Earnings Call Transcript
CAPITAL ONE FINANCIAL CORP (COF)
Earnings Call Transcript - COF Q2 2025
Jeff Norris, Senior Vice President of Finance
Thanks very much, Josh, and welcome, everybody. Just a few opening remarks. To access the live webcast of this call, please go to the Investors section of Capital One's website, capitalone.com. A copy of the earnings presentation, press release and financial supplement can also be found on the Investors section of Capital One's website by selecting Financials then Quarterly Earnings Releases. With me tonight 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 are going to walk you through the presentation, summarizing our second quarter results for 2025. 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 of our annual and quarterly reports accessible at Capital One's website and filed with the SEC. And with that, I'll turn the call over to Mr. Fairbank. Rich?
Richard Fairbank, Chairman and Chief Executive Officer
Thanks, Jeff, and good evening to everyone on tonight's call. I want to begin tonight by welcoming our colleagues at Discover to the Capital One journey. As you know, we completed our acquisition of Discover on May 18, and we're fully mobilized and hard at work on integration, which is going well. It's still early days, but we very much like what we've seen so far. We share key cultural attributes with Discover, including a deep shared commitment to customers, and we're as excited as ever by the expanding set of opportunities to grow and create value as a combined company. From our founding days, we've been on a quest to build a great financial institution, an integrated banking and global payments platform that's positioned at the forefront of the opportunities that will come as technology and data transform financial services. Discover enhances and accelerates our progress on this quest. I'll share additional thoughts on the hard work, investments and compelling opportunities we see going forward at the conclusion of tonight's call. But for now, I'll turn the call over to Andrew to discuss the balance sheet and purchase accounting impacts of the deal as well as our financial performance in the second quarter. Andrew?
Andrew Young, Chief Financial Officer
Thanks, Rich, and good afternoon, everyone. I will start on Slide 3 of tonight's presentation. As Rich just discussed, we closed the acquisition of Discover on May 18. We have now completed provisional purchase accounting and incorporated Discover's business lines into our reported segments, with Discover's domestic card and personal loans now included in our Credit Card segment, and Discover's deposits and network businesses in our Consumer segment. As part of the acquisition, we acquired $98.3 billion of domestic card loans with a net fair value discount of $220 million. We also acquired $9.9 billion of personal loans with a net fair value discount of $114 million. And we acquired $106.7 billion of deposits with a net fair value discount of $30 million. The amortization of these net fair value marks decreased net interest income by $85 million in the quarter. The full loan and deposit amortization schedule is included on Slide 17 of the appendix. We also acquired $7.9 billion of home loans, which have been marked as held for sale and are now included in discontinued operations. The net credit mark on the Discover loan portfolio increased the allowance on the balance sheet by $8.4 billion, with $8.8 billion of provision expense for non-PCD loans flowing through the P&L. I will discuss the allowance in greater detail in a moment. There were multiple amortizing intangibles created as a result of the acquisition. We recognized a core deposit intangible of $1 billion, a purchase credit card relationships intangible of $10.3 billion and network and financial partner relationships intangibles of $1.5 billion. The amortization of these intangibles increased noninterest expense by $255 million in the second quarter. We have included a full intangible amortization schedule on Slide 18 in the appendix. We also recognized two intangibles with indefinite lives: a network intangible of $3.1 billion and brand and trade name intangibles of $2.3 billion. And finally, we recorded goodwill of $13.2 billion. Including the impact of purchase accounting and the allowance build, the partial quarter impact of the legacy Discover businesses contributed $2 billion of revenue and a $6.4 billion net loss to the results from continuing operations. I'll also note that as we bring the two companies together, there are financial reporting presentation realignments and business changes that impacted the reporting geography of revenue, marketing and operating expense recognition. In total, these moves increased the operating efficiency by roughly 30 basis points and the total efficiency by roughly 15 basis points in the second quarter. Looking ahead, we expect the run rate impact of these changes to result in a roughly 90 basis point increase to the operating efficiency ratio and a roughly 50 basis point increase to the total efficiency ratio, all else equal. There is no impact from the reclassifications to the timing of recognition in either the second quarter or in future quarters, so the net impact to the bottom line is negligible. Turning to Slide 4, I'll cover the second quarter financial highlights for the combined company. Our results for the quarter were significantly impacted by the completion of the Discover acquisition. On a GAAP basis, we had a net loss of $4.3 billion or a loss of $8.58 per diluted common share. Included in the results for the quarter were multiple adjusting items related to Discover as well as a small addition to our legal reserves. Net of these adjusting items, net income in the quarter was $2.8 billion and diluted earnings per share was $5.48. There was also one notable item in the quarter. A law change in the state of California increased our effective tax rate but also created a one-time $128 million tax benefit as a result of truing up our deferred tax assets. Revenue in the second quarter increased $2.5 billion or 25% compared to the first quarter. Adjusted revenue increased 26% or $2.6 billion. Noninterest expense increased 18% or 14% net of adjustments. Pre-provision earnings in the second quarter were up 34% relative to the first quarter. Net of adjustments, pre-provision earnings increased by 40%. The increase in pre-provision earnings was largely driven by the partial quarter impact of Discover, while also benefiting from strong legacy Capital One results. On a GAAP basis, our provision for credit losses was $11.4 billion in the quarter. Excluding the $8.8 billion initial allowance build for Discover, the provision for credit losses was $2.7 billion, an increase of $294 million compared to the prior quarter. The increase was more than driven by $324 million in higher net charge-offs. A decline in charge-offs at legacy Capital One was more than entirely offset by the addition of the partial quarter of the Discover portfolio. Turning to Slide 5, I'll now cover the allowance in greater detail. We built $7.9 billion of allowance in the quarter, bringing the allowance balance to $23.9 billion. The primary drivers of the change in allowance related to the Discover acquisition included an $8.8 billion expense for non-PCD loans and a $2.9 billion initial allowance for PCD loans offset by a $3.3 billion benefit from the expected recoveries of acquired Discover loans that are fully charged off. Excluding these Discover impacts, the allowance balance declined by approximately $400 million. Our total portfolio coverage ratio increased 52 basis points to 5.43% driven largely by the mix shift of our portfolio. I'll cover the drivers of the changes in allowance and coverage ratio by segment on Slide 6. In our Credit Card segment, we built approximately $8 billion of allowance in the quarter. Roughly $760 million of the build is driven by the acquisition of Discover's personal loan portfolio, with the remaining $7.2 billion build in the domestic card business. The domestic card build was driven by two factors. First, we released approximately $400 million of allowance in the legacy Capital One portfolio. This legacy card release was driven by continued favorable credit performance in the quarter partially offset by a modestly worse economic outlook. And second, we built $7.6 billion of allowance for the Discover domestic card loans added in the quarter. The combination of incorporating an updated economic outlook, aligning allowance methodologies and reserving for growth in the portfolio led to a roughly $400 million increase in the allowance for Discover's card loans relative to the equivalent balance as a standalone company at the end of Q1. The consolidated domestic card coverage ratio now stands at 7.62%. The allowance balance in our Consumer Banking segment was largely flat at $1.9 billion. Observed credit favorability and the impact of stable auction prices was largely offset by growth in the auto business. The ending coverage ratio of 2.29% was down 8 basis points from the prior quarter. And finally, the commercial banking allowance balance of $1.5 billion and coverage ratio of 1.74% are largely flat to the prior quarter. Turning to Page 7, I'll now discuss liquidity. Total liquidity reserves ended the second quarter at $144 billion, up roughly $13 billion relative to last quarter. Our cash position sits at $59.1 billion, up $10.5 billion from the prior quarter. The increase in cash was primarily driven by proceeds from the sale of a portion of Discover's securities as well as the addition of acquired cash from Discover. Our preliminary average liquidity coverage ratio increased slightly during the second quarter to 157% and our average NSFR remained roughly flat at 136%. Turning to Page 8, I'll cover our net interest margin. Our second quarter net interest margin was 7.62%, 69 basis points higher than the prior quarter. The partial quarter impact of adding Discover increased NIM by roughly 40 basis points. This 40 basis point increase includes the roughly offsetting effects of a 6 basis point drag from the fair value marks and a 6 basis point tailwind from changing Discover's historical practice to now include late fees in interest income. The remaining nearly 30 basis point improvement in NIM was driven by legacy Capital One, which had lower rates paid on deposits, a liability mix shift towards deposits and one additional day in the quarter. Looking ahead, we expect the full quarter benefit from the Discover acquisition to drive an additional 40 basis point increase to NIM, all else equal. Turning to Slide 9, I will end by discussing our capital position. Our common equity Tier 1 capital ratio ended the quarter at 14%, approximately 40 basis points higher than the prior quarter. The impact of the equity issuance for the acquisition was partially offset by the additional goodwill and intangible assets, the increase in risk-weighted assets, the net loss in the quarter, dividends and $150 million of share repurchases. During the quarter, the Federal Reserve released the results of their stress test. Our preliminary stress capital buffer requirement is 4.5%, resulting in a CET1 need of 9%. The new SCB becomes effective on October 1. Now that we've closed the Discover transaction, we are working through our internal modeling of the combined company's capital need and look forward to sharing an update once our work is complete. With that, I will turn the call back over to Rich.
Richard Fairbank, Chairman and Chief Executive Officer
Thanks, Andrew. Slide 11 shows second quarter results in our Credit Card business. Credit Card segment results are largely a function of our domestic card results and trends, which are shown on Slide 12. The Discover acquisition was the dominant driver of second quarter domestic card results, including the impact of a partial quarter of combined operations, a combined quarter-end balance sheet and purchase accounting effects. Looking through the Discover impact, the combined domestic card business delivered another quarter of top line growth, strong margins and improving credit. Year-over-year purchase volume growth for the quarter was 22%, which includes $26.5 billion of Discover purchase volume. Excluding Discover, year-over-year purchase volume growth was about 6%. Ending loan balances increased 72% and largely as a result of adding $99.7 billion of Discover card loans. Excluding Discover, ending loans grew about 4% year-over-year. Revenue was up 33% from the second quarter of 2024 driven largely by adding the partial quarter of Discover revenue. Excluding Discover, year-over-year revenue growth was about 8% driven by underlying growth in purchase volume and loans. Revenue margin for the quarter was 17.3%, including a 121 basis point impact from the partial quarter of combined operations and amortization of the purchase accounting fair value mark. Excluding these Discover impacts, revenue margin would have been 18.5%. The domestic card net charge-off rate was 5.25%, down 80 basis points from the prior year quarter. The 30-plus delinquency rate was 3.60%, down 54 basis points from the prior year. These metrics were impacted by the addition of Discover, which has historically had lower losses and delinquencies than Capital One. The delinquency metric was also impacted by aligning methodologies between Discover and Capital One. Capital One's legacy domestic card portfolio would have had a net charge-off rate of 5.50%, down 55 basis points year-over-year; and a 30-plus delinquency rate of 3.92%, down 22 basis points from the prior year. Capital One's card delinquencies have been improving on a seasonally adjusted basis since October of last year, and our losses have been improving since January of 2025. Discover's card credit metrics peaked about a quarter later, but are now improving steadily following a similar path to what we observe on the legacy Capital One portfolio. Domestic card noninterest expense was up 42% compared to the second quarter of 2024. Operating expense and marketing both increased year-over-year. Total company marketing expense in the quarter was $1.35 billion, up 26% year-over-year. Our choices in domestic card are the biggest driver of total company marketing. We continue to see compelling growth opportunities in our domestic card business. Our marketing continues to deliver strong new account growth across the domestic card business and build an enduring franchise with heavy spenders at the top of the market. Compared to the second quarter of 2024, domestic card marketing in the quarter included the addition of Discover marketing, higher direct response marketing, higher media spend and increased investment in premium benefits and differentiated customer experiences. As always, all of our marketing and origination choices are informed by our continuous monitoring of portfolio trends, market conditions, and consumer and competitor behaviors. Slide 13 shows second quarter results in our consumer banking business. Global payment network transaction volume from the May 18 close of the Discover acquisition through quarter end was about $74 billion. Auto originations were up 28% from the prior year quarter driven by overall market growth and our strong position to pursue resilient growth in the current marketplace. Consumer banking ending loan balances increased $5.6 billion or about 7% year-over-year. Average loans were up 6%. Compared to the year-ago quarter, ending consumer deposits grew at 36% and average consumer deposits were up about 21% driven largely by the addition of Discover deposits. Looking through the Discover impact, our digital-first national consumer banking business continues to grow and gain traction, powered by our technology information and our compelling no fees, no minimums and no overdraft fees customer value proposition. Consumer banking revenue for the quarter was up about 16% year-over-year driven predominantly by the partial quarter of Discover as well as growth in auto loans. Noninterest expense was up about 37% compared to the second quarter of 2024 driven largely by the partial quarter of Discover as well as increased auto originations, the legal reserve addition that Andrew mentioned, higher marketing to drive growth in our national consumer banking business and continued technology investments. The auto charge-off rate for the quarter was 1.25%, down 56 basis points year-over-year. Largely as the result of our choice to tighten credit and pull back in 2022, auto charge-offs are improving on a seasonally adjusted basis. The 30-plus delinquency rate was 4.84%, down 83 basis points year-over-year. Slide 14 shows second quarter results for our commercial banking business. Compared to the linked quarter, both ending and average loan balances were up 1%. Ending deposits were down about 2% from the linked quarter. Average deposits were down 4%. We continue to manage down selected less attractive commercial deposit balances. Second quarter revenue was up 6% from the linked quarter and noninterest expense was up by about 1%. The commercial banking annualized net charge-off rate for the second quarter increased 22 basis points from the sequential quarter to 0.33%. The commercial criticized performing loan rate was 5.89%, down 52 basis points compared to the linked quarter. The criticized nonperforming loan rate was down 10 basis points to 1.30%. As we close this presentation and before we open it up for Q&A, I want to pull up and reflect not just on the quarter but also on where we are. In the second quarter, bringing on Discover for a partial quarter and the related purchase accounting impacts dominated our reported results. But looking through these effects, our adjusted earnings top line growth, credit results and capital generation continued to be strong. We completed the Discover acquisition on May 18, and we continue to be very excited about the opportunity. Here are some early financial observations. They are, of course, still subject to change, but we wanted to share our thoughts with you. Let me start with integration costs. Our integration budget covers a wide array of expenses, including deal costs, moving Discover on to our tech stack, integrating their products and experiences, making additional investments in risk management and compliance, and integrating the talent and taking care of the associates along the way. The integration is off to a great start. But as we have gotten more granularity on each of these efforts, we expect our integration costs will be somewhat higher than our previously announced $2.8 billion. Let me turn now to synergies. We are on track to deliver the $2.5 billion in total net synergies we discussed on the April earnings call. There are significant cost savings and also significant real revenue synergies, and we have line of sight to achieving them. I also want to savor this moment and where we are. We are on the cusp of even greater opportunities down the road. These opportunities come both from this deal and also from Capital One's transformation to be at the frontier of a rapidly changing marketplace. These opportunities are exciting, but they will require significant investment to bring them home. Let me start with the opportunities with Discover. The revenue synergies we have already identified come from moving our debit business and a portion of our credit business onto the Discover network. To move more volume and capitalize on the tremendous scale benefits of the network, we need to achieve greater international acceptance and then build a global network brand. This will enable moving bigger spenders on to the Discover network. These additional moves require sustained investment for a number of years, and we will begin to undertake these investments first in acceptance and then when we get the network to critical mass, we will invest in the network brand. There are only two banks in the world with their own network, and we are one of them. We are moving to capitalize on this rare and valuable opportunity. With all the discussion of Discover, we can lose sight of the very important place legacy Capital One is in. We are in the 13th year of an all-in technology transformation. While most companies have invested in transforming technology at the top of the tech stack, in other words, leading with customer-facing applications, we have taken the much harder but ultimately necessary journey. We have been rebuilding the company from the bottom of the tech stack up, essentially building a modern technology company that does banking. As we move up the tech stack, the opportunities are accelerating. We are also the beneficiary of decades of investment in our data and analytics capabilities and the building of a well-known national brand. Together with our leading technology capabilities, they are the enablers of our many opportunities. Take our retail bank. The universal playbook in banking is to build a national bank through acquisitions. However, we are doing it organically on the shoulders of our modern tech stack, our full-service digital banking offerings, our thin physical distribution of showroom branches, and our national brand. We are enjoying a lot of traction, and the acquisition of a network propels us forward even more. Building the national bank requires sustained investment in marketing, and we are doing that, and we expect to lean in even more. Let me turn to our card business. After building a mass market credit card business, we declared in 2010, we were launching a quest to win at the top of the market with heavy spenders. Few card players have chosen sustainably to take on this quest. We have been steadfast. We have had a lot of success in this journey, but it is a long one. Our two biggest competitors are investing heavily, and we know we will need to keep leaning into this big opportunity. As we have moved up the tech stack, we have seized the opportunity to pursue emerging growth opportunities across our company, some of the salient ones you have seen and hopefully experience, like Capital One Shopping and Capital One Travel. Another example is Auto Navigator, which is a three-party platform designed to reduce friction for consumers and dealers in buying and financing a car. Most importantly, we continue to invest in our modern technology stack. The gap between the modern technology companies fully in the cloud, built on modern applications and data, and the rest of corporate America continues to grow. The modern tech companies are well positioned to win as the world continues to evolve, and we have spent years to become one of them. The rage of the world is AI. Some aspects of the AI revolution will be broadly accessible to all companies and other aspects will be very exclusive. Most companies will benefit from the transformation in how work is done that will be available through third-party AI tools but only the companies built on a modern tech stack and deeply invested in data will be in a position to reinvent their business model to put AI at the heart of operations, risk management and the customer experience. The opportunities are transformational, and we are well positioned in that quest. But these opportunities require sustained investment in AI and in AI talent, and we are doing that. In a company built for innovation and organic growth, I am struck by the number of compelling opportunities for innovation and value creation that we see. These opportunities are made possible by the choices we have made over the last many years. As I have been saying, these opportunities require investment, and for many of them, timing is critical as we strive to seize competitive advantage. Collectively, these investments across Discover and legacy Capital One are significant but they also will be the basis for our sustained growth and strong returns over the longer term. The opportunities we are describing here have been years in the making, and you have heard me talking about them for quite some time. Importantly, the earnings power of our combined company that we envision on the other side of the deal integration is consistent with what we assumed at the time of our deal announcement even though some individual variables have moved along the way. When I reflect on our journey from founding the company to where we are today, we got here by always working backwards from where winning is and driving the continual transformations and investments to get there. The choices we made over the years also created the opportunity for us to acquire Discover. And in the spirit of that quest, 38 years after the founding idea for Capital One, we find ourselves as well positioned as we've ever been to drive future success and value creation. And now we'll be happy to answer your questions. Jeff?
Jeff Norris, Senior Vice President of Finance
Thank you, Rich. We'll now start the Q&A session. If you have follow-up questions after the Q&A session, the Investor Relations team will be available. Josh, please start the Q&A session.
Operator, Operator
Our first question comes from Terry Ma with Barclays.
Terry Ma, Analyst
Now that you've closed the acquisition, and I do appreciate the updated financial observations, but do you have any kind of updated thoughts on the economics of the deal that you can share, whether it's earnings power over time or some sort of return targets that investors should be thinking about?
Richard Fairbank, Chairman and Chief Executive Officer
Thank you, Terry. We're very pleased to finally have closed the deal, and it's been a few weeks since we moved forward. I mentioned in my prepared remarks our strong belief in the earnings potential of our combined entity. Additionally, we're focusing on opportunities that are characteristic of Capital One, which will help establish a foundation for long-term earnings enhancement. Aside from my previous comments, I don't have any specific updates at this time, but we are quite optimistic about the deal, its economics, and the earnings potential and opportunities ahead.
Terry Ma, Analyst
Got it. And then as a follow-up, just on capital level, you mentioned you guys are doing your internal work. Any sense of the timing of when you will kind of get that informed view and communicate that to investors? And then as I step back, you were at 14% CET1. That's meaningfully above what legacy Capital One's target was of 11% and Discover's of 10% to 11%. Is there any reason why, on a consolidated basis, it would be kind of meaningfully different?
Andrew Young, Chief Financial Officer
Yes, Terry, having closed the deal just a couple of months ago, we are just getting full access to all of Discover's customer-level data, and we need to run all of that information through our models. And so while we received the SCB from the Fed, and it declined to 9%, as you well know, that number has fluctuated from 10.3% to 7% over the last handful of years, so we think about capital largely through the lens of our internal assessment of our longer-term capital need versus the Feds, which is why we need to do that modeling. And so we are still in the middle of that work right now. I will say that we're not finding anything surprising at all in our analysis. And we feel comfortable that at 14%, we're operating with excess capital above the long-term need of the combined company, and we have the flexibility with our repurchase actions as we're operating under the SCB, but we need to complete that work. So as we get closer to finishing the work, I think it's reasonable to assume that we'll begin to step up our repurchases from recent levels, but we look forward to sharing an update more broadly on our work when it's complete.
Operator, Operator
Our next question comes from Rick Shane with JPMorgan.
Rick Shane, Analyst
Look, I'm going to break my own personal role here. Congratulations on the completion of the acquisition. It's transformational, and it's going to be very interesting to see what happens from here. Rich, you alluded to the fact that the integration expenses are going to be above the initial $2.8 billion target. Could you help us understand that more specifically? And also, could you put into context where you're seeing the opportunity for incremental investment so that we can sort of translate what the opportunity would be?
Richard Fairbank, Chairman and Chief Executive Officer
Thank you, Rick, for your congratulations. We are all very excited about this development, and so are our investors. Regarding the integration costs, at the outset of any deal, we do our best to gather input on all aspects of integration and combine those insights. As we progress, we're noticing that costs are coming in a bit higher than expected, not due to a specific issue, but rather across various elements of this deal. We wanted to highlight this as we realized the costs would be somewhat elevated. Now, let’s discuss the investments. Everything I mentioned earlier about investments reflects opportunities we've been considering for quite some time. We are not introducing anything entirely new. The key point I wanted to emphasize is that these opportunities build on the foundational investments we’ve made over many years, especially in transforming Capital One's technology, along with significant investments in brand, data, analytics, machine learning, and AI. As we dive deeper into these opportunities, we are excited to see some accelerating trends. However, the way to achieve these goals is by continuing our investments. We've been investing for a while, but we plan to intensify our focus on pursuing these opportunities, which, in the context of Capital One's history, represent the most extensive and significant portfolio of opportunities we've ever had. Getting to the next stage requires investment, and we are rigorous in assessing each opportunity and its costs. We believe that there will be substantial value creation for our investors, consistent with the principles that have guided Capital One from the start, but we will need to invest significantly to realize that potential.
Operator, Operator
Our next question comes from Sanjay Sakhrani with KBW.
Sanjay Sakhrani, Analyst
Rich, obviously, Discover was working through a number of credit issues and not really leaning into growth like Capital One had been. I guess since credit is now somewhat under control there, do you expect to sort of lean into growth at Discover as well inside of Prime as we look forward?
Richard Fairbank, Chairman and Chief Executive Officer
Yes, we plan to focus on growth opportunities with Discover. Their card business has developed an impressive franchise over the years. They faced higher credit losses than anticipated, which prompted them to make some important adjustments and return to the fundamentals that built their business. This has led to a slowdown in their originations and growth during this time, but these choices have also supported their strong credit performance, with recent vintages performing better than in previous years. While growth has been somewhat muted due to these adjustments, we are now getting familiar with their impressive card business, and we appreciate their products. We intend to continue promoting their flagship credit card product and are excited about their successful student credit card business and their secured starter card offerings. We will also focus on enhancing their customer experience, which scores highly on various metrics we track. We plan to adopt many of their customer technology strategies and maintain their excellent servicing experience. Although Discover will no longer function as a corporate brand, it will remain a strong product brand in the credit card sector. We will pursue growth opportunities while acknowledging the current muted growth situation. As we integrate further, there may be areas where we scale back a bit, but I am confident there will also be opportunities to push for greater growth. Our goal is to enhance the franchise while preserving the unique qualities that have made them a leading credit card company in America.
Sanjay Sakhrani, Analyst
Just a follow-up for Andrew. Sorry to ask this question because I'm sure I can parse through all of this excellent disclosure that you provided in your comments to get to some of my conclusions. But just as we look ahead, what are some of the variables that we need to think about as a result of these purchase accounting changes? I heard you mention the NIM, having a 40 basis point tailwind because of the reclass of late fees and such. But maybe, Andrew, can you just like help us think through some of the progression of the major line items as a result of this?
Andrew Young, Chief Financial Officer
I appreciate the acknowledgment, Sanjay. We worked hard to provide a lot of information, and you'll find additional disclosures on delinquency and charge-offs in the presentation, footnotes, and the monthly data released today. We made an effort to give visibility into all these aspects. I'm hesitant to provide a full reconciliation of all metrics, but I direct you to the slides in the appendix, which clearly outline the implications for NIM and operating expenses. In the footnotes, we provided both annual and quarterly views for this year. For example, the non-PCD card loans, marked above par, create an immediate net drag due to their short life, but this effect diminishes quickly. The PCD that carries forward will serve as a good guide for NIM over the next few years. It’s challenging to summarize all these elements succinctly, which is why we aimed to present everything as clearly as possible. These figures are subject to revisions over time, which is why I communicated it this way, but we hope these will eventually reflect the final numbers.
Operator, Operator
Our next question comes from Ryan Nash with Goldman Sachs.
Ryan Nash, Analyst
So Rich, you talked about significant sustained investment. I think the phrase was used several times to talk about acceptance, marketing, the tech stack and AI. And I think you know this will obviously create questions about how much all of this is going to cost. So is there anything that you can share that can give the market comfort that there isn't significant synergy reinvestment risk and that eventually, this will result in a more efficient, consolidated company over time?
Richard Fairbank, Chairman and Chief Executive Officer
Thank you, Ryan. When considering the investment opportunities we're discussing, there are familiar concepts for investors that we've highlighted before. Our technology transformation is a key focus and has been ongoing for 13 years. As the world evolves, we are committed to modernizing our entire technology framework. Progress has been impressive, but we still have work to do. Our aim is not just to update the company but to rebuild it for greater efficiency, innovation, and risk management, enhancing the customer experience in the process. We have identified the capabilities we want to foster through this tech modernization and will keep investing in it. Investors shouldn't expect any surprises in this regard. However, modernizing core infrastructure is a challenging journey, and until more systems are updated, the tangible benefits may not be immediately visible. Advancing up the tech stack will help us better monetize opportunities. Additionally, we see significant potential in the Discover integration, which involves moving our debit and a portion of our credit card business onto the network to fully leverage its scale. Our strategy includes investing in international acceptance and establishing a global network brand, both of which we’ve previously discussed with investors. It's clear that this is a long-term process that will demand substantial investments. In discussing our national bank, we are uniquely focused on building a full-service bank organically, unlike others who rely on acquisitions. This path also requires significant investment, and we've had notable success in developing this, especially as we incorporate the Discover network, which is gaining traction in our business. There's considerable opportunity to enhance our national bank operations further. At the higher end of the market, we observe other players aggressively investing because the upside potential there is significant, albeit not universally accessible among credit card companies. It necessitates ongoing investment in brand development, technology, and customer experiences. We’re encouraged by our continued growth, particularly among higher spenders within our card business, which signals our success in strengthening our brand. Each year, as we ascend to the higher echelons of the market, we validate the returns on our investments. Moreover, as we progress up the technology stack, we're also enhancing customer experiences. Our goal is to establish a bank that is central to the financial lives of consumers and businesses, fostering primary banking and spending relationships. We now serve over 100 million customers and see the potential to deepen our offerings with these highly engaged users. This is why we are actively pursuing avenues like Capital One Shopping, Capital One Travel, and Auto Navigator to expand our franchise, all of which are experiencing notable growth and benefiting from our larger customer base following this acquisition. To convey to our investors, throughout my tenure at Capital One, we have consistently embraced the philosophy of working backward from the winning outcomes. We are committed to investing strategically and rigorously, focusing on value creation to adapt as the marketplace evolves. Given where we currently stand in the company's evolution, I believe we have some of the best opportunities ahead of us. Even while discussing these investments, we anticipate maintaining consistent earnings power, aligning with our expectations from the announcement.
Operator, Operator
Our next question comes from Erika Najarian with UBS.
L. Erika Penala, Analyst
I'm going to just move off the expense question for a second and reask the question on capital. Fully appreciate that you're going through a review and fully appreciate the statement that you found nothing yet that's surprising. As we think about the 14% versus the legacy targets of Capital One and Discover, I guess another way to ask the question is how much time will you give yourself to optimize the capital to where you think the right level is for the company?
Andrew Young, Chief Financial Officer
Yes. Well, there's two parts, I think, to that question, Erika. One is kind of what level are we heading towards, which is also impact at any point in time of what's just happening more broadly around us, which then spills into the second piece of it, of how much do we want to be repurchasing at any one moment in time. So I don't have a precise answer for you. Of course, there is some upper bound in terms of SEC limitations to repurchases. But really, what I would point you to is we're going to work through the customer-level data, determine our longer-term capital need. And as we move towards finishing that work, I think the operative phrase that I said earlier is we'll likely begin to step up our repurchases from recent levels. But once that work is complete, which we're doing as quickly as we can, we'll provide an update at that time.
L. Erika Penala, Analyst
And just a quick follow-up for me. Ryan mentioned it was important to investors. And I just picked up on something that Rich said at the end of his answers to Ryan, which is that EPS power remains consistent with how you thought about it in the beginning of this journey with Discover. And I guess if I break it down, your integration expenses are coming in a little heavier than the $2.8 billion. You did mention, you did reiterate the synergy targets, which I would surmise to include the expense synergy target. And so I guess the last piece that everyone is trying to get at is does the run rate of expense growth, that flipped, for lack of a better word, legacy Capital One accelerate? And I guess based on the explanation of what you're investing in, it seems like that would have been the case. But then, Rich, threw in EPS power should remain consistent with what you originally thought. So again, I know we're belaboring a point but I think it's critical for investors as we think about the pro forma EPS power of this company.
Richard Fairbank, Chairman and Chief Executive Officer
Yes, Erika, I think you were breaking up a little bit, but we got the essence of what you were saying there. So Capital One and Discover have both historically had strong earnings power. And in combining them, we can create a very strong institution and, of course, also add synergies. There have been many moving pieces since we announced the deal in both companies' actual operating results and investment choices and, of course, in the broader economic, competitive and credit backdrop. Since the deal announcement, individual line items have, of course, drifted, but the net drift has so far been in a favorable direction. At the same time, the opportunities and the investment associated with them have also grown. So we estimate that the net earnings power of our combined company as it emerges from integration is similar to our estimates in the deal model.
Operator, Operator
Our next question comes from Moshe Orenbuch with TD Cowen.
Moshe Orenbuch, Analyst
Rich, a couple of times you kind of alluded to competition in the high end of the card business. I was hoping you could kind of give us your sense as to how that's likely to evolve this year given what you've got going on at 2 of the major competitors, perhaps 3, if you include all of the ones that have made announcements thus far, and whether there are any elements of the transaction that will be kind of helpful to Capital One in addressing that. And I do have a follow-up.
Richard Fairbank, Chairman and Chief Executive Officer
Yes, Moshe. When we examine the competitive landscape, it’s clear that competition in the card business is very intense. Recently, the most notable competition has been at the high end of the market. Before discussing specific recent developments, it's worth noting that the stakes and investments required to compete at this level have increased, particularly in the area of lounges. We've observed significant efforts from major players to construct their own lounges while also partnering with existing networks. Capital One has been actively involved in this space, and we’re very pleased with our five lounges, including the one at Reagan National Airport. Research indicates that customers value lounges, which is encouraging as we see positive customer reactions and increased originations from these offerings. Another competitive aspect is marketing expenditures and the creation of unique experiences for customers. We are excited about the distinctive access we provide, like our partnership with Taylor Swift, which has been a significant opportunity for us. However, we also notice that a small group of companies are distinguishing themselves through their offerings and commitment in this sector. This opens up competitive opportunities as we navigate these higher investment requirements. Regarding products, it’s notable that both Chase and American Express have announced changes aimed at the top of the market. While American Express hasn't specified their plans yet, Chase has unveiled a higher fee structure alongside enhanced rewards and an expanded list of promotional offers. This trend is something we've observed at Amex for several years. We’ve positioned our strategy at the top of the market to not merely replicate competitors but rather to create a truly exceptional experience tailored for the right customers. Take, for instance, our Venture X product, which offers a 2x earning rate that exceeds some competitive products. While other products may have co-brand relationships with airlines, leading to additional expenses, Venture X offers unique benefits like 2x earning on all purchases. We're satisfied with the positive traction Venture X has been receiving, and our ongoing marketing efforts on television aim to showcase our advantages. As competitors launch their different strategies, we believe there is ample opportunity at our price point and in our diverse set of offerings and experiences. We are making significant strides with Venture X and are also enhancing our digital experiences, product offerings, lounges, and special access, positioning Capital One favorably amid heightened competition. You inquired about the impact of adding Discover to our network. Discover brings additional scale, which offers us greater opportunities, even though they aren’t a leading player in this segment. Looking ahead, we also see potential opportunities on the network side concerning the high-end market, though those developments are likely to take time. Thank you.
Moshe Orenbuch, Analyst
Maybe just as a kind of a follow-up. One of the things that we've thought about a little bit is using the benefit of unregulated debit interchange to help build the banking franchise and to go to a rewards checking model. And you talked about the banking franchise and some of those impacts. Could you talk about how you see that, now that you've got access to this and can start migrating your debit accounts?
Richard Fairbank, Chairman and Chief Executive Officer
So our national bank strategy has always been about offering industry-leading products backed by a business model that can economically support that. So when you think about that, we have a full-service digital bank. There are a lot of folks out there with digital banking capabilities. A key differentiator is Capital One has full-service digital banking. We do believe physical presence matters, and our research continues to confirm that. Even ironically, so many people say, "Yes, I never go in the branch." But in their choices, physical presence does matter to a lot of people. And that's why we have built our thin distribution model of these sort of showroom branches. But again, importantly, working backwards from having the economics, that's different from a branch on every corner kind of a thing. So the economics of this have supported a product offer that's industry-leading: no fees, no minimums and no overdraft fees. And no other major bank has a primary offering that matches that. And actually, our product offer is democratizing banking by making it available to anyone at no cost, and customers have responded very positively. Now let me turn to Discover. Discover has a small portfolio of cash-back debit cards. We plan to keep those customers in their current product. And with the benefit of the network now and bringing Discover on, we are raising the investment levels in our flagship product to help propel our national bank growth with a very successful industry-leading value proposition that has gotten us here.
Operator, Operator
Our next question comes from Don Fandetti with Wells Fargo.
Donald Fandetti, Analyst
Rich, can you share a little bit more about your international acceptance build-out plans? I'm just trying to think if there's a way you can help size it or talk about how the expenses get funded because I guess the revenue benefit of moving the bulk of the credit cards over to the network happens after you get the acceptance. And if there are any sort of guideposts or targets that you have, that would be helpful.
Richard Fairbank, Chairman and Chief Executive Officer
We haven't been in the network business before, so over the past several months before the deal, we did everything we could to understand this sector. We brought in consultants to share their expertise, and now, as we move forward, we are gaining valuable insights from Discover. I've seen many scalable businesses, but the network business stands out due to its scale-driven nature. The marginal cost of a transaction here is nearly zero, while the fixed costs are significant. This explains why two giants, Visa and Mastercard, dominate the space, as many banks lack the scale to develop their own networks. We consider ourselves fortunate to have a network. I'm surprised by Discover's level of international acceptance despite its relatively small scale domestically and modest global presence. While it's not where we want it to be to attract more international travelers, it's impressive given their size. They have successfully achieved decent international acceptance and possess a strategy to expand it further. There are four key methods Discover has used to create this international network acceptance: partnering with other networks, collaborating with merchant acquirers, working with card-issuing financial institutions, and engaging directly with merchants. They have utilized a mix of these approaches. We've discussed with them the feasibility of increasing acceptance, and the response is to leverage these methods more aggressively and invest more than they have in the past. Capital One has historically taken on similar challenges and made strategic investments, so this aligns well with our approach. We don’t have a precise estimate of what it will take, and acceptance levels are something we will better understand as we explore our customers’ experiences. However, I’m confident that the strategy is solid and the opportunity to increase volume is evident. Plus, Discover already has a network brand, and we aim to enhance that into a more global market presence. This is a clear pathway for us, aligning with Capital One's history of tackling challenges and seizing opportunities effectively.
Operator, Operator
Our next question comes from John Pancari with Evercore.
John Pancari, Analyst
Just to go back to the cost topic, again, the expense topic, sorry to go back to it. But just to clarify, what type of costs are included in the upfront integration costs that you indicated are likely to come in higher? And then what types of investments are netted against the $1.5 billion in cost saves that you set out?
Andrew Young, Chief Financial Officer
John, I want to ask for clarification on the back half of your question. But in terms of what is included in the integration costs, we had deal costs. We are making additional investments in their risk management. We're integrating their people. We're moving them to our tech stack. So those are the components that were included in the integration costs. So it's not one specific thing that I would point you to in terms of what is increasing the integration and signaling that we think they might be somewhat higher. But I didn't quite follow the second half of your question. So could you just repeat that?
John Pancari, Analyst
Yes. I was just trying to determine the difference between the type of costs that are included in the upfront integration costs that are coming in higher versus the type of investments, like the investments in the network, and investments in regulatory areas that may be netted against the net cost saves that you set out.
Andrew Young, Chief Financial Officer
Yes. So investments would include things like building out additional capabilities for debit on the network to enable future spend and increase customer engagement as opposed to, in the integration costs, that just reflects the sheer act of taking our debit volume and moving them on to their system. So philosophically, hopefully, that provides a bit of a window into the distinction between what is an integration spend versus what is an ongoing investment.
John Pancari, Analyst
Right. So those investments, those ongoing investments that you mentioned, being that they are netted against the cost saves and that you feel good about or that you had indicated in your prepared remarks that you are on track to achieve the expected $2.5 billion synergies, so is it fair to assume that there's no implied expected change in those investments that are within that $2.5 billion?
Andrew Young, Chief Financial Officer
There are three pieces to this. Maybe I'll put it in my language to make sure we're saying the same thing. One are the integration costs, the $2.8 billion number that Rich referenced in his prepared remarks. Those are the necessary expenses, deal costs, people costs, integrating them onto our tech stack, moving our debit onto their network. The second piece are the cost synergies that we have identified as a result of bringing our two organizations together, and those cost synergies are fully intact. The third piece to it is additional investments that, in some ways, like Rich enumerated that we will be making beyond the current levels of investments in certain areas that we're making today. So that is distinct from the achievement of the cost synergies that you articulated in the bucket. And I think you are netting the second and third category in your question, but I really want to create a firm distinction between those two things because the additional investments are things that will power future growth and create additional value. And the window or the evaluation process that we use for considering those investments are just like any other investment that we would make in Capital One, which is importantly distinct from achieving the synergies that we laid out in announcing the deal.
Operator, Operator
Our next question comes from Jeff Adelson with Morgan Stanley.
Jeffrey Adelson, Analyst
Most of my questions have been asked and answered. But just on the debit conversion, I know you sort of characterized this as something that can happen relatively quickly. Can you just give us an update on where you are in that process, how quickly you'll be able to pull that off, achieve the full debit interchange benefit on a run rate basis? And maybe what are some of the steps you need to take from here to go through that and complete the conversion? And as a part of that question, have you had any discussions with some of the largest merchants where your legacy Capital One debit customers are shopping today? Are those merchants on board with some of the changes that are coming forth? Or are there any sort of negotiation that needs to happen?
Richard Fairbank, Chairman and Chief Executive Officer
We started reissuing Capital One debit cards on the Discover network with initial pilot groups in June, and we anticipate the transition will occur in stages until early 2026. By the fourth quarter of 2025, we expect most customers to be using the Discover network, with all debit purchase volume processed through it by early 2026. A key advantage of acquiring a network is the ability to establish direct relationships with merchants. This is crucial because I have always believed that the forefront of technological advancement in financial services lies in payments, and we aimed to create a payments-focused company. It's somewhat unusual for a significant part of the value chain to be managed by an intermediary, but this is often due to the scale-driven nature of the industry. However, within Capital One, we have been actively working on building direct relationships with merchants since we have 100 million customers, and merchants aim to increase sales. With this large customer base, we can help merchants achieve better deals. Another strategy for Capital One is to engage directly with merchants to leverage our substantial investment in data and technology, and increasingly in AI, to provide greater value to merchants, like fraud reduction. We are making significant progress in establishing direct relationships with merchants and specific merchant-funded initiatives. The Discover acquisition enables us to transform a segment of the value chain previously managed by intermediaries and allows us to engage directly in some aspects of our business. As we move forward with this, we will continue discussions with merchants and share data demonstrating the value we provide, including our debit offerings. Enhancing our debit business will be integral to these conversations and our expanding partnerships with merchants. Overall, we are excited about scaling Capital One's direct-to-merchant business model.
Operator, Operator
Our next question comes from Brian Foran with Truist Securities.
Brian Foran, Analyst
I know you haven't been big users of guidance historically, but there have been times where you set out these guideposts, whether it's the OpEx efficiency target, I think there was threading the theme at one point, loss guidance, EPS guidance, those kind of things, when you're helping investors navigate periods of transition or trying to understand an issue. I know you're kind of deferring to give specific guidance right now, but is that something you're contemplating? I mean it is hard to look at the kind of numbers for 2Q with the mid-quarter close and all the adjustments and really get comfortable or confidence of what the core is going to look like over the next couple of quarters. Is there a thought of giving guidance on some high-level metrics or targets on returns or something like that? Or is it going to be a little bit more of a "chips fall where they may" philosophy?
Richard Fairbank, Chairman and Chief Executive Officer
Thank you for your question, Brian. Reflecting on the day we launched the IPO of Capital One, my previous experience as a strategy consultant made me aware of how guidance can sometimes become the main focus of a business rather than truly providing value for investors. We have aimed to run our company without being overly reliant on guidance. From the beginning, we developed what I call horizontal accounting, recognizing that businesses often make choices based on vertical earnings instead of carefully assessing horizontal returns. We believe every decision has upfront costs and anticipated returns, and we measure the value created before, during, and after these decisions. Our business model emphasizes making significant investments while ensuring they generate value in the end, which has been central to our approach. Throughout this process, we've worked to establish a strong brand and credibility with investors, reflecting our commitment to long-term value creation. We occasionally provide guidance when we believe it is essential for investors to understand crucial aspects that matter to them, especially when we have insights that can be beneficial. Our goal is to help investors see the rationale behind our decisions and how we are focused on building a sustainable franchise that fosters long-term growth and earning power for them. As we integrate Discover into Capital One and explore the associated earnings potential, my earlier comments aimed to clarify our perspective on the situation, particularly regarding earnings potential despite changes in metrics. We recognize that many will make their own estimations, but our guidance will be situation-dependent. While we may provide it in the future, I wouldn't want to create an expectation that we will offer specific numbers right now as we start this transition with Discover.
Operator, Operator
And our final question comes from the line of John Hecht with Jefferies.
John Hecht, Analyst
Thank you for the update on Discover. I have a two-part question for you, Rich. What is your opinion on the current state of the U.S. consumer? Has anything changed in the last quarter? Additionally, have you observed any differences in payment or spending behaviors between your customer base and Discover’s customers?
Richard Fairbank, Chairman and Chief Executive Officer
Yes. Thank you so much. So the U.S. consumer is in a great place here that we see the U.S. consumer as a source of strength in the economy. The unemployment rate remains low and stable. Job creation remains healthy. Real wages are, of course, growing steadily. Consumer debt servicing burdens remain stable and near pre-pandemic levels. In our card portfolio, we're seeing improving delinquency rates and lower delinquency entries and payment rates are improving on a year-over-year basis. Now of course, the circumstances of individual consumers and households will vary as they always do. And as we've mentioned in past earnings calls, some pockets of consumers are feeling pressure from the cumulative effects of inflation and higher interest rates. And we're still seeing some delayed charge-off effects from the pandemic, although the improving trend in our delinquencies suggest these effects are moderating. But on the whole, I'd say the U.S. consumer is in really quite good shape. And of course, like all of you, we're keeping a close eye on the potential impact of tariffs and other public policy changes. And sort of with the tariffs, there's been a lot of uncertainty. But for now, even in that area, of course, we've all seen markets rebound. Most economic metrics have remained strong. And we haven't seen any adverse signals in our credit performance in spend or in payments even in the most leading-edge data. We're also watching closely as student loan repayments and collections resume after a pause of almost five years. Specifically, we're watching the performance of card and auto customers with student loans and especially those customers whose student loans are now being reported as delinquent. So far, we haven't seen any spillover effects in these segments, but we'll continue to monitor this closely. So pulling way up, there's a lot of positive momentum in our performance, in our improving overall credit metrics and in the performance of our front book of new originations.
Jeff Norris, Senior Vice President of Finance
Thank you. That concludes our session for this evening. Thank you for joining us on this call today, and thank you for your interest in Capital One. Have a great evening, everybody.
Operator, Operator
Thank you. This concludes today's conference call. Thank you for participating. You may now disconnect.