Capital One's FY22 Annual Report MD&A

The Annual Report MD&A with the most Heart & Soul in Corporate America - and what may have inspired Buffett to buy Capital One ($COF). Later this month: $COF stock report for paid subscribers!

Jul 09, 2023

“Soldiers of the 5th, I am your Emperor, recognise me! If there is a soldier amongst you who wants to kill his emperor, I am here!” — Napoleon Bonaparte at Grenoble, after escaping from exile on Elba Island.

Following his first defeat by the coalition forces at Leipzig, Napoleon Bonaparte was exiled to the small French island of Elba — whereupon he promptly escaped to the mainland within a year. While marching to the kingdom with his ragtag collection of soldiers who deserted the royal army to follow him, he was met with some resistance at the town of Grenoble. However, instead of giving orders to turn his guns on his own Frenchmen, Napoleon boldly stood unprotected before the opposing army and chanted the above proclamation — whereupon the resisting soldiers threw down their guns and joined his ranks to overthrow the puppet Bourbon monarchy.

Reading Capital One’s MD&A in their latest FY22 Annual Report awakened a similar sense of charisma within me — it was so inspiring that I just felt that I had to bring it to the world’s attention. For the uninitiated, Berkshire’s 13-F first reported a nearly $1B stake in COF 0.00%↑ in May 2023, and those who are familiar with Buffett’s research style knows that he tends to read each company’s annual report cover-to-cover before making an investment decision. If I was impressed by their MD&A, you can bet that it caught Buffett’s attention as well.

If you’d like to learn more about Capital One’s business history, I’d recommend reading Net Interest’s excellent writeup below for additional context. Also, I’m going to be researching COF 0.00%↑ for this month’s stock report for paid subscribers — so sign up below to get a notification when it’s published, or become a paid subscriber to read it once it’s out!

Net Interest

Capital One: Buffett’s Latest Banking Pick

Warren Buffett knows a thing or two about banks. His portfolio has long been stocked with them and if it wasn’t for a 1970 amendment to the Bank Holding Company Act, he would likely have owned them outright, too, as he does in insurance. “We feel it’s something…that falls within our circle of competence to evaluate… We don’t think it’s beyond us to understand the banking business,” he told attendees at his annual general meeting in 1995…

2 years ago · 72 likes · 12 comments · Marc Rubinstein

COF’s Chairman’s Letter

To be clear, the part of their MD&A that I’m referring to is their Chairman’s Letter at the beginning of their FY22 Annual Report (AR22) — which can sometimes be distinct from the MD&A in the annual reports of other companies. However, in Capital One’s (COF) case, they are one and the same — the Chairman also happens to be COF’s founder and CEO Richard Fairbank.

The first thing I noticed very early on while reading Capital One’s MD&A was how different in tone it was to nearly every other company’s MD&A. Many MD&A’s are boilerplate — and even the ones that do make an effort tend to sound like legalese. You know, boring jargon while still conveying useful information.

In contrast, Capital One’s MD&A casts a spell on the reader right out of the gate. It starts by spelling out how the bank is contributing towards society via its customer value proposition (specifically in the context of US consumers) — and it does so in a surprisingly humble manner. The reference point here is the kind of business clickbait that we’ve all seen before — where companies say that they’re adding value by doing the best of ‘x’ or ‘y’ at number ‘1000S’, but where the the delivery ultimately falls flat because it is absolutely meaningless and unrelatable to the reader. In contrast, COF’s MD&A appears to empathize with the real-life struggles of its customers, and illustrates how they’re enriching their customer’s lives through their products with real-life examples. It has a very grounded tone with its feet firmly planted on the ground in terms of understanding the value that they’re delivering to customers, which is where my description of their tone as ‘humble’ earlier came from.

If all this sounds more like how one would describe a storybook instead of an MD&A in an annual report, well that’s exactly what I’m going for. For instance, the following quote is taken from pg. 6 of their AR22, under the heading ‘We Are Helping Customers Succeed’:

The Capital One story plays out one customer at a time, across tens of millions of customers who can feel our mission in our products and customer experiences. It's the story of a first-generation immigrant who gets a chance to build credit in a new country. Or the small-business owner who uses credit card rewards to pay for employee health care. And the commuter in Boston who stops by for a cup of coffee but opens up about their financial goals and dreams.

I don’t know about you, but that doesn’t sound like blanched copywriting by a bored management executive to me. In fact, it sounds like it was written by the Chairman himself, based on his personal experiences. This degree of heart is felt throughout much of their MD&A, and feels strikingly different from nearly every other MD&A that I’ve read over the past decade.

The beginning of their FY22 MD&A describes the company’s vision, and is also similarly emotive. In it, the Chairman describes what he refers to as ‘the triple revolution’. This trio consists of the three waves of innovation which happened in relatively close succession starting from the late-2000’s — the arrival of the smartphone with its always-on capabilities; cloud computing with its nearly unlimited compute and very low storage cost; which ushered in an explosion of computing capability that subsequently enabled machine learning & artificial intelligence. The letter goes on to project how this triple revolution is changing the world ‘at the speed of now’ — enabling mass-customization in real time via machine learning. The section ends with the Chairman describing this phenomenon as the ‘real-time, intelligent revolution.’

The following section titled ‘We Have Been On A Decade-long Technology Transformation’ goes on to expound how this real-time, intelligent revolution will be a huge disrupting force in many industries, as well as COF’s place amidst this cataclysmic disruption. For context, COF is regularly known in the industry for being ‘The Original Fintech’ — and the Chairman’s letter also describes the technological transformations which the bank has instituted since 2005. Basically, they realized in 2005 that the industry’s legacy banking infrastructure was not capable of meeting the future requirements and speed of change demanded by the upcoming real-time, intelligent revolution as they anticipated — so they disrupted themselves and rebuilt their banking infrastructure core from the ground-up with a technological focus, in order to enable future bolt-on capabilities in a way that their competitors cannot when the waves of change sweep over.

Some of these ‘real-time, intelligent’ capabilities include COF’s ability to monitor customer credit trends in real-time, better extrapolate forecasts about credit trends with more accurate data, and proactively take risk-mitigating measures to reduce future credit losses. COF is well-known for having slightly better credit performance metrics amongst its banking peers (also partly due to its payments focus) — and this superior data analysis might also explain why COF’s management style tends to bear a contrarian streak. For instance, sellside reports note how COF pulled back on their auto loans disbursements ahead of peers over the past year, thus contributing to lower current NCO and delinquency levels. This could have been due to COF having superior real-time credit data vs. competitors to base their lending decisions on, owing to the greater technological make-up of their banking infrastructure.

Leaning further into this emotive style, the Chairman’s letter goes on to describe how banking used to be about ‘physical buildings, long lines and endless paper’ — but how this has since changed to become so much more. For instance, COF’s line of Capital One Cafés marries the concepts of bank branches with coffee houses, infusing rounded edges into the traditionally stoic banking experience. This may sound like typical business window dressing at first glance, but when paired with the Chairman’s speech it does seem like a genuine attempt at softening the banking experience for humans instead of machines.

The aforementioned vision can be encapsulated within how the Chairman describes how COF’s strategic direction is based on a core principle:

“We don’t start with where we currently are and try to get better.”
“We focus obsessively on where the world is going and where winning is. And then we work backwards from that.”
“Success is about identifying waves of change and riding them.”

Perhaps similarly to how META 0.00%↑ claims to be at the forefront of the future Metaverse economy, COF 0.00%↑ is trying to anticipate what the future of the banking industry looks like and adapting ahead of the curve. This is ever more important in COF’s hyper-commoditized banking industry, where not only do banks tend to offer undifferentiated products but are also hostage to the whims of the macroenvironment and the central bank. If this ‘real-time, intelligent revolution’ truly represents the future of banking, then Capital One’s MD&A has basically described how it is thinking two steps ahead and setting the groundwork for scalable change to take full advantage of the anticipated earthquake that’s about to rock the industry.

Capital One’s FY22 MD&A sounded authentic, refreshing, inspiring and visionary all at once, and was a truly breathtaking read relative to most of its listed company peers — a rare unicorn in the legalese world of business documents. I like to describe charisma as the ability to evoke emotion in others — and that’s exactly how I would describe COF’s FY22 MD&A as well. Charismatic.

But wait, there’s more… if you thought that Capital One’s MD&A was interesting, you have no idea what’s in store in this month’s upcoming COF 0.00%↑ stock report for paid subscribers. Sign up for free below to get a notification when it’s published in the coming weeks!