Earnings Call Transcript - COF Q1 2023

Jeff Norris, Senior Vice President of Finance

Thanks very much, and welcome, everybody, to Capital One's First Quarter 2023 Earnings Conference Call. As usual, we are webcasting live over the Internet. To access the call on the Internet, please log on to Capital One's website, capitalone.com, and follow the links from there. In addition to the press release and financials, we've included a presentation summarizing our first quarter 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. 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 that are accessible at the Capital One website and filed with the SEC. With that, I'll turn the call over to Andrew.

Andrew Young, CFO

Thanks, and good afternoon, everyone. I'll start on Slide 3 of tonight's presentation. In the first quarter, Capital One earned $960 million or $2.31 per diluted common share. Pre-provision earnings of $4 billion were flat to the fourth quarter and up 3% relative to the fourth quarter net of adjustments. Period-end loans held for investment declined 1% and average loans were flat. Total deposits grew throughout the quarter, increasing 4% on average and 5% on an ending basis. The increase in deposits was driven by strong retail deposit inflows, which was slightly offset by a decline in our commercial deposits. Our strong retail deposit growth drove our percentage of FDIC insured deposits up 2% to end the quarter at 78% of total deposits. Revenue in the linked quarter decreased 2%, primarily driven by lower noninterest income while net interest income was largely flat. Noninterest expense decreased 3% in the quarter, driven by a decline in marketing from the seasonally higher fourth quarter. Provision expense was $2.8 billion, driven by net charge-offs of $1.7 billion and an allowance build of $1.1 billion. Turning to Slide 4, I will cover the changes in our allowance in greater detail. The $1.1 billion increase in allowance brings our total company allowance balance up to $14.3 billion as of March 31st. The total company coverage ratio is now 4.64%, up 40 basis points from the prior quarter. In our allowance, our assumptions for key economic variables remain similar to those of last quarter. We continue to assume economic worsening from today's levels on most measures. I'll cover the drivers of the changes in allowance and coverage ratio by segment on Slide 5. In our Domestic Card business, the allowance balance increased by $867 million, increasing our coverage ratio by 69 basis points to 7.66%. Our build in the quarter was primarily driven by three factors: the first factor is the impact of underlying growth in the quarter, which replaced seasonal balances from the fourth quarter for which we held minimal allowance. The second factor is the impact of removing the relatively lower loss content from the first quarter of 2023 and replacing it with higher forecasted loss content for the first quarter of 2024. Recall that our allowance methodology uses a 12-month reasonable and supportable forecast period before it begins to revert to our historical loss average with additional consideration of qualitative factors. And finally, the third factor in our allowance build was the impact of acquiring the BJ's portfolio in the quarter. In our Consumer Banking segment, the allowance balance declined by $32 million, mostly driven by the decline in loans. The coverage ratio increased by 2 basis points and now stands at 2.82%. And finally, in our Commercial Banking business, the allowance increased by $245 million. The coverage ratio increased by 28 basis points and now stands at 1.82%. The allowance increase was driven by a $262 million reserve build related to our $3.6 billion commercial office portfolio. The coverage on the commercial office portfolio increased about 770 basis points and now stands at 13.9%. We have provided additional details on this portfolio on Slide 17 of the presentation. Turning to Page 6, I'll now discuss liquidity. You can see our preliminary average liquidity coverage ratio during the first quarter was 148%, up from 143% last quarter and 140% a year ago. Total liquidity reserves in the quarter increased by $20 billion to $127 billion, primarily driven by increased levels of cash. Our cash position ended the quarter at $47 billion, up $16 million from the prior quarter. This increase in our cash position was primarily driven by the strong consumer deposit growth I referenced earlier. We expect average cash balances in the near term to be elevated relative to pre-pandemic levels. In addition to the higher cash, the market value of our AFS securities portfolio grew $5 billion to $82 billion at the end of the quarter. Turning to Page 7, I'll cover our net interest margin. Our first quarter net interest margin was 6.6%, 24 basis points lower than last quarter and 11 basis points higher than the year ago quarter. The 24 basis point quarter-over-quarter decline in NIM was driven by two factors: first, 15 basis points of the decline was a result of having two fewer days in the quarter; and second, the mix impact of the elevated cash balances that I previously described pressured NIM by approximately 11 basis points. Outside of these two effects, higher asset yields roughly offset higher funding costs. Turning to Slide 8, I will end by discussing our capital position. Our common equity Tier 1 capital ratio ended the quarter at 12.5%, flat to the prior quarter. Net income in the quarter and lower risk-weighted assets were offset by common and preferred dividends, the $150 million of share repurchase we completed in the quarter and a 17 basis point impact from the phase-in of the CECL transition. At the end of the first quarter, the unrealized losses in AOCI from our AFS investment portfolio were $6.7 billion. If we were to include the impact of these unrealized losses in our regulatory capital, our CET1 ratio would have ended the quarter at 10.5%, and we continue to estimate that our longer-term CET1 capital need is around 11%. With that, I will turn the call over to Rich.

Richard Fairbank, Chairman and CEO

Thanks, Andrew, and good evening, everyone. I'll begin on Slide 10 with first quarter results in our credit card business. Year-over-year growth in loans and purchase volume drove an increase in revenue compared to the prior year quarter. Credit Card segment results are largely a function of our domestic card results and trends, which are shown on Slide 11. In the first quarter, strong year-over-year growth in every top line metric continued in our Domestic Card business. Purchase volume for the first quarter was up 10% from the first quarter of 2022, ending loan balances increased $23 billion or about 21% year-over-year and revenue was up 17% year-over-year, driven by the growth in purchase volume and loans. Revenue margin declined 58 basis points from the prior year quarter and remains strong at 17.7%. Revenue margin continues to benefit from growth in the high-margin segments of our card business. In the first quarter, that benefit was more than offset by two factors: first, loans are currently growing at a faster rate than purchase volume and net interchange revenue, which is a tailwind to revenue dollars, but a headwind to revenue margin. And second, as charge-offs increase, we're reversing more finance charge and fee revenue. Both the charge-off rate and the delinquency rate continued to normalize. The domestic card charge-off rate for the quarter was up 192 basis points year-over-year to 4.04%. The 30-plus delinquency rate at quarter end increased 134 basis points from the prior year to 3.66% and is now essentially at its March 2019 level. The charge-off rate hasn't caught up yet, but based on what we see in our delinquencies, we think the monthly charge-off rate will get back to 2019 levels around the middle of this year. Noninterest expense was up 11% from the first quarter of 2022, driven by higher operating expense, partially offset by a modest year-over-year decline in marketing. Total company marketing expense was $897 million in the first quarter. Our choices in domestic card marketing are the biggest driver of total company marketing. First quarter marketing was down about 2% from the year ago quarter and down about 20% from the fourth quarter of 2022 as the first quarter is typically the seasonal low point for domestic card marketing. We continue to see attractive growth opportunities in our Domestic Card business. Our opportunities are enhanced by our technology transformation, and we're leaning into marketing to drive resilient growth. As always, we're keeping a close eye on competitor actions and potential marketplace risks. We are seeing the success of our marketing and strong growth in domestic card new accounts, purchase volume and loans across our card business and strong momentum in our decade-long focus on heavy spenders at the top of the marketplace continues. Slide 12 shows first quarter results for our Consumer Banking business. In the first quarter, auto originations declined 47% year-over-year and 6% from the linked quarter. Driven by the decline in auto originations, Consumer Banking ending loans decreased $2.2 billion or 3% year-over-year. On a linked-quarter basis, ending loans were down 2%. We posted another quarter of strong retail deposit growth. First quarter ending deposits in the consumer bank were up almost $33 billion or 13% year-over-year and up 8% compared to the sequential quarter. Average deposits were up 9% year-over-year and up 6% from the sequential quarter. Powered by our modern technology and leading digital capabilities, our digital-first national direct banking strategy continues to get good traction. Consumer Banking revenue was up 12% year-over-year driven by deposit growth. Noninterest expense was up 4% compared to the first quarter of 2022. The auto charge-off rate for the quarter was 1.53%, up 87 basis points year-over-year. The 30-plus delinquency rate was 5.0%, up 115 basis points year-over-year. Compared to the linked quarter, the charge-off rate was down 13 basis points and the 30-plus delinquency rate was down 62 basis points. The linked quarter trends were consistent with expected seasonal patterns. Slide 13 shows first quarter results for our commercial banking business. Compared to the linked quarter, first quarter ending loan balances were down 1% and average loans were down 2%. The decline is the result of choices we made earlier in the year to tighten credit as well as higher customer paydowns in the quarter. Ending deposits were down 6% from the linked quarter. Average deposits declined 7%. We saw normal outflows throughout the first quarter as clients used their cash for payroll, tax payments and other business-as-usual disbursements. And consistent with the general trend we've seen for several quarters, we also continued to manage down selected less attractive commercial deposit balances. First quarter revenue was up 10% from the linked quarter. Recall that revenue in the prior quarter was unusually low, driven by a company-neutral move in internal funds transfer pricing. Excluding this prior quarter impact, first quarter commercial revenue would have been down 10%, driven by a decline in noninterest income from our capital markets and agency businesses. Noninterest expense was down 5% from the linked quarter. The Commercial Banking annualized charge-off rate was 9 basis points. Criticized loan balances increased primarily in our commercial real estate business. The criticized performing loan rate increased 60 basis points from the linked quarter to 7.31% and the criticized nonperforming loan rate was up 5 basis points from the linked quarter to 0.79%. In closing, once again, we delivered strong growth in domestic card revenue, purchase volume and loans in the first quarter. We continue to see opportunities for resilient domestic card growth that can deliver sustained revenue annuities, and we continue to lean into marketing. And as always, we're closely monitoring and assessing competitive dynamics and economic uncertainty. In our Consumer Banking business, loans declined modestly and consumer deposits grew in the quarter. Our national digital-first consumer banking strategy continued to grow and gain traction, and we're leaning into marketing to grow our consumer deposit franchise. In our commercial bank, ending loans and deposits were down compared to the linked quarter, reflecting our cautious stance in the commercial banking marketplace. Our commercial bank continues to focus on winning through deep industry specialization. And across our businesses, credit trends continued to normalize in the quarter, and we reached or were approaching pre-pandemic levels at quarter end. We continue to expect that the full year 2023 annual operating efficiency ratio net of adjustments will be roughly flat to modestly down compared to 2022. And our balance sheet demonstrated its strength through the recent period of turmoil in the banking industry. In the first quarter, we built additional balance sheet strength as we increased allowance for credit losses, grew retail deposits and maintained or increased strong levels of capital and liquidity. Pulling way up, the future of everything in banking is digital. And with each passing quarter, banking is accelerating toward its inevitable destination. Capital One is at the vanguard of a very small number of players who are investing to build and leverage a modern technology infrastructure from the bottom of the tech stack up to truly transform technology and put themselves in an advantaged position to win as banking goes digital. Our modern technology capabilities are generating and expanding a set of opportunities across our businesses. We are driving improvements in underwriting, modeling and marketing as we increasingly leverage machine learning at scale. We are transforming the customer experience in banking. And our tech engine drives growth efficiency improvement and enduring value creation over the long term. Our investments to transform our technology and to drive resilient growth put us in a strong position to deliver compelling long-term shareholder value and thrive in a broad range of possible economic scenarios.

Jeff Norris, Senior Vice President of Finance

If you have any follow-up questions after the Q&A session, the Investor Relations team will be available after the call. Amy, please start the Q&A.

Kevin Barker, Analyst

I just want to follow up on the reserve build within the card portfolio. You said it in the slide presentation worsening credit trends and domestic credit cards. But at the same time, your prepared remarks said this is more of a normalization than anything else and you continue to grow. So what gives you confidence that this reserve build and the fairly rapid increase in delinquency and net charge-offs is truly a normalization as opposed to signs of further deterioration that's likely to occur.

Richard Fairbank, Chairman and CEO

Thanks for your question, Kevin. I want to address this. As we return to pre-pandemic conditions, the term normalization will eventually become obsolete as things stabilize. Let’s discuss what we’re observing and how this shapes our outlook. Currently, many of our credit metrics have reverted to pre-pandemic levels, while others are on their way back. A key metric to examine is delinquencies, which stood at 3.66% in the first quarter, essentially aligning with 2019 figures. Our charge-offs have not yet followed suit, but based on delinquency trends, we anticipate they will return to 2019 levels around the middle of this year. Historically, our credit metrics tend to shift ahead of the industry, both upward and downward. We witnessed this during the global financial crisis and the pandemic, and we seem to be seeing it again now. Regarding our outlook and loss forecasting, there's a factor that seems more pronounced at Capital One related to recovery, which applies to the industry overall but is particularly significant for us. Let me explain that further. Past charge-offs serve as the foundation for future recoveries, and we have recently experienced three years of very low charge-offs. As a result, our recoveries will be particularly low in the short to medium term. This poses a bigger challenge for us compared to many others because we typically achieve significantly higher recovery rates than the industry average and we often handle most of our recoveries independently rather than selling them. Consequently, recoveries occur gradually over time instead of in a lump sum, as would be the case with a debt sale. This is a distinct aspect of Capital One that we have discussed for some time, stemming from the dynamics of how our charge-offs are functioning and will continue to function. Additionally, we are anticipating significant deterioration in the labor market, with the unemployment rate rising from its current low levels to over 5% by the end of 2023. We also expect negative impacts from inflation and a further decline in consumer profiles, reflecting the reversal of their significant outperformance during the earlier phase of the pandemic. This outlines our approach to creating outlooks. We continue to feel optimistic about the business. We are focusing on our growth opportunities, our originations are consistently strong, and we appreciate the prospects we see. We have always underwritten for potential downturns. As the economy and credit performance normalize, which we have anticipated for some time, we are continuing on our established path. Each quarter, we make slight adjustments where we foresee potential vulnerabilities among customers. We are also encouraged by the ongoing growth of resilient opportunities, which we are actively pursuing. Our business model is designed to manage volatility in losses and handle increased loss rates. Our current actions align with our expectations, and we remain positive about the opportunities ahead.

Kevin Barker, Analyst

Okay. In the past, you mentioned that the new growth and flow rates were relatively normal for many of your newer businesses. Are you still observing that? Additionally, in the near term, are you experiencing the same level of traction from your marketing spending in the first quarter as you did in 2022?

Richard Fairbank, Chairman and CEO

Yes. Regarding your question about flow rates, let me take a moment to discuss some of our credit metrics. We have mentioned delinquencies and losses previously. Our individual flow rates have returned to normal levels, and when we examine very early entry flow rates along with a few delinquency categories, some are slightly higher than what we saw back in 2019, but overall, things are back on track. Payment rates are particularly noteworthy, as indicated by the significant increase in trust data. The industry's flow rates have risen dramatically, with Capital One experiencing the most considerable increase. This notable shift is mainly due to two factors: the outstanding credit performance of consumers, who have been paying off their cards at high rates, and the ongoing shift towards higher spending consumers. So payment rates have declined from the very high levels. They're not even close to where they were originally. But because of these two effects, if we separate them out and look segment by segment, we see that payment rates are declining in every segment, but not yet back to where they were pre-pandemic. So that's something to keep an eye on there. Our revolve rate is roughly flat to last year and remains below pre-pandemic levels. But I think, again, there's a growth in transacting balances effect there. So we'll have to adjust for that. And then a very important one is new originations. Let's talk about that. So we see early performance that is consistent with our expectations, the earliest delinquencies, so we of course look very carefully at the early delinquencies on our most recent vintages that would be some months ago because they have to have a few months where we can start reading them. But the earliest delinquencies on our newest monthly vintages of origination are consistent with pre-pandemic originations as we compare one segment at a time on current originations versus several years ago. And then vintage over vintage month over month for recent vintages, we're seeing pretty stable risk levels. We feel very good about our situation. I've mentioned before that we have consistently adjusted our approach in anticipation of market changes, which has allowed our originations to perform similarly to how they did several years ago. This proactive management has likely helped mitigate some underlying challenges in the marketplace. If we look at our metrics, we remain confident in the decisions we're making. This positions us to continue investing in marketing. As we initiate our originations, we expect some deterioration in underwriting, but we are still committed to marketing while making slight adjustments as needed. Our message remains consistent with what we have communicated over the past several quarters.

Betsy Graseck, Analyst

So just want to make sure I understand on the reserve ratio. I know you already spoke a lot about it. So I just want to make sure I understand you just say yes or no. Is it fair to assume that the reserve ratio should go up every quarter where the macro stays in the current situation that we've got right now because the book that's rolling on is worse quality than the book that's rolling off. Is that fair?

Andrew Young, CFO

I don't want to limit myself to a simple yes or no in response to your question. The short answer is no. I will avoid going into the detailed explanation I provided a quarter ago. Essentially, we have accounted for the losses based on the current balances on our books at the end of the quarter, estimating what we will face over the next 12 months. So if you are simply replacing one loan with another of similar characteristics, you wouldn't necessarily see a build. I hope I am interpreting your question correctly.

Betsy Graseck, Analyst

Okay. And then the follow-up question is just on a slightly different topic, which has to do with the expense ratio. I know you mentioned that you're looking for the operating efficiency to be flat to down this year on a year-on-year basis. I'm just wondering how to square that with what you mentioned on the marketing side where it sounds like you see a lot of opportunities in card and you are planning on leaning into the marketing side. So I just wanted to square those two things up.

Andrew Young, CFO

Well, let me just clarify, and then I'll turn it over to Rich. When our guidance for efficiency relates to operating expenses, it is not a total efficiency point. And so it would exclude whatever choices we make in marketing from that calculation. But I'll turn it to Rich to respond to the broader question.

Richard Fairbank, Chairman and CEO

Yes. Well, I was going to say the same thing. So our guidance is with respect to operating efficiency ratio to be flat to modestly down relative to 2022. And we continue to put a lot of energy into that, of course. The total efficiency ratio includes also the marketing side of the business, as we've talked about. That's not part of our specific guidance. Our marketing choices are very dependent on the opportunity that we see, and Betsy, you and most of the people on this call have known Capital One for a long time. When we see opportunities, we really lean in on them.

Moshe Orenbuch, Analyst

Great. Rich, you mentioned that you expected card charge-offs to return to 2019 levels by mid-year. You also noted the assumption of rising unemployment over time. What should we anticipate regarding the trajectory? In other words, is 2019 a target to reach, or if we hit your expected unemployment levels, should we expect those losses to increase even further?

Richard Fairbank, Chairman and CEO

Moshe, just with respect to the unemployment rate. I want to make a comment on that. All companies, including Capital One, try to look into limited historical data. And the thing I often call trying to model on two humps of the camel because it's only been a small number of times in the history of the card business that various economic metrics have gone up and gone down. So limited to the camel hump point, we all do our best to try to look at the drivers and the correlations with respect to credit losses. A striking thing all along in our journey has been the sort of parallel movement of unemployment rates and credit losses. So it turns out from a modeling point of view, while often in the standard way people talk about things is to focus on the level of unemployment, in many of our models, actually, the rate of change is what matters most either as a measure like monthly job creation or as the change to the unemployment rate. An increase in the unemployment rate from the 3s to the 5s is a significant worsening. However, we should be cautious, as historically, credit losses have closely tracked the unemployment rate during two notable periods in the past. We place a stronger emphasis on the effects of changes in the unemployment rate, which makes it a more significant factor in our models. I would also like to note a couple of intuitive points about the economy. First, consumers are currently in a strong position. While consumer excess savings are decreasing, they still exist. Credit losses occur at the margin rather than just on average. Additionally, there are effects that we won't fully understand until afterward; one of these will remain uncertain, but I want to mention them because they influence our outlook on credit losses. One, of course, is inflation. And none of us really have historical data in the card business to understand or predict the effects of significant increases and levels of inflation, but we are expecting inflation to impact consumer credit by compressing real incomes and as kind of a separate effect from an unemployment effect. Since we haven't seen sustained inflation for more than 40 years, we can't really model this effect directly, but we make informed assumptions in our outlook to sort of account for this effect. So for example, a way to think about this is if there is a decline in real income that happens with this, we can look at our history and our cross-sectional evaluation of how people do as a function of different income levels, and then we can sort of extrapolate from those credit effects and proxy how something like inflation can have an effect there. So it's sort of using proxies, but it matches off to an intuitive assumption that high levels of inflation are going to be challenging for people. And finally, the other effect is, as I intuitively think about the marketplace, over all the years of sort of my journey in this, we've tended to see that periods of abnormally good credit are followed by periods of worse credit and vice versa. The credit performance we saw over the past three years was unprecedented. So there's what maybe we could call a catching-up effect that happens on the other side of that for consumers who might otherwise have charged off over the past three years. And sort of the reverse of this effect happened in the global financial crisis where charge-offs were accelerated and then it was kind of followed by a period of strikingly benign credit. This is an effect, I intuitively believe, we can't measure it. We won't even in hindsight, be able to measure it, but I just think it's part of the intuition that we bring into the business. So when we pull kind of way up on things, we share with you the credit metrics that we see. And pretty much what you see is all that we see. So now we're all in the business of saying, where does this go from here? I shared with you some intuitive views that would lead to higher charge-off levels over time. And when we look at those, when we look at our card how we underwrite in card, we both can believe effects like this or will happen over time and also how strong the opportunity in card continues to be.

Andrew Young, CFO

Yes, Moshe, it's Andrew. We look at a number of things as we are considering our capital actions. And so I've been saying for a couple of quarters now, we've seen an increased level of uncertainty in the economic environment, wide ranges around growth opportunities and everything that's happened over the last 1.5 months has increased that level of uncertainty. And so we continue to believe that it's prudent to operate above our 11% long-term target, both until we have more clarity, both not only on the economic front but to the potential regulatory changes that may be coming down the pike, which could very well include treatment of AOCI in capital. But of course, we don't know that yet. And so for now, we're continuing to operate above that long-term target. But suffice it to say, we have substantial capital generation capacity, and we regularly evaluate our plans in light of the economic changes in light of regulatory changes. We have the ability to pivot quickly in our deployment, and certainly we'll do so when we feel like the time is right.

Richard Shane, Analyst

Andrew, I'd like to talk a little bit about the impact of the surge in deposits. When we look at the impact, it appears that it primarily runs through the corporate and other line in terms of where the NIM impact is. But the other change that I think we see is that it looks like the transfer pricing on deposits went down modestly. When we think about things going forward, should we assume that there's a continued drag at the corporate line from the elevated deposits and that because the reinvestment rate is lower, that the transfer pricing is going to be a little bit lower as well.

Andrew Young, CFO

Well, Rick, let me just clarify first. And I'm assuming you're just looking at the net interest income trends in other, which does serve as a clearing house for FTPs, but happy to talk to you offline in more detail about this. But the basic tenets of the FTP process or there's an arm's length transaction between corporate and other and deposits. And so they're getting a prevailing rate, which shows up in the revenue of either the Consumer Banking segment or the commercial banking segment. And so there isn't a subsidy or drag going on there. There's just a number of other clearing factors that happen in other.

Arren Cyganovich, Analyst

Maybe talk a little bit about credit card purchase volumes look like they inched up a little bit during the quarter. We've heard that from others that they're seeing slowdown in purchase volume in March and into April. What are you seeing within your portfolio? And are there kind of any differences between different income demographics that you're seeing within your customers?

Richard Fairbank, Chairman and CEO

So Aaron, yes. Let’s discuss purchase volume. In Q1, our card purchase volume increased by 10% year-over-year. While this growth is solid, it has decreased from the beginning of 2022. It's important to differentiate between spend per active account and the growth of accounts, alongside the benefits from our recent origination efforts. Currently, spend per active account has rebounded from the lows of the pandemic, reaching levels similar to last year. We observe that spend per active account has remained relatively flat compared to a year ago, though it has been declining slightly in recent months, possibly sitting a bit below last year's levels. Interestingly, we often notice that effects begin with lower-income, lower credit score segments before spreading upwards. This trend has been consistent throughout both the recovery and normalization phases of credit during the pandemic. We are experiencing strong growth in accounts, which continues to drive purchase volume, even as spending levels off. It seems reasonable for consumers to adjust their previously high spending. Overall, we are optimistic about this. Both discretionary and nondiscretionary spending have significantly slowed over the past year, with growth rates decreasing. However, the mix of spending categories shows that despite changes, many aspects have returned to pre-pandemic levels.

Andrew Young, CFO

Yes. Let me start by talking about kind of what isn't in the disclosure that we provided because I know there's differences across various organizations. I mean as you know, Arren, that it's a little less than $4 billion and represents about 1% of our total loans, but this is our commercial office space. It is excluding, as you probably saw in the footnote, medical office and REIT and REIF medical office just has very different characteristics and so 2 does that's REIT and REIF. So in terms of the commercial office portfolio on our books, it's roughly two-thirds concentrated in New York, D.C. and San Francisco. It is roughly 60% B, C and obviously 40% Class A. And so it has been accumulated over time, but it also was a business that up until a few years ago, we were active in, but we haven't had any new originations for the past few quarters and reduced our exposure to this segment over the past year by a little north of I think it's 10%. But given right now just the uncertainty that we see with office vacancies being elevated and utilization rates significantly below pre-pandemic levels and increasing debt service burdens despite the fact that we are getting 100% payment on principal and interest just in light of the continued uncertainty that I described just in terms of utilization and other factors. We decided to increase the coverage ratio quite a bit this quarter, and that's what you see in the disclosure in the back.

Ryan Nash, Analyst

Maybe I know there's been a lot of questions on credit, but maybe just to follow up on another one, Rich. So can you maybe just talk about where the credit performance was worse or where it deteriorated? And also I'm surprised by the comment that you're reaching normal levels despite continued elevated payment rates and lower revolve rate. So how do you think about from here balancing growth versus the risk of credit continuing to not only normalize but get worse?

Richard Fairbank, Chairman and CEO

So yes, Ryan, I think the overall impression is positive even though some of our credit metrics haven't fully returned to pre-pandemic levels. My instinct is that it's better to view them as mostly back. I believe the ongoing focus on spenders, not just at the top tier but within our segments, and our emphasis on spending through our products, marketing, account management, and the customers we approve for credit, indicate a subtle shift towards spending. This might help explain why some metrics are lagging, but I perceive that we're generally at levels similar to a few years ago. We now feel confident about the decisions we’re making, and let me explain why. As I mentioned, we prepare for potential worsening conditions. Reflecting on the past when consumer behavior was unprecedented in our company’s history, credit performance was exceptionally strong, which we believed was not sustainable. Therefore, we planned for significantly higher loss levels. As conditions stabilize, this approach does not fundamentally change what we do at Capital One. However, we are aware of the various signals in the market. We diligently search for any deviations from expected or historical performance using advanced machine learning monitoring tools. We have identified some of these deviations in certain areas and have adjusted accordingly. We actively explore potential vulnerabilities related to the direction of the economy and proactively make adjustments as needed. However, I am encouraged by the number of new opportunities arising from the company’s technological transformation, including new channels and innovative ways to engage with customers. Despite any setbacks, we continue to see new possibilities emerge, and we focus on those. Regarding the card business, I want to emphasize that we remain optimistic about our growth opportunities, marketing, and the potential to create significant value in this sector as we navigate the current cycle.

Jeff Norris, Senior Vice President of Finance

This concludes the earnings call for this evening. Thank you for joining us on this conference call, and thank you for your interest in Capital One. The IR team will be here later this evening to answer any questions that may remain. Have a good night, everybody.

Operator, Operator

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