And how do the revolve rates compare today versus maybe where they were pre-pandemic?

[Andrew Young, executive]

Yes. So part of it, Arren, is just said, if you're looking at yield as opposed to margin is you get a tailwind just from the the Fed rate changes, but the other primary and larger factor than the Fed changes is, I would say, largely seasonal which does -- we typically see revolve rates in the third quarter just naturally be higher than they are throughout the year. And we also tend to see a bit more on the late fee piece there. So there is a seasonality dimension in terms of where we are with revolve rates going forward. I'll let Rich talk a little bit about the trends that we're seeing in the portfolio.

[Richard Fairbank, executive]

Yes, Arren. So overall, in our Domestic Card business, revolve rates are basically where they were. So for example, third quarter 2023 revolve rates right on top of third quarter 2019, but it's very sort of very different within segments. The place that the revolver rate is quite a bit higher is in our partnerships business because we have the Walmart portfolio. We didn't have before the pandemic pretty much everywhere else across our branded book revolve rates are a little bit generally speaking a little bit to quite a bit lower than they were before. But the net impression I would leave with you, so our branded book overall is somewhat lower. And the -- and the partnerships have offset that.

[Arren Cyganovich, analyst]

Got it. And then on the marketing, it looks like it was down just slightly year-over-year, still almost double where it was from a pre-pandemic perspective. Have you essentially hit kind of a almost a peak here in terms of marketing dollars? And how do you think the expenses will go from there with respect to that?

[Richard Fairbank, executive]

Okay. Well, Arren, the -- on marketing. So just pulling up total company marketing was up 10% compared to the prior quarter and flat year-over-year. let's just pull up and talk about the big drivers of our marketing. First, we continue to really like the opportunities we're seeing in the market. Including additional -- the opportunities that we get in expanding channels and growing the number of card products, we have the benefit from our technology transformation that sort of is everywhere in what we do as we leverage more data. We're able to take advantage of powerful machine learning models, create customized better experiences for consumers. So that continues to have a lot of traction, and we are leaning into that.

We also a very important part of our marketing spend and a thing we're really leaning into is our focus on heavy spenders. So -- when we think about our quest for heavy spenders, it really goes back to 2010 when we launched our Venture card, and that was the beginning of a strategic push that we have continued and accelerated ever since. And that involved more than just putting an attractive product out there. Heavy spenders of course, to win with heavy spenders, we need great servicing, jaw-dropping customer experiences, of course, great value propositions.

And this takes a significant investment in upfront promotions and in marketing and in brand building. And this is all about my observation, all the years of doing this business and watching players who succeed here and those who get less traction is very much about a sustained investment and the -- ultimately, the brand that one builds.

So we're continuing to invest also in building the properties and experiences to drive heavy spender growth at the top of the market. So these investments include our travel portal. Access to exclusive properties and experiences, airport lounges and Capital One shopping. And our sustained investment at the top of the market has helped drive momentum in -- overall in our spender business, but we've grown even faster with the heaviest of spenders.

And we very much like this business. In addition to the obvious spend growth we're enjoying, it generates strong revenues, has very low losses, low attrition. And lifts the entire brand of the company. The final factor driving our marketing levels is our investment in continuing to build our national bank. And of course, as we have a smaller branch footprint, our growth is powered by modern technology compelling digital experience, a cafe presence in heavily traveled locations across the nation and, of course, a sustained investment in marketing.

So these are the really compelling opportunities that are driving our marketing levels. And we continue to see great traction pretty much across the board, and we continue to lean into these opportunities. And it's an important part of the creation of long-term value for our shareholders.

[Operator]

Our next question comes from Rick Shane with JPMorgan.

[Richard Shane, analyst]

I'd just like to talk a little bit about the depository franchise. Obviously, there's been very strong growth this year in the consumer banking franchise, particularly on the deposit side. Can you just talk a little bit about the competitive landscape -- you started -- Rich, you talked a little bit about the network, the cafes, the less concentrated branch approach. But can you describe what you're seeing sort of broadly in the market where you think you're gaining share? .

[Richard Fairbank, executive]

Well, one of the -- thank you, Rick. One of the core strategic approaches of Capital One, it really defines the founding idea of the company and pretty much all the choices we've made sense is to look at the marketplace and the [ Tsunami ] forces that are driving such change in the marketplace and really try to discern with all the noise in these marketplaces. Where is it that -- where is winning going to be? What's the future of these things? And almost always, it's a question of how technology is driving change. And so in retail banking, we, of course, entered banking way back in the mid OOs driven most importantly by a desire to transform the balance sheet of our company to get away from capital market reliance and get not just a deposit driven balance sheet, but an insured deposit-driven balance sheet, hence, the quest for a consumer deposit franchise.

Now along the way, as a very important part of our strategy as well. We look forward to trying to get at the forefront of where the world was going to go over time with respect to retail banking. From a heavy reliance on branches. And by the way, I want to say at the outset, I think branches will be an important thing in the -- in banking for as far out as we can see. But you just can't help but see the evolution from the branch on the corner to the branch in your hand and really over time -- sorry, to the bank in your hand, to, over time, the bank in your life that's very digitally interactive and both reactively and proactively being there where a consumer needs it on a real-time customized basis.

So that's -- that's where we have -- that's the vision that we've been working backwards from. So in that journey, the first step, of course, was building a national savings business that was absolutely central to our balance sheet strategy for the company. But beyond that, we have worked very much to build a not just a national savings business, but a national full-service bank. And to do that, it's not just a matter of sort of offering checking accounts, but I think Capital One was in a unique position, having retail banks in branches in about 20% of the nation and have a lot of experience with retail banking.

Our view was if we're going to win in National Banking, we actually have to digitize the entire customer experience and just about everything that you can get in a branch to be able to -- for customers to get that on a digital basis. So what we've done over the years is build a full service digital, national bank. And we -- then as we have built this, we have then leveraged the big customer base we have, the national brand that we have and really added to our marketing and everywhere in our strategy, the build-out of this national bank, and we're getting a lot of traction, nice growth and a lot of traction on the brand side as consumers realize that Capital One, even though the [indiscernible] branches across the nation really is a full service national bank. So that's been our strategy for years. We continue to -- it's an important thing that we lean into from a marketing point of view.

But basically, our quest is to build -- continue to build a national bank without getting there by virtue of just lots and lots of acquisitions of branch-based banks.

[Operator]

Our next question comes from Don Fandetti with Wells Fargo.

[Donald Fandetti, analyst]

Rich, I was wondering, given your good trends in auto delinquency, are you sort of inclined to be leaning a little harder into auto lending? Or do you need to see something before making that decision? .

[Richard Fairbank, executive]

Don, thank you for your question. It's funny. We have [ Zing ], while others is [ ZAG ] for so long -- as long as I can remember in the auto business. And our strategy isn't just as [ Zig ], while others [indiscernible], it's always to look at this marketplace. And really objectively see where the opportunities are. This is a more volatile business in terms of our growth strategies, then the credit card business is because of the role that a dealer plays in the business in a sense, holding auctions at the dealership such that -- we -- our growth strategies are particularly sensitive to the credit and underwriting choices that our competitors make because it's sort of amplified in this auction-based environment with dealers really quite a contrast from the credit card business -- to the credit card business where certainly the competitive choices matter.

But it's really still a one-on-one business with our customers and prospective customers. That's why you see so much more stability in sort of the marketing and the marketing sort of and the and leaning into the growth that you see on the card side. So as when you think about the last few years. So we've certainly had in the last 5 or 6 years, tremendous growth and traction in the auto business. And we -- our strategy was so powered by our technology that we've invested in the business, the data, the underwriting capabilities and the very deep relationships that we've been building with dealers. Over the last couple of years, were concerned at what was happening with margins as they were pressured by interest rate increases in 2022 and early 2023. Some competitors were slow to adjust their pricing. Now more recently, industry lending margins have largely normalized as interest rates have stabilized and many players, including late movers, have continued to increase pricing.

The -- the other thing, of course, was watching very closely the credit side of the business. And we -- just as we did in the card business, probably actually more proactively and more significantly in auto we trimmed back around the edges in anticipation of certain worsening and with concerns about score drift in with respect to the data for -- from consumers. So that has -- and you've seen the data that where Capital One has pulled back quite a bit. Our outstandings have been shrinking a little bit. You also have seen the striking credit performance we've had and the stability now that is at least 2 quarters long in terms of what we're seeing on various credit metrics.

So seeing the good metrics and seeing the marketplace, we're certainly on the lookout for opportunities, but I'm not here to predict an acceleration, but we certainly do like the performance of both our front book and our back book at this point.

[Operator]

Our next question comes from Sanjay Sakhrani with KBW.

[Sanjay Sakhrani, analyst]

First question just on the adjusted operating efficiency rate. You've seen some nice improvements over the last 2 quarters. And I know, Rich, you talked about sort of the year outlook. I'm just wondering if we could see this type of level or trends sustain itself into next year? .

[Richard Fairbank, executive]

Sanjay, we're not going to be giving out guidance on at this point on where operating efficiency goes. We certainly are pleased with the progress that we've made over time in operating efficiency ratio even as we've continued to really invest in the business and we're starting to see -- we have these 2 competing things going on inside Capital One, both a real investment in technology and also at the same time, generating a bunch of benefits and efficiencies from that technology.

So the net result of these 2 things has been -- we've been able to really make tremendous strides forward in technology and also get some efficiencies along the way. I wouldn't put too much reliance on any 1 quarter. You know these numbers kind of bounce around. But certainly, you probably noticed that in our guidance, we had guidance of flat to modestly down with respect to our efficiency ratio for full year 2023, and we took the the flat part out, and we're now just at modestly down. So we continue to believe, over the long term, that our technology transformation offers a lot of promise for operating efficiencies and delivering operating efficiency is an important part of, I think, the value creation equation for investors.

I do want to say, though, at the same time, we continue to really see great opportunities in the business. We continue to still invest in technology to capitalize on even greater opportunities over time. And that's that's the story of our operating efficiency ratio.

[Sanjay Sakhrani, analyst]

Perfect. Then I have a follow-up question just on the leaning into growth in card. Where exactly is that happening? I mean, obviously, you talked about adjusting the risk parameters, and that's obviously flowing through in the credit numbers improving. Is it more on the transactor side that you're leading into growth? Or is it balanced across all segments? I'm just curious sort of the implications on a go-forward basis?

[Richard Fairbank, executive]

Yes. Thank you. So we are finding traction across the spectrum really. So -- and we're leaning in across the spectrum. One thing I do want to say about growth, the outstandings growth if we really think about just the strength of loan growth -- for a while, the striking loan growth for Capital One and the industry was we all said, well, this is just reversing the pullbacks from the pandemic. But I think for us and for a lot of players in the industry, these loan numbers have blown past prior levels. And let's just reflect a little bit on what has sustained this. My view is Well, there's the Capital One effect. We continue to have significant new account growth, and that obviously powers a lot of overtime loan growth.

Payment rates are coming down. Interestingly, they have come down quite a bit. But as a general statement, they're not down to where they were before. Part of that mix effect at Capital One because we've had a lot of traction on the spending side. But even within segments, if I were to generalize, payment rates, the payment rates are still higher than they were pre-pandemic.

So again, inside that, there's partly a Capital One effect, but I think also sort of a strength of the consumer effect. However, the payment rates have come down and that somewhat and that has powered growth. And I think likely no one's going to be able to prove this, but I think there are inflation effects underneath the surface. When things cost more as long as consumer incomes stay -- stay up to where inflation is, you generally have some natural, I think, inflation effects that drive some of this growth as well. So we see a lot of strength there. And some of those are Capital One specific comments I'm making and several of those are really kind of industry points.

[Operator]

Our next question comes from John Pancari with Evercore ISI.

[John Pancari, analyst]

On the -- back to the -- your commentary around the slowing pace of the increase in delinquencies that you're seeing in card and some of the stabilization that you're citing I know you indicated that charge-offs should of course, lag that. Can you give us maybe some way to think about how long that lag could be? Is it a 2- to 3-quarter type of window that we're looking for for losses to follow through on that front? .

[Richard Fairbank, executive]

Well, I don't want to make a precise prediction on that. I want to first of all, pull up and say, when we -- it's -- the thing that we tell everybody to look at is -- what we say is what we look at is delinquencies because that is the that is the first indicator. That's why we have been talking not just quarterly but really even looking at the last couple of months and seeing the sort of more stabilization on the credit card side, which is very encouraging. Delinquency basically customers go delinquent and ultimately charge off 6 months later.

And so there is -- but sometimes they go faster, sometimes they go slower. And of course, lots of times they make their payments. But we're talking about these things being measured in over a couple of quarters. The relationship between the delinquencies and the charge-offs .

[Jeff Norris, executive]

Next question, please.

[Operator]

Our next question comes from Erika Najarian with UBS.

[L. Erika Penala, analyst]

Yes. I hate to re-ask this question, but I think a lot of investors want to make a fine point on this in the fourth quarter. Going back to Ryan and John's question about net charge-offs I think that perhaps what's holding back credit-sensitive financials is obviously the prospect of recession -- but Rich, everything that you've said has seen positive pace of delinquency rate normalization slowing, stability of credit performance in recent vintages. As we think about what happened in September in terms of the card charge-off rate and look at the quarterly charge-off rate in third quarter and second quarter. Is it fair to draw the conclusion that as we look forward to the fourth quarter net charge-off rate that given the stability of all the leading indicators that the charge-off rate will be mostly driven by seasonality rather than normalization if normalization has stabilized for now?

[Richard Fairbank, executive]

Yes. So Erika, thanks for your question. Let me say a few things. So let's -- first of all, one of the things that makes this already challenging business for everyone studying it, including those of us who live it every day. is the seasonality in the volatility, which a big element of that is seasonality. So let's just let's talk just a little bit about seasonality. Card and auto delinquencies tend to improve each year around the tax refund season and then they worsen gradually over the rest of the year. .

The second quarter is typically the seasonal low point for card delinquencies and Q4 is the seasonal high point. Card losses lag relative to delinquencies. So they tend to be seasonally lowest in the third quarter and highest in the first quarter. And now in the third quarter, so our domestic card delinquencies increased. So it's kind of interesting that we're talking about sort of a leveling -- a stabilizing kind of direction when we're actually looking at delinquencies for the quarter that went up 57 basis points on a a sequential quarter basis. And that's versus a typical seasonal expectation of kind of -- sort of somewhere in the neighborhood of like 37 basis points. But -- so you can even see for the quarter that most of the increase that we observed was seasonal. But then that's where we've said. If you zoom in the month -- the months of August and September, the month-over-month movement is getting really close to just the normal seasonal trend.

And so this is one of the early indications that the trend of normalization we've been seeing may be stabilizing. Now one thing I want to say, obviously, you hear bullish man in my commentary, I'm not here to just wave my arms and declare a turn. We have a couple of months of very encouraging data. We'd love to see more data where we have seen a couple of quarters where we've seen a longer stretch of data is in the -- more on the lower end of the card business, interestingly, as I talked about, and in the auto business.

So that's where things have really kind of appear to have stabilized. Our upmarket card business is getting there a little bit not quite as -- not quite there yet. So I start by saying we'd love to see a little more data to be fully confident of what we're seeing. The second thing I want to say with -- then now to your question about charge-offs, first of all, what we see, especially in the months of August and September, you're not going to see that show up with stabilized charge-offs as soon as the fourth quarter because it really is a couple of quarters that -- to the earlier question that was asked, it's really a couple of quarters before the charge-offs performed sort of in line with the -- with the delinquencies.

So we're not going to make predictions here, and I don't -- I just I always -- we're always very kind of try to be as clear as we can on what we see. We happen to see some pretty positive things here, but they can also be ahead fake and a head fake and not be as good as they appear.

[Jeff Norris, executive]

Next question, please.

[Operator]

Our next question comes from Dominick Gabriele with Oppenheimer.

[Dominick Gabriele, analyst]

When you think about capital ratios and Basel game and the need to build capital specifically for unused lines, how do you think about mitigating if at all, mitigating your unused lines and given your capital target of about 11% today, maybe you could just talk to us about the factor of Basel unused lines and the effect going over on your capital levels and the ROTCE target? And then I just have a follow-up, if you don't mind.

[Andrew Young, executive]

Yes, I'm going to come back, Dominick, because the last half of your question. I wasn't sure I followed it. But in terms of unused lines, one of our long-standing strategies has been to start people with smaller lines and allow them to grow. And so I would say, I wouldn't expect a meaningful shift in that strategy solely in the service of risk-weighted assets. So overall, though, as you look at the risk weightings that have come out in the end game proposal. For us, in aggregate, recall, we're not in mortgage or trading.

So -- looking at the net of retail and commercial, inclusive of the gold plating, those are largely fighting to a draw in terms of overall risk-weighting impact, specifically on the asset side. Like everyone else, of course, we're going to have an impact from the operational risk RWA. But I didn't quite follow the second half of your question around ROTCEs. Could you just for me?

[Dominick Gabriele, analyst]

Sure. Sorry about that. I was just curious if you basically had to hold more capital because it's my understanding that you would have to hold additional capital against unused lines versus just drawn lines now. And so I was just curious if your capital ratio would have to rise and -- and if that would affect the long-term return on like return on in any way?

[Andrew Young, executive]

Got it. Yes, sorry, I didn't quite follow the second half of it. That was what I was trying to explain in my answer is -- the net of all of that ultimately ends up being a wash, the part where we will be holding more capital on the denominator side, strictly for the risk-weighting assets again, I should highlight that it's in a comment period, a lot of industry focus on it and well, particularly as it relates to the opt risk calculation, there could be material impacts the final outcome relative to what's proposed.

But taking what is currently proposed, the asset side specifically outside of the operational risk ends up being roughly a draw for us, and it's really just the operational risk that's going to require us to hold more capital.

[Jeff Norris, executive]

Dominick, you have a follow-up? Next question, please. .

[Operator]

Our next question comes from Bill Carcache with Wolfe Research.

[Bill Carcache, analyst]

So I wanted to ask about the leaf fee proposal. The consensus view is that we'll get it very soon. It will be immediately litigated. Can you give us your view on the likely path that you would anticipate and possibly speak to any potential costs that might be associated with it?

[Richard Fairbank, executive]

Okay. Thank you, Bill. So the CFPB's late fee proposal as currently contemplated would reduce late fees by approximately 75%. And while the CFPB's proposal has not yet been finalized, we expect the CFPB to publish a proposal soon, probably before the end of the year. Now once the CFPB publishes its final rule, we expect there to be industry litigation that could delay or block the implementation of this rule. And this litigation will likely delay the implementation of the rule until at least the second half of 2024 and maybe longer. If the proposed rule is implemented, there will be a significant impact to our P&L in the near term. .

However, we have a set of mitigating actions that we're working through that we believe will gradually resolve this impact a couple of years after the rule goes into effect. These choices include changes to our policies, products and investment choices. Some of these actions will take place before the rule change takes effect many will come after the rule change takes effect .

[Jeff Norris, executive]

Next question, please. .

[Operator]

Our final question is a follow-up from Dominick Gabriele with Oppenheimer.

[Dominick Gabriele, analyst]

Sorry about that. I think I got cut off. Can you hear me okay? .

[Richard Fairbank, executive]

Yes, we can Dominick.

[Dominick Gabriele, analyst]

All right. Sorry about that, guys. I was actually just curious on the quarter-over-quarter increase in domestic card yield. I know that there's sometimes some seasonality in the third quarter, and we've also had a lot of rate hikes in previous years around the third quarter. I was wondering if you could just walk us through some of the dynamics in the quarter-over-quarter increase in domestic card?

[Andrew Young, executive]

Yes, Dominick, I can't remember who asked it earlier, but just reiterating some of those points, I think you largely answered answered your own question, which is there is seasonality that in part is -- or is a function of the revolve rates driven by some of the dynamics Rich talked about over the course of the year, we did see the Fed the Fed move. And then we also saw a bit of late fees, which I would lump into the seasonality dimension. And then finally, we had one more day in the third quarter, so day count in an absolute sense, not necessarily relative to peers, which I think was the nature of the question earlier. But but at least in an absolute sense. Those are the big drivers of what drove the quarter-over-quarter yield.

[Jeff Norris, executive]

Well, thanks, everybody, for joining us on the conference call this evening, and thank you for your continuing interest in Capital One. Investor Relations team will be here later this evening to answer any questions that you may have. Have a great evening, everyone.

[Operator]

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