Earnings Call Transcript - COF Q1 2024

Jeff Norris, Senior Vice President of Finance

Good day, and thank you for standing by. Welcome to the Capital One Q1 2024 Earnings Call. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Jeff Norris, Senior Vice President of Finance. Please go ahead. Thanks very much, Josh, and welcome to everyone. We are webcasting live over the internet this evening. To access the call online, please visit Capital One's website at capitalone.com and follow the links. In addition to the press release and financials, we have included a presentation summarizing our first quarter 2024 results. Joining 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 guide you through this presentation. To access a copy of the presentation and press release, please visit Capital One's website and click on Investors, then Financials, and finally 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 made today reflect only the particular date or dates indicated in the materials, and Capital One does not have any obligation to update or revise this information due to new information, future events, or otherwise. Various factors could cause our actual results to differ significantly from those described in forward-looking statements. For more details on these factors, please refer to the Forward-looking information section in the earnings release presentation and the Risk Factors section of our annual and quarterly reports available on Capital One's website and filed with the SEC. And with that, I'll turn the call over to Rich; to Andrew, Mr. Young?

Andrew Young, CFO

Thanks, Jeff, and good afternoon, everyone. I will start on Slide 3 of tonight's presentation. In the first quarter, Capital One earned $1.3 billion or $3.13 per diluted common share. Included in the results for the quarter was a $42 million additional accrual for our updated estimate of the FDIC special assessment. Net of this adjusting item, first quarter earnings per share were $3.21. Relative to the prior quarter, period-end loans held for investment decreased 2% and period-end deposits increased 1%. Both average loans and average deposits were flat. Our percentage of FDIC insured deposits remained at 82% of total deposits. Pre-provision earnings in the first quarter increased 13% from the fourth quarter or 6% adjusting for the impacts of FDIC special assessments in both quarters. Revenue in the linked quarter declined 1%, largely driven by lower noninterest income. Noninterest expense decreased 6% on an adjusted basis, driven by declines in both operating and marketing expenses. Our provision for credit losses was $2.7 billion in the quarter, a decrease of $174 million compared to the prior quarter. The decrease was driven by $57 million lower net reserve build, partially offset by an $83 million increase in net charge-offs. Turning to Slide 4, I will cover the allowance in greater detail. We built $91 million in allowance this quarter, bringing the balance to $15.4 billion, an increase of less than 1% from the fourth quarter. The slight increase in allowance balance was driven by modest builds in our Auto and Domestic Card portfolios. Our total portfolio coverage ratio increased 11 basis points to 4.88%. I'll cover the drivers of the changes in allowance and coverage ratio by segment on Slide 5. Our baseline economic forecast modestly improved this quarter compared to what we assumed last quarter, which generally aligns with consensus. We continue to consider a range of economic outcomes in our reserving process. In our Domestic Card business, the allowance coverage ratio increased by 22 basis points to 7.85%. The increase in coverage was primarily driven by the denominator effect of the runoff of the fourth quarter's seasonal outstandings. In our Consumer Banking segment, the allowance increased by $46 million, resulting in a 7 basis point increase to the coverage ratio. The allowance increase was primarily driven by a higher level of originations in the Auto Finance business. And finally, our Commercial Banking allowance decreased by $7 million, primarily driven by portfolio contraction. Coverage ratio increased by 1 basis point to 1.72%. Turning to Page 6. I'll now discuss liquidity. Total liquidity reserves in the quarter increased to $127 billion, about $7 billion higher than last quarter. Our cash position ended the quarter at approximately $51 billion, up about $8 billion from the prior quarter. The increase in cash was driven by continued strong deposit growth in our retail banking business and the seasonality of our card balances. Our average liquidity coverage ratio during the first quarter remained strong and well above regulatory minimums at 164%. Turning to Page 7, I'll cover our net interest margin. Our first quarter net interest margin was 6.69%, 4 basis points lower than last order and 9 basis points higher than the year-ago quarter. The quarter-over-quarter decrease in NIM was largely driven by the impact of having one fewer day in the quarter. Modestly higher asset yields were mostly offset by higher funding costs in the quarter. Turning to Slide 8, I will end by discussing our capital position. Our common equity Tier 1 capital ratio ended the quarter at 13.1%, approximately 20 basis points higher than the prior quarter. Strong earnings and lower risk-weighted assets more than offset the impact of CECL phase-in dividends and share repurchases. We repurchased approximately $100 million of shares in the first quarter. Our repurchase activity in the quarter was impacted by blackout restrictions and daily purchase volume limitations related to the announcement of the Discover transaction. With that, I will turn the call over to Rich. Rich?

Richard Fairbank, Chairman and CEO

Thanks, Andrew, and good evening, everyone. Slide 10 shows first 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. Top line growth trends in the Domestic Card business remained strong in the first quarter. Year-over-year purchase volume growth for the first quarter was 6%. Ending loan balances increased $12.9 billion or about 10% year-over-year. Average loans increased 11%, and first quarter revenue was up 12% year-over-year, driven by the growth in purchase volume and loans. The charge-off rate for the quarter was up 190 basis points year-over-year to 5.94%, about 18% above its pre-pandemic level in the first quarter of 2019. The 30-plus delinquency rate at quarter end increased 82 basis points from the prior year to 4.48%. On a sequential quarter basis, the charge-off rate was up 59 basis points, and the 30-plus delinquency rate was down 13 basis points. The linked-quarter delinquency and charge-off rate trends were modestly worse than what we would expect from normal seasonality. We believe this is largely driven by lower and later tax refund payments to consumers so far in 2024, relative to what we've historically observed. Tax refunds are an important factor in credit seasonality. Each year, they drive an improvement in delinquency payments and recoveries starting in February. Our portfolio trends generally have a more pronounced seasonal pattern than the industry average. Last quarter, our view was that the charge-off rate was settling out about 15% above 2019 levels in the near term. That was based on an extrapolation of our delinquency inventory and flow rates over 3 to 6 months, and that was the horizon of our estimate. If the trend of lower tax refunds sustains, it could raise the level of charge-off somewhat in the near term but this does not change our view that credit is settling out modestly above pre-pandemic levels in 2018 and 2019. The continuing deceleration in the pace of credit normalization trends sometimes referred to as the improving second derivative supports our view. The pace of year-over-year increases in both the charge-off rate and the delinquency rate have been steadily declining for several quarters and continued to shrink in the first quarter. Domestic Card noninterest expense was up 6% compared to the first quarter of 2023, with increases in both operating expense and marketing expense. Total company marketing expense of about $1 billion for the quarter was up 13% year-over-year. Total company marketing drives growth and builds franchise in our Domestic Card and Consumer Banking businesses and builds and leverages the value of our brand. 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. Our marketing continues to deliver strong new account growth across the domestic Card business. And in the first quarter, Domestic Card marketing also included higher early spend businesses driven by strong new account growth, higher media spend and increased marketing for franchise enhancements like our travel portal, airport lounges and Capital One shopping. We continue to lean 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. Slide 12 shows first quarter results for our Consumer Banking business. In the first quarter, Auto originations increased 21% from the prior year quarter, a return to growth after several quarters of year-over-year declines. Consumer Banking ending loans decreased about $3.1 billion or 4% year-over-year, on a linked quarter basis ending loans were essentially flat. We posted another quarter of year-over-year growth in consumer deposits. First quarter ending deposits in the consumer bank were up just under $10 billion or 3% year-over-year. Compared to the sequential quarter, ending deposits were up about 2%. Average deposits were up 6% 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 consumer deposit growth. Consumer Banking revenue for the quarter was down about 13% year-over-year, largely driven by lower auto loan balances and higher deposit costs. Noninterest expense was down about 3% compared to the first quarter of 2023. 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 1.99%, up 46 basis points year-over-year. The 30-plus delinquency rate was 5.28%, up 28 basis points year-over-year. Compared to the linked quarter, the charge-off rate was down 20 basis points, while the 30-plus delinquency rate was down 106 basis points. The linked-quarter charge-off rate improvement modestly underperformed the typical seasonal patterns we've historically observed driven by the tax refund trends I just discussed. Even with the tax refund effects, auto credit performance remains strong. Slide 13 shows first quarter results for our Commercial Banking business. Compared to the linked quarter ending loan balances decreased about 1%. Average loans were also down about 1%. The modest declines are largely the result of choices we made in 2023 to tighten credit. Ending deposits were down about 5% from the linked quarter. Average deposits were down about 8%. The declines are largely driven by our continued choices to manage down selected less attractive commercial deposit balances. First quarter revenue was up 2% from the linked quarter. Noninterest expense was up about 6%. The Commercial Banking annualized net charge-off rate for the first quarter decreased 40 basis points from the sequential quarter to 0.13%. The Commercial Banking criticized performing loan rate was 8.39%, down 42 basis points compared to the linked quarter. The criticized nonperforming loan rate increased 44 basis points to 1.28%. Commercial credit risks continue to be most pronounced in the commercial office portfolio, which is less than 1% of total company loan balances. In closing, we continued to deliver strong results in the first quarter. We posted another quarter of top-line growth in Domestic Card revenue, purchase volume and loans. Domestic Card credit trends continue to stabilize and Auto credit trends remained stable and in line with normal seasonal patterns. We grew consumer deposits and we added liquidity and maintained capital to further strengthen our already strong and resilient balance sheet. Over the last decade, we've driven significant operating efficiency improvement even as we've invested to transform our technology, and we continue to drive for efficiency improvement over time. For the full year 2024, we continue to expect annual operating efficiency ratio net of adjustments to be flat to modestly down compared to 2023. Our expectation includes the partial year impact of the proposed CFPB late fee rule, assuming the rule takes effect in October 2024. The timing of the new rule remains uncertain. If the rule were to take effect at an earlier date, it would be a headwind to the 2024 operating efficiency ratio. Of course, the biggest news in the quarter was our announcement that we entered into a definitive agreement to acquire Discover. We've submitted our application for regulatory approval and we're fully mobilized to plan and deliver a successful integration. The combination of Capital One and Discover creates game-changing strategic opportunities. The Discover payment position Capital One as a more diversified, vertically integrated global payments platform and adding Capital One's debit spending and a growing portion of Credit Card purchase volume to the Discover network will add significant scale, increasing the network's value to merchants, small businesses, and consumers and driving enhanced network growth. In the Credit Card business, we're bringing together two proven franchises with complementary strategy and a shared focus on the customer. And we can accelerate the growth of our national digital-first consumer banking business by adding Discover's consumer deposit franchise and the vertical integration benefits of the debt network. We will be able to leverage and scale the benefits of our 11 years of transformation across every business and the network, which will serve as the catalyst for innovation and enhanced capabilities in risk management and compliance underwriting marketing and customer service. Pulling way up, the acquisition of Discover is a singular opportunity. It will create Consumer Banking and a global payments platform with unique capability, modern technology, powerful brands, and a franchise of more than 100 million customers. It delivers compelling financial results and it offers the potential to create significant value for merchants and customers, and an unparalleled strategic and economic upside over the long term. And now we'll be happy to answer your questions. Jeff?

Jeff Norris, Senior Vice President of Finance

Thank you, Rich. We'll now begin the Q&A session. Josh, please go ahead and start.

Operator, Operator

Our first question comes from Ryan Nash with Goldman Sachs.

Ryan Nash, Analyst

So Rich, maybe just start off on credit. It sounds like you're running a little bit ahead of what you had outlined in the last quarter. But when you put aside the time with the tax refund, maybe just talk about what you're seeing from the consumer? And do you think we've now reached the inflection where we can more closely follow seasonal patterns? And once the noise settles, do you think we're kind of back at that 15% level that you had outlined?

Richard Fairbank, Chairman and CEO

Thank you, Ryan. I believe the narrative remains focused on the consumer. Let's take a moment to discuss the consumer's health and then address Capital One's credit performance. The U.S. consumer continues to show strength in the economy, with a remarkably resilient labor market. Rising incomes have kept consumer debt servicing burdens relatively low compared to historical standards. Our customers are maintaining higher bank balances than they did before the pandemic, which holds true across various income levels. However, inflation has reduced real incomes for nearly two years, and in this environment of high-interest rates, the cost of new borrowing has increased across all major asset categories, stretching some consumers financially. Overall, I would say that consumers are in reasonably good shape compared to historical benchmarks. Regarding Capital One’s performance, we are observing a settling trend. While I can’t speak for all card issuers, we have perceived a sort of landing, and we feel very confident about our credit situation. On the topic of tax refunds, there is some uncertainty surrounding the reasons for seasonality, but we consider it an important factor. It has a more significant impact on us compared to other players since cash refunds play a larger role across our customer base. In the short term, tax refunds affect credit performance. The 15% guidance we provided was not an annual forecast, but rather an extrapolation based on current delinquencies and delinquency roll rates, indicating where we anticipate charge-offs, which tend to peak in the first half of the year. This higher figure is in relation to levels seen in 2019, factoring in tax refunds and seasonal effects. Government data shows that tax refunds are coming in lower and later than usual, which impacts our short-term credit performance. We often note that once charge-offs begin, we can see their trajectory through the roll rate buckets. However, tax refunds influence payment rates across all categories. Thus, in the near term, we expect a slightly higher charge-off rate than we previously guided. This does not alter our perspective that credit has stabilized, but we have not provided annual credit guidance. We observe a settling of credit and want to highlight that, especially in our Credit Card and Auto businesses, while credit remains robust and delinquencies are improving, the current environment relative to historical seasonality and tax refund patterns indicates lower and later refunds. This will consequently impact the near-term figures we mentioned earlier.

Ryan Nash, Analyst

Got it. Maybe as my quick follow-up for Andrew. I guess, given Rich's answer, what does that mean for the trajectory of the allowance? It seems like we've heard a handful of other issuers talk about us being at the peak or maybe even coming down and potentially being below where it ended the prior year. Can you maybe just talk about what you think this means for Capital One, given your credit expectations?

Andrew Young, CFO

Yes, Ryan. From my perspective, the answer isn't straightforward. Several factors will influence the allowance going forward, with growth being a significant one. Specifically regarding coverage, I mentioned in my talking points that the fourth quarter had seasonal balances that quickly pay off in the first quarter, resulting in negligible coverage, as we observe annually. The slight increase in the coverage ratio this quarter compared to last quarter is primarily due to this dynamic. When we look at the current coverage ratio, it's mostly aligned with previous quarters. The key factor moving forward will be the projected loss rates, and as we have noted for several quarters, delinquencies are the best leading indicator of those rates. Each quarter, we will consider the next 12 months and the potential variations and uncertainties involved. Over the past few quarters, we have maintained a stable coverage ratio. However, even in periods where projected future losses are lower—which might suggest a release of allowance—it's possible for the coverage ratio to remain flat or only decrease slightly as we factor in uncertainties regarding future projections. Ultimately, lower projected losses will eventually impact the allowance and reduce the coverage ratio as uncertainties become clearer. That said, I’m not going to forecast when this will happen, as we need to continuously address the uncertainties every quarter during our reserving process.

Jeff Norris, Senior Vice President of Finance

Next question, please.

Operator, Operator

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

Mihir Bhatia, Analyst

Rich, if I could switch for a second to the Discover acquisition. There's been a lot of talk around deal approval, particularly focusing around potential antitrust issues within the Card business. And I was wondering if you could share your thoughts and perspective on that issue if you've heard anything from regulators but also just to hear how you are thinking about that issue?

Richard Fairbank, Chairman and CEO

Thank you, Mihir. We have submitted our merger applications to both the Federal Reserve and the OCC, and we are also in communication with the DOJ, which plays a crucial role in advising the Fed and the OCC on competition matters. We believe our applications present a strong case for approval, as we are confident that this merger will enhance competition among banks, credit card issuers, and payment networks, ultimately benefiting consumers, merchants, and the communities we serve. Although some have expressed concerns regarding competition, we maintain that the evidence supporting the deal will be convincing. It’s important to note that we do not currently operate in the network space. If the merger is approved, we will still have four networks as we do now, but we will be attracting new customers and expanding the smallest of the four networks, allowing us to leverage our technology and marketing expertise to significantly boost Discover's competitive position. Their market share has decreased from 6% a decade ago to 4% today. The substantial investments we are planning will yield significant advantages for consumers and merchants, as detailed in our regulatory applications. Regarding the credit card market, regulators consistently find it to be highly competitive and not concentrated. In fact, it has become less concentrated over the past decade. Consumers have access to over 4,000 issuers, each able to offer similar products. For instance, a card from a small credit union works just like a card from a bank such as Capital One, usable globally; this level of competition is unmatched in other industries, like airlines or grocery stores. There's a reason we frequently ask about what's in your wallet. We are not only competing with those 4,000 issuers for your initial business but also against every card you already possess. This means we need to compete daily for every transaction since customers can easily switch to another card at any time. If they find their card unsatisfactory, they can stop using it or close the account, and switch to another card with another bank without much hassle. We also believe the evidence will confirm that there are no barriers to entry in the credit card industry, as demonstrated by the thousands of current issuers and the emergence of new ones. Well-funded fintechs are leveraging credit card infrastructure providers like Marqeta to quickly achieve scale and growth. Any existing bank can also adapt its credit policy to enter different segments of the credit market. Additionally, consumers have the option to use other payment methods, like cash, debit, or buy now pay later services, which are rapidly gaining traction. New fintechs enter the payments and small-dollar credit markets daily, all vying for market share from traditional credit card companies like Capital One. We have faced this competition for years and will continue to do so in the future, which is strong evidence of a competitive marketplace. Our success is rooted in addressing our customers' needs by offering credit card and retail banking products with straightforward terms and minimal fees. We are the only major bank that provides all deposit products with no fees, no minimum balance requirements, and no overdraft fees. In summary, we believe the evidence will demonstrate that this transaction is both pro-competitive and beneficial for consumers, expanding our top-tier products and services to a wider audience of consumers and small businesses while significantly enhancing opportunities and benefits for merchants. Ultimately, we believe the regulators will carefully assess this during their thorough evaluation process.

Mihir Bhatia, Analyst

Got it. That is helpful. Just turning back to the health of the consumer for a second for my follow-up. If you could just talk a little bit about the environment for card acquisitions, you did mention, I think, that the growth you see good growth opportunities in the card business. So wondering if you can expand on that. Maybe talk about just some of the puts and takes as you consider where to make those investments? Are there parts of the market where you're being more cautious given the environment?

Richard Fairbank, Chairman and CEO

We are fully committed to the card business, driven by a strong consumer base and the positive momentum we're experiencing. Every segment of our card business is witnessing impressive account originations and increased purchase volumes. It's an encouraging time for investment, as reflected in our marketing strategies and growth metrics, which show substantial progress. I want to highlight two key factors that are fueling this growth: first, our ongoing investment in market leadership, which not only enhances our top-tier performance but also benefits the entire organization. Second, our technology transformation is contributing significantly, improving customer experiences and product capabilities, and enhancing our operational efficiency, particularly in credit and marketing. This allows us to offer customized solutions that support our growth. Additionally, we're encouraged by the improvements in our Auto business and continue to see significant progress in our national bank.

Jeff Norris, Senior Vice President of Finance

Next question, please.

Operator, Operator

Our next question comes from Rick Shane with JPMorgan.

Rick Shane, Analyst

Rich, I want to make sure I fully understand what you're describing in terms of credit. The framework is that charge-off rates will be about 15% higher than '18, '19 levels in the near term. But now with tax refunds, it might be a little bit higher than that, that over time, it will converge back towards slightly above '18, '19 levels. When I look at the delinquencies. And one of the things we've observed is that role from delinquency to charge-off is actually higher than it has been pretty much at any time in recent history. Does that suggest that delinquencies actually need to get back below '18, '19 levels to achieve that level of charge-off performance?

Richard Fairbank, Chairman and CEO

So Rick, there’s a lot to discuss. First, I want to clarify some of the points you made that may not align with our intentions. We did talk about credit and mentioned that in the near term, charge-offs tend to be higher in the first half of the year. Based on our analysis of delinquency buckets and roll rates, we expect them to settle around 15% higher than pre-pandemic levels. This expectation is a short-term forecast, not an annual one. Regarding your comments about it converging back to slightly above 2018 and 2019 levels, those are your words, not ours. We haven't provided guidance on full-year charge-offs, as we typically do not. However, we want to give you a feel for how things are progressing. We are seeing credit settling out, and the trends in delinquencies are improving, which is encouraging. Another factor influencing charge-offs is recoveries. We have noted that recoveries have been lower than usual due to the very low charge-offs we've seen over the past three years. This situation has increased net losses compared to pre-pandemic levels, and it may affect us more significantly than some competitors since we generally have higher recovery rates. This is likely due to our business mix and strategy since we tend to manage most recoveries in-house rather than selling debt. As a result, we see a longer recovery period from previous charge-offs than others. We believe recoveries are at a low point now, but they are likely headed in a more positive direction over time. Overall, we don’t have full-year credit guidance, but we are pleased to see charge-offs normalizing. We also need to address seasonality. It remains uncertain whether tax refunds are simply lower or if they are delayed. What’s clear is that they are cumulatively lower than pre-pandemic levels for this time frame. We will watch how this unfolds to determine how much is due to delays versus being lower overall. While lower refunds could impact our near-term charge-off numbers, it does not change our perspective on credit settling out or our positive outlook on consumer credit performance. We wanted to highlight this as it pertains to both our Credit Card and Auto businesses.

Jeff Norris, Senior Vice President of Finance

Next question, please.

Operator, Operator

Our next question comes from John Pancari with Evercore ISI.

John Pancari, Analyst

I guess back to the Discover combination, any update to your thoughts around the timing of the deal close? I know the Fed, the OCC just extended the comment period. And I know you put out there, you expect late '24, early '25. So any change in terms of your expectation around the timing of the close or any of the key financial metrics that you set out?

Richard Fairbank, Chairman and CEO

Okay. Thanks, John. So let me comment on the Federal Reserve and the OCC extending the comment period. It's standard practice for the Federal Reserve to extend the comment period on bank mergers. We expected the extension and we don't take any signaling on our deal from the Fed's decision here. So with respect to the overall timing, the Fed and the OCC typically take several months to work through bank merger applications in consultation with the DOJ on competition questions and they engage frequently with our team along the way. And of course, that process is underway. And we continue to have the same views about the timing of all of this that we did at the time of the announcement.

John Pancari, Analyst

Okay, great. Regarding your expectation for a pro forma CET1 ratio of just below 14%, has there been any change to that expectation? Also, what are your thoughts on buyback activity in the near term? Will you remain active in that area?

Andrew Young, CFO

Yes, John, with respect to the deal, I'll just say, as we talked about when we announced it, we at the time, used a blend of consensus estimates of where we would have the CET1 at the time of close. There's a number of variables that are going to move between now and in legal day one, not just the stand-alone performance of each of our companies but balance sheet marks, some of which are driven by credit and stock price. And so I'm not going to be in the business of sort of recasting every time a little number moves. But I will say our valuation of the deal considered a wide range of outcomes. And so we remain just as excited today about the financial and strategic benefits of the transaction as we did when we announced the deal. With respect to our stand-alone repurchases, Capital Ones, I'll note that the agreement with Discover does not prohibit us from buying shares. I noted in my prepared remarks, we were blacked out for a period leading up to the deal. And afterwards, the SEC has safe harbor rules that limit the daily average amount of purchases we can do for a period of time after the announcement. So as a result of those limitations, Q1 had a pace that was less than what we've done in recent quarters. I will also just note that there are also blackout restrictions on repurchases during the proxy vote period. But again, outside of those blackouts, we're not prohibited, and we're able to continue repurchasing shares.

Jeff Norris, Senior Vice President of Finance

Next question, please.

Operator, Operator

Our next question comes from Moshe Orenbuch with TD Cowen.

Moshe Orenbuch, Analyst

Rich, if we put aside the tax refund issue, you find yourself in a situation where inflation remains relatively high, and there's a possibility of rising unemployment. Considering the nature of your portfolio, which includes both lower-end and higher-end consumers, how do you assess these factors regarding the charge-off levels you anticipate over the next year or two? Are these factors suggesting a higher expectation for charge-offs, or how should we interpret this?

Richard Fairbank, Chairman and CEO

Moshe, I understand your concern regarding the performance of our subprime consumer portfolio, especially in a high inflation environment. Historically, during the global financial crisis, we noticed that credit metrics for subprime consumers reacted earlier and more drastically, and while subprime deteriorated, it did so somewhat less than prime credit in relative terms. During that crisis, all portfolios saw significant declines, but subprime credit began to improve and normalize more quickly post-crisis. It's essential to note that while subprime is related to lower income, they are not the same. Looking at recent performance, we've observed consistent income growth for lower-income consumers over the past few years. Aside from the effects of tax refunds, which are more pronounced among our lower-end customers, our subprime segment has performed very strongly, albeit with quicker deterioration initially. However, it tends to rebound faster and stabilize before other areas of our portfolio. As for our current outlook, we feel optimistic across the entire credit spectrum. We are mindful of inflation and its potential impacts, and we are closely monitoring the market conditions. We remain committed to exploring growth opportunities while making slight adjustments to our credit policies. Overall, we maintain a positive outlook on the marketplace and its growth prospects.

Moshe Orenbuch, Analyst

Got it. As a follow-up, you mentioned that you expect to achieve your efficiency ratio goals even with the late fee being implemented. Could you share your thoughts on any strategies you are considering or currently undertaking to mitigate this? Alternatively, are you thinking of leveraging it to gain a competitive edge and increase your market share? What are your thoughts on this?

Richard Fairbank, Chairman and CEO

Okay. Thanks, Moshe. So let's just pull up and reflect on the fact that the CFPB's rule on late fees is scheduled to take effect on May 14. We are prepared to implement the rule on this timeline, if necessary, but ongoing litigation efforts continue to create uncertainty on the ultimate outcome and the timing of the rule. As we've said before, when the rule is implemented, there will be significant impact to our P&L. We expect that this impact will gradually resolve itself within a couple of years from the implementation of our mitigating actions. These mitigating actions include changes to our policies, products, and investment choices. Some of these mitigating actions have already been implemented and are underway. We are planning on additional actions once we learn more about where the litigation settles out. Ultimately, these mitigating actions will play through different line items in the P&L and will mitigate the impact of the late fee rule on our P&L within a couple of years of their implementation.

Jeff Norris, Senior Vice President of Finance

Next question, please.

Operator, Operator

Our next question comes from Don Fandetti with Wells Fargo.

Donald Fandetti, Analyst

Yes. Rich, can you share your current views on auto lending? I know there has been a lot of attention on cards, but used car prices have dipped a bit recently, along with some tax considerations. Could you discuss a possible shift in that area?

Richard Fairbank, Chairman and CEO

Yes. So we're feeling very good about the Auto business. So let's just pull way up. Auto industry margins have recovered somewhat over the past few quarters. Our origination volumes in Q1 were up 20% on a year-over-year basis and a quarter-over-quarter basis, and we're pleased with that growth. Now there are still headwinds to the auto business. Affordability remains a concern due to the combined effects of high interest rates and still high car prices. And even as car prices have normalized significantly from their peaks, they haven't yet reached a new equilibrium. So we anticipated the risks in this business, tightening up credit back in 2022, I think, several quarters before some of our competitors. As a result, the performance of recent originations from '22 and '23 has been really strong and frankly, even better than our pre-pandemic originations. And vintage over vintage, that risk remains stable. And as margins have recovered a bit, we're seeing an opportunity to lean back in. So our years of investments in industry-leading technology and credit infrastructure have allowed us to remain nimble and enabled us to make targeted adjustments to our origination strategies where we see opportunities for growth or emerging risks. So looking ahead, we remain confident in the business that we're booking and bullish about the opportunities for growth. So we continue to set pricing in terms that we're comfortable with and feel good about the opportunities that we see in the market. And after talking for really a couple of years about sort of dialing back, I think this is sort of a period where it's moving more into a leaning into it situation for Capital One. And we're, I think, very benefited by the choices that we made over the last couple of years and seeing very strong performance in our vintages.

Jeff Norris, Senior Vice President of Finance

Next question, please.

Operator, Operator

Our next question comes from Sanjay Sakhrani with KBW.

Sanjay Sakhrani, Analyst

Rich, I think your point on tax refund is clearly a very valid one. Interestingly, though, to your point on the second derivative, that's improved quite nicely even into March. And I think when I look at the tax refund stats now from the IRS, it seems like you've seen a catch-up in refunds and it seems like the average refund numbers have kind of come in line with last year, if not slightly higher. So I think those are improving, too. Is there a lag effect there? So like should we see that more pronounced if that's the case in April and May? How has been in the past?

Richard Fairbank, Chairman and CEO

Yes, I see you're well-informed about tax refunds. Consider all the knowledge you've gained over the years in understanding this credit card business, areas we hadn't anticipated needing to learn about. Let me make a few remarks. A crucial question is what we're using as our benchmark. If we compare to last year, we were lagging behind, but recently we've surpassed last year's figures, which I believe you are referencing. However, last year was an unusual case compared to the pre-pandemic period. Some may wonder why we didn't use last year as the benchmark for seasonality; the truth is, it was a peculiar year, making it hard to interpret the data amid all the normalization. As we observe this year's trends, we will eventually compare it to last year to see whether both years create a new seasonality that requires adjustments from historical patterns. At this point, it's too early to conclude. It's also challenging to analyze last year's credit metrics because of the high levels of normalization. We've been monitoring this situation and typically stick to our seasonality benchmarks developed over many years. Once this period concludes, we will reflect on whether we've gleaned insights about the business, potentially indicating that seasonality in our industry is less pronounced than before. However, it is still too early to determine. To your other point, we have recently surpassed last year's figures in terms of tax refunds, and indeed, this process has a lag effect since people must receive their refunds and then make payments. Thus, we are highlighting a phenomenon that is currently unfolding. I'm focusing on this matter because previously we made a near-term projection based on our delinquency data regarding where things were stabilizing in the peak of the year, which is the first half. I wanted to clarify that while we are not revising our numbers, if the seasonality patterns influenced by the tax refund effect do not align with historical trends, the figures in the short term may exceed the 15% figure I mentioned.

Sanjay Sakhrani, Analyst

Understood. Understood. The second derivative looked good nonetheless for March.

Richard Fairbank, Chairman and CEO

Right. So I want to emphasize that the second derivative continues to be strong. When you compare all the card players, it's clear that Capital One's second derivative shows significant strength. This is an interesting point considering how relevant it is to our work. There are many positives to take from this. I also wanted to clarify the impact of the tax refund effect, which appears to have a greater influence on Capital One compared to some of our competitors. We actually believe we are seeing this effect in both of our consumer businesses.

Jeff Norris, Senior Vice President of Finance

Next question, please.

Operator, Operator

Our next question comes from Andrew Young with Morgan Stanley.

Andrew Young, Analyst

Just one follow-up for Andrew. Just on the capital return question earlier. Can we step up the run rate relative to some of the last quarters as we look ahead? I know there's been a lot of volatility on some of the regulatory proposals on capital. But as we look ahead, I know there's no limitations, but can we see a step up in the level of capital return relative to the past few quarters as we look ahead, given your capital levels today? Well, there's two parts to that, Sanjay. The first is, given the transaction, we are in the process of submitting a new capital plan. So that's just a procedural piece. So once that new capital plan is approved, then we have unlimited capacity relative to the SCB in this intervening period, the amount that we repurchase is constrained to what we've requested.

Jeff Norris, Senior Vice President of Finance

Next question, please.

Operator, Operator

Our next question comes from Bill Carcache with Wolfe Research.

Bill Carcache, Analyst

Rich and Andrew, following up on your comments on Auto, how much of an advantage is your excess capital position? Are you seeing competitors who are capital constrained and perhaps can't take advantage of the attractive market conditions to the same degree? And then I'll just ask my follow-up now. As Capital One continues to grow, could you speak to your category 2 preparedness?

Andrew Young, CFO

Yes, I'll start, Bill, with the Rich, do you want to do the...

Richard Fairbank, Chairman and CEO

Competitive dynamics in auto. Here my observation about the auto business is that it's still a very competitive marketplace. But when we see our opportunities to grow, we tend to zig a little bit while others zag. And so we sort of pulled back for a little while and others leaned in. And my point is really now I think we're leaning in and others are pulling back a little bit more. I hadn't really sort of analyzed it in terms of really capital choices really as much as just the very natural rhythms of the marketplace and some of the advantages that Capital One has by virtue of our choices that we made over the last couple of years. But we'll have to think about that. But I just think this is just very much sort of as you've seen numerous times in the past where there's a little bit of an inflection point for Capital One at a time that's a little different and occasionally in a different direction than the inflection points of others.

Andrew Young, CFO

And then, Bill, with respect to category 2. Well, first, let me just note, we're going to be below the $700 billion threshold at closing and the trigger is really a four-quarter average beyond that. So I just wanted to mention the specifics of what is going to trigger it. But within category 2 to category 3, there's really three big distinctions. The first one is losing the tailoring benefit for LCR and NSFR, and you can see based on the ratios that we hold there and our conservatism around liquidity. We feel very well prepared. The other two, which are the inclusion of AOCI in regulatory capital and the DTA threshold going from 25 to 10, those are both already included at least in what was proposed for the Basel III end-game rules. We all know that those proposals are being debated and refined. But ultimately, we're looking at those two implications as part of the proposal anyway. And so we don't really see a big difference in the long-term implications, at least as we sit today, again, the proposal may take a different form. But from a planning perspective, those were two things that we already had our eye on. And so we ultimately feel well prepared all of the implications of either category 2 or the Basel III end-game proposals if they were to go in as currently constructed.

Jeff Norris, Senior Vice President of Finance

Next question, please.

Operator, Operator

And our final question comes from Jeff Adelson with Morgan Stanley.

Jeffrey Adelson, Analyst

Rich, I just wanted to circle back on your comment about how you continue to kind of trim around the edges. I think last quarter, you were suggesting that the trimming was sort of abating after a number of years of trimming. But given your comments today about how you're continuing to lean in, how the U.S. consumer remains a strength of source, how are you thinking about potentially opening up the credit box a little bit more from here? And relatedly, does the pending deal with Discover factor into how you're thinking about allocating capital at all into more growth at this point?

Richard Fairbank, Chairman and CEO

Thanks, Jeff. We continually make adjustments based on what we see in the marketplace as well as what we anticipate might happen. Our situation is very similar to where we were three months ago. The adjustments and reductions during the significant credit normalization were more noticeable than what we observe now as things stabilize. The factors influencing this are not only related to consumer behavior but also to how we monitor our credit performance, including both the overall portfolio and our originations. Notably, our originations have consistently performed well quarter after quarter, even though this data is somewhat lagged. We have been surprised by how consistently strong our originations have been, despite some slight declines in overall consumer credit metrics. Therefore, we are in a comparable position to where we were before. We feel confident about our credit and origination performance and are actively engaging across the credit spectrum. Regarding the Discover deal, it hasn't changed our origination strategy, which remains the same. While we are excited about the Discover deal, our overall strategy continues as it has been.

Jeff Norris, Senior Vice President of Finance

Thanks, Rich and Andrew. Thanks, everybody, for joining us this evening and for your continuing interest in Capital One. Have a great evening.

Operator, Operator

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